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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

Commission File No. 0-30260

eGAIN COMMUNICATIONS CORPORATION

(Exact name of registrant as specified in its charter)

624 E. Evelyn Avenue, Sunnyvale, CA

(Address of principal executive offices)

94086

(Zip Code)

(408) 212-3400

(Registrant’s telephone number, including area code)

N/A

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

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

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

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

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eGAIN COMMUNICATIONS CORPORATION

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

eGAIN COMMUNICATIONS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

See accompanying notes

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eGAIN COMMUNICATIONS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

See accompanying notes

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eGAIN COMMUNICATIONS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

See accompanying notes

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eGAIN COMMUNICATIONS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Organization, Nature of Business and Basis of Presentation

We are a leading provider of customer service and contact center software, used by global enterprises for over a decade. eGain Service 6^™, our software suite, available through licensed or hosted models, includes integrated, best-in-class applications for customer email management, live web collaboration, virtual agent customer service, knowledge management, and web self-service. These robust applications are built on the eGain SMP^™, a scalable next-generation framework that includes end-to-end service process management, multi-channel, multi-site contact center management, a flexible integration approach, and certified out-of-the-box integrations with leading call center and business systems.

We have prepared the condensed consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission and included the accounts of our wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated.

The accompanying financial statements have been prepared on the basis that we will continue as a going concern. We have incurred significant operating losses and negative cash flows since inception. As of March 31, 2004, we have working capital of $2.7 million. We have not achieved profitability and may not be able to realize sufficient revenues to achieve or sustain profitability in the future. Our working capital requirements in the foreseeable future are subject to numerous risks and will depend on a variety of factors, in particular, that revenues maintain at the levels achieved in the quarter ended March 31, 2004 and that customers continue to pay on a timely basis. We believe that existing capital resources will enable us to maintain current and planned operations for the next 12 months but we may need to raise additional capital due to unforeseen or unanticipated market conditions. Such financing may be difficult or impossible to obtain on terms acceptable to us and will almost certainly dilute existing stockholder value. These conditions raise doubt about our ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

Certain information and footnote disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted pursuant to such rules and regulations. In our opinion, the unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of our financial position, results of operations and cash flows for the periods presented. These financial statements and notes should be read in conjunction with our audited consolidated financial statements and notes thereto for the year ended June 30, 2003, included in our Annual Report on Form 10-K. The condensed consolidated balance sheet at June 30, 2003 has been derived from audited financial statements as of that date but does not include all the information and footnotes required by generally accepted accounting principals for complete financial statements. The results of our operations for the interim periods presented are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year ending June 30, 2004.

Certain prior year amounts in the consolidated financial statements have been reclassified to conform with the current year presentation.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The estimates are based upon information available as of the date of the financial statements. Actual results could differ from those estimates.

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Note 2. Software Revenue Recognition

We recognize revenue in accordance with Statement of Position 97-2, Software Revenue Recognition (“SOP 97- 2”), as amended. Under SOP 97-2, revenue from license fees is recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, no significant obligations for us remain, the fee is fixed or determinable, and collectibility is probable. License revenue in multiple element contracts is recognized using the residual method when there is vendor specific objective evidence of the fair value of all undelivered elements in an arrangement but vendor specific objective evidence of fair value does not exist for one or more of the delivered elements in an arrangement. Under the residual method, the total fair value of the undelivered elements, as indicated by vendor specific objective evidence, is deferred and the difference between the total arrangement fee and the amount deferred for the undelivered elements is recognized as revenue related to the delivered elements. If sufficient vendor specific objective evidence does not exist for undelivered elements in an arrangement, all revenue from the arrangement is deferred until the earlier of the point at which (a) such sufficient vendor specific objective evidence does exist for the undelivered elements or (b) all elements of the arrangement without sufficient vendor specific objective evidence have been delivered.

Support and Service revenues are primarily derived from hosting fees, consulting fees, maintenance agreements, and training. Revenue from hosting services is recognized ratably over the period of the agreement as services are provided. Hosting agreements are typically for a period of one year and automatically renew unless either party cancels the agreement. Service revenue from consulting and training, billed on a time and materials basis, is recognized as performed. Service revenue on fixed price service arrangements is recognized upon completion of specific contractual milestone events, or based on an estimated percentage of completion as work progresses. Maintenance agreements typically include the right to software updates on an if-and-when-available basis. The fair value of maintenance revenue, established by annual maintenance renewals of existing customers, is deferred and recognized on a straight-line basis as service revenue over the life of the related agreement, which is typically one year.

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

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

Note 3. Stock-Based Compensation

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

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

As of March 31, 2004, there was no outstanding balance of deferred stock compensation. We amortized $0 and $31,000 of deferred compensation in the quarters ended March 31, 2004 and March 31, 2003, respectively. The deferred compensation expense for the nine months ended March 31, 2004 was $0, compared to $136,000 in the same period last year.

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

Note 4. Goodwill and Other Intangible Assets

In June 2001, the FASB issued SFAS 141 “Business Combinations” and SFAS 142 “Goodwill and Other Intangible Assets.” SFAS 141 requires business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting. SFAS 141 also included guidance on the initial recognition and measurement of goodwill and other intangible assets arising from business combinations and includes criteria that required intangible assets such as assembled workforce to be recognized as part of goodwill. As of July 1, 2002, we reclassified $750,000 of assembled workforce from intangibles to goodwill.

Effective July 1, 2002, we adopted SFAS No. 142 “Goodwill and Other Intangible Assets” and ceased amortization of goodwill and began reviewing it annually (or more frequently if impairment indicators arise) for impairment. In addition, we evaluated our remaining purchased intangible assets to determine that all such assets have determinable lives. We operate under a single reporting unit and accordingly, all of our goodwill is associated with the entire company. Prior to the adoption of SFAS No. 142, we amortized goodwill on a straight-line basis over its estimated useful life of three years. The purchased intangible assets, including customer base and acquired technology, are being amortized over the assets useful lives, which range from three to four years.

In connection with the transitional goodwill impairment evaluation provisions of SFAS 142, we performed our annual goodwill impairment review as of April 1, 2003 and found no impairment for fiscal year 2003. Due to the decline in revenue and reduced stock price, we performed goodwill impairment reviews for the first two quarters of fiscal year 2004 and found no impairment. We did not perform a goodwill impairment review in the third fiscal quarter of 2004 as we did not identify any unfavorable indicators during the quarter.

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As of July 1, 2002, in accordance with the provisions of Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS 144”), we review long-lived assets, including property and equipment and intangible assets, for impairment whenever events or changes in business circumstances indicate that the carrying amounts of the assets may not be fully recoverable. Under SFAS 144, an impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount. Impairment, if any, is assessed using discounted cash flows. During the quarter ended March 31, 2004, we did not have any such impairments.

The following table provides a summary of the carrying amount of goodwill which includes amounts originally allocated to assembled workforce upon adoption of SFAS 142 (in thousands):

Purchased intangible assets are carried at cost less accumulated amortization. Amortization is computed over the estimated useful lives of the respective assets, generally 3 to 4 years. The following tables summarize the carrying amount of other intangible assets that continue to be amortized and excludes amounts originally allocated to assembled workforce (in thousands):

The amortization expense on these intangible assets was $302,000 during the quarter ended March 31, 2004. The remaining net carrying amount of $289,000 will be fully amortized by the end of fiscal 2004.

Note 5. Net Loss Per Common Share

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

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

Outstanding options and warrants to purchase 1,233,291, and 812,837 shares of common stock at March 31, 2004 and 2003, respectively, and convertible preferred stock convertible into 1,983,047 and 1,855,339 shares of common stock at March 31, 2004 and 2003, respectively, were not included in the computation of diluted net loss per common share for the periods presented as a result of their anti-dilutive effect. Such securities could have a dilutive effect in future periods.

Note 6. Comprehensive Loss

We report comprehensive loss and its components in accordance with Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income (“SFAS 130”). Under SFAS 130, comprehensive income includes all changes in equity during a period except those resulting from investments by or distributions to owners. Total comprehensive loss was $925,000 and $2.5 million for the quarters ended March 31, 2004 and 2003, respectively. Comprehensive loss was $4.0 million and $9.8 million for the nine months ended March 31, 2004 and 2003, respectively. Accumulated other comprehensive loss presented in the accompanying consolidated balance sheets at March 31, 2004 consists solely of accumulated foreign currency translation adjustments.

Note 7. Segment Information

Operating segments are identified as components of an enterprise for which discrete financial information is available and regularly reviewed by our chief operating decision-makers to make decisions about resources to be allocated to the segment and assess its performance. Our chief operating decision-makers, as defined under SFAS No. 131, are our executive management team. Our chief operating decision makers review financial information presented on a consolidated basis, accompanied by separate information about operating results by geographic region for purposes of making operating decisions and assessing financial performance. Accordingly, we operate in one segment, namely, the development, license, implementation and support of our customer service infrastructure software solutions.

Information relating to our geographic areas is as follows (in thousands):

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In addition, identifiable tangible assets corresponding to our geographic areas are as follows (in thousands):

During the three months ended March 31, 2004 and 2003, no single customer accounted for more than 10% of our total revenue.

Note 8. Related Party Notes Payable

On March 31, 2004, we entered into a Note and Warrant Purchase Agreement with Ashutosh Roy, our Chief Executive Officer, Oak Hill Capital Partners L.P., Oak Hill Capital Management Partners L.P., and FW Investors L.P. (“the lenders”) pursuant to which the lenders loaned to us $2.5 million evidenced by secured promissory notes and received warrants to purchase shares of our common stock in connection with such loan. The secured promissory notes have a term of five years and bear interest at an effective annual rate of 12% due and payable upon the maturity of such notes. We have the option to prepay the notes at any time subject to the prepayment penalties set forth in such notes. The warrants allow the lenders to purchase a number of shares of up to 25% of the aggregate amount loaned at an exercise price of $2.00. The warrants become exercisable as to 50% of the warrant shares nine months after issuance of the warrants and the remaining 50% of the warrants become exercisable on the first anniversary of the issuance of the warrants. We recorded $2.28 million in related party notes payable and $223,000 of discount on the notes related to the relative value of the warrants issued in the transaction that will be amortized to interest expense over the five year life of the notes. The fair value of these warrants was determined using the Black-Scholes valuation method with the following assumptions: an expected life of 3 years, an expected stock price volatility of .75, a risk free interest rate of 2%, and a dividend yield of 0%.

On December 24, 2002, we entered into a Note and Warrant Purchase Agreement (the “2002 Purchase Agreement”) with Ashutosh Roy, our Chief Executive Officer, pursuant to which Mr. Roy will make loans to us evidenced by one or more subordinated secured promissory notes and will receive warrants to purchase shares of our common stock in connection with such loans (the “2002 Credit Facility”). Each subordinated secured promissory note will have a term of five years and will bear interest at an effective annual rate of 12% due and payable upon the maturity of such note. We have the option to prepay each note at any time subject to the prepayment penalties set forth in such note. The warrants allow Mr. Roy to purchase a number of shares of up to 25% of the aggregate

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amount loaned at an exercise price equal to 110% of the fair market value of our common stock (based on a five days trailing closing price average at the time of each loan). The warrants issued in connection with the initial advance became fully exercisable on December 31, 2003. An initial advance of $2.0 million under the 2002 Credit Facility occurred on December 31, 2002. We recorded $1.83 million in related party notes payable and $173,000 of discount on the notes related to the relative value of the warrants issued in the transaction that will be amortized to interest expense over the five year life of the note. The fair value of these warrants was determined using the Black-Scholes valuation method with the following assumptions: an expected life of 3 years, an expected stock price volatility of .75, a risk free interest rate of 2%, and a dividend yield of 0%. On October 31, 2003 we entered into an amendment to the 2002 Purchase Agreement with Mr. Roy, pursuant to which: 1) Mr. Roy provided an additional $2.0 million loan under the 2002 Purchase Agreement, even though we had not met the milestones initially required for such further loan; 2) only the final milestone, as amended, remains applicable to the remaining $1.0 million available under the 2002 Purchase Agreement and 3) any additional warrants issued under the 2002 Purchase Agreement, including the warrants issued in connection with the second loan, will vest fully on issuance and expire five years after issuance thereof. In December 2003 we recorded an additional $1.8 million in related party notes payable and $195,000 of discount on the notes related to the relative value of the warrants issued in the transaction that will be amortized to interest expense over the five year life of the note. The fair value of these warrants was determined using the Black-Scholes valuation method with the following assumptions: an expected life of 3 years, an expected stock price volatility of .75, a risk free interest rate of 2.25%, and a dividend yield of 0%.

As of March 31, 2004, the outstanding balance of related party notes payable of $6.50 million was net of $531,000 of unamortized discount and included accrued interest of $407,000 at an annual rate of 12%.

Note 9. Bank Borrowings

On September 20, 2002, we entered into a new accounts receivable purchase agreement (the “AR Facility”) with Silicon Valley Bank (“SVB”), which replaced the existing revolving line of credit. The AR Facility provides for the sale of up to $5.0 million in certain qualified receivables, bears interest at a rate of prime plus 5.0% per annum and carries a 0.5% monthly administrative fee. As part of this agreement, the existing term loan and equipment loan with SVB were combined into one term loan facility in the amount of $2.6 million, which was secured by establishing a restricted certificate of deposit. This amount was reduced by scheduled amortization payments on the term loan until the term loan was paid in full on February 27, 2004. There are no financial or operational covenant requirements under this agreement. On March 25, 2003, we entered into a modification agreement with SVB which extended the term of the AR Facility through June 30, 2003 and revised the sale amount of qualified receivables from $5.0 million to $1.9 million. On June 25, 2003, we entered into a new modification agreement for the AR Facility with SVB that extended the term of the AR Facility through September 30, 2003. On September 25, 2003, we entered into a modification agreement with SVB that extended the term of the AR Facility through December 31, 2003 and revised the interest to a rate of prime plus 3% or 7% per annum, whichever is greater. On December 19, 2003 we entered into a modification agreement with SVB that extended the term of the AR Facility for an additional six months. As of March 31, 2004, the outstanding balance under the AR Facility was $821,397, collateralized by $1,026,747 of receivables.

Note 10. Restructuring

During the quarter ended March 31, 2004, there was no restructuring charge recorded. The total payments of $555,000 for the quarter ended March 31, 2004, consisted of $14,000, $480,000 and $61,000 of expenses accrued in fiscal year 2003, 2002 and 2001, respectively.

In the quarter ended December 31, 2003, we entered into a settlement agreement to terminate a lease agreement for one of our excess facilities in Novato, CA. In connection with this settlement agreement we recorded an additional restructuring charge of $46,000 to increase the restructuring accrual for this facility to $703,000. Under this agreement, we agreed to pay up to $1.5 million to the landlord. Of this obligation, $456,000 was paid in January 2004. The remaining balance will be paid in the event we make a distribution of cash, stock, or other consideration to holders of our 6.75% Series A Cumulative Convertible Preferred Stock (the “Series A Preferred”) with respect to the shares of Series A Preferred held by such Series A Preferred holders. In such event, the

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landlord would receive a payment equal to the lesser of (i) $1.0 million or (ii) the amount payable to a holder of shares of Series A Preferred with an aggregate stated value of $1.0 million. As of December 31, 2003 we have accrued $247,000 of the total potential $1.0 million contingent payment based on our current estimate of the future payout under the lease settlement. The total payments of $247,000, consisted of $70,000, $107,000 and $70,000 of expenses accrued in fiscal year 2003, 2002 and 2001, respectively.

During the quarter ended September 30, 2003, we incurred and paid a restructuring charge of $121,000 which consisted of $80,000 in employee severance payments and $41,000 in liquidation cost related to the French subsidiary. Total payments of $306,000 in the quarter included $121,000, $91,000, $86,000 and $8,000 of expenses accrued in fiscal year 2004, 2003, 2002 and 2001, respectively.

Details of restructuring charges incurred in fiscal 2004 are as follows (in thousands):

During fiscal year 2003, we recorded a net restructuring charge of $620,000. This amount consisted of $2.3 million of new restructuring expenses partially offset by a reversal of $1.7 million, previously recorded as restructuring expense in fiscal 2002, related to a settlement of a dispute with respect to the termination of a facility lease agreement for 628 E. Evelyn Avenue, Sunnyvale, CA. The $2.3 million of expenses included $772,000 related to the closure of local offices in Holland, France, Germany, Australia and Singapore, $225,000 for additional consolidation of excess facilities in North America, $1.2 million in employee severance payments and $61,000 in professional services and miscellaneous charges related to the restructuring.

The total payments of $3.3 million in fiscal year 2003 consisted of $1.9 million, $1.4 million and $40,000 of expenses accrued in fiscal year 2003, 2002 and 2001, respectively. The $1.9 million included $1.3 million for employee severance payments, professional services and miscellaneous charges related to the restructuring, as well as $613,000 for excess worldwide facilities recorded in fiscal year 2003. The payment of $222,000 was made for the excess facilities for the nine months ended March 31, 2004 and resulted in an unpaid balance of $162,000.

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

During fiscal year 2002, we recorded restructuring charges totaling $9.0 million pursuant to a plan approved by the required level of management necessary to execute its components. These charges were primarily related to the $6.4 million consolidation of our facilities in North America, $1.3 million in write-offs of leasehold improvement and $15,000 in professional services and miscellaneous charges associated with the exited facilities. In addition, we recorded a total severance charge of $1.2 million that was primarily due to the reduction in worldwide workforce of 190 employees across all departments. Total payments of $4.0 million in fiscal year 2002 consisted of $1.5 million for excess facilities in North America, $1.3 million in write-offs of leasehold improvement

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and $1.2 million in employee severance, professional services and miscellaneous charges. In fiscal year 2003, an additional payment of $1.4 million was made for the excess facilities. During the nine months ended March 31, 2004, a payment of $673,000 was made for the excess facilities and resulted in an unpaid balance of $1.2 million. The unpaid balance is the accrual of the potential contingent payments related to two lease settlements that are excluded from the calculation of contractual obligations of our operating leases. These contingent payments will be made in the event we make a distribution of cash, stock or other consideration to our holders of our Series A Preferred with respect to the shares of Series A Preferred held by such Series A Preferred holders. If not sooner, this will occur on August 5, 2005.

In fiscal 2001, we recorded restructuring charges totaling $1.4 million. These charges primarily related to a reduction in our worldwide workforce of 141 employees across all departments and office closures in North America pursuant to the adoption of our expense management strategy. The total charges were primarily comprised of $917,000 related to severance costs, $263,000 related to office closure costs and $263,000 related to professional services and miscellaneous charges associated with the employee terminations. Total payments of $1.4 million were made through fiscal year 2003. During the nine months ended March 31, 2004, the total payment was $92,000, including $40,000 of professional expense and $52,000 settlement fee with terminated employees. There was no unpaid balance as of March 31, 2004.

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

Note 11. Other income and expense

During the quarter ended March 31, 2004, included in non-operating income we recorded other income of $28,000 compared to $340,000 in the prior quarter. The total primarily consisted of a $15,000 insurance reimbursement for settlement of a lawsuit and a $19,000 refund for an overpayment of a capital equipment lease.

Note 12. Warranties

We generally warrant that the program portion of our software will perform substantially in accordance with certain specifications for a period of 90 days. Our liability for a breach of this warranty is either a return of the license fee or providing a fix, patch, work-around or replacement of the software. We also generally warrant that our professional services will meet agreed specifications and expectations with a remedy of reperformance of such services until conforming.

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We also provide standard warranties against and indemnification for the potential infringement of third party intellectual property rights to our customers relating to the use of our products, as well as indemnification agreements with certain officers and employees under which we may be required to indemnify such persons for liabilities arising out of their duties to us. The terms of such obligations vary. Generally, the maximum obligation is the amount permitted by law.

Historically, costs related to these guarantees have not been significant, and as of March 31, 2004, there was no reserve, however we cannot guarantee that a warranty reserve will not become necessary in the future.

Note 13. New Accounting Pronouncements

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (“SFAS 150”). SFAS 150 establishes how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We adopted this statement on July 1, 2003 and the adoption did not have a material impact on our financial position or results of operations.

Note 14. Litigation

Beginning on October 25, 2001, a number of securities class action complaints were filed against us, and certain of our then officers and directors and underwriters connected with our initial public offering of common stock in the U.S. District Court for the Southern District of New York (consolidated into In re Initial Public Offering Sec. Litig.). The complaints alleged generally that the prospectus under which such securities were sold contained false and misleading statements with respect to discounts and excess commissions received by the underwriters as well as allegations of “laddering” whereby underwriters required their customers to purchase additional shares in the aftermarket in exchange for an allocation of IPO shares. The complaints sought an unspecified amount in damages on behalf of persons who purchased the common stock between September 23, 1999 and December 6, 2000. Similar complaints were filed against 55 underwriters and more than 300 other companies and other individuals. The over 1,000 complaints were consolidated into a single action. We reached an agreement with the plaintiffs to resolve the cases as to our liability and that of our officers and directors. The settlement involved no monetary payment by us or our officers and directors and no admission of liability. The Court has not yet approved the settlement.

On December 13, 2002, Mindfabric, Inc. filed an action for patent infringement against us. The suit was settled and resolved with no cash payments and the execution of a cross-licensing agreement between the parties.

On February 26, 2003, Golden Gate Plaza, LLC filed a complaint for unlawful detainer against us. On December 23, 2003 we entered into a settlement agreement (see Notes to Condensed Consolidated Financial Statements, Note 10: Restructuring) with the Plaintiff to resolve the case. A Request for Dismissal was entered by the court on January 12, 2004 and the settlement was later approved.

On February 12, 2004, we filed suit against Insight Enterprises, Inc., the acquirer of Comark, Inc., a value-added reseller of our software, claiming inter alia breach of contract and failure to pay in connection with a sale of our software to one customer. The lawsuit seeks in excess of $600,000 in damages.

With the exception of these matters, we are not a party to any other material pending legal proceedings, nor is our property the subject of any material pending legal proceeding, except routine legal proceedings arising in the ordinary course of our business and incidental to our business, none of which are expected to have a material adverse impact, as taken individually or in the aggregate, upon our business, financial position or results of operations. However, even if these claims are not meritorious, the ultimate outcome of any litigation is uncertain, and it could divert management’s attention and impact other resources.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This report on Form 1O-Q and the documents incorporated herein by reference contain forward-looking statements that involve risks and uncertainties. These statements may be identified by the use of the words such as “anticipates,” “believes,” “continue,” “could,” “would,” “estimates,” “forecasts,” “expects,” “intends,” “may,” “might,” “plans,” “potential,” “predicts,” “should,” or “will” and similar expressions or the negative of those terms. The forward-looking statements include, but are not limited to, risks stemming from strategic and operational choices in recent quarters, failure to improve our sales results and grow revenue, failure to compete successfully in the markets in which we do business, our continued net losses since inception, our limited operating history, our equity structure and the significant risk of dilution, the adequacy of our capital resources and need for additional financing, liquidation preferences related to our preferred stock, continued lengthy and delayed sales cycles, the development of our strategic relationships and third party distribution channels, broad economic and political instability around the world affecting the market for our goods and services, the continued need for customer service and contact center software solutions and the continued acceptance of our Web-native architecture, our ability to respond to rapid technological change and competitive challenges, the effects of cost reductions on our workforce and ability to service customers, risks from our substantial international operations, adverse results in pending litigation, legal and regulatory uncertainties and other risks related to protection of our intellectual property assets and the operational integrity and maintenance of our systems. Our actual results could differ materially from those discussed in statements relating to our future plans, product releases, objectives, expectations and intentions, and other assumptions underlying or relating to any of these statements. Factors that could contribute to such differences include those discussed in “Factors That May Affect Future Results” and elsewhere in this document. These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or understanding to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

Overview

We are a leading provider of customer service and contact center software, used by global enterprises for over a decade. eGain Service 6^™, our software suite, available through licensed or hosted models, includes integrated, best-in-class applications for customer email management, live web collaboration, virtual agent customer service, knowledge management, and web self-service. These robust applications are built on the eGain Service Management Platform (eGain SMP^™), a scalable next-generation framework that includes end-to-end service process management, multi-channel, multi-site contact center management, a flexible integration approach, and certified out-of-the-box integrations with leading call center and business systems.

Recent Developments

On March 31, 2004, we entered into a Note and Warrant Purchase Agreement with Ashutosh Roy, our Chief Executive Officer, Oak Hill Capital Partners L.P., Oak Hill Capital Management Partners L.P., and FW Investors L.P. (“the lenders”) pursuant to which the lenders loaned to us $2.5 million evidenced by secured promissory notes and received warrants to purchase shares of our common stock in connection with such loan. The secured promissory notes have a term of five years and bear interest at an effective annual rate of 12% due and payable upon the maturity of such notes. We have the option to prepay the notes at any time subject to the prepayment penalties set forth in such notes. The warrants allow the lenders to purchase a number of shares of up to 25% of the aggregate amount loaned at an exercise price of $2.00. The warrants become exercisable as to 50% of the warrant shares nine months after issuance of the warrants and the remaining 50% of the warrants become exercisable on the first anniversary of the issuance of the warrants. We recorded $2.28 million in related party notes payable and $223,000 of discount on the notes related to the relative value of the warrants issued in the transaction that will be amortized to interest expense over the five year life of the notes. The fair value of these warrants was determined using the Black-Scholes valuation method with the following assumptions: an expected life of 3 years, an expected stock price volatility of .75, a risk free interest rate of 2%, and a dividend yield of 0%.

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In February 2004, we were delisted from the Nasdaq SmallCap Market due to noncompliance with Marketplace Rule 4310(c)(2)(B), which requires companies listed to have a minimum of $2,500,000 in stockholders’ equity or $35,000,000 market value of listed securities or $500,000 of net income from continuing operations for the most recently completed fiscal year or two of the three most recently completed fiscal years. Our common stock now trades in the over-the-counter market on the OTC Bulletin Board owned by The Nasdaq Stock Market, Inc., which was established for securities that do not meet the listing requirements of the Nasdaq National Market or the Nasdaq SmallCap Market.

On December 24, 2002, we entered into a Note and Warrant Purchase Agreement (the “2002 Purchase Agreement”) with Ashutosh Roy, our Chief Executive Officer, pursuant to which Mr. Roy will make loans to us evidenced by one or more subordinated secured promissory notes and will receive warrants to purchase shares of our common stock in connection with such loans (the “2002 Credit Facility”). Each subordinated secured promissory note will have a term of five years and will bear interest at an effective annual rate of 12% due and payable upon the maturity of such note. We have the option to prepay each note at any time subject to the prepayment penalties set forth in such note. The warrants allow Mr. Roy to purchase a number of shares of up to 25% of the aggregate amount loaned at an exercise price equal to 110% of the fair market value of our common stock (based on a five days trailing closing price average at the time of each loan). The warrants issued in connection with the initial advance became fully exercisable on December 31, 2003. An initial advance of $2.0 million under the 2002 Credit Facility occurred on December 31, 2002. We recorded $1.83 million in related party notes payable and $173,000 of discount on the notes related to the relative value of the warrants issued in the transaction that will be amortized to interest expense over the five year life of the note. The fair value of these warrants was determined using the Black-Scholes valuation method with the following assumptions: an expected life of 3 years, an expected stock price volatility of .75, a risk free interest rate of 2%, and a dividend yield of 0%. On October 31, 2003 we entered into an amendment to the 2002 Purchase Agreement with Mr. Roy, pursuant to which: 1) Mr. Roy provided an additional $2.0 million loan under the 2002 Purchase Agreement, even though we had not met the milestones initially required for such further loan; 2) only the final milestone, as amended, remains applicable to the remaining $1.0 million available under the 2002 Purchase Agreement and 3) any additional warrants issued under the 2002 Purchase Agreement, including the warrants issued in connection with the second loan, will vest fully on issuance and expire five years after issuance thereof. In December 2003 we recorded an additional $1.8 million in related party notes payable and $195,000 of discount on the notes related to the relative value of the warrants issued in the transaction that will be amortized to interest expense over the five year life of the note. The fair value of these warrants was determined using the Black-Scholes valuation method with the following assumptions: an expected life of 3 years, an expected stock price volatility of .75, a risk free interest rate of 2.25%, and a dividend yield of 0%.

Critical Accounting Policies and Estimates

Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to revenue recognition, valuation allowances and accrued liabilities, long-lived assets and restructuring. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Revenue Recognition

We derive revenues from two sources: license fees, and support and services. Support and services includes hosting, software maintenance and support, training, and system implementation consulting. Maintenance and support consists of technical support and software upgrades and enhancements. Significant management judgments and estimates are made and used to determine the revenue recognized in any accounting period. Material differences may result in the amount and timing of our revenue for any period if different conditions were to prevail.

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

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

We recognize hosting services revenue ratably over the period of the applicable agreement as services are provided. Hosting agreements are typically for a period of one year and automatically renew unless either party cancels the agreement.

We use signed software license and services agreements and order forms as evidence of an arrangement for sales of software, hosting, maintenance and support. We use signed engagement letters to evidence an arrangement for system implementation consulting and training.

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

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

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

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

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

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Valuation of Long-Lived Assets

Effective July 1, 2002, we adopted SFAS No. 142 and ceased amortization of goodwill and began reviewing it annually (or more frequently if impairment indicators arise) for impairment. In addition, we evaluated our remaining purchased intangible assets to determine that all such assets have determinable lives. We operate under a single reporting unit and accordingly, all of our goodwill is associated with the entire company. Prior to the adoption of SFAS No. 142, we amortized goodwill on a straight-line basis over its estimated useful life of three years.

In connection with the transitional goodwill impairment evaluation provisions of SFAS 142, we performed a goodwill impairment review as of July 1, 2002 and found no impairment. We also performed our annual goodwill impairment review as of April 1, 2003 and found no impairment. The impairment review as of March 31, 2004 indicated no impairment was needed.

As of July 1, 2002, in accordance with the provisions of Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS 144”), we review long-lived assets, including property and equipment and intangible assets, for impairment whenever events or changes in business circumstances indicate that the carrying amounts of the assets may not be fully recoverable. Under SFAS 144, an impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount. Impairment, if any, is assessed using discounted cash flows. Significant management judgment is required in the forecasting of future operating results which are used in the preparation of projected discounted cash flows and, should different conditions prevail or judgments be made, material write-downs of net intangible assets and/or goodwill could occur. In addition, our depreciation and amortization policies reflect judgments on the estimated useful lives of assets.

Restructuring

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

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts to reserve for potential uncollectable trade receivables. We review our trade receivables by aging category to identify specific customers with known disputes or collectability issues. We exercise judgment when determining the adequacy of these reserves as we evaluate historical bad debt trends, general economic conditions in the U.S. and internationally, and changes in customer financial conditions. If we made different judgments or utilized different estimates, material differences may result in additional reserves for trade receivables, which would be reflected by charges in general and administrative expenses for any period presented.

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Results of Operations

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

Total revenue was $5.2 million in the quarter ended March 31, 2004 unchanged from the quarter ended March 31, 2003. Total revenue for the nine months ended March 31, 2004 decreased 11% to $14.9 million, compared to $16.7 million in the same period last year. This decrease was primarily due to a decline in licensed customer orders in our international markets. During the quarters ended March 31, 2004 and 2003, no single customer accounted for more than 10% of total revenue.

License revenue increased 29% to $1.3 million in the quarter ended March 31, 2004 from $983,000 in the quarter ended March 31, 2004. This increase was primarily due to increased license customer orders of eGain Service 6 in North America. License revenue for the nine months ended March 31, 2004 decreased 28% to $3.3 million, compared to $4.6 million in the same period last year. For the nine months ended March 31, 2004, license revenue from our international markets declined approximately 53% and increased approximately 13% for our North American customers. We believe the decline in licensed customer orders in our international markets resulted from lengthened sales cycles caused by increased customer due diligence, while the increase in North America business was partially due to improved macroeconomic conditions and the results of rebuilding the North America sales force that began in the second half of fiscal 2003. License revenue represented 24% and 19% of total revenue for the quarters ended March 31, 2004 and 2003, respectively.

Support and services revenue decreased 7% to $3.9 million in the quarter ended March 31, 2004 from $4.2 million in the quarter ended March 31, 2003. Support and services for the nine months ended March 31, 2004 decreased 4% to $11.6 million, compared to $12.1 million in the same period last year. The decrease was due in part from the decline in license revenues. Services and support revenue represented 76% and 81% of total revenue for the quarters ended March 31, 2004 and 2003, respectively.

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Operating Costs and Expenses Overview

Total operating costs and expenses decreased 24% to $3.9 million in the quarter ended March 31, 2004 from $5.1 million in the quarter ended March 31, 2003. The decrease was primarily due to the reduction in restructuring and depreciation expenses. Total operating costs and expenses for the nine months ended March 31, 2004 decreased 29% to $12.4 million, compared to $17.3 million in the same period last year. This reduction has been due primarily to the adoption of our ongoing expense management strategy, whereby we have reduced our worldwide workforce by 208 employees across all departments over the last 24 months and reduced our direct operating presence in several international countries.

In the short term, based upon our current revenue expectations, we anticipate total operating costs and expenses will remain relatively constant in absolute dollars. If our revenue for a particular quarter is below expectations, we may be unable to reduce our operating expenses proportionately for that quarter. Accordingly, such a revenue shortfall would have a disproportionate effect on our expected operating results for that quarter. For this reason, period-to-period comparisons of our operating results may not be a good indication of our future performance.

Cost of License

Cost of license primarily includes the amortization of prepaid third-party software royalties and delivery costs for shipments to customers. Cost of license decreased 14% to $383,000 in the quarter ended March 31, 2004, compared to the quarter ended March 31, 2004. Cost of license was $1.3 million for the nine months ended March 31, 2004 and 2003. The decrease was primarily due to the extension of one of the royalty agreements that resulted in a reduction in the amortization of prepaid royalties. We expect this to continue to decline in future periods with the expiration or renewal of other third party royalty agreements.