SERVICEWARE TECHNOLOGIES INC/ PA - 10-K Annual Report

Back to GetFilings.com

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

(Mark One)

[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2001

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________

COMMISSION FILE NUMBER 000-30277
SERVICEWARE TECHNOLOGIES, INC.
(Exact Name of Registrant as Specified in Its Charter)

DELAWARE 25-1647861
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)

333 ALLEGHENY AVENUE, SUITE 301 NORTH
OAKMONT, PA 15139
(Address of Principal Executive Offices) (Zip Code)

Registrant's telephone number, including area code: (412) 826-1158

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

COMMON STOCK, PAR VALUE $.01 PER SHARE
(Title of Class)

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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

As of March 19, 2002, the aggregate market value of voting common stock held
by non-affiliates of the registrant, based upon the last reported sale price for
the registrant's Common Stock on the Nasdaq National Market on such date, as
reported in The Wall Street Journal, was $6,435,306 (calculated by excluding
shares owned beneficially by directors and executive officers as a group from
total outstanding shares solely for the purpose of this response).

The number of shares of the registrant's Common Stock outstanding as of the
close of business on March 19, 2002 was 23,868,168.

DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of the definitive Proxy Statement of ServiceWare
Technologies, Inc. to be used in connection with the 2002 Annual Meeting of
Stockholders (the "Proxy Statement") are incorporated by reference into Part III
of this Annual Report on Form 10-K to the extent provided herein. Except as
specifically incorporated by reference herein, the Proxy Statement is not to be
deemed filed as part of this Annual Report on Form 10-K.

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

SERVICEWARE TECHNOLOGIES, INC.

ANNUAL REPORT ON FORM 10-K

FOR THE YEAR ENDED DECEMBER 31, 2001

TABLE OF CONTENTS

2

PART I

ITEM 1. BUSINESS

Certain statements contained in this Annual Report on Form 10-K constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. These statements involve known and unknown risks,
uncertainties and other factors that may cause our or our industry's actual
results, levels of activity, performance or achievements to be materially
different than any expressed or implied by these forward-looking statements. In
some cases, you can identify forward-looking statements by terminology such as
"may", "will", "should", "expects", "plans", "anticipates", "believes",
"estimates", "predicts", "potential", "continue", or the negative of these terms
or other comparable terminology.

Although we believe that the expectations in the forward-looking statements
are reasonable, we cannot guarantee future results, levels of activity,
performance or achievements.

We were initially incorporated as a Pennsylvania corporation in January
1991 as ServiceWare, Inc. In May 2000, we changed our name to ServiceWare
Technologies, Inc. and reincorporated as a Delaware corporation. The Company had
two reportable business segments: Software and Content. However, on July 20,
2001, the Company completed the sale of its Content segment to RightAnswers LLC
("RightAnswers"). Financial information for our operating segments is found in
Note 16 to the consolidated financial statements in Item 8 below, which is
incorporated herein by reference.

We have not incorporated by reference into this Annual Report on Form 10-K
the information on our Web site, and you should not consider it to be a part of
this document. Our Web site address is included in this document as an inactive
textual reference only.

OVERVIEW

ServiceWare Technologies is a leading provider of enterprise Knowledge
Management (KM) solutions that enable organizations to deliver superior service
to customers, employees and partners by transforming information into knowledge.

ServiceWare's Web-based eService Suite(TM) software, powered by
MindSync(TM), a patented self-learning search technology, enables organizations
to capture and manage intellectual capital. This repository of corporate
knowledge, known as a knowledge base, can then be easily accessed via a browser
to effectively answer inquiries made either over the Web or through the
telephone to a customer contact center or help desk.

Customers use ServiceWare's Knowledge Management solutions to:

- Strengthen relationships with customers, partners, suppliers and
employees

- Decrease operating costs

- Improve creation, dissemination and sharing of enterprise knowledge

- Integrate seamlessly with existing technology investments

eService Suite(TM) is a software solution that allows ServiceWare customers
to provide personalized, automated Web-based service tailored to the needs of
their users. eService Suite enables businesses to capture enterprise knowledge,
solve customer problems, reuse solutions and share captured knowledge throughout
the extended enterprise. It also enables the extended enterprise to access this
knowledge online. In addition, through the self-learning features of
ServiceWare's patented MindSync technology, the solutions generated by these
products are intelligent in that they have the capability to learn from each
interaction and automatically update themselves accordingly. eService Suite
includes the software products eService Site(TM) (Web-based self-service for
customers, partners and employees), eService Professional(TM) (for customer
service, sales and field service personnel) and eService Architect(TM) (for
knowledge managers, subject matter experts and system administrators).

ServiceWare customers represent a cross-section of industry leaders in the
financial services, technology, manufacturing, healthcare, entertainment,
education and government sectors. Customers include H&R Block,

3

Northeast Utilities, Amgen, Stream International, QUALCOMM, Marconi, AT&T
Wireless, Cingular Wireless and Reuters.

INDUSTRY BACKGROUND

BUSINESS CASE FOR KNOWLEDGE MANAGEMENT

The information age has increased the demand for immediate access to
customer data, product information and corporate knowledge, making the need to
retain intellectual capital greater than ever. At the same time, the loss of
corporate knowledge has been perpetuated by the downsizing and reorganizations
that are common in today's economy. In order to attain a competitive advantage
in this volatile market, we believe organizations are turning to Knowledge
Management solutions to improve the creation, preservation, dissemination and
application of knowledge throughout the enterprise. Knowledge Management can be
used to achieve a wide range of strategic business objectives from providing a
superior service experience for employees and customers to managing
relationships with partners and suppliers.

REQUIREMENTS OF A COMPREHENSIVE E-SERVICE SOLUTION- KNOWLEDGE MANAGEMENT

Increasingly, companies need to improve customer loyalty and retention
while also consolidating corporate and customer information into a single
knowledge repository. The key to "Knowledge Management" according to
International Data Corporation is the development of a formal process that
evaluates a company's organizational processes, people, and technology and
develops a system that leverages the relationships between these components in
order to get the right information to the right people at the right time so as
to improve productivity.

Knowledge Management is gaining acceptance, particularly due to the growth
of e-business. We believe companies understand now more than ever the need to
protect intellectual capital, capture the knowledge of its workforce and sustain
competitive advantage by focusing on the effectiveness of employees, customers
and partners. Knowledge Management provides companies with a process to capture
enterprise knowledge, organize knowledge and disseminate knowledge to key
audiences.

In order to enable businesses to provide superior service, a comprehensive
solution needs to:

- provide the option for a self-service experience;

- provide the end-user with the ability to escalate to assisted service and
seamlessly transfer information across all communication channels,
including e-mail, telephone, or chat, at any stage of interaction;

- consolidate the knowledge base and intellectual capital throughout the
organization and make it available throughout the extended enterprise;

- learn through cumulative customer feedback and rapidly develop solutions
to allow the enterprise to provide proactive service to its end-users;

- offer the flexibility necessary to integrate with existing solutions and
enable enterprises to rapidly deploy the technology; and

- scale cost-effectively as the organization's service needs grow.

CALL CENTERS ARE EVOLVING INTO MULTI-CHANNEL CONTACT CENTERS

For the last several years, many companies have spent heavily to implement
technology based Customer Relationship Management (CRM) software. The strategic
goal is to enhance pre- and post-sales customer relationships, improve customer
satisfaction and influence customer retention.

Traditionally, companies created call centers to handle only voice
interactions. Today, there are thousands of call centers globally. Many of these
centers have evolved into multi-channel contact centers that handle customer
interactions via the phone, e-mail, chat, Web, fax, and instant messaging. As
more call centers adopt these additional communication channels, e-service
continues to play a key role in the infrastructure of contact centers.
Additionally, many companies seek to complement their ability to offer
high-quality human level based service provided by the support organization with
a Web based self-service capability, also known as e-service. The

4

benefits of e-service include 24/7 availability, cost-savings, scalability,
consistency, and improved customer satisfaction and customer retention.

THE SERVICEWARE SOLUTION

We provide Knowledge Management solutions that enable companies to
strengthen relationships with their customers, partners, suppliers and
employees. We license software products to enterprises that form the basis of
their Knowledge Management strategy or function as a component of their contact
center or help desk infrastructure. Our solutions enable businesses to capture
enterprise knowledge, solve customer problems, reuse solutions and share
captured knowledge throughout the extended enterprise. Our solutions also enable
the extended enterprise to access this knowledge online. In addition, through
the self-learning capabilities of our patented MindSync search technology the
solutions generated by our products are intelligent in that they are
interactive, adaptable and have the capability to update automatically. We
believe our solutions provide our customers with a number of key benefits,
including:

- DECREASED OPERATING COSTS. By enabling end-users to access customer
service online and by aiding customer service agents to more effectively
handle user requests, our solutions often provide cost savings and
improve employee productivity. These savings and increased productivity
are a result of reduced telephone call volume, the ability to process
more end-user interactions per employee and reduced levels of employee
training.

- STRENGTHENED RELATIONSHIPS WITH THEIR END-USERS. Our solutions allow
enterprises to provide their customers and other end-users with improved,
timely and accurate service. Enterprises realize that the service
function provides them with their closest contact with their customers,
and, by providing superior self or assisted service, they can create
long-term customer satisfaction and loyalty. We believe that by providing
better and more user-friendly service, our solutions increase the
likelihood that a business' customers will complete specific transactions
and that the enterprise will be able to attract and retain its customers.

- IMPROVED DISSEMINATION OF ENTERPRISE KNOWLEDGE. Our eService Suite
enables our customers to develop a common knowledge base of intellectual
capital, which is collected from their business systems and experts
throughout their organization, and makes it available throughout the
extended enterprise. All communications from a business to its customers,
partners, suppliers or employees, whether through telephone support,
self-service, or e-mail, draw from this knowledge base. Additionally, the
patented MindSync technology contained in our eService Suite provides a
self-learning capability that continually learns at each request, which
keeps responses up to date and provides end-users with accurate answers
to their questions.

- SEAMLESS INTEGRATION WITH EXISTING SOLUTIONS. Our products are designed
for rapid deployment, typically in eight to 12 weeks. Our software helps
our customers to preserve their investments in, and deployments of, call
center and help desk products, CRM solutions, workflow tools, knowledge
bases and other applications. Our solution enhances these capabilities
and integrates them into a cohesive and automated Internet service
infrastructure by integrating with applications from leading companies
such as Clarify/Amdocs, Peregrine Systems, and Siebel Systems. As a
result, this enables our customers to deploy best of breed applications
configured to suit their particular e-service needs.

- CONSISTENT SERVICE ACROSS COMMUNICATION CHANNELS. Our solution allows
access to knowledge from a wide variety of communication channels. Our
proprietary software enables end-users to transfer inquiries easily from
self-help to e-mail responses to live interaction. Escalation of end-user
inquiries helps ensure that our clients efficiently apply the appropriate
level of resources toward their customers' satisfaction while reducing
the risk of losing a customer because of perceived unresponsiveness.

- SCALABILITY FOR LARGE AND GROWING ENTERPRISES. The architecture of the
eService Suite allows both large and growing organizations to maintain a
consistent level of service as the volume of traffic across their
communication channels increases. By adding additional servers, providing
replication features between

5

servers and capitalizing on the capabilities of our Java-based
architecture, our products provide consistent responsiveness to end-user
interactions despite rising volumes of traffic.

STRATEGY

Our solutions enable enterprises to provide a Web-based platform by which
customers, partners, suppliers and employees access and manage business critical
knowledge. Our objective is to leverage this platform to become a leading
worldwide provider of Knowledge Management solutions. To achieve our goal, we
intend to:

- ENHANCE TECHNOLOGY AND PRODUCT LEADERSHIP. We intend to broaden our
leadership position in the Knowledge Management and e-service solutions
market by continuing to increase the performance, functionality and
scalability of our eService Suite. We plan to continue to design our
products to be highly scalable throughout the extended enterprise, easily
configurable and able to integrate with both front-end best of breed
applications and existing enterprise systems. We plan to continue to
devote resources to the development of new and innovative technologies,
to increase efficiencies, offer immediate answers and minimize service
response time. We intend to expand the current eService Suite offering to
incorporate advances in knowledge acquisition.

- EXPAND STRATEGIC ALLIANCES. In order to broaden our market presence,
enter new geographic and vertical markets, and increase adoption of our
solutions, we plan to strengthen existing and pursue additional strategic
alliances with consultants, systems integrators, value-added resellers
and independent software vendors of complementary products. We intend to
use these relationships to increase our sales by leveraging these
organizations' industry expertise, business relationships and sales and
marketing resources. Currently, we have strategic alliances with
Electronic Data Systems Corporation, Clarify/Amdocs, Oracle, Siebel and
EPAm Systems. Additionally, we plan to increase our service capabilities
by pursuing strategic relationships with leading systems integrators and
consultants.

- FURTHER DEVELOP INTERNATIONAL PRESENCE. To capitalize on international
opportunities for our e-service solutions, we have completed the first
stage of our product localization efforts, concentrating on European
markets. The eService Suite interface is currently available in French,
Spanish, German and Dutch. Furthermore, we intend to increase our
relationships with local distributors in international markets, including
German-based MATERNA.

PRODUCTS

ServiceWare's Knowledge Management solutions enables organizations to
easily provide customers, partners, suppliers and employees with fast, accurate
answers to inquiries across various communication channels including the phone,
e-mail and the Web. Based on the Company's software and MindSync technology,
software empowers organizations to deliver superior service and support, while
reducing expenses. Our eService Suite includes our eService Site, eService
Professional and eService Architect software products.

eSERVICE SITE allows our customers to provide Web-based self-service to
their end-users. End-users can access the eService Site through the Internet or
a corporate Intranet. This Web-based e-service solution allows self-help users
to access the knowledge base at any time, using an easy-to-use, intuitive
interface via a natural language query. The eService Site can be customized to
adopt the look and feel of the company's Web site.

eSERVICE PROFESSIONAL provides a Web-based application interface for
customer service professionals to more easily navigate through the knowledge
base, view various components of the knowledge base, capture and revise
additional knowledge, and provide accurate answers to end-user questions.
eService Professional integrates with many types of customer relationship
applications to provide a seamless interface for a customer service
professional.

eSERVICE ARCHITECT provides a robust set of knowledge tools that allows
customers' subject matter experts and system administrators to design, manage
and maintain knowledge bases. The eService Architect provides knowledge
authoring and editing capabilities as well as administrative tools for all
necessary product suite functions.

6

SERVICES

PROFESSIONAL SERVICES. Our professional services organization provides our
customers with pre- and post-sales services. Pre-sales consulting services
include our Decision Integrity process, which applies analytical methodologies
and an understanding of business processes to help organizations make an
informed decision regarding the choice of Knowledge Management as a
technological solution. Post-sales implementation, integration and Knowledge
Management consulting services, allow our customers to deploy our e-service
solutions effectively. In addition, our professional services organization
offers education and training to enable our customers' internal team to
understand how to use our products, support the implementation and maintain of
our solutions.

CUSTOMER SUPPORT. All customers under a maintenance agreement have access
to our technical support engineers via telephone, fax or e-mail. In addition, we
provide self-service support to our customers on a 24/7 basis through our
www.serviceware.com Web site.

TECHNOLOGY AND ARCHITECTURE

We employ industry-standard technologies to create an object-based open
architecture for all of our applications. The suite is based on an n-tiered
architecture, which permits the use of multiple servers for scalability and a
clear division of responsibility between our software programs. This division
provides flexibility and scalability.

At the core of our technology is MindSync, which provides self-learning
capability to our eService Suite. MindSync uses patented algorithm technology
based on neural network and Bayesian statistical principles. Through these
algorithms, MindSync is capable of learning from past transactions. Access to
MindSync is provided via our knowledge server, which performs the role of an
application server. The replication capability of the server was designed to
update multiple databases worldwide on a distributed network by using any
leading database application. This permits our customers to locate servers in
various locations close to their end-user base.

The architecture is a framework built using Java and XML that includes
components specifically designed to take advantage of each element of the modern
Web environment. This enables an extremely configurable, extensible application
to be delivered based on current Internet standards.

We are continually updating our software to run in the most common
environments. ServiceWare now supports Solaris, Windows 2000 and NT operating
environments to provide customers greater flexibility and security when
implementing its solutions.

CUSTOMERS

We have traditionally marketed our products and services to Global 2000
call centers and help desks in a wide range of vertical industries. Major
customers during 2001 included Cingular Wireless and Reuters. The following is a
partial list of our other customers during 2001.

Allegheny Energy Made2Manage Systems
Allina Health Systems Marconi Communications
Amgen Marriott
AT&T Wireless NCS Pearson
Concord EFS Qualcomm
Compaq Respironics
EATON/Cutler-Hammer Stream International
First Union National Bank Texas Instruments
Fourth Shift, a SoftBrands Company United Messaging
Gelco Government Services U.S. Army
H&R Block U.S. Navy
Hewlett-Packard U.S. Patent & Trademark Office
Hughes Supply

7

SALES AND MARKETING

We market our solutions through a direct sales force and indirect sales
channels. We sell our solutions primarily through our direct sales force. We
have sales personnel throughout North America and internationally in the United
Kingdom.

To increase the effectiveness of our direct selling efforts and our
penetration of the Knowledge Management solutions market, we build brand
awareness of ServiceWare and our solutions through marketing programs. These
programs include print and Web advertisements, direct mailings, public relations
activities, seminars and other major industry/partner events, market research
and our Web site.

Our marketing organization creates materials to support the sales process,
including brochures, data sheets, case studies, presentations, white papers and
demonstrations. In addition, our marketing group helps identify and develop key
alliance opportunities and channel distribution relationships.

STRATEGIC ALLIANCES

We have established strategic alliances with leading providers of
e-business software technologies. These alliances augment our sales and
marketing initiatives by enabling us to increase market awareness, distribution
and market penetration of our solutions and services, as well as to extend the
technical and functional application of our e-service solutions.

Historically, we have had several categories of alliances, including
distribution, software and services alliances. We have established distribution
alliances with leading providers of complementary e-business and CRM
technologies who resell or co-market our solutions. We benefit from the lead
generation and established marketing capabilities of these firms. In turn, our
alliance partners benefit from being able to offer more comprehensive solutions
in their product offerings and thereby increase their customers' satisfaction.
We currently have alliances with several vendors, including Clarify/Amdocs and
Siebel.

We have established service alliances with leading systems integrators,
including Electronic Data Systems Corporation and Materna, to increase our
breadth of implementation services both nationally and around the globe. These
services alliance partners complete a rigorous training program to become fully
certified to implement our solutions, and we continue to work with our service
alliance partners as a team to ensure a fast, effective path to the deployment
of our Knowledge Management solution to enable our customers to reap the
benefits of our Knowledge Management solution immediately.

We intend to continue to build and refine our strategies in selecting
leading alliance partners in the dynamic and ever-changing marketplace. We
believe that building key relationships with market leaders increase our
opportunities in global expansion, enhanced solutions, and continued product
innovations.

RESEARCH AND DEVELOPMENT

We have a 6 person internal research and development team that, together
with our outside development resources, develop our product and service
offerings. In conjunction with our outside development resources, we continue to
enhance the features and performance of our existing products and services. In
addition, we are continuing to develop new products and services to meet our
customers' expectations of ongoing innovation and enhancement within our suite
of products and services. We have entered into a strategic relationship with
EPAm Systems, of Princeton, New Jersey, and Minsk, Belarus, to augment its
research and development capabilities. This relationship gives ServiceWare
access to approximately 250 developers in a cost effective offshore model. EPAm
Systems is ISO 9001 certified and has completed complicated projects for major
international corporations including Fortune 500 companies. This relationship
has allowed us to streamline operating costs and increase productivity. Research
and development is conducted by way of a clearly defined process that is a
subset of industry standard Rational Unified Process.

The agreement with EPAm Systems states that consulting services will be
provided in accordance with specific work orders. Payment for these services is
billed weekly at a fixed fee. Additionally, pursuant to the agreement we are
appointed resellers of their technical consulting and software development
services. This

8

contract expired in January 2002, but we are continuing to operate under this
agreement while we are negotiating an extension.

Our ability to meet our customers' expectations depend on a number of
factors, including our ability to identify and respond to emerging technological
trends in our target markets, develop and maintain competitive products, enhance
our existing products and services by adding features and functionality that
differentiate them from those of our competitors and bring products and services
to market on a timely basis and at competitive prices. Consequently, we have
made, and we intend to continue to make, investments in research and
development.

COMPETITION

Competition in our marketplace is rapidly evolving and intense, and we
expect competition to intensify further in the future as current competitors
expand their product offerings and new competitors enter the market. Current
competitors include in-house developed applications and providers of
commercially available Knowledge Management solutions, including Kana Software,
eGain Communications, and Primus Knowledge Solutions.

We believe that the principal competitive factors affecting our market
include referenceable customers, the breadth and depth of a given solution,
product quality and performance, core technology, product scalability and
reliability, product features and the ability to implement solutions and respond
timely to customer needs.

Although we believe that we currently compete favorably with respect to the
principal competitive factors in our market, we may not be able to maintain our
competitive position against current and potential competitors, especially those
with significantly greater financial, marketing, service, support, technical and
other resources. It is possible that new competitors or alliances among
competitors may emerge and rapidly acquire significant market share. We also
expect that competition will increase as a result of industry consolidation.

INTELLECTUAL PROPERTY

Our success and ability to compete effectively depends, in part, upon our
proprietary rights. We rely on a combination of patent, copyright, trade secret
and trademark laws, confidentiality procedures and contractual provisions to
establish and protect our proprietary rights in our software, documentation and
other written materials. These legal protections afford only limited protections
for our proprietary rights and may not prevent misappropriation of our
technology or deter third parties from developing similar or competing
technologies.

We have two patents. One patent pertaining to our MindSync technology
(formerly known as Cognitive Processor) was issued in the United States on July
28, 1998 and was also filed in Australia, Canada and the European Union. The
other patent pertaining to certain proprietary data structures was issued on
September 28, 1998.

We also have four trademark registrations in the United States and a
Service mark for "ServiceWare" issued December 28, 1999.

We seek to avoid disclosure of our intellectual property by generally
entering into confidentiality or license agreements with our employees,
consultants and companies with which we have alliances, and generally control
access to, and distribution of, our software, documentation and other
proprietary information. Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy or otherwise obtain and use our
products or technology or to develop products with the same functionality as our
products.

Policing unauthorized use of our proprietary information is difficult, and
we may be unable to determine the extent of unauthorized copying or use of our
products or technology. Further, third parties, which have been granted certain
limited contractual rights to use proprietary information, may improperly use or
disclose such proprietary information. In addition, certain components of our
product suite require us to have licenses from third parties for use. These
licenses may be subject to cancellation or non-renewal. In this event, we will
be required to obtain new licenses for use of these products, which may not be
available on commercially reasonable terms, if at all, and could result in
product shipment delays and unanticipated product development costs.

9

EMPLOYEES

Due to the difficult environment for technology companies in 2001 and a
need to reduce our costs, we reduced staff during the year from 252 as of
December 31, 2000 to 54 as of December 31, 2001. Our 54 employees include 14 in
sales, 18 in professional services, 6 in research and development, 4 in
marketing, 8 in general and administration, and 4 in operations. In spite of the
difficult economic environment, we continue to believe that one of our strengths
is the quality and dedication of our people and the shared sense of being part
of a team. We strive to maintain a work environment that fosters
professionalism, excellence, diversity and cooperation among our employees.

ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS

Set forth below and elsewhere in this Form 10-K and in other documents we
file with the Securities and Exchange Commission are risks and uncertainties
that could cause actual results to differ materially from the results
contemplated by the forward-looking statements contained in this Form 10-K.

WE MAY NEED ADDITIONAL CAPITAL TO FUND CONTINUED BUSINESS OPERATIONS AND WE
CANNOT BE SURE THAT ADDITIONAL FINANCING WILL BE AVAILABLE.

We have historically required substantial amounts of capital to fund our
business operations. Despite efforts to reduce our cost structure, we may
experience negative cash flow from operations for the next few quarters.

We continue to evaluate alternative means of financing to meet our needs on
terms that are attractive to us. We currently anticipate that our available
funds will be sufficient to meet our projected needs to fund operations for the
next 12 months. However, we may pursue additional financing to fund operations.
From time to time, we have considered and discussed various financing
alternatives and expect to continue such efforts to raise additional funds to
support our operational plan. However, we cannot be certain that additional
financing will be available to us on favorable terms when required, or at all.

IF WE ARE NOT ABLE TO OBTAIN SUCH CAPITAL, WE MAY NEED TO DRAMATICALLY CHANGE
OUR BUSINESS STRATEGY AND DIRECTION, INCLUDING PURSUING THE OPTIONS TO SELL OR
MERGE OUR BUSINESS, OR LIQUIDATE.

In the past, we have funded our operating losses and capital expenditures
through proceeds from equity offerings. Changes in equity markets in the past
year have adversely affected our ability to raise equity financing and have
adversely affected the markets for debt financing for companies with a history
of losses such as ours. If we raise additional funds through the issuance of
equity, equity-linked or debt securities, those securities may have rights,
preferences or privileges senior to those of the rights of our common stock and,
in light of our current market capitalization, our stockholders may experience
substantial dilution.

WE HAVE A HISTORY OF LOSSES, ANTICIPATE THAT WE WILL CONTINUE TO INCUR LOSSES
FOR THE NEXT SEVERAL QUARTERS AND MAY NEVER ACHIEVE PROFITABILITY.

Our limited operating history in our current line of business and the
uncertain nature of the markets in which we compete make it difficult or
impossible to predict future results of operations. As of December 31, 2001, we
had an accumulated deficit of $66.7 million. We have not achieved profitability
on a quarterly or annual basis to date. In 2001, we incurred net losses of $29.7
million and in 2000, we incurred net losses of $19.8 million. We expect to have
decreased operating expenses as a result of our restructuring activities.
However, if revenues do not stabilize or if they continue to decline, our losses
will continue.

WE MAY NOT SUCCEED IN ATTRACTING AND RETAINING THE PERSONNEL WE NEED FOR OUR
BUSINESS AND THE INTEGRATION OF NEW MANAGEMENT AND PERSONNEL MAY STRAIN OUR
RESOURCES.

Our business requires the employment of highly skilled personnel,
especially experienced software developers. The inability to recruit and retain
experienced software developers in the future could result in delays in
developing new versions of our software products or the release of deficient
software products. Any such delays or defective products would likely result in
lower sales. We may also experience difficulty in hiring and retaining sales
personnel, product managers and professional services employees. The average
tenure of our current employees is 2.7 years. Additionally, we have experienced
a high turn-over rate in some of our senior

10

management positions in the past few years. Continued high turn-over in
management positions could have an adverse effect on our operations and
business.

A SIGNIFICANT PERCENTAGE OF OUR PRODUCT DEVELOPMENT IS PERFORMED BY A THIRD
PARTY INTERNATIONALLY, THE LOSS OF WHICH COULD SUBSTANTIALLY HARM OUR PRODUCT
DEVELOPMENT EFFORTS.

A significant percentage of our product development work, and some of our
implementation services, are performed by a third-party development organization
in Minsk, Belarus. Unpredictable developments in the political, economic and
social conditions in Belarus, or our failure to maintain or renew our business
relationship with this organization on terms similar to those which exist
currently, could reduce or eliminate product development and implementation
services. If access to these services were to be unexpectedly eliminated or
significantly reduced, our ability to meet development objectives vital to our
ongoing strategy would be hindered, and our business could be seriously harmed.

OUR HISTORICAL FINANCIAL RESULTS MAY NOT BE HELPFUL IN EVALUATING OUR PROSPECTS
BECAUSE OUR CURRENT LINE OF PRODUCTS IS RELATIVELY NEW.

We have undergone a number of changes in our business model. We began in
1991 as a provider of consulting services, and later developed and sold content
relating to technology products for use by customer service operations. In July
1999, we acquired the Molloy Group and its complementary software product suite.
Last year we integrated our product offerings with those of the Molloy Group and
launched a suite of software and content products intended to form the basis of
businesses' Knowledge Management solutions.

Since the announcement of our corporate restructuring in February 2001, we
have re-allocated our resources to the ongoing enhancement of our eService Suite
software product and in July 2001 sold our Content business. Because our current
line of software products is relatively new, our historical financial results
may not be helpful in evaluating our prospects.

IT IS DIFFICULT TO DRAW CONCLUSIONS ABOUT OUR FUTURE PERFORMANCE BASED ON OUR
PAST PERFORMANCE DUE TO SIGNIFICANT FLUCTUATIONS IN OUR QUARTERLY OPERATING
RESULTS.

Our projected expense levels are based on our expectations regarding future
revenues and are relatively fixed in the short term. Therefore, if revenue
levels are below expectations in a particular quarter, operating results and net
income are likely to be disproportionately adversely affected because our
expenses are relatively fixed. In addition, a significant percentage of our
revenues is typically derived from non-recurring sales to a limited number of
customers, so it is difficult to estimate accurately future revenues.

Our quarterly results are also impacted by our revenue recognition
policies. Our revenues are unpredictable and in recent quarters have fluctuated
from $6.2 million in third quarter 2000 to $4.4 million in fourth quarter 2000
to $2.3 million in first quarter 2001 to $3.3 million in second quarter 2001 to
$2.1 million in third quarter 2001 to $4.3 million in fourth quarter 2001.
Because we generally recognize license revenues upon installation and training,
sales orders from new customers in a quarter might not be recognized during that
quarter. Delays in the implementation and installation of our software near the
end of a quarter could also cause recognized quarterly revenues and, to a
greater degree, results of operations to fall substantially short of anticipated
levels. We often recognize revenues for existing customers shortly after an
order is received because installation and training can generally be completed
in significantly less time than for new customers. However, we may miss
recognizing expected revenues at the end of a quarter due to delays in the
receipt of expected orders by existing customers.

Revenues in any one quarter are not indicative of revenues in any future
period because of these and other factors and, accordingly, we believe that
certain period-to-period comparisons of our results of operations are not
necessarily meaningful and should not be relied upon as indicators of future
performance.

THE KNOWLEDGE MANAGEMENT MARKET IS EVOLVING AND, IF IT DOES NOT GROW RAPIDLY,
OUR BUSINESS WILL BE ADVERSELY AFFECTED.

The Knowledge Management solutions market is an emerging industry, and it
is difficult to predict how large or how quickly it will grow, if at all.
Customer service historically has been provided primarily in person or

11

over the telephone with limited reference materials available for the customer
service representative. Our business model assumes that companies which provide
customer service over the telephone will find value in aggregating institutional
knowledge by using our eService Suite and will be willing to access our content
over the Internet. Our business model also assumes that companies will find
value in providing some of their customer service over the Internet rather than
by telephone. Our success will depend on the broad commercial acceptance of, and
demand for, these Knowledge Management solutions.

DUE TO THE LENGTHY SALES CYCLES OF OUR PRODUCTS AND SERVICES, THE TIMING OF OUR
SALES ARE DIFFICULT TO PREDICT AND MAY CAUSE US TO MISS OUR REVENUE
EXPECTATIONS.

Our products and services are typically intended for use in applications
that may be critical to a customer's business. In certain instances, the
purchase of our products and services involves a significant commitment of
resources by prospective customers. As a result, our sales process is often
subject to delays associated with lengthy approval processes that accompany the
commitment of significant resources. These delays may worsen in the future as a
greater proportion of our total revenues will be derived from our eService
Suite, for which contracts have a higher average dollar value. For these and
other reasons, the sales cycle associated with the licensing of our products and
subscription for our services typically ranges between six and eighteen months
and is subject to a number of significant delays over which we have little or no
control. While our customers are evaluating whether our products and services
suit their needs, we may incur substantial sales and marketing expenses and
expend significant management effort. We may not realize forecasted revenues
from a specific customer in the quarter in which we expend these significant
resources because of the lengthy sales cycle for our products and services.

WE MAY NOT BE ABLE TO EXPAND OUR BUSINESS INTERNATIONALLY, AND, IF WE DO, WE
FACE RISKS RELATING TO INTERNATIONAL OPERATIONS.

Our business strategy includes efforts to attract more international
customers. We are currently exploring business opportunities in the United
Kingdom and continental Europe. To date, we have only limited experience in
providing our products and services internationally. If we are not able to
market our products and services successfully in international markets, our
expenses may exceed our revenues. By doing business in international markets we
face risks, such as unexpected changes in tariffs and other trade barriers,
fluctuations in currency exchange rates, difficulties in staffing and managing
foreign operations, political instability, reduced protection for intellectual
property rights in some countries, seasonal reductions in business activity
during the summer months in Europe and certain other parts of the world, and
potentially adverse tax consequences, any of which could adversely impact our
international operations and may contribute further to our net losses.

IF WE ARE NOT ABLE TO KEEP PACE WITH RAPID TECHNOLOGICAL CHANGE, SALES OF OUR
PRODUCTS MAY DECREASE.

The software industry is characterized by rapid technological change,
including changes in customer requirements, frequent new product and service
introductions and enhancements and evolving industry standards. If we fail to
keep pace with the technological progress of our competitors, sales of our
products may decrease.

WE DEPEND ON TECHNOLOGY LICENSED TO US BY THIRD PARTIES, AND THE LOSS OF THIS
TECHNOLOGY COULD DELAY IMPLEMENTATION OF OUR PRODUCTS, INJURE OUR REPUTATION OR
FORCE US TO PAY HIGHER ROYALTIES.

We rely, in part, on technology that we license from a small number of
software providers for use with our products. After the expiration of these
licenses, this technology may not continue to be available on commercially
reasonable terms, if at all, and may be difficult to replace. The loss of any of
these technology licenses could result in delays in introducing or maintaining
our products until equivalent technology, if available, is identified, licensed
and integrated. In addition, any defects in the technology we may license in the
future could prevent the implementation or impair the functionality of our
products, delay new product introductions or injure our reputation. If we are
required to enter into license agreements with third parties for replacement
technology, we could be subject to higher royalty payments.

12

PROBLEMS ARISING FROM THE USE OF OUR PRODUCTS WITH OTHER VENDORS' PRODUCTS COULD
CAUSE US TO INCUR SIGNIFICANT COSTS, DIVERT ATTENTION FROM OUR PRODUCT
DEVELOPMENT EFFORTS AND CAUSE CUSTOMER RELATIONS PROBLEMS.

Our customers generally use our products together with products from other
companies. As a result, when problems occur in a customer's systems, it may be
difficult to identify the source of the problem. Even when these problems are
not caused by our products, they may cause us to incur significant warranty and
repair costs, divert the attention of our technical personnel from our product
development efforts and cause significant customer relations problems.

IF CERTAIN COMPANIES CEASE TO PROVIDE OPEN PROGRAM INTERFACES FOR THEIR CUSTOMER
RELATIONSHIP MANAGEMENT SOFTWARE, IT WILL BE DIFFICULT TO INTEGRATE OUR SOFTWARE
WITH THEIRS. THIS WILL DECREASE THE ATTRACTIVENESS OF OUR PRODUCTS.

Our ability to compete successfully also depends on the continued
compatibility and interoperability of our products with products and systems
sold by various third parties, specifically including CRM software sold by
Clarify, Oracle, Peregrine Systems, and Siebel Systems. Currently, these vendors
have open applications program interfaces, which facilitate our ability to
integrate with their systems. If any one of them should close their programs'
interface or if they should acquire one of our competitors, our ability to
provide a close integration of our products could become more difficult, or
impossible, and could delay or prevent our products' integration with future
systems. Inadequate integration with other vendors' products would make our
products less desirable and could lead to lower sales.

WE FACE INTENSE COMPETITION FROM BOTH ESTABLISHED AND RECENTLY FORMED ENTITIES,
AND THIS COMPETITION MAY ADVERSELY AFFECT OUR REVENUES AND PROFITABILITY BECAUSE
WE COMPETE IN THE EMERGING MARKET FOR KNOWLEDGE MANAGEMENT SOLUTIONS.

We compete in the emerging market for Knowledge Management solutions and
changes in the Knowledge Management solutions market could adversely affect our
revenues and profitability. We face competition from many firms offering a
variety of products and services. In the future, because there are relatively
low barriers to entry in the software industry, we expect to experience
additional competition from new entrants into the Knowledge Management solutions
market. It is also possible that alliances or mergers may occur among our
competitors and that these newly consolidated companies could rapidly acquire
significant market share. Greater competition may result in price erosion for
our products and services, which may significantly affect our future operating
margins.

IF OUR SOFTWARE PRODUCTS CONTAIN ERRORS OR FAILURES, SALES OF THESE PRODUCTS
COULD DECREASE.

Software products frequently contain errors or failures, especially when
first introduced or when new versions are released. In the past, we have
released products that contained defects, including software errors in certain
new versions of existing products and in new products after their introduction.
In the event that the information contained in our products is inaccurate or
perceived to be incomplete or out-of-date, our customers could purchase our
competitors' products or decide they do not need Knowledge Management solutions
at all. In either case, sales would decrease. Our products are typically
intended for use in applications that may be critical to a customer's business.
As a result, we believe that our customers and potential customers have a great
sensitivity to product defects.

WE COULD INCUR SUBSTANTIAL COSTS AS A RESULT OF PRODUCT LIABILITY CLAIMS BECAUSE
OUR PRODUCTS ARE CRITICAL TO THE OPERATIONS OF OUR CUSTOMERS' BUSINESSES.

Our products are critical to the operations of our customers' businesses.
Any defects or alleged defects in our products entail the risk of product
liability claims for substantial damages, regardless of our responsibility for
the failure. Although our license agreements with our customers typically
contain provisions designed to limit our exposure to potential product liability
claims, these provisions may not be effective under the laws of certain
jurisdictions. In addition, product liability claims, even if unsuccessful, may
be costly and divert management's attention from our operations. Software
defects and product liability claims may result in a loss of future revenue,

13

a delay in market acceptance, the diversion of development resources, damage to
our reputation or increased service and warranty costs.

IF OUR CUSTOMERS' SYSTEM SECURITY IS BREACHED AND CONFIDENTIAL INFORMATION IS
STOLEN, OUR BUSINESS AND REPUTATION COULD SUFFER.

Users of our products transmit their and their customers' confidential
information, such as names, addresses, social security numbers and credit card
information, over the Internet. In our license agreements with our customers, we
disclaim responsibility for the security of confidential data and have
contractual indemnities for any damages claimed against us. However, if
unauthorized third parties are successful in illegally obtaining confidential
information from users of our products, our reputation and business may be
damaged, and if our contractual disclaimers and indemnities are not enforceable,
we may be subject to liability.

WE MAY ACQUIRE OR MAKE INVESTMENTS IN COMPANIES OR TECHNOLOGIES THAT COULD CAUSE
DISRUPTIONS TO OUR BUSINESS.

We intend to explore opportunities to acquire companies or technologies in
the future. Entering into an acquisition entails many risks, any of which could
adversely affect our business, including:

- failure to integrate the acquired assets and/or companies with our
current business;

- the price we pay may exceed the value we eventually realize;

- potential loss of share value to our existing stockholders as a result of
issuing equity securities as part of all of the purchase price;

- potential loss of key employees from either our current business or the
acquired business;

- entering into markets in which we have little or no prior experience;

- diversion of management's attention from other business concerns;

- assumption of unanticipated liabilities related to the acquired assets;
and

- the business or technologies we acquire or in which we invest may have
limited operating histories and may be subject to many of the same risks
we are.

WE MAY NOT BE ABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, WHICH MAY CAUSE
US TO INCUR SIGNIFICANT COSTS IN LITIGATION AND AN EROSION IN THE VALUE OF OUR
BRANDS AND PRODUCTS.

Our business is dependent on proprietary technology and the value of our
brands. We rely primarily on patent, copyright, trade secret and trademark laws
to protect our technology and brands. We currently have two patents. One of
these patents pertains to certain proprietary data structures and the other
pertains to our Cognitive Processor, now known as MindSync technology. Our
patents may not survive a legal challenge to their validity or provide
meaningful protection to us. Litigation to protect our patents would be
expensive and the loss of our patents would decrease the value of our products.
Defending against claims of patent infringement would also be expensive and, if
successful, we could be forced to redesign our products, pay royalties, or cease
selling them. In addition, effective trademark protection may not be available
for our trademarks. The use by other parties of our trademarks would dilute the
value of our brands.

Notwithstanding the precautions we have taken, a third party may copy or
otherwise obtain and use our software or other proprietary information without
authorization or may develop similar software independently. Policing
unauthorized use of our technology is difficult, particularly because the global
nature of the Internet makes it difficult to control the ultimate destination or
security of software or other transmitted data. Further, we have granted certain
third parties limited contractual rights to use proprietary information which
they may improperly use or disclose. The laws of other countries may afford us
little or no effective protection of our intellectual property. The steps we
have taken may not prevent misappropriation of our technology, and the
agreements entered into for that purpose may not be enforceable. The
unauthorized use of our proprietary technologies could also decrease the value
of our products.

14

THE SUCCESS OF OUR SOFTWARE PRODUCTS DEPENDS ON ITS ADOPTION BY OUR CUSTOMERS'
EMPLOYEES. IF THESE EMPLOYEES DO NOT ACCEPT THE IMPLEMENTATION OF OUR PRODUCTS,
OUR CUSTOMERS MAY FAIL TO RENEW THEIR SERVICE CONTRACTS AND WE MAY HAVE
DIFFICULTY ATTRACTING NEW CUSTOMERS.

The effectiveness of our eService Suite depends in part on widespread
adoption and use of our software by our customers' customer service personnel
and on the quality of the solutions they generate. Resistance to our software by
customer service personnel and an inadequate development of the knowledge base
may make it more difficult to attract new customers and retain old ones.

Some of our customers have found that customer service personnel
productivity initially drops while customer service personnel become accustomed
to using our software. If an enterprise deploying our software has not
adequately planned for and communicated its expectations regarding that initial
productivity decline, customer service personnel may resist adoption of our
software.

The knowledge base depends in part on solutions generated by customer
service personnel and, sometimes, on the importation of our customers' legacy
solutions. If customer service personnel do not adopt and use our products
effectively, necessary solutions will not be added to the knowledge base, and
the knowledge base will not adequately address service needs. In addition, if
less-than-adequate solutions are created and left uncorrected by a user's
quality-assurance processes or if the legacy solutions are inadequate, the
knowledge base will similarly be inadequate, and the value of our eService Suite
to end-users will be impaired. Thus, successful deployment and broad acceptance
of our eService Suite will depend in part on whether our customers effectively
roll-out and use our software products and the quality of the customers'
existing knowledge base of solutions.

WE DEPEND ON INCREASED BUSINESS FROM OUR NEW CUSTOMERS AND, IF WE FAIL TO GROW
OUR CLIENT BASE OR GENERATE REPEAT BUSINESS, OUR OPERATING RESULTS COULD BE
ADVERSELY AFFECTED.

If we fail to grow our customer base or generate repeat and expanded
business from our current and future customers, our business and operating
results will be seriously harmed. Some of our customers initially make a limited
purchase of our products and services for pilot programs. If these customers do
not successfully develop and deploy such initial applications, they may choose
not to purchase complete deployment or development licenses. Some of our
customers who have made initial purchases of our software have deferred or
suspended implementation of our products due to slower than expected rates of
internal adoption by customer service personnel. If more customers decide to
defer or suspend implementation of our products in the future, we will be unable
to increase our revenue from these customers from additional licenses or
maintenance agreements, and our financial position will be seriously harmed.

In addition, as we introduce new versions of our products or new products,
our current customers may not need our new products and may not ultimately
license these products. Any downturn in our software licenses revenues would
negatively impact our future service revenues because the total amount of
maintenance and service fees we receive in any period depends in large part on
the size and number of licenses that we have previously sold. In addition, if
customers elect not to renew their maintenance agreements, our service revenues
could be significantly adversely affected.

A DECLINE IN INFORMATION TECHNOLOGY SPENDING COULD REDUCE THE SALE OF OUR
PRODUCTS.

The license fees for our products typically range from approximately
several hundred thousand to several million dollars. These fees often represent
a significant expenditure of Information Technology ("IT") capital for our
customers. It is possible for our customers' and potential customers' IT
spending to decline as a result of a weakened economy, or due to other factors.
Such a decline could cause us to be unable to maintain or increase our sales
volumes and achieve our targeted revenue growth.

INCREASING GOVERNMENT REGULATION OF THE INTERNET COULD HARM OUR BUSINESS.

As e-business, Knowledge Management and the Internet continue to evolve, we
expect that federal, state and foreign governments will adopt laws and
regulations tailored to the Internet covering issues like user privacy, taxation
of goods and services provided over the Internet, pricing, content and quality
of products and services. If enacted, these laws and regulations could limit the
market for e-business and Knowledge Management and, therefore, the market for
our products and services.

15

The Telecommunications Act of 1996 prohibits certain types of information
and content from being transmitted over the Internet. The prohibition's scope
and the liability associated with a violation of the Telecommunications Act's
information and content provisions are currently unsettled. The imposition upon
us and other software and service providers of potential liability for
information carried on or disseminated through our applications could require us
to implement measures to reduce our exposure to this liability. These measures
could require us to expend substantial resources or discontinue certain
services. In addition, although substantial portions of the Communications
Decency Act, the Act through which the Telecommunications Act of 1996 imposes
criminal penalties, were held to be unconstitutional, similar legislation may be
enacted and upheld in the future. It is possible that this new legislation and
the Communications Decency Act could expose companies involved in e-business to
liability, which could limit the growth of Internet usage and e-business
generally and, therefore, the demand for Knowledge Management solutions. In
addition, similar or more restrictive laws in other countries could have a
similar effect and hamper our plans to expand overseas.

WE MAY BECOME INVOLVED IN SECURITIES CLASS ACTION LITIGATION WHICH COULD DIVERT
MANAGEMENT'S ATTENTION AND HARM OUR BUSINESS.

The stock market is currently experiencing significant price and volume
fluctuations that have affected the market price for the common stocks of
technology companies. These broad market fluctuations may cause the market price
of our common stock to decline. In the past, following periods of volatility in
the market price of a particular company's securities, securities class action
litigation has often been brought against that company. We may become involved
in that type of litigation in the future. Litigation is often expensive and
diverts management's attention and resources, which could harm our business and
operating results.

THE LOW PRICE OF OUR COMMON STOCK AND THE LOW MARKET VALUE OF PUBLIC FLOAT COULD
RESULT IN THE DELISTING OF OUR COMMON STOCK.

On February 14, 2002, we received a compliance notice from The Nasdaq Stock
Market. In this letter, Nasdaq informed us that our common stock had failed to
maintain a minimum bid price per share of $1.00 over the last 30 consecutive
trading days, as required by The Nasdaq National Market under Marketplace Rule
4450(a)(5).

In accordance with Marketplace Rule 4450(e)(2), we will have until May 15,
2002, or 90 calendar days from such notification, to regain compliance with
Nasdaq's continued listing requirements. If at any time before May 15, 2002 the
minimum bid price per share is $1.00 for a minimum of ten consecutive trading
days, Nasdaq will determine if we then comply with Nasdaq's continued listing
requirements. If we are unable to demonstrate compliance with the continued
listing requirements on or before May 15, 2002, Nasdaq staff will provide us
with written notification that its securities will be removed from the Nasdaq
National Market.

In response to the letter from Nasdaq, we submitted an application to
transfer the listing of its common stock to The Nasdaq SmallCap Market. If the
application is approved, we will be afforded an additional 180-day grace period
which will extend the delisting determination until August 13, 2002. We may also
be eligible for an additional 180-day grace period provided that it meets the
initial listing criteria for the SmallCap Market under Market Place Rule
4310(c)(2)(A). There can be no assurance that Nasdaq will approve our
application to transfer to the SmallCap Market or that if approved we will
remain compliant with the applicable continued listing requirements.

If our common stock is permitted to move to the SmallCap Market and is
unable to meet the minimum maintenance requirements during the extended grace
period, then we would be subject to delisting from the Nasdaq SmallCap Market.
In that event, we would be notified of any Nasdaq staff determination to this
effect and it would then have the right to appeal such a delisting determination
to the Nasdaq Listings Qualifications Panel.

If our common stock would be delisted by Nasdaq, our securities would be
eligible to trade on the OTC Bulletin Board maintained by Nasdaq, another
over-the-counter quotation system, or on the pink sheets where an investor may
find it more difficult to dispose of or obtain accurate quotations as to the
market value of the securities. In addition, we would be subject to a Rule
promulgated by the Securities and Exchange Commission that, if we fail to meet
criteria set forth in such Rule, imposes various practice requirements on
broker-dealers who sell securities governed by the Rule to persons other than
established customers and accredited investors. For

16

these types of transactions, the broker-dealer must make a special suitability
determination for the purchaser and have received the purchaser's written
consent to the transactions prior to sale. Consequently, the Rule may deter
broker-dealers from recommending or selling our common stock, which may further
affect the liquidity of our common stock.

Delisting from Nasdaq will make trading our shares more difficult for
investors, potentially leading to further declines in our share price. It would
also make it more difficult for us to raise additional capital. Further, if we
are delisted we would also incur additional costs under state blue sky laws in
connection with any sales of our securities.

17

MANAGEMENT
EXECUTIVE OFFICERS

The following table sets forth specific information regarding our executive
officers as of March 19, 2002:

THOMAS UNTERBERG has served as Chairman of the Board of Directors since
June 2001. He is a co-founder and has served as a Chairman of C.E. Unterberg,
Towbin, an investment banking firm, since June 1989. Prior to that he served as
Head of Technology Banking and a Partner of Lehman Brothers from 1987 to 1990.
From 1977 through 1986 Mr. Unterberg was a General Partner/ Managing Director,
and Chairman of L.F. Rothschild, Unterberg, Towbin Holdings, Inc. and from 1960
to 1977 he was a partner of C.E. Unterberg, Towbin. Mr. Unterberg currently
serves on the boards of directors of Electronics for Imaging, Inc., Systems and
Computer Technology Corporation, ECCS, Inc., Centrax Corporation, Inc., AES
Corporation, and Club One, LLC. Mr. Unterberg is a graduate of Princeton
University and received a Master's degree in Business Administration from the
Wharton School, University of Pennsylvania.

KENT HEYMAN joined ServiceWare in September 2001 to serve as President and
Chief Executive Officer. Prior to that he was one of three founding employees
and a senior vice president at Mpower Communications, where he was responsible
for the strategic direction of the company. During his five-year tenure, Mr.
Heyman helped take the company from a start-up to a national integrated
communications company with more than 2,000 employees in 42 markets across the
nation. He has also served as litigation department chairman and lead trial
counsel for Dowling Magarian Aaron and Heyman. Mr. Heyman earned a doctor of law
(J.D.) degree from University of the Pacific's McGeorge School of Law, and
received a bachelor's degree from California State University, Fresno.

SCOTT SCHWARTZMAN has served as our Chief Operating Officer since October
2001 and was named Treasurer in September 2001. Mr. Schwartzman previously
served as our Vice President of Global Enterprise Services since joining
ServiceWare in October 2000. From September 1998 to September 2000, he was
employed as Vice President of Professional Services at Firepond, Inc., a
provider of e-business selling solutions. From February 1994 to August 1998 Mr.
Schwartzman was employed by SAP America, an Enterprise Resource Planning (ERP)
software company, where he held a variety of positions and was most recently
Director of Professional Services. Prior to SAP, Schwartzman held positions in
operations and systems management at Star Dynamic Corporation, Dep Corporation
and Revlon Corporation. Mr. Schwartzman received a Bachelor of Science degree in
Business Administration from Syracuse University.

RICHARD LIEBMAN has been our Interim Chief Financial Officer since January
2002. Prior to joining us, Mr. Liebman was Chief Financial Officer for eCal
Corporation, a provider of Internet based calendar services, from October 1998
until January 2001. Prior to that, Mr. Liebman was Senior Vice President of
Pennsylvania Merchant Group, Ltd., an investment banking firm from January 1997
to October 1998. From June 1994 until January 1997, Mr. Liebman was Managing
Director of Liebman Capital, Inc., which focused on investing in businesses in
the technology field. Mr. Liebman received his Bachelor of Arts degree in
economics from Brown University and his Masters in Business Administration from
Columbia Business School.

CHARLES RUDISILL has served as our Vice President of Business Development
since December 2000. From October 1999 to November 2000, Mr. Rudisill was
employed as Managing Director of Trans@ctive Partners, Inc. a boutique
investment banking firm. From June 1994 to June 1999 Mr. Rudisill held positions
at Mastech Corporation (now iGATE Capital Corporation) as Investor Relations
Director and Director of Corporate Development. Mr. Rudisill received a Bachelor
of Science degree in Business Administration from Shenandoah University.

18

ITEM 2. PROPERTIES

We own no real property. Our largest facility is located in Oakmont,
Pennsylvania, where we lease office space. The term of the lease expires in
2006. We also leased an office in Parsippany, New Jersey. The Parsippany lease
expired in January 2002, and a small executive office suite was sublet in
Princeton, New Jersey. We also lease small offices in Redwood City, California
with the term of lease expiring in June 2002 and in the United Kingdom. We
believe that our current facilities are adequate to support our existing
operations. We also believe that we will be able to obtain suitable additional
facilities on commercially reasonable terms on an "as needed" basis.

ITEM 3. LEGAL PROCEEDINGS

We are not a party to any material legal proceedings.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

19

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET FOR THE COMPANY'S COMMON STOCK

Our common stock has been quoted on the Nasdaq National Market since August
25, 2000. On March 19, 2002, the last sale price of our common stock was $0.37
per share. The following table sets forth the range of high and low bid prices
for our common stock for the periods indicated. Such over-the-counter market
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commission and may not necessarily represent actual transactions.

As of March 19, 2002, there were approximately 365 holders of record of our
common stock. We believe that a substantially larger number of beneficial owners
hold shares of our common stock in depository or nominee form.

DIVIDEND POLICY

Prior to our initial public offering in August 2000, we declared and paid
dividends on our Series A and Series B preferred stock in cash and shares of
common stock. Series C preferred stock also received dividend shares as a result
of anti-dilution provisions. A total of $157,925 was paid in cash and 670,138
shares of common stock were issued in conjunction with these dividends. At the
time of our initial public offering, all shares of our preferred stock were
converted into shares of our common stock.

We do not anticipate paying any cash dividends in the foreseeable future.
We currently intend to retain any future earnings to finance the expansion of
our business. Moreover, our bank credit facility restricts our ability to pay
cash dividends.

RECENT SALES OF UNREGISTERED SECURITIES

None.

USES OF PROCEEDS FROM REGISTERED SECURITIES

On August 24, 2000, the SEC declared effective our initial public offering
Registration Statement on Form S-1 (File No. 333-33818). The managing
underwriter in the offering was C.E. Unterberg, Towbin. The Registration
Statement covered the sale of 4,500,000 shares of our common stock at an
offering price of $7 per share. In addition to the 4,500,000 shares of common
stock offered, C.E. Unterberg, Towbin was given an option to purchase up to an
additional 675,000 shares of common stock at an offering price of $7 per share.
C.E. Unterberg, Towbin purchased an aggregate of 5,175,000 shares of our common
stock for an aggregate consideration of approximately $36.2 million. Proceeds
after accounting for approximately $2.5 million in underwriting discounts and
commissions and approximately $2.1 million in other expenses were $31.6 million.
The underwriting discounts and commissions of approximately $2.5 million were
paid to C.E. Unterberg, Towbin, which beneficially owns over 10% of our common
stock. Principally all of the net proceeds had been invested in United States
government securities and investment-grade, interest-bearing instruments with
maturities of a maximum of two years. Of the net proceeds, we used $2.5 million
to repay our term loan, $1.0 million to

20

repay our revolving credit facility, and $3.3 million for property and equipment
acquisitions. The remaining $24.8 million has been used to support ongoing
operating expenses. As of the date of this filing, all of the net proceeds from
the IPO have been fully utilized.

ITEM 6. SELECTED FINANCIAL DATA

You should read the selected consolidated financial data set forth below
along with "Management's Discussion and Analysis of Financial Condition of
Operations" and our consolidated financial statements and related notes. We have
derived the consolidated statement of operations data for the year ended
December 31, 2001 and the consolidated balance sheet data as of December 31,
2001 from our consolidated financial statements. We have derived all other data
in this table from financial statements not included in this Form 10-K.

21

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with our consolidated
financial statements and related notes.

OVERVIEW

During 2001, we took several steps to try to improve our financial results.
In February 2001, we announced a strategic corporate restructuring program
pursuant to which we would reduce costs and focus our business exclusively on
revenue growth opportunities in our Software business. Another restructuring
plan was implemented in July 2001. As part of the restructuring plans, 55
employees were laid off on February 28, 2001, and an additional 75 employees
were laid off on July 10, 2001. On October 22, 2001, we announced that in order
to address the challenges of the on-going economic downturn, we had taken
aggressive steps to further reduce our cost structure, including a company wide
workforce reduction of approximately 50 people. The costs recognized for these
plans totaled $2.6 million.

In July 2001, we announced that our Content business segment was sold to
RightAnswers in accordance with the terms of a Purchase and Sale Agreement dated
July 20, 2001. RightAnswers is a limited liability company that was formed to
acquire our Content business. The Chief Executive Officer of RightAnswers, Mark
Finkel, was our Chief Financial Officer from January 2000 to July 2001. In
addition, Mr. Finkel owns an equity interest in RightAnswers. The consideration
we received for the sale consisted of an assumption of approximately $0.5
million of net liabilities associated with the business.

In September 2001, we announced that Kent Heyman was appointed CEO and
President by our Board of Directors. Prior to joining ServiceWare, Mr. Heyman
was one of three founding employees and a senior vice president at Mpower
Communications.

In October 2001, we announced a strategic relationship with EPAm Systems, a
provider of outsourced application development services. EPAm is knowledgeable
about our products because of its past involvement in our product development.
In the near term, our relationship with EPAm will enable us to deliver customer
focused product enhancements and improved product functionality. Under the
agreement, we will be a strategic reseller of EPAm's development services within
the United States. This contract expired in January 2002, but we are continuing
to operate under this agreement while we are negotiating an extension.

Our operating losses, as well as our negative operating cash flow, have
been significant to date. We expect to have positive operating margins over time
by increasing the number of our customers and selling them additional services
without significantly increasing related capital expenditures and other
operating costs. We do not know if we will be able to achieve these objectives.

As of December 31, 2001, we had $4.8 million in cash and short-term
investments. Based upon internal projections as well as the additional $1.5
million of capital (described in footnote 18 of the financial statements), we
expect that this amount will allow us to remain funded for the next 12 months.
We also expect to pursue additional funding to finance our operations and the
development of our business. We have several one-time obligations to be paid
generally through 2002 including items such as severances, but have taken steps
to reduce our recurring costs to approximate our anticipated level of revenues.
These steps included layoffs in July, August and October 2001 of approximately
50, 75 and 50 employees, respectively. We sold our Content business segment in
July 2001. As a result, all financial data for the Content business has been
presented separately as discontinued operations. Financial information for prior
periods has been restated accordingly. Our future capital needs will be highly
dependent on market demand for our products and services as well as our ability
to control expenses and to manage the restructuring of operations.

We market and sell our products in North America through our direct sales
force. Internationally, we market products primarily through value-added
resellers, software vendors and system integrators. International revenues were
8% of total revenues in 2001, but historically have not been a significant
percentage of total revenues. We derive our revenues from licenses for software
products and from providing related services, including installation, training,
consulting, customer support and maintenance contracts. Licenses revenues
include fees for perpetual and annual licenses. Services revenues contain
variable fees for installation, training and consulting, as
22

well as fixed fees for customer support and maintenance contracts. We recognize
revenues on license fees after a non-cancelable license agreement has been
signed, the product has been delivered, the fee is fixed, determinable and
collectable, and there is vendor-specific objective evidence to support the
allocation of the total fee to elements of a multiple-element arrangement using
the residual method. We recognize revenues on installation, training and
consulting on a time-and-material basis, and customer support and maintenance
contracts are recognized over the life of the contract.

Cost of license revenues consists primarily of the expenses related to
royalties, the cost of media on which our product is delivered, product
fulfillment costs, amortization of purchased technology, salaries, benefits,
direct expenses and allocated overhead costs related to product fulfillment.
Cost of services revenues consists of the salaries, benefits, direct expenses
and allocated overhead costs of customer support and services personnel, fees
for sub-contractors and the costs associated with maintaining our customer
support site.

We classify our core operating costs into four general categories: sales
and marketing, research and development, general and administrative, and
intangible assets amortization based upon the nature of the costs. Special one
time charges, including restructuring costs, are presented separately as
restructuring and other non-recurring charges to enable the reader to determine
core operating costs. We allocate the total costs for overhead and facilities,
based upon headcount, to each of the functional areas that benefit from these
services. Allocated charges include general overhead items such as building
rent, equipment-leasing costs, telecommunications charges and depreciation
expense. Sales and marketing expenses consist primarily of employee compensation
for direct sales and marketing personnel, travel, public relations, sales and
other promotional materials, trade shows, advertising and other sales and
marketing programs. Research and development expenses consist primarily of
expenses related to the development and upgrade of our proprietary software and
other technologies. These expenses include employee compensation for software
developers and quality assurance personnel and third-party contract development
costs. General and administrative expenses consist primarily of compensation for
personnel and fees for outside professional advisors. Intangible assets
amortization expense consists primarily of the amortization of intangible assets
acquired through our acquisition of the Molloy Group in 1999. These assets are
amortized on a straight line basis over their respective estimated useful lives.
Restructuring and other non-recurring charges consist of costs incurred for
restructuring plans and other costs related to the separation of senior
executives.

Net income from discontinued operations represents the net results of
operations of the Content business through July 20, 2001, the date of sale.
Revenues from discontinued operations were derived from licenses for content
products including both perpetual licenses and periodic subscription access and
from providing content writing services under contract. We recognized revenues
on license fees after a non-cancelable license agreement was signed, the product
was delivered, the fee was fixed, determinable and collectable, and there was
vendor-specific objective evidence to support the allocation of the total fee to
elements of a multiple-element arrangement using the residual method. We
recognized revenues on periodic subscription licenses over the subscription
term. We recognized revenues on content writing services as performed over the
life of the contract.

Cost of license revenues from discontinued operations consisted primarily
of the expenses related to royalties, the cost of media on which our product was
delivered, product fulfillment costs, and the costs associated with maintaining
our RightAnswers.com Web site. Cost of service revenues from discontinued
operations consisted of the salaries, benefits, direct expenses and allocated
overhead costs of personnel providing content writing services.

Operating costs from discontinued operations consisted of sales and
marketing efforts related to the Content business and research and development
expenses consisting primarily of expenses related to the development and upgrade
of our content technologies and employee compensation for content developers.

The gain on the sale of the segment of $532,000 represents the net
liabilities assumed by the buyer. No other consideration was involved.

23

Our contractual obligations as of December 31, 2001 consist of the
following:

During 2001, the Company entered into a sublease for part of its office
space in Oakmont, Pennsylvania. The monthly lease payment is $5,927. The term of
the sublease is concurrent with the Company's lease which is through March 31,
2006, however, the sublease may be terminated by either party with 90 days
written notice at any time after January 31, 2002. In 2001, $25,811 was received
in rental payments for this sublease.

RESULTS OF OPERATIONS

The following table sets forth consolidated statement of operations data as
a percentage of revenues for the periods indicated:

24

YEARS ENDED DECEMBER 31, 2001 AND 2000

REVENUES

Total revenues decreased 30.4% to $11.9 million in 2001 from $17.1 million
in 2000 caused by a variety of factors including a general weakness in the
technology sector. License revenues decreased 47.1% to $5.9 million in 2001 from
$11.2 million in 2000. The decrease in license revenues was primarily
attributable to a decreased number of contracts with new customers. In 2001, we
recognized revenue for 13 contracts versus 71 contracts in 2000. Service
revenues remained steady with $6.0 million reported in both periods. An increase
in the amount of software maintenance revenue was offset by a decrease in the
amount of professional service revenues.

COST OF REVENUES

Cost of revenues increased to $10.9 million in 2001 from $9.6 million in
2000. Cost of revenues as a percentage of revenues increased to 91.7% from
55.9%. Cost of license revenues increased to $2.7 million in 2001 from $1.4
million in 2000. As a percentage of revenues, it increased to 22.5% from 8.3%.
The increase in the cost of license revenues was primarily attributable to an
increase in product royalties paid to third parties as a result of new
agreements entered into late in 2000.

Cost of service revenues increased slightly to $8.3 million in 2001 from
$8.2 million in 2000. As a percentage of revenues, it increased to 69.2% from
47.6%. The increase in the cost of service revenues was primarily attributable
to higher personnel costs in 2001 offset by a decrease in the use of third
parties to perform services.

OPERATING EXPENSES

SALES AND MARKETING. Sales and marketing expenses decreased to $13.6
million, or 113.8% of revenues, in 2001 from $16.6 million, or 96.8% of
revenues, in 2000. The decrease in sales and marketing expenses is primarily the
result of significant decreases in sales personnel costs including salaries,
bonus, commission and recruiting fees. The number of sales employees decreased
throughout the year to 17 at December 31, 2001 from 76 at December 31, 2000, an
overall decrease of 78%. Additionally, a decrease in marketing spending for
tradeshows and advertising as well as amounts spent in 2000 that were not spent
in 2001 to change our name and update our corporate image and to hold a user
group conference contributed to the decrease in sales and marketing expenses.
The increase as a percentage of revenues was attributable to the decrease in
revenues exceeding the decrease in sales and marketing expenses.

RESEARCH AND DEVELOPMENT. Research and development expenses increased to
$6.3 million, or 53.2% of revenues, in 2001 from $4.4 million, or 25.7% of
revenues, in 2000. The increase is a result of no allocation of software
development costs to discontinued operations in 2001 as opposed to 2000 where a
portion of software development costs were allocated to discontinued operations
and greater use of third party contractors to perform research and development
work in 2001.

GENERAL AND ADMINISTRATIVE. General and administrative expenses increased
slightly to $3.6 million, or 30.4% of revenues in 2001 from $3.5 million, or
20.2% of revenues in 2000. The increase in general and administrative expenses
was primarily the result of increased legal, accounting, investor relations and
other expenses related to being a public company for the full year 2001 versus 4
months in 2000.

INTANGIBLE ASSETS AMORTIZATION. Intangible assets amortization decreased
to $4.8 million, or 40.5% of revenues in 2001 from $5.1 million, or 29.5% of
revenues in 2000. Intangible assets amortization consists of the amortization
expense in respect of the consideration in excess of the fair value of assets
acquired and liabilities assumed in our acquisition of the Molloy Group in July
1999.

RESTRUCTURING AND OTHER NON-RECURRING CHARGES. Restructuring and other
non-recurring charges increased to $4.5 million, or 38.1% of revenues, in 2001
from $0.4 million, or 2.5% of revenues, in 2000. In 2001, restructuring charges
totaling $2.6 million primarily represent excess facilities costs and severance
benefits resulting from reductions in force of 55 employees in February 2001, 75
employees in July 2001 and approximately 50 employees in October 2001.

Other non-recurring charges in 2001 consist of $1.1 million in costs
recognized in conjunction with forgiveness of stockholder loans to certain
executives in connection with their severance agreements and the related taxes
as well as severance costs for senior executives of $0.6 million and a reserve
for stockholder loans of
25

$0.3 million. Other non-recurring charges in 2000 consist of severance charges
for senior executives of $0.3 million and forgiveness of stockholder loans of
$0.1 million.

OTHER INCOME (EXPENSE), NET

Other income (expense), net consists primarily of interest income received
from short-term investments, offset by interest expense and other fees related
to our bank borrowings. Other income (expense), net decreased to $449,000 or
3.8% of revenues in 2001 from $602,000 or 3.5% of revenues in 2000. The decrease
was primarily the result of a decrease in interest earned on investments offset
by a decrease in interest paid on outstanding debt.

YEARS ENDED DECEMBER 31, 2000 AND 1999

REVENUES

Revenues increased 152.7% to $17.1 million in 2000 from $6.8 million in
1999. Licenses revenues increased 226.6% to $11.2 million in 2000 from $3.4
million in 1999. Services revenues increased 77.5% to $6.0 million in 2000 from
$3.4 million in 1999. The increases were primarily attributable to an increased
number of new customers and a significant increase in the size of contracts. In
2000, we added 41 new software customers. The average sales price of a new
software deal increased 26.4% to $275,000 in 2000 from $217,000 in 1999.

COST OF REVENUES

Cost of revenues increased to $9.6 million in 2000 from $3.3 million in
1999. Cost of revenues as a percentage of revenues increased to 55.9% from
48.6%. Cost of licenses revenues increased to $1.4 million in 2000 from $0.5
million in 1999. Cost of licenses revenues as a percentage of revenues increased
to 8.3% from 6.8%. The increase in the cost of licenses revenues was primarily
attributable to the overall growth in the number of customers. In 2000, we added
41 new software customers. The increase in the cost of licenses revenues as a
percentage of revenues was principally due to the increase in product royalties.

Cost of service revenues increased to $8.2 million in 2000 from $2.8
million in 1999. Cost of services revenues as a percentage of revenues increased
to 47.6% from 41.9%. The increase in the cost of services revenues was primarily
attributable to an increase in the size of the services staff. Services staff
increased 70.0% to 51 in 2000 from 30 in 1999. The increase in cost of services
revenues as a percentage of revenues was primarily the result of the increased
use of third parties to perform services.

OPERATING EXPENSES

SALES AND MARKETING. Sales and marketing increased to $16.6 million in
2000 from $9.5 million in 1999. Sales and marketing expenses as a percentage of
revenues decreased to 96.8% from 140.1%. The increase in sales and marketing
expenses in absolute dollars was primarily attributable to additional staffing
and investments in sales and marketing activities. Sales and marketing staff
increased 74.5% to 82 in 2000 from 47 in 1999. The decrease in sales and
marketing expenses as a percentage of revenues was primarily attributable to the
pace of revenue growth exceeding the rate of growth in sales and marketing
expenses.

RESEARCH AND DEVELOPMENT. Research and development expenses increased to
$4.4 million, or 25.7% of revenues, in 2000, from $2.6 million, or 37.7% of
revenues, in 1999. The increase in research and development expenses was
primarily attributable to the increase in the number of software developers
hired. Software development staff increased 22.5% to an average of 49 in 2000
from an average of 40 in 1999. The decrease in research and development expenses
as a percentage of revenues was primarily attributable to the pace of revenue
growth exceeding the rate of growth in research and development expenses.

GENERAL AND ADMINISTRATIVE. General and administrative expenses increased
to $3.5 million, or 20.2% of revenues in 2000, from $2.3 million, or 34.4% of
revenues in 1999. The increase resulted primarily from the addition of finance,
human resources, executive and administrative personnel and the recognition of
stock based compensation expense. Stock based compensation relates to the
issuance of stock options with exercise or purchase prices below the deemed fair
market value of the common stock for financial reporting purposes on the date of
the grant and related to modifications of certain stock options. We incurred
stock compensation charges of $0.9 million in 2000 which was 5.0% of revenues
and nothing in 1999. The decrease in general and administrative expenses as a
percentage of revenues was primarily attributable to the pace of revenue growth
exceeding the rate of growth in general and administrative expenses.
26

INTANGIBLE ASSETS AMORTIZATION. Intangible assets amortization increased,
to $5.1 million, or 29.5% of revenues in 2000, from $2.2 million, or 32.5% of
revenues in 1999. Intangible assets amortization consists of the amortization
expense in 2000 and the second half of 1999 in respect of the consideration in
excess of the fair value of assets acquired and liabilities assumed in our
acquisition of the Molloy Group in July 1999.

RESTRUCTURING AND OTHER NON-RECURRING CHARGES. Restructuring and other
non-recurring charges increased to $0.4 million, or 2.5% of revenues, in 2000
from $0.1 million, or 1.2% of revenues, in 1999. Restructuring and other
non-recurring charges consist of severance charges for senior executives.

OTHER INCOME (EXPENSE), NET

Other income (expense), net consists primarily of interest income received
from the investment of proceeds from our financing activities, offset by
interest expense and other fees related to our bank borrowings. Other income
(expense), net increased to approximately $602,000 in 2000 from $(173,000) in
1999. The increase was a result of interest earned primarily on the proceeds
from the initial public offering exceeding interest paid on outstanding loans.

LIQUIDITY AND CAPITAL RESOURCES

Historically, we have satisfied our cash requirements primarily through
private placements of convertible preferred stock and common stock and our
initial public offering.

We have incurred a net loss of $29.7 million for 2001. We have taken
substantial measures to reduce our costs and improve our chances to achieve
profitability in 2002, however we may continue to incur net losses for the
foreseeable future.

We continue to use cash for operating activities as a result of our net
losses. We expect the levels of cash used by current operations to be
substantially lower next year due to lower personnel and office costs as a
result of our restructuring activities.

The significant decreases in accounts receivable and deferred revenue in
2001 compared to 2000 are the result of a decrease in customer orders. Customer
orders decreased 42.6% in 2001 compared to 2000. The significant decrease in
other assets resulted from the prepayment of royalties in late 2000 and the
subsequent recognition of the related expense in 2001. The significant decrease
in accounts payable is due to lower operating costs as a result of our
restructuring activities.

Net cash provided by investing activities was primarily attributable to
sales of short-term investments. Consistent with the decline in revenues and
overall cost cutting, our need for capital spending for new equipment also
declined.

Net cash provided by financing activities resulted primarily from proceeds
borrowed under the revolving line of credit. The revolving line of credit was
repaid in full in November 2001.

As of December 31, 2001, we had $4.8 million in cash and cash equivalents.
We believe that our existing cash balances should be sufficient to meet
anticipated cash requirements for the next 12 months. We have several one-time
obligations to be paid, including items such as severance benefits, but have
taken steps to reduce our recurring costs to approximate our anticipated levels
of revenue. These steps included lay offs in February, July and October 2001 of
approximately 55,75, and 50 employees, respectively.

On April 1, 2002, the Company signed a binding commitment letter to sell
$1,500,000 of Convertible Notes to a current investor. The funds, net of all
transaction costs of approximately $150,000, are to be received by April 20,
2002. The notes mature 18 months from the closing date, bear interest at 10% per
annum, and are convertible at any time at the option of the holder, into shares
of the Company's common stock at a conversion price of $0.30 per share. Interest
can be paid in cash or additional notes, at the option of the Company. The Notes
will be senior unsecured obligations that will rank senior to all future
subordinated indebtedness, pari passu to all existing and future senior,
unsecured indebtedness and subordinated to all existing and future senior
secured indebtedness. The Company may borrow an additional $1,500,000 under the
arrangement, which is contingent on shareholder approval. We will continue to
pursue additional funding if necessary.
27

On February 14, 2002, we received a compliance notice from The Nasdaq Stock
Market. In this letter, Nasdaq informed us that our common stock had failed to
maintain a minimum bid price per share of $1.00 over the last 30 consecutive
trading days, as required by The Nasdaq National Market under Marketplace Rule
4450(a)(5).

In accordance with Marketplace Rule 4450(e)(2), we will have until May 15,
2002, or 90 calendar days from such notification, to regain compliance with
Nasdaq's continued listing requirements. If at any time before May 15, 2002 the
minimum bid price per share is $1.00 for a minimum of ten consecutive trading
days, Nasdaq will determine if we then comply with Nasdaq's continued listing
requirements. If we are unable to demonstrate compliance with the continued
listing requirements on or before May 15, 2002, Nasdaq staff will provide us
with written notification that its securities will be removed from the Nasdaq
National Market.

In response to the letter from Nasdaq, we submitted an application to
transfer the listing of its common stock to The Nasdaq SmallCap Market. If the
application is approved, we will be afforded an additional 180-day grace period
which will extend the delisting determination until August 13, 2002. We may also
be eligible for an additional 180-day grace period provided that it meets the
initial listing criteria for the SmallCap Market under Market Place Rule
4310(c)(2)(A). There can be no assurance that Nasdaq will approve our
application to transfer to the SmallCap Market or that if approved we will
remain compliant with the applicable continued listing requirements.

If our common stock is permitted to move to the SmallCap Market and is
unable to meet the minimum maintenance requirements during the extended grace
period, then we would be subject to delisting from the Nasdaq SmallCap Market.
In that event, we would be notified of any Nasdaq staff determination to this
effect and it would then have the right to appeal such a delisting determination
to the Nasdaq Listings Qualifications Panel.

If our common stock would be delisted by Nasdaq, our securities would be
eligible to trade on the OTC Bulletin Board maintained by Nasdaq, another
over-the-counter quotation system, or on the pink sheets where an investor may
find it more difficult to dispose of or obtain accurate quotations as to the
market value of the securities. In addition, we would be subject to a Rule
promulgated by the Securities and Exchange Commission that, if we fail to meet
criteria set forth in such Rule, imposes various practice requirements on
broker-dealers who sell securities governed by the Rule to persons other than
established customers and accredited investors. For these types of transactions,
the broker-dealer must make a special suitability determination for the
purchaser and have received the purchaser's written consent to the transactions
prior to sale. Consequently, the Rule may deter broker-dealers from recommending
or selling our common stock, which may further affect the liquidity of our
common stock.

Delisting from Nasdaq will make trading our shares more difficult for
investors, potentially leading to further declines in our share price. It would
also make it more difficult for us to raise additional capital. Further, if we
are delisted we would also incur additional costs under state blue sky laws in
connection with any sales of our securities.

If we trade on the OTC Bulletin Board maintained by Nasdaq, another
over-the-counter quotation system, or on the pink sheets, this may make it more
difficult to raise funds in the future. Changes in equity markets in the past
year have adversely affected our ability to raise equity financing and have
adversely affected the markets for debt financing for companies with a history
of losses such as ours. If additional financing is not available to us we may
need to dramatically change our business strategy and direction, including
pursuing the options to sell or merge our business, or liquidate.

There can be no assurance that additional capital will be available to us
on reasonable terms, if at all, when needed or desired. If we raise additional
funds through the issuance of equity, equity-related or debt securities, such
securities may have rights, preferences or privileges senior to those of the
rights of our common stock. Furthermore, because of the low trading price of our
common stock, the number of shares of new equity or equity-related securities
that we may be required to issue may be greater than it otherwise would be. As a
result, our stockholders may suffer significant additional dilution. Further,
the issuance of debt securities