SERVICEWARE TECHNOLOGIES INC/ PA - 10-K Annual Report

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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, 2002

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 whether the registrant is an accelerated filer as
defined in Rule 12b-2 of the Act. Yes [ ] No [X]

The aggregate market value of common equity held by non-affiliates of the
registrant as of June 28, 2002, the last business day of the registrant's most
recently completed second quarter, was approximately $9,000,000, computed by
reference to the price at which the common equity was last sold on the Nasdaq
SmallCap Market on June 28, 2002, as reported in The Wall Street Journal. This
figure has been 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, 2003 was 24,145,870.

DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of the definitive Proxy Statement of ServiceWare
Technologies, Inc. to be used in connection with the 2003 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.

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. [ ]

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SERVICEWARE TECHNOLOGIES, INC.

ANNUAL REPORT ON FORM 10-K

FOR THE YEAR ENDED DECEMBER 31, 2002

TABLE OF CONTENTS

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PART I

ITEM 1. BUSINESS

We were initially incorporated as a Pennsylvania corporation in January
1991 as ServiceWare, Inc. In July 1999, we acquired the Molloy Group, Inc., a
leading provider of knowledge-empowered software for strengthening customer
relationships. In May 2000, we changed our name to ServiceWare Technologies,
Inc. and reincorporated as a Delaware corporation. In August 2000, we closed our
initial public offering. Prior to July 2001, we had two reportable business
segments: Software and Content. In July 2001, we completed the sale of our
Content business to RightAnswers LLC ("RightAnswers"). Financial information
regarding revenues and long lived assets attributable to the United States
versus international is found in Note 16 to the consolidated financial
statements in Item 8 below. In response to poor financial performance and the
economic downturn, during 2001 we announced strategic corporate restructuring
programs pursuant to which we have significantly reduced costs and we have
focused our business exclusively on revenue growth opportunities in our Software
business. As part of the restructuring plans, approximately 180 employees were
laid off during 2001. In August 2002, we acquired all existing technology
assets, certain customer and vendor contracts of InfoImage, Inc., a privately
held enterprise portal company which filed for bankruptcy protection prior to
our agreement to acquire these assets.

Our primary office is located at 333 Allegheny Avenue, Oakmont,
Pennsylvania 15139, and our website address is www.serviceware.com. 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 for 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 Enterprise(TM) (formerly named eService Suite), powered by The
Cognitive Processor(R), 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

ServiceWare Enterprise(TM) is a software solution that allows ServiceWare
customers to provide personalized, automated Web-based service tailored to the
needs of their users. ServiceWare Enterprise 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 Cognitive Processor 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. ServiceWare Enterprise includes the software products ServiceWare
Self-Service(TM) (Web-based self-service for customers, partners and employees),
ServiceWare Professional(TM) (for customer service, sales and field service
personnel) and ServiceWare Architect(TM) (for quality assurance managers and
system administrators). ServiceWare also

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provides a portal solution, ServiceWare Knowledge Portal, based on the
technology acquired from InfoImage in August 2002

ServiceWare customers represent a cross-section of industry leaders in the
financial services, technology, manufacturing, healthcare, entertainment,
education and government sectors. Customers include EDS, H&R Block, AT&T
Wireless, Cingular Wireless, Fifth Third Bancorp, Green Mountain Energy,
Reuters, Stream International, and QUALCOMM.

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."Knowledge Management" is the development of a formal
process that evaluates a company's organizational processes, people, and
technology and develops a system that uses the relationships between these
components 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.

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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 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 Cognitive Processor 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 ServiceWare
Enterprise 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 Cognitive Processor technology contained in
our ServiceWare Enterprise 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, Remedy, 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

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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
ServiceWare Enterprise allows both large and growing organizations to
maintain a consistent level of service as the volume of traffic across
their communication channels increases. By deploying in a cluster and
capitalizing on the capabilities of our J2EE 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 solutions. 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 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, Remedy, 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 knowledge-powered solutions, we have completed the
first stage of our product localization efforts, concentrating on
European markets. The interface is currently available in French,
Spanish, German and Dutch. Furthermore, we intend to increase our
relationships with local distributors in international markets, including
Merlin Information Systems and Al-Moammar Information Systems.

PRODUCTS

ServiceWare's Knowledge Management solutions enable organizations to easily
provide customers, partners, suppliers and employees with fast, accurate answers
to inquiries across various communication channels including the phone, e-mail,
chat and the Web. Based on our software and Cognitive Processor technology,
ServiceWare Enterprise software empowers organizations to deliver superior
service and support, while reducing expenses. ServiceWare Enterprise includes
our ServiceWare Self-Service, ServiceWare Professional and ServiceWare Architect
software products.

SERVICEWARE SELF-SERVICE allows our customers to provide Web-based
self-service to their end-users. End-users can access the Self-Service solution
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. ServiceWare
Self-Service can be customized to adopt the look and feel of our customer's Web
site.

SERVICEWARE 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.
ServiceWare Profes-
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sional includes a complete case management system that serves as a workstation
for customer service and support agents. Agents have a visual queue of cases
that can be viewed based on skills based routing. The system also contains
e-mail and chat components that enable agents to easily communicate with
customers and employees without having to pick up the phone. ServiceWare
Professional integrates with many types of customer relationship applications to
provide a seamless interface for a customer service professional.

SERVICEWARE ARCHITECT provides a robust set of knowledge tools that allows
customers' quality assurance managers and system administrators to design,
manage and maintain knowledge bases. ServiceWare Architect provides robust
quality assurance and workflow capabilities as well as administrative tools for
all necessary product suite functions.

The recent poor economic climate has contributed to stagnant IT purchasing
for our target market, Fortune 1000 companies, and we anticipate a stagnant IT
purchasing environment to continue in our target market in the near future. As a
result, we are experiencing price compression and a slowdown in overall demand
for our products and services. With that in mind, we have redirected some of our
efforts towards the mid-market. Specifically, we have redesigned parts of our
product, added the ability to host the solution and created attractive pricing
and packages for these midmarket companies. We are optimistic that this business
will increase sales opportunities and product and services revenue in 2003.

SERVICES

PROFESSIONAL SERVICES. Our professional services team 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 team offers
education and training to enable our customers' internal team to understand how
to use our products, support the implementation and maintain 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. ServiceWare Enterprise 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. The architecture is based on the
Java 2 Enterprise Edition or "J2EE" framework that includes components
specifically designed to take advantage of each element of the modern Web
environment. This enables a configurable, extensible application to be delivered
based on current Internet standards.

At the core of our technology is Cognitive Processor, which provides
self-learning capability to ServiceWare Enterprise. The Cognitive Processor uses
patented algorithm technology based on neural network and Bayesian statistical
principles. Through these algorithms, the Cognitive Processor is capable of
learning from past transactions.

We are continually updating our software to run in the most common
environments. ServiceWare now supports Solaris, Windows 2000 and NT operating
environments.We support BEA Weblogic, Macromedia JRUN and IBM Websphere for the
application servers.

We provide an extensive set of integration Application Programming
Interfaces or "APIs" that allow us to integrate with a broad range of
applications using industry standard protocols. ServiceWare Enterprise is also
available as a Web service through ServiceWare's Simple Object Access Protocol
(SOAP) adapter. The SOAP adapter provides the mechanism by which ServiceWare
Enterprise will be available as a Web service
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within the enterprise. Any application will be able to utilize the Web service
to add and retrieve from a knowledge base and take advantage of ServiceWare's
patented self-learning and self-organizing search technology, the Cognitive
Processor.

CUSTOMERS

We have traditionally marketed our products and services to Global 2000
call centers and help desks in a wide range of vertical industries. EDS
accounted for 11% of our 2002 revenues. The following is a partial list of our
other customers during 2002.

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

SALES AND MARKETING

We sell our solutions primarily through our direct sales force. We have
sales personnel throughout North America and 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,
Remedy and Siebel Systems.

We have established service alliances with leading systems integrators,
including Electronic Data Systems Corporation to increase our breadth of
implementation services both nationally and around the globe. These service
alliance partners complete a rigorous training program to become fully certified
to implement
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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. We believe that building key relationships with
market leaders increase our opportunities in global expansion, enhanced
solutions, and continued product innovations.

RESEARCH AND DEVELOPMENT

Our internal research and development team 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 our products and services to meet our customers'
expectations of ongoing innovation and enhancement within our suite of products
and services. We have entered into an agreement with EPAm Systems, of Princeton,
New Jersey, and Minsk, Belarus, to augment our research and development
capabilities. This relationship gives us 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.

We renewed our agreement with EPAm Systems on April 1, 2002. This agreement
states that consulting services will be provided in accordance with specific
work orders. Payment for these services is billed as the work is incurred or at
a fixed fee agreed upon for the work order.

Our ability to meet our customers' expectations depends 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.

For a description of our research and development related expenses, see the
Management's Discussion and Analysis of Financial Condition and Results of
Operations in Item 7 of this Form 10-K.

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.

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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 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 we 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 our 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.

EMPLOYEES

As of December 31, 2002, we had 67 employees consisting of 23 in sales, 20
in professional services and support, seven in research and development, seven
in marketing, and ten in general and administration. 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.

FORWARD-LOOKING STATEMENTS

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.

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 or
the results indicated or projected by our historical results.

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 expect to
continue to experience negative cash flow from operations in

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2003. We cannot assure investors that we will attain break-even cash flow from
operations at any particular time in the future, or at all.

We continue to evaluate alternative means of financing to meet our needs on
terms that are attractive to us. Our ability to continue as a business in our
present form is largely dependent on our ability to generate additional
revenues, reduce overall operating expense, and achieve profitability and
positive cash flows or to obtain additional debt or equity financing. We believe
that we have the ability to do so and plan to fund 2003 operations through
product sales, reduced spending and utilizing the available funding under our
existing debt facilities. 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. Further, we believe that in order to sustain business
operations at the current level through 2004, we will need to obtain significant
additional funding.

IF WE ARE NOT ABLE TO OBTAIN NECESSARY CAPITAL, WE MAY NEED TO DRAMATICALLY
CHANGE OUR BUSINESS STRATEGY AND DIRECTION, INCLUDING PURSUING 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 and debt. Changes in equity markets in
the recent past 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. Further, the issuance of debt securities could
increase the risk or perceived risk of our company. If we are not able to obtain
necessary capital, we may need to dramatically change our business strategy and
direction, including pursuing options to sell or merge our business, or
liquidate.

WE HAVE A HISTORY OF LOSSES, ANTICIPATE THAT WE WILL CONTINUE TO INCUR LOSSES IN
2003 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, 2002, we
had an accumulated deficit of $73.5 million. We have not achieved profitability
on a quarterly or annual basis to date. In 2002 and 2001, we incurred net losses
of $6.8 million and $29.7 million, respectively. We expect to have decreased
operating expenses as a result of our restructuring activities. However, if
revenues do not significantly increase, our losses will continue. In addition,
our history of losses may cause some of our potential customers to question our
viability, which might hamper our ability to make sales.

OUR CASH FLOW MAY NOT BE SUFFICIENT TO PERMIT REPAYMENT OF OUR DEBT WHEN DUE.

The $3.25 million of convertible notes we issued in second quarter 2002
will be due no later than July 15, 2004. To the extent the note purchasers do
not elect to convert the notes into common stock, we will be required to retire
or refinance that debt at that time. In addition, any borrowings that we make
under our revolving debt facility will be due in October 2003. Our ability to
retire or to refinance our indebtedness will depend on our ability to generate
cash flow in the future. Our cash flow from operations will likely be
insufficient to repay this indebtedness at scheduled maturity and some or all of
our indebtedness, which is not converted to equity, will likely have to be
refinanced. If we are unable to refinance our debt or if additional financing is
not available on acceptable terms, or at all, we could be forced to dispose of
assets under circumstances that might not be favorable to realizing the highest
price for the assets or to default on our obligations with respect to this
indebtedness.

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 could result in the release
of deficient software

11

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.

Our senior management team consists of only two individuals, neither of
whom has been with us for more than three years. The loss of either of these
officers could have an adverse effect on our operations, business, and prospects
and our ability to carry out our business plan. We do not maintain key man
insurance on our officers.

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.

Since the announcement of our corporate restructurings in 2001, we have
reallocated our resources to the ongoing enhancement of our software product,
and in July 2001, we 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 relatively large orders from a limited number
of customers, so it is difficult to estimate accurately the timing of future
revenues.

Our quarterly results are also impacted by our revenue recognition
policies. Our revenues are unpredictable and in our last six quarters have
fluctuated from a low of $2.2 million in third quarter 2001 and third quarter
2002 to a high of $4.4 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 in a shorter time frame because
installation and training can generally be completed in significantly less time
than for new customers. However, we may not be able to recognize expected
revenues at the end of a quarter due to delays in the receipt of expected orders
from 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 over the
telephone with limited reference materials available for the customer service
representative. Our

12

business model assumes that companies which provide customer service over the
telephone will find value in aggregating institutional knowledge by using our
software 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.

WE CURRENTLY HAVE ONE PRODUCT FAMILY. IF THE DEMAND FOR THIS LINE OF PRODUCTS
DECLINES, OUR BUSINESS WILL BE ADVERSELY AFFECTED.

ServiceWare's Knowledge Management solution, ServiceWare Enterprise,
includes our ServiceWare Self-Service, ServiceWare Professional and ServiceWare
Architect software products. Our past and expected future revenues consist
primarily of license fees for these software solutions and fees for related
services. Factors adversely affecting the demand for these products and our
products in general, such as competition, pricing or technological change, could
materially adversely affect our business, financial condition, operating results
and the value of our stock price. Our future financial performance will
substantially depend on our ability to sell current versions of our entire suite
of products and our ability to develop and sell enhanced versions of our
products.

DUE TO THE LENGTHY SALES CYCLES OF OUR PRODUCTS AND SERVICES, THE TIMING OF OUR
SALES IS 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
significant amount of our total revenues will be derived from our ServiceWare
Enterprise solutions, 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.

13

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.

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/Amdocs, Remedy, 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 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, our 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.

14

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, 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
typically 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 or 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

- 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. 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 indepen-
15

dently. 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.

THE SUCCESS OF OUR SOFTWARE PRODUCTS DEPENDS ON THEIR 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 ServiceWare Enterprise 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 solutions to
end-users will be impaired. Thus, successful deployment and broad acceptance of
ServiceWare Enterprise 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. Due to the slowdown in the national and global economy and the
uncertainties resulting

16

from recent acts of terrorism, we believe that many existing and potential
customers are reducing or reassessing their planned IT expenditures. Such
reductions in or eliminations of IT spending could cause us to be unable to
maintain or increase our sales volumes, and therefore, have a material adverse
affect on our revenues, operating results and stock price.

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.

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.

In recent years, the common stocks of technology companies have experienced
significant price and volume fluctuations. 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 AMOUNT OF OUR STOCKHOLDERS' EQUITY
COULD RESULT IN THE DELISTING OF OUR COMMON STOCK.

On March 18, 2003, we received a letter from Nasdaq that our common stock
will be delisted as of March 27, 2003. We have filed an appeal, and the
delisting will be delayed pending the outcome of the appeal. We cannot assure
investors that our stock will continue to be listed on Nasdaq after our appeal
is heard.

If our common stock is delisted by Nasdaq, we expect that our securities
will begin to trade on the OTC Bulletin Board maintained by Nasdaq, another
over-the-counter quotation system, or on the pink sheets. As a result, investors
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 would 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.

17

Further, if we are delisted we could also incur additional costs under state
blue sky laws in connection with any sales of our securities.

OUR MANAGEMENT OWNS A SIGNIFICANT PERCENTAGE OF OUR COMPANY AND WILL BE ABLE TO
EXERCISE SIGNIFICANT INFLUENCE OVER OUR ACTIONS.

We are controlled by our officers and directors, who in the aggregate
directly or indirectly could control more than 50% of our outstanding common
stock and voting power, assuming conversion of all of our convertible notes.
These stockholders collectively will likely be able to control our management
policy, decide all fundamental corporate actions, including mergers, substantial
acquisitions and dispositions, and elect our board of directors.

TERRORIST ATTACKS SUCH AS THE ATTACKS THAT OCCURRED IN NEW YORK AND WASHINGTON,
D.C. ON SEPTEMBER 11, 2001 AND OTHER ATTACKS OR ACTS OF WAR MAY ADVERSELY AFFECT
THE MARKETS ON WHICH OUR COMMON STOCK TRADES, OUR FINANCIAL CONDITION AND OUR
RESULTS OF OPERATIONS.

On September 11, 2001, the United States was the target of terrorist
attacks of unprecedented scope. In March 2003, the United States and allied
nations commenced a war in Iraq. These attacks and the war in Iraq have caused
major instability in the United States and other financial markets. There could
be further acts of terrorism in the United States or elsewhere that could have a
similar impact. Armed hostilities or further acts of terrorism could cause
further instability in financial markets and could directly impact our financial
condition and our results of operations.

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 lease an office in Iselin, New Jersey, replacing a small executive
office suite that was sublet in Princeton, New Jersey. We also continue to lease
small offices in Atlanta, Georgia; Phoenix, Arizona; Pittsford, New York; and
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

During the fourth quarter of 2002, no matters were submitted to a vote of
the security holders. However, we held a Special Meeting of Stockholders on
February 10, 2003. Two matters were considered and voted upon at the Special
Meeting:

- the approval of an amendment to our Certificate of Incorporation to
effect a reverse stock split of our Common Stock and to grant our Board
of Directors the authority to set the ratio for the reverse split or to
not complete the reverse split

- the approval of an amendment to our Certificate of Incorporation to
decrease the number of authorized shares of Common Stock to 50,000,000
shares subject to completion of the reverse stock split

The votes on the matters presented to our Stockholders were as follows:

18

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 from August
25, 2000 until April 24, 2002 and on the Nasdaq SmallCap Market since that time.
On March 19, 2003, the last sale price of our common stock was $0.29 per share.
The following table sets forth the range of high and low sale prices for our
common stock for the periods indicated.

As of March 19, 2003, there were approximately 350 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

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.

19

ITEM 6. SELECTED FINANCIAL DATA

The following financial information for the five years ended December 31,
2002 has been derived from our consolidated financial statements. You should
read the selected consolidated financial data set forth below along with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our consolidated financial statements and related notes.

20

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

We are 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. Founded in 1991 in
Oakmont, Pennsylvania, we sell our products throughout the United States and
have a European subsidiary based in the United Kingdom.

ServiceWare Enterprise(TM) (formerly named eService Suite), powered by The
Cognitive Processor(R) (formerly known as MindSync), 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

ServiceWare Enterprise(TM) is a software solution that allows our customers
to provide personalized, automated Web-based service tailored to the needs of
their users. ServiceWare Enterprise 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 Cognitive Processor 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. ServiceWare
Enterprise includes the software products ServiceWare Self-Service(TM)
(Web-based self-service for customers, partners and employees), ServiceWare
Professional(TM) (for customer service, sales and field service personnel) and
ServiceWare Architect(TM) (for quality assurance managers and system
administrators). We also provide a portal solution, ServiceWare Knowledge
Portal, based on the technology acquired from InfoImage in August 2002.

Prior to July 2001, we had two reportable business segments: Software and
Content. In July 2001, we completed the sale of all of our Content segment to
RightAnswers LLC ("RightAnswers"). The Content segment is reported as a
discontinued operation, and all previously reported financial information has
been restated accordingly. See Note 6 to our consolidated financial statements.

In response to poor financial performance and the economic downturn, during
2001 we announced strategic corporate restructuring programs pursuant to which
we have significantly reduced costs and we have focused our business exclusively
on revenue growth opportunities in our Software business. As part of the
restructuring plans, approximately 180 employees were laid off during 2001. The
savings from the restructuring plans offset by a decrease in revenues and
increased interest expenses related to our convertible notes resulted in a
decrease in our net loss for 2002 to $6.8 million, or $0.28 per share, compared
to a loss of $29.7 million, or $1.23 per share for 2001.

On March 18, 2003, we received a delisting notice from The Nasdaq Stock
Market. In this letter, Nasdaq informed us that our common stock has continued
to fail to maintain a minimum bid price per share of $1.00, that we do not
qualify for any further extensions and that our common stock will be delisted as
of March 27, 2003. We have filed an appeal, and the delisting will be delayed
pending the outcome of the appeal. We cannot assure investors that our common
stock will continue to be listed on Nasdaq after our appeal is heard.

21

At a special meeting of our stockholders on February 10, 2003, our
stockholders approved an amendment to our Certificate of Incorporation to effect
a reverse stock split of our common stock and to grant our board of directors
the authority to set the ratio for the reverse split or to not complete the
reverse split. As necessary, we intend to consider implementing a reverse stock
split if we believe it would increase the probability that we would be able to
continue to meet the Nasdaq SmallCap Market listing requirements.

On August 21, 2002, we acquired all existing technology assets, certain
customer and vendor contracts of InfoImage, Inc., a privately held enterprise
portal company which filed for bankruptcy protection prior to our agreement to
acquire these assets. We paid initial consideration of $100,000 and will pay
contingent consideration not to exceed a total of $1.5 million to be
predominantly based on future sales of InfoImage products and services.
InfoImage's feature product, Decision Portal, provides companies with an
enterprise portal framework that consolidates key information from disparate
data sources and provides collaboration tools in one unified view.

On October 16, 2002, we entered into a $2.5 million loan and security
agreement with Comerica Bank -- California (the "Bank"). The agreement allows
for a revolving line of credit and a term loan. Borrowings on the revolving line
can be in amounts up to the lesser of $2.0 million or 75% of eligible
receivables and mature October 1, 2003. Such amounts will bear interest at a
rate of 1.5% above the Bank's prime rate. Advances of up to $0.5 million on the
term loan can be taken until October 16, 2003, and the term loan will mature one
year from the date of the advance. Such amounts are to be repaid in 12 monthly
installments and will bear interest at the Bank's prime rate which was 4.25% at
December 31, 2002. In conjunction with this loan agreement, a Warrant was issued
to the Bank to purchase 50,000 shares of our common stock at an exercise price
of $0.46 per share, with a 10-year maturity. The Warrant includes assignability
to Bank's affiliates, antidilution protection and a net exercise provision. In
addition, the Bank can require us to repurchase the Warrant for $69,000 after a
change of control as defined in the agreement.

FACTORS AFFECTING FUTURE OPERATIONS

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 our customer base without significantly increasing related capital
expenditures and other operating costs. We do not know if we will be able to
achieve these objectives.

DESCRIPTION OF STATEMENT OF OPERATIONS

REVENUES

We market and sell our products primarily in North America through our
direct sales force. Internationally, we market our products through value-added
resellers, software vendors and system integrators as well as our direct sales
force. International revenues were 12% and 8% of total revenues in 2002 and
fiscal 2001. We derive our revenues from licenses for software products and from
providing related services, including installation, training, consulting,
customer support and maintenance contracts. License revenues primarily represent
fees for perpetual licenses. Service revenues contain variable fees for
installation, training and consulting, reimbursements for travel expenses that
are billed to customers, as well as fixed fees for customer support and
maintenance contracts.

COST OF REVENUES

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, and salaries, benefits,
direct expenses and allocated overhead costs related to product fulfillment.
Cost of service revenues consists of the salaries, benefits, direct expenses and
allocated overhead costs of customer support and services personnel,
reimbursable expenses for travel that are billed to customers, fees for
sub-contractors, and the costs associated with maintaining our customer support
site.

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OPERATING COSTS

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
(other than goodwill) 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.

RESTRUCTURING AND OTHER NON-RECURRING CHARGES

In 2001, we implemented a strategic restructurings to reduce our cost
structure and focus on revenue growth opportunities in the Knowledge Management
software market. The plans of restructuring approved by our board of directors
included severance and other benefit costs, costs for reduction and relocation
of facilities, termination costs for certain service contracts and an equipment
write off. As part of the restructuring plan, 55 employees were laid off on
February 28, 2001. In July 2001, we implemented a revision to our organizational
structure and a workforce reduction of an additional 75 employees. In October
2001, we implemented a workforce reduction of approximately 50 people to further
reduce our cost structure.

A portion of the restructuring charge related to potential costs for
terminating certain real estate leases at our corporate headquarters, in
addition to amounts related to unused capacity within the building. We have been
successful in sub-leasing much of the unused capacity and consequently we have
reduced our reserve for excess capacity. Additionally, we decided not to
terminate the lease on the property as anticipated and accordingly reversed
approximately $302,000 in exit reserves in 2002. Furthermore, a change in the
estimate of the termination costs for certain service contracts was recorded as
a reduction to the restructuring expense of $130,000 in 2002.

The remaining restructuring liability of $116,000, related to reduction of
facilities, is expected to be fully amortized by June 2003.

23

A summary of the restructuring activity is as follows (amounts in
thousands):

Other non-recurring charges consist of severance costs for senior
executives, forgiveness of loans in connection with repurchases of common stock,
and income tax gross-ups related to the loan forgiveness.

DISCONTINUED OPERATIONS

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. Net income from discontinued operations represents the net
results of operations of the Content business through July 20, 2001, the date of
sale.

CRITICAL ACCOUNTING POLICIES

Our discussion and analysis of our financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with generally accepted accounting principles. The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosure of contingent assets and liabilities. On an
on-going basis, we evaluate our estimates, including those related to allowance
for doubtful accounts and intangible assets. We base our estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. We believe the following
critical accounting policies affect our more significant judgments and estimates
used in the preparation of our consolidated financial statements.

REVENUE RECOGNITION

We recognize revenues on license fees after a non-cancelable license
agreement is signed, the product is delivered, the fee is fixed, determinable
and collectible, 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. Customer support and maintenance
contracts are recognized over the life of the contract.

Our revenue recognition policy is governed by Statement of Position (SOP)
97-2, "Software Revenue Recognition", issued by the American Institute of
Certified Public Accountants (AICPA), as amended by SOP 98-9 "Modification of
SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions".
These statements provide guidance on applying generally accepted accounting
principles in recognizing revenue on software and services transactions. In
addition, the AICPA and its Software Revenue Recognition

24

Task Force continue to issue interpretations and guidance for applying the
relevant standards to a wide range of sales contract terms and business
arrangements that are prevalent in the software industry. Also, the Securities
and Exchange Commission (SEC) has issued Staff Accounting Bulletin No. 101
"Revenue Recognition in Financial Statements," which provides guidance related
to revenue recognition based on interpretations and practices followed by the
SEC, and the Emerging Issues Task Force of the Financial Accounting Standards
Board continues to issue additional guidance on revenue recognition. Future
interpretations of existing accounting standards or changes in our business
practices could result in future changes in our revenue accounting policies that
could have a material effect on our financial condition and results of
operations.

ACCOUNTS RECEIVABLE

We maintain allowances for doubtful accounts for estimated losses resulting
from the inability of customers to make required payments. If the financial
condition of these customers were to deteriorate, resulting in an impairment of
their ability of make payments, we may require additional allowances or we may
defer revenue until we determine that collectibility is probable. We perform a
quarterly analysis to determine the appropriate allowance for doubtful accounts.
This analysis includes a review of specific individual balances in our accounts
receivable, our history of collections, as well as the overall economic
environment.

INTANGIBLE ASSETS AND GOODWILL

Since adoption of SFAS No. 142, goodwill is no longer amortized but instead
is assessed for impairment at least as often as annually and as triggering
events occur. In making this assessment, we rely on a number of factors
including operating results, business plans, economic projections, anticipated
future cash flows, and transactions and market place data. There are inherent
uncertainties related to these factors and management's judgment in applying
them to the analysis of goodwill impairment. Since our judgment is involved in
performing goodwill valuation analyses, there is risk that the carrying value of
our goodwill may be misstated. As a result of implementing SFAS No. 142, expense
of $2.3 million was not recognized during 2002 that would have otherwise fully
amortized the balance of goodwill. During 2002, we performed the required
impairment tests of goodwill and indefinite lived intangible assets as of
January 1, 2002 and determined that we did not have an impairment loss.

CONTRACTUAL OBLIGATIONS

Our contractual obligations as of December 31, 2002 consist of the
following:

During 2001, we entered into a sublease for part of our office space in
Oakmont, Pennsylvania. The term of the sublease is concurrent with our lease
which is through March 31, 2006, however, the sublease may be terminated by
either party with 90 days written notice at any time. In 2002 and 2001, we
received $71,124 and $25,811 in rental payments for this sublease.

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RESULTS OF OPERATIONS

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

YEARS ENDED DECEMBER 31, 2002 AND 2001

REVENUES

Total revenues decreased 18.3% to $10.2 million in 2002 from $12.4 million
in 2001 caused by a variety of factors. The biggest factor was and continues to
be the poor economic climate. This has translated into significant cuts in
enterprise software purchases and stagnant IT purchasing for our target market,
Fortune 1000 companies. We anticipate a stagnant IT purchasing environment to
continue in our target market in the near future. As a result, we are
experiencing price compression and a slowdown in overall demand for our products
and services.

License revenues decreased 36.0% to $3.8 million in 2002 from $5.9 million
in 2001. Although the number of contracts with new customers increased to 21 in
2002 from 14 in 2001, the average amount recognized per contract decreased to
$119,000 in 2002 from $357,000 in 2001 which was the primary reason for the
overall decrease in license revenues. The decrease in license revenues from
contracts with new customers was offset in part by an increase in license
revenues from contracts with existing customers. In 2002, there were 31
contracts with existing customers averaging $41,000 per contract which was an
increase from 2001 where there were 26 contracts averaging $25,000 per contract.

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Service revenues decreased 2.1% to $6.4 million in 2002 from $6.5 million
in 2001. A $0.1 million increase in the amount of software maintenance revenue
was offset by a $0.2 million decrease in the amount of professional service
revenues. Professional services revenues decreased as a result of a 9.6%
decrease in billable hours rendered.

COST OF REVENUES

Cost of revenues decreased to $4.6 million in 2002 from $11.4 million in
2001. Cost of revenues as a percentage of revenues decreased to 45.6% from
92.0%. Cost of license revenues decreased to $1.0 million in 2002 from $2.7
million in 2001. As a percentage of revenues, it decreased to 9.5% from 21.6%.
The decrease in the cost of license revenues was primarily attributable to a
decrease in product royalties payable to third parties, costs incurred only in
2001 for equipment for specific implementations, and a decrease in amortization
of purchased technology, which was fully amortized in July 2002.

Cost of service revenues decreased to $3.7 million in 2002 from $8.7
million in 2001. As a percentage of revenues, it decreased to 36.1% from 70.4%.
The decrease in the cost of service revenues was principally the result of a
42.4% decrease in customer support and services personnel to an average of 19 in
2002 from an average of 33 in 2001 primarily attributable to the 2001
restructurings. In addition, there was a decrease in the use of third parties to
perform services and a decrease in travel and recruiting expenses.

OPERATING EXPENSES

SALES AND MARKETING. Sales and marketing expenses decreased to $5.4 million, or
52.9% of revenues, in 2002 from $13.6 million, or 109.2% of revenues, in 2001.
The decrease is attributable to a reduction in sales and marketing staff of
53.4% to an average of 24 in 2002 from an average of 52 in 2001 primarily
attributable to the 2001 restructurings and a decrease in expenses for marketing
programs of 87.4% to $0.3 million in 2002 from $2.5 million in 2001.
Additionally, significant decreases in commission expense, travel and recruiting
costs contributed to the decrease in sales and marketing expenses.

RESEARCH AND DEVELOPMENT. Research and development expenses decreased to $2.9
million, or 28.5% of revenues, in 2002 from $6.3 million, or 51.1% of revenues,
in 2001. The decrease is principally the result of a 61.8% reduction in software
development staffing levels to an average of seven in 2002 from an average of 18
in 2001 primarily attributable to the 2001 restructurings.

GENERAL AND ADMINISTRATIVE. General and administrative expenses decreased to
$3.0 million, or 29.2% of revenues in 2002 from $3.6 million, or 29.2% of
revenues in 2001. The decrease was primarily attributable to a 50.0% reduction
in general and administrative staffing levels to an average of 11 in 2002 from
an average of 22 in 2001 and reductions of bad debt, third party contractor and
legal and accounting expenses.

INTANGIBLE ASSETS AMORTIZATION. Intangible assets amortization decreased to $0.3
million, or 3.4% of revenues in 2002 from $4.8 million, or 38.9% of revenues in
2001. 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 1999. The decrease
is primarily the result of the implementation of new accounting rules that
discontinue the amortization of goodwill and provide for write off of the
goodwill value should it become impaired.

RESTRUCTURING AND OTHER NON-RECURRING CHARGES. Restructuring and other
non-recurring charges decreased to $(0.4) million in 2002 from $4.5 million, or
36.6% of revenues, in 2001. In 2001, restructuring charges totaling $2.6 million
primarily represent excess facilities costs and severance benefits resulting
from reductions in force of approximately 180 employees in 2001. A portion of
these restructuring charges related to potential costs for terminating certain
real estate leases. However, we have been able to sublease a significant portion
of our unused space and have decided not to terminate the lease. Consequently,
we have reduced this accrual by $0.4 million in 2002 to reflect changes in
assumptions made for the initial charge. Additionally, a credit of $0.1 million
to restructuring expense was recorded in 2002 representing a change in the
estimate of termination costs for certain service contracts.

27

Other non-recurring charges in 2002 of $112,000 consist of adjustments to a
tax gross-up related to forgiveness of stockholder loans and a reserve for
accrued interest related to outstanding stockholder loans. 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 $0.3 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 convertible notes entered into in second quarter 2002 and bank
borrowings. Other income (expense), net decreased to $(1.2) million in 2002 from
$449,000 or 3.6% of revenues in 2001. The decrease was primarily the result of
increased interest expense incurred in conjunction with our convertible notes as
well as a decrease in interest earned on investments. The interest expense
primarily represents amortization of the beneficial conversion feature
recognized in conjunction with the issuance of the convertible notes, in
addition to the 10% interest, amortization of the discount, and debt issue costs
on the convertible notes.

YEARS ENDED DECEMBER 31, 2001 AND 2000

REVENUES

Total revenues decreased 30.3% to $12.4 million in 2001 from $17.8 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 decreased slightly with $6.5 million reported in 2001 compared to $6.6
million reported in 2000. 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 $11.4 million in 2001 from $10.2 million in
2000. Cost of revenues as a percentage of revenues increased to 92.0% from
57.5%. 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 21.6% from 7.9%.
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 decreased slightly to $8.7 million in 2001 from
$8.8 million in 2000. As a percentage of revenues, it increased to 70.4% from
49.6%. The decrease in the cost of service revenues was primarily attributable
to higher personnel costs in 2001 which was more than offset by a decrease in
the use of third parties to perform services and reimbursable expenses.

The increases in cost of revenues, cost of license revenues and cost of
service revenues, as a percentage of total revenues was related more to a
reduction in the amount of license revenues, which resulted in a reduction of
total revenues, than to an increase in cost.

OPERATING EXPENSES

SALES AND MARKETING. Sales and marketing expenses decreased to $13.6 million, or
109.2% of revenues, in 2001 from $16.6 million, or 93.2% 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 an