SERVICEWARE TECHNOLOGIES INC/ PA - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------

FORM 10-K

(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, 2003

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
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SERVICEWARE TECHNOLOGIES, INC.
(Exact Name of Registrant as Specified in Its Charter)

DELAWARE 25-1647861
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
ONE NORTH SHORE CENTRE, 12 FEDERAL STREET, SUITE 15212
503 (Zip Code)
PITTSBURGH, PA
(Address of Principal Executive Offices)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(412) 222-4450

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 30, 2003, the last business day of the registrant's most
recently completed second quarter, was $7,774,886, computed by reference to the
price at which the common equity was last sold on the Over the Counter Bulletin
Board on June 30, 2003, 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 18, 2004 was 52,252,474.

DOCUMENTS INCORPORATED BY REFERENCE

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. [ ]
EXHIBITS INDEX IS LOCATED ON PAGE 66

SERVICEWARE TECHNOLOGIES, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2003

TABLE OF CONTENTS

1

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
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
and certain customer and vendor contracts of InfoImage, Inc., a privately held
enterprise portal company that filed for bankruptcy protection prior to our
agreement to acquire these assets.

Our primary office is located at One North Shore Centre, 12 Federal Street,
Suite 503, Pittsburgh, Pennsylvania 15212, and our Web site 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. We make available free of charge (other than an
investor's own Internet access charges) through our website our Annual Report on
Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and
amendments to these reports, through a link to the EDGAR database, as soon as
reasonably practicable after we electronically file such material with, or
furnish such material to, the Securities and Exchange Commission.

As used in this report, the terms "we", "us", "our", "our company" and
"ServiceWare" means ServiceWare Technologies, Inc. and its subsidiaries.

OVERVIEW

We are a provider of knowledge-powered support solutions that enable
organizations to deliver superior service for customers, employees and partners
by transforming information into knowledge. Our solutions allow customers to
capture enterprise knowledge, solve customer problems, reuse solutions and share
captured knowledge throughout the extended enterprise. Customers use our
knowledge-powered support solutions to achieve some or all of the following
benefits:

- Strengthen relationships with customers, partners, suppliers and
employees

- Decrease operating costs

- Improve creation, dissemination and sharing of enterprise knowledge

- Provide easy access to knowledge online on an enterprise-wide basis

- Integrate seamlessly with existing technology investments

With ServiceWare Enterprise(TM), our core software product line, our
customers can provide personalized, automated Web-based service tailored to the
needs of their applicable users. ServiceWare Enterprise is based on our patented
self-learning search technology called the Cognitive Processor(R). This
technology enables organizations to capture and manage repositories of
intellectual capital, or corporate knowledge, in a manner that can be easily
accessed by way of a browser to effectively answer inquiries made either over
the Web or through the telephone to a customer contact center or help desk.
Through the self-learning features of the Cognitive Processor, our ServiceWare
Enterprise products provide our customers an intelligent solution in that the
solutions have the capability to learn from each interaction and automatically
update themselves accordingly.

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The ServiceWare Enterprise suite is comprised of the following software
products:

ServiceWare This product is a Web-based, self-service product designed
Self-Service(TM): for use by an organization's customers, partners and
employees.
ServiceWare Agent(TM): This product is designed for use by Level 1 agents or for
any company that needs to provide a complete agent
workstation knowledge management center.
ServiceWare This product is designed for use by customer service, sales
Professional(TM): and field service personnel.
ServiceWare Architect(TM): This product is designed for quality assurance managers and
system administrators.

In addition to ServiceWare Enterprise, we have created a solution for
mid-market companies called ServiceWare Express(TM). ServiceWare Express is a
comprehensive product and services package that includes browser-based
applications, technical implementation, training services and customer support.
ServiceWare Express is designed to enable midsize enterprises or call center and
help desk divisions of large enterprises to effectively utilize corporate
knowledge to improve customer satisfaction, enhance service quality and reduce
operating costs.

We target the sale of our products throughout the United States and Europe.
Our customers represent a cross-section of industry leaders in the financial
services, technology, manufacturing, health care, entertainment, education and
government sectors. Our customers include EDS, H&R Block, AT&T Wireless,
Cingular Wireless, Fifth Third Bancorp, Green Mountain Energy, Reuters,
Countrywide Home Loans, Wausau Financial Systems, Raytheon Company, PAR
Technology, 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. 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 KNOWLEDGE MANAGEMENT SOLUTION

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 to
improve productivity. Knowledge management provides companies with a process to
capture, organize and disseminate enterprise knowledge to key audiences.

We believe knowledge management continues to gain acceptance, particularly
due to the growth of electronic commerce. We believe companies understand now
more than ever the need to protect intellectual capital, capture the knowledge
of its workforce and sustain a competitive advantage by focusing on the
effectiveness of employees, customers and partners.

To enable businesses to provide superior service, we believe a
comprehensive knowledge management 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

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- 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

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

CALL CENTERS ARE EVOLVING INTO MULTI-CHANNEL CONTACT CENTERS

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

Traditionally, companies created call centers to handle only voice
interactions. Today, many call centers have evolved into multi-channel contact
centers that handle customer interactions by phone, e-mail, chat, Web, fax, and
instant messaging. 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 customer
service and support. The benefits of customer service and support include 24/7
availability, cost-savings, scalability, consistency, and improved customer
satisfaction and customer retention.

THE SERVICEWARE SOLUTION

ServiceWare provides knowledge-powered service and support 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 help 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
result from reduced telephone call volume, the ability to process more
end-user interactions per employee and reduced levels of employee
training.

- Strengthened Relationships with 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. 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
from each interaction. This enables the knowledge base to be up to date
and helps provide end-users with accurate answers to their questions.

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- Seamless Integration with Existing Solutions. Our products are designed
for rapid deployment, typically in eight to twelve weeks. ServiceWare
Enterprise 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 Hewlett Packard,
Clarify/Amdocs, Remedy, and Siebel Systems. As a result, this supports
our customers' deployment of applications configured to suit their
particular customer service and support needs.

- Consistent Service Across Communication Channels. Our solutions allow
access to knowledge from a wide variety of communication channels. Our
proprietary software enables end-users to transfer inquiries easily from
self-help to e-mail responses to live interaction. Escalation of end-user
inquiries helps ensure that our clients efficiently apply the appropriate
level of resources toward their customers' satisfaction while reducing
the risk of losing a customer because of perceived unresponsiveness.

- Scalability for Large and Growing Enterprises. The architecture of
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 use 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
position in the knowledge management and customer service and support
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 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. 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 taking advantage of these
organizations' industry expertise, business relationships and sales and
marketing resources. Currently, we have strategic alliances with
Stratacom, M-Tech, Electronic Data Systems Corporation, Clarify/Amdocs,
Remedy, Siebel, Hewlett-Packard, Control F-1, and EPAm Systems. In
addition, in 2003 we joined the Consortium for Service Innovation, a
national, non-profit alliance of customer service organizations that are
working together to address industry-wide challenges. In the future, 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 expand our
international presence through local distributors, including Merlin
Information Systems in the United Kingdom.

PRODUCTS

Our knowledge-powered service and support solutions enable organizations to
easily provide customers, partners, suppliers and employees with fast, accurate
answers to inquiries across various communication

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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 customer service
and support solution allows self-help users to access the knowledge base at any
time, using an easy-to-use, intuitive interface using a natural language query.
ServiceWare Self-Service can be customized to adopt the look and feel of our
customer's Web site.

ServiceWare Agent(TM) is designed for "Level 1" agents or for any company
that needs to provide a complete agent workstation knowledge management center.
The functionality of ServiceWare Agent is similar to ServiceWare's other
agent-facing application, ServiceWare Professional, but with a portal-based user
interface. Agent utilizes a side-by-side search capability, and contributions
are made on the same page as the search results to ensure ease of knowledge
entry. Agent also includes additional portal-like features, including common
links, urgent notices and agent-to-agent collaboration capabilities via e-mail,
instant messenger and expertise location.

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

ServiceWare Express is a comprehensive product and services package that
includes browser-based applications, technical implementation, training services
and customer support. ServiceWare Express is designed to enable midsize
enterprises or call center and help desk divisions of large enterprises to
effectively utilize corporate knowledge to improve customer satisfaction,
enhance service quality and reduce operating costs.

SERVICES

Professional Services. Our professional services team provides our
customers with pre- and post-sales services. Pre-sales consulting services
include our business impact analysis, 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 customer service and
support solutions effectively. In addition, our professional services team
offers education and training to enable our customers' internal teams 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 by 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

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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 the 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
or "SOAP" adapter. The SOAP adapter provides the mechanism by which ServiceWare
Enterprise is available as a Web service 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 our self-learning and self-organizing search
technology.

CUSTOMERS

We have traditionally marketed our products and services to Global 2000
call centers and help desks in a wide range of vertical industries. Cingular
Wireless accounted for 12% of our 2003 revenues. The following is a partial list
of our other new and follow-on customers during 2003.

Allegheny Energy Hughes Supply
Allina Health Systems InterSystems Corporation
Amgen Made2Manage Systems
AT&T Wireless Nestle Waters North America, Inc.
Aventis PAR Technology
C3I, Inc. Prudential Insurance Company of America
Cingular Wireless Qualcomm
Concord EFS Raytheon Company
Countrywide Home Loans Respironics
EATON/Cutler-Hammer Schlumberger Information Solutions Ltd.
EDS Scientific Atlanta
Fifth Third Bancorp Texas Instruments
Wachovia United Health Technologies
Fourth Shift, a SoftBrands Company US Cellular
Gelco Government Services U.S. Navy
H&R Block U.S. Patent & Trademark Office
Hewlett-Packard Wausau Financial Systems
HRC Alexandria

SALES AND MARKETING

We sell our solutions primarily through our direct sales force. We have
sales personnel throughout North America and a distributor 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
strategic alliance opportunities and channel distribution relationships.

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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 knowledge management 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 Hewlett Packard,
Clarify/Amdocs, Remedy, M-Tech, and Siebel Systems.

We have established service alliances with leading systems integrators,
including Electronic Data Systems Corporation (EDS) and Stratacom 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 our solutions, and we continue to work with our
service alliance partners as a team to seek 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.

In addition, in 2003 we joined the Consortium for Service Innovation, a
national, non-profit alliance of customer service organizations that are working
together to address industry-wide challenges.

We intend to continue to build and refine our strategies in selecting
leading alliance partners. We believe that building key relationships with
market leaders increases 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. In 2001, we 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 500
developers in what we believe to be 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. As of December 31, 2003 the
agreement remains in effect.

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.

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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, Inc.,
eGain Communications Corporation, Kanisa, Inc., and Primus Knowledge Solutions,
Inc.

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
quickly to customer needs.

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

INTELLECTUAL PROPERTY

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

We 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 who 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, 2003, we had 51 employees consisting of 17 in sales, 15
in professional services and support, five in research and development, five in
marketing, and nine 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, 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

9

such as "may", "will", "should", "expects", "plans", "anticipates", "believes",
"estimates", "predicts", "potential", "continue", or the negative of these terms
or other comparable terminology.

We often use these types of statements when discussing:

- our plans and strategies

- our anticipation of profitability or cash flow from operations

- the development of our business

- the expected market for our services and products

- other statements contained in this report regarding matters that are not
historical facts.

We caution you these forward-looking statements are only predictions and
estimates regarding future events and circumstances. Actual results could differ
materially from those anticipated as a result of factors described in "Risk
Factors" or as a result of other factors. We cannot assure you we will achieve
the future results reflected in these statements. We undertake no obligation to
publicly update or revise any forward-looking statements, whether as a result of
new information, future events or otherwise. In light of these risks and
uncertainties, the forward-looking events and circumstances discussed in this
report might not transpire.

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 HAVE A HISTORY OF LOSSES 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, 2003, we
had an accumulated deficit of $76.5 million. We have not achieved profitability
on a quarterly or annual basis to date and incurred a net loss of $3.0 million
in 2003. 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.

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 have
continued to experience negative cash flows from operations in 2003. We cannot
assure investors that we will attain break-even cash flows from operations at
any particular time in the future, or at all.

Our ability to continue as a business in our present form is largely
dependent on our ability to generate additional revenues, achieve profitability
and positive cash flows or to obtain additional debt or equity financing. 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 as needed. However, we cannot be certain that additional
financing will be available to us on favorable terms when required, or at all.

IF WE ARE NOT ABLE TO OBTAIN NEEDED 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. If we are required to 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

10

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 do
not have, and 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.

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

At December 31, 2003, we had borrowings outstanding under our line of
credit of $250,000 and convertible debt with a face value of approximately
$3,733,000. In January 2004, we repaid the borrowings outstanding under the line
and on January 30, 2004, the line of credit expired. On February 10, 2004, all
of our outstanding convertible debt was converted into equity in connection with
a private placement equity offering, which raised $7.5 million, net of expenses.

As such, as of February 10, 2004, we had no outstanding debt other than
trade debt incurred in the normal course of business. However, we may need to,
in the future raise additional money to satisfy our continuing operations
through bank financing or debt investments. Our ability to retire or to
refinance any such indebtedness will depend on our ability to generate cash
flows in the future. Our cash flows from operations may be insufficient to repay
this indebtedness at scheduled maturity and some or all of our indebtedness may
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 WE HAVE A SMALL SENIOR MANAGEMENT TEAM.

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 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.
Our senior management team consists of only two individuals. 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 life 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
located 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.

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

We manage our expense levels based on our expectations regarding future
revenues and our expenses 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 large orders from a limited number of
customers, so it is difficult to estimate accurately the timing of future
revenues. Our revenues are unpredictable and in our last eight quarters have
fluctuated up and down from a low of $2.1 million in first quarter 2003 to a
high of $3.6 million in fourth quarter 2003.

11

Our quarterly results are also impacted by our revenue recognition
policies. 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 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 CORE PRODUCT FAMILY. IF THE DEMAND FOR THIS LINE OF
PRODUCTS DECLINES, OUR BUSINESS WILL BE ADVERSELY AFFECTED.

ServiceWare's knowledge management solutions, ServiceWare Enterprise and
ServiceWare Express, include our ServiceWare Self-Service, ServiceWare Agent,
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
greater proportion 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, or at all, because of the lengthy sales cycle for
our products and services.

12

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. By doing business in international markets we face risks, such as
unexpected changes in tariffs and other trade barriers, fluctuations in currency
exchange rates, 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.

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

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

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

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

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 THIRD PARTIES 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

13

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 some 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.

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 some
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

14

- 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 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 independently. In addition,
employees, consultants and others who participate in the development of our
products may breach their agreements with us regarding our intellectual
property. 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 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 might not be
enforceable. The unauthorized use of our proprietary technologies could also
decrease the value of our products.

WE HAVE INITIATED A PATENT INFRINGEMENT LAWSUIT AGAINST ONE OF OUR COMPETITORS,
PRIMUS KNOWLEDGE SOLUTIONS, INC., AND WE MAY INITIATE ADDITIONAL LAWSUITS TO
PROTECT OR ENFORCE OUR PATENTS, WHICH MAY BE EXPENSIVE AND, IF WE LOSE, MAY
CAUSE US TO LOSE SOME, IF NOT ALL, OF OUR INTELLECTUAL PROPERTY RIGHTS, AND
THEREBY IMPAIR OUR ABILITY TO COMPETE IN THE MARKET.

On October 1, 2003, we filed suit against Primus Knowledge Solutions, Inc.
in the United States District Court for the Western District of Pennsylvania. It
is our position that Primus has infringed, contributed to the infringement of
and induced infringement of our patents. Primus has denied our allegations and
has asserted counterclaims against us. We also believe that other companies,
including direct and indirect competitors, may be infringing our patents. In
order to protect or enforce our patent rights, we may initiate additional patent
litigation suits against third parties, such as infringement suits or
interference proceedings. The suit against Primus and any other lawsuits that we
may file are likely to be expensive, take significant time and divert
management's attention from other business concerns. Litigation also places our
patents at risk of being invalidated or interpreted narrowly. We may also
provoke these third parties to assert claims against us. Patent law relating to
the scope of claims in the technology fields in which we operate is still
evolving and, consequently, patent positions in our industry are generally
uncertain. We may not prevail in any of these suits, the damages or other
remedies that may be, awarded to us may not be commercially valuable and we
could be held liable for damages as a result of counterclaims.

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

The effectiveness of our ServiceWare Enterprise product 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

15

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
our ServiceWare Enterprise product 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 often represent a significant expenditure
of information technology ("IT") capital for our customers. As a result of
general economic conditions and global economy and the uncertainties resulting
from recent acts of terrorism and the war in Iraq, 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 effect on our revenues, operating results, ability to generate
positive cash flow and stock price.

INCREASING GOVERNMENT REGULATION OF THE INTERNET COULD HARM OUR BUSINESS.

As 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
knowledge management services and, therefore, the market for our products and
services. Additionally, Internet security issues could deter customers from
using the Internet for certain transactions or from implementing customer
support websites.

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,

16

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 Internet liability, which could limit the
growth of Internet usage 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.

OUR COMMON STOCK HAS BEEN DELISTED FROM THE NASDAQ STOCK MARKET.

As of May 5, 2003, our common stock was delisted from The Nasdaq Stock
Market and began trading on the OTC Bulletin Board.

As a result of our trading on the OTC Bulletin Board, investors may find it
more difficult to dispose of or obtain accurate quotations as to the market
value of the securities. In addition, we are subject to a Rule promulgated by
the Securities and Exchange Commission that, if we fail to meet criteria set
forth in such Rule, various practice requirements are imposed 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 makes trading our shares more difficult for
investors, potentially leading to further declines in our share price. It may
also make it more difficult for us to raise additional capital. Further, we may
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 control more than 40% of our outstanding common stock and
voting power. 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
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, our results of operations and our stock price.

ITEM 2. PROPERTIES

We own no real property. We terminated the lease for our corporate
headquarters located in Oakmont, Pennsylvania as of December 31, 2003 pursuant
to a mutual written agreement entered into between us and

17

the owner of such facility. Our new corporate headquarters of approximately
10,400 square feet is located in Pittsburgh, Pennsylvania and leased pursuant to
a lease that expires in 2009. We believe that our current office is adequate to
support our existing operations. If necessary, however, we believe that we will
be able to obtain suitable additional facilities on commercially reasonable
terms when needed.

ITEM 3. LEGAL PROCEEDINGS

On October 1, 2003, we filed a lawsuit against Primus Knowledge Solutions,
Inc. ("Primus") in the United States District Court for the Western District of
Pennsylvania. It is our position that Primus has infringed, contributed to the
infringement of and induced infringement of our patents. We are seeking the
following damages: (1) a judgment that Primus has infringed our patents; (2)
preliminary and permanent injunctions enjoining and restraining Primus, its
officers, directors, agents, servants, employees, attorneys and all others in
active concert or participation with them from directly infringing or inducing
or contributing to the infringement of our patents; and (3) a judgment and order
requiring Primus to pay damages, together with interest, costs, and reasonable
attorneys' fees. In February 2004, Primus filed an answer to our complaint
denying our allegations that they infringed our patents. Along with its answer,
Primus filed a counterclaim against us claiming, among other things, that our
patents are invalid and unenforceable. In addition, Primus's counterclaim
asserts claims against us alleging that we, and/or certain of our employees,
performed acts constituting unfair competition, tortious interference, breach of
non-disclosure promises, misappropriation of trade secrets, disparagement,
defamation, a consumer protection act violation, and a Lanham Act violation. We
believe that the counterclaim is without merit, we deny any liability to Primus
and we intend to vigorously defend against their counterclaims. We are not able
to predict the outcome of this lawsuit.

On January 16, 2004, we entered into a release agreement with our prior
landlord, Sibro Enterprises, LP ("Sibro"), pursuant to which we settled all
outstanding disputes under the lawsuit Sibro had filed in the Court of Common
Pleas of Allegheny County, Pennsylvania. Pursuant to the release agreement, we
paid Sibro Enterprises an agreed upon amount representing rent due through
December 31, 2003, which was recorded in our 2003 consolidated financial
statements and issued Sibro Enterprises a warrant to purchase 125,000 shares of
common stock at a purchase price of $0.84 per share. In exchange, we mutually
agreed to terminate the lease as of December 31, 2003, dismiss the lawsuit with
prejudice, and release each other from any and all claims as of the date of the
release agreement.

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

None.

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PART II

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

MARKET FOR THE COMPANY'S COMMON STOCK

Our common stock was quoted on the Nasdaq National Market from August 25,
2000 until April 24, 2002 and on the Nasdaq SmallCap Market from April 25, 2002
until May 4, 2003. Since May 5, 2003, our common stock has been traded on the
over the counter bulletin board. On March 18, 2004, the last sale price of our
common stock was $0.70 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 18, 2004, there were approximately 400 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.

RECENT SALES OF UNREGISTERED SECURITIES

As of October 31, 2003, we issued convertible notes ("Additional Notes") in
an aggregate principal amount of $177,748 to the twelve holders of our
previously issued convertible notes in payment of accrued interest on the
outstanding notes. The Additional Notes contain the same terms and conditions as
the convertible notes with respect to which the Additional Notes were issued and
are convertible into common stock at a conversion price of $.25 per share. The
Additional Notes are exempt from registration under Section 4(2) of the
Securities Act of 1933. All of the convertible notes, including the Additional
Notes, have been converted into common stock as of February 10, 2004.

ITEM 6. SELECTED FINANCIAL DATA

The following financial information for the five years ended December 31,
2003 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.

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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 provider of knowledge-powered support solutions that enable
organizations to deliver superior service for customers, employees and partners
by transforming information into knowledge. Our solutions allow customers to
capture enterprise knowledge, solve customer problems, reuse solutions and share
captured knowledge throughout the extended enterprise. Customers use our
knowledge-powered support solutions to achieve some or all of the following
benefits:

- Strengthen relationships with customers, partners, suppliers and
employees

- Decrease operating costs

- Improve creation, dissemination and sharing of enterprise knowledge

- Provide easy access to knowledge online on an enterprise-wide basis

- Integrate seamlessly with existing technology investments

With ServiceWare Enterprise(TM), our core software product line, our
customers can provide personalized, automated Web-based service tailored to the
needs of their applicable users. ServiceWare Enterprise is based on our patented
self-learning search technology called the Cognitive Processor(R). This
technology enables organizations to capture and manage repositories of
intellectual capital, or corporate knowledge, in a manner that can be easily
accessed by way of a browser to effectively answer inquiries made either over
the Web or through the telephone to a customer contact center or help desk.
Through the self-learning features of the Cognitive Processor, our ServiceWare
Enterprise products provide our customers an intelligent solution in that the
solutions have the capability to learn from each interaction and automatically
update themselves accordingly.

20

The ServiceWare Enterprise suite is comprised of the following software
products:

ServiceWare This product is a Web-based, self-service product designed
Self-Service(TM): for use by an organization's customers, partners and
employees.
ServiceWare Agent(TM): This produce is designed for use by Level 1 agents or for
any company that needs to provide a complete agent
workstation knowledge management center.
ServiceWare This product is designed for use by customer service,
Professional(TM): sales and field service personnel.
ServiceWare Architect(TM): This product is designed for quality assurance managers
and system administrators.

In 2001, we incurred other special charges, which consisted 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 in the
amount of $1,750,000.

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

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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 accounting principles generally accepted in the
United States of America. 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 or 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

23

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 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. 104 "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 an allowance 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 to make payments, we may be required to increase our
allowance of doubtful accounts or to 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, transactions and our current market value. 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 2003, we performed the required
impairment tests of goodwill and indefinite lived intangible assets as of
January 1, 2003 and determined that we did not have an impairment loss.

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TRENDS/UNCERTAINTIES THAT MAY AFFECT OUR BUSINESS AND COMMON STOCK

Please refer to the Risk Factors discussed elsewhere in this report.

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, 2003 AND 2002

REVENUES

Total revenues increased 13.3% to $11.5 million in 2003 from $10.2 million
in 2002. The increase was primarily attributable to a 40% increase in revenue
recognized per new contract.

License revenues increased 30.5% to $4.9 million in 2003 from $3.8 million
in 2002. The average amount of revenue recognized per new contract increased to
$167,000 in 2003 from $119,000 in 2002, which was the primary reason for the
overall increase in license revenues.

Service revenues increased 3.1% to $6.6 million in 2003 from $6.4 million
in 2002. The primary reason for the increase was the increase in the average
contract price from 2002 to 2003. Although the number of

25

services contracts from existing customers remained the same from 2002 to 2003,
the average contract price increased from $33,000 to $51,000 in 2003.

COST OF REVENUES

Cost of revenues decreased to $3.2 million in 2003 from $4.6 million in
2002. Cost of revenues as a percentage of revenues decreased to 27.7% from
45.6%. Cost of license revenues decreased to $0.3 million in 2003 from $1.0
million in 2002. As a percentage of revenues, the cost of license revenues
decreased to 2.3% from 9.5%. The decrease in the cost of license revenues was
primarily attributable to a decrease in product royalties payable to third
parties, and a decrease in amortization of purchased technology.

Cost of service revenues decreased to $2.9 million in 2003 from $3.7
million in 2002. As a percentage of revenues, the cost of service revenues
decreased to 25.4% from 36.1%. The decrease in the cost of service revenues was
principally the result of an 18.9% decrease in customer support and services
personnel to an average of 16 in 2003 from an average of 19 in 2002. In
addition, allocated overhead expenses were significantly less as a result of an
overall reduction in overhead spending across the board.

OPERATING EXPENSES

Sales and Marketing. Sales and marketing expenses decreased to $5.1
million, or 44.4% of revenues, in 2003 from $5.4 million, or 52.9% of revenues,
in 2002. The decrease is primarily attributable to the closing of our United
Kingdom sales office in July 2003. In addition, allocated overhead expenses were
significantly less as a result of an overall reduction in overhead spending
across the board.

Research and Development. Research and development expenses decreased to
$2.0 million, or 17.0% of revenues, in 2003 from $2.9 million, or 28.5% of
revenues, in 2002. The decrease is primarily attributable to the reduced use of
a third party for development as a major product release was completed and
issued in February 2003. The development resources have been redeployed as
services contractors whose cost is now included in cost of services. In
addition, allocated overhead expenses were significantly less as a result of an
overall reduction in overhead spending across the board.

General and Administrative. General and administrative expenses decreased
to $2.1 million, or 18.4% of revenues in 2003 from $3.0 million, or 29.2% of
revenues in 2002. The decrease resulted primarily from a reduction of
depreciation expense due to a reduction in capital spending as well as a
reduction in legal expense as we hired an in-house counsel in third quarter
2003. In addition, allocated overhead expenses were significantly less as a
result of an overall reduction in overhead spending across the board.

Intangible Assets Amortization. Intangible assets amortization decreased
to $0.1 million, 1.3% of revenues in 2003 from $0.3 million, or 3.4% of revenues
in 2002. Intangible assets amortization consists of the amortization expense for
the intangible assets resulting from our acquisition of the Molloy Group in
1999. The decrease is primarily due to components of our intangible assets
becoming fully amortized.

Restructuring and other special charges. During 2003, There were no
restructuring or other special charges, but there was a reversal of a previous
accrual in the amount of $20,000. In 2001, we recognized a restructuring charge
primarily representing excess facilities costs and severance benefits resulting
from reductions in force of approximately 180 employees. A portion of these
restructuring charges related to potential costs for terminating certain real
estate leases. In 2002, we reduced this accrual by $0.4 million 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.

Other special charges in 2002 of $112,000 consisted 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 income (expense), net. Other income (expense), net consists
primarily of interest income received from short-term investments, interest
expense and amortization expense related to our convertible notes entered into
in second quarter 2002 and bank borrowings. Other expense, net increased to $2.0
million in

26

2003 from $1.2 million in 2002. The increase 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, 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 principal
target market, Fortune 1000 companies.

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.

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, cost of license revenues 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, cost of service revenues 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.

27

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 for intangible assets resulting from 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.

Restructuring and other special charges. During 2002, there were no
restructuring or other special charges, but there was a reversal of a previous
accrual. Restructuring and other special 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 restruc