** **

**FORM 10-Q**

** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

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**ý****   QUARTERLY REPORT PURSUANTTO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

** **

**For thequarterly period ended April 30, 2005**

** **

**OR**

 

**o****   ****TRANSITION REPORT PURSUANT TO SECTION 13OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

** **

**For thetransition period from             to              **

 

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**CommissionFile Number  0-21709**

** **

**INTELLISYNC CORPORATION**

(Exact name ofRegistrant as specified in its charter)

 
| **Delaware**                                                     | ** ** | **77-0349154**                           |
|------------------------------------------------------------------|------------|------------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) | ** ** | (I.R.S. Employer  Identification Number) |

** **

**2550North First Street, San Jose, California 95131**

(Address ofprincipal executive office and zip code)

 

**(408) 321-7650**

 (Registrant’s telephone number, including areacode)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934, during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.

Yes ýNo o

 

Indicateby check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).Yes ý No o

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of June 6,2005: 66,633,155

 

 

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**INTELLISYNCCORPORATION**

** **

**10-QREPORT**

** **

**INDEX**

** **
| **PART I - FINANCIAL INFORMATION** |     |
|-----------------------------------------|----------|
|                                    |     |   |   |
|                                    | Item 1.  | Unaudited Condensed Consolidated Financial  Statements | 1 |
|                                    |     |   |   |
|                                    |     | Condensed  Consolidated Balance Sheets as of April 30, 2005 and July 31, 2004 | 1 |
|                                    |     | Condensed  Consolidated Statements of Operations for the three and nine months ended  April 30, 2005 and 2004 | 2 |
|                                    |     | Condensed  Consolidated Statements of Cash Flows for the nine months ended  April 30, 2005 and 2004 | 3 |
|                                    |     |   |   |
|                                    |     | Notes  to Unaudited Condensed Consolidated Financial Statements | 4 |
|                                    |     |   |   |
|                                    | Item 2.  | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 24 |
|                                    |     |   |   |
|                                    | Item 3.  | Quantitative  and Qualitative Disclosures About Market Risk | 58 |
|                                    |     |   |   |
|                                    | Item 4.  | Controls and  Procedures | 59 |
|                                    |     |   |   |
| **PART II  - OTHER INFORMATION**   | 60       |
|                                    |     |   |   |
|                                    | Item 1.  | Legal Proceedings | 60 |
|                                    |     |   |   |
|                                    | Item 2.  | Changes in Securities and Use of  Proceeds | 60 |
|                                    |     |   |   |
|                                    | Item 3.  | Defaults Upon Senior Securities | 60 |
|                                    |     |   |   |
|                                    | Item 4.  | Submission of Matters to a Vote  of Security Holders | 60 |
|                                    |     |   |   |
|                                    | Item 5.  | Other Information | 60 |
|                                    |     |   |   |
|                                    | Item  6. | Exhibits | 60 |
|                                    |     |
| **SIGNATURE**                           | 61       |
|                                    |     |
| **EXHIBIT INDEX**                  | 62       |

 

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**INTELLISYNCCORPORATION**

 

**PART I****- FINANCIAL INFORMATION**

 

**Item 1.****    Unaudited Condensed Consolidated FinancialStatements**

 

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

(In thousands,except per share data)

(Unaudited)

 
| ** **                                                                                                                                                 | ** ** | **April 30,  2005** | ** ** | **July 31,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
|                                                                                                                                                       |       |                     |       |                    |       |
| **Assets**                                                                                                                                                 |       |                     |       |                    |       |
| Current assets:                                                                                                                                            |       |                     |       |                    |       |
| Cash and cash  equivalents                                                                                                                                 |       | $                        | 23,910     |                    | $          | 12,991 |   |
| Short-term  investments                                                                                                                                    |       | 23,235                   |       | 40,657                  |       |
| Accounts  receivable, net of allowance for doubtful accounts of $560 and $470                                                                              |       | 11,682                   |       | 10,380                  |       |
| Inventories                                                                                                                                                |       | 33                       |       | 69                      |       |
| Other current  assets                                                                                                                                      |       | 2,435                    |       | 2,485                   |       |
|                                                                                                                                                       |       |                     |       |                    |       |
| Total current  assets                                                                                                                                      |       | 61,295                   |       | 66,582                  |       |
|                                                                                                                                                       |       |                     |       |                    |       |
| Property and  equipment, net                                                                                                                               |       | 2,357                    |       | 1,540                   |       |
| Goodwill                                                                                                                                                   |       | 67,536                   |       | 65,288                  |       |
| Other intangible  assets, net                                                                                                                              |       | 25,876                   |       | 29,828                  |       |
| Restricted cash                                                                                                                                            |       | 3,979                    |       | 4,032                   |       |
| Other assets                                                                                                                                               |       | 2,810                    |       | 3,084                   |       |
| Total assets                                                                                                                                               |       | $                        | 163,853    |                    | $          | 170,354 |   |
|                                                                                                                                                       |       |                     |       |                    |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                             |       |                     |       |                    |       |
| Current  liabilities:                                                                                                                                      |       |                     |       |                    |       |
| Accounts payable                                                                                                                                           |       | $                        | 2,337      |                    | $          | 1,562 |   |
| Accrued  liabilities                                                                                                                                       |       | 6,675                    |       | 7,482                   |       |
| Current portion  of obligations under capital lease                                                                                                        |       | 149                      |       | 51                      |       |
| Deferred revenue                                                                                                                                           |       | 6,093                    |       | 5,794                   |       |
|                                                                                                                                                       |       |                     |       |                    |       |
| Total current liabilities                                                                                                                                  |       | 15,254                   |       | 14,889                  |       |
|                                                                                                                                                       |       |                     |       |                    |       |
| Obligations  under capital lease                                                                                                                           |       | 250                      |       | 144                     |       |
| Convertible  senior notes                                                                                                                                  |       | 57,884                   |       | 58,443                  |       |
| Other  liabilities                                                                                                                                         |       | 2,674                    |       | 2,487                   |       |
|                                                                                                                                                       |       |                     |       |                    |       |
| Total  liabilities                                                                                                                                         |       | 76,062                   |       | 75,963                  |       |
|                                                                                                                                                       |       |                     |       |                    |       |
| Commitments and  contingencies (Note 8)                                                                                                                    |       |                     |       |                    |       |
|                                                                                                                                                       |       |                     |       |                    |       |
| Stockholders’  equity:                                                                                                                                |       |                     |       |                    |       |
| Preferred stock,  $0.001 par value; 2,000 shares authorized; none issued and outstanding at  April 30, 2005 and July 31, 2004                    |       | —                   |       | —                  |       |
| Common stock,  $0.001 par value; 160,000 shares authorized; 66,630 and 65,592 shares issued  and outstanding at April 30, 2005 and July 31, 2004 |       | 67                       |       | 66                      |       |
| Additional  paid-in capital                                                                                                                                |       | 227,026                  |       | 225,832                 |       |
| Accumulated  deficit                                                                                                                                       |       | (139,957                 | )          | (131,116                | )          |
| Accumulated  other comprehensive income (loss)                                                                                                             |       | 655                      |       | (391                    | )          |
| Total  stockholders’ equity                                                                                                                           |       | 87,791                   |       | 94,391                  |       |
| Total  liabilities and stockholders’ equity                                                                                                           |       | $                        | 163,853    |                    | $          | 170,354 |   |

 

The accompanying notesare an integral part of these unaudited condensed consolidated financialstatements.

 

1

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**INTELLISYNCCORPORATION**

** **

**CONDENSED****CONSOLIDATED STATEMENTS OF OPERATIONS**

(In thousands,except per share data)

(Unaudited)

 
| ** **                                                                                                    | ** ** | **Three Months Ended  April 30,** | ** ** | **Nine Months Ended  April 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                    | ** ** | **2005**                               | ** ** | **2004**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                          |       |                                   |       |                                  |       |   |   |   |   |
| Revenue                                                                                                       |       |                                   |       |                                  |       |   |   |   |   |
| License                                                                                                       |       | $                                      | 9,643      |                                  | $          | 7,512 |   | $ | 28,662 |   | $ | 20,336 |   |
| Services                                                                                                      |       | 5,594                                  |       | 3,495                                 |       | 15,133 |   | 8,690 |   |
| Total revenue                                                                                                 |       | 15,237                                 |       | 11,007                                |       | 43,795 |   | 29,026 |   |
|                                                                                                          |       |                                   |       |                                  |       |   |   |   |   |
| Cost and  operating expenses:                                                                                 |       |                                   |       |                                  |       |   |   |   |   |
| Cost of revenue  (includes non-cash stock compensation of $2, $(94), $(19) and $8,  respectively)             |       | 2,537                                  |       | 2,237                                 |       | 7,397 |   | 5,667 |   |
| Amortization of developed and core technology                                                                 |       | 1,187                                  |       | 990                                   |       | 3,515 |   | 1,543 |   |
| Research and  development (includes non-cash stock compensation of $5, $(30), $1 and $37,  respectively)      |       | 3,810                                  |       | 3,495                                 |       | 10,819 |   | 8,098 |   |
| Sales and  marketing (includes non-cash stock compensation of $43, $(206), $4 and $11,  respectively)         |       | 8,209                                  |       | 4,612                                 |       | 20,055 |   | 11,463 |   |
| General and  administrative (includes non-cash stock compensation of $20, $(205), $5 and  $673, respectively) |       | 2,221                                  |       | 1,582                                 |       | 6,383 |   | 5,894 |   |
| Amortization of other intangibles                                                                             |       | 1,074                                  |       | 679                                   |       | 3,176 |   | 1,003 |   |
| In-process research and development                                                                           |       | —                                 |       | 775                                   |       | — |   | 3,667 |   |
| Other charges                                                                                                 |       | —                                 |       | 253                                   |       | — |   | 929 |   |
| Total cost and  operating expenses                                                                            |       | 19,038                                 |       | 14,623                                |       | 51,345 |   | 38,264 |   |
| Operating loss                                                                                                |       | (3,801                                 | )          | (3,616                                | )          | (7,550 | ) | (9,238 | ) |
| Other income  (expense):                                                                                      |       |                                   |       |                                  |       |   |   |   |   |
| Interest income                                                                                               |       | 304                                    |       | 171                                   |       | 813 |   | 410 |   |
| Interest expense                                                                                              |       | (389                                   | )          | (99                                   | )          | (907 | ) | (99 | ) |
| Other, net                                                                                                    |       | (158                                   | )          | (99                                   | )          | (625 | ) | (86 | ) |
| Litigation  settlement gain, net                                                                              |       | —                                 |       | 1,576                                 |       | — |   | 1,576 |   |
| Total other  income (expense)                                                                                 |       | (243                                   | )          | 1,549                                 |       | (719 | ) | 1,801 |   |
| Loss before  income taxes                                                                                     |       | (4,044                                 | )          | (2,067                                | )          | (8,269 | ) | (7,437 | ) |
| Provision for  income taxes                                                                                   |       | (317                                   | )          | (117                                  | )          | (572 | ) | (260 | ) |
| Net loss                                                                                                      |       | $                                      | (4,361     | )                                     | $          | (2,184 | ) | $ | (8,841 | ) | $ | (7,697 | ) |
|                                                                                                          |       |                                   |       |                                  |       |   |   |   |   |
| Basic and  diluted net loss per common share                                                                  |       | $                                      | (0.07      | )                                     | $          | (0.03 | ) | $ | (0.14 | ) | $ | (0.14 | ) |
|                                                                                                          |       |                                   |       |                                  |       |   |   |   |   |
| Shares used in  computing basic and diluted net loss per common share                                         |       | 66,523                                 |       | 63,859                                |       | 65,451 |   | 55,575 |   |

 

The accompanyingnotes are an integral part of these unaudited condensed consolidated financialstatements.

 

2

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**INTELLISYNCCORPORATION**

** **

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

(In thousands)

(Unaudited)

 
| ** **                                                                   | ** ** | **Nine Months Ended  April 30,** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| **Cash  flows from operating activities:**                                   |       |                                  |       |   |   |
| Net loss                                                                     |       | $                                     | (8,841     | ) | $ | (7,697 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                  |       |   |   |
| In-process  research and development                                         |       | —                                |       | 3,667 |   |
| Allowance for  doubtful accounts                                             |       | 90                                    |       | 193 |   |
| Depreciation                                                                 |       | 898                                   |       | 753 |   |
| Amortization                                                                 |       | 6,691                                 |       | 2,546 |   |
| Amortization of  debt issuance costs                                         |       | 495                                   |       | 92 |   |
| Non-cash stock  compensation (recovery)                                      |       | (9                                    | )          | 729 |   |
| Changes in  operating assets and liabilities, net of business acquisitions:  |       |                                  |       |   |   |
| Accounts  receivable                                                         |       | (1,081                                | )          | (1,628 | ) |
| Inventories                                                                  |       | 36                                    |       | (87 | ) |
| Other current  assets                                                        |       | 276                                   |       | (709 | ) |
| Other assets                                                                 |       | 75                                    |       | (294 | ) |
| Accounts payable                                                             |       | 775                                   |       | (1,940 | ) |
| Accrued  liabilities                                                         |       | (1,553                                | )          | (3,430 | ) |
| Deferred revenue                                                             |       | 299                                   |       | 49 |   |
| Net cash used in  operating activities                                       |       | (1,849                                | )          | (7,756 | ) |
|                                                                         |       |                                  |       |   |   |
| **Cash  flows from investing activities:**                                   |       |                                  |       |   |   |
| Purchase of  property and equipment                                          |       | (1,412                                | )          | (441 | ) |
| Purchase of  short term investments                                          |       | (5,902                                | )          | (30,565 | ) |
| Proceeds from  the sales of short-term investments                           |       | 17,347                                |       | 5,100 |   |
| Proceeds from  the maturities of short-term investments                      |       | 5,950                                 |       | 5,650 |   |
| Increase in  restricted cash                                                 |       | (61                                   | )          | (3,709 | ) |
| Acquisitions,  net of cash acquired                                          |       | (4,095                                | )          | (17,951 | ) |
| Net cash  provided by (used in) investing activities                         |       | 11,827                                |       | (41,916 | ) |
|                                                                         |       |                                  |       |   |   |
| **Cash  flows from financing activities:**                                   |       |                                  |       |   |   |
| Proceeds from  long-term debt                                                |       | —                                |       | 60,000 |   |
| Debt issuance  cost                                                          |       | (229                                  | )          | (2,878 | ) |
| Principal  payments on borrowings                                            |       | —                                |       | (1,764 | ) |
| Principal  payments on capital lease                                         |       | (92                                   | )          | (18 | ) |
| Note repayments  from stockholders                                           |       | —                                |       | 310 |   |
| Proceeds upon  exercise of stock options                                     |       | 585                                   |       | 1,549 |   |
| Proceeds from  ESPP shares issued                                            |       | 619                                   |       | 337 |   |
| Net cash  provided by financing activities                                   |       | 883                                   |       | 57,536 |   |
|                                                                         |       |                                  |       |   |   |
| Effect of exchange rate changes on cash and cash equivalents                 |       | 58                                    |       | 18 |   |
|                                                                         |       |                                  |       |   |   |
| Net increase in  cash and cash equivalents                                   |       | 10,919                                |       | 7,882 |   |
| Cash and cash  equivalents at beginning of period                            |       | 12,991                                |       | 7,842 |   |
| Cash and cash  equivalents at end of period                                  |       | $                                     | 23,910     |   | $ | 15,724 |   |

 

The accompanyingnotes are an integral part of these unaudited condensed consolidated financialstatements.

 

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**INTELLISYNCCORPORATION**

** **

**NOTES TOUNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

** **

**Note 1  The Company and a Summary of its SignificantAccounting Policies**

** **

*TheCompany*

 

IntellisyncCorporation, Intellisync or the “Company,” develops, markets and supportsdesktop, enterprise and mobile carrier-class push-email, synchronization and systemsmanagement software that enables consumers, business professionals andinformation technology professionals to extend the capabilities of enterprisegroupware and vertical applications, handheld organizers/computers, Web-enabledmobile phones, pagers and other wireless or wireline personal communicationsplatforms.  The Company’s IdentitySystems (formerly Search Software America) subsidiaries develop, market andsupport global solutions that enhance an organization’s ability to search,find, match (synchronize), screen and group identity data within their computersystems and network databases.

 

*Liquidity and Capital Resources*

* *

The Company has incurredlosses and negative cash flows since inception. The Company incurred a net loss of approximately $8,841,000 and negativecash flows from operations of approximately $1,849,000 for the nine monthsended April 30, 2005.  The Company’scash balances may decline further, although the Company believes that itsexisting cash resources, combined with revenue from continuing operations, willbe adequate to fund its operations, including potential acquisitions, for atleast the next 12 months.  Failure togenerate sufficient revenue or control spending could adversely affect theCompany’s ability to achieve its business objectives. 

 

*Basis ofPresentation and Consolidation*

* *

The accompanying condensedconsolidated financial statements of Intellisync as of April 30, 2005 andfor the three and nine months ended April 30, 2005 are unaudited andreflect all normal recurring adjustments which are, in the opinion ofmanagement, necessary for their fair statement. These condensed consolidated financial statements should be read inconjunction with the Company’s consolidated financial statements and notesthereto included in the Company’s Annual Report on Form 10-K for thefiscal year ended July 31, 2004. The condensed consolidated balance sheet as of July 31, 2004 hasbeen derived from the audited financial statements at that date but does notinclude all of the information and footnotes required by generally acceptedaccounting principles for complete financial statements.  The results of operations for the interimperiod ended April 30, 2005 are not necessarily indicative of results tobe expected for the full year. 

 

Theaccompanying condensed consolidated financial statements include the accountsof the Company and its wholly owned subsidiaries.  All significant inter-company balances andtransactions have been eliminated in consolidation.  

 

*Use ofEstimates and Assumptions*

 

The preparation of thecondensed consolidated financial statements in conformity with generallyaccepted accounting principles requires the Company to make estimates andassumptions that affect the reported amounts of assets and liabilities and disclosureof contingent assets and liabilities at the date of the condensed consolidatedfinancial statements and the reported amounts of revenue and expenses duringthe reporting period.  On an on-goingbasis, the Company evaluates its estimates, including those related toprovision for doubtful accounts, channel inventory and product returns,valuation of intangibles, investments and other long-lived assets,restructuring accruals, license and service revenue recognition, taxes andcontingencies.  The Company bases itsestimates on various factors and information which may include, but are notlimited to, history and prior experience, experience of other enterprises inthe same industry, new related events, current economic conditions andinformation from third party professionals that are believed to be reasonableunder the circumstances, the results of which form the basis for

 

4

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taking judgments about the carrying values of assets and liabilitiesthat are not readily apparent from other sources.  Actual results may differ from theseestimates under different assumptions or conditions. 

 

*RevenueRecognition*

 

Revenue is derived fromsoftware licenses and related services, which include implementation and integrationof software solutions, post contract support, training, hosting andconsulting.  

 

Transactions involvingthe sale of software products are accounted for under the American Institute ofCertified Public Accountants (AICPA) Statement of Position (SOP) No. 97-2,“*Software Revenue Recognition*,” asamended by SOP No. 98-9, “*Modification of 97-2,Software Revenue Recognition with Respect to Certain Transactions*.”  For contracts with multiple elements, and forwhich vendor-specific objective evidence of fair value for the undeliveredelements exists, revenue is recognized for the delivered elements based uponthe residual contract value as prescribed by SOP No. 98-9.  The Company has accumulated relevantinformation from contracts to use in determining the availability ofvendor-specific objective evidence and believes that such information complieswith the criteria established in SOP No. 97-2 as follows:

 

•                  Customersare required to pay separately for maintenance. Optional stated future renewal rates are included as a term of thecontracts. The Company uses the renewal rate as vendor-specific objectiveevidence of fair value for maintenance.  

 

•                  TheCompany charges standard hourly rates for consulting services, when suchservices are sold separately, based upon the nature of the services andexperience of the professionals performing the services.

 

•                  Fortraining, the Company charges standard rates for each course based upon theduration of the course, and such courses are separately priced in contracts. TheCompany has a history of selling such courses separately.

 

Revenue from license feesis recognized when persuasive evidence of an arrangement exists, delivery ofthe product has occurred, no significant Company obligations with regard toimplementation or integration exist, the fee is fixed or determinable andcollectibility is probable. Arrangements for which the fees are not deemedprobable for collection are recognized upon cash collection.  Payments from customers received in advanceof revenue recognition are recorded as deferred revenue.

 

Service revenue primarilycomprises revenue from consulting fees, maintenance contracts, training andhosting fees.  Service revenue fromconsulting, hosting and training is recognized as the service is performed.  Maintenance contracts include the right tounspecified upgrades and ongoing support. Maintenance revenue is deferred and recognized ratably as services areprovided over the maintenance period.

 

License and servicerevenue on contracts involving significant implementation, customization orservices, that are essential to the functionality of the software is recognizedover the period of each engagement, primarily using thepercentage-of-completion method. Labor hours incurred is generally used as themeasure of progress towards completion as prescribed by SOP No. 81-1,“*Accounting for Performance of Construction-Type andCertain Product-Type Contracts*.” Revenue for these arrangements isclassified as license revenue and service revenue based upon estimates of fairvalue for each element, and the revenue is recognized based on thepercentage-of-completion ratio for the arrangement. A provision for estimatedlosses on engagements is made in the period in which the loss becomes probableand can be reasonably estimated. The Company considers a project completed whenall contractual obligations have been met (generally the go live date).

 

The Company currentlylicenses its products directly to individuals, small businesses andcorporations, to original equipment manufacturers, or OEMs, and to distributorsand value-added resellers in North America, Europe, the Asia-Pacific region,South America and Africa. Revenue from products distributed indirectly throughmajor distributors and resellers is recognized on a sell through basis.Agreements with the Company’s major distributors and resellers contain specificproduct return privileges for stock rotation and obsolete products that aregenerally limited to contractual amounts. Reserves for estimated future returnsare provided for upon revenue recognition.

 

5

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Product returns are recorded as a reduction of revenue. Accordingly,the Company has established a product returns reserve composed of 100% ofproduct inventories held at the Company’s distribution partners, as well as anestimated amount for returns from customers of the distributors and otherresellers as a result of stock rotation and obsolete products. Such reservesare based on:

 

•                  historicalproduct returns and inventory levels on a product by product basis; 

•                  currentinventory levels and sell through data on a product by product basis asreported by the Company’s major distributors worldwide; 

•                  demandforecast by product in each of the principal geographic markets, which isimpacted by the Company’s product release schedule, seasonal trends andanalyses developed by the Company’s internal sales and marketing group; and 

•                  generaleconomic conditions.

 

The Company licensesrights to use its technology portfolio, whereby licensees, particularly OEMs,typically pay a non-refundable license fee in one or more installments andon-going royalties based on their sales of products incorporating the Company’stechnology.  Revenue from OEMs underminimum guaranteed royalty arrangements, which are not subject to futureobligations, is recognized when such royalties are earned and becomepayable.  Royalty revenue is recognizedas earned when reasonable estimates of such amounts can be made. Royaltyrevenue that is subject to future obligations is recognized when suchobligations are fulfilled.  Royaltyrevenue that exceeds minimum guarantees is recognized in the periodearned.  

 

*Stock-Based Compensation*

* *

The Company accounts fornon-cash stock-based employee compensation using the intrinsic method inaccordance with Accounting Principles Board (APB) Opinion No. 25, “*Accounting for Stock Issued to Employees and Related Interpretations*,”and complies with the disclosure provisions of Statement of FinancialAccounting Standards (SFAS) No. 123, “*Accounting for Stock-BasedCompensation*” and SFAS No. 148, “*Accountingfor Stock-Based Compensation, Transition and Disclosures*.”  Stock and other equity instruments issued tonon-employees is accounted for in accordance with SFAS No. 123 andEmerging Issues Task Force Issue (EITF) No. 96-18, “*Accounting for Equity Instruments Issued to Other than Employees forAcquiring, or in Conjunction with Selling Goods or Services*” andvalued using the Black-Scholes model. Expense associated with stock-based compensation is being amortized onan accelerated basis over the vesting period of the individual award consistentwith the method described in Financial Accounting Standards Board (FASB)Interpretation (FIN) No. 28.

 

If compensation cost forthe Company’s stock plans had been determined consistent with SFAS No. 123“*Accounting for Stock-Based Compensation*,”the Company’s net loss and loss per common share would have been adjusted tothe pro-forma amounts indicated below (in thousands, except per common sharedata):

 
| ** **                                                                                                  | ** ** | **Three Months Ended  April 30,** | ** ** | **Nine Months Ended  April 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                  | ** ** | **2005**                               | ** ** | **2004**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                        |       |                                   |       |                                  |       |   |   |   |   |
| Net loss as  reported                                                                                       |       | $                                      | (4,361     | )                                     | $          | (2,184 | ) | $ | (8,841 | ) | $ | (7,697 | ) |
| Add: Stock-based  employee compensation expense (recovery) included in reported net loss                    |       | 70                                     |       | (535                                  | )          | (9 | ) | 729 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value method  for all awards |       | 1,782                                  |       | 1,127                                 |       | 4,280 |   | 2,926 |   |
| Pro forma net  loss                                                                                         |       | $                                      | (6,073     | )                                     | $          | (3,846 | ) | $ | (13,130 | ) | $ | (9,894 | ) |
|                                                                                                        |       |                                   |       |                                  |       |   |   |   |   |
| Basic and  diluted net loss per common share as reported                                                    |       | $                                      | (0.07      | )                                     | $          | (0.03 | ) | $ | (0.14 | ) | $ | (0.14 | ) |
|                                                                                                        |       |                                   |       |                                  |       |   |   |   |   |
| Basic and  diluted pro forma net loss per common share                                                      |       | $                                      | (0.09      | )                                     | $          | (0.06 | ) | $ | (0.20 | ) | $ | (0.18 | ) |

 

6

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Because the Black-Scholesoption valuation model was developed for traded options and requires the inputof subjective assumptions and the number of future shares to be issued orcancelled is not known, the resulting pro forma compensation cost may not berepresentative of that to be expected in future years.

 

*Derivative Instruments*****

** **

The Company applies SFAS No. 133,“*Accounting for Derivative Instruments and HedgingActivities*,” as amended, which establishes accounting and reportingstandards for derivative instruments and for hedging activities. SFAS No. 133requires that an entity recognize derivatives as either assets or liabilitieson the balance sheet and measure those instruments at fair value. Theaccounting for changes in the fair value of a derivative depends on theintended use of the derivative and the resulting designation.  The Company designates its derivatives basedupon criteria established by SFAS No. 133. For a derivative designated as a fair value hedge, the gain or loss isrecognized in earnings in the period of change together with the offsettingloss or gain on the hedged item attributed to the risk being hedged.  For a derivative designated as a cash flowhedge, the effective portion of the derivative’s gain or loss is initiallyreported as a component of accumulated other comprehensive income andsubsequently reclassified into earnings when the hedged exposure affectsearnings. The ineffective portion of the gain or loss is reported in earningsimmediately.  Refer to Note 7 for detailson the Company’s only derivative instrument.

 

**Note 2  Recently Issued Accounting Pronouncements**

** **

*Other-Than-Temporary Impairment*

 

In March 2004, theEITF reached consensus on Issue 03-01, “*The Meaningof Other-Than-Temporary Impairment and Its Application to Certain Investments*.”EITF No. 03-01 includes new guidance for evaluating and recordingimpairment losses on debt and equity investments, as well as new disclosurerequirements for investments that are deemed to be temporarily impaired. The disclosurerequirements are effective for fiscal years ending after June 15, 2004.The Company has adopted the disclosure requirements in fiscal 2004 accordinglyand incorporated such disclosures in note 3 to consolidated financialstatements included in its Annual Report on Form 10-K for the fiscalyear ended July 31, 2004.  Theaccounting guidance of EITF No. 03-01 is applicable for reportingperiods after June 15, 2004. However, the effective date of such guidancehas been delayed until the FASB issues a Staff Interpretation on this matter.The delay does not have a specified date. Until an effective date isdetermined, existing guidance continues to apply in determining if animpairment is other than temporary.  TheCompany will evaluate the impact of EITF No. 03-01 once finalguidance is issued. 

 

*Contingently Convertible Debt onDiluted Earnings per Share*

 

In October 2004, the EITF reached a consensus onEITF No. 04-8 “*The Effect of ContingentlyConvertible Debt on Diluted Earnings per Share,*” that the dilutiveeffect of contingent convertible debt instruments (“CoCo’s”) must be includedin diluted earnings per share regardless of whether the triggering contingencyhas been satisfied, if dilutive. Adoption of EITF No. 04-08 would beon a retroactive basis and would require restatement of prior period dilutedearnings per share, subject to certain transition provisions.  It is effective for all periods ending after December 15,2004.  Due to the losses the Companyincurred for the three and nine months ended April 30, 2005, diluted netloss per share does not differ from basic net loss per share, since potentialshares of common stock issuable upon the conversion of the convertible debt areanti-dilutive for all periods presented. EITF No. 04-8 could have a future impact on the Company’sresults of operations in the event that the potential shares of common stockissuable upon conversion of the convertible debt were included in the dilutedearnings per share calculation. 

 

*Inventory Costs*

* *

In November 2004, theFASB issued SFAS No. 151, “*Inventory Costs - anamendment of ARB No. 43, Chapter 4,”* that requires that itemssuch as idle facility expense, excessive spoilage, double freight and handlingcosts be recognized as current period charges. In addition, it requires thatallocation of fixed production overheads to the costs of conversion be based onthe normal capacity of the production facilities.  SFAS No. 151 will be effective in

 

7

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fiscal years beginning after June 2005. The Company expects SFAS No. 151to have no material effect on its consolidated financial statements. 

 

*Discontinued Operations*

* *

In November 2004, the EITF reached a consensus onNo. 03-13, *“Applying theConditions in Paragraph 42 of FASB Statement No. 144 in DeterminingWhether to Report Discontinued*Operations.”  EITF No. 03-13 relates tocomponents of an enterprise that are either disposed of or classified as heldfor sale in fiscal periods beginning after December 15, 2004. EITF No. 03-13allows significant events or circumstances that occur after the balance sheetdate but before the issuance of financial statements to be taken intoconsideration in the evaluation of whether a component should be presented asdiscontinued or continuing operations, and modifies assessment period guidanceto allow for an assessment period greater than one year.  The consensus in EITF No. 03-13was effective for the Company beginning February 1, 2005. The impact tothe Company of adopting EITF Issue No. 03-13 will depend on thenature and extent of any long-lived assets disposed of or held for sale afterthe effective date, but the Company does not currently expect EITF No. 03-13to have a material impact on its consolidated results of operations, cash flowsor financial position. 

 

*Exchanges of Nonmonetary Assets*

* *

In December 2004,the FASB issued SFAS No. 153, *“Exchanges of NonmonetaryAssets, an amendment of APB Opinion No. 29, Accounting for NonmonetaryTransactions.*”  SFAS No. 153states that exchanges of nonmonetary assets should be measured based on thefair value of the assets exchanged. Further, SFAS No. 153 eliminates the narrow exception fornonmonetary exchanges of similar productive assets and replaces it with abroader exception for exchanges of nonmonetary assets that do not havecommercial substance. SFAS No. 153 is effective for nonmonetary assetexchanges occurring in fiscal periods beginning after June 15, 2005.Earlier application is permitted for nonmonetary asset exchanges occurring infiscal periods beginning after the date of issuance. The provisions of SFAS No. 153shall be applied prospectively. The Company does not believe the adoption ofSFAS No. 153 will have a significant impact on its consolidated results ofoperations or financial position. 

 

*Share-Based Payment*

* *

In December 2004,the FASB issued SFAS No. 123R, “*Share-BasedPayment, an amendment of FASB Statements No. 123 and 95*.”  The principal effect of SFAS No. 123Rwill be to require the inclusion in the Company’s earnings of a compensationexpense for stock option grants and employee stock plan purchases thatpreviously was only reported as a disclosure in a note to the Company’sconsolidated financial statements. The Company is required to adopt theprovisions of SFAS No. 123R as of August 1, 2005 but may elect toearly adopt the provision effective the first day of any quarter prior to thatdate. The Company is presently studying SFAS No. 123R and has not yetdetermined which method it will select for its adoption of SFAS No. 123R,which the Company expects to have a potential material impact on its annualearnings.  

 

On March 29, 2005,the SEC staff issued Staff AccountingBulletin (SAB) No. 107,*“Share-BasedPayment”*to express the views of the staff regarding theinteraction between SFAS No. 123R and certain SEC rules andregulations and to provide the staff’s views regarding the valuation ofshare-based payment arrangements for public companies.  The Company is currently in the process ofimplementing SFAS No. 123R, effective as of August 1, 2005, and willtake into consideration the additional guidance provided by SAB No. 107 inconnection with the implementation of SFAS No. 123R.

 

*Tax Deduction Provided For In theAmerican Jobs Creation Act of 2004*

* *

In December 2004,the FASB issued FASB Staff Position No. 109-1, “*Applicationof SFAS No. 109 to the Tax Deduction on Qualified Production ActivitiesProvided by the American Jobs Creation Act of 2004.*” This staffposition provides guidance for the accounting of a deduction provided to U. S.manufacturing companies and is effective immediately. The Company believes theadoption of this position will not currently have a material effect

 

8

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on its financial position or results of operations due to the Company’snet operating losses. However, there is no assurance that there will not be amaterial impact in the future. 

 

*ForeignEarnings Repatriation Provision within the American Jobs Creation Act of 2004*

* *

In December 2004,the FASB issued FASB Staff Position No. 109-2, *“Accounting and Disclosure Guidance for the ForeignEarnings Repatriation Provision within the American Jobs Creation Act of 2004”.*The American Jobs Creation Act introduces a special one-timedividends received deduction on the repatriation of certain foreign earnings toa U.S. taxpayer (repatriation provision), provided certain criteria are met.This position provides accounting and disclosure guidance for the repatriationprovision. The Company does not believe the Foreign Earnings RepatriationProvision within the American Jobs Creation Act of 2004 nor the FASB StaffPosition will have a material impact on its financial condition or results ofoperations.

*** ***

*Accountingfor Conditional Asset Retirement Obligations, an interpretation of FASBStatement No. 143*

 

In March 2005, the FASB issued FIN No. 47, *“Accounting for Conditional Asset Retirement Obligations, aninterpretation of FASB Statement No. 143*, *‘Accounting forAsset Retirement Obligations.’ ”* FIN No. 47 clarifies when an entity would be required to recognizea liability for the fair value of an asset retirement obligation that isconditional on a future event if the liability’s fair value can be reasonablyestimated. Uncertainty surrounding the timing and method of settlement that maybe conditional on events occurring in the future would be factored into themeasurement of the liability rather than the recognition of the liability.  FIN No. 47 is effective for fiscal yearsending after December 15, 2005.  TheCompany is currently assessing the impact that the interpretation may have on itsconsolidated financial position and results of operations. 

 

**Note 3  Balance Sheets Components**

** **

Inventoriesconsist of the following (in thousands):

 
| ** **                         | ** ** | **April 30,  2005** | ** ** | **July 31,  2004** | ** ** |
|------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| Raw materials                      |       | $                        | 28         |                    | $          | 54 |   |
| Finished goods and work-in-process |       | 5                        |       | 15                      |       |
| Inventories                        |       | $                        | 33         |                    | $          | 69 |   |

 

**Note 4  Acquisitions**

** **

The Company acquired TourmalineNetworks, Inc. in March 2005. In addition, the following acquisitions were closed in fiscal 2004: SoftVisionSRL’s workforce through a transfer agreement; SPL Worldgroup Software, Inc., SPL Worldgroup Ltd. and SearchSoftware America Pty. Ltd., or collectively SSA and now called IdentitySystems; Synchrologic, Inc.; and Spontaneous Technology, Inc.  The Tourmaline, Identity Systems,Synchrologic and Spontaneous Technology transactions were accounted for as abusiness combination under SFAS No. 141, “*BusinessCombinations*.” The SoftVision workforce transfer was accounted foras an asset purchase. 

 

*Tourmaline Networks, Inc.*

* *

On March 1, 2005, the Company completed itsacquisition of all of the issued and outstanding stock of Tourmaline Networks, Inc.,a privately held developer and marketer of mobile email based on QUALCOMM’sBREW® solution headquartered in San Diego, California.  Under the terms of an Agreement and Plan of Merger,dated as of February 9, 2005, the outstanding shares of Tourmaline commonstock were converted into the right to receive (i) an aggregate ofapproximately $4,118,000 in aggregate initial cash consideration and (ii) anaggregate of up to $2,881,918 in cash earnout consideration (based on futurerevenue generated by the Company from the former Tourmaline client base),subject to the deposit of a certain portion of the initial cash considerationand earnout

 

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consideration inescrow to be available to compensate Intellisync pursuant to theindemnification obligations of the holders of Tourmaline common stock.  The earnout consideration is due and payableshortly following the first anniversary of the acquisition.

 

The condensedconsolidated financial statements include the results of operations ofTourmaline since the date of acquisition. Under the purchase method ofaccounting, the total purchase price was allocated to Tourmaline’s net tangibleand intangible assets based upon their estimated fair value as of theacquisition date. The purchase price of $4,218,000 (including estimatedacquisition costs of $100,000) was assigned to the fair value of the assetsacquired, including the following (in thousands):

* *
| Tangible assets acquired        |   | $     | 342    |   |
|---------------------------------|--------|-------|--------|--------|
| Deferred tax  assets            |   | 795   |   |
| Liabilities assumed             |   | (275  | )      |
| Deferred tax  liability assumed |   | (795  | )      |
| Developed and core technology   |   | 712   |   |
| Customer base                   |   | 1,285 |   |
| Goodwill                        |   | 2,154 |   |
|                            |   | $     | 4,218  |   |

 

In accordance with SFAS No. 109,“*Accounting for Income Taxes*,” deferredtax liabilities of approximately $795,000 have been recorded for the tax effectof the amortizable intangible assets. Deferred tax assets of $795,000 have alsobeen recorded by the Company to account for the tax effect of the Company’s netoperating loss and credit carryforwards. 

 

Tangible assets acquired,which includes $23,000 of cash, and liabilities assumed were valued at their respectivecarrying amounts as the Company believes that these amounts approximated theircurrent fair values at the acquisition date. The valuation of identifiableintangible assets acquired was based on management’s estimates, currentlyavailable information and reasonable and supportable assumptions.  This allocation was generally based on thefair value of these assets determined using the income approach. 

 

An estimate of $2,154,000has been allocated to goodwill. Goodwill represents the excess of the purchaseprice over the fair value of the net tangible and intangible assets acquired.In accordance with SFAS No. 142, “*Goodwill and OtherIntangible Assets*,” goodwill will not be amortized but will betested for impairment at least annually. 

 

The purchase priceallocation for Tourmaline is subject to further revision as more detailedanalysis is completed and additional information on the fair values of Tourmaline’sassets and liabilities becomes available. Any change in the fair value of thenet assets of Tourmaline will change the amount of the purchase price allocableto goodwill. Final purchase accounting may therefore differ materially from theinformation presented above. 

 

Of the total purchaseprice, $1,997,000 was allocated to amortizable intangibles included in theabove list. The amortizable intangible assets are being amortized using anaccelerated method according to the expected cash flows to be received from theunderlying assets over their respective estimated useful life of three to sixyears. Refer to Note 5.

 

*SoftVision SRL*

 

On June 14,2004, the Company completed the transfer of 91 employees from SoftVision SRL,an offshore software development company with headquarters in Cluj-Napoca,Romania, pursuant to an Employee Transfer Agreement dated as of February 5,2004. Under the terms of the agreement, the Company paid cash of approximately$693,000 and assumed certain employee-related liabilities of approximately$31,000. The SoftVision workforce acquisition was accounted for as an asset purchase.The condensed consolidated financial statements include the effect ofadditional employees the Company acquired from SoftVision since the date ofacquisition.  

 

10

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The full amount ofthe preliminary purchase price of $724,000 was assigned to the fair value ofthe acquired workforce. The amortizable acquired workforce is being amortizedusing the straight-line method over its estimated useful life of two years.Refer to Note 5.

 

*Identity Systems (formerly SearchSoftware America)*

 

On March 16, 2004,the Company completed its acquisition of all of the issued and outstandingstock of SPL Worldgroup Software, Inc., SPL Worldgroup Ltd. and SearchSoftware America Pty. Ltd., or collectively SSA , privately held divisions ofSPL WorldGroup and headquartered in Sydney, Australia, pursuant to a StockPurchase Agreement dated as of February 24, 2004.  SSA, now called Identity Systems, withoperations in the United States, United Kingdom, and Australia, is a developerof solutions that enhance the ability to find, match and group (synchronize)identity data within computer systems and network databases. Under the terms ofthe stock purchase agreement, the Company paid cash of $22,129,000.

 

The condensedconsolidated financial statements include the results of operations of IdentitySystems since the date of acquisition. Under the purchase method of accounting,the total purchase price was allocated to Identity System’s net tangible andintangible assets based upon their estimated fair value as of the acquisitiondate. The purchase price of $22,179,000 (including acquisition costs of$50,000) was assigned to the fair value of the assets acquired, including thefollowing (in thousands):

* *
| Tangible assets acquired            |   | $      | 3,728  |   |
|-------------------------------------|--------|--------|--------|--------|
| Liabilities assumed                 |   | (3,987 | )      |
| Deferred tax  liability assumed     |   | (646   | )      |
| In-process research and development |   | 775    |   |
| Developed and core technology       |   | 5,513  |   |
| Customer base                       |   | 8,777  |   |
| Goodwill                            |   | 8,019  |   |
|                                |   | $      | 22,179 |   |

 

In accordance with SFAS No. 109,“*Accounting for Income Taxes*,” deferredtax liabilities of approximately $646,000 have been recorded for the tax effectof the amortizable intangible assets, which are not deductible for taxpurposes. 

 

The valuation ofidentifiable intangible assets acquired was based on management’s estimates,currently available information and reasonable and supportable assumptions.This allocation was generally based on the fair value of these assetsdetermined using the income approach.

 

Tangible assets acquired,which includes $2,146,000 of cash, and liabilities assumed were valued at theirrespective carrying amounts as the Company believes that these amountsapproximated their current fair values at the acquisition date. The valuationof identifiable intangible assets acquired was based on management’s estimates,currently available information and reasonable and supportableassumptions.  This allocation wasgenerally based on the fair value of these assets determined using the incomeapproach. 

 

$8,019,000 was allocatedto goodwill. Goodwill represents the excess of the purchase price over the fairvalue of the net tangible and intangible assets acquired. In accordance withSFAS No. 142, “*Goodwill and OtherIntangible Assets*,” goodwill will not be amortized but will be testedfor impairment at least annually. 

 

Of the total purchaseprice, $14,290,000 was allocated to amortizable intangibles included in theabove list. The amortizable intangible assets are being amortized using anaccelerated method according to the expected cash flows to be received from theunderlying assets over their respective estimated useful life of seven to tenyears. Refer to Note 5.

 

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As of the acquisitiondate, technological feasibility of the in-process technology had not beenestablished and the technology had no alternative future use. Accordingly, theCompany expensed the in-process research and development at the date of theacquisition. 

 

The amount of thepurchase price allocated to in-process research and technology was based onestablished valuation techniques used in the high-technology software industry.The fair value assigned to the acquired in-process research and development wasdetermined using the income approach, which discounts expected future cashflows to present value. The key assumptions used in the valuation include,among others, expected completion date of the in-process projects identified asof the acquisition date, estimated costs to complete the projects, revenue contributionsand expense projections assuming the resulting product has entered the market,and discount rate based on the risks associated with the development life cycleof the in-process technology acquired. The discount rate used in the presentvalue calculations are normally obtained from a weighted-average cost ofcapital analysis, adjusted upward to account for the inherent uncertaintiessurrounding the successful development of the in-process research anddevelopment, the expected profitability levels of such technology, and theuncertainty of technological advances that could potentially impact theestimates. The Company assumes the pricing model for the resulting product ofthe acquired in process research and technology to be standard within its industry.The Company, however, did not take into consideration any consequential amountof expense reductions from integrating the acquired in-process technology withother existing in-process or completed technology. Therefore, the valuationassumptions do not include significant anticipated cost savings.

 

The keyassumptions underlying the valuation of acquired in-process research anddevelopment from Identity Systems are as follows (in thousands): 

 

Project names: SSA-NAME3 Version 3.0 and IDS Version 3.0  

Percent completed as of acquisition date: 10% 

Estimated costs to complete technology at acquisition date:$600,000

Risk-adjusted discount rate: 25% 

First period expected revenue: June 2005

 

The development of theabove technology remains highly dependent on the remaining efforts to achievetechnical viability, rapidly changing customer markets, uncertain standards fora new product, and significant competitive threats from several companies.  The nature of the efforts to develop thistechnology into a commercially viable product consists primarily of planning,designing, experimenting, and testing activities necessary to determine thatthe technology can meet market expectations, including functionality andtechnical requirements. Failure to bring the product to market in a timelymanner could result in a loss of market share or a lost opportunity tocapitalize on emerging markets, and could have a material adverse impact on theCompany’s business and operating results. 

 

Subsequent to theacquisition of Identity Systems, there have been no significant developmentsrelated to the current status of the acquired in-process research anddevelopment project that would result in material changes to the assumptions.

 

*Synchrologic, Inc.*

* *

On December 29,2003, the Company completed its acquisition of all of the issued andoutstanding stock of Synchrologic, Inc. headquartered in Atlanta, Georgiapursuant to an Agreement and Plan of Merger, dated as of September 14,2003.  Synchrologic’s product lineprovides mobile access to enterprise applications, email and personalinformation management, or PIM, data, file content, intranet sites, and Webcontent, while giving IT groups the tools to manage mobile devices remotely. 

 

In the merger, alloutstanding shares of Synchrologic common stock and preferred stock wereconverted into the right to receive a total of 15,130,171 shares of the Company’scommon stock. In addition, all outstanding options to purchase Synchrologiccommon stock were converted into options to purchase a total of 1,018,952shares of the Company’s common stock. The total number of shares issued wasdetermined by dividing $60,000,000 by the

 

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average closing price of$5.22 of the shares of the Company’s common stock for the thirty consecutivetrading days ending on the last complete trading day immediately preceding theclosing date of the merger (which amount was subject to adjustment based on thetransaction expenses incurred by Synchrologic in connection with the merger),provided that the number of shares did not exceed 19,800,000 or be fewer than16,200,000 (in each case subject to adjustment based on the transactionexpenses incurred by Synchrologic in connection with the merger). The shareswere valued at approximately $62,125,000 using the five-trading-day averageprice surrounding the date the acquisition was announced of $4.11 per share,and the options were valued at approximately $4,123,000 using the Black-Scholesoption pricing model. The following assumptions were used to perform thecalculations of the fair market value of stock options issued: fair value ofCompany’s common stock of $4.05, expected life of 3.9 years, risk-free interestrate of 3.4%, expected volatility of 132% and no expected dividend yield. 

 

The condensed consolidatedfinancial statements include the results of operations of Synchrologic sincethe date of acquisition. Under the purchase method of accounting, the totalpurchase price was allocated to Synchrologic’s net tangible and intangibleassets based upon the fair value as of the acquisition date. The purchase priceof $67,037,000 (comprising the value of the shares and options described aboveand the estimated acquisition costs of $900,000 and net of a $111,000adjustment for writing-off a certain liability due to Synchrologic) wasassigned to the fair value of the assets acquired, including the following (inthousands): 

 
| Tangible assets acquired            |   | $      | 4,105  |   |
|-------------------------------------|--------|--------|--------|--------|
| Deferred tax  assets                |   | 6,094  |   |
| Liabilities assumed                 |   | (5,552 | )      |
| Deferred tax  liability assumed     |   | (6,094 | )      |
| In-process research and development |   | 2,423  |   |
| Developed and core technology       |   | 10,493 |   |
| Patents                             |   | 1,321  |   |
| Customer base                       |   | 3,487  |   |
| Goodwill                            |   | 50,760 |   |
|                                |   | $      | 67,037 |   |

 

In accordance with SFAS No. 109,“*Accounting for Income Taxes*,” deferredtax liabilities of approximately $6,094,000 have been recorded for the taxeffect of the amortizable intangible assets. Deferred tax assets of $6,094,000have also been recorded by the Company to account for the tax effect ofSynchrologic’s net operating loss and credit carryforwards. 

 

The valuation ofidentifiable intangible assets acquired was based on management’s estimates,currently available information and reasonable and supportable assumptions.This allocation was generally based on the fair value of these assetsdetermined using the income approach. 

 

Approximately$50,760,000, as adjusted, was allocated to goodwill. Goodwill represents theexcess of the purchase price over the fair value of the net tangible andintangible assets acquired. In accordance with SFAS No. 142, *“Goodwill and Other Intangible Assets,”* goodwill associatedwith Synchrologic acquisition will not be amortized but will be tested forimpairment at least annually. 

 

Of the total purchaseprice, $15,301,000 was allocated to amortizable intangibles included in theabove list. The amortizable intangible assets are being amortized using thestraight-line method over the estimated useful life of the respective assets offour years. Refer to Note 5. 

 

As of the acquisitiondate, technological feasibility of the in-process technology had not beenestablished and the technology had no alternative future use. Accordingly, theCompany expensed the in-process research and development at the date of theacquisition. 

 

The amount of thepurchase price allocated to in-process research and technology was based onestablished valuation techniques used in the high-technology software industry.The fair value assigned to the acquired

 

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in-process research and development was determined using the incomeapproach, which discounts expected future cash flows to present value. The keyassumptions used in the valuation include, among others, expected completiondate of the in-process projects identified as of the acquisition date,estimated costs to complete the projects, revenue contributions and expenseprojections assuming the resulting product has entered the market, and discountrate based on the risks associated with the development life cycle of thein-process technology acquired. The discount rate used in the present valuecalculations are normally obtained from a weighted-average cost of capitalanalysis, adjusted upward to account for the inherent uncertainties surroundingthe successful development of the in-process research and development, theexpected profitability levels of such technology, and the uncertainty oftechnological advances that could potentially impact the estimates. The Companyassumed the pricing model for the resulting product of the acquired in processresearch and technology to be standard within its industry. The Company,however, did not take into consideration any consequential amount of expensereductions from integrating the acquired in-process technology with otherexisting in-process or completed technology. Therefore, the valuationassumptions do not include significant anticipated cost savings.

 

The keyassumptions underlying the valuation of acquired in-process research anddevelopment from Synchrologic were as follows (in thousands): 

 

Project names: Version upgrade of Data Sync, FileSync, E-mail Accelerator and Systems Management products 

Percent completed as of acquisition date: 60%-70%

Estimated costs to complete technology at acquisition date:$3,000,000

Risk-adjusted discount rate: 22%

First period expected revenue: calendar year 2004

 

The development of theabove technology was highly dependent on the remaining efforts to achievetechnical viability, rapidly changing customer markets, uncertain standards fora new product, and significant competitive threats from several companies.  The nature of the efforts to develop thistechnology into a commercially viable product consisted primarily of planning,designing, experimenting, and testing activities necessary to determine thatthe technology could meet market expectations, including functionality andtechnical requirements. Failure to bring the product to market in a timelymanner could have resulted in a loss of market share or a lost opportunity tocapitalize on emerging markets, and could have a material adverse impact on theCompany’s business and operating results. 

 

Subsequent to theacquisition of Synchrologic, there have been no significant developmentsrelated to the current status of the acquired in-process research anddevelopment project that would result in material changes to the assumptions.

 

The liabilities assumedby the Company included Synchrologic’s outstanding balance of approximately$1,764,000 under a credit facility agreement with a bank.  The Company fully paid the outstandingbalance during fiscal 2004.  The bankcredit facility agreement was automatically terminated upon the Company’sacquisition of Synchrologic.

 

*Spontaneous Technology, Inc.*

* *

On September 17,2003, the Company consummated the acquisition of Spontaneous Technology, Inc.of Salt Lake City, Utah, a provider of enterprise secure Virtual PrivateNetwork, or sVPNTM, software designed to extend existing corporateapplications to most wireless devices. Under the terms of the agreement, theCompany issued a total of 869,259 shares of Intellisync’s common stock valuedat approximately $2,999,000 using the five-trading-day average pricesurrounding the date the acquisition was announced of $3.45 per share, lessregistration costs. The number of shares were calculated using the averageprice of the Company’s common stock for ten consecutive trading days endedthree business days prior the date of acquisition.  Later during fiscal 2004, Intellisync paidcash of approximately $752,000 for the satisfaction of another pre-acquisitionclause related to an acquired customer contract. There were also 224,417additional shares released from escrow during fiscal 2005 that were issued uponsatisfaction of a pre-acquisition clause. Additionally, Intellisync was required to pay Spontaneous Technology

 

14

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additional consideration of up to $7,000,000 in shares of Intellisync’scommon stock. The additional consideration was contingent upon the amount ofIntellisync’s revenue associated with sales of its products including certaintechnology of Spontaneous Technology during the period ended September 30,2004. The earnout period ended with Intellisync’s aggregate revenue on productsassociated with Spontaneous Technology amounting to less than the given earnoutthreshold. Consequently, no additional consideration was paid to SpontaneousTechnology.

 

The condensedconsolidated financial statements include the results of operations ofSpontaneous Technology since the date of acquisition. Under the purchase methodof accounting, the total purchase price was allocated to Spontaneous Technology’snet tangible and intangible assets based upon their fair value as of theacquisition date. The purchase price of $4,071,000 (including acquisition costsof $320,000 and the payment made for the resolution of the contingency of$752,000) was assigned to the fair value of the assets acquired, including thefollowing (in thousands):

 
| Tangible assets acquired            |   | $      | 18     |   |
|-------------------------------------|--------|--------|--------|--------|
| Liabilities assumed                 |   | (1,726 | )      |
| In-process research and development |   | 469    |   |
| Developed and core technology       |   | 889    |   |
| Patents                             |   | 168    |   |
| Customer base                       |   | 499    |   |
| Goodwill                            |   | 3,754  |   |
|                                |   | $      | 4,071  |   |

 

Tangible assets acquired andliabilities assumed were valued at their respective carrying amounts as theCompany believes that these amounts approximated their current fair values atthe acquisition date. The valuation of identifiable intangible assets acquiredwas based on management’s estimates, currently available information andreasonable and supportable assumptions. This allocation was generally based on the fair value of these assetsdetermined using the income approach. 

 

Approximately $3,754,000, asadjusted, was allocated to goodwill. Goodwill represents the excess of thepurchase price over the fair value of the net tangible and intangible assetsacquired. In accordance with SFAS No. 142, *“Goodwilland Other Intangible Assets,”* goodwill will not be amortized butwill be tested for impairment at least annually.  

 

Of the totalpurchase price, $1,556,000 was allocated to amortizable intangibles included inthe above list.  The amortizableintangible assets are being amortized using the straight-line method over theestimated useful life of the respective assets of four years.  Refer to Note 5. 

 

As of the acquisition date,technological feasibility of the in-process technology had not been establishedand the technology had no alternative future use. Accordingly, the Companyexpensed the in-process research and development at the date of theacquisition. 

 

The amount of the purchaseprice allocated to in-process research and technology was based on establishedvaluation techniques used in the high-technology software industry. The fairvalue assigned to the acquired in-process research and development wasdetermined using the income approach, which discounts expected future cashflows to present value. The key assumptions used in the valuation include,among others, expected completion date of the in-process projects identified asof the acquisition date, estimated costs to complete the projects, revenuecontributions and expense projections assuming the resulting product hasentered the market, and discount rate based on the risks associated with thedevelopment life cycle of the in-process technology acquired. The discount rateused in the present value calculations are normally obtained from aweighted-average cost of capital analysis, adjusted upward to account for theinherent uncertainties surrounding the successful development of the in-processresearch and development, the expected profitability levels of such technology,and the uncertainty of technological advances that could potentially impact theestimates. The Company assumed the pricing model for the resulting product ofthe acquired in process research and technology to be standard within itsindustry. The Company, however, did not take into consideration anyconsequential amount of expense reductions from integrating the acquiredin-process

 

15

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technology with other existing in-process or completedtechnology. Therefore, the valuation assumptions do not include significantanticipated cost savings. 

 

The key assumptionsunderlying the valuation of acquired in-process research and development fromSpontaneous Technology were as follows (in thousands): 

 

Project names: Version upgrade of Spontaneous Technology’ssecure Virtual Private Network (sVPN) 

Percent completed as of acquisition date: 60% 

Estimated costs to complete technology at acquisition date:$125,000 

Risk-adjusted discount rate: 22% 

First period expected revenue: calendar year 2004 

 

The development of theabove technology was highly dependent on the remaining efforts to achievetechnical viability, rapidly changing customer markets, uncertain standards fora new product, and significant competitive threats from several companies.  The nature of the efforts to develop thistechnology into a commercially viable product consisted primarily of planning,designing, experimenting, and testing activities necessary to determine thatthe technology could meet market expectations, including functionality andtechnical requirements. Failure to bring the product to market in a timelymanner could have resulted in a loss of market share or a lost opportunity tocapitalize on emerging markets, and could have had a material adverse impact onthe Company’s business and operating results. 

 

Subsequent to theacquisition of Spontaneous Technology, there have been no significantdevelopments related to the current status of the acquired in-process researchand development project that would result in material changes to theassumptions.

 

# ***Unaudited Pro Forma ConsolidatedCombined Results***

# *** ***

The following unauditedpro-forma consolidated financial information reflects the results of operationsfor the three and nine months ended April 30, 2005 and 2004, as if Tourmaline,Identity Systems, Synchrologic and Spontaneous Technology acquisitions hadoccurred on the beginning of each period presented and after giving effect topurchase accounting adjustments. The effect of SoftVision’s transfer ofworkforce has been excluded from the pro forma financial information as amountsare considered immaterial to the Company. 

 

These pro forma resultshave been prepared for comparative purposes only and do not purport to beindicative of what operating results would have been had the acquisitions inaggregate actually taken place on the beginning of each period presented. Inaddition, these results are not intended to be a projection of future resultsand do not reflect any synergies that might be achieved from the combinedoperation (in thousands, except per share data): 

 
| ** **                                             | ** ** | **Three Months Ended  April 30,** | ** ** | **Nine Months Ended  April 30,** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                                             | ** ** | **2005**                               | ** ** | **2004**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                   |       |                                   |       |                                  |       |   |   |   |   |
| Pro forma  revenue                                     |       | $                                      | 15,386     |                                  | $          | 12,339 |   | $ | 44,544 |   | $ | 40,940 |   |
|                                                   |       |                                   |       |                                  |       |   |   |   |   |
| Pro forma net  loss                                    |       | $                                      | (4,407     | )                                     | $          | (1,949 | ) | $ | (5,377 | ) | $ | (11,811 | ) |
|                                                   |       |                                   |       |                                  |       |   |   |   |   |
| Pro forma basic  and diluted net loss per common share |       | $                                      | (0.07      | )                                     | $          | (0.03 | ) | $ | (0.08 | ) | $ | (0.18 | ) |

 

The effect of thein-process research and development charges has been excluded in the aboveunaudited pro forma consolidated financial information as they representnon-recurring charges directly related to the acquisitions.

 

16

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**Note 5  Goodwill, Developed and Core Technology andOther Intangible Assets**

 

The following table sets forth the changes in goodwillduring the first two quarters of fiscal 2005 (in thousands):

 
| ** **                                                      | ** ** | **Goodwill** | ** ** |
|-----------------------------------------------------------------|------------|--------------|------------|
| **Balance  at July 31, 2004**                              |       | $            | 65,288     |   |
| Acquired from  Tourmaline                                       |       | 1,911        |       |
| Foreign exchange  effects on non-US dollar-denominated goodwill |       | 94           |       |
| **Balance  at April 30, 2005**                             |       | $            | 67,293     |   |

 

Other intangible assets,net, consist of the following (in thousands, except weighted average usefullife): 

 
| ** **                    | ** ** | **Weighted  Average  Useful Life** | ** ** | **April 30, 2005**       | ** ** | **July 31, 2004** | ** ** |
|-------------------------------|------------|------------------------------------|------------|-------------------------------|------------|------------------------|------------|
| ** **                    | ** ** | **Gross**                          | ** ** | **Accumulated  Amortization** | ** ** | **Net**                | ** ** | **Gross** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
| Developed and core technology |       | 4.3 years                          |       | $                             | 22,536     |                   | $          | (8,964 | ) | $ | 13,572 |   | $ | 21,237 |   | $ | (5,370 | ) | $ | 15,867 |   |
| Patents                       |       | 4.0 years                          |       | 1,680                         |       | (610                   | )          | 1,070 |   | 1,680 |   | (298 | ) | 1,382 |   |
| Trademarks                    |       | 2.5 years                          |       | 250                           |       | (160                   | )          | 90 |   | 250 |   | (75 | ) | 175 |   |
| Customer base                 |       | 5.1 years                          |       | 14,676                        |       | (3,822                 | )          | 10,854 |   | 13,129 |   | (1,472 | ) | 11,657 |   |
| Covenant not-to-compete       |       | 2.0 years                          |       | 105                           |       | (93                    | )          | 12 |   | 105 |   | (54 | ) | 51 |   |
| Existing contracts            |       | 16.5 months                        |       | 313                           |       | (306                   | )          | 7 |   | 313 |   | (296 | ) | 17 |   |
| Acquired workforce            |       | 16 months                          |       | 724                           |       | (453                   | )          | 271 |   | 724 |   | (45 | ) | 679 |   |
|                          |       |                               |       | $                             | 40,284     |                   | $          | (14,408 | ) | $ | 25,876 |   | $ | 37,438 |   | $ | (7,610 | ) | $ | 29,828 |   |

 

Other intangible assetsas of April 30, 2005 include a total of approximately $1,997,000amortizable identifiable intangibles obtained from the Company’s acquisition ofTourmaline during the third quarter of fiscal 2005.  The foreign exchange effects on non-USdollar-denominated intangibles and associated accumulated depreciation were$849,000 and $107,000, respectively, for the first three quarters of fiscal2005.

 

The amortization ofdeveloped technology amounted to $1,187,000 and $3,515,000 for the three andnine months ended April 30, 2005, respectively, and $990,000 and $1,543,000for the corresponding periods in fiscal 2004. The amortization of other intangible assets amounted to $1,074,000 and$3,176,000 for the three and nine months ended April 30, 2005,respectively, and $679,000 and $1,003,000 for the corresponding periods infiscal 2004.  

 

Based on acquisitionscompleted as of April 30, 2005, the estimated future amortization expenseof other intangible assets is as follows (in thousands): 

 
| ** **                             | ** ** | **Developed  and Core  Technology** | ** ** | **Other  Intangibles** | ** ** |
|----------------------------------------|------------|-------------------------------------|------------|------------------------|------------|
| Three months ending July 31, 2005 |       | $                                   | 1,183      |                   | $          | 1,056 |   |
| Fiscal year ending July 31,       |       |                                |       |                   |       |
| 2006                                   |       | 4,624                               |       | 3,614                  |       |
| 2007                                   |       | 4,381                               |       | 3,076                  |       |
| 2008                                   |       | 2,046                               |       | 1,793                  |       |
| 2009                                   |       | 685                                 |       | 955                    |       |
| 2010                                   |       | 456                                 |       | 679                    |       |
| Thereafter                             |       | 197                                 |       | 1,131                  |       |
|                                   |       | $                                   | 13,572     |                   | $          | 12,304 |   |

 

17

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**Note 6  Restructuring Accrual**

** **

The Company implemented anumber of cost-reduction plans aimed at reducing costs that were not integralto its overall strategy, better aligning its expense levels with currentrevenue levels and ensuring conservative spending during periods of economicuncertainty.  These initiatives includeda reduction in workforce and facilities consolidation.  

 

The followingtable sets forth the activities in the restructuring accrual account during thefirst three quarters of fiscal 2005 (in thousands):

 
| ** **                            | ** ** | **Consolidation  of Excess  Facilities** | ** ** |
|---------------------------------------|------------|------------------------------------------|------------|
| **Balance  at July 31, 2004**    |       | $                                        | 1,080      |   |
| Cash payments                         |       | (330                                     | )          |
| **Balance  at October 31, 2004** |       | $                                        | 750        |   |
| Cash payments                         |       | (218                                     | )          |
| **Balance  at January 31, 2005** |       | $                                        | 532        |   |
| Cash payments                         |       | (225                                     | )          |
| **Balance  at April 30, 2005**   |       | $                                        | 307        |   |

 

The remaining unpaidamount as of April 30, 2005 of $307,000 related to the net lease expensedue to the consolidation of excess facilities, will be paid over the respectivelease terms through June 2006 using cash from operations.  

 

The current and long-termportions of the restructuring accrual of $267,000 and $40,000 are classified as“Accrued Liabilities” and “Other Liabilities,” respectively, in the condensedconsolidated balance sheet as of April 30, 2005.

 

The Company continuallyevaluates the balance of the restructuring reserve it records in prior periodsbased on the remaining estimated amounts to be paid.  Differences, if any, between the estimatedamounts accrued and the actual amounts paid will be reflected in operatingexpenses in future periods.

 

# **Note 7 Long-Term Debt**

# ** **

The following table setsforth the Company’s long-term obligations, excluding capital lease obligations(in thousands):

 
| ** **                                                                                          | ** ** | **April 30,  2005** | ** ** | **July 31,  2004** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| 3% convertible  senior notes, interest due semi-annually, principal due in March 2009          |       | $                        | 57,884     |                    | $          | 58,443 |   |
| Interest rate  swap fair value hedge adjustment on $60 million of 3% convertible senior  notes |       | 2,116                    |       | 1,557                   |       |
|                                                                                                |       | 60,000                   |       | 60,000                  |       |
| Less: current portion                                                                               |       | —                   |       | —                  |       |
| Long-term portion                                                                                   |       | $                        | 60,000     |                    | $          | 60,000 |   |

 

# ***3% Convertible Senior Notes***

# *** ***

During the third quarter of fiscal 2004, the Companycompleted the offering of $60,000,000 of convertible senior notes to qualifiedinstitutional buyers in reliance on Rule 144A under the Securities Act.The notes are senior

 

18

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unsecured obligations of Intellisync and rank juniorto any future secured debt, on a parity with all of the Company’s otherexisting and future senior unsecured debt and prior to any existing or futuresubordinated debt. As of April 30, 2005, the Company had no other senioror subordinated debt, except for ordinary course trade payables. The Companymay not redeem any of the notes prior to their maturity. Holders, however, mayrequire the Company to repurchase the notes upon some types of change in controltransactions. The notes will mature on March 1, 2009 unless earlierconverted or redeemed. Neither the Company nor any of its subsidiaries aresubject to any financial covenants under the indenture. In addition, neitherthe Company nor any of its subsidiaries are restricted under the indenture frompaying dividends, incurring debt, or issuing or repurchasing its securities.

 

The notes are convertibleinto shares of common stock of the Company at any time prior to the close ofbusiness on the final maturity date of the notes, subject to prior redemptionof the notes. The initial conversion rate is 250.0000 shares per each $1,000principal amount of notes which represents an initial conversion price of $4.00per share. The conversion rate is subject to adjustment for certain events,including the payment of dividends, and other events specified in theindenture.

 

The notes bear interestat a rate of 3% per annum. Interest on the notes will be paid on March 1and on September 1 of each year.

 

*Interest RateSwap*

* *

During fiscal 2004, theCompany entered into two interest rate swap agreements with a financialinstitution on a total notional amount of $60,000,000, whereby the Companyreceives fixed-rate interest of 3% in exchange for variable interest payments.  The interest rate swaps expire upon thematurity of the Company’s $60,000,000, 3% convertible senior notes in March 2009,and effectively convert fixed-rate notes into variable-rate borrowings. Theinterest rate is reset semi-annually and is equal to the 6-month LIBOR rateless a rate spread. The total variable interest rate, approximately 2.9% at April 30,2005, resulted in interest expense savings relative to fixed rates ofapproximately $486,000 for the first three quarters of fiscal 2005. Under theprovisions of SFAS No. 133, “*Accounting for DerivativeInstruments and Hedging Activities*,” as amended, this arrangementhas been designated and qualifies as an effective fair value hedge of interestrate risk related to the $60,000,000 convertible senior notes. As the terms ofthe swaps match those of the underlying hedged debt, the changes in the fairvalue of these swaps are offset by corresponding changes in the carrying valueof the hedged debt, and therefore do not impact the Company’s net earnings. Asof April 30, 2005, the fair value of the interest rate swaps wasapproximately $2,116,000 and recorded in “Other Liabilities” with an equaladjustment recorded to the carrying value of the $60,000,000 convertible seniornotes.

 

Refer to Note 8 for thedescription of the collateral required on the interest rate swap.

 

**Note 8  Commitments and Contingencies**

** **

*Leases*

* *

During the first quarter of fiscal 2005, the Companyentered into a capital lease agreement for computer peripherals, which expiresin September 2007.  In addition,during fiscal 2004, the Company entered into a capital lease agreement for aphone system, which expires in February 2008. Assets and futureobligations related to the capital leases are included in the accompanyingcondensed consolidated balance sheet as of April 30, 2005 in property andequipment and in the respective liability accounts, respectively. Current andlong-term portions of the capital leases amounted to $149,000 and $250,000,respectively, at April 30, 2005. Depreciation of assets held under thecapital leases is included in depreciation and amortization expense.

 

The Company leases its facilities under operatingleases that expire at various dates through December 2008. The totalamount of rental payments due over the lease term is being charged to rent onthe straight-line method over the term of the lease. The difference betweenrent expense recorded and the amount paid is credited or charged to “deferredrent” which is included in current liabilities in the accompanying balancesheets. Deferred rent was approximately $301,000 at April 30, 2005. Totalrent expense was approximately $645,000 and $1,851,000 for the

 

19

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three and nine months ended April 30, 2005,respectively, and approximately $499,000 and $1,152,000 for the correspondingperiods in fiscal 2004.

 

Future minimum lease payments for all non-cancelablecapital and operating lease agreements at April 30, 2005, were as follows(in thousands):

 
| ** **                    | ** ** | **Total**  | ** ** | **Three months  ending  July 31, 2005** | ** ** | **Fiscal year ending July 31,** | ** ** |
|-------------------------------|------------|------------|------------|----------------------------------------------|------------|--------------------------------------|------------|
| ** **                    | ** ** | ** ** | ** ** | **2006**                                     | ** ** | **2007**                             | ** ** | **2008** | ** ** | **2009** | ** ** |
| Capital lease obligation(1)   |       | $          | 438        |                                         | $          | 44                                   |       | $ | 177 |   | $ | 177 |   | $ | 40 |   | $ | — |   |
| Operating  leases:            |       |       |       |                                         |       |                                 |       |   |   |   |   |   |   |
| Operating leases              |       | 5,225      |       | 924                                          |       | 2,786                                |       | 766 |   | 544 |   | 205 |   |
| Proceeds from  subleases      |       | (162       | )          | (116                                         | )          | (46                                  | )          | — |   | — |   | — |   |
| Net operating leases          |       | 5,063      |       | 808                                          |       | 2,740                                |       | 766 |   | 544 |   | 205 |   |
| Future minimum lease payments |       | $          | 5,501      |                                         | $          | 852                                  |       | $ | 2,917 |   | $ | 943 |   | $ | 584 |   | $ | 205 |   |

 

----

(1) Includesinterest payments due. 

 

*Guarantees*

* *

The Company has threeletters of credit that collateralize certain operating lease obligations andtotal approximately $369,000 and $397,000 at April 30, 2005 and July 31,2004, respectively.  The Companycollateralizes these letters of credit with cash deposits made with three ofits financial institutions and has classified the short-term and the long-termportions of approximately $187,000 and $182,000 at April 30, 2005, and$101,000 and $296,000 at July 31, 2004 as “Other Current Assets” and  “Restricted Cash,” respectively, in thecondensed consolidated balance sheets. The long-term portion expires through June 2006.  The holders of the letters of credit are ableto draw on each respective letter of credit in the event that the Company isfound to be in default of its obligations under each of its operating leases.

 

Under the terms of the interest rate swap agreementinto which the Company entered during fiscal 2004, the Company must providecollateral to match any unfavorable mark-to-market exposure (fair value) on theswap. The amount of collateral required totals a minimum of $1,800,000 plus anamount equal to the unfavorable mark-to-market exposure on the swap. Generally,the required collateral will rise as interest rates rise. As of April 30,2005, and July 31, 2004, the Company has posted approximately $3,797,000and $3,736,000, respectively, of collateral under this swap agreement which isincluded in “Restricted Cash” in its condensed consolidated balance sheet.

 

In the event of early termination of the Company’sservice agreement with eˆdeltacom, a division of ITC^DeltaCom, Inc. and amanaged service provider, the Company may be required to pay eˆdeltacom apenalty fee of up to approximately $45,000.

 

*Litigation*

* *

In August 2004, a patent-infringement claimwas filed against the Company by NCR Corporation in the U.S. District Court forthe Southern District of Ohio. In the complaint, NCR alleged certain of theCompany’s products infringe three of its patents which allegedly covertechnology for synchronizing databases between personal digital assistants andhost computers.  Based on a lengthyreview, the Company believes that NCR’s claims against it are without merit andthe Company does not infringe on any of the asserted NCR patents.  Separately, on September 9, 2004, theCompany filed a complaint in the U.S. District Court for the NorthernDistrict of California against NCR requesting, among other things, thata declaratory judgment be entered finding that the Company does notinfringe an NCR patent (6,473,765) that was asserted against one of theCompany’s licensees, Garmin Ltd.  The Company has certain indemnificationobligations to Garmin for claims related to intellectual propertyinfringement.  In response, NCR amended its suit against Garmin towithdraw its allegation of infringement of the ‘765 patent and stated that theCompany has no liability to NCR for infringement of the ‘765 patent.  NCRthen moved to dismiss the California case on the basis that, because theCompany could not be sued for infringement, the Court lacked jurisdiction to

 

20

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adjudicatethe Company’s declaratory judgment action.  Subsequently, the motion wasgranted and the California case was dismissed. 

 

The Company isalso involved in various litigation and claims arising in the normal course ofbusiness.  In management’s opinion, thesematters are not expected to have a material impact on the Company’sconsolidated results of operations or financial condition. 

 

**Note9  Net Loss Per Common Share**

** **

Basic net loss per common share is computed bydividing net loss available to common stockholders by the weighted averagenumber of common shares outstanding for the period.  Diluted net loss per common share is computedby dividing net loss by the weighted average number of dilutive potentialcommon shares that were outstanding during the period.  Diluted weighted average shares reflect thedilutive effect, if any, of potential common shares based on the treasury stockmethod.

 

Basicand diluted net loss per common share were calculated as follows (in thousands,except per common share amounts): 

 
| ** **                                                                                       | ** ** | **Three Months Ended  April 30,** | ** ** | **Nine Months Ended  April 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                       | ** ** | **2005**                               | ** ** | **2004**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| *Numerator:*                                                                                     |       |                                   |       |                                  |       |   |   |   |   |
| Net loss                                                                                         |       | $                                      | (4,361     | )                                     | $          | (2,184 | ) | $ | (8,841 | ) | $ | (7,697 | ) |
|                                                                                             |       |                                   |       |                                  |       |   |   |   |   |
| *Denominator:*                                                                                   |       |                                   |       |                                  |       |   |   |   |   |
| Weighted average shares outstanding used to compute basic and diluted  net loss per common share |       | 66,523                                 |       | 63,859                                |       | 65,451 |   | 55,575 |   |
|                                                                                             |       |                                   |       |                                  |       |   |   |   |   |
| Basic and diluted net loss per common share                                                      |       | $                                      | (0.07      | )                                     | $          | (0.03 | ) | $ | (0.14 | ) | $ | (0.14 | ) |

 

All common shares that were held in escrow or thatwere subject to repurchase by the Company, totaling approximately zero and1,389,000 as of April 30, 2005 and 2004, respectively, were excluded frombasic and diluted net loss per common share calculations.

 

Potential common shares attributable to stock options,convertible senior notes, shares held in escrow and shares subject torepurchase by the Company of 27,701,165 and 25,784,894 were outstanding at April 30,2005 and 2004, respectively. However, as a result of a net loss incurred by theCompany in the three and nine months ended April 30, 2005 and 2004, noneof the in-the-money potential common shares were included in the weightedaverage outstanding shares (using the treasury stock method) used to calculatenet loss per common share because the effect would have been antidilutive.

 

21

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**Note 10  Comprehensive Loss**

** **

Accumulated other comprehensive loss consists of netunrealized gain/loss on available for sale investments and foreign currencytranslation adjustments.  Totalcomprehensive loss for the three and nine months ended April 30, 2005 and2004, respectively, is presented in the following table (in thousands): 

 
| ** **                                            | ** ** | **Three Months Ended  April 30,** | ** ** | **Nine Months Ended  April 30,** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                                            | ** ** | **2005**                               | ** ** | **2004**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss                                              |       | $                                      | (4,361     | )                                     | $          | (2,184 | ) | $ | (8,841 | ) | $ | (7,697 | ) |
| Other comprehensive income (loss):                    |       |                                   |       |                                  |       |   |   |   |   |
| Change in net unrealized income (loss) on investments |       | 18                                     |       | (47                                   | )          | (7 | ) | (81 | ) |
| Realized loss on investments                          |       | (10                                    | )          | —                                |       | (10 | ) | — |   |
| Change in currency translation adjustments            |       | 7                                      |       | (32                                   | )          | 1,063 |   | 23 |   |
| Total other comprehensive income (loss)               |       | 15                                     |       | (79                                   | )          | 1,046 |   | (58 | ) |
| Total comprehensive loss                              |       | $                                      | (4,346     | )                                     | $          | (2,263 | ) | $ | (7,795 | ) | $ | (7,755 | ) |

 

**Note 11  Business Segments**

** **

Operating segments are identified as components of anenterprise about which separate, discrete financial information is availablethat is evaluated by the chief operating decision maker or decision-makinggroup to make decisions about how to allocate resources and assess performance.The Company’s chief operating decision maker is the chief executive officer. Todate, the Company has reviewed its operations principally in a single segment.

 

The Companyoperates in a single industry segment encompassing the development, marketingand support of software and services that provide synchronization, wirelessemail, mobile application development, application/device management, real-timeremote information access, secure VPN and identity searching/matching/screeningcapabilities.  The Company’s customerbase consists primarily of corporate organizations, business developmentorganizations, industry associations, mobile carriers, resellers, internationalsystem integrators, large OEMs in the personal computer, or PC, market andselected distributors, which primarily market to the retail channel, in NorthAmerica, Europe, the Asia-Pacific region, South America, and Africa.

 

Revenue isattributed to regions based on the location of customers. Revenue informationby geographic region is as follows (in thousands):

 
| ** **          | ** ** | **Three Months Ended  April 30,** | ** ** | **Nine Months Ended  April 30,** | ** ** |
|---------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **          | ** ** | **2005**                               | ** ** | **2004**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| United States       |       | $                                      | 10,287     |                                  | $          | 7,658 |   | $ | 29,704 |   | $ | 19,291 |   |
| Japan               |       | 677                                    |       | 1,174                                 |       | 2,053 |   | 4,547 |   |
| Other International |       | 4,273                                  |       | 2,175                                 |       | 12,038 |   | 5,188 |   |
| Total revenue       |       | $                                      | 15,237     |                                  | $          | 11,007 |   | $ | 43,795 |   | $ | 29,026 |   |

 

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Revenue information byproduct group is as follows (in thousands):

 
| ** **                      | ** ** | **Three Months Ended  April 30,** | ** ** | **Nine Months Ended  April 30,** | ** ** |
|---------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                      | ** ** | **2005**                               | ** ** | **2004**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Enterprise and retail products  |       | $                                      | 7,803      |                                  | $          | 6,576 |   | $ | 25,880 |   | $ | 14,172 |   |
| Technology licensing components |       | 7,434                                  |       | 4,431                                 |       | 17,915 |   | 14,854 |   |
| Total revenue                   |       | $                                      | 15,237     |                                  | $          | 11,007 |   | $ | 43,795 |   | $ | 29,026 |   |

 

The Company’s enterprise and retail products includeIntellisync® Handheld Edition, Intellisync Handheld Edition for Enterprise,Intellisync Phone Edition, Intellisync Mobile Suite® and Identity Search Server,as well as related support and maintenance. Technology licensing componentsinclude various licensed technology platforms, including Intellisync MobileSuite, Identity Search Server, Intellisync goAnywhere, Intellisync SoftwareDevelopment Platform, Intellisync Server-to-Server, professional services, hostingservices, non-recurring engineering services and related maintenance contractprograms.  Technology licensingcomponents also include our Tourmaline products such as Soda-Pop Mail®, EmailExecutiveTM, AOL® Mail and Eudora2go

 

One customer accounted for11% of the Company’s total revenue for the three months ended April 30,2005. No customers accounted for more than 10% of the Company’s total revenuefor the nine months ended April 30, 2005 and for the three and nine monthsended April 30, 2004.

 

Goodwill information by geographic region is asfollows (in thousands):

 

| ** **           | ** ** | **April 30,  2005** | ** ** | **July 31,  2004** | ** ** |
|----------------------|------------|--------------------------|------------|-------------------------|------------|
| United States        |       | $                        | 60,691     |                    | $          | 58,780 |   |
| United Kingdom       |       | 4,922                    |       | 4,828                   |       |
| Other  International |       | 1,680                    |       | 1,680                   |       |
| Total goodwill       |       | $                        | 67,293     |                    | $          | 65,288 |   |

 

Other long-lived assetinformation by geographic region is as follows (in thousands):

 

| ** **              | ** ** | **April 30,  2005** | ** ** | **July 31,  2004** | ** ** |
|-------------------------|------------|--------------------------|------------|-------------------------|------------|
| United States           |       | $                        | 27,362     |                    | $          | 29,829 |   |
| United Kingdom          |       | 1,776                    |       | 2,030                   |       |
| Australia               |       | 5,624                    |       | 6,209                   |       |
| Other  International    |       | 503                      |       | 416                     |       |
| Total long-lived assets |       | $                        | 35,265     |                    | $          | 38,484 |   |

 

23

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**Item 2****.    Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

*The following informationshould be read in conjunction with the condensed consolidated financialstatements and the notes thereto contained elsewhere in this Form 10-Q andin conjunction with the consolidated financial statements and management’sdiscussion and analysis of financial condition and results of operations in ourForm 10-K for the fiscal year ended July 31, 2004.  This quarterly report on Form 10-Q, andin particular management’s discussion and analysis of financial condition andresults of operations, contains forward-looking statements regarding futureevents or our future performance that involve certain risks and uncertaintiesincluding those discussed in “Factors That May Affect Future OperatingResults” below.  In this Form 10-Q,the words “anticipates,” “believes,” “expects,” “intends,” “future” and similarexpressions identify forward-looking statements.  All statements that address operatingperformance, our stock price, expectations regarding the impact  of litigation, events or developments that weexpect or anticipate will occur in the future, including statements relating toplanned product releases and composition of revenue, both in terms of segmentand geographical source and our expectations as to the future revenue from ourenterprise and retail products, are forward-looking statements.  Such forward-looking statements are based onmanagement’s current views and assumptions regarding future events andoperating performance, and speak only as of the date hereof.  We undertake no obligation to publicly updateor revise any forward-looking statements whether as a result of newinformation, future events or otherwise. Actual events or our actual future results may differ materially fromany forward-looking statements due to the risks and uncertainties outlinedbelow. *

 

Management’s discussionand analysis includes:

 

•                  Abusiness overview.

 

•                  Estimates,assumptions and critical accounting policies.

 

•                  Acomparison of our results of operations in the three and nine months ended April 30,2005 with the results in the corresponding periods in fiscal 2004.

 

•                  Recentlyissued accounting pronouncements.

 

•                  Adiscussion of our operating liquidity and capital resources.

 

•                  Adiscussion of factors that may affect our future operating results.

 

**BusinessOverview**

** **

We develop, marketand support desktop, enterprise and mobile carrier-class push-email,synchronization and systems management software that enables consumers,business professionals and information technology professionals to extend thecapabilities of enterprise groupware and vertical applications, handheldorganizers/computers, Web-enabled mobile phones, pagers and other wireless orwireline personal communications platforms. Our Identity Systems (formerly Search Software America, or SSA)subsidiaries develop, market and support global solutions that enhance anorganization’s ability to search, find, match (synchronize), screen and groupidentity data within their computer systems and network databases.

 

We have organizedour operations into a single operating segment encompassing the development,marketing and support of software and services that provide synchronization,wireless email, mobile application development, application/device management,real-time remote information access, secure VPN and identitysearching/matching/screening capabilities.

 

We license oursoftware products directly to corporations, mobile carriers, original equipmentmanufacturers, or OEMs, and business development organizations worldwide. Inaddition, we sell our retail products through several

 

24

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distribution channelsboth in the United States and internationally, including major distributors,resellers, computer dealers, retailers and mail-order companies.Internationally, we are represented by distributors, resellers and retailers inNorth America, Europe, the Asia-Pacific region, South America and Africa.

 

***Recent Event***

*** ***

On March 1, 2005, we completed our acquisition ofall of the issued and outstanding stock of Tourmaline Networks, Inc., aprivately held developer and marketer of mobile email based on QUALCOMM’s BREW®solution headquartered in San Diego, California.  Refer to the discussion under the caption “*Liquidity and Capital Resources*” set forth below for moreinformation.

 

# **Estimates,Assumptions and Critical Accounting Policies**

# ** **

Ourfinancial statements and accompanying notes are prepared in accordance withgenerally accepted accounting principles in the United States of America. Preparing financial statements requires management to make estimates andassumptions that affect the reported amounts of assets, liabilities, sales andexpenses. These estimates and assumptions are affected by management’sapplication of accounting policies.  Our critical accounting policiesinclude license and service revenue recognition, channel inventory and productreturns, valuation of goodwill, other intangibles, investments and otherlong-lived assets, restructuring accruals, loss contingencies and provision fordoubtful accounts which are discussed in more detail under the caption “*Estimates, Assumptions and Critical Accounting Policies*” inour  Annual Report on Form 10-K forthe fiscal year ended July 31, 2004.

 

25

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**Resultsof Operations**

 

The followingtable sets forth items included in the condensed consolidated statements ofoperations as a percentage of revenue for the periods indicated.  

 
| ** **                                     | ** ** | **Three Months Ended  April 30,** | ** ** | **Nine Months Ended  April 30,** | ** ** |
|------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                                     | ** ** | **2005**                               | ** ** | **2004**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                           |       |                                   |       |                                  |       |   |   |   |   |
| Revenue                                        |       |                                   |       |                                  |       |   |   |   |   |
| License                                        |       | 63.3                                   | %          | 68.2                                  | %          | 65.4 | % | 70.1 | % |
| Services                                       |       | 36.7                                   |       | 31.8                                  |       | 34.6 |   | 29.9 |   |
| Total revenue                                  |       | 100.0                                  | %          | 100.0                                 | %          | 100.0 | % | 100.0 | % |
|                                           |       |                                   |       |                                  |       |   |   |   |   |
| Cost and  operating expenses:                  |       |                                   |       |                                  |       |   |   |   |   |
| Cost of revenue                                |       | 16.6                                   |       | 20.3                                  |       | 16.9 |   | 19.5 |   |
| Amortization of  developed and core technology |       | 7.8                                    |       | 9.0                                   |       | 8.0 |   | 5.3 |   |
| Research and  development                      |       | 25.0                                   |       | 31.8                                  |       | 24.7 |   | 27.9 |   |
| Sales and  marketing                           |       | 53.9                                   |       | 41.9                                  |       | 45.8 |   | 39.5 |   |
| General and  administrative                    |       | 14.6                                   |       | 14.4                                  |       | 14.6 |   | 20.3 |   |
| Amortization of  intangibles                   |       | 7.0                                    |       | 6.2                                   |       | 7.2 |   | 3.5 |   |
| In-process  research and development           |       | —                                 |       | 7.0                                   |       | — |   | 12.6 |   |
| Other charges                                  |       | —                                 |       | 2.3                                   |       | — |   | 3.2 |   |
| Total cost and  operating expenses             |       | 124.9                                  |       | 132.9                                 |       | 117.2 |   | 131.8 |   |
| Operating loss                                 |       | (24.9                                  | )          | (32.9                                 | )          | (17.2 | ) | (31.8 | ) |
| Other income (expense):                        |       |                                   |       |                                  |       |   |   |   |   |
| Interest income                                |       | 2.0                                    |       | 1.6                                   |       | 1.8 |   | 1.4 |   |
| Interest expense                               |       | (2.6                                   | )          | (0.9                                  | )          | (2.1 | ) | (0.3 | ) |
| Other, net                                     |       | (1.0                                   | )          | (0.9                                  | )          | (1.4 | ) | (0.3 | ) |
| Litigation  settlement gain, net               |       | —                                 |       | 14.3                                  |       | — |   | 5.4 |   |
| Total other  income (expense)                  |       | (1.6                                   | )          | 14.1                                  |       | (1.7 | ) | 6.2 |   |
| Loss before  income taxes                      |       | (26.5                                  | )          | (18.8                                 | )          | (18.9 | ) | (25.6 | ) |
| Provision for  income taxes                    |       | (2.1                                   | )          | (1.1                                  | )          | (1.3 | ) | (0.9 | ) |
| Net loss                                       |       | (28.6                                  | )%         | (19.9                                 | )%         | (20.2 | )% | (26.5 | )% |

** **

*Revenue*

 
| ** **    | ** ** | **Three Months Ended April 30,** | ** ** | **Nine Months Ended April 30,** | ** ** |
|---------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **    | ** ** | **2005**                              | ** ** | **Percent  Change**                  | ** ** | **2004** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** |
| ** **    | ** ** | **(In thousands, except percentage)** | ** ** |
| Total revenue |       | $                                     | 15,237     |                                 | 38.4       | % | $ | 11,007 |   | $ | 43,795 |   | 50.9 | % | $ | 29,026 |   |
|               |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

We derive revenue fromtwo primary sources: software licenses and fees for services. The increase inrevenue for the three and nine months ended April 30, 2005 was primarilydue from revenue contributions of Synchrologic, Inc. and Identity Systems(formerly Search Software America, or SSA) product sales, both of which weacquired during fiscal 2004.  Theincrease was also brought about by the continued fundamental shift in ourcustomer base and revenue streams as we launched new wireless products andramped up our wireless email solution with the global wireless market.  

 

While the market forsmartphones and other wireless mobile devices has grown recently, the marketfor wired or traditional personal digital assistants, or PDAs, has continued toface challenges. The overall decline in traditional PDA sales has had a directimpact on sales of our Intellisync products through the consumer and onlinechannels,

 

26

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where sales of oursynchronization software typically occur at the same time a PDA is purchased,or shortly thereafter. Due to this decline, our retail revenue, which consistsof sales to distributors and direct sales to end-users, decreased during thefirst three quarters of fiscal 2005.

 

•                  *License Revenue*

 
| ** **                      | ** ** | **Three Months Ended April 30,** | ** ** | **Nine Months Ended April 30,** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **2005**                              | ** ** | **Percent  Change**                  | ** ** | **2004** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** |
| ** **                      | ** ** | **(In thousands, except percentage)** | ** ** |
| License revenue                 |       | $                                     | 9,643      |                                 | 28.4       | % | $ | 7,512 |   | $ | 28,662 |   | 40.9 | % | $ | 20,336 |   |
| As percentage of  total revenue |       | 63.3                                  | %          |                                 |       | 68.2 | % | 65.4 | % |   |   | 70.1 | % |
|                                 |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

License revenue is earnedfrom the sale and use of software products (including our technology licensingcomponents) and royalty agreements with original equipment manufacturers, or OEMs. Theincrease in license revenue in absolute dollars for the three months ended April 30,2005 as compared with that for the corresponding period of fiscal 2004reflected an increase of $1,395,000 in revenue from technology licensingcomponents and $736,000 in revenue from enterprise products.  The increase in license revenue in absolutedollars for the nine months ended April 30, 2005 as compared with that forthe corresponding period of fiscal 2004 reflected an increase of $6,536,000 inrevenue from enterprise products and an increase of $1,790,000 in revenue fromtechnology licensing components. A significant portion of the increase in ourenterprise revenue was contributed by Synchrologic, Inc. (acquired in December 2003),particularly Intellisync Mobile Suite, and Identity Systems (acquired in March 2004)product sales.   The decrease in licenserevenue as a percentage of total revenue was primarily due to the increase inservice revenue in the three and nine months ended April 30, 2005 asdescribed below.

 

•                  *Service Revenue*

 
| ** **                      | ** ** | **Three Months Ended April 30,** | ** ** | **Nine Months Ended April 30,** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **2005**                              | ** ** | **Percent  Change**                  | ** ** | **2004** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** |
| ** **                      | ** ** | **(In thousands, except percentage)** | ** ** |
| Service revenue                 |       | $                                     | 5,594      |                                 | 60.1       | % | $ | 3,495 |   | $ | 15,133 |   | 74.1 | % | $ | 8,690 |   |
| As percentage of  total revenue |       | 36.7                                  | %          |                                 |       | 31.8 | % | 34.6 | % |   |   | 29.9 | % |
|                                 |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Service revenue isderived from fees for services, including fixed-price and time-and-materialsprofessional services arrangements and amortization of maintenance contractprograms.  The increase in servicerevenue for the three months ended April 30, 2005 as compared with thatfor the corresponding period of fiscal 2004 resulted from a total increase of $2,756,000brought about by an increase in amortization of our maintenance contractprograms relating to the increase in license revenue, as well as revenue fromour hosting services.  This increase wasoffset by a $657,000 decrease in professional service revenue associated withour technology licensing partners.  Theincrease in service revenue for the nine months ended April 30, 2005 ascompared with that for the corresponding period of fiscal 2004 reflected anincrease of $8,055,000 in revenue from our maintenance contract programs andhosting services, slightly offset by $1,612,000 decrease in professionalservice revenue.

 

In any period, servicerevenue from time and materials contracts is dependent, among other things, onlicense transactions closed during the current and preceding quarters andcustomer decisions regarding implementations of licensed software.

 

27

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*Enterprise and Retail Products*

 
| ** **                      | ** ** | **Three Months Ended April 30,** | ** ** | **Nine Months Ended April 30,** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **2005**                              | ** ** | **Percent  Change**                  | ** ** | **2004** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** |
| ** **                      | ** ** | **(In thousands, except percentage)** | ** ** |
| Enterprise and  retail products |       | $                                     | 7,803      |                                 | 18.7       | % | $ | 6,576 |   | $ | 25,880 |   | 82.6 | % | $ | 14,172 |   |
| As percentage of  total revenue |       | 51.2                                  | %          |                                 |       | 59.7 | % | 59.1 | % |   |   | 48.8 | % |
|                                 |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Our enterprise andretail products revenue includes sales to retail distribution channels, as wellas direct sales of our personal and server products licensed to corporationsfor internal use. Enterprise and retail products include Intellisync HandheldEdition, Intellisync Handheld Edition for Enterprise, Intellisync PhoneEdition, Intellisync Mobile Suite and Identity Search Server (formerlyIdentity Systems), as well as related support and maintenance. Enterprise salesfrequently involve large up-front license fees, which can result in lengthysales cycles and uncertainties as to the timing of sales driven by customers’budgetary processes. As a result, we generally have less visibility into futureenterprise sales than is typically the case in our royalty-based technologylicensing business. In addition, while enterprise sales generally result inongoing maintenance revenue and may lead to follow-on purchases or upgrades, weare typically dependent on sales to new customers for a significant portion ofour enterprise revenue in a given quarter.

 

The increase inenterprise and retail products revenue for the three months ended April 30,2005 as compared with that for the corresponding period of fiscal 2004 resultedfrom contributions of $1,503,000 from Identity Systems and Synchrologicproducts and an increase of $987,000 in revenue from amortization of supportand maintenance based on a higher license revenue base.  This increase was slightly offset by a $1,263,000decrease in revenue from Intellisync Handheld Edition for Enterprise and inretail sales of our Intellisync software. The increase in enterprise and retail products revenue for the ninemonths ended April 30, 2005 as compared with that for the correspondingperiod of fiscal 2004 resulted from contributions of $9,576,000 from IdentitySystems and Synchrologic products and an increase of $4,948,000 in revenue fromamortization of support and maintenance, slightly offset by a $2,816,000decrease in revenue from retail sales of our Intellisync software.  Less emphasis on marketing of IntellisyncHandheld Edition for Enterprise, and more on the transition of our enterpriseserver offering to Intellisync Mobile Suite, during the most recent quarterscontributed to the decrease in revenue from Intellisync Handheld Edition forEnterprise.  We expect revenue inabsolute dollars from enterprise and retail products to remain at the currentlevel or decrease in the following quarter, which we believe will occur as a resultof seasonal factors in the enterprise and retail business inherent with thesummer, as well as of continued decrease in revenue related to our legacyproducts.

 

*TechnologyLicensing Components*

 
| ** **                       | ** ** | **Three Months Ended April 30,** | ** ** | **Nine Months Ended April 30,** | ** ** |
|----------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                       | ** ** | **2005**                              | ** ** | **Percent  Change**                  | ** ** | **2004** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** |
| ** **                       | ** ** | **(In thousands, except percentage)** | ** ** |
| Technology  licensing components |       | $                                     | 7,434      |                                 | 67.8       | % | $ | 4,431 |   | $ | 17,915 |   | 20.6 | % | $ | 14,854 |   |
| As percentage of  total revenue  |       | 48.8                                  | %          |                                 |       | 40.3 | % | 40.9 | % |   |   | 51.2 | % |
|                                  |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Technology licensing components include variouslicensed technology platforms, including Intellisync Mobile Suite, IntellisyncgoAnywhere, Intellisync Software Development Platform, IntellisyncServer-to-Server, professional services, non-recurring engineering services andrelated maintenance contract programs. The increase in technology licensing revenue for the three months ended April 30,2005 as compared with that for the corresponding period of fiscal 2004 resultedfrom contributions of $3,164,000 from Intellisync Software Development Platformand hosting service revenue, offset slightly by a $161,000 decrease in revenuefrom professional services.  Revenue fromhosting services grew in the quarter through a combination of growth from existingcarrier customers and the signing of several new carrier contracts during thequarter.  The increase in technologylicensing revenue for the nine months ended April 30, 2005 as comparedwith that for the corresponding period of fiscal 2004 resulted fromcontributions of $4,896,000 from Intellisync Software Development Platform and

 

28

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hosting service revenue, offset slightly by $1,835,000decrease in revenue from professional services. We expect that a further increase in revenue from our carrier businessduring the next quarter will result in an overall increase in our technologylicensing revenue as compared with the recent previous quarters.

 

*InternationalRevenue*

 
| ** **                      | ** ** | **Three Months Ended April 30,** | ** ** | **Nine Months Ended April 30,** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **2005**                              | ** ** | **Percent  Change**                  | ** ** | **2004** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** |
| ** **                      | ** ** | **(In thousands, except percentage)** | ** ** |
| International  revenue          |       | $                                     | 4,950      |                                 | 47.8       | % | $ | 3,349 |   | $ | 14,091 |   | 44.7 | % | $ | 9,735 |   |
| As percentage of  total revenue |       | 32.5                                  | %          |                                 |       | 30.4 | % | 32.2 | % |   |   | 33.5 | % |
|                                 |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

The year-over-year increase in our internationalrevenue represented 38% and 29% of our total revenue increase for the three andnine months ended April 30, 2005.  Ourinternational revenue growth, in absolute dollars, was a result of a number offactors including an increase in the number of our international technologylicensing partners, particularly in Europe; the full-quarter and the fullnine-month revenue effect of Identity Systems during fiscal 2005; an increasein the number of sales people worldwide; and the effect of foreign exchangetranslation.  The slight decrease ininternational revenue as a percentage of total revenue for the nine monthsended April 30, 2005, on the other hand, is primarily due to increasedrevenue from our newer offerings in the United States. We expect that ouracquisitions of Synchrologic and Identity Systems will further strengthen ourpresence in Europe, as well as in Asia-Pacific. We believe, however, thatinternational revenue will fluctuate on a quarter to quarter basis as weperiodically enter into new agreements for professional services and newinternational partner contracts for technology licensing. International revenuemay be subject to certain risks not normally encountered in operations in theUnited States, including exposure to tariffs, various trade regulations,fluctuations in currency exchange rates, as well as international softwarepiracy as described more fully in “*Factors That May AffectFuture Operating Results*” set forth below. We believe that continuedgrowth will require further expansion in international markets. We haveutilized and will likely continue to utilize substantial resources both toexpand and establish international operations in the future.

 

*TopCustomers*

* *

One customer accounted for11% of our total revenue for the three months ended April 30, 2005. Nocustomers accounted for more than 10% of our total revenue for the nine monthsended April 30, 2005 and for the three and nine months ended April 30,2004.

 

*Cost of Revenue*  

 
| ** **                      | ** ** | **Three Months Ended April 30,** | ** ** | **Nine Months Ended April 30,** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **2005**                              | ** ** | **Percent  Change**                  | ** ** | **2004** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** |
| ** **                      | ** ** | **(In thousands, except percentage)** | ** ** |
| Cost of revenue                 |       | $                                     | 2,537      |                                 | 13.4       | % | $ | 2,237 |   | $ | 7,397 |   | 30.5 | % | $ | 5,667 |   |
| As percentage of  total revenue |       | 16.6                                  | %          |                                 |       | 20.3 | % | 16.9 | % |   |   | 19.5 | % |
|                                 |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Cost of revenue consistsof license costs and service costs. License costs comprise product-packaging expenses such as product mediaand duplication, manuals, packing supplies, and shipping costs.  Service costs comprise personnel-relatedexpenses such as salaries and other related costs associated with workperformed under professional service contracts, non-recurring engineeringagreements, post-sales customer support costs and hosting costs for hostingservices associated with technology licensing partners and end users. Hostingcosts include expenses related to bandwidth for hosting, tape backup, securityand storage, third-party fees and internal personnel costs associated withlogistics and operational support of the hosting services. Service costs can beexpected to vary significantly from period to period depending on the mix ofservices we provide.

 

29

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In general,license revenue costs represent a smaller percentage of license revenue whencompared with service revenue costs as a percentage of service revenue; this isdue to the high cost structure of service revenue. Additionally, license coststend to be variable based on license revenue volumes, whereas service coststend to be fixed within certain service revenue volume ranges. We would expectthat an increase in service revenue as a percentage of our total revenue wouldgenerate lower overall gross margins as a percentage of total revenue. Also,given the high level of fixed costs associated with the professional servicesgroup and our hosting operations, our inability to generate revenue sufficientto absorb these fixed costs could lead to low or negative service grossmargins.

 

The increase in cost of revenue in absolute dollarsreflected the effect of planned increases in mobile hosting and post-salessupport infrastructure.  The increase inoverall revenue contributed to improvement in our gross margins for the threeand nine months ended April 30, 2005. In future periods, cost of revenue may further fluctuate from quarter toquarter due to potential changes in the infrastructure and other requirementsof our hosting operations to meet carriers demand. These changes, which may becostly, are difficult to forecast. In addition, our cost of revenue isprimarily driven by our expectation for different margin characteristics withinand between license and service revenue as well as the expected mix betweenproducts and channels.

 

*Amortization of Developed andCore Technology*

 
| ** **                                     | ** ** | **Three Months Ended April 30,** | ** ** | **Nine Months Ended April 30,** | ** ** |
|------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                     | ** ** | **2005**                              | ** ** | **Percent  Change**                  | ** ** | **2004** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** |
| ** **                                     | ** ** | **(In thousands, except percentage)** | ** ** |
| Amortization of  developed and core technology |       | $                                     | 1,187      |                                 | 19.9       | % | $ | 990 |   | $ | 3,515 |   | 127.8 | % | $ | 1,543 |   |
| As percentage of  total revenue                |       | 7.8                                   | %          |                                 |       | 9.0 | % | 8.0 | % |   |   | 5.3 | % |
|                                                |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

The increase in theamortization of developed and core technology was primarily due to theamortization of the recently purchased technology from Tourmaline, as well as theimpact of a full-quarter amortization of the purchased technology from IdentitySystems in the three months ended April 30, 2005, and a full-nine monthsamortization of the purchased technology from Synchrologic and Identity Systemsin the nine months ended April 30, 2005. Based on acquisitions completedas of April 30, 2005, we expect the future amortization expense ofdeveloped and core technology to be as follows (in thousands): 

 

| Three months ending July 31, 2005 |   | $      | 1,183  |   |
|----------------------------------------|--------|--------|--------|--------|
| Fiscal year ending July 31,       |   |   |   |
| 2006                                   |   | 4,624  |   |
| 2007                                   |   | 4,381  |   |
| 2008                                   |   | 2,046  |   |
| 2009                                   |   | 685    |   |
| 2010                                   |   | 456    |   |
| Thereafter                             |   | 197    |   |
|                                   |   | $      | 13,572 |   |

 

Weexpect that we may acquire additional developed and core technology associatedwith any acquisitions we may complete in the future.  As a result, we may further increase ouramortization expense of developed and core technology.

 

30

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*Researchand Development*

 
| ** **                      | ** ** | **Three Months Ended April 30,** | ** ** | **Nine Months Ended April 30,** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **2005**                              | ** ** | **Percent  Change**                  | ** ** | **2004** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** |
| ** **                      | ** ** | **(In thousands, except percentage)** | ** ** |
| Research and  development       |       | $                                     | 3,810      |                                 | 9.0        | % | $ | 3,495 |   | $ | 10,819 |   | 33.6 | % | $ | 8,098 |   |
| As percentage of  total revenue |       | 25.0                                  | %          |                                 |       | 31.8 | % | 24.7 | % |   |   | 27.9 | % |
|                                 |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Research anddevelopment expenses consist primarily of salaries and other related costs forresearch and development personnel, quality assurance personnel, productlocalization, fees to outside contractors and the cost of facilities anddepreciation of capital equipment. We invest in research and development bothfor new products and to provide continuing enhancements to existing products.Our engineering group is currently focused on developing new functionality forwireless handhelds, smartphones, laptops and tablets, at extending our core synchronizationtechnology to increase scalability and extensibility, and at supporting nextgeneration wireless technology and device platforms.  The increase in research and developmentspending in absolute dollars was due to the relative impact of the acquiredworkforce of approximately six engineers from the acquisition of Tourmalineduring the third quarter of fiscal 2005 and 71 engineers from the acquisitionof Spontaneous Technology, Inc., Synchrologic and Identity Systems duringthe first three quarters of fiscal 2004.  The decrease in research and development expense as a percentage ofrevenue was due to an increase in overall revenue.

 

*Sales andMarketing*

 
| ** **                      | ** ** | **Three Months Ended April 30,** | ** ** | **Nine Months Ended April 30,** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **2005**                              | ** ** | **Percent  Change**                  | ** ** | **2004** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** |
| ** **                      | ** ** | **(In thousands, except percentage)** | ** ** |
| Sales and  marketing            |       | $                                     | 8,209      |                                 | 78.0       | % | $ | 4,612 |   | $ | 20,055 |   | 75.0 | % | $ | 11,463 |   |
| As percentage of  total revenue |       | 53.9                                  | %          |                                 |       | 41.9 | % | 45.8 | % |   |   | 39.5 | % |
|                                 |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Sales and marketing expenses consist primarily ofsalaries, commissions, promotional expenses (marketing and sales literature andpresentations), marketing programs (trade shows, public relations) and othercosts relating to sales and marketing employees, as well as to technicalsupport personnel associated with pre-sales activities such as building brandawareness, performing product and technical presentations and answeringcustomers’ product and service inquiries. Sales and marketing expensesincreased year-over-year as a result of an increase in number of sales peopleworldwide and in sales commissions effecting an increase in personnel costs of$1,783,000 and $5,127,000 for the three and nine months ended April 30,2005, respectively.  We acquired 22 newsales and marketing employees from Synchrologic and 11 from Identity Systemsduring fiscal 2004.  The increase insales and marketing expenses was also due to an increase in marketing programs andother related activities of approximately $1,421,000 and $2,696,000 to supportincreased revenue activities driven by our recent acquisitions and establishingstrategic relationships with our existing and prospective enterprisecustomers.  Consequently, sales andmarketing-related travel increased by approximately $393,000 and $769,000,respectively.  We intend to increaseawareness and market presence of our existing and new products, services ortechnology over time, which may require us to substantially increase the amountwe spend on sales and marketing in future periods. We expect that these expenseswill continue to increase as we increase our sales and marketing efforts andsales team worldwide. 

 

31

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*General andAdministrative*

* *
| ** **                      | ** ** | **Three Months Ended April 30,** | ** ** | **Nine Months Ended April 30,** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **2005**                              | ** ** | **Percent  Change**                  | ** ** | **2004** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** |
| ** **                      | ** ** | **(In thousands, except percentage)** | ** ** |
| General and  administrative     |       | $                                     | 2,221      |                                 | 40.4       | % | $ | 1,582 |   | $ | 6,383 |   | 8.3 | % | $ | 5,894 |   |
| As percentage of  total revenue |       | 14.6                                  | %          |                                 |       | 14.4 | % | 14.6 | % |   |   | 20.3 | % |
|                                 |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

General andadministrative expenses consist primarily of salaries and other costs relatingto administrative, executive and financial personnel and outside professionalfees.  The increase in general andadministrative spending for the three months ended April 30, 2005 was dueto an increase of $473,000 in personnel costs which resulted from hiring threeadditional staff, not including consultants, and the absence of approximately$205,000 recovery of stock compensation charge we had in the third quarter offiscal 2004.  The increase was also dueto an increase in outside professional services and other costs of $166,000associated mainly with the Sarbanes-Oxley compliance.  The increase in general and administrativespending  for the nine months ended April 30,2005 was due to the costs of Sarbanes-Oxley compliance, the three additionalstaff, not including consultants, and other costs of $2,018,000.  This increase was offset by certain costsincurred in fiscal 2004 that were diminished in the first quarter of fiscal2005.  Such costs include a significantnon-cash variable accounting charge of $667,000 associated with certainoutstanding stock options and outside services costs brought about primarily bylegal costs of $862,000 associated with certain patent infringement lawsuits thathave been resolved. The decrease in general and administrative expense as apercentage of revenue for the nine months ended April 30, 2005 was due toan increase in overall revenue.

 

Depending on the degreeof the fluctuation of our stock price in the future, we may incur a significantvariable accounting charge or a recovery of charges from prior quartersassociated with certain employee stock options. The charge or the recovery mayincrease or decrease our total general and administrative costs in the next fewquarters. The charge or the recovery may also further increase or offset ourexpected total cost of revenue, research and development and sales andmarketing costs in the near future.

 

In addition, the FASBissued in December 2004  Statementof Financial Accounting Standards (SFAS) No. 123R, “*Share-BasedPayment, an amendment of FASB Statements Nos. 123 and 95*,” thataddresses the accounting treatment for employee stock options and othershare-based payment transactions. The statement generally would require thatshare-based compensation transactions be accounted for using a fair-value-basedmethod and recognized as expenses. The statement and the change in accountingtreatment could result in our reporting increased operating expenses starting August 1,2005.  Refer to the caption “*Recently Issued Accounting Pronouncement*s”set forth below for further details on SFAS No. 123R.

 

*Amortization of Other Intangibles*  

 
| ** **                         | ** ** | **Three Months Ended April 30,** | ** ** | **Nine Months Ended April 30,** | ** ** |
|------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                         | ** ** | **2005**                              | ** ** | **Percent  Change**                  | ** ** | **2004** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** |
| ** **                         | ** ** | **(In thousands, except percentage)** | ** ** |
| Amortization of  other intangibles |       | $                                     | 1,074      |                                 | 58.2       | % | $ | 679 |   | $ | 3,176 |   | 216.7 | % | $ | 1,003 |   |
| As percentage of  total revenue    |       | 7.0                                   | %          |                                 |       | 6.2 | % | 7.2 | % |   |   | 3.5 | % |
|                                    |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

32

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The increase inthe amortization of other intangibles was primarily due to the impact ofrecently acquired intangibles from Tourmaline, as well as the relative impactof intangibles acquired from Spontaneous Technology, Synchrologic and IdentitySystems during fiscal 2004.  Based onacquisitions completed as of April 30, 2005, we expect the futureamortization expense of other intangible assets is as follows (in thousands): 

 

| Three months ending July 31, 2005 |   | $      | 1,056  |   |
|----------------------------------------|--------|--------|--------|--------|
| Fiscal year ending July 31,       |   |   |   |
| 2006                                   |   | 3,614  |   |
| 2007                                   |   | 3,076  |   |
| 2008                                   |   | 1,793  |   |
| 2009                                   |   | 955    |   |
| 2010                                   |   | 679    |   |
| Thereafter                             |   | 1,131  |   |
|                                   |   | $      | 12,304 |   |

** **

Weexpect that we may acquire additional intangibles associated with anyacquisitions we may complete in the future. As a result, we may further increase our amortization expense of otherintangibles.

 

*In-Process Research andDevelopment*

* *
| ** **                           | ** ** | **Three Months Ended April 30,** | ** ** | **Nine Months Ended April 30,** | ** ** |
|--------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                           | ** ** | **2005**                              | ** ** | **Percent  Change**                  | ** ** | **2004** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** |
| ** **                           | ** ** | **(In thousands, except percentage)** | ** ** |
| In-process  research and development |       | $                                     | —     |                                 | N/A        |   | $ | 775 |   | $ | — |   | N/A |   | $ | 3,667 |   |
| As percentage of  total revenue      |       | —                                | %          |                                 |       | 7.0 | % | — | % |   |   | 12.6 | % |
|                                      |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

In the three and ninemonths ended April 30, 2004, we recorded a charge of $775,000 and $3,667,000,respectively, for in-process research and development associated with theacquisition of Identity Systems in the third quarter of fiscal 2004, Synchrologicin the second quarter of fiscal 2004 and of Spontaneous Technology in the firstquarter of fiscal 2004.  The purchaseprices of Identity Systems, Synchrologic and Spontaneous Technology wereassigned to the fair value of the assets acquired, including the in-processresearch and development.  As of theacquisition dates of the three companies, technological feasibility of thein-process technology had not been established and the technology had noalternative future use.  Accordingly, weexpensed the in-process research and development at the date of theacquisitions.  

 

The amount of the purchaseprice allocated to in-process research and technology was based on establishedvaluation techniques used in the high-technology software industry. The fairvalue assigned to the acquired in-process research and development wasdetermined using the income approach, which discounts expected future cashflows to present value. The key assumptions used in the valuation include,among others, expected completion date of the in-process projects identified asof the acquisition date, estimated costs to complete the projects, revenuecontributions and expense projections assuming the resulting product hasentered the market, and discount rate based on the risks associated with thedevelopment life cycle of the in-process technology acquired. The discount rateused in the present value calculations is normally obtained from aweighted-average cost of capital analysis, adjusted upward to account for theinherent uncertainties surrounding the successful development of the in-processresearch and development, the expected profitability levels of such technology,and the uncertainty of technological advances that could potentially impact theestimates.  We assumed the pricing modelfor the resulting product of the acquired in-process research and technology tobe standard within its industry.  We,however, did not take into consideration any consequential amount of expensereductions from integrating the acquired in-process technology with otherexisting in-process or completed technology. Therefore, the valuationassumptions do not include significant anticipated cost savings. 

 

33

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The key assumptionsunderlying the valuation of acquired in-process research and development wereas follows (in thousands): 

 

*Identity Systems*

* *

Project names: SSA-NAME3 Version 3.0 and IDS Version 3.0  

Percent completed as of acquisition date: 10% 

Estimated costs to complete technology at acquisition date:$600,000

Risk-adjusted discount rate: 25% 

First period expected revenue: June 2005

 

*Synchrologic*

* *

Project names: Version upgrade of Data Sync, FileSync, E-mail Accelerator and Systems Management products 

Percent completed as of acquisition date: 60%-70%

Estimated costs to complete technology at acquisition date:$3,000,000

Risk-adjusted discount rate: 22%

First period expected revenue: calendar year 2004

 

*Spontaneous Technology*

* *

Project names: Version upgrade of Spontaneous Technology’ssecure Virtual Private Network (sVPN) 

Percent completed as of acquisition date: 60% 

Estimated costs to complete technology at acquisition date:$125,000 

Risk-adjusted discount rate: 22% 

First period expected revenue: calendar year 2004 

 

The development of theabove technologies were highly dependent on the remaining efforts to achievetechnical viability, rapidly changing customer markets, uncertain standards fora new product, and significant competitive threats from several companies.  The nature of the efforts to develop thistechnology into a commercially viable product consisted primarily of planning,designing, experimenting, and testing activities necessary to determine thatthe technology could meet market expectations, including functionality andtechnical requirements. Failure to bring the product to market in a timelymanner could have resulted in a loss of market share or a lost opportunity tocapitalize on emerging markets, and could have a material adverse impact on ourbusiness and operating results. 

 

Subsequent to theacquisition of Identity Systems, Synchrologic and Spontaneous Technology, therehave been no significant developments related to the current status of theacquired in-process research and development project that would result inmaterial changes to the assumptions.

 

*Other Charges*

 
| ** **                      | ** ** | **Three Months Ended April 30,** | ** ** | **Nine Months Ended April 30,** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **2005**                              | ** ** | **Percent  Change**                  | ** ** | **2004** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** |
| ** **                      | ** ** | **(In thousands, except percentage)** | ** ** |
| Other charges                   |       | $                                     | —     |                                 | N/A        |   | $ | 253 |   | $ | — |   | N/A |   | $ | 929 |   |
| As percentage of  total revenue |       | —                                | %          |                                 |       | 2.3 | % | — | % |   |   | 3.2 | % |
|                                 |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

•                  *Facilities Exit Costs and Restructuring Accrual. *During the third quarter of fiscal2004, we implemented a reduction in workforce affecting 17 employees in variousbusiness functions (9 in research and development and 8 in sales andmarketing).  The program was completed bythe end of April 2004, and the associated severance costs incurred wereapproximately $253,000, none of which remained unused as of April 30,2005.  

 

During the three monthsended January 31, 2004, we recorded facilities exit costs of $600,000 forvacating our remaining office space in Santa Cruz, California and a floor ofour office facility in San Jose,

 

34

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California.  Inherent in the estimation of the costsrelated to our restructuring efforts are assessments related to the most likelyexpected outcome of the significant actions to accomplish therestructuring.  In determining the excessfacilities exit costs, we were required to estimate future sublease income,negotiated lease settlement costs, future net operating expenses of thefacilities, and brokerage commissions, among other expenses.  These estimates, along with other estimatesmade by management in connection with restructuring, may vary significantlydepending, in part, on factors that may be beyond our control.  Specifically, these estimates will depend onour success in negotiating with lessors, the time periods required to locateand contract suitable subleases and the market rates at the time of suchsubleases. Adjustments to the reserve for the consolidation of excessfacilities will be required if actual lease exit costs or sublease incomediffer from amounts currently expected.

 

The following table setsforth the activities in the restructuring accrual account for the nine monthsended April 30, 2005 (in thousands):

 

| ** **                            | ** ** | **Consolidation  of Excess  Facilities** | ** ** |
|---------------------------------------|------------|------------------------------------------|------------|
| **Balance  at July 31, 2004**    |       | $                                        | 1,080      |   |
| Cash payments                         |       | (330                                     | )          |
| **Balance  at October 31, 2004** |       | $                                        | 750        |   |
| Cash payments                         |       | (218                                     | )          |
| **Balance  at January 31, 2005** |       | $                                        | 532        |   |
| Cash payments                         |       | (225                                     | )          |
| **Balance  at April 30, 2005**   |       | $                                        | 307        |   |

 

The remainingunpaid amount as of April 30, 2005 of $307,000 related to the net leaseexpense due to the consolidation of excess facilities, will be paid over therespective lease terms through June 2006 using cash from operations.  The current and long-term portions of therestructuring accrual of $267,000 and $40,000 are classified as “AccruedLiabilities” and “Other Liabilities,” respectively, in the condensedconsolidated balance sheet as of April 30, 2005.

 

We continually evaluatethe balance of the restructuring reserve it records in prior periods based onthe remaining estimated amounts to be paid. Differences, if any, between the estimated amounts accrued and theactual amounts paid will be reflected in operating expenses in future periods.

 

•                  *Other Charges.*  During the firstquarter of fiscal 2004, we incurred residual costs of approximately $76,000 foroperating expenses, mainly legal and accounting, relating to an acquisitionthat we ceased pursuing.  

 

*Interest Income*

 
| ** **                      | ** ** | **Three Months Ended April 30,** | ** ** | **Nine Months Ended April 30,** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **2005**                              | ** ** | **Percent  Change**                  | ** ** | **2004** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** |
| ** **                      | ** ** | **(In thousands, except percentage)** | ** ** |
| Interest income                 |       | $                                     | 304        |                                 | 77.8       | % | $ | 171 |   | $ | 813 |   | 98.3 | % | $ | 410 |   |
| As percentage of  total revenue |       | 2.0                                   | %          |                                 |       | 1.6 | % | 1.8 | % |   |   | 1.4 | % |
|                                 |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Interest income represents interest earned on cash andshort-term investments and realized gains on miscellaneous investments. Theincrease in net interest income was due to an increase in balances of cash andinvestments mainly from the realized proceeds from issuance of convertiblesenior notes during fiscal 2004.

 

35

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*Interest Expense*

 
| ** **                      | ** ** | **Three Months Ended April 30,** | ** ** | **Nine Months Ended April 30,** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **2005**                              | ** ** | **Percent  Change**                  | ** ** | **2004** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** |
| ** **                      | ** ** | **(In thousands, except percentage)** | ** ** |
| Interest expense                |       | $                                     | (389       | )                                    | (292.9     | )% | $ | (99 | ) | $ | (907 | ) | (816.2 | )% | $ | (99 | ) |
| As percentage of  total revenue |       | (2.6                                  | )%         |                                 |       | (0.9 | )% | (2.1 | )% |   |   | (0.3 | )% |
|                                 |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Interest expense for three and nine months ended April 30,2005 and 2004 reflects interest charge associated with the convertible seniornotes we issued in March 2004.

 

*Other, Net*

 
| ** **                      | ** ** | **Three Months Ended April 30,** | ** ** | **Nine Months Ended April 30,** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **2005**                              | ** ** | **Percent  Change**                  | ** ** | **2004** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** |
| ** **                      | ** ** | **(In thousands, except percentage)** | ** ** |
| Other, net                      |       | $                                     | (158       | )                                    | (59.6      | )% | $ | (99 | ) | $ | (625 | ) | (626.7 | )% | $ | (86 | ) |
| As percentage of  total revenue |       | (1.0                                  | )%         |                                 |       | (0.9 | )% | (1.4 | )% |   |   | (0.3 | )% |
|                                 |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Other, net, represents amortization of debt issuancecosts, miscellaneous bank fees and charges and realized gain or loss on foreignexchange and investments. Other, net, for the three and nine months ended April 30,2005 reflects $175,000 and $495,000, respectively, of debt issuance costsamortization expense associated with the convertible senior notes we issued in March 2004and net other income of $17,000 and net other expense of $130,000,respectively, of bank charges and investment management fees, net realized gainon foreign exchange and other expenses. 

 

*Litigation Settlement Gain, Net*

 
| ** **                       | ** ** | **Three Months Ended  April 30,** | ** ** | **Nine Months Ended  April 30,** | ** ** |
|----------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                       | ** ** | **2005**                               | ** ** | **Percent  Change**                   | ** ** | **2004** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** |
| ** **                       | ** ** | **(In thousands, except percentage)**  | ** ** |
| Litigation  settlement gain, net |       | $                                      | —     |                                  | N/A        |   | $ | 1,576 |   | $ | — |   | N/A |   | $ | 1,576 |   |
| As percentage of  total revenue  |       | —                                 | %          |                                  |       | 14.3 | % | — | % |   |   | 5.4 | % |
|                                  |            |                                        |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

The gain of$1,576,000, net of $424,000 related expenses incurred, in the third quarter offiscal 2004 resulted from the settlement of litigation against ExtendedSystems.

 

*Provision for Income Taxes*  

 
| ** **                      | ** ** | **Three Months Ended April 30,** | ** ** | **Nine Months Ended April 30,** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **2005**                              | ** ** | **Percent  Change**                  | ** ** | **2004** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** |
| ** **                      | ** ** | **(In thousands, except percentage)** | ** ** |
| Provision for  Income Taxes     |       | $                                     | (317       | )                                    | 170.9      | % | $ | (117 | ) | $ | (572 | ) | 120.0 | % | $ | (260 | ) |
| As percentage of  total revenue |       | (2.1                                  | )%         |                                 |       | (1.1 | )% | (1.3 | )% |   |   | (0.9 | )% |
|                                 |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

# **Theprovision for income taxes primarily represents foreign withholding taxes onroyalties earned from certain foreign customers and state franchise and incometaxes and estimated taxes for foreign subsidiaries. **The increase in the provision for incometaxes for the three and nine months endedApril 30, 2005 was due to an increase in our international operations as aresult of our acquisitions and related increase in their net operating income.

 

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# **RecentlyIssued Accounting Pronouncements**

# ** **

*Other-Than-Temporary Impairment*

 

In March 2004, theEmerging Issues Task Force Issue (EITF) reached consensus on Issue 03-01, “*The Meaning of Other-Than-Temporary Impairment and Its Application toCertain Investments*.” EITF No. 03-01 includes new guidance forevaluating and recording impairment losses on debt and equity investments, aswell as new disclosure requirements for investments that are deemed to betemporarily impaired. The disclosure requirements are effective for fiscalyears ending after June 15, 2004. We have adopted the disclosurerequirements in fiscal 2004 accordingly and incorporated such disclosures innote 3 to consolidated financial statements included in our Annual Report on Form 10-Kfor the fiscal year ended July 31, 2004. The accounting guidance of EITF No. 03-01 is applicable forreporting periods after June 15, 2004. However, the effective date of suchguidance has been delayed until the Financial Accounting Standards Board (FASB)issues a Staff Interpretation on this matter. The delay does not have aspecified date. Until an effective date is determined, existing guidancecontinues to apply in determining if an impairment is other than temporary.  We will evaluate the impact of EITF No. 03-01once final guidance is issued. 

 

*Contingently Convertible Debt onDiluted Earnings per Share*

 

In October 2004, theEITF reached a consensus on EITF No. 04-8 “*The Effect of ContingentlyConvertible Debt on Diluted Earnings per Share,*” that thedilutive effect of contingent convertible debt instruments (“CoCo’s”) must beincluded in diluted earnings per share regardless of whether the triggeringcontingency has been satisfied, if dilutive. Adoption of EITF No. 04-08 would be on a retroactive basis andwould require restatement of prior period diluted earnings per share, subjectto certain transition provisions. It is effective for all periods ending after December 15,2004.  Due to the losses we incurred forthe three and nine months ended April 30, 2005, diluted net loss per sharedoes not differ from basic net loss per share, since potential shares of commonstock issuable upon the conversion of the convertible debt are anti-dilutivefor all periods presented.  EITF No. 04-8could have a future impact on our results of operations in the event that thepotential shares of common stock issuable upon conversion of the convertibledebt were included in the diluted earnings per share calculation. 

 

*Inventory Costs*

* *

In November 2004, theFASB issued SFAS No. 151, “*Inventory Costs - anamendment of ARB No. 43, Chapter 4,”* that requires that itemssuch as idle facility expense, excessive spoilage, double freight and handlingcosts be recognized as current period charges.  In addition, it requires that allocation offixed production overheads to the costs of conversion be based on the normalcapacity of the production facilities. SFAS No. 151 will be effective infiscal years beginning after June 2005.  We expect SFAS No. 151 to have no materialeffect on our consolidated financial statements. 

 

*Discontinued Operations*

* *

In November 2004, the EITF reached a consensus onNo. 03-13, *“Applying the Conditions inParagraph 42 of FASB Statement No. 144 in Determining Whether to ReportDiscontinued*Operations.” EITF No. 03-13 relates to components of an enterprise that areeither disposed of or classified as held for sale in fiscal periods beginningafter December 15, 2004. EITF No. 03-13 allows significant events orcircumstances that occur after the balance sheet date but before the issuanceof financial statements to be taken into consideration in the evaluation ofwhether a component should be presented as discontinued or continuingoperations, and modifies assessment period guidance to allow for an assessmentperiod greater than one year.  Theconsensus in EITF No. 03-13 was effective for us beginning February 1,2005. The impact to us of adopting EITF Issue No. 03-13 will depend on thenature and extent of any long-lived assets disposed of or held for sale afterthe effective date, but we do not currently expect EITF No. 03-13 to havea material impact on our consolidated results of operations, cash flows orfinancial position. 

 

37

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*Exchanges of Nonmonetary Assets*

* *

In December 2004,the FASB issued SFAS No. 153, *“Exchanges of NonmonetaryAssets, an amendment of APB Opinion No. 29, Accounting for NonmonetaryTransactions.*”  SFAS No. 153states that exchanges of nonmonetary assets should be measured based on thefair value of the assets exchanged. Further, SFAS No. 153 eliminates the narrow exception fornonmonetary exchanges of similar productive assets and replaces it with abroader exception for exchanges of nonmonetary assets that do not have commercialsubstance. SFAS No. 153 is effective for nonmonetary asset exchangesoccurring in fiscal periods beginning after June 15, 2005. Earlierapplication is permitted for nonmonetary asset exchanges occurring in fiscalperiods beginning after the date of issuance. The provisions of SFAS No. 153shall be applied prospectively. We do not believe the adoption of SFAS No. 153will have a significant impact on our consolidated results of operations orfinancial position. 

 

*Share-Based Payment*

* *

In December 2004,the FASB issued SFAS No. 123R, *“Share-BasedPayment, an amendment of FASB Statements No. 123 and 95.”*  The principal effect of SFAS No. 123Rwill be to require the inclusion in the earnings of a compensation expense forstock option grants and employee stock plan purchases that previously was onlyreported as a disclosure in a note to our consolidated financial statements. Weare required to adopt the provisions of SFAS No. 123R as of August 1,2005 but may elect to early adopt the provision effective the first day of anyquarter prior to that date. We are presently studying SFAS No. 123R andhave not yet determined which method we will select for our adoption ofSFAS No. 123R, which we expect to have a potential material impact onour annual earnings.

 

StaffAccounting Bulletin (SAB) No. 107,*“Share-BasedPayment.” *On March 29,2005, the SEC staff issued SAB No. 107 to express the views of the staffregarding the interaction between SFAS No. 123R and certain SEC rules andregulations and to provide the staff’s views regarding the valuation ofshare-based payment arrangements for public companies.  We are currently in the process ofimplementing SFAS No. 123R, effective as of August 1, 2005, and willtake into consideration the additional guidance provided by SAB No. 107 inconnection with the implementation of SFAS No. 123R.

 

*Tax Deduction Provided For In theAmerican Jobs Creation Act of 2004*

* *

In December 2004,the FASB issued FASB Staff Position No. 109-1, “*Applicationof SFAS No. 109 to the Tax Deduction on Qualified Production ActivitiesProvided by the American Jobs Creation Act of 2004.*”  This staff position provides guidance for theaccounting of a deduction provided to U. S. manufacturing companies and iseffective immediately.  We believe theadoption of this position currently will not have a material effect on ourfinancial position or results of operations due to our net operatinglosses.  However, there is no assurancethat there will not be a material impact in the future. 

 

*ForeignEarnings Repatriation Provision within the American Jobs Creation Act of 2004*

* *

In December 2004,the FASB issued FASB Staff Position No. 109-2, *“Accounting and Disclosure Guidance for the Foreign EarningsRepatriation Provision within the American Jobs Creation Act of 2004”.*TheAmerican Jobs Creation Act introduces a special one-time dividends receiveddeduction on the repatriation of certain foreign earnings to a U.S. taxpayer(repatriation provision), provided certain criteria are met. This positionprovides accounting and disclosure guidance for the repatriation provision. Wedo not believe the Foreign Earnings Repatriation Provision within the AmericanJobs Creation Act of 2004 nor will the FASB Staff Position have a materialimpact on our financial condition or results of operations.

 

*Accountingfor Conditional Asset Retirement Obligations, an interpretation of FASBStatement No. 143*

 

In March 2005, the FASB issued Interpretation (FIN)No. 47, *“Accounting for Conditional Asset RetirementObligations, an interpretation of FASB Statement No. 143*.”  FIN No. 47 clarifies when an entity wouldbe required to recognize a liability for the fair value of an asset retirementobligation that is conditional on a future event if the liability’s fair valuecan be reasonably estimated. Uncertainty surrounding the timing and method ofsettlement that

 

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may be conditional onevents occurring in the future would be factored into the measurement of theliability rather than the recognition of the liability.  FIN No. 47 is effective for fiscal yearsending after December 15, 2005.  We arecurrently assessing the impact that the interpretation may have on ourconsolidated financial position and results of operations.

 

**Liquidityand Capital Resources**

 

*Working Capital*

 

The following summarizes our cash and cashequivalents, short-term investments and working capital:

 

| ** **                 | ** ** | **April 30,   2005**                              | ** ** | **Percent   Change** | ** ** | **July 31,   2004** | ** ** |
|----------------------------|------------|---------------------------------------------------|------------|----------------------|------------|---------------------|------------|
| ** **                 | ** ** | **(In thousands, except percentages and ratios)** | ** ** |
| Cash and cash  equivalents |       | $                                                 | 23,910     |                 | 84.1       | %                   | $          | 12,991 |   |
| Short-term  investments    |       | $                                                 | 23,235     |                 | (42.9      | )%                  | $          | 40,657 |   |
| Working capital            |       | $                                                 | 46,041     |                 | (10.9      | )%                  | $          | 51,693 |   |
| Current ratio              |       | 4.0                                               |       | —               |       | 4.5                 |       |

 

We invest excess cash in fixed income securities thatare highly liquid, of high-quality investment grade. We intend to make suchfunds readily available for operating purposes, if needed. In addition to theabove cash, cash equivalents and short-term investments at April 30, 2005, wehave a total of $3,797,000 restricted cash that is pledged as collateral forcertain stand-by letters of credit issued by certain financial institutions andcollateral to match any unfavorable mark-to-market exposure on an interest swapagreement. Refer to the discussion under the caption “*RestrictedCash*” set forth below for more information.

 

The significant factorsunderlying the decrease in cash, cash equivalents and investments during thefirst three quarters of fiscal 2005 were the acquisition of Tourmaline for$4,095,000, net cash flow used in operations of $1,849,000 and capitalacquisitions of $1,412,000, slightly offset by the proceeds from stock issuanceof $1,204,000.

 

*Cash Flows*

 

*Operating Activities.* Cash flowsfrom operating activities are as follows (in thousands):

 

| ** **                             | ** ** | **Nine Months Ended April 30,** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **2005**                        | ** ** | **Change** | ** ** | **2004** | ** ** |
| Net cash used in  operating activities |       | $                               | (1,849     | ) | $ | 5,907 |   | $ | (7,756 | ) |
|                                        |            |                                 |            |  |  |  |  |  |  |  |

 

The majority ofcash applied to cash working capital for the current fiscal year resulted from adecrease in accrued liabilities of $1,553,000 and an increase in accounts receivableof $1,081,000 for the first three quarters of fiscal 2005.  Accrued liabilities decreased due to the useof restructuring accrual, the timing of commissions and bonus payments, andlower accruals.  We have not experiencedany significant trends in accounts receivable other than changes relative tothe increase in our revenue. Fluctuations in accounts receivable from period to period relative tochanges in revenue are a result of timing of customer invoicing and receipt ofpayments from customers.  Days salesoutstanding decreased to 68 days in the current quarter compared with 76 daysin the corresponding quarter of fiscal 2004. The majority of cash applied to cash working capital for fiscal 2004resulted from an increase in accounts receivable of $1,628,000, as well asdecrease in accrued liabilities and accounts payable of $5,370,000 due totiming of payments particularly of litigation costs and other expensesassociated with acquisitions for the first three quarters of fiscal 2004.

 

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*Investing Activities.* Significantitems included in cash flows from investing activities are as follows (inthousands):

 

| ** **                                           | ** ** | **Nine Months Ended April 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                           | ** ** | **2005**                        | ** ** | **Change** | ** ** | **2004** | ** ** |
| Net  sale/maturities of short-term investments       |       | $                               | 17,395     |   | $ | 37,210 |   | $ | (19,815 | ) |
| Increase in  restricted cash                         |       | (61                             | )          | 3,648 |   | (3,709 | ) |
| Capital  expenditures                                |       | (1,412                          | )          | (971 | ) | (441 | ) |
| Acquisitions,  net of cash acquired                  |       | (4,095                          | )          | 13,856 |   | (17,951 | ) |
| Net cash  provided by (used in) investing activities |       | $                               | 11,827     |   | $ | 53,743 |   | $ | (41,916 | ) |

 

The net cash flows provided in investing activitiesduring first three quarters of fiscal 2005 were due primarily to cash movementbetween investments and cash and cash equivalents, slightly offset byTourmaline acquisition, capital expenditures and the increase in restrictedcash associated with a collateral under an interest rate swap agreement.

 

On March 1, 2005, we completed our acquisition of allof the issued and outstanding stock of Tourmaline Networks, Inc., a privatelyheld developer and marketer of mobile email based on QUALCOMM’s BREW® solutionheadquartered in San Diego, California. Under the terms of an Agreement and Plan of Merger, dated as of February9, 2005, the outstanding shares of Tourmaline common stock were converted intothe right to receive (i) an aggregate of approximately $4,118,000 in aggregateinitial cash consideration and (ii) an aggregate of up to $2,881,918 in cash earnoutconsideration, subject to the deposit of a certain portion of the initial cashconsideration and earnout consideration in escrow to be available to compensateIntellisync pursuant to the indemnification obligations of the holders ofTourmaline common stock.  The earnoutconsideration is due and payable shortly following the first anniversary of theacquisition.

 

*Financing Activities.* Significantitems included in cash flows from financing activities are as follows (inthousands):

 

| ** **                                                               | ** ** | **Nine Months Ended April 30,** | ** ** |
|--------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                               | ** ** | **2005**                        | ** ** | **Change** | ** ** | **2004** | ** ** |
| Proceeds from  stock option exercises                                    |       | $                               | 1,204      |   | $ | (992 | ) | $ | 2,196 |   |
| Proceeds from  long-term debt                                            |       | —                          |       | (60,000 | ) | 60,000 |   |
| Debt issuance  costs and repayment of capital lease and other borrowings |       | (321                            | )          | 4,339 |   | (4,660 | ) |
| Net cash  provided by financing activities                               |       | $                               | 883        |   | $ | (56,653 | ) | $ | 57,536 |   |

 

During the first three quarters of fiscal 2005, cashflow generated from financing activities was primarily from stock optionexercises.  Our future cash flows fromstock options are difficult to project as such amounts are a function of ourstock price, the number of options outstanding, and the decisions by employeesto exercise stock options. In general, we expect proceeds from stock optionexercises to increase during periods in which our stock price has increasedrelative to historical levels.

 

Refer to the caption *“Commitments”*below for more details on the $60,000,000 convertible senior notes issued infiscal 2004.

 

*Commitments*

 

*CapitalLeases. *During thefirst quarter of fiscal 2005, we entered into a capital lease agreement forcomputer peripherals, which expires in September 2007.  In addition, during fiscal 2004, we enteredinto a capital lease agreement for a phone system, which expires in February2008.  Current and long-term portions ofthe capital leases amounted to $149,000 and $250,000, respectively, at April 30,2005.

 

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*Operating Leases.* We lease ourfacilities under operating leases that expire at various dates through December2008. The leases provide for escalating lease payments.

 

# ***3% Convertible Senior Notes.***  During thethird quarter of fiscal 2004, we completed the offering of $60,000,000 ofconvertible senior notes to qualified institutional buyers in reliance on Rule144A under the Securities Act.  The notesare convertible into shares of our common stock at any time prior to the closeof business on the final maturity date of the notes, subject to priorredemption of the notes. The initial conversion rate is 250.0000 shares pereach $1,000 principal amount of notes which represents an initial conversionprice of $4.00 per share. The conversion rate is subject to adjustment for certainevents, including the payment of dividends, and other events specified in theindenture.  The notes bear interest at arate of 3% per annum. Interest on the notes will be paid on March 1 and onSeptember 1 of each year.

 

*Interest RateSwap. *Duringfiscal 2004, we entered into two interest rate swap agreements with a financialinstitution on a total notional amount of $60,000,000, whereby we receivefixed-rate interest of 3% in exchange for variable interest payments.  The interest rate swaps expire upon thematurity of the $60,000,000, 3% convertible senior notes in March 2009, andeffectively convert fixed-rate notes into variable-rate borrowings. Theinterest rate is reset semi-annually and is equal to the 6-month LIBOR rateless a rate spread.  The total variableinterest rate, approximately 2.9% at April 30, 2005, resulted in interestexpense savings relative to fixed rates of approximately $486,000 for the firstthree quarters of fiscal 2005.  Under theprovisions of SFAS No. 133, “*Accounting for DerivativeInstruments and Hedging Activities*,” as amended, this arrangementhas been designated and qualifies as an effective fair value hedge of interestrate risk related to the $60,000,000 convertible senior notes. As the terms ofthe swaps match those of the underlying hedged debt, the changes in the fairvalue of these swaps are offset by corresponding changes in the carrying valueof the hedged debt, and therefore does not impact our net earnings. As of April30, 2005, the fair value of the interest rate swaps was approximately $2,116,000and recorded in “Other Liabilities” with an equal adjustment recorded to thecarrying value of the $60,000,000 convertible senior notes.

 

The followingtable summarizes our material obligations and commitments to make futurepayments, for which we anticipate using cash from operations, under certaincontracts, including long-term debt obligations and operating leases as of April30, 2005 (in thousands):

 
| ** **                  | ** ** | ** ** | ** ** | **Three months**  | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------|------------|------------|------------|-------------------|------------|---------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                  | ** ** | ** ** | ** ** | **ending**        | ** ** | **Fiscal year ending July 31,** | ** ** |
| ** **                  | ** ** | **Total**  | ** ** | **July 31, 2005** | ** ** | **2006**                        | ** ** | **2007**   | ** ** | **2008**   | ** ** | **2009**   | ** ** |
| Long-term debt(1):          |       |       |       |              |       |                            |       |       |       |       |       |       |       |
| Principal                   |       | $          | 60,000     |              | $          | —                          |       | $          | —     |       | $          | —     |       | $ | — |   | $ | 60,000 |   |
| Interest                    |       | 9,396      |       | —            |       | 1,947                           |       | 2,380      |       | 2,502      |       | 2,567      |       |
| Capital lease obligation(2) |       | 438        |       | 44                |       | 177                             |       | 177        |       | 40         |       | —     |       |
| Operating  leases:          |       |       |       |              |       |                            |       |       |       |       |       |       |       |
| Operating leases            |       | 5,225      |       | 924               |       | 2,786                           |       | 766        |       | 544        |       | 205        |       |
| Proceeds from  subleases    |       | (162       | )          | (116              | )          | (46                             | )          | —     |       | —     |       | —     |       |
| Net operating leases        |       | 5,063      |       | 808               |       | 2,740                           |       | 766        |       | 544        |       | 205        |       |
| Total                       |       | $          | 74,897     |              | $          | 852                             |       | $          | 4,864      |       | $          | 3,323      |       | $ | 3,086 |   | $ | 62,772 |   |

 

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(1)Represents our 3% convertible senior notes and the associated interest rateswap.  Interest on the senior notes andinterest rate swap is payable in cash on March 1 and September 1 of each year.  The senior notes mature on March 1, 2009.

(2)Includes interest payments due. 

 

In the event of early termination of our serviceagreement with eˆdeltacom, a division of ITC^DeltaCom, Inc. and a managedservice provider, we may be required to pay eˆdeltacom a penalty fee of up toapproximately $45,000.

 

*Capital Expenditures*

 

We expect total capitalexpenditures of approximately $600,000 for the three months ending July 31,2005 principally for support of the hosting operations and purchase ofcomputers and other various system upgrades.

 

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*Restricted Cash*

 

We havethree letters of credit that collateralize certain operating lease obligationsand total approximately $369,000 and $397,000 at April 30, 2005 and July 31,2004, respectively.  We collateralizethese letters of credit with cash deposits made with three of its financialinstitutions and has classified the short-term and the long-term portions ofapproximately $187,000 and $182,000 at April 30, 2005, and $101,000 and$296,000 at July 31, 2004 as “Other Current Assets” and  “Restricted Cash,” respectively, in thecondensed consolidated balance sheets. The long-term portion expires through June 2006.  The holders of the letters of credit are ableto draw on each respective letter of credit in the event that we are found tobe in default of its obligations under each of its operating leases.

 

Under the terms of the interest rate swap agreementinto which we entered during fiscal 2004, we must provide collateral to matchany unfavorable mark-to-market exposure (fair value) on the swap. The amount ofcollateral required totals a minimum of $1,800,000 plus an amount equal to theunfavorable mark-to-market exposure on the swap. Generally, the requiredcollateral will rise as interest rates rise. As of April 30, 2005, and July 31,2004, we have posted approximately $3,797,000 and $3,736,000, respectively, ofcollateral under this swap agreement which is included in “Restricted Cash” inits condensed consolidated balance sheet.

 

*Litigation*

 

In August 2004, a patent-infringement claim wasfiled against us by NCR Corporation in the U.S. District Court for the SouthernDistrict of Ohio. In the complaint, NCR alleged certain of our productsinfringe three of its patents which cover technology for synchronizingdatabases between personal digital assistants and host computers. Based on alengthy review, we believe that NCR’s claims against it are without merit andwe do not infringe on any of the asserted NCR patents. We do not believe thatthe outcome of this patent infringement claim, even if adverse to us, wouldhave a material adverse effect on our results of operations and financialcondition. Separately, on September 9, 2004, we filed a complaint in theU.S. District Court for the Northern District of California against NCRrequesting, among other things, that a declaratory judgment beentered finding that we do not infringe an NCR patent (6,473,765)that was asserted against one of our licensees, Garmin Ltd.  We havecertain indemnification obligations to Garmin for claims related tointellectual property infringement.  In response, NCR amended its suitagainst Garmin to withdraw its allegation of infringement of the ‘765 patentand stated that we have no liability to NCR for infringement of the ‘765patent.  NCR then moved to dismiss the California case on the basis that,because we could not be sued for infringement, the Court lacked jurisdiction toadjudicate our declaratory judgment action.  The motion was granted andthe California case was dismissed on November 22, 2004.

 

We are alsoinvolved in various litigation and claims arising in the normal course ofbusiness.  In management’s opinion, thesematters are not expected to have a material impact on our consolidated results ofoperations or financial condition.

 

We believe that ourcurrent cash, cash equivalents and short-term investment balances, includingcash generated from operations, if any, will be sufficient to meet our workingcapital and other cash requirements for at least the next 12 months. Beyond thenext 12 months, we expect our cash flow from operations and the remainingproceeds from the convertible senior notes we issued in fiscal 2004 to remainsufficient to fund any ongoing investments in capital equipment and interestpayments on our notes. There are no arrangements and other relationships withunconsolidated entities or other persons that are reasonably likely tomaterially affect liquidity or the availability of our requirements forcapital.

 

We believe that the moststrategic uses of our cash resources include strategic investments to gainaccess to new technologies, acquisitions, financing activities, and workingcapital. Therefore, from time-to-time, we may consider additional acquisitionsand a wide range of other business opportunities. To the extent that ourcurrent cash, cash equivalents and short-term investment balances and cash flowfrom operations are insufficient to fund any new acquisition, businessopportunity or venture, as well as to fund future operating requirements, wemay seek to raise cash through further issuance of debt or equity securities.We cannot be certain that such financing would be available to us at all, or onterms favorable to us.

 

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**Factors That May Affect FutureOperating Results**

 

There are many factorsthat affect our business and the results of our operations, some of which arebeyond our control.  The following is adescription of some of the important factors that may cause the actual resultsof our operations in future periods to differ materially from those currentlyexpected or desired.

 

***Wehave historically incurred losses and we expect these losses to continue in thefuture. We may not be able to sustain consistent future revenue growth on aquarterly or annual basis, or achieve or maintain profitability.***

 

We have not beenprofitable since fiscal 1998. We cannot be certain that our revenue willcontinue to grow or remain at the same level, or that our revenue will notdecline in the future. We have experienced losses of $4,361,000 and $8,841,000for the three and nine months ended April 30, 2005, respectively, and $2,184,000and $7,697,000 for the corresponding periods in fiscal 2004.  At April 30, 2005, we had an accumulateddeficit of $140.0 million. To become profitable and sustain profitability, wewill need to generate additional revenue to offset our expenses. We may notachieve or sustain revenue growth and our losses may continue or increase inthe future. The synchronization market is new and evolving, and as a result wecannot accurately predict either the future growth rate, if any, or theultimate size of the market for our products and services. Because ouroperating expenses are relatively fixed in the short term, any shortfalls inrevenue would materially affect our results of operations.

 

***Ourquarterly revenue and operating results are subject to significantfluctuations, and our stock price may decline if we do not meet theexpectations of investors and analysts.***

 

Our quarterly revenue andoperating results are difficult to predict and have and may in the futurefluctuate significantly from quarter to quarter due to a number of factors,many of which are outside our control. These factors include, but are notlimited to:

 

•                  marketacceptance of products in which our software is integrated by originalequipment manufacturers, or OEMs;

 

•                  growthin the market for enterprise synchronization applications and our ability tosuccessfully address this market;

 

•                  ourreliance on international sales and growth;

 

•                  ourability to penetrate the international market;

 

•                  ourability to realize our goals with respect to recent and potential futureacquisitions;

 

•                  ourneed and ability to generate and manage growth;

 

•                  rapidevolution of technology;

 

•                  ourevolving business model;

 

•                  litigation-relatedexpenses;

 

•                  fluctuationsin gross margins;

 

•                  theseasonal nature of the market for some of our products;

 

•                  changesin the market for mobility and identity search/screening software;

 

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•                  introductionof new products and services by us or our competitors;

 

•                  therecent decline in the market for traditional personal digital assistants;

 

•                  changesin our mix of sources of revenue; and

 

•                  entrenchedand substantial competition.

 

Additionally, wegenerally derive our technology licensing revenue from multi-year contractswith enterprise and other customers that frequently include license fees,professional services fees, royalty payments and maintenance. We typically earnboth the license fees and the professional services in the initial one or twoquarters subsequent to the signing of a contract. We periodically have largeprofessional services implementations that individually contribute as much as5% or more to quarterly revenue. Combined with related license revenue, totalrevenue from individual customers in the initial quarters of a contract mayexceed the revenue we earn during subsequent periods covered by the contract.To the extent that we do not secure additional contracts with the same customeror secure comparably sized commitments from other customers, we may not be ableto sustain or grow our revenue.

 

***If wefail to develop and sell products designed for OEMs, enterprises and mobilecarriers, our revenue and operating results will be adversely affected.***

 

We have recentlymade substantial investments to develop and offer an expanded range ofenterprise synchronization applications, including our acquisition ofSynchrologic and Identity Systems. Our operating plans assume revenue growthfrom the enterprise market. Enterprise sales present a variety of challengesthat are different from those inherent in our historical licensing and consumerbusiness model, and we have limited experience addressing these challenges. Forexample, enterprise sales typically involve large up-front license fees, whichcan result in lengthy sales cycles and uncertainties as to the timing of salesdriven by customers’ budgetary processes. As a result, we generally have lessvisibility into future enterprise sales than is typically the case in ourroyalty-based technology licensing business. In addition, while enterprisesales generally result in ongoing maintenance revenue and may lead to follow-onpurchases or upgrades, we are typically dependent on sales to new customers fora significant portion of our enterprise revenue in a given quarter. If ourproduct and service offerings fail to achieve market acceptance, or ifenterprise sales fail to meet our expectations in a particular quarter, ourrevenue and operating results may be materially and adversely affected.

 

***Ourbusiness and prospects depend, to a significant degree, on demand for wirelessand other mobile computing devices.***

 

The use of wireless andother mobile computing devices for retrieving, sharing and transferringinformation among businesses, consumers, suppliers and partners has begun todevelop only in recent years. Our success will depend in large part oncontinued growth in the use of wireless and other mobile computing devices,including handheld computers, smart phones, pagers and other mobile devices. Inaddition, our markets face critical unresolved issues concerning the commercialuse of wireless and other mobile computing devices, including security,reliability, cost, ease of access and use, quality of service, regulatoryinitiatives and necessary increases in bandwidth availability. Demand for, andmarket acceptance of, wireless and other mobile computing devices which requireour products and services are subject to a high level of uncertainty and aredependent on a number of factors, including:

 

•                  growthin sales of handheld devices, smart phones and other mobile computing devicessupported by our software and growth in wireless network capabilities to matchend-user demand and requirements;

 

•                  emergenceof a viable and sustainable market for wireless and mobile computing services;

 

•                  ourproduct and service differentiation and quality;

 

•                  thedevelopment of technologies that facilitate interactive communication betweenorganizations;

 

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•                  ourdistribution and pricing strategies as compared with those of our competitors;

 

•                  thegrowth in access to, and market acceptance of, new interactive technologies;

 

•                  increasesin bandwidth for data transmission;

 

•                  theeffectiveness of our marketing strategy and efforts;

 

•                  ourindustry reputation; and

 

•                  generalindustry and economic conditions such as slowdowns in the computer or softwaremarkets or the economy in general.

 

If the market forwireless and other mobile computing devices as a commercial or business mediumdoes not develop, or develops more slowly than expected, our business, resultsof operations and financial condition will be seriously harmed.

 

Even if the wireless andmobile computing services market does develop, our products and services maynot achieve widespread market acceptance. If our target customers do not adopt,purchase and successfully deploy our other current and planned products andservices, our revenue will not grow significantly and our business, results ofoperations and financial condition will be seriously harmed.

 

***If wefail to complete our internal control evaluations or if our independentregistered public accounting firm does not attest to our evaluation in a timelymanner, we could be subject to regulatory scrutiny and a loss of publicconfidence in our internal controls.***

 

Pursuant to Section 404of the Sarbanes-Oxley Act of 2002 (“Section 404”), we have begun to perform anevaluation of our internal controls over financial reporting and are requiredto have our independent registered public accounting firm test and evaluate thedesign and operating effectiveness of such internal controls and publicly attestto such evaluation in our annual report on Form 10-K for our fiscal year endingJuly 31, 2005. We have prepared an internal plan of action for compliance withthe requirements of Section 404, which includes a timeline and scheduledactivities, although as of the date of this filing we have not yet completedthe evaluation. Compliance with the requirements of Section 404 is expected tobe expensive and time-consuming, and may require us to increase staffinglevels. If we fail to complete this evaluation in a timely manner, or if ourindependent registered public accounting firm cannot attest in a timely mannerto our evaluation, we could be subject to regulatory scrutiny and a loss ofpublic confidence in our internal controls. In addition, any failure toimplement required new or improved controls, or difficulties encountered intheir implementation, could harm our operating results or cause us to fail tomeet our reporting obligations.

 

In addition, our recentacquisitions of companies, some of which have operations outside the UnitedStates, provided us with challenges in implementing the required processes andprocedures in our acquired operations. Acquired companies may not havedisclosure controls and procedures or internal control over financial reportingthat are as thorough or effective as those required by securities law in theUnited States. We, therefore, intend to devote substantial time and haveincurred and will continue to incur substantial costs during fiscal 2005 toensure ongoing compliance. We cannot, however, be certain that we will besuccessful in complying with Section 404.

 

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***Weare placing increasing emphasis on our hosting services, of whichpotential  growth may be difficult to manageeffectively, and, as a result, our results of operations could be adverselyaffected.***

 

We areincreasingly focusing our sales and marketing and engineering efforts onhosting services.  This focus may causeincreased business risks associated specifically with our ability to manage thelevel of complexity involved in executing successfully our strategies toprovide superior services for mobile carriers. The rapid growth of our hostingbusiness may place a significant strain on our management, operations andresources. Our future performance and profitability will depend on our abilityto:

 

•                  increaseour capital investments and further build our infrastructure to meet thedemands of our carrier customers;

 

•                  maintaintechnical capabilities to compete effectively in the hosting business; and

 

•                  effectivelyoversee and manage our outsourced hosting center.

 

There can be no assurancethat our systems, procedures and controls will be adequate to support rapidexpansion of our hosting services.  If weare unable to manage such growth successfully, our business and results ofoperations could be harmed.

 

***Weexpect that we may become increasingly dependent on mobile carriers for thesuccess of our wireless software.***

 

The success of ourwireless business strategy is increasingly becoming dependent on our ability toestablish new relationships and build on our existing relationships withdomestic and international mobile carriers. We cannot assure you that we willbe successful in establishing new relationships or advancing existingrelationships with mobile carriers or that these mobile carriers will act in amanner that will promote the success of our wireless products. Factors that arelargely within the control of mobile carriers but which are important to our success,include:

 

•                  thedegree to which mobile carriers facilitate the introduction of and activelypromote, distribute and resell our products;

 

•                  testingof our products on mobile carriers’ networks;

 

•                  qualityand coverage area of wireless services offered by the mobile carriers;

 

•                  theextent to which mobile carriers require specific hardware and software featureson our products to be used on their networks;

 

•                  contractualterms and conditions imposed on us by mobile carriers that, in some circumstances,could limit our ability to make similar products available through competitivecarriers in some market segments; and

 

•                  mobilecarriers’ pricing requirements and subsidy programs.

 

Mobile carriers havesignificant bargaining power as we negotiate agreements with them. They couldrequire contract terms that are difficult for us to meet and could result inhigher costs to complete certification requirements and negatively impact ourresults of operations and financial condition. Mobile carriers also placesignificant conditions on our ability to develop and launch products for use ontheir wireless networks. If we fail to address the needs of mobile carriers,identify new product and service opportunities or modify or improve ourproducts in response to changes in technology, industry standards or mobilecarrier requirements, our products could rapidly become less competitive orobsolete. If we fail to timely develop products that meet carrier productplanning cycles or fail to deliver sufficient quantities of products in atimely manner to mobile carriers, those carriers may choose to 

 

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offer similar productsfrom our competitors and thereby reduce their focus on and cease offering ourproducts which would have a negative impact on our business, results ofoperations and financial condition.

 

In addition, thepotential rapid growth of our business, as we become more dependent on mobilecarriers, may place a strain on our management, operations, employees, orresources. We may not be able to maintain a rapid growth rate, effectivelymanage our expanding operations, or achieve planned growth on a timely orprofitable basis. If we are unable to manage our growth effectively, we mayexperience operating inefficiencies, and our net income may be materiallyadversely affected.

 

***Mostsales with mobile carriers and enterprises have a long sales cycle process,which increases the cost of completing sales and renders completion of salesless predictable.***

 

The sales cycle processwith mobile carriers could be long, making it difficult to predict the quarterin which we may recognize revenue from a sale, if at all. The general length ofthe sales cycle increases our costs and may cause license revenue and otheroperating results to vary significantly from period to period. Our products ortechnology often are part of significant strategic decisions by our customersregarding their information systems. Accordingly, the decision to license ourproducts typically requires significant pre-purchase evaluation. We spendsubstantial time providing information to prospective customers regarding theuse and benefits of our products. During this evaluation period, we may expendsignificant funds in sales and marketing efforts. If anticipated sales from aspecific customer for a particular quarter are not realized in that quarter,our operating results may be adversely affected.

 

***Revenuefrom hosting services may carry lower gross margins and an overall increase insuch revenue as a percentage of total revenue could have an adverse impact onour business.***

 

Our commitment toproviding quality services to our enterprise and mobile carrier customers mayresult in our hosting service revenue having a lower gross margin than otherservices and license revenue. Due to the lower margin, an increase in thehosting service revenue as a percentage of total revenue could have adetrimental impact on our overall gross margins and could adversely affectoperating results. In addition, a change in the mix between services that areprovided by our own employees and those services provided by third-partyvendors may negatively affect our gross margins.

 

***Systemfailures or accidental or intentional security breaches could disrupt ouroperations, cause us to incur significant expenses, expose us to liability andharm our reputation.***

 

Our operations, includinghosting services, depend upon our ability to maintain and protect our computersystems and core business applications, which are located at our offices, aswell as hosted by third-party vendors. Although we are taking variousprecautions to maintain and protect our systems, they could still be vulnerableto damage from break-ins, unauthorized access, vandalism, fire, floods,earthquakes, power loss, telecommunications failures and similar events. Wemaintain insurance against break-in, unauthorized access, vandalism, fires,floods, earthquakes and general business interruptions. The amount of coverage,however, may not be adequate in any particular case, and will not likelycompensate us for all the damages caused by these or similar events. Inaddition, while we put various security measures in place to detect anyunauthorized access to our computers and computer networks, we may be unable toprevent computer programmers or hackers from penetrating our network securityor creating viruses to sabotage or otherwise attack our computer networks fromtime to time. A breach of our security could seriously damage our operations orreputation. In addition, because a hacker who penetrates our network securitycould misappropriate proprietary information or cause interruptions in ourservices, we might be required to expend significant resources to protectagainst, or to alleviate, problems caused by hackers. We might also faceliability to persons harmed by misappropriation of secure information if it isdetermined that we did not exercise sufficient care to protect our systems.

 

Systems failure or damagecould cause an interruption of our services and result in loss of customers,difficulties in attracting new customers and could adversely impact ouroperating results. In addition, if the number of customers who purchase ourhosting services increases over time, our systems must be able to accommodateincreased usage. If we are unable to increase our capacity to accommodategrowth in usage, we could encounter system performance issues, which could harmour relationships with customers and our reputation.

 

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***Ourstock price has historically been and may continue to be volatile, which maycause you to lose money and could lead to costly litigation against us thatcould divert our resources.***

 

Stock markets haverecently experienced dramatic price and volume fluctuations, particularly forshares of technology companies. These fluctuations can be unrelated to theoperating performance of these companies. Broad market fluctuations may reducethe market price of our common stock and cause you to lose some or all of yourinvestment. These fluctuations may be exaggerated if the trading volume of ourcommon stock is low. In addition, due to the technology-intensive nature andgrowth rate of our business and the mobile computing synchronization market,the market price of our common stock has in the past and may in the future riseand fall in response to:

 

•                  quarterlyvariations in operating results;

 

•                  seasonalfluctuations on product sales;

 

•                  announcementsof technological innovations;

 

•                  announcementsof new software or services by us or our competitors;

 

•                  acquisitionsor strategic alliances by us or by our competitors;

 

•                  commencementor outcome of litigation involving us;

 

•                  changesin financial estimates by securities analysts; and

 

•                  otherevents beyond our control, including general market conditions.

 

Furthermore, ouroperating results and prospects from time to time may be below the expectationsof public market analysts or investors. Any negative change in the public’sperception of companies in the wireless communications market could depress ourstock price regardless of our operating results. Recently, companiesexperiencing high volatility or significant drops in their stock prices havefaced securities class action lawsuits when the market price of a stock hasbeen volatile. Holders of that stock have often instituted securities classaction litigation against the company that issued the stock when such stockdeclines. If any of our stockholders brought such a lawsuit against us, wecould incur substantial costs defending the lawsuit. The lawsuit could alsodivert the time and attention of our management. Further, any settlement ofsuch a lawsuit could adversely affect us.

 

***Wemay be unable to adequately protect our proprietary rights.***

 

The rights we rely uponto protect our intellectual property underlying our products and services maynot be adequate, which could enable third parties to use our technology andwould reduce our ability to compete in the market. To protect our proprietaryrights, we rely on a combination of patent, trademark, copyright and tradesecret laws, confidentiality agreements with our employees and third parties,and protective contractual provisions. These efforts to protect ourintellectual property rights may not be effective in preventing misappropriationof our technology. These efforts also may not prevent others from developingproducts or technologies similar to, competitive with, or superior to those wedevelop. Any of these results could reduce the value of our intellectualproperty. We may be forced to litigate to enforce or defend our intellectualproperty rights and to protect our trade secrets. Any such litigation could bevery costly and could distract our management from focusing on operating ourbusiness. Moreover, our business could be harmed if our patents were determinedto be invalid.

 

***Wemay be subject to intellectual property infringement claims, which are costlyto defend and could limit our ability to use certain technologies in thefuture.***

 

Third parties may assertinfringement or other intellectual property claims against us. From time totime, we receive notices from third parties alleging that our products orservices infringe proprietary rights held by them. For 

 

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example, as we announcedin August 2004, NCR Corporation has filed a complaint alleging patentinfringement in the U.S. District Court for the Southern District of OhioWestern Division (Dayton). In the complaint, NCR alleges that certain of ourproducts infringe upon three of NCR’s patents. Our customers may receive notices of patent or other infringement fromthird parties and ask for indemnification in the future. We cannot predictwhether third parties will assert claims of infringement against us, or whetherany past, present or future claims will prevent us from offering products oroperating our business as planned.

 

Separately, on September 9, 2004, we filed a complaintin the U.S. District Court for the Northern District of California against NCRrequesting, among other things, that a declaratory judgment beentered finding that we do not infringe an NCR patent (6,473,765) assertedagainst one of our licensees, Garmin Ltd., and finding that patent to beinvalid. In response, NCR amended its suit against Garmin to withdraw itsallegation of infringement of the ‘765 patent and stated that the Company hasno liability to NCR for infringement of the ‘765 patent.  NCR then movedto dismiss the California case on the basis that, because the Company could notbe sued for infringement, the Court lacked jurisdiction to adjudicate theCompany’s declaratory judgment action.  The motion was granted and theCalifornia case was dismissed on November 22, 2004.

 

Due to the inherentlyuncertain nature of intellectual property protection and the competitive areain which we operate our business, it is possible that some or all of ourproducts and services could be found to be infringing on the intellectualproperty of others. We may have to pay substantial damages, including trebledamages, for past infringement if it is ultimately determined that our productsor services infringe a third party’s proprietary rights. We may have to complywith injunctions, or stop distributing our products and services while were-engineer them or seek licenses to necessary technology, which might not beavailable on reasonable terms, or at all. We could also be subject to claimsfor indemnification resulting from infringement claims made against ourcustomers, which could increase our defense costs and potential damages. Evenif the claims are without merit, defending a lawsuit takes significant time,may be expensive and may divert management’s attention from other businessconcerns.

 

***Wehave been, are and may in the future be involved in litigation that couldresult in significant costs to us.***

 

In order to protect ourproprietary rights, we may decide to sue other companies.  Litigation proceedings are inherentlyuncertain, and we may not prevail in our defenses or claims. In addition, suchlitigation is expensive and time-consuming, and management has been in the pastand may in the future be required to spend significant time in the prosecutionof such suits. If we do not prevail in our claims, we might be forced to acceptan unfavorable settlement or judgment and even be required to reimburse othercompanies in a suit for their legal expenses in defending the suit. Anunfavorable settlement or judgment could also materially harm our ability touse existing intellectual property and severely harm our business as a result.

 

***Weface intense competition in the market for mobile computing synchronizationproducts and services, which could reduce our market share and revenue.***

 

Our market contains fewsubstantial barriers to entry. We believe we will face additional competitionfrom existing competitors and new market entrants in the future. We are subjectto current and potential competition with respect to our Intellisync HandheldEdition, Intellisync Handheld Edition for Enterprise, Intellisync Mobile Suite,Intellisync Phone Edition, Intellisync goAnywhere and Identity Search Servers.

 

•                  IntellisyncMobile Suite enterprise server software —CommonTime, Extended Systems, GoodTechnology, Inc., JP Mobile, Inc., Research In Motion Limited, Sybase Inc.’siAnywhere, and others.

 

•                  IntellisyncMobile Suite and Intellisync goAnywhere software for mobile carriers — GoodTechnology, Inc., Research In Motion Limited, Seven Networks, Inc., SmartnerInformation Systems Ltd, Visto Corporation, and others.

 

•                  Intellisyncconsumer and enterprise desktop sync products — Chapura, Inc.’s Pocket Mirror,CommonTime’s Cadenza mNotes, Extended Systems, Inc., IBM Corporation, MicrosoftCorporation ActiveSync, Palm Desktop from PalmSource, Inc., Sybase Inc.’siAnywhere, and others.

 

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•                  IntellisyncPhone Edition software — FutureDial, Inc.’s SnapSync, Susteen, Inc.’s DataPilotand others.

 

•                  IdentitySearch Server — Ascential, Dataflux, Firstlogic, Group1, IBM Corporation, IntelligentSearch Technology, Language Analysis Systems, Trillium Software, and others.

 

In addition to the directcompetition noted above, we face indirect competition from existing andpotential customers that may provide internally developed solutions for each ofour technology licensing components. As a result, we must educate prospectivecustomers as to the advantage of our products compared to internally developedsolutions. We currently face limited direct competition from major applicationsand operating systems software vendors who may in the future choose toincorporate data synchronization functionality into their operating systemssoftware, thereby potentially reducing the need for OEMs to include ourproducts in their devices. For example, Microsoft’s inclusion of certainfeatures permitting data synchronization between computers utilizing theWindows 2000, Windows Me, Windows NT or Windows XP operating systems, or theExchange 2003 platform, may have the effect of reducing revenue from oursoftware if users of these operating systems perceive that their datasynchronization needs are adequately met by Microsoft.

 

Many of our competitorshave substantially greater financial, technical and marketing resources, largercustomer bases, longer operating histories, greater brand recognition and moreestablished relationships in the industry than we do. Our larger competitorsmay be able to provide customers with additional benefits in connection withtheir products and costs, including reduced communications costs. As a result,these companies may be able to price their products and services morecompetitively than we can and respond more quickly to new or emergingtechnologies and changes in customer requirements. If we are unable to competesuccessfully against our current or future competitors, we may lose marketshare, and our business and prospects would suffer.

 

***Futuresales of our common stock, including the shares underlying the convertiblesenior notes we recently issued, may depress our stock price.***

 

If our currentstockholders sell substantial amounts of common stock in the public market, themarket price of our common stock could fall. In addition, these sales of commonstock could adversely affect the trading price of our recently issued convertiblesenior notes and impede our ability to raise funds in the future at anadvantageous price, or at all, through another sales of securities.

 

As of April 30, 2005, wehad approximately 66,629,823 shares of common stock outstanding.  Assuming that the maximum number of shares andoptions are issued and registered by us in connection with all of our recentacquisitions and assuming that all shares subject to vested options to purchasecommon stock under our stock plans are issued, additional shares of our commonstock could become issued or issuable and freely tradeable in the public marketthrough approximately April 30, 2006, as follows:

 

•                  approximately340,000 shares of our common stock that may be issued in August 2005 andFebruary 2006 under our employee stock purchase plan; and

 

•                  6,267,281shares issuable upon exercise of outstanding options that will be vested by April30, 2006.

 

In addition, conversionof some or all of the $60,000,000 aggregate principal amount of convertiblesubordinated notes that we issued in March 2004 will dilute the ownershipinterests of investors. Any sales in the public market of the common stockissuable upon such conversion could adversely affect prevailing market pricesfor our common stock.

 

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***If wefail to maintain our existing relationships or enter into new relationshipswith OEM and business development organizations, or if products offered by ourOEM partners fail to achieve or maintain market acceptance, our brand awareness,the sales of our products and use of our services would suffer.***

 

Our revenue fromtechnology licensing depend, in large part, on our ability to develop andmaintain relationships with OEMs and business development organizations thathelp distribute our products and promote our services. We depend on theserelationships to:

 

•                  distributeour products to purchasers of mobile devices;

 

•                  increasethe use of our technology licensing components;

 

•                  buildbrand awareness through product marketing; and

 

•                  marketour products and services cooperatively.

 

If the productsthat these equipment manufacturers or business development organizations sell,or if the operating systems upon which these products are based, fail toachieve or sustain market acceptance, or if any of these companies cease to useour product and service offerings in significant volumes, our product saleswould decline and our business would suffer. For example, if growth in thenumber of devices sold by our OEM partners is delayed or did not occur, ourbusiness would suffer.

 

Although several OEMs aresubject to certain contractual minimum purchase obligations, we cannot becertain that any particular OEM will satisfy its minimum obligations. Weakeningdemand from any key OEM and the inability to replace revenue provided by suchan OEM could have a material adverse effect on our business, operating resultsand financial condition. We maintain individually significant receivablebalances from major OEMs. If these OEMs fail to meet their payment obligations,our operating results could be materially and adversely affected.

 

Our agreements with OEMs,distributors, and resellers generally are nonexclusive and may be terminated onshort notice by either party without cause. Furthermore, our OEMs, distributorsand resellers are not within our control, are not obligated to purchaseproducts from us, and may represent other lines of products, includingcompeting products. A reduction in sales effort or discontinuance of sales ofour products by our OEMs, distributors, and resellers could lead to reducedsales and could materially adversely affect our operating results.

 

***Ourmarket changes rapidly due to evolution in technology and industry standards.If we do not adapt to meet the sophisticated needs of our customers, ourbusiness and prospects will suffer.***

 

The market for ourproducts and services is characterized by rapidly changing technology, evolvingindustry standards and frequent new product and service introductions. Forexample, the traditional personal digital assistant market, is declining andmay continue to do so.  Our futuresuccess will depend to a substantial degree on our ability to offer productsand services that adapt to these changing markets, incorporate leadingtechnology, address the increasingly sophisticated and varied needs of ourcurrent and prospective customers and respond to technological advances andemerging industry standards and practices on a timely and cost-effective basis.Our rapidly evolving market makes it more likely that:

 

•                  ourtechnology or products may become obsolete upon the introduction of alternativetechnologies;

 

•                  wemay not have sufficient resources to develop or acquire new technologies or tointroduce new products or services capable of competing with futuretechnologies or service offerings of other companies; and

 

•                  wemay not have sufficient resources to develop or acquire new technologies or tointroduce new products or services capable of competing with futuretechnologies or service offerings of other companies.

 

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To the extent wedetermine that new technologies and equipment are required to remaincompetitive, the development, acquisition and implementation of thesetechnologies and equipment are likely to continue to require significantcapital investment by us. Moreover, we cannot be certain that we can develop,market and deliver new products and technology on a timely basis. Sufficientcapital may not be available for this purpose in the future, and even if it isavailable, investments in new technologies may not result in commerciallyviable technological processes and there may not be commercial applications forsuch technologies. If we do not develop, acquire and introduce new products andservices and achieve market acceptance in a timely manner, our business andprospects will suffer.

 

***If wefail to maintain an effective system of internal controls, we may not be ableto detect fraud or report our financial results accurately, which could harmour business.***

 

Effective internalcontrols are necessary for us to provide reliable financial reports and todetect and prevent fraud. We periodically assess our system of internalcontrols, and the internal controls of service providers upon which we rely, toreview their effectiveness and identify potential areas of improvement. Theseassessments may conclude that enhancements, modifications or changes to oursystem of internal controls are necessary. In addition, from time to time weacquire businesses, many of which have limited infrastructure and systems ofinternal controls. Performing assessments of internal controls, implementingnecessary changes, and maintaining an effective internal controls process isexpensive and requires considerable management attention, particularly in thecase of newly acquired entities. Internal control systems are designed in partupon assumptions about the likelihood of future events, and all such systems,however well designed and operated, can provide only reasonable, and notabsolute, assurance that the objectives of the system are met. Because of theseand other inherent limitations of control systems, there can be no assurancethat any design will succeed in achieving its stated goals under all potentialfuture conditions, regardless of how remote. If we fail to implement andmaintain an effective system of internal controls or prevent fraud, we couldsuffer losses, could be subject to costly litigation, investors could loseconfidence in our reported financial information and our brand and operatingresults could be harmed, which could have a negative effect on the tradingprice of our common stock.

 

***Wemay incur significant stock-based compensation charges related to certain stockoptions and restricted stock in future periods.***

 

Based on accountingstandards involving stock compensation, we have incurred and will continue toincur non-cash accounting charges related to stock options, including thoseassociated with our cancellation/regrant programs. Those standards require usto remeasure compensation costs for such options each reporting period based onchanges in the market value of the underlying common stock. Depending uponmovements in the market value of our common stock, the variable accountingtreatment of those stock options may result in significant additional non-cashcompensation costs in future periods.

 

In addition, the FASBissued in December 2004 SFAS No. 123R, “*Share-Based Payment, anamendment of FASB Statements Nos. 123 and 95*,” that addresses the accountingtreatment for employee stock options and other share-based paymenttransactions. The statement eliminates the ability to account for share-basedcompensation transactions using Accounting Principles Board (APB) Opinion No.25, “*Accounting for Stock Issued to Employees*,”and generally requires that such transactions be accounted for using afair-value-based method and recognized as expenses. The statement and thechange in accounting treatment could result in our reporting increasedoperating expenses beginning for our next fiscal year after June 15, 2005,which would decrease any reported net income or increase any reported net loss,and could adversely affect the market price of our common stock.

 

***Weare dependent on our international operations for a significant portion of ourrevenue.***

 

International revenue,primarily from customers based in Japan and Europe, accounted for 32% of ourrevenue for the three and nine months ended April 30, 2005, and 30% and 34% forthe corresponding periods in fiscal 2004, respectively.  In the future, we may further expand ourinternational presence. As we continue to expand internationally, we areincreasingly subject to risks of doing business internationally, including:

 

•                  longerpayment cycles and problems in collecting accounts receivable;

 

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•                  seasonalreductions in business activity during the summer months in Europe and certainother parts of the world;

 

•                  unexpectedchanges in regulatory requirements and tariffs;

 

•                  exportcontrols relating to encryption technology and other export restrictions;

 

•                  reducedprotection for intellectual property rights in some countries;

 

•                  fluctuationsin currency exchange rates, against which we do not currently hedge;

 

•                  difficultiesin staffing and managing international operations; and

 

•                  anadverse effect on our provision for income taxes based on the amount and mix ofincome from international customers.

 

Our international salesgrowth will be limited if we, in the future, are unable to expand internationalsales channel management and support, customize products for local markets, anddevelop relationships with international service providers, distributors anddevice manufacturers. For example, in recent quarters we have investedsubstantially in expanding sales operations, and these investments may notgenerate offsetting increases in revenue. Even if we are able to expandinternational operations successfully, we cannot be certain that we willsucceed in maintaining or expanding international market demand for ourproducts.

 

***Geographicexpansion and growth, including the establishment of new sales or engineeringoperations, may negatively affect our overall operations and cause us to incursignificant additional costs and expenses.***

 

We establishedengineering facilities in Sofia, Bulgaria and Cluj-Napoca, Romania and, in thefuture, we may further expand our engineering or sales operations to othergeographic areas within the United States and internationally. Our expansionmay cause us to incur various costs and expenses, and may place a significantstrain upon our operating and financial systems and resources that couldmaterially adversely affect our financial results following such an expansion.We also face significant business risks related to the difficulty inassimilating new operations and the diversion of management’s attention fromother business. Additionally, if we fail to align  employee skills and populations with revenueand market requirements, it may have a material adverse impact on our businessand operating results. Moreover, these newly established operations may notcontribute significantly to our sales or earnings.

 

***Foreignexchange fluctuations could decrease our revenue or cause us to lose money,especially since we do not hedge against currency fluctuations.***

 

We believe that in thefuture, an increasing portion of our costs will be denominated in foreigncurrencies as we increase operations in Europe and open offices in othercountries. We currently do not engage in foreign exchange hedging activitiesand, although we have not yet experienced any material losses due to foreigncurrency fluctuation, a small portion of our international revenue arecurrently subject to the risks of foreign currency fluctuations, and theserisks will increase as our international revenue increases.

 

***Ourrecent and any potential acquisitions could require significant managementattention and prove difficult to integrate with our business, which coulddistract our management, disrupt our business, dilute stockholder value andadversely affect our operating results.***

 

As part of our strategy,we intend to continue to make investments in complementary companies, productsor technologies. We recently acquired Tourmaline Networks, Inc. (in March2005), SoftVision SRL’s workforce (through a transfer in June 2004), SearchSoftware America (in March 2004), Synchrologic, Inc. (in December 2003) andSpontaneous Technology, Inc. (in September 2003).  We may not realize future benefits from any ofthese acquisitions, or from any acquisition we may make in the future. If wefail to integrate successfully our past and 

 

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future acquisitions, orthe technologies associated with such acquisitions, into our company, therevenue and operating results of the combined company could be adverselyaffected. Any integration process will require significant time and resources,and we may not be able to manage the process successfully. If our customers areuncertain about our ability to operate on a combined basis, they could delay orcancel orders for our products. We may not successfully evaluate or utilize theacquired technology and accurately forecast the financial impact of anacquisition transaction, including accounting charges.

 

Acquisitions involve anumber of additional difficulties and risks to our business, including, but notlimited to, the following:

 

•                  failureto integrate management information systems, personnel, research anddevelopment and marketing, sales and support operations;

 

•                  potentialloss of key employees from Intellisync or the acquired company;

 

•                  disruptionof our ongoing business;

 

•                  potentialloss of the acquired company’s customers;

 

•                  failureto develop further the acquired company’s technology successfully, resulting inthe potential impairment of amounts capitalized as intangible assets;

 

•                  unanticipatedcosts and liabilities, including those that may arise from disputes over the earnoutprovision of the acquisition agreement;

 

•                  amortizationexpenses related to intangible assets (other than goodwill); and

 

•                  impairmentcharges under SFAS No. 142, “*Goodwill and OtherIntangible Assets*” and SFAS No. 144, “*Accountingfor the Impairment or Disposal of Long-Lived Assets.*”

 

Further, we have issuedcommon stock and paid cash for recent acquisitions and may have to pay cash,incur debt or issue equity securities to pay for any future acquisition, eachof which could affect our financial condition or the market price of our commonstock. The sale of additional equity or debt to finance such futureacquisitions could result in dilution to our stockholders. The incurrence ofindebtedness would result in increased fixed obligations and could also includecovenants or other restrictions that would impede our ability to manage ouroperations.

 

***Goodwilland other intangibles resulting from our acquisitions could become impaired.***

 

As of April 30, 2005, ourgoodwill, developed and core technology and other intangibles amounted to$93,412,000, net of accumulated amortization. We ceased to amortize ourexisting goodwill upon our adoption of SFAS No. 142 in the beginning of fiscal2003. We will amortize approximately $2,239,000 for the three months ended July31, 2005, and $8,238,000, $7,457,000, $3,839,000, $1,640,000 and $2,463,000 forfiscal 2006, 2007, 2008, 2009 and thereafter, respectively, of developed andcore technology and other intangibles. We expect, however, that amortizationexpense may increase significantly as a result of any future acquisitions. Tothe extent we do not generate sufficient cash flows to recover the net amountof any investment in goodwill and other intangibles recorded, the investmentcould be considered impaired and subject to write-off. We expect to record furthergoodwill and other intangible assets as a result of any future acquisitions wemay complete. Future amortization of such other intangible assets orimpairments, if any, of goodwill would adversely affect our results ofoperations in any given period.

 

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***Wedepend on key employees in a competitive market for skilled personnel.***

 

The success of ourbusiness will continue to depend upon certain key technical and seniormanagement personnel, including our president and chief executive officer,Woodson Hobbs; chief operating officer, Clyde Foster; chief marketing officer,Robert Gerber; chief strategy officer, Steven Goldberg; chief financialofficer, J. Keith Kitchen; and chief technology officer, Said Mohammadioun,many of whom would be extremely difficult to replace. Competition for suchpersonnel is intense, and we cannot be certain that we will be able to retainour existing key managerial, technical, or sales and marketing personnel. Theloss of these officers and other or key employees in the future might adverselyaffect our business and impede the achievement of our business objectives. Webelieve our ability to achieve increased revenue and to develop successful newproducts and product enhancements will depend in part upon our ability toattract and retain highly skilled sales and marketing and qualified productdevelopment personnel. In addition, competition for employees in our industryand geographic location could be intense. We may not be able to continue toattract and retain skilled and experienced personnel on acceptable terms. Ourability to hire and retain such personnel will depend in part upon our abilityto raise capital or achieve increased revenue levels to fund the costsassociated with such personnel. Failure to attract and retain key personnelwill adversely affect our business.

 

***Ourrevenue from consumer sales is subject to risks associated with the decliningwired PDA market and reliance on sales distribution channels.***

 

While the market forconverged mobile devices or smartphones and other wireless mobile devices hasexperienced growth recently, the market for traditional personal digitalassistants, or PDAs, has declined. In addition, Sony Corporation recentlyannounced its departure from the worldwide PDA market, dropping development ofits CLIE product line. The decline in traditional PDA sales had a direct impacton sales of our Intellisync products through the consumer and online channels,where sales of our synchronization software typically occur at the same time aPDA is purchased, or shortly thereafter. The increase in demand for smartphonesand other such devices may not offset the decline in traditional PDA sales. Ourconsumer sales are also dependent upon distribution and marketing channelsoutside our control.  There are also asignificant number of our customers that purchase our products and servicesthrough other resellers, and we anticipate they will continue to do so as weexpand our product offerings. Our sales, therefore, could also be negativelyaffected by disruptions in our relationships with resellers or disruptions inthe relationships between our resellers and customers. Resellers may alsochoose not to emphasize our products to their customers. If we are unable to offsetdeclining revenue from PDA-related software, or if we experience disruption in,or reduced selling efforts from, our distribution channels, our revenue derivedfrom consumer sales would be adversely affected.

 

***If weare unable to provide satisfactory and high quality services through ourprofessional services group, customer satisfaction and demand for our productswill suffer.***

 

Many of our customershave been successful in implementing our various technology initiatives withoutfurther provision of technical service. However, we believe that buildingstrong relationships with our customers, as well as future growth in ourproduct sales, depends on our ability to provide our customers withprofessional services, including customer support, training, consulting andinitial implementation and deployment of our products when necessary. We havean in-house professional services group and use international softwaredevelopment partners with a workforce that can perform these tasks and thatalso educates third-party systems integrators in the use of our products sothat these systems integrators can provide these services to our customers. Ifwe are unable to develop sufficient relationships with third-party systemsintegrators and other customers, unable to complete product implementations ina timely manner, or unable to provide customers with satisfactory and qualitysupport, consulting, maintenance and other services, we could face customerdissatisfaction, damage to our reputation, decreased overall demand for ourproducts and loss of revenue.

 

***Wemay have to spend substantial funds on sales and marketing in the future.***

 

To increase awareness forour new and existing products, technology and services, we may have to spendsignificantly more on sales and marketing in the future. We also plan tocontinue to leverage our relationships with industry leaders and to expand anddiversify our sales and marketing initiatives to increase our sales to mobilecarriers and enterprises. If our marketing strategy is unsuccessful, we may notbe able to recover these expenses or even generate any revenue. We will berequired to develop a marketing and sales campaign that will effectively 

 

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demonstrate theadvantages of our products, technology and services. We may also elect to enterinto agreements or relationships with third parties regarding the promotion ormarketing of our products, technology and services. We cannot be certain thatwe will be able to establish adequate sales and marketing capabilities, that wewill be able to enter into marketing agreements or relationships with thirdparties on financially acceptable terms, or that any third parties with whom weenter into such arrangements will be successful in marketing and promoting theproducts, technology and services offered by us.

 

***Ourproducts may contain errors that could subject us to product-related claims.***

 

Our products may containundetected errors or failures, which can result in loss of or delay in marketacceptance and could adversely impact future operating results. Our insurancemay not cover us for certain claims related to product failures. Although ourlicense agreements contain provisions limiting our liability in the case ofdamages resulting from use of the software, in the event of such damages, wemay be found liable, and in such event, such damages could materially affectour business, operating results and financial condition.

 

***Wemay need to raise additional capital in the future resulting in dilution to ourstockholders.***

 

We may need toraise additional funds for our business operations and to execute our businessstrategy. We may seek to sell additional equity or debt securities or to obtainan additional credit facility. The sale of additional equity or convertibledebt securities could result in additional dilution to our stockholders. Ifadditional funds are raised through the issuance of debt securities, thesesecurities could have rights that are senior to holders of common stock and couldcontain covenants that would restrict our operations. Any additional financingmay not be available in amounts or on terms acceptable to us, if at all.

 

***Wemay not have sufficient cash flow to make payments on any debt we may incur.***

 

Our ability to pay principaland interest on our existing and any future indebtedness and to fund ourplanned capital expenditures depends on our future operating performance. Ourfuture operating performance is subject to a number of risks and uncertaintiesthat are often beyond our control, including general economic conditions andfinancial, competitive and regulatory factors. Consequently, we cannot assureyou that we will have sufficient cash flow to meet our liquidity needs,including making payments on existing and any future indebtedness.

 

***Thefundamental change redemption rights in our outstanding convertible seniornotes could discourage a potential acquirer.***

 

If we engage in anytransaction or event in connection with which all or substantially all of ourcommon stock is exchanged for, converted into, acquired for or constitutessolely the right to receive, consideration which is not all or substantiallyall common stock listed on a United States national securities exchange orapproved for quotation on the Nasdaq National Market or any similar UnitedStates system of automated dissemination of quotations of securities prices,or, if for any reason, our common stock is no longer listed for trading on aUnited States national securities exchange nor approved for trading on theNasdaq National Market (a “fundamental change”), we may be required to redeemall or part of the notes and this could discourage a potential acquirer.However, this redemption feature is not the result of management’s knowledge ofany specific effort to obtain control of us by means of a merger, tender offeror solicitation, or part of a plan by management to adopt a series ofanti-takeover provisions. The term “fundamental change” is limited to specifiedtransactions and may not include other events that might adversely affect ourfinancial condition or business operations. Our obligation to offer to redeemthe notes upon a fundamental change would not necessarily afford you protectionin the event of a highly leveraged transaction, reorganization, merger orsimilar transaction involving us.

 

***Wemay not have the ability to raise the funds necessary to finance thefundamental change redemption option associated with our outstandingconvertible senior notes.***

 

If we engage in anytransaction or event in connection with which all or substantially all of ourcommon stock is exchanged for, converted into, acquired for or constitutessolely the right to receive consideration which is not all or substantially allcommon stock listed on a United States national securities exchange or approvedfor quotation on 

 

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the Nasdaq NationalMarket or any similar United States system of automated dissemination ofquotations of securities prices, or, if for any reason, our common stock is nolonger listed for trading on a United States national securities exchange norapproved for trading on the Nasdaq National Market, we may be required toredeem all or part of the notes. We may not have enough funds to pay theredemption price for all tendered notes. In addition, any credit agreement orother agreements relating to our indebtedness may contain provisionsprohibiting redemption of the notes under certain circumstances, or expresslyprohibit our redemption of the notes upon a designated event or may providethat a designated event constitutes an event of default under that agreement.Our failure to redeem tendered notes would constitute an event of default underthe indenture, which might also constitute a default under the terms of ourother indebtedness.

 

***Ourcertificate of incorporation, our bylaws, Delaware law and our stockholderrights plan contain provisions that could discourage a takeover.***

 

Provisions of ourcertificate of incorporation, our bylaws, Delaware law and our stockholderrights plan contain provisions that may discourage, delay or prevent a mergeror acquisition or other change of control that a stockholder may considerfavorable.

 

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**Item 3****.****           Quantitativeand Qualitative Disclosures About Market Risk**

 

We are exposed toa variety of risks, including changes in interest rates and foreign currencyfluctuations, which could impact our results of operations and financialcondition.

 

*Interest Rate Risk*

 

At April 30, 2005, we hadan investment portfolio of mostly fixed income securities, including thoseclassified as cash equivalents and securities available-for-sale, of $36,308,000.These securities, like all fixed income instruments, are subject to interestrate risk and will fall in value if market interest rates increase. If marketinterest rates were to increase immediately and uniformly by 10% from levels asof April 30, 2005, the decline of the fair value of the portfolio would beimmaterial. We attempt to mitigate risk by holding our fixed income investmentsuntil maturity to avoid recognizing an adverse impact in income or cash flowsin the event of an increase in market interest rates, but an increase in ourliquidity needs may require us to sell fixed-rate securities prior to maturity.

 

The table belowpresents the carrying value (which approximates fair value) and relatedweighted average coupon interest rates for our investment portfolio at April 30,2005 (in thousands, except interest rates).

 

| ** **                                                           | ** ** | **Carrying   Amount** | ** ** | **Average Coupon   Interest Rate** | ** ** |
|----------------------------------------------------------------------|------------|-----------------------|------------|------------------------------------|------------|
| Cash equivalents                                                     |       | $                     | 13,073     |                               | 2.7        | % |
| Securities with  maturity:                                           |       |                  |       |                               |       |
| Due within one  year or less                                         |       | 12,874                |       | 2.6                                | %          |
| Due after one  year through two years                                |       | 740                   |       | 2.4                                | %          |
| Auction rate  receipts due after 25 years through 40 years           |       | 3,700                 |       | 2.9                                | %          |
| Annuities,  auction rate preferred stock and other, with no maturity |       | 5,921                 |       | 3.0                                | %          |
| Total portfolio                                                      |       | $                     | 36,308     |                               | 2.8        | % |

 

*Debt andInterest Expense.*We incurred $60,000,000 of principalindebtedness from the issuance of convertible senior notes in March 2004. Thefair market value of these 3% convertible senior notes is sensitive to changesin interest rates and to the prices of our common stock into which it can beconverted as well as our financial stability. In order to manage interest costsand risk, we entered into an interest rate swap agreement during fiscal 2004with a financial institution on a total notional amount of $50,000,000 and$10,000,000, whereby we receive fixed-rate interest of 3% in exchange forvariable interest payments. The interest rate swaps expire upon the maturity ofour $60,000,000, 3% convertible senior notes in March 2009, and effectivelyconverts those fixed-rate notes into variable-rate borrowings.  The interest rate is reset semi-annually andis equal to the 6-month LIBOR rate less a rate spread.  The total variable interest rate,approximately 2.9% at April 30, 2005, resulted in interest expense savingsrelative to fixed rates of approximately $486,000 for the first three quartersof fiscal 2005.  Under the provisions ofSFAS No. 133, “*Accounting for Derivative Instruments andHedging Activities*,” as amended, this arrangement has beendesignated and qualifies as an effective fair value hedge of interest rate riskrelated to the $60,000,000 convertible senior notes. As the terms of the swapsmatch those of the underlying hedged debt, the changes in the fair value ofthese swaps are offset by corresponding changes in the carrying value of thehedged debt, and therefore does not impact our net earnings. As of April 30,2005, the fair value of the interest rate swaps was approximately $2,116,000with an equal adjustment recorded to the carrying value of the $60,000,000convertible senior notes. Assuming a one percentage point increase in theprevailing LIBOR rate, holding other terms of the swap constant, the fair valueof the interest rate swap and the underlying senior notes would change byapproximately $1,980,000.

 

*Foreign Currency Risk*

 

With our acquisitions ofSynchrologic and Identity Systems in fiscal 2004, more of our product andservice revenue has been derived from international markets and denominated inthe currency of the applicable market. As we increasingly pursue businessopportunities in foreign countries, our foreign revenue and operating resultsmay 

 

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become subject tosignificant currency fluctuations based upon changes in exchange rates ofcertain currencies in relation to the United States dollar.

 

We are also exposed toforeign currency exchange rate fluctuations as the financial statements offoreign subsidiaries are translated into United States dollar inconsolidation.  As exchange rates vary,these results, when translated, may vary from expectations and adversely impactoverall expected profitability.  Assetsand liabilities of most of our subsidiaries are translated into U.S. dollars atexchange rates in effect as of the applicable balance sheet date and anyresulting translation adjustments are included as an adjustment to stockholders’equity. Revenue and expenses generated from these subsidiaries are translatedat average monthly exchange rates during the quarter the transactions occur.Gains and losses from these currency transactions are included in net earnings.Recently, we have increasingly generated a portion of our revenue and incurreda portion of our expenses in euros, British pounds, the Japanese yen andAustralian dollars.

 

We currently do not haveany hedging or similar foreign currency contracts to mitigate our exposure to therisk of changes in foreign currency rates. Although we may begin to hedge inthe future, we cannot be sure that any hedging techniques we may implement willbe successful or that our business, results of operations, financial conditionor cash flows will not be adversely affected by exchange rate fluctuations.

 

We may continue to expandinternationally in the future and become increasingly subject to other risks ofdoing business internationally including, but not limited to, differingeconomic conditions, changes in political climate, differing tax structures,and other regulations and restrictions. We will also be exposed to increasedrisk of non-payment by our customers in foreign countries, especially those ofhighly inflationary economies. Accordingly, our future results could bematerially adversely impacted by changes in these and other factors.Furthermore, to the extent that we engage in international sales denominated inUnited States dollars, an increase in the value of the United States dollarrelative to foreign currencies could make our products and services lesscompetitive in international markets.

 

## **Item 4.  Controls And Procedures**

## ** **

*Evaluationof disclosure controls and procedures*

 

Based on our management’sevaluation (with the participation of our principal executive officer andprincipal financial officer), as of the end of the period covered by thisreport, our principal executive officer and principal financial officer haveconcluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended,(the “Exchange Act”)) are effective to ensure that information required to bedisclosed by us in reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin Securities and Exchange Commission rules and forms.

 

*Changesin internal control over financial reporting*

 

We generate a significantportion of our revenue in remote sales offices throughout the world, where wetransact business in multiple languages and often employ personnel that are notas familiar with U.S. GAAP as are our personnel in the United States. In thethird quarter of fiscal 2005, we began the process of centralizing a number ofsignificant internal controls and extending headquarters-based enterpriseaccounting and revenue systems to certain of our remote offices. These changesare designed to establish consistent information systems and internal controlsthroughout the company and ensure a centralized review in the United States ofsignificant contracts from foreign jurisdictions.

 

There were no otherchanges in our internal control over financial reporting during the thirdquarter of fiscal 2005 that have materially affected, or are reasonably likelyto materially affect, our internal control over financial reporting.

 

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**INTELLISYNC CORPORATION**

 

**PART II****- OTHERINFORMATION**

 

**Item 1.****           Legal proceedings**

 

There were no updates or developments during thethree months ended April 30, 2005 on any pending legal proceedings, includingthe patent-infringement claim filedagainst us by NCR Corporation, to which we, or any of oursubsidiaries, are a party.  For additional discussion of ourpending legal proceedings, see our Annual Report on Form 10-K for the periodended July 31, 2004 and the Quarterly Reports on Form 10-Q for the period endedOctober 31, 2004 and January 31, 2005.

 

**Item 2.****           Changes in securities and use of proceeds**– Not Applicable.

 

**Item 3.****           Defaults upon senior securities**– NotApplicable.

 

**Item 4.****           Submission of matters to a vote ofsecurity holders**– Not Applicable.

 

**Item 5.****        Other information** – Not Applicable.

 

**Item 6.****        Exhibits**

 

**(a)****          Exhibits**

 
| 3.1  |   | Amended and Restated Bylaws  of Pumatech, Inc., a Delaware corporation (Incorporated herein by reference  to Registrant’s Annual Report on Form 10-K for fiscal year ended July 31,  2002, filed on October 17, 2002, Commission File No. 000-21709).                                                                                                                                                                                                                                                                                |
|------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.2  |   | Charter for the Audit  Committee of the Board of Directors (Incorporated herein by reference to  Registrant’s joint proxy statement/prospectus on Form S-4/A, filed on  November 26, 2003, Registration No. 333-109881).                                                                                                                                                                                                                                                                                                                  |
| 10.1 |   | Master Software  License, Software Development Agreement, Maintenance and Services Agreement  and Reseller Agreement dated July 2, 2004 by and between Intellisync  Corporation and Cellco Partnership d/b/a Verizon Wireless (Certain portions  of this exhibit have been omitted and filed separately with the Securities  and Exchange Commission) (Incorporated herein by reference to Registrant’s  Annual Report on Form 10-K for fiscal year ended July 31, 2004, filed on  October 14, 2004, Commission File No. 000-21709). |
| 31.1 |   | Certification of  Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 31.2 |   | Certification of  Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 32.1 |   | Certification of  Principal Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                        |
| 32.2 |   | Certification of  Principal Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                        |

 

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**SIGNATURE**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned hereunto dulyauthorized.

 

 
|               |   | **INTELLISYNC CORPORATION**                   |                       |   |   |
|--------------------|--------|-----------------------------------------------|----------------------------|--------|--------|
|               |   | (Registrant)                                  |                       |   |   |
|               |   |                                          |                       |   |   |
|               |   |                                          |                       |   |   |   |   |
| Date: June 9, 2005 |   | By:                                           | /s/ J. KEITH  KITCHEN      |   |   |   |
|               |   |                                          | **J. Keith Kitchen**       |   |   |   |
|               |   |                                          | *Chief  Financial Officer* |   |   |   |
|               |   | (Principal Financial  and Accounting Officer) |                       |   |   |
|                    |        |                                               |                            |        |        |  |  |

 

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**EXHIBIT INDEX**

 
| **Exhibit No.** | ** ** | ** ** |
|----------------------|------------|------------|
|                 |       |       |
| 3.1                  |       |       | Amended and Restated  Bylaws of Pumatech, Inc., a Delaware corporation (Incorporated herein by  reference to Registrant’s Annual Report on Form 10-K for fiscal year ended  July 31, 2002, filed on October 17, 2002, Commission File  No. 000-21709). |
| 3.2                  |       |       | Charter for the Audit  Committee of the Board of Directors (Incorporated herein by reference to  Registrant’s joint proxy statement/prospectus on Form S-4/A, filed on  November 26, 2003, Registration No. 333-109881). |
| 10.1                 |       |       | Master Software  License, Software Development Agreement, Maintenance and Services Agreement  and Reseller Agreement dated July 2, 2004 by and between Intellisync  Corporation and Cellco Partnership d/b/a Verizon Wireless (Certain portions  of this exhibit have been omitted and filed separately with the Securities  and Exchange Commission) (Incorporated herein by reference to Registrant’s  Annual Report on Form 10-K for fiscal year ended July 31, 2004, filed on  October 14, 2004, Commission File No. 000-21709). |
| 31.1                 |       |       | Certification of  Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002. |
| 31.2                 |       |       | Certification of  Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002. |
| 32.1                 |       |       | Certification of  Principal Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| 32.2                 |       |       | Certification of  Principal Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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