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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10 - Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2005

Commission File Number 000-27183

E.PIPHANY, INC.

(Exact name of registrant as specified in its charter)

475 Concar Drive

San Mateo, California 94402

(Address of principal executive offices)

(650) 356-3800

(Registrant’s telephone number, including area code)

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  x    NO  ¨

The number of shares outstanding of the registrant’s common stock, par value $0.0001 per share, as of April 30, 2005, was 77,555,229.

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EPIPHANY, INC.

QUARTERLY REPORT ON FORM 10-Q

QUARTER ENDED MARCH 31, 2005

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PART I: FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

EPIPHANY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

The accompanying notes are an integral part of the condensed consolidated financial statements.

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EPIPHANY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

The accompanying notes are an integral part of the condensed consolidated financial statements.

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EPIPHANY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

The accompanying notes are an integral part of the condensed consolidated financial statements.

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EPIPHANY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Basis of Presentation

The condensed consolidated financial statements included herein have been prepared by E.piphany, Inc. (hereafter “Epiphany” or the “Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The Condensed Consolidated Balance Sheet as of December 31, 2004 is derived from audited consolidated financial statements. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with United States Generally Accepted Accounting Principles (“US GAAP”) have been condensed or omitted pursuant to the rules and regulations regarding interim financial statements. These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in Epiphany’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004, filed with the SEC on March 16, 2005.

The unaudited condensed consolidated financial statements included herein reflect all adjustments (which include normal recurring adjustments and restructuring charges in each of the periods presented) which are, in the opinion of management, necessary to state fairly the financial position of Epiphany as of March 31, 2005, the results of its operations and cash flows for the three months ended March 31, 2005 and 2004. The results for the three months ended March 31, 2005 are not necessarily indicative of the results expected for the full fiscal year.

2. Summary of Significant Accounting Policies

Principles of Consolidation

The condensed consolidated financial statements include the accounts of Epiphany and its subsidiaries. As of March 31, 2005, the Company owns 100% of the outstanding stock of all its subsidiaries. Intercompany accounts and transactions have been eliminated.

Use of Estimates in Preparation of Financial Statements

The condensed consolidated financial statements have been prepared in accordance with US GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect reported assets and liabilities, disclosure of contingent assets and liabilities as of the date of the financial statements, and reported expenses during the reporting period. Actual results in these particular areas could differ from those estimates.

Foreign Currency Translation

The functional currency of our foreign subsidiaries is the local currency. The Company translates the assets and liabilities of non-U.S. functional currency subsidiaries into dollars at the current rates of exchange in effect as of the balance sheet date. Revenues and expenses are translated using average exchange rates during each reporting period. Gains and losses from translation adjustments are included on the balance sheet in stockholders’ equity under the caption “Accumulated other comprehensive loss.” Currency transaction gains or losses, derived from monetary assets and liabilities stated in a currency other than the functional currency, are recognized in current operations and have not been significant to the Company’s operating results in any period. The effect of foreign currency rate changes on cash and cash equivalents has not been significant in any period.

Cash Equivalents, Investments in Marketable Securities, Long-Term Investments and Restricted Cash and Investments

The Company considers all highly liquid investments with a maturity of 90 days or less from the date of purchase to be cash equivalents. The Company has classified its investments as “available for sale.” Investments in marketable securities generally consist of highly liquid securities that the Company intends to hold for more than 90 days but less than 1 year. Long-term investments generally consist of securities that the Company intends to hold for more than one year. Such investments are carried at fair value with unrealized gains and losses reported, net of tax, as other comprehensive income (loss) in stockholders’ equity. The Company periodically reviews these investments for other-than-temporary impairments. Realized gains and losses and declines in value which are determined to be other-than-temporary on available-for-sale securities are included in other income, net and are derived using the specific identification method for determining the cost of securities.

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From time to time, we are required to obtain letters of credit that serve as collateral for our obligations to third parties under facility lease agreements. These letters of credit are secured by cash and investments. As of March 31, 2005, we had $5.7 million securing letters of credit, which are classified as restricted cash and investments in the accompanying Condensed Consolidated Balance Sheets. The classification of restricted cash and investments as short-term or long-term is determined based on the termination date of the underlying lease agreement irrespective of the expiration date of the letter of credit, as the Company is contractually required to maintain letters of credit during the lease term.

Accounts Receivable and Deferred Revenue

Accounts receivable consists of amounts due from customers for which revenue has been recognized. Deferred revenue consists of amounts received from customers for which revenue has not been recognized. Deferred license revenue is recognized upon delivery of our product, as services are rendered, or as other criteria for revenue recognition are satisfied. Deferred maintenance revenue is recognized ratably over the term of the maintenance agreement, typically one year, and deferred professional services revenue is recognized as services are rendered or as other criteria for revenue recognition are satisfied.

Allowances for Doubtful Accounts

We evaluate the collectability of our accounts receivable based on a combination of factors. When we believe a collectability issue exists with respect to a specific receivable, we record an allowance to reduce that receivable to the amount that we believe to be collectable. For all other receivables, we record an allowance based on an assessment of the aging of such receivables, our historical experience with bad debts and the general economic environment.

Property and Equipment

Property and equipment are stated at cost. Depreciation is computed using the straight-line method based on estimated useful lives. The estimated useful lives for computer software and equipment is three years, furniture and fixtures is five years and leasehold improvements range from the shorter of five years or applicable lease term. Depreciation expense is included in operating expenses and cost of revenues based on how the assets are utilized.

Fair Value of Financial Instruments, Concentration of Credit Risk and Significant Customers

The carrying value of the Company’s financial instruments, including cash and cash equivalents, investments, and accounts receivable approximates fair market value. Financial instruments that subject the Company to concentrations of credit risk consist primarily of investments in debt securities and trade accounts receivable. Management believes the financial risks associated with these financial instruments are not significant. The Company invests its cash and investments in government agencies, U.S. treasuries, money market instruments, auction rate securities, taxable municipal bonds and corporate debt rated A1/P1 or higher.

The Company’s customer base consists of businesses in Asia, Australia, Europe, Latin America and North America. The Company performs ongoing credit evaluations of its customers and generally does not require collateral on accounts receivable. The Company maintains reserves for potential credit losses. Historically, such reserves have been adequate to cover the actual losses incurred. No individual customer accounted for more than 10% of our total revenues for the three months ended March 31, 2005. As of March 31, 2005, one customer accounted for 14% of our total accounts receivable balance. Two individual customer account receivable balances accounted for 17% and 12%, respectively, of our total accounts receivable as of December 31, 2004.

Impairment of Long-Lived Assets and Definite Lived Intangible Assets

The Company evaluates long-lived assets for impairment on a periodic basis or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair market value.

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Acquired goodwill and other intangible assets with indefinite useful lives are not amortized over time, but are subject to impairment tests on an annual basis, and on an interim basis in certain circumstances. The Company performs annual impairment tests in the fourth quarter of each year. The Company completed annual impairment tests on its Goodwill and Purchased Intangibles assets during the fourth quarter of 2004 and 2003, which did not result in an impairment charge. The Company intends to perform annual impairment testing in the fourth quarter of 2005. The Company did not identify events or circumstances during the three months ended March 31, 2005 which would more likely than not reduce the fair value of previously recorded intangible assets.

Revenue Recognition

Epiphany recognizes revenue under the following policies which are in accordance with the provisions of Statement of Position 97-2, “Software Revenue Recognition” as amended by SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions”:

Licenses. Fees from licenses are recognized as revenue upon contract execution, provided all delivery obligations have been met, fees are fixed or determinable and collection is probable. We consider all arrangements with payment terms extending beyond six months not to be fixed or determinable, and revenue is recognized as payments become due from the customer, assuming all other revenue recognition conditions are met. If collection is not considered probable, revenue is recognized when the fee is collected. The Company uses the residual method to recognize revenue from a license arrangement with multiple elements when vendor specific objective evidence of the fair value exists for all of the undelivered elements in the arrangement, but does not exist for one of the delivered elements in the arrangement. Vendor specific objective evidence for undelivered elements is based on normal pricing for those elements when sold separately. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue. If vendor specific objective evidence does not exist to allocate the total fee to all undelivered elements of the arrangement, revenue is deferred until the earlier of the time at which (1) such evidence does exist for the undelivered elements, or (2) all elements are delivered. We recognize license fees from resellers as revenue when the above criteria have been met and the reseller has sold the subject licenses through to the end-user.

When licenses are sold together with consulting and implementation services, license fees are recognized upon delivery, provided that (1) the criteria set forth in the above paragraph have been met, (2) payment of the license fees is not dependent upon the performance of the consulting or 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 professional services revenues are recognized under the percentage of completion contract method in accordance with the provisions of Statement of Position 81-1, “Accounting for Performance of Construction Type and Certain Production Type Contracts” (“SOP 81-1”). To date, when the Company has been primarily responsible for the implementation of the software, services have been considered essential to the functionality of the software products and therefore license and services revenue have been recognized pursuant to SOP 81-1. The Company follows the percentage of completion method since reasonably dependable estimates of progress toward completion of a contract can be made. The Company estimates the percentage of completion on contracts utilizing hours incurred to date as a percentage of the total estimated hours to complete the project. Recognized revenues and profit are subject to revisions as the contract progresses to completion. Revisions in profit estimates are charged to income in the period in which the facts that give rise to the revision become known.

From time to time, our license and service arrangements include acceptance provisions. When acceptance provisions exist, we apply judgment in assessing the significance of the provision. If the Company determines that the likelihood of non-acceptance in these arrangements is remote, we recognize revenue once all of the criteria described above have been met. If such a determination cannot be made, revenue is recognized upon the earlier of customer acceptance or expiration of the acceptance period, provided that all of the criteria described above have been met.

Maintenance Services. Maintenance services include technical support and unspecified software updates to customers. Revenue derived from maintenance services is recognized ratably over the applicable maintenance term, typically one year, and is included in maintenance revenue in the accompanying consolidated statements of operations.

Professional, Implementation and Training Services. Epiphany provides consulting, implementation and training services to its customers. Revenue from such services is generally recognized as the services are performed, except when such services are subject to acceptance provisions, as discussed above, and is included in services revenue in the accompanying consolidated statements of operations.

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Warranties and Indemnification

The Company generally provides a warranty for its software products and services to its customers and accounts for its warranties under the Financial Accounting Standards Board’s (“FASB’s”) Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies” (“SFAS No. 5”). The Company’s products are generally warranted to perform substantially as described in the associated product documentation for a period of one year. The Company’s services are generally warranted to be performed consistent with industry standards for a period of ninety days from delivery. In the event there is a failure of such warranties, the Company generally is obligated to correct the product or service to conform to the warranty provision or, if the Company is unable to do so, the customer is entitled to seek a refund of the purchase price of the product or service. The Company has not provided for a warranty accrual as of March 31, 2005 or December 31, 2004. To date, the Company’s product warranty expense has not been significant.

The Company generally agrees to indemnify its customers against legal claims that the Company’s software products infringe certain third-party intellectual property rights and accounts for its indemnification obligations under SFAS No. 5. In the event of such a claim, the Company is generally obligated to defend its customer against the claim and to either settle the claim at the Company’s expense or pay damages that the customer is legally required to pay to the third-party claimant. In addition, in the event of an infringement, the Company agrees to modify or replace the infringing product, or, if those options are not reasonably possible, to refund the cost of the software, as pro-rated over a five-year period. To date, the Company has not been required to make any payment resulting from infringement claims asserted against our customers. As such, the Company has not provided for an infringement indemnification accrual as of March 31, 2005 or December 31, 2004 and has not deferred revenue recognition on license agreements which provide for a pro-rated refund over a five-year period.

During the quarter ended September 30, 2003, the Company sold all of the outstanding capital stock of its Japanese subsidiary, Epiphany Software, K.K. (“Epiphany Japan”), to Braxton Ltd. for approximately $4.2 million in cash. The stock purchase agreement contained customary representations, warranties and covenants of the parties, including covenants to indemnify each other in the event of a breach of warranty or representation. Claims under the indemnification covenants may be submitted within two years from the date of closing, for a maximum of $0.7 million, and only to the extent that losses exceed 10% of the purchase price. The fair value of these indemnification provisions were not material to the Company’s financial position, results of operations or cash flows for the three months ended March 31, 2005.

The Company indemnifies its directors and officers in their capacity as such. To date, the Company has not been required to make any payment resulting from these indemnification obligations. Additionally, the fair value of these indemnification provisions was not material to the Company’s financial position, results of operations or cash flows for the three months ended March 31, 2005.

Stock-Based Compensation

The Company accounts for stock issued to employees in accordance with Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees” and complies with the disclosure provisions of SFAS No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation” and SFAS No. 148 (“SFAS 148”), “Accounting for Stock-Based Compensation – Transition and Disclosure.” Under APB 25, compensation expense for fixed stock options is based on the difference between the fair market value of the Company’s stock and the exercise price of the option on the date of grant, if any.

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The following table illustrates the effect on net loss and loss per share as if the Company had applied the fair value recognition provisions of SFAS No. 123 using the Black-Scholes stock option pricing model (in thousands except per share amounts):

During the fourth quarter of 2004, the Company recorded an aggregate of $1.2 million of deferred compensation in connection with restricted stock granted to certain officers of the Company, which the Company is amortizing on a straight-line basis over the respective vesting periods. The Company has reflected $77,000 and zero in compensation expense associated with these restricted shares in the accompanying condensed consolidated statements of operations during the three months ended March 31, 2005 and 2004, respectively.

3. Computation of Basic and Diluted Net Loss Per Share

Basic and diluted net loss per common share has been computed using the weighted average number of shares of common stock outstanding during the period, less shares subject to repurchase. The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share amounts):

The Company excludes potentially dilutive securities from its diluted net loss per share computation when their effect would be antidilutive to net loss per share amounts. The following common stock equivalents were excluded from the net loss per share computation (in thousands):

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4. Legal Proceedings

As of the date hereof, there is no material litigation pending against us. From time to time, the Company may become a party to litigation and subject to claims incident to the ordinary course of our business. Although the results of litigation and claims cannot be predicted with certainty, the Company believes that the final outcome of such matters will not have a material adverse effect on our business, results of operations or financial condition.

The Company, two of its current officers, one of its former officers and three underwriters in its initial public offering (“IPO”) were named as defendants in a consolidated shareholder lawsuit in the United States District Court for the Southern District of New York, In re E.piphany, Inc. Initial Public Offering Securities Litigation, 01-CV-6158. This is one of a number of actions coordinated for pretrial purposes as In re Initial Public Offering Securities Litigation, 21 MC 92. Plaintiffs in the coordinated proceeding have brought claims under the federal securities laws against numerous underwriters, companies, and individuals, alleging generally that defendant underwriters engaged in improper and undisclosed activities concerning the allocation of shares in the IPOs of more than 300 companies during the period from late 1998 through 2000. Specifically, among other things, the plaintiffs allege that the prospectus pursuant to which shares of Company common stock were sold in the Company’s IPO contained certain false and misleading statements regarding the practices of the Company’s underwriters with respect to their allocation of shares of common stock in the Company’s IPO to their customers and their receipt of commissions from those customers related to such allocations, and that such statements and omissions caused the Company’s post-IPO stock price to be artificially inflated. The consolidated amended complaint in the Company’s case seeks unspecified damages on behalf of a purported class of purchasers of the Company’s common stock between September 21, 1999 and December 6, 2000. The court has appointed a lead plaintiff for the consolidated action. The underwriter and issuer defendants have filed motions to dismiss. These motions were denied as to all the underwriter defendants and the majority of issuer defendants including the Company. The individual defendants have been dismissed from the action without prejudice pursuant to a tolling agreement. In June 2004, a stipulation for the settlement and release of claims against the issuer defendants, including the Company, was submitted to the court. The settlement is subject to a number of conditions, including the final approval of the court. If the settlement does not occur, and litigation against the Company continues, the Company believes it has meritorious defenses and intends to defend the case vigorously.

On February 8, 2005, New York University (“NYU”) filed a complaint against the Company in the United States District Court for the Southern District of New York, alleging patent infringement. The Company believes it has meritorious defenses and intends to vigorously defend itself.

5. Restructuring

In the quarter ended September 30, 2001, the Company began restructuring worldwide operations to reduce costs and improve efficiencies in response to a slower economic environment. Since that time, operations have been streamlined, sales models have changed in certain geographies and facilities have been abandoned to align the Company’s cost structure to current market conditions. Charges for these restructuring activities have been recorded in accordance with Emerging Issues Task Force No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity” (“EITF 94-3”), SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”), and SFAS No. 112, “Employers’ Accounting for Post-employment Benefits”, as applicable. In accordance with these standards, specified restructuring activities are deemed the commencement of a separate restructuring plan in the quarter in which those activities could be specifically identified. The first plan was initiated in the quarter ended September 30, 2001 (“Plan 1”). The second plan, initiated during the quarter ended June 30, 2002, consisted of actions which were primarily supplemental to Plan 1 (“Plan 2”). A third plan was initiated during the quarter ended March 31, 2003 (“Plan 3”) and a fourth plan was initiated during the quarter ended March 31, 2005 (“Plan 4”). Charges for these plans were based on assumptions and related estimates that were appropriate for the economic environment that existed at the time these charges were recorded. However, due to the continued deterioration of the commercial real estate market, primarily in the U.S. and the United Kingdom, we have made subsequent adjustments to the initial restructuring charges recorded under these plans.

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The following table summarizes the Company’s restructuring accrual as of March 31, 2005 (in thousands):

Severance and related charges consist primarily of involuntary termination benefits and related payroll taxes resulting from a reduction in workforce. The impairment of property and equipment primarily relates to leasehold improvements and other property and equipment impaired as a result of the abandonment of leased facilities and a reduction in workforce. Lease costs reflect remaining operating lease obligations and brokerage fees stated at actual costs reduced by estimated sublease income. The Company calculates the estimated costs of abandoning these leased facilities, including estimated sublease costs and income, with the assistance of market information trend analyses provided by commercial real estate brokerage firms retained by the Company.

Year Ended December 31, 2004

For the year ended December 31, 2004, the Company recorded adjustments to previously-recorded restructuring estimates totaling $0.7 million primarily associated with facilities in Illinois, California, and the United Kingdom.

Quarter ended March 31, 2005

On February 15, 2005, the Company adopted a restructuring plan designed to reduce operating expenses and to further focus its resources on its core markets (“Plan 4”). The total restructuring charge under this plan is estimated to be up to $4.5 million and is expected to be incurred principally in the second quarter of 2005. Of the $4.5 million, $3.5 million is expected to be attributable to lease termination costs associated with our facility in the United Kingdom and $1.0 million is attributable to one-time severance and related costs for a reduction in workforce. As of March 31, 2005, a total of 16 sales and marketing employees have been terminated under this plan. For the quarter ended March 31, 2005, the Company recorded severance and related costs for the reduction of sales and marketing employees of approximately $0.2 million in accordance with SFAS No. 112, “Employers’ Accounting for Post Employment Benefits” and recorded adjustments to previously-recorded restructuring estimates of lease termination costs totaling less than $0.1 million.

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The accrued liability of $19.9 million at March 31, 2005 is net of $27.1 million of estimated sublease income. Of this total sublease income, $12.5 million represents future sublease income due under non-cancelable subleases and $14.6 million represents our estimates of future sublease income on excess facilities we expect to sublease in the future. Our ability to generate this amount of sublease income, as well as our ability to terminate certain lease obligations at the amounts we have estimated, is highly dependent upon the existing economic conditions, particularly lease market conditions in certain geographies, at the time we negotiate the lease termination and sublease arrangements with third parties. While the amount we have accrued is our best estimate, these estimates are subject to change and may require periodic adjustment as conditions change through the implementation period. If macroeconomic conditions, particularly as they pertain to the commercial real estate market, continue to worsen, we may be required to increase our estimated cost to exit certain facilities. The current estimates accrued for abandoned leases, net of anticipated sublease proceeds, are projected to be paid over their respective lease terms through 2017.

6. Segment Information

The Company is organized and operates as one business segment, which is responsible for the design, development, marketing and sale of software products and related services. The Company distributes its products in the United States and in foreign countries through direct sales personnel and indirect channel partners.

The Company classifies revenues based on the country in which the applicable sales contracts originate. The following table details revenues by country (in thousands):

7. Purchased Intangible Assets

Definite lived intangible assets were fully amortized as of March 31, 2004. Amortization for the three months ended March 31, 2005 and 2004 was zero and $0.7 million, respectively.

8. Comprehensive Loss

Comprehensive loss consists of net loss plus all other non-owner changes in equity. The components of comprehensive loss are as follows (in thousands):

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

The following discussion of our financial condition and results of operations should be read in conjunction with our financial statements and related notes. This document contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they prove incorrect or never materialize, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Such forward-looking statements include, without limitation, projections of expenses or other financial items; statements regarding our plans, strategies, and objectives for future operations, including the timing, execution costs and potential cost-savings of restructuring plans; statements concerning proposed new products, services, developments, or the anticipated performance of products or services; statements regarding the financial statement impact of FAS 123R; statements regarding our ability to meet our liquidity needs; statements regarding receipt of future sublease income; statements regarding future economic conditions or performance; statements of belief and any statement of assumptions underlying any of the foregoing. The risks, uncertainties and assumptions referred to above include, but are not limited to, those discussed under the heading “Risk Factors” in this quarterly report on Form 10-Q and the risks discussed from time to time in our other public filings. We assume no obligation to update any forward-looking statements.

Overview

Background

We were founded in November 1996 and were primarily engaged in research and development activities until early 1998 when we shipped our first software product and generated our first revenues from software license, professional services and maintenance fees. In September 1999 and January 2000, we raised approximately $426 million through the sale of our common stock in registered public offerings to fund growth and to acquire complementary businesses and technologies. During 2000 and 2001, we completed several acquisitions using stock consideration including the acquisition of RightPoint Software, Inc., Octane Software, Inc. and Moss Software, Inc. We grew our revenues from $3 million in 1998 to $19 million in 1999 and $131 million in 2000. However, in 2001 a general economic slowdown resulted in a reduction in technology spending worldwide. As a result, we began restructuring our worldwide operations to reduce costs and improve efficiencies during 2001 and recorded our first restructuring charge. Also during 2001, we reviewed the fair value of our purchased intangible assets recorded through the acquisitions discussed above and recorded a $1.7 billion impairment charge to write these assets down to their fair values. Our revenues declined to $129 million in 2001 and $84 million in 2002. We increased revenue to $96 million in 2003 on the strength of the release of our E6 suite of products.

The general economic slowdown has continued to apply substantial pressure on the CRM industry. Small competitors are facing weakening financial conditions which has resulted in competitive pricing pressures. In addition, the consolidation of software vendors and the resulting volatility in the marketplace has further delayed technology spending decisions for some of our potential customers. These factors have combined to result in longer than expected sales cycles and lower average selling prices for license transactions. In addition, we experienced poor sales productivity in North America during 2004, in part, because of the general IT spending environment and attrition within our sales personnel including the departure of our Senior Vice President of Worldwide Field Operations in July 2004.

As a result of these factors, we experienced a decline in revenues to $79 million in 2004. We have continued to focus on cost containment and as a result have reduced our net losses from $72 million in 2002 to $24 million in 2003 and $14 million in 2004.

Performance Indicators, Opportunities and Risks

We believe the key indicators of our operating performance and financial condition are annual product license revenues and net income (loss). We believe our future profitability and success is more dependent upon growth in our product license revenues and total revenues than further cost containment initiatives. We are focusing our sales and marketing efforts on solutions that address organic growth, relationship marketing and the contact center. Although these solutions have broad applicability in the business-to-consumer market, our focus is on key verticals which include financial services, telecommunications and insurance. We believe that focusing our marketing and sales efforts on these industries will allow us to enhance our sales effectiveness and leverage our technological advantages with customers who are more likely to understand the benefits that our products offer. The growth of

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our product license revenues and our total revenues will be dependent upon IT and CRM spending by large enterprises, our relationships with key partners including systems integrators, our ability to compete effectively against significant competitors, improved market awareness and enhanced sales effectiveness primarily within our key vertical industries.

Sources of Revenue

We generate revenues principally from licensing our software products directly to customers and providing related services including implementation, professional, maintenance and training services. Through March 31, 2005, the substantial majority of our revenues were generated by our direct sales force. Our license agreements generally provide that customers pay a software license fee to perpetually use one or more software products within specified limits. The amount of the license fee varies depending on which software products are purchased, the number of software products purchased and the scope of usage rights. Customers can subsequently pay additional license fees to expand the right to use previously licensed software products, or to purchase additional software products. Our software products are made available to our customers electronically via Internet download or on compact disk.

Customers generally require consulting and implementation services, which include evaluating their business needs, identifying the data sources necessary to meet these needs and installing the software solution in a manner that fulfills their requirements. Customers can purchase these services directly from third party consulting organizations, such as Accenture, BearingPoint, Cap Gemini, Deloitte Consulting, or IBM. Alternatively, customers can purchase these services directly from us through our internal professional services organization, Epiphany Consulting. We generate services revenues primarily by providing assistance to third party consulting organizations through the implementation lifecycle. Consulting and implementation services are generally sold to customers on a time and expense basis. We have also historically supplemented the capacity of our internal professional services organization by subcontracting some of these services to third party consulting organizations.

Maintenance services are generally sold under services agreements which are renewed annually with the customer. Under these agreements, we provide customers with technical support as well as software updates if and when they are made generally available during the term of the agreement.

Cost of Revenues and Operating Expenses

Cost of revenues includes the cost of product license revenues, the cost of services revenues, the cost of maintenance revenues and the amortization of purchased technology. Our cost of product license revenues primarily consists of license fees payable to third parties for technology integrated into our products. Our cost of services and cost of maintenance revenues primarily consist of salaries and related expenses and an allocation of facilities, information technology, communications and depreciation expenses. Cost of services revenues also includes the cost of reimbursable expenses incurred by our professional services organization and the cost of subcontracting professional services from third party consulting organizations. Amortization of purchased technology represents the cost of technology acquired through our business acquisitions recognized as expense over the respective estimated useful lives of such assets. Our operating expenses are classified into three general categories: sales and marketing, research and development, and general and administrative. We classify all charges to these operating expense categories based on the nature of the expenditures. We allocate the costs for overhead and facilities to each of the functional areas that use the overhead and facilities services based on headcount. These allocated charges include facilities, information technology, communications and depreciation expenses.

Software development costs incurred prior to the establishment of technological feasibility are included in research and development costs as they are incurred. Since license revenues from our software solutions are not recognized until after technological feasibility has been established, software development costs are not generally expensed in the same period in which license revenues for the developed products are recognized.

Critical Accounting Policies and Estimates

Accounting policies, methods and estimates are an integral part of the consolidated financial statements prepared by management and are based upon management’s current judgments. Those judgments are based on knowledge and experience with regard to past and current events and assumptions about future events. Certain accounting policies, methods and estimates are particularly sensitive because of their significance to the financial statements and because of the possibility that future events affecting them may differ markedly from management’s

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current judgments. While there are a number of accounting policies, methods and estimates affecting our financial statements, areas that are particularly significant and subject to the exercise of judgment include revenue recognition policies, allowances for doubtful accounts, the measurement and recoverability of goodwill and purchased intangible assets, restructuring accruals for the abandonment of certain leased facilities, and stock-based compensation. These policies and our practices related to these policies are described below and in Note 2 of Notes to Condensed Consolidated Financial Statements.

Revenue Recognition

We recognize revenue in accordance with generally accepted accounting principles which have been prescribed for the software industry and we follow detailed guidelines discussed in Note 2 of Notes to Condensed Consolidated Financial Statements. The accounting rules related to revenue recognition are complex and are affected by interpretations of the rules and an understanding of industry practices, both of which are subject to change. Consequently, the revenue recognition accounting rules require management to make significant judgments.

We do not record revenue on sales transactions when collectibility is in doubt at the time of sale. Rather, revenue is recognized from these transactions as cash is collected. The determination of collectibility requires significant judgment.

We use the residual method to recognize revenue from a license arrangement with multiple elements when vendor specific objective evidence (“VSOE”) of fair value exists for all the undelivered elements in the arrangement, but does not exist for one of the delivered elements in the arrangement. VSOE of the fair value of undelivered elements is based on normal pricing for those elements when sold separately. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue. Maintenance services are typically an undelivered element of our license arrangements. The determination as to whether VSOE of fair value exists for our maintenance services requires significant judgment. If we determined that VSOE of fair value did not exist for maintenance services, we would be required to defer revenue recognition and would, generally, recognize revenue ratably over the customer’s maintenance term which is typically one year.

To date, when we have been primarily responsible for the implementation of the software under a customer contract, both product license revenues and service revenues are recognized under the percentage of completion contract method in accordance with the provisions of Statement of Position 81-1, “Accounting for Performance of Construction Type and Certain Production-Type Contracts” (“SOP 81-1”). This is based on our assessment that the implementation services for these arrangements are essential to the functionality of our software. Throughout the year ended December 31, 2004 and the three months ended March 31, 2005, third-party consulting organizations have been primarily responsible for implementation services for the majority of our license arrangements. As a result, approximately 10% of license revenue was recognized under SOP 81-1 during the three months ended March 31, 2005. This figure was 20% for the three months ended March 31, 2004.

We estimate the percentage of completion on contracts utilizing hours incurred to date as a percentage of the total estimated hours to complete the project. The percentage of completion method of accounting involves an estimation process and is subject to risks and uncertainties inherent in projecting future events. A number of internal and external factors can affect our estimates, including the nature of the services being performed, the complexity of the customer’s information technology environment and the utilization and efficiency of our professional services employees. Recognized revenues and profit are subject to revisions as the contract progresses to completion. Revisions in profit estimates are charged to income in the period in which the facts that give rise to the revision become known.

Allowances for Doubtful Accounts

A considerable amount of judgment is required when we assess the realization of receivables, including assessing the probability of collection and the current creditworthiness of each customer. When we believe a collectibility issue exists with respect to a specific receivable, we record an allowance to reduce that receivable to the amount that we believe is collectible. For all other receivables, we record an allowance based on an assessment of the aging of such receivables, our historical experience with bad debts and the general economic environment. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, or if the general economic environment or our experience with bad debts were to worsen, additional allowances may be required that would result in additional general and administrative expense in the period such

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determination is made. In addition, if we determined that fewer allowances were required due to improvements in these areas, we would be required to reduce the allowances for doubtful accounts which would result in a benefit to general and administrative expense in the period such determination is made.

Acquisitions, Goodwill and Purchased Intangible Assets

We record goodwill and purchased intangible assets when we acquire other companies. The cost of the acquisition is allocated to the assets and liabilities acquired, including purchased intangible assets, and the remaining amount is classified as goodwill. Certain purchased intangible assets such as purchased technology and customer lists are amortized to cost of revenues and operating expense over time, while in-process research and development is recorded as a one-time charge on the acquisition date. Goodwill arising from purchase transactions is not amortized to expense, but rather periodically assessed for impairment. The allocation of the acquisition cost to purchased intangible assets and goodwill, therefore, has a significant impact on our operating results. The allocation process involves an extensive use of estimates and assumptions, including estimates of future cash flows to be generated by the acquired assets.

Our net goodwill asset was $81.5 million as of March 31, 2005 and December 31, 2004. We perform an annual impairment test on goodwill. We also perform an impairment test on goodwill and purchased intangible assets when events occur or circumstances change that would more likely than not reduce the fair value of these previously recorded intangible assets. If the fair value of such assets is considered to be reduced, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair market value. Fair market value is determined by independent valuation experts using, among other things, discounted future cash flow techniques. Estimating discounted future cash flows requires significant management judgment concerning revenue, profitability and discount rates. Differences between forecasted and actual results as well as changes in the general economic environment could result in material write-downs of goodwill and purchased intangible assets. We performed an annual impairment test on December 31, 2004 and determined that no impairment existed at that time. In addition, the Company did not identify events or circumstances during the three months ended March 31, 2005 which would more likely than not reduce the fair value of previously recorded intangible assets. During the quarter ended March 31, 2005, the Company’s market capitalization declined. In addition, we reduced our projections of the Company’s near term revenues. Future declines in market capitalization or any further downward revisions to our projected revenues may result in an impairment charge in future periods.

Restructuring Charges

As discussed in Note 5 of Notes to Condensed Consolidated Financial Statements, we have recorded significant restructuring charges, primarily in connection with the abandonment of certain leased facilities. The lease abandonment costs were estimated to include remaining lease liabilities and brokerage fees offset by estimated sublease income. Estimates related to sublease costs and income are based on assumptions regarding the period required to sublease the facilities and the likely sublease rates. These estimates are based on market trend information analyses provided by commercial real estate brokerage firms retained by us. We review these estimates each reporting period and, to the extent that market conditions and our assumptions change, adjustments to the restructuring accrual are recorded. If the real estate market worsens and we are not able to sublease the properties as early as, or at the rates estimated, the accrual will be increased, which would result in additional restructuring costs in the period in which such determination is made. If the real estate market strengthens and we are able to sublease the properties earlier or at more favorable rates than projected, the accrual may be decreased, which would increase net income in the period in which such determination is made. The accrued liability of $19.9 million as of March 31, 2005 relates primarily to lease abandonment costs and is net of $27.1 million of estimated sublease income. Sublease income is comprised of future minimum sublease payments as well as the reimbursement of future expected operating expenses. Of this total sublease income, $12.5 million represents future sublease income due under non-cancelable subleases and $14.6 million represents our estimate of future sublease income from excess facilities that we expect to sublease in the future.

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Future expected payments of lease costs net of contractual and projected sublease receipts which have been included in our accrued restructuring costs are as follows (in thousands):

During the quarter ended March 31, 2005, we adopted a restructuring plan designed to reduce operating expenses and further focus our resources on our core markets. See further discussion under Results of Operations, below.

Stock-Based Compensation

We elect to account for compensation expense related to stock options issued to employees in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). Under APB 25, compensation expense for fixed stock options is based on the difference between the market value of our stock and the exercise price of the option on the date of grant, if any. This election is available to companies under SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). Had we elected to apply the fair value method for valuing stock options under SFAS 123, our net loss and net loss per share would have been substantially higher as discussed in Note 2 of Notes to Condensed Consolidated Financial Statements. The fair value method of option valuation was applied for disclosure purposes by utilizing the Black-Scholes option-pricing model. This option-pricing model is commonly used by companies to calculate the fair value of options under SFAS 123 and utilizes certain variables including the exercise price of the option, expected life of the option, the market value of the underlying stock as of the grant date, the expected volatility of the underlying stock during the life of the option, and a risk-free interest rate of return. Although some of these variables are known at the date of grant, other variables are based on estimates of future events. Changes in these estimates may have a material impact on the compensation expense calculated under the fair value method. For example, an increase in the estimated expected life of the option or the stock volatility would increase the fair market value of the option and result in an increase to compensation expense calculated under the fair value method.

In December 2004, the Financial Accounting Standards Board (FASB) issued a revision to FASB Statement No. 123, Share-Based Payment (“FASB No. 123R”) which eliminates the ability to account for share-based compensation transactions using APB 25 and generally requires that such transactions be accounted for using a fair value method. This statement is effective for companies’ first fiscal year beginning after June 15, 2005 and allows companies to choose between the following methods of adoption: (i) A “modified prospective” method in which compensation cost is recognized beginning with the effective date, or (ii) A “modified retrospective” method which permits entities to restate prior period financial statements based on the amounts previously disclosed in the footnotes to the financial statements under Statement 123.

Had we adopted FASB No. 123R in prior periods, the impact of that standard would have approximated the impact of Statement 123 as described in the disclosure of pro forma net income and earnings per share in Note 2 of Notes to Condensed Consolidated Financial Statements.

Results of Operations

Revenues

The following table sets forth our revenues, both in absolute dollars and expressed as a percentage of total revenues, for the three months ended March 31, 2005 and 2004 (in thousands, except percentages):

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The following table sets forth our revenues by geography, both in absolute dollars and expressed as a percentage of total revenues, for the three months ended March 31, 2005 and 2004 (in thousands, except percentages):

Product license revenue for the three months ended March 31, 2005 decreased by $2.8 million, or 40%, over product license revenue for the same period in the prior year. As a percentage of total revenues, product license revenue decreased to 26% in 2005 from 35% in 2004. The decrease in product license revenue is due to a decline in licenses sold in North America during 2004 and the first quarter of 2005.

Services revenue consists of revenue from professional and training services. Services revenue for the first quarter of 2005 decreased by $1.3 million, or 24%, over the first quarter of 2004. The decrease resulted from a decrease in both the number and size of engagements for which services were rendered due to a decrease in product sales. Maintenance revenue for the first quarter of 2005 was comparable to maintenance revenue for the first quarter of 2004.

The relative amount of license revenue as compared to services revenue has varied historically depending on the extent to which third-party consulting organizations have been engaged directly by customers to provide professional services, the nature of products licensed, the complexity of our customers’ information technology environment, the resources allocated by customers to implementation projects and the scope of licensed rights. Services revenue has substantially lower margins than product license revenue. This is especially true when we are required to subcontract with consulting organizations to supplement our internal professional services organization. To the extent that services revenue becomes a greater percentage of our total revenues, our overall gross margins will decline.

Cost of Revenues

The following table sets forth our cost of revenues and gross profit, both in absolute dollars and expressed as a percentage of total revenues, for the three months ended March 31, 2005 and 2004 (in thousands, except percentages):

Cost of product license revenues consists primarily of license fees paid to third parties under technology license arrangements, and, as a percentage of license revenues, have not been significant to date.

Cost of services revenues consists primarily of personnel and related costs of providing professional services and training services. The decrease in cost of services revenue was due primarily to a reduction in the number of internal professional services employees.

Cost of maintenance revenues consists primarily of personnel and related costs of providing customer telephone support services under maintenance agreements. The increase in cost of maintenance revenue was due primarily to an increase in the number of customer support personnel.

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The amortization of purchased technology consists of amortization from technology purchased in the acquisitions of iLeverage, eClass Direct, Moss Software and certain intellectual property assets of Radnet. Purchased technology assets were fully amortized as of March 31, 2004.

Operating Expenses

Research and Development

The following table sets forth our research and development expenses for the three months ended March 31, 2005 and 2004, expressed both in absolute dollars and as a percentage of total revenues (in thousands, except percentages):

Research and development expenses consist primarily of personnel and related costs associated with our product development efforts. Research and development expenses for the three months ended March 31, 2005 are comparable to the same period in the prior year.

Sales and Marketing

The following table sets forth our sales and marketing expenses for the three months ended March 31, 2005 and 2004, expressed both in absolute dollars and as a percentage of total revenues (in thousands, except percentages):

Sales and marketing expenses consist primarily of employee salaries, benefits and commissions, and the costs of trade shows, seminars, promotional materials and other sales and marketing programs. The decrease in these expenses was primarily due to a reduction in the number of sales and marketing employees. The number of sales and marketing employees decreased from 112 as of March 31, 2004 to 89 as of March 31, 2005. Of the total reduction, 16 related to the restructuring of our operations and the remainder related to voluntary and other terminations.

General and Administrative

The following table sets forth our general and administrative expenses for the three months ended March 31, 2005 and 2004, expressed both in absolute dollars and as a percentage of total revenues (in thousands, except percentages):

General and administrative expenses consist primarily of employee salaries and related expenses for executive, finance, legal and administrative personnel. The increase in these expenses was primarily due to an increase in legal costs associated with a legal action filed by us against a private third party to protect our intellectual property rights. Excluding these legal costs, a portion of which we expect to be non-recurring, our general and administrative expenses for 2005 would have been lower than expenses in 2004.

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Restructuring Charges

The following table sets forth our restructuring charges for the three months ended March 31, 2005 and 2004, expressed both in absolute dollars and as a percentage of total revenues (in thousands, except percentages):

In the quarter ended September 30, 2001, we began restructuring worldwide operations to reduce costs and improve efficiencies in response to a slower economic environment. Since that time, operations have been streamlined, sales models have changed in certain geographies and facilities have been abandoned to align our cost structure with current market conditions.

Restructuring charges recorded in the three months ended March 31, 2005 relate to severance and related charges under Plan 4 initiated during the current quarter. Restructuring charges recorded in the same period in the prior year relate to changes in estimated lease costs related primarily to facilities located in Chicago, Illinois and San Mateo, California. See Note 5 in Notes to Condensed Consolidated Financial Statements for more details.

Other Income, Net

The following table sets forth our other income, net for the three months ended March 31, 2005 and 2004, expressed both in absolute dollars and as a percentage of total revenues (in thousands, except percentages):

Other income, net consists primarily of interest income on investments. The increase in interest income for the three months ended March 31, 2005 as compared to the same period in the prior year is primarily due to an increase in the average rate of return on our investments.

Liquidity and Capital Resources

Cash Flow

As of March 31, 2005, our primary sources of liquidity consisted of $160.3 million in cash, cash equivalents and investments in marketable securities and $84.2 million in long-term investments for a total of $244.5 million in cash and investments. Long-term investments generally consist of securities that we intend to hold for more than one year with maturity dates of less than two years from the date of purchase.

Net cash used in operating activities totaled less than $0.1 million and $4.8 million for the quarters ended March 31, 2005 and 2004, respectively. The decrease in cash used in operations is primarily due to a reduction in accounts receivable and an increase in deferred revenue resulting from strong cash collection in the current quarter.

We expect to incur significant operating expenses, particularly research and development and sales and marketing expenses, for the foreseeable future in order to execute our business plan. We anticipate that such operating expenses will comprise a material expenditure of our current cash resources. As a result, our net operating cash flows will depend on the level of future revenues and our ability to effectively manage costs.

Net cash provided by investing activities results primarily from the net movement from investments to cash and cash equivalents for the purpose of funding current operating activities. Net cash provided by investing activities totaled $3.5 million and $5.0 million for the quarters ended March 31, 2005 and 2004, respectively. This decrease is a result of less cash required for operating activities compared to the same period in the prior year.

Net cash provided by financing activities totaled $0.1 million and $2.8 million for the quarters ended March 31, 2005 and 2004, respectively. Cash provided by financing activities for each period resulted from the receipt of proceeds from the issuance of common stock pursuant to the exercise of stock options. These proceeds decreased for the quarter ended March 31, 2005 over the same period in the prior year due to a decline in the number of stock options exercised during the period.

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In October 2004, our board of directors authorized a program to repurchase up to $30 million of our outstanding common stock. Although we may utilize cash during 2005 for the purpose of stock repurchases, the timing of stock repurchases as well as the total amount of cash used for stock repurchases depends on several factors including our stock price, corporate and regulatory requirements and general business and market conditions.

Restricted Cash and Investments

From time to time, we are required to obtain letters of credit that serve as collateral for our obligations to third parties under facility lease agreements. These letters of credit are secured by cash and cash equivalents and are recorded as restricted cash in the balance sheet. As of March 31, 2005, we had $5.7 million of restricted cash and investments, $0.5 million of which are classified as short-term and relate to facility lease agreements that have expiration dates within 12 months, and $5.2 million of which are classified as long-term and relate to facility lease agreements that have expiration dates greater than twelve months from March 31, 2005.

Contractual Obligations

Our contractual obligations as of March 31, 2005 are comprised of operating leases, purchase obligations and long-term liabilities. Our purchase obligations and long-term liabilities have not changed materially since December 31, 2004.

Operating Leases. We lease certain facilities under operating lease agreements which expire at various dates through 2017. In addition, we receive sublease income from non-cancelable subleases of excess facilities. Future minimum lease payments due and receivable under these leases as of March 31, 2005 were as follows (in thousands):

Net operating lease commitments shown above include $25.8 million of operating lease commitments net of contractual sublease income under leases for abandoned facilities which are recorded as restructuring costs in the accompanying balance sheet as of March 31, 2005. We do not have commercial commitments under lines of credit, standby lines of credit, guarantees, standby repurchase obligations or other such arrangements.

We believe that our cash, cash equivalents and investment balances will be sufficient to meet our anticipated liquidity needs for working capital and capital expenditures for at least 12 months. If we require additional capital resources to grow our business internally or to acquire complementary technologies and businesses at any time in the future, we may seek to liquidate our long-term investments, issue additional equity or debt securities or secure a bank line of credit. The sale of additional equity or convertible debt securities could result in additional dilution to our stockholders. We cannot assure you that any financing arrangements will be available in amounts or on terms acceptable to us in the future.

Off-Balance Sheet Arrangements

We generally agree to indemnify our customers against legal claims that our software products infringe certain third-party intellectual property rights and account for our indemnification obligations under SFAS No. 5. In the event of such a claim, we are generally obligated to defend our customer against the claim and to either settle the claim at our expense or pay damages that the customer is legally required to pay to the third-party claimant. In addition, in the event of an infringement, we agree to modify or replace the infringing product, or, if those options are not reasonably possible, to refund the cost of the software, as pro-rated over a five-year period. To date, we have not been required to make any payment resulting from infringement claims asserted against our customers. As such, we have not provided for an infringement accrual as of December 31, 2004 or March 31, 2005 and have not deferred revenue recognition on license agreements which provide for a pro-rated refund over a five-year period.

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During the quarter ended September 30, 2003, we sold all of the outstanding capital stock of our Japanese subsidiary, Epiphany Software, K.K. (“Epiphany Japan”), to Braxton Ltd. for approximately $4.2 million in cash. The stock purchase agreement contained customary representations, warranties and covenants of the parties, including covenants to indemnify each other in the event of a breach of warranty or representation. Claims under the indemnification covenants may be submitted within two years from the date of closing, for a maximum of $0.7 million, and only to the extent that losses exceed 10% of the purchase price. The fair value of these indemnification provisions were not material to our financial position, results of operations or cash flows for the three months ended March 31, 2005.

We indemnify our directors and officers in their capacity as such. To date, we have not been required to make any payment resulting from these indemnification obligations. Additionally, the fair value of these indemnification provisions was not material to our financial position, results of operations or cash flows for the quarter ended March 31, 2005.

Recent Accounting Pronouncements

Share Based Payments

In December 2004, the Financial Accounting Standards Board (FASB) issued a revision to FASB Statement No. 123, Share-Based Payment (“FASB No. 123R”) which eliminates the ability to account for share-based compensation transactions using APB 25 and generally requires that such transactions be accounted for using a fair value method. This statement is effective for companies’ first fiscal year ending after June 15, 2005 and allows companies to choose between two of the following methods of adoption: (i) A “modified prospective” method in which compensation cost is recognized beginning with the effective date, or (ii) A “modified retrospective” method which permits entities to restate prior period financial statements based on the amounts previously disclosed in the footnotes to the financial statements under Statement 123.

Had we adopted FASB No. 123R in prior periods, the impact of that standard would have approximated the impact of Statement 123 as described in the disclosure of pro forma net income and earnings per share in Note 2 of Notes to Condensed Consolidated Financial Statements.

Exchanges of Nonmonetary Assets

On December 16, 2004, the FASB issued Statement No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29. Statement 153 addresses the measurement of exchanges of nonmonetary assets and redefines the scope of transactions that should be measured based on the fair value of the assets exchanged. Statement 153 is effective for nonmonetary asset exchanges beginning in our second quarter of fiscal 2006. We do not expect the adoption of Statement 153 to have a material effect on our consolidated financial position, results of operations or cash flows.

Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004 (the “AJCA”)

In December 2004, the FASB issued FASB Staff Position No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creations Act of 2004 (“FAS 109-2”). The AJCA introduces an 85% dividends received deduction for a limited time on the repatriation of certain foreign earnings to a U.S. taxpayer (repatriation provision), provided certain criteria are met. FAS 109-2 provides accounting and disclosure guidance for the repatriation provision. We are currently in a net loss position in our foreign operations and have substantial net operating losses both in the U.S. and abroad that can be used to offset taxable income for many years. As a result, we do not expect FAS 109-2 to have a material impact on our financial condition, results of operations or cash flows.

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RISK FACTORS

An investment in our common stock is very risky. You should carefully consider the risks discussed below, together with all of the other information included in this quarterly report on Form 10-Q before investing in Epiphany. If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected, the trading price of our common stock could decline, and you may lose all or part of your investment.

We have a history of losses, may incur losses in the future and may not be able to achieve or sustain annual profitability.

We incurred net losses of $6.4 million for the quarter ended March 31, 2005, $14.2 million for the year ended December 31, 2004, and $24.2 million for the year ended December 31, 2003. We had an accumulated deficit of $3.5 billion as of March 31, 2005. We expect to continue to incur losses in the foreseeable future. These losses may be substantial and we may not be able to achieve or sustain annual profitability. Our operating results will be harmed if our revenues do not keep pace with our expenses or are not sufficient for us to achieve and maintain profitability.

Our revenues may be harmed if general and industry specific economic conditions do not improve or worsen.

Our revenues are dependent on the health of the economy and the growth of our customers and potential future customers. If the economies in the United States or in other territories in which we do business worsen, or do not substantially improve, our customers may delay or reduce their spending on customer relationship management software. When economic conditions weaken, sales cycles for software products tend to lengthen and companies’ information technology budgets tend to be reduced. When this happens, our revenues suffer and our stock price may decline.

Competition from other software vendors could adversely affect our ability to sell our products and services and could result in pressure to price our products in a manner that reduces our margins.

Competitive pressures could prevent us from growing, reduce our market share or require us to reduce prices of our products and services, any of which could harm our business. We compete principally with vendors of traditional customer relationship management software, enterprise resource planning software and data analysis and marketing software. Our competitors include, among others, companies such as Chordiant, NCR, Oracle, PeopleSoft, SAP AG, SAS Institute, Siebel Systems and Unica.

Many of these companies have significantly greater financial, technical, marketing, sales, service and other resources than we do. Many of these companies also have a larger installed base of users, have been in business longer and/or have greater name recognition than we do. In addition, some large companies have and will continue to attempt to build capabilities into their products that are similar to the capabilities of our products. Some of our competitors’ products may be more effective than our products at performing particular functions or be more customized for customers’ particular needs. Even if these functions are more limited than those provided by our products, our competitors’ software products could discourage potential customers from purchasing our products. Further, our competitors may be able to respond more quickly than we can to changes in customer requirements.

We have recently experienced price erosion with respect to particular products as new competitors enter the market and existing competitors reduce prices. Our strategy is to develop, market and support a broad set of customer relationship management products. If we are not able to effectively develop, market and support a diversified portfolio of products, or if we underinvest in one line of products while investing in others, thereby losing competitive technical superiority, our revenues and operating margins will be harmed.

Our competitors have made and may continue to make strategic acquisitions or establish cooperative relationships among themselves or with other software vendors. This may increase the capability of their products and reduce or eliminate the need for our software products. Our competitors may also establish or strengthen cooperative relationships with our current or future distributors, partners or other parties with whom we have relationships, thereby limiting our ability to sell through these channels, reducing the promotion of our products and limiting the number of personnel available to implement our software.

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If we fail to establish, maintain or enhance our relationships with third parties, our ability to grow revenues could be harmed.

In order to grow our business, we must generate, retain and strengthen relationships with third parties. To date, we have established relationships with several companies, including consulting organizations and system integrators that implement our software, including Accenture, BearingPoint, Cap Gemini, Deloitte Consulting, and IBM; resellers, including Accenture, Harte-Hanks, Hewlett-Packard, IBM, Mitsucon, Satyam Computer Services and Unisys; hardware and software technology partners, including BEA Systems, IBM, Microsoft, Oracle, SmartPath and Sun Microsystems, as well as outsourcing or application services providers that use our software products to provide hosted services to their customers over the internet, including Harte-Hanks, Knowledgebase Marketing and Merkle. If the third parties with whom we have relationships do not provide sufficient, high-quality service or integrate and support our software correctly, our revenues may be harmed. In addition, the third parties with whom we have relationships may offer products of other companies, including products that compete with our products. We typically enter into contracts with third parties that generally set out the nature of our relationships. Our contracts, however, do not typically require these third parties to devote substantial resources to promoting, selling or supporting our products. We, therefore, have little control over the actions of these third parties. We may not be able to generate and maintain relationships that offset the significant time and effort that are necessary to develop these relationships. In addition, our pricing policies and contract terms with our distribution partners are designed to support each partner with a minimum level of channel conflict. If we fail to minimize channel conflicts between our direct sales force and our channel partners, or among our channel partners, our operating results and financial condition could be harmed.

Development of in-house customer relationship management software by our potential customers could adversely affect the growth of our revenues.

Many of our customers and potential customers attempt to develop sales, marketing, customer service and employee relationship information systems in-house, either by themselves or with the help of third-party systems integrators, at times relying on lower cost offshore information technology personnel. In some cases, internal development projects have been successful in satisfying the needs of an organization and have obviated the need for our products within these organizations. To the extent that a large number of our potential customers develop in-house customer relationship management solutions, we may lose opportunities to increase our revenues and customer base and our business may suffer.

Variations in quarterly operating results may cause our operating results to fall below the expectations of market analysts and investors and our stock price to decline.

We expect our quarterly operating results to fluctuate. We believe, therefore, that quarter-to-quarter comparisons of our operating results may not be a good indication of our future performance, and you should not rely on them to predict our future performance or the future performance of our stock price. Our short-term expense levels are relatively fixed and are based on our expectations of future revenues. As a result, a reduction in revenues in a quarter may harm our operating results for that quarter. Our quarterly revenues and operating results could vary significantly from quarter to quarter. If our operating results in future quarters fall below the expectations of market analysts and investors, the trading price of our common stock may fall. Factors that may cause our operating results to fluctuate on a quarterly basis or fall below the expectations of market analysts and investors in a particular quarter are:

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Our financial results for a particular quarter may be materially adversely affected by the delay or cancellation of large transactions.

Although no single customer accounted for more than 10% of total revenues for the three months ended March 31, 2005, a few large license transactions may from time to time account for a substantial amount of our license revenues. For example, for the quarter ended March 31, 2002, revenues from one customer accounted for 12% of total revenues. For the quarter ended December 31, 2002, revenues from one customer accounted for 17% of total revenues. If a customer or potential customer cancels or does not enter into a large transaction that we may anticipate in a certain quarter, or delays the transaction beyond the end of the quarter, our financial results in that quarter may be materially adversely affected.

If our internal professional services organization does not provide implementation services effectively and according to schedule, our revenues and profitability would be harmed.

Customers that license our products typically require consulting and implementation services and can obtain them from our internal professional services organization, or from outside consulting organizations. When we are primarily responsible for implementation services, we generally recognize software license revenue as the implementation services are performed. If our internal professional services organization does not effectively implement our products, or if we are unable to maintain our internal professional services organization as needed to meet our customers’ needs, the recognition of revenue from such transactions will be delayed. In addition, our ability to sell software, and accordingly our revenues, will be harmed. We may be required to increase our use of subcontractors to help meet our implementation and service obligations, which would result in lower gross margins. In addition, we may be unable to negotiate agreements with subcontractors to provide a sufficient amount and quality of services. If we do not retain sufficient qualified subcontractors, our ability to sell software for which these services are required will be harmed and our revenues will suffer.

Many of our products are new, and if they contain defects, or our services are not perceived as high quality, we could lose potential customers or be subject to damages.

We released version 6.5 of our suite of products in November 2003. Our products are complex and may contain currently unknown errors, defects or failures, particularly since many are new and recently released. In the past, we have discovered software errors in our products after introduction. We may not be able to detect and correct errors before releasing our products commercially. If our commercial products contain errors, we may be required to:

Our customers also may encounter system configuration problems that require us to spend additional consulting or support resources to resolve these problems.

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Because our software products are used for important decision-making processes and enable our customers to interact with their customers, product defects may also give rise to liability claims. Although our license agreements with customers typically contain provisions designed to limit our exposure, some courts may not enforce all or part of these limitations. Although we have not experienced any such liability claims to date, we may encounter these claims in the future. Liability claims, whether or not successful, could:

Our liability insurance may not be adequate to cover all of the expenses resulting from a claim. In addition, if our customers do not find our services to be of high quality or are otherwise dissatisfied with our services, we may lose revenue.

If customers do not contract directly with third party consulting organizations to implement our products, our revenues, profitability and margins may be harmed.

We focus on providing software products rather than services. As a result, we encourage our customers to purchase consulting and implementation services directly from third-party consulting organizations instead of purchasing these services from us. While we do not receive any fees directly from these consulting organizations when they contract directly with our customers, we believe that these consulting organizations increase market awareness and acceptance of our software products and allow us to focus on software development, marketing, licensing and support.

From time to time, our customers nonetheless require that we provide services directly to them, especially when such customers have licensed new releases of our products. If consulting organizations are unwilling or unable to provide a sufficient amount and quality of services directly to our customers or if customers are unwilling to contract directly with these consulting organizations, we may not realize these benefits and our revenues and profitability may be harmed.

When we provide consulting and implementation services to our customers, we do so either directly through our internal professional services organization or indirectly through subcontractors we hire to perform these services on our behalf. Because our margins on service revenues are less than our margins on license revenues, our overall margins decline when we provide these services to customers. This is particularly true if we hire subcontractors to perform these services because it costs us more to hire subcontractors to perform these services than to provide the services ourselves.

Our products have long sales cycles that make it difficult to plan expenses and forecast results.

It typically takes us between six and twelve months to complete a sale of our products, but it can take us longer. It is difficult, therefore, to predict if, and the quarter in which, a particular sale will occur and to plan expenditures accordingly. The period between initial contact with a potential customer and such customer’s purchase of products and services is relatively long due to several factors, including:

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The delay or failure to complete sales in a particular quarter could reduce our revenues in that quarter, as well as subsequent quarters over which revenues for the sale would likely be recognized. Our sales cycles lengthen when economic conditions worsen and spending on information technology declines. If our sales cycles unexpectedly lengthen in general, or for one or more large orders, our revenues could be adversely affected.

In addition, some customers receive the right to perform acceptance testing after the sale of our products with respect to some or all of the products licensed. If these customers do not accept the products or otherwise terminate their customer agreements, our revenues could be adversely affected.

Also, some customers elect to initially license our products on a preliminary or “proof of concept” basis to enable them to evaluate the extent to which such products meet their specific needs within their technical environment. If such customers conclude the products meet their needs, they may elect to expand the scope of usage rights to deploy our products more broadly within their enterprises. Our customers’ election to license our products on this basis could delay or place at risk our receipt of revenue with respect to such transactions.

If we do not manage reductions in the size of our business, our operating results will be harmed.

We recently restructured our operations by, among other things, reducing the size of our workforce. We may need to further reduce expenses in the future. If we are unable to effectively address the effects of reducing the workforce, such as the deterioration of employee morale and productivity, unfavorable publicity and the general reduction of available human resources, our business may be harmed. In addition, future expansion in the size of our business, if any, will require that we hire, train and integrate new personnel in key areas. If future expansion becomes necessary and we are unable to successfully expand our workforce, our revenues will be harmed.

If the market for our products does not grow, our revenues may not increase.

If the market for customer relationship management software does not grow as quickly, or become as large, as we anticipate, our revenues will be lower than our expectations. Our market is still emerging, and our success depends, in part, on its growth. Our potential customers may:

Doing business abroad exposes us to greater management, intellectual property and other risks and our development, marketing and sales activities in international markets may require us to incur significant additional expenses.

We market and sell our products and services abroad. Our revenue from the sale of our products and services outside of the United States accounted for 34% of our total revenues for the quarter ended March 31, 2005. Doing business internationally involves greater expense and many additional risks and challenges, particularly:

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