**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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**FORM 10-Q**

** **
| **ý**                              |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-----------------------------------------|--------|----------------------------------------------------------------------------------------------|
|                                    |   |                                                                                         |
| **For the Quarter Ended June 30, 2003** |
|                                    |   |                                                                                         |
| **Commission File Number 000-31589**    |

 

**VASTERA, INC.**

(Exact Name of Registrant as Specified in itsCharter)

 

| **Delaware**                                                               |   | **54-1616513**                           |
|----------------------------------------------------------------------------|--------|------------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization)            |   | (I.R.S. Employer  Identification Number) |
|                                                                       |   |                                     |
| **45025 Aviation Drive, Suite 300  Dulles, VA 20166  (703) 661-9006** |
| (Address and Phone Number of Principal  Executive Offices)                 |

 

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Indicate by check number whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the Securities ExchangeAct of 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

Yes   ý   No  o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Exchange Act Rule 12b-2) Yes ýNo o

 

As of August 8, 2003, there were 41,405,310 shares of the registrant’scommon stock, $.01 par value per share, outstanding.

 

 

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**VASTERA, INC.**

 

**TABLE OF CONTENTS**

 
| PART I –  FINANCIAL INFORMATION (UNAUDITED) |
|--------------------------------------------------|
|                                             |   |
| Item 1:                                          | Financial Statements |
|                                             |   |
|                                             | CONDENSED  CONSOLIDATED BALANCE SHEETS |
|                                             |   |
|                                             | CONDENSED  CONSOLIDATED STATEMENTS OF OPERATIONS |
|                                             |   |
|                                             | CONDENSED  CONSOLIDATED STATEMENTS OF CASH FLOWS |
|                                             |   |
|                                             | NOTES  TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS |
|                                             |   |
| Item 2:                                          | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |
| Item 3:                                          | Qualitative and Quantitative Disclosures  About Market Risk |
| Item 4:                                          | Controls and Procedures |
|                                             |   |
| Part II – Other  Information                |
|                                             |   |
| Item 1:                                          | Legal Proceedings |
| Item 2:                                          | Changes in Securities and Use of Proceeds |
| Item 3:                                          | Defaults Upon Senior Securities |
| Item 4:                                          | Submission of Matters to a Vote of Security  Holders |
| Item 5:                                          | Other Information |
| Item 6:                                          | Exhibits and Reports on Form 8-K |
|                                             |   |
| SIGNATURES                                       |
|                                                  |  |  |

 

2

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# **PART I - FINANCIAL INFORMATION (UNAUDITED)**

## ** **

## **Item 1:  **Financial Statements

 

**VASTERA, INC. AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

 

**(In thousands, except per share data)**

 
|                                                                                                                      |   | **June 30,  2003** |    | **December 31,  2002** |   |
|---------------------------------------------------------------------------------------------------------------------------|--------|--------------------|---------|------------------------|--------|
|                                                                                                                      |   | **(Unaudited)**    |    |                   |   |
| **Assets**                                                                                                                |   |               |    |                   |   |
| Current assets:                                                                                                           |   |               |    |                   |   |
| Cash and cash equivalents                                                                                                 |   | $                  | 11,166  |                   | $      | 23,696 |   |
| Short-term investments                                                                                                    |   | 40,470             |    | 33,261                 |   |
| Accounts receivable, net of allowance for  doubtful accounts of $1,005 and $948, respectively                             |   | 18,945             |    | 18,409                 |   |
| Prepaid expenses and other current assets                                                                                 |   | 3,035              |    | 2,535                  |   |
| Total current assets                                                                                                      |   | 73,616             |    | 77,901                 |   |
| Property and equipment, net                                                                                               |   | 12,206             |    | 11,934                 |   |
| Intangible assets, net                                                                                                    |   | 9,513              |    | 9,098                  |   |
| Goodwill                                                                                                                  |   | 67,906             |    | 65,657                 |   |
| Deposits and other assets                                                                                                 |   | 1,650              |    | 974                    |   |
|                                                                                                                      |   |               |    |                   |   |
| Total assets                                                                                                              |   | $                  | 164,891 |                   | $      | 165,564 |   |
|                                                                                                                      |   |               |    |                   |   |
| **Liabilities and  Stockholders’ Equity**                                                                            |   |               |    |                   |   |
| Current liabilities:                                                                                                      |   |               |    |                   |   |
| Line of credit and capital lease  obligations, current                                                                    |   | $                  | 2,623   |                   | $      | 2,150 |   |
| Accounts payable                                                                                                          |   | 893                |    | 4,277                  |   |
| Accrued expenses                                                                                                          |   | 5,754              |    | 6,937                  |   |
| Accrued compensation and benefits                                                                                         |   | 1,810              |    | 1,543                  |   |
| Deferred revenue, current                                                                                                 |   | 10,976             |    | 9,446                  |   |
| Total current liabilities                                                                                                 |   | 22,056             |    | 24,353                 |   |
| Long-term liabilities:                                                                                                    |   |               |    |                   |   |
| Line of credit and capital lease  obligations, net of current portion                                                     |   | 798                |    | 1,078                  |   |
| Deferred revenue, net of current portion                                                                                  |   | 1,631              |    | 2,476                  |   |
| Total liabilities                                                                                                         |   | 24,485             |    | 27,907                 |   |
| Commitments and contingencies (See Note 6)                                                                                |   |               |    |                   |   |
|                                                                                                                      |   |               |    |                   |   |
| Stockholders’ equity:                                                                                                |   |               |    |                   |   |
| Common stock, $0.01 par value; 100,000  shares authorized; 41,168 and 40,490 shares issued and outstanding,  respectively |   | 412                |    | 405                    |   |
| Additional paid-in capital                                                                                                |   | 325,255            |    | 323,010                |   |
| Accumulated other comprehensive loss                                                                                      |   | (938               | )       | (2,280                 | )      |
| Deferred compensation                                                                                                     |   | (343               | )       | (988                   | )      |
| Accumulated deficit                                                                                                       |   | (183,980           | )       | (182,490               | )      |
|                                                                                                                      |   |               |    |                   |   |
| Total stockholders’ equity                                                                                           |   | 140,406            |    | 137,657                |   |
| Total liabilities and stockholders’ equity                                                                           |   | $                  | 164,891 |                   | $      | 165,564 |   |

 

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

 

3

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**VASTERA, INC. AND SUBSIDIARIES**

** **

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

** **

**(UNAUDITED)**

** **

**(In thousands, except per share data)**

** **
|                                        |   | **Three Months Ended****June 30,** |   | **Six Months Ended****June 30,** |   |
|---------------------------------------------|--------|------------------------------------|--------|----------------------------------|--------|
|                                        |   | **2003**                           |   | **2002**                         |   | **2003** |   | **2002** |   |
| **Revenues:**                               |   |                               |   |                             |   |   |   |   |   |
| Managed services revenues                   |   | $                                  | 13,644 |                             | $      | 11,044 |   | $ | 27,259 |   | $ | 21,974 |   |
| Software revenues                           |   | 2,885                              |   | 3,109                            |   | 5,616 |   | 6,628 |   |
| Services revenues                           |   | 4,995                              |   | 4,185                            |   | 9,593 |   | 8,791 |   |
| Total revenues                              |   | 21,524                             |   | 18,338                           |   | 42,468 |   | 37,393 |   |
|                                        |   |                               |   |                             |   |   |   |   |   |
| **Cost of revenues:**                       |   |                               |   |                             |   |   |   |   |   |
| Cost of managed services revenues           |   | 7,499                              |   | 5,411                            |   | 14,935 |   | 10,788 |   |
| Cost of software revenues                   |   | 712                                |   | 667                              |   | 1,394 |   | 1,203 |   |
| Cost of services revenues                   |   | 3,637                              |   | 3,291                            |   | 7,006 |   | 6,668 |   |
|                                        |   |                               |   |                             |   |   |   |   |   |
| **Operating expenses:**                     |   |                               |   |                             |   |   |   |   |   |
| Sales and marketing                         |   | 2,302                              |   | 3,256                            |   | 4,546 |   | 6,643 |   |
| Research and development                    |   | 2,999                              |   | 3,493                            |   | 6,036 |   | 7,441 |   |
| General and administrative                  |   | 2,733                              |   | 2,308                            |   | 5,473 |   | 4,862 |   |
| Depreciation                                |   | 1,263                              |   | 1,094                            |   | 2,564 |   | 2,064 |   |
| Intangible amortization expense             |   | 707                                |   | 740                              |   | 1,387 |   | 1,193 |   |
| Restructuring                               |   | —                             |   | 1,976                            |   | — |   | 1,976 |   |
| Stock-based compensation                    |   | 275                                |   | 710                              |   | 645 |   | 1,562 |   |
| Total operating expenses                    |   | 10,279                             |   | 13,577                           |   | 20,651 |   | 25,741 |   |
|                                        |   |                               |   |                             |   |   |   |   |   |
| Loss from operations                        |   | (603                               | )      | (4,608                           | )      | (1,518 | ) | (7,007 | ) |
| Other income, net                           |   | 148                                |   | 228                              |   | 336 |   | 533 |   |
| Loss before income taxes                    |   | (455                               | )      | (4,380                           | )      | (1,182 | ) | (6,474 | ) |
| Income taxes                                |   | (157                               | )      | (91                              | )      | (308 | ) | (182 | ) |
|                                        |   |                               |   |                             |   |   |   |   |   |
| Net loss                                    |   | $                                  | (612   | )                                | $      | (4,471 | ) | $ | (1,490 | ) | $ | (6,656 | ) |
|                                        |   |                               |   |                             |   |   |   |   |   |
| Basic and diluted net loss per common share |   | $                                  | (0.01  | )                                | $      | (0.11 | ) | $ | (0.04 | ) | $ | (0.17 | ) |
|                                        |   |                               |   |                             |   |   |   |   |   |
| Weighted-average common shares outstanding  |   | 40,849                             |   | 40,124                           |   | 40,725 |   | 39,700 |   |

 

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

 

4

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**VASTERA, INC. AND SUBSIDIARIES**

** **

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

** **

**(UNAUDITED)**

** **

**(In thousands)**

** **
|                                                                                                    |   | **Six Months Ended  June 30,** |   |
|---------------------------------------------------------------------------------------------------------|--------|--------------------------------|--------|
|                                                                                                    |   | **2003**                       |   | **2002** |   |
| **Cash flows from  operating activities:**                                                              |   |                           |   |   |   |
| Net loss                                                                                                |   | $                              | (1,490 | ) | $ | (6,656 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities:                            |   |                           |   |   |   |
| Stock-based compensation                                                                                |   | 645                            |   | 1,562 |   |
| Depreciation and intangible amortization  expense                                                       |   | 3,951                          |   | 3,257 |   |
| Provision for allowance for doubtful  accounts                                                          |   | 96                             |   | 117 |   |
| Amortization of revenue discount related to  Ford contract                                              |   | 150                            |   | 150 |   |
| Amortization of capitalized internal-use  software costs                                                |   | 220                            |   | — |   |
| Changes in operating assets and  liabilities:                                                           |   |                           |   |   |   |
| Accounts receivable                                                                                     |   | (247                           | )      | (1,519 | ) |
| Prepaid expenses and other current assets                                                               |   | (348                           | )      | (265 | ) |
| Deposits and other assets                                                                               |   | (685                           | )      | (65 | ) |
| Accounts payable and accrued expenses                                                                   |   | (4,910                         | )      | 2,958 |   |
| Accrued compensation and benefits                                                                       |   | 226                            |   | (4,546 | ) |
| Deferred revenue                                                                                        |   | 576                            |   | 2,418 |   |
| Net cash used in operating activities                                                                   |   | (1,816                         | )      | (2,589 | ) |
|                                                                                                    |   |                           |   |   |   |
| **Cash flows from  investing activities:**                                                              |   |                           |   |   |   |
| Acquisition of subsidiaries                                                                             |   | (3,000                         | )      | (5,682 | ) |
| Net (purchases) sales of short-term investments                                                         |   | (7,239                         | )      | 17,071 |   |
| Acquisition of property and equipment                                                                   |   | (1,893                         | )      | (6,258 | ) |
| Net cash (used in) provided by investing  activities                                                    |   | (12,132                        | )      | 5,131 |   |
|                                                                                                    |   |                           |   |   |   |
| **Cash flows from  financing activities:**                                                              |   |                           |   |   |   |
| Proceeds from the exercise of stock options  and issuance of stock for the employee stock purchase plan |   | 1,940                          |   | 3,276 |   |
| Principal payments on long-term debt                                                                    |   | (1,342                         | )      | 1,168 |   |
| Proceeds from equipment line of credit                                                                  |   | 614                            |   | — |   |
| Net cash provided by financing activities                                                               |   | 1,212                          |   | 4,444 |   |
| Effect of foreign currency exchange rate  changes on cash and cash equivalents                          |   | 206                            |   | 15 |   |
| Net (decrease) increase in cash and cash  equivalents                                                   |   | (12,530                        | )      | 7,001 |   |
| Cash and cash equivalents, beginning of  period                                                         |   | 23,696                         |   | 10,982 |   |
| Cash and cash equivalents, end of period                                                                |   | $                              | 11,166 |   | $ | 17,983 |   |

 

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

 

5

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**VASTERA, INC. ANDSUBSIDIARIES**

** **

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

** **

**(Unaudited)**

** **

**1.             Basisof Presentation and Nature of Business:**

** **

The accompanying unaudited condensed consolidated financial statementsof Vastera, Inc. and its subsidiaries (“Vastera” the “Company,” “we,” or “us”)have been prepared on the same basis as audited financial statements andinclude all adjustments, including all normal recurring adjustments that arenecessary for a fair presentation of the financial condition, results ofoperations, and cash flows for the interim periods presented. The results ofoperations for the interim periods presented are not necessarily indicative ofthe results to be expected for any subsequent quarter or for the entire yearending December 31, 2003. All significant intercompany balances andtransactions have been eliminated in consolidation. Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with generally accepted accounting principles have been condensed oromitted pursuant to the Securities and Exchange Commission’s (the “SEC”) rulesand regulations. The Company’s interim financial statements should be read inconjunction with the Company’s audited consolidated financial statements andnotes thereto, as filed with the SEC with the Company’s Annual Report onForm 10-K and other reports filed with the SEC.

 

Vastera is a leading provider of solutions for Global Trade Managementand was incorporated in Virginia in November 1991 under the name ExportSoftware International, Inc. The Company reincorporated in Delaware inJuly 1996 and changed its name to Vastera, Inc. in June 1997.The Company’s offerings include a library of global trade content, web-basedsoftware solutions, trade management consulting, and managed services. Managedservices range in nature from management of a specific global trade function toproviding complete management of a client’s global trade operations. TheCompany has operations in the United States, Belgium, Brazil, Canada, France,Germany, Ireland, Japan, Mexico, the Netherlands, Poland, Spain, and the UnitedKingdom.

 

The Company’s operations are subject to certain risks anduncertainties, including among others, uncertainties relating to productdevelopment, rapidly changing technology, current and potential competitorswith greater financial, technological, production, and marketing resources, thepotential loss of significant customers, dependence on key managementpersonnel, limited protection of intellectual property and proprietary rights,uncertainty of future profitability, exposure to risks related to conductingbusiness internationally, and possible fluctuations in financial results.

 

### **2.**                                      Summary ofSignificant Accounting Policies:

### ** **

**Use of Estimates**

** **

The preparation of the condensed consolidated financial statements inconformity with accounting principles generally accepted in the United Statesrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosures of contingent assets andliabilities as of the date of the financial statements and the reported amountsof revenues and expenses during the reporting period. Actual results coulddiffer from those estimates. Estimates that are most susceptible to change arethe Company’s estimates of collections of accounts receivable and the estimatedlives and the realization of its intangible assets and internal use software.

 

**Revenue Recognition**

** **

The Company’s revenues consist of managed services revenues, softwarerevenues, and services revenues.

 

*Managed Services Revenues*

* *

Managed services revenues are derived from agreements that provide fortransaction or services fees based on the performance of the Company’s managedservices solutions. Managed services solutions include the processing of aclient’s customs entries and the classifying of a clients’ goods. Managedservices transaction arrangements are often subject to annual or quarterlyminimum transaction thresholds, and revenues are recognized based on the lowerof the cumulative actual transactions processed during the period using aweighted-average transaction rate or the cumulative amounts billable. Forthose managed services transaction arrangements subject to annual minimums andfor those arrangements where the amount billable for interim periods is

 

6

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limitedto the pro rata portion of the annual minimum, transactions processed in excessof the minimum in each period are not billable, and, therefore, revenue is notrecognized until the end of the related year. Certain managed servicesarrangements are based upon a fixed services fee. Revenues associated withthese arrangements are recognized ratably over the term of the arrangement andlimited to the amounts billable. In addition, Vastera may receive annual gainsharingfees under certain managed services arrangements based on a percentage of theclient’s annual cost savings, as defined in the managed services arrangements.These fees are recognized when they become fixed and determinable.

 

*Software Revenues*

* *

Software revenues consist of term license revenues, perpetual softwarelicense revenues, and transaction-based revenues. The Company recognizesrevenue from the sale of software products in accordance with Statement ofPosition (“SOP”) 97-2, *Software Revenue Recognition*.

 

Term license revenues are derived from term software licensearrangements in which the Company’s clients license its software products andobtain the right to unspecified enhancements on a when-and-if-available basisand ongoing support and content update services. Content updates aresignificant and frequent. Revenues are recognized ratably over the contractterm. Term license arrangements typically range from three to five years. Tothe extent the Company hosts the software for its customers, the hosting fee isrecognized ratably over the contract period in conjunction with the recognitionof the license fee.

 

Perpetual software license revenues are derived from perpetual softwarelicense arrangements and related maintenance contracts. Maintenance contractsinclude the right to unspecified enhancements on a when-and-if available basis,ongoing support, and content update services. The content updates providedunder maintenance arrangements are significant and frequent, and, as a result,revenues from perpetual software license sales are recognized ratably over theestimated economic life of the product. The Company has estimated that the lifeof the product is three years, which is consistent with the historical periodsbetween major upgrades to the functionality and architecture of its products.Revenues from maintenance contracts are recognized ratably over the contractterm, which is typically one year. To the extent the Company hosts the softwarefor its customers, the hosting fee is recognized ratably over the contractperiod in conjunction with the recognition of the license fee.

 

Transaction-based revenues are derived from arrangements that providefor transaction fees based on a client’s usage of the Company’s softwareproducts. Revenues from the usage of its software products are recognized astransactions occur.

 

The Company recognizes revenues from arrangements with resellersbeginning when the software product is sold to the end user. Any annualtransaction minimums required of the reseller but not sold by the reseller toend customers are recognized as revenues upon the expiration of the annualminimum period.

 

*Services Revenues*

* *

Services revenues are derived from implementation, managementconsulting, and training services. Services are performed on a time andmaterials basis or under fixed price arrangements. Revenues on time andmaterials contracts are recognized based on fixed billable rates for hoursdelivered, and revenues on fixed priced contracts are recognized as theservices are performed or using the percentage of completion method ofaccounting based on the ratio of costs incurred to total estimated costs to beincurred. Losses on arrangements are recognized when known.

 

For multiple-element arrangements where the Company provides bothsoftware and services, the Company defers the service fee, based onvendor-specific objective evidence of fair value, and recognizes the servicesas performed.

 

**Deferred Revenues**

** **

Deferred revenues include amounts paid by clients for revenues thathave not been recognized and generally result from billed, but deferred termand perpetual license revenues and services not yet performed. Deferredrevenues are recognized on a monthly basis over the term of the agreement, theremaining economic life of the product, or when the services are performed.

 

7

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**Cost of Revenues**

** **

Cost of revenues includes the cost of managed services revenues, thecost of software revenues, and the cost of services revenues.

 

Cost of managed services revenues consists of the cost of salaries andrelated expenses for the Company’s managed services organization and theamortization of capitalized internal use software costs related to theimplementation and integration of the Company’s trade management platform tothe managed services operation.

 

Cost of software revenues includes royalties owed to third parties fortechnology products integrated into the Company’s software products, as well asthe cost of salaries and related expenses for the technical supportorganization.

 

Cost of services revenues includes the cost of salaries and relatedexpenses for implementation, management consulting and training servicesprovided to clients, as well as the cost of third parties contracted to provideeither application consulting or implementation services to the Company’sclients.

 

**Internal Use Software**

** **

In accordance with SOP 98-1, *Accountingfor the Costs of Computer Software Developed or Obtained for Internal Use*,the Company capitalizes costs associated with the implementation andintegration of its trade management platform to its managed servicesoperations, related to certain capitalizable tasks including the technicaldesign, system configuration, and testing phases of the integration process.The Company capitalized approximately $93,000 and $463,000 in the secondquarters of 2003 and 2002, respectively, and $284,000 and $810,000 in the sixmonths ended June 30, 2003 and 2002, respectively. These costs are amortized ascosts of managed services revenues over three years, and amortization commencesupon the completion of the integration to the Vastera platform. The Companybegan amortizing these costs in the fourth quarter of 2002. Total amortizationexpense in the three months and six months ended June 30, 2003 wasapproximately $97,000 and $220,000, respectively. Net capitalized costs on thebalance sheets as of June 30, 2003 and December 31, 2002 wereapproximately $1.6 million and $1.5 million, respectively.

 

**Concentrations of Credit Risk**

** **

Financial instruments that potentially subject the Company toconcentrations of credit risk consist primarily of cash equivalents, short-terminvestments, and accounts receivable. The Company limits the amount ofinvestment exposure in any one financial instrument and does not have anyforeign currency investments. The Company sells products and services tocustomers across several industries throughout the world without requiringcollateral. However, the Company routinely assesses the financial strength ofits customers and maintains allowances for anticipated losses.

 

As of June 30, 2003 and December 31, 2002, Ford Motor Companyaccounted for 26% and 16%, respectively, of total accounts receivable. LucentTechnologies accounted for 13% and 19% of total accounts receivable as of June30, 2003 and December 31, 2002, respectively.

 

**Net Loss Per Common Share**

** **

Basic net loss per common share is computed by dividing net lossapplicable to common stockholders by the weighted-average number ofcommon shares outstanding for the period. Diluted net loss per common shareincludes the potential dilution that could occur if securities or othercontracts to issue common stock were exercised or converted into common stock.As of June 30, 2003 and December 31, 2002, options to purchaseapproximately 8,538,000 and 4,776,000 shares of common stock were outstanding,respectively. Due to the anti-dilutive effect of the options, they have beenexcluded from the calculation of weighted-average shares for dilutedearnings per share. As a result, the basic and diluted loss per share amountsare identical.

 

**Comprehensive Income (Loss)**

** **

As of June 30, 2003 and December 31, 2002, accumulated othercomprehensive income (loss) includes unrealized gains and losses on investmentsand foreign currency translation adjustments. As of June 30, 2003, accumulatednet unrealized gains on investments available for sale was approximately$150,000 and the accumulated foreign currency translation adjustment was a lossof

 

8

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approximately$1.1 million. The comprehensive loss for the six months ended June 30,2003 and 2002, was $148,000 and $7.9 million, respectively.

 

**Goodwill and Intangible Assets**

** **

Goodwill represents the excess of costs over fair value of assets ofbusinesses acquired. The Company adopted the provisions of SFAS No. 142, *Goodwill and Other Intangible Assets,* asof January 1, 2002. Goodwill and intangible assets acquired in a purchasebusiness combination and determined to have an indefinite useful life are notamortized, but instead tested for impairment at least annually in accordancewith the provisions of SFAS No. 142. SFAS No. 142 also requires thatintangible assets with estimable useful lives be amortized over theirrespective estimated useful lives to their estimated residual values, andreviewed for impairment in accordance with SFAS No. 144, *Accounting for Impairment or Disposal of Long-LivedAssets*.

 

On January 1, 2002, in accordance with SFAS No. 141, theCompany reclassified its assembled workforce intangible assets to goodwill.Prior to January 1, 2002, assembled workforce intangibles were amortizedon a straight-line basis over two or three years. The value assigned to theassembled workforce in the acquisition of Ford’s global customs operation wasallocated to each country in which the Company acquired Ford’s global customsoperations, based upon the number of employees in that country. The relatedamortization was recorded over three years from the date the Company assumedFord’s customs operations in that country.

 

All other intangible assets are amortized on a straight-line basis overtheir expected economic life, generally one to five years. The value assignedto the Ford contract in connection with the Ford acquisition is being amortizedas a discount to revenue over the minimum term of the contract. Beginning July1, 2003, the amount allocated to the GE contract and customer relationshipacquired in the acquisition of GE’s internal US customs operations will be amortizedas a discount to revenue over five years, the estimated useful life of theasset.

 

**Stock Options**

** **

The Company has adopted the disclosure requirements of SFASNo. 123, *Accounting for Stock-BasedCompensation*. The Company applies Accounting Principles Board(“APB”) Opinion No. 25, *Accounting forStock Issued to Employees*, and related interpretations in accountingfor its stock option plans. Under the intrinsic-value method prescribed in APBNo. 25, compensation expense is recorded on the date of grant only if thecurrent market price of the underlying stock exceeds the exercise price. Nooptions granted during the first and second quarters of 2003 and 2002 weregranted with exercise prices that were less than the current market price. Hadcompensation expense for the Company’s 1996 Plan, 2000 Plan and Employee StockPurchase Plan been determined based on the fair value at the grant dates forawards under these plans consistent with the method of SFAS No. 123, theCompany’s net loss would have been increased to the pro forma amounts indicatedbelow (in thousands, except per share data). 

 
|                                                                                                |   | **Three Months Ended****June 30,** |   | **Six Months Ended  June 30,** |   |
|-----------------------------------------------------------------------------------------------------|--------|------------------------------------|--------|--------------------------------|--------|
|                                                                                                |   | **2003**                           |   | **2002**                       |   | **2003** |   | **2002** |   |
|                                                                                                |   |                               |   |                           |   |   |   |   |   |
| Net loss, as reported                                                                               |   | $                                  | (612   | )                              | $      | (4,471 | ) | $ | (1,490 | ) | $ | (6,656 | ) |
| Add: stock-based compensation included in  net loss, net of tax                                     |   | 275                                |   | 710                            |   | 645 |   | 1,562 |   |
| Deduct: stock-based compensation determined  under the fair value method for all awards, net of tax |   | (9,566                             | )      | (3,898                         | )      | (11,640 | ) | (8,939 | ) |
| Pro forma net loss                                                                                  |   | $                                  | (9,903 | )                              | $      | (7,659 | ) | $ | (12,485 | ) | $ | (14,033 | ) |
| Pro forma net loss per share                                                                        |   | $                                  | (0.24  | )                              | $      | (0.19 | ) | $ | (0.31 | ) | $ | (0.35 | ) |

 

**Income Taxes**

** **

Deferred taxes are recorded utilizing the asset and liability method asprescribed by SFAS No. 109, *Accountingfor Income Taxes*, whereby deferred tax assets are recognized fordeductible temporary differences and operating loss and tax creditcarryforwards and deferred tax liabilities are recognized for taxable temporarydifferences. Temporary differences are the differences between the reportedamounts of assets and liabilities and their tax bases. Deferred tax assets andliabilities are adjusted for the effects of changes in tax laws and rates onthe date of enactment. Deferred tax assets are reduced by a valuation allowancewhen, in the opinion of management, it is more likely than not that someportion or all of the deferred tax assets will not be realized.

 

9

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For the first and second quarters of 2003 and 2002, the tax provisionwas comprised of state and foreign taxes. No provision for federal income taxeshas been recorded for the first and second quarters of 2003 and 2002, due toaccumulated net operating losses. The Company has recorded a valuationallowance for the full amount of its net deferred tax assets because of theuncertainty surrounding the timing of the realization of these future taxbenefits.

 

**Recent Accounting Pronouncements**

** **

In November 2002, the EITF reached a Consensus on EITF IssueNo. 00-21, *Revenue Arrangements WithMultiple Deliverables,* as to when and how to allocate revenue fromthe sale of products and services delivered separately in a bundled salesarrangement. The Consensus is effective prospectively for arrangements enteredinto in fiscal periods beginning after June 15, 2003. Companies, however,may elect to apply the Consensus to existing arrangements as well and to recordthe income-statement impact of the change as a cumulative effect of a change inaccounting principle.

 

In January 2003, the FASB issued Interpretation No. 46, *Consolidation of Variable Interest Entities, aninterpretation of ARB No. 51*. This interpretation addresses theconsolidation by business enterprises of variable interest entities as definedin the interpretation. The interpretation applies immediately to variableinterest in variable interest entities created or obtained after January 31,2003. The interpretation is applied to the enterprise no later than the end ofthe first reporting period beginning after June 15, 2003. The interpretationrequires certain disclosures in financial statements issued after January 31,2003 if it is reasonably possible that the Company will consolidate or discloseinformation about variable interest entities when the interpretation becomeseffective. The adoption of this interpretation is not expected to have amaterial effect on the Company’s financial statements.

 

In March 2003, the Emerging Issues Task Force issued a preliminaryconsensus on EITF No. 01-08, *DeterminingWhether an Arrangement Contains a Lease*. This guidance is effectivefor arrangements entered into in fiscal periods beginning after May 28, 2003.EITF No. 01-08 discusses the criteria necessary to determine if an arrangementcontains a lease. The adoption of EITF No. 01-08 is not expected to have amaterial effect on the Company’s financial statements.

 

In May 2003, the FASB issued SFAS No. 150, *Accounting for Certain Financial Instruments with Characteristics ofboth Liabilities and Equity.*SFAS No. 150 establishes standards forhow an issuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity. SFAS No. 150 is effective forfinancial instruments entered into or modified after May 31, 2003, andotherwise is effective at the beginning of the first interim period beginningafter June 15, 2003. The adoption of SFAS No. 150 is not expected to have amaterial effect on the Company’s financial statements.

 

### **3.**                                      Restructuring

### ** **

The Company recorded approximately $2.0 million and$1.6 million of restructuring costs, respectively, during the second andthird quarters of 2002. The Company reduced its restructuring reserve duringthe fourth quarter of 2002 by approximately $274,000, based on differencesbetween actual costs incurred compared to their original estimates. Costsassociated with the termination of employees totaled approximately$1.1 million. Costs associated with the closing of redundant facilities,the cancellation of certain contracts, and other non-personnel related actionstotaled approximately $2.2 million. As of December 31, 2002, thebalance of the restructuring reserve was approximately $1.3 million. TheCompany paid approximately $146,000 of these costs in the second quarter of2003 and $577,000 in the six months ended June 30, 2003. As of June 30, 2003,the balance of the restructuring reserve was approximately $800,000. TheCompany expects to pay out the remainder of the restructuring reserve in 2003and 2004.

 

### **4.**                                      Acquisitions

### ** **

**2003 Acquisition**

** **

On June 19, 2003, the Company acquired General Electric Company’s(“GE”) internal U.S. customs operations. The Company also entered into amanaged services agreement under which Vastera will manage the U.S. customsoperations for five of GE’s US divisions for a minimum term of 3 years. Thepurchase method of accounting has been applied to this acquisition, andaccordingly, the results of GE’s internal US customs operations will beincluded in the Company’s operations beginning July 1, 2003, the effective dateof the acquisition.

 

10

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In exchange for its internal US customs operations, GE received $3.0million and 51,046 shares of the Company’s common stock valued at approximately$312,000. The purchase price, including transaction costs of approximately$62,000, has been preliminarily allocated based on fair values as follows:

 

|                                  |   | **Value** |   |
|---------------------------------------|--------|-----------|--------|
| Prepaid expenses                      |   | $         | 126    |   |
| Property and equipment                |   | 150       |   |
| Acquired technology and know-how      |   | 1,000     |   |
| GE contract and customer relationship |   | 200       |   |
| Goodwill                              |   | 1,898     |   |
|                                  |   | $         | 3,374  |   |

 

Beginning July 1, 2003, the amount allocated to the acquired technologyand know-how intangible will be amortized on a straight-line basis over fiveyears, the estimated useful life of the asset. Beginning July 1, 2003, theamount allocated to the GE contract and customer relationship will be amortizedas a discount to revenue over five years, the estimated useful life of theasset.

 

**2002 Acquisitions**

** **

In the first quarter of 2002, the Company acquired companies in Mexico,Canada, and Brazil. The shares of common stock issued by the Company inconnection with each of these acquisitions were valued at the average of theclosing prices for the three days before and the three days after the date eachacquisition’s definitive terms were finalized.

 

On January 3, 2002, the Company entered into a definitiveagreement to acquire Prisma Tecnologia Computacional, S.A. de C.V. (“Prisma”)for approximately $5.3 million. Prisma was a provider of Global TradeManagement solutions in Mexico. The Company consummated this transaction onFebruary 1, 2002 and paid approximately $2.5 million in cash, issuedapproximately 150,000 shares of its common stock, valued at approximately$2.4 million, and paid approximately $400,000 in transaction and issuancecosts.

 

On February 12, 2002, the Company acquired Imanet, an Ontariocorporation for approximately $2.5 million. Imanet was a provider ofGlobal Trade Management solutions in Canada. The Company paid $850,000 in cash,issued approximately 90,000 shares of its common stock, valued at approximately$1.4 million, and paid approximately $300,000 in transaction and issuancecosts.

 

On March 8, 2002, the Company acquired BergenInformatica Ltda (“Bergen”) for approximately $6.4 million. Bergenwas a provider of Global Trade Management solutions in Brazil. The Company paid$2.4 million in cash, issued approximately 223,000 shares of its commonstock, valued at approximately $3.1 million, and incurred approximately$900,000 in transaction and issuance costs, including the issuance of 10,000shares of common stock valued at approximately $71,000 to an investmentadvisor.

 

The following unaudited pro forma information has been prepared as ifthe 2002 acquisitions had occurred as of January 1, 2001(in thousands,except per share data).

 
|                                               |   | **Pro Forma  for the  Six Months Ended  June 30, 2002** |   | **Pro Forma  for the  Year Ended  December 31, 2001** |   |
|----------------------------------------------------|--------|---------------------------------------------------------|--------|-------------------------------------------------------|--------|
|                                               |   | **(unaudited)**                                         |   | **(unaudited)**                                       |   |
| Total  revenues                                    |   | $                                                       | 38,020 |                                                  | $      | 69,715 |   |
| Net loss                                           |   | (6,976                                                  | )      | (48,704                                               | )      |
| Pro forma  basic and diluted loss per common share |   | (0.18                                                   | )      | (1.28                                                 | )      |
|                                                    |        |                                                         |        |                                                       |        |  |  |

 

The unaudited pro forma information is not necessarily indicative ofthe results of operations that would have occurred had the acquisition beenmade at the beginning of the periods presented or the future results of thecombined operations.

 

11

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### **5.**                                      Long-TermDebt:

### ** **

**Line of Credit**

** **

In July 2002, the Company refinanced $3.9 million ofoutstanding debt under its former credit facility with a new facility fromComerica Bank. The term loan matures in June 2004 and bears interest atthe bank’s prime rate plus 50 basis points (4.50% as of June 30, 2003). Thebalance outstanding under the term loan was approximately $2.0 million asof June 30, 2003. The Company also obtained a secured revolving line of credit(“Line of Credit”) and an equipment line of credit (“Equipment Line of Credit”)with Comerica Bank.

 

The Company may borrow up to $10.0 million under the Line ofCredit, with a $2.5 million sub-limit for the issuance of letters ofcredit. Advances under the Line of Credit are limited to the lesser of$10 million or 80% of eligible accounts receivable, as defined in the loanagreement. The Line of Credit bears interest at the bank’s prime rate  (4.00% as of June 30, 2003). The Line ofCredit matures in July 2004. There was no outstanding balance under theLine of Credit as of June 30, 2003.

 

The Company may borrow up to $5.0 million under the Equipment Lineof Credit that bears interest at the bank’s prime rate plus 50 basis points(4.50% as of June 30, 2003). The Equipment Line of Credit has two interest-onlypayment periods and matures in July 2005. In the first quarter of 2003,the Company borrowed approximately $614,000 against the Equipment Line ofCredit. The outstanding balance under the Equipment Line of Credit wasapproximately $532,000 as of June 30, 2003. On July 30, 2003, the Companyborrowed approximately $488,000 against its Equipment Line of Credit.

 

The terms of the Line of Credit and Equipment Line of Credit requirethe Company to comply with certain financial covenants, including, restrictionsand limitations on future indebtedness, sales of assets and material changes inthe business. The financial covenants include a minimum modified quick ratio,as defined in the loan agreement, of 2.0 to 1.0 and a maximum ratio of totalliabilities to tangible net worth of 1.5 to 1.0. Under the most restrictive ofthe financial covenants, the Company’s quarterly pro forma income cannot beless than $0. Through June 30, 2003, the Company was in compliance with thesecovenants.

 

Pro forma income (loss) is defined in the loan agreement as net income,plus interest expense, taxes, non-cash charges (including depreciation,amortization, stock-based compensation, research and development related chargesand one-time restructuring charges), and cash restructuring charges (not toexceed $5.0 million in the aggregate), less interest income and anyone-time or non-recurring revenue.

 

**Capital Lease Obligations**

** **

In the first quarter of 2003, the Company obtained a new equipmentleasing arrangement with a vendor for approximately $886,000. Amounts borrowedare payable over 36 months. Total capital lease obligations outstanding as ofJune 30, 2003, were approximately $878,000.

 

### **6.**                                      Commitmentsand Contingencies:

### ** **

The Company is periodically a party to disputes arising from normalbusiness activities. In the opinion of management, resolution of these matterswill not have a materially adverse effect upon the financial condition orfuture operating results of the Company.

 

On March 14, 2001, Expeditors International of Washington, Inc. andExpeditors Tradewin, L.L.C. (collectively “Expeditors”) filed suit against theCompany in the United States District Court for the Eastern District ofMichigan, Southern Division primarily alleging that the Company misappropriatedcertain of Expeditors’ trade secrets in connection with its acquisition ofFord’s customs operations, by utilizing systems and business processes thatExpeditors assisted in developing for Ford and through its employee hiringpractices. Trial in this matter is scheduled to commence in August 2003. Inconnection with its acquisition of Ford’s customs operations, Ford agreed toindemnify the Company for intellectual property infringement claims, and Fordis currently indemnifying the Company in connection with this litigation.

 

Incertain of its software license arrangements, the Company has agreed toindemnify customers for damages, if any, they might incur as a result of aclaim brought for intellectual property infringement. The Company is unable toestimate the maximum exposure of such indemnifications due to the inherentuncertainty and the varying nature of the contractual terms.

 

12

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### **7.**                                      SegmentInformation:

### ** **

The Company has three reportable operating segments: managed services,software, and services. The managed services segment generates revenues frommanaged services transaction and service arrangements. The software segmentgenerates revenues from term license, perpetual license, and transactionlicense agreements of its Global Trade Management solutions. The servicessegment generates revenues by charging its customers for implementation,management consulting and training services.

 

The Company evaluates the performance of each segment based on revenuesand gross profit. The Company’s unallocated costs include corporate and othercosts not allocated to the segments for management’s reporting purposes.

 

The following table summarizes the Company’s three segments (inthousands): 

 
|                       |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |   |
|----------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                       |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
|                       |   | **(unaudited)**                  |   | **(unaudited)**                |   | **(unaudited)** |   | **(unaudited)** |   |
| Revenues:                  |   |                             |   |                           |   |   |   |   |   |
| Managed services           |   | $                                | 13,644 |                           | $      | 11,044 |   | $ | 27,259 |   | $ | 21,974 |   |
| Software                   |   | 2,885                            |   | 3,109                          |   | 5,616 |   | 6,628 |   |
| Services                   |   | 4,995                            |   | 4,185                          |   | 9,593 |   | 8,791 |   |
| Total revenues             |   | 21,524                           |   | 18,338                         |   | 42,468 |   | 37,393 |   |
|                       |   |                             |   |                           |   |   |   |   |   |
| Gross Profit:              |   |                             |   |                           |   |   |   |   |   |
| Managed services           |   | 6,145                            |   | 5,633                          |   | 12,324 |   | 11,186 |   |
| Software                   |   | 2,173                            |   | 2,442                          |   | 4,222 |   | 5,425 |   |
| Services                   |   | 1,358                            |   | 894                            |   | 2,587 |   | 2,123 |   |
| Gross profit               |   | 9,676                            |   | 8,969                          |   | 19,133 |   | 18,734 |   |
|                       |   |                             |   |                           |   |   |   |   |   |
| Net loss:                  |   |                             |   |                           |   |   |   |   |   |
| Unallocated expense        |   | (10,279                          | )      | (13,577                        | )      | (20,651 | ) | (25,741 | ) |
| Interest income            |   | 204                              |   | 354                            |   | 433 |   | 771 |   |
| Interest and other expense |   | (56                              | )      | (126                           | )      | (97 | ) | (238 | ) |
| Income tax                 |   | (157                             | )      | (91                            | )      | (308 | ) | (182 | ) |
| Net loss                   |   | $                                | (612   | )                              | $      | (4,471 | ) | $ | (1,490 | ) | $ | (6,656 | ) |

 

**Geographic Information**

** **

The Company sells its products and services through its offices in theUnited States, Brazil, Canada, Mexico, Germany, Japan, and the United Kingdom.Information regarding revenues and long-lived assets attributable to the UnitedStates and to all foreign countries is stated below. The geographicclassification of product and services revenues was based upon the location ofthe customer. Vastera’s product and services revenues were generated in thefollowing geographic regions (in thousands): 

 
|                        |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |   |
|-----------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                        |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
|                        |   | **(unaudited)**                  |   | **(unaudited)**                |   | **(unaudited)** |   | **(unaudited)** |   |
| United States               |   | $                                | 15,813 |                           | $      | 15,072 |   | $ | 31,750 |   | $ | 31,051 |   |
| Other North America         |   | 2,609                            |   | 2,059                          |   | 4,706 |   | 4,126 |   |
| Europe                      |   | 2,053                            |   | 278                            |   | 3,829 |   | 482 |   |
| Other international regions |   | 1,049                            |   | 929                            |   | 2,183 |   | 1,734 |   |
| Total revenues              |   | $                                | 21,524 |                           | $      | 18,338 |   | $ | 42,468 |   | $ | 37,393 |   |

 

13

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The Company’s tangible long-lived assets were located as follows (inthousands): 

 
|                          |   | **June 30,  2003** |   | **December 31,  2002** |   |
|-------------------------------|--------|--------------------|--------|------------------------|--------|
|                          |   | **(unaudited)**    |   |                   |   |
| United States                 |   | $                  | 10,934 |                   | $      | 10,729 |   |
| Other North America           |   | 923                |   | 839                    |   |
| Europe                        |   | 244                |   | 278                    |   |
| Other international locations |   | 105                |   | 88                     |   |
| Total long-lived assets       |   | $                  | 12,206 |                   | $      | 11,934 |   |

 

**Significant Customers**

** **

For the quarters ended June 30, 2003 and 2002, Ford accounted for 31%and 34% of total revenues, respectively. For the six months ended June 30, 2003and 2002, Ford accounted for 30% and 35% of total revenues, respectively. Forthe quarter and six months ended June 30, 2003, Lucent Technologies accountedfor 15% of total revenues. There were no other customers that accounted forgreater than 10% of the Company’s revenues for the quarters or six months endedJune 30, 2003 and 2002. For the quarters ended June 30, 2003 and 2002, theCompany derived approximately 65% and 61%, respectively, of total revenues fromits top five customers. For the six months ended June 30, 2003 and 2002, theCompany derived approximately 66% and 61%, respectively, of total revenues fromits top five customers.

 

### **8.**                                      Transactionswith Ford Motor Company:

### ** **

On August 29, 2000, the Company acquired Ford’s global customsoperations and merged Ford’s global customs operations into its managedservices operations. Ford received 8,000,000 shares of the Company’s commonstock valued at approximately $79.2 million in consideration at the timeof the transaction. As of June 30, 2003, Ford owned 8,000,000 shares, orapproximately 19.4% of the Company’s common stock.

 

In August 2000, the Company also entered into a managed servicesagreement under which Vastera manages Ford’s global trade operations. InJanuary 2001 and March 2001, the Company entered into a managedservices agreements with Ford Mexico and Ford Canada, respectively. InNovember 2002, the Company entered into a managed services agreement withFord Europe to manage Ford’s global trade operations in the United Kingdom,Spain, Belgium, and Germany. The agreements with Ford initially had minimumterms of four years, and each may continue for a total of ten years.

 

In February 2002, the Company amended its agreement with Ford U.S.to provide for quarterly minimum transaction levels in lieu of annual minimumtransaction levels. By amending the agreement in this manner, the Company wasable to bill Ford on a quarterly basis for the transactions processed in excessof the minimum levels. In connection with the amendment, the Company agreed toreduce Ford’s U.S. aggregate annual minimum revenue guarantee from$11.6 million to $11.0 million. For the quarter and six months endedJune 30, 2002, the Company derived approximately $1.0 million and $2.5million, respectively, in revenues related to transactions in excess of thequarterly minimum.

 

In July 2002, the Company further amended its agreement with FordU.S. to provide for billing Ford at a fixed annual rate of $11.8 millionfor the remaining life of the agreement, beginning January 1, 2003. Byamending the agreement in this manner, the Company bills Ford a fixed annualservice fee instead of on a per transaction processed basis. In connection withthis amendment, the Company and Ford agreed that the Company would bill Ford$4.9 million ratably over the remainder of 2002.

 

For the quarters ended June 30, 2003 and 2002, Ford accounted for 31%and 34% of total revenues, respectively. For the six months ended June 30, 2003and 2002, Ford accounted for 30% and 35% of total revenues, respectively. As ofJune 30, 2003 and December 31, 2002, Ford owed the Company approximately$4.8 million and $3.0 million, or 26% and 16%, of the Company’s totalaccounts receivable, respectively.

 

The Company reimburses Ford for expenses incurred by Ford for theCompany’s use of Ford’s facilities, the costs of leased employees, and themaintenance and expenses related to the acquired technology. For the quartersended June 30, 2003 and 2002, the Company paid Ford approximately$1.9 million, and $1.4 million, respectively. For the six monthsended June 30, 2003 and 2002, the Company paid Ford approximately $3.9 millionand $2.7 million, respectively. These payments increased beginning inDecember 2002 when the Company assumed responsibility for managing Ford’soperations in Europe. However, the Company

 

14

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expectspayments to decrease in the future as the Company leverages its existingfacilities and employees and deploys its own technology.

 

### **9.**                                      Stock-basedCompensation

### ** **

In October 2002, the Company offered each employee an opportunityto cancel certain stock options (the “Options Exchange”) in exchange for theright to receive a future stock option grant for the same number of shares sixmonths and one day from the date of cancellation with a strike price equal tothe market price on the new grant date. Options to purchase approximately 3.8million shares were cancelled pursuant to the Options Exchange. In April 2003,the Company issued replacement options to employees to purchase approximately3.6 million shares of common stock at an exercise price of $4.06 per share inexchange for the options previously canceled. The vesting schedule of thecanceled options remained in effect for the replacement options. The Companydeferred the issuance of annual option grants to employees during thissix-month period and accordingly, in April 2003, the Company issued additionaloptions to purchase 930,000 shares of common stock to these employees at anexercise price of $4.06 per share. As of June 30, 2003, options to purchaseapproximately 8,538,000 shares of common stock were outstanding.

 

The Company applies APB Opinion No. 25, *Accounting for Stock Issued to Employees*, and relatedinterpretations in accounting for it stock option plan. The Company recordeddeferred compensation cost of approximately $6.4 million in the last sixmonths of 1999 and approximately $13.4 million in the first nine months of2000. On March 29, 2001, the Company also recorded approximately $465,000 ofdeferred compensation in connection with the issuance of options to acquire64,000 shares of its common stock in exchange for the unvested Speedchain stockoptions it assumed in the related business combination. These deferredcompensation amounts represent the aggregate difference between the exerciseprice and the fair value for accounting purposes of the underlying shares ofcommon stock at the date of grant. This amount is included as a component ofstockholders’ equity and is being amortized on an accelerated basis over theapplicable vesting period. Stock-based compensation, which has been separatelyidentified in the accompanying condensed consolidated statement of operations,has not been included in costs of revenues, sales and marketing, research anddevelopment, and general and administrative expense as indicated below (inthousands):

 
|                              |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |   |
|-----------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                              |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
|                              |   | **(unaudited)**                  |   | **(unaudited)**                |   | **(unaudited)** |   | **(unaudited)** |   |
| Cost of managed services revenues |   | $                                | 8      |                           | $      | 20 |   | $ | 18 |   | $ | 44 |   |
| Cost of software revenues         |   | 1                                |   | 3                              |   | 3 |   | 7 |   |
| Cost of services revenues         |   | 39                               |   | 99                             |   | 91 |   | 218 |   |
| Sales and marketing               |   | 110                              |   | 286                            |   | 258 |   | 628 |   |
| Research and development          |   | 27                               |   | 69                             |   | 63 |   | 152 |   |
| General and administrative        |   | 90                               |   | 233                            |   | 212 |   | 513 |   |
| Total stock-based compensation    |   | $                                | 275    |                           | $      | 710 |   | $ | 645 |   | $ | 1,562 |   |

 

### **10.**                               SupplementalInformation:

### ** **

**Cash Flow Information**

** **

Cash paid for interest was approximately $81,000 and $252,000 for thesix months ended June 30, 2003 and 2002, respectively. Noncash activities wereas follows (in thousands):

 
|                                                                                                                    |   | **Six Months Ended  June 30,** |   |
|-------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------|--------|
|                                                                                                                    |   | **2003**                       |   | **2002** |   |
|                                                                                                                    |   | **(unaudited)**                |   |   |   |
| Increase in capital lease obligations                                                                                   |   | $                              | 886    |   | $ | 1,243 |   |
| Issuance of common stock and stock options  in acquisitions                                                             |   | 312                            |   | 6,933 |   |
| Assumed liabilities, transaction costs and  other, net of tangible assets and deferred revenue acquired in acquisitions |   | (214                           | )      | 2,040 |   |
|                                                                                                                         |        |                                |        |  |  |  |  |

 

15

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## **Item 2:   Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

## ** **

The following discussion and analysis of our financial condition andresults of operations should be read in conjunction with our condensedconsolidated financial statements and related notes appearing elsewhere in thisReport, which are deemed to be incorporated into this section. Our actualresults could differ materially from those anticipated in such forward—lookingstatements due to various factors, including, but not limited to, those setforth under “Risks Relating to our Business” and elsewhere in this Report.

 

Some of the statements we make in “Management’s Discussion and Analysisof Financial Condition and Results of Operations” and elsewhere in this Reportconstitute forward-looking statements within the meaning of Section 21E of theSecurities Exchange Act of 1934, as amended (the “Exchange Act”). Thesestatements involve known and unknown risks, uncertainties and other factorsthat may cause our actual results, levels of activity, performance orachievements as expressed or implied by such forward-looking statements not tobe achieved fully. These forward-looking statements relate to future events andour future financial performance. In some cases, you can identifyforward-looking statements by words such as “may,” “should,” “expect,” “plan,”“anticipate,” “intend,” “believe,” “estimate,” “predict,” and “continue,” orthe negative of such terms or other comparable words. These statements are onlypredictions and included risks and uncertainties particularly those describedin this Report under the caption “Risks Relating to Our Business.”  Consequently, our actual results may differmaterially from those expressed or implied by these forward-looking statements.

 

**Overview**

** **

Vastera is the worldwide leading provider of solutions for Global TradeManagement. Vastera provides solutions that manage the information flowassociated with the cross border component of an international shipment for itsclients, thereby accelerating the flow of goods through the global supplychain. Global trade is regulated by dynamic, country-specific rules andinvolves a complex network of trade participants, including exporters,forwarders, carriers, brokers, importers, financial institutions and customsand regulatory agencies. Since our inception, we have continued to developcomprehensive solutions with features, functionality, and services that allowcompanies to manage the complexities of global trade.

 

We provide our solutions to over 400 clients from our offices in theUnited States, Belgium, Brazil, Canada, France, Germany, Ireland, Japan,Mexico, the Netherlands, Poland, Spain, and the United Kingdom. Our clientstypically acquire software or purchase managed services for a division ordepartment. As they expand the utilization of our solutions globally and totheir clients, suppliers and business partners, our clients often acquireadditional software licenses or expand managed services arrangements. Wecurrently market our products and services on a global basis through our directsales force and other channels, such as strategic alliances and partners. Weexpect revenues from our international operations to increase as we continue toexpand our international sales and services organizations. Although ourcustomer base spans several diverse industries, a significant portion of ourrevenues are generated by customers in the automotive and high-technologyindustries.

 

**Relationship with Ford Motor Company**

** **

In August 2000, we entered into an agreement to acquire Ford MotorCompany’s global customs operations and merged Ford’s global customs operationsinto our managed services operations. The Ford operations that were merged intous consisted of Ford personnel and technology utilized by Ford to manage itsinternational trade transactions. By combining our existing technology andintellectual capital with that acquired from Ford, we intend to expand ourmanaged services to companies of varying sizes on a global basis. Ford received8,000,000 shares of our common stock, valued at approximately$79.2 million at the time of the transaction. As of June 30, 2003, Fordowned 8,000,000 shares, or approximately 19.4% of our common stock.

 

In August 2000, we also entered into a Global Trade Managementservices agreement under which we manage Ford’s global trade operations. InJanuary 2001 and March 2001, we expanded the Global Trade Managementservices we provide to Ford by assuming responsibility for administering andmanaging Ford’s global trade operations in Mexico and Canada, respectively. InNovember 2002, we further expanded the Global Trade Management services weprovide to Ford by assuming responsibility for administering and managingFord’s global trade operations in the United Kingdom, Germany, Belgium, andSpain (collectively, “Ford Europe”). Our agreements with Ford initially had aminimum term of four years.

 

These agreements provide us with a guaranteed, predictable, andrecurring revenue stream from Ford. We expect to derive at least$25 million in revenues on an annual basis from our agreements with FordU.S., Ford Mexico, Ford Canada, and Ford Europe.

 

16

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Webelieve our client relationship with Ford will have a significant impact on ourtotal revenues and is expected to account for greater than 10% of our revenuesfor the foreseeable future.

 

For the quarters ended June 30, 2003 and 2002, Ford accounted for 31%and 34% of our total revenues, respectively. For the six months ended June 30,2003 and 2002, Ford accounted for 30% and 35% of our total revenues,respectively. As of June 30, 2003 and December 31, 2002, Ford owed usapproximately $4.8 million and $3.0 million, or 26% and 16%, of ourtotal accounts receivable, respectively.

 

In February 2002, we amended our agreement with Ford U.S. toprovide for quarterly minimum transaction levels in lieu of annual minimumtransaction levels. By amending the agreement in this manner, we were able tobill on a quarterly basis the transactions processed in excess of the minimumlevels. In connection with the amendment, we agreed to reduce Ford’s U.S.aggregate annual minimum revenue guarantee from $11.6 million to$11.0 million. For the quarter and six months ended June 30, 2002, wederived approximately $1.0 million and $2.5 million, respectively, inrevenues related to transactions in excess of the quarterly minimum.

 

In July 2002, we further amended our agreement with Ford U.S. toprovide that we bill Ford U.S. at a fixed annual service fee rate of$11.8 million for the remaining life of the agreement. By amending theagreement in this manner, we bill Ford U.S. a fixed annual service fee insteadof on a per transaction processed basis. In connection with this amendment,Ford U.S. agreed that we would bill Ford U.S. $4.9 million ratably overthe remainder of 2002.

 

**Acquisitions**

** **

On June 19, 2003, we acquired GE’s internal U.S. customs operations. Wealso entered into a managed services agreement under which Vastera will managethe U.S. customs operations for five of GE’s US divisions for a minimum term of3 years. The purchase method of accounting has been applied to thisacquisition, and accordingly, the results of GE’s internal US customsoperations will be included in our operations beginning July 1, 2003, theeffective date of the acquisition. In exchange for its internal US customsoperations, GE received $3.0 million and 51,046 shares of our common stockvalued at approximately $312,000. The purchase price, including transactioncosts of approximately $62,000, totaled approximately $3.4 million.

 

In the first quarter of 2002, we executed on our strategy of expandingour global presence to enhance our competitive position worldwide and ourability to serve and support our clients. As part of this strategy, we acquiredcompanies in Mexico, Canada, and Brazil. The shares of common stock we issuedwere valued at the average of the closing prices for the three days before andthe three days after the date each acquisition’s definitive terms werefinalized.

 

On January 3, 2002, we entered into a definitive agreement toacquire Prisma Tecnologia Computacional, S.A. de C.V. (“Prisma”) forapproximately $5.3 million. Prisma was a provider of Global TradeManagement solutions in Mexico. We consummated this transaction onFebruary 1, 2002 and paid approximately $2.5 million in cash, issuedapproximately 150,000 shares of its common stock, valued at approximately$2.4 million, and paid approximately $400,000 in transaction and issuancecosts.

 

On February 12, 2002, we acquired Imanet, an Ontario corporationfor approximately $2.5 million. Imanet was a provider of Global TradeManagement solutions in Canada. We paid $850,000 in cash, issued approximately90,000 shares of its common stock, valued at approximately $1.4 million,and paid approximately $300,000 in transaction and issuance costs.

 

On March 8, 2002, we acquired Bergen Informatica Ltda.(“Bergen”) for approximately $6.4 million. Bergen was a provider of GlobalTrade Management solutions in Brazil. We paid $2.4 million in cash, issuedapproximately 223,000 shares of its common stock, valued at approximately$3.1 million, and incurred approximately $900,000 in transaction andissuance costs, including the issuance 10,000 shares of common stock valued atapproximately $71,000 to an investment advisor.

 

All of these acquisitions were accounted for under the purchase methodof accounting. The excess of the consideration over the fair value of theacquired assets and liabilities and identified intangibles were accounted foras goodwill. We recorded in the aggregate approximately $10.8 million and$4.0 million of identified intangibles and goodwill, respectively, in 2002in connection with the Prisma, Imanet, and Bergen acquisitions.

 

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**Critical Accounting Policies**

** **

We consider our accounting policies related to revenue recognition,deferred revenues, internal use software and intangible assets to be criticalto our business operations and the understanding of our results of operations.The impact and associated risks related to these policies on our businessoperations is discussed throughout Management’s Discussion and Analysis ofFinancial Condition and Results of Operations where such policies affect ourreported and expected financial results. For a summary of significantaccounting policies used in the preparation of our consolidated financialstatements, see the Notes to our Consolidated Financial Statements in Item 1 ofthis Report. Our preparation of this Report requires us to make estimates andassumptions that affect the reported amount of assets and liabilities,disclosure of contingent assets and liabilities at the date of our financialstatements, and the reported amounts of revenue and expenses during thereporting period. We cannot be sure that actual results will not differ fromthose estimates.

 

**Source of Revenues and Revenue RecognitionPolicy**

** **

*Managed Services Revenues*

* *

Managed services revenues are derived from agreements that provide fortransaction or services fees based on the performance of our managed servicessolutions. Managed services solutions include the processing of our clients’customs entries and the classifying of clients’ goods. Managed services transactionarrangements are often subject to annual or quarterly minimum transactionthresholds and revenues are recognized based on the lower of the cumulativeactual transactions processed during the period using a weighted-averagetransaction rate or the amount billable for the period. For those managedservices transaction arrangements subject to annual minimums and for thosearrangements where the amount billable for interim periods is limited to thepro-rata portion of the annual minimum, transactions processed in excess of theminimum in each period are not billable, and, therefore, revenue is notrecognized until the end of the related year. Certain managed servicesarrangements are based upon a fixed services fee. Revenues associated withthese arrangements are recognized ratably over the term of the arrangement andlimited to the amounts billable. In addition, we may receive annual gainsharingfees under certain managed services arrangements based on a percentage of theclient’s annual cost savings, as defined in the managed services arrangements.These fees are recognized when they become fixed and determinable. Managedservices transaction minimums and fixed service fees are typically billedmonthly.

 

*Software Revenues*

* *

Software revenues consist of term license revenues, perpetual softwarelicense revenues, and transaction-based revenues. We recognize revenue from thesale of software products in accordance with Statement of Position (“SOP”)97-2, *Software Revenue Recognition*.

 

Term license revenues are derived from term software licensearrangements in which our clients license our software products and obtain theright to unspecified enhancements on a when-and-if-available basis and ongoingsupport and content update services. Content updates are significant andfrequent. Revenues are recognized ratably over the contract term. Term licensearrangements typically range from three to five years. To the extent we hostthe software for our customers, the hosting fee is recognized ratably over thecontract period in conjunction with the recognition of the license fee. Termlicense fees are typically billed annually, quarterly or monthly.

 

Perpetual software license revenues are derived from perpetual softwarelicense arrangements and related maintenance contracts. Maintenance contractsinclude the right to unspecified enhancements on a when-and-if available basis,ongoing support, and content update services. The content updates providedunder maintenance arrangements are significant and frequent, and, as a result,revenues from perpetual software license sales are recognized ratably over theestimated economic life of the product. We have estimated that the life of theproduct is three years, which is consistent with the historical periods betweenmajor upgrades to the functionality and architecture of our products. Revenuesfrom maintenance contracts are recognized ratably over the contract term,typically one year. To the extent we host the software for our customers, thehosting fee is recognized ratably over the contract period in conjunction withthe recognition of the license fee.

 

Transaction-based revenues are derived from agreements that provide fortransaction fees based on a client’s usage of our software products. Revenuesfrom the usage of its software products are recognized as transactions occur.

 

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We recognize revenues from arrangements with resellers beginning whenthe software product is sold to the end user. Any annual minimums required ofthe reseller but not sold by the reseller to end customers are recognized asrevenues upon the expiration of the annual minimum period.

 

*Services Revenues*

* *

Services revenues are derived from implementation, managementconsulting and training services. Services are performed on a time andmaterials basis or under fixed price arrangements. Revenues on time andmaterials contracts are recognized based on fixed billable rates for hoursdelivered, and revenues on fixed priced contracts are recognized as the servicesare performed using the percentage of completion method of accounting based onthe ratio of costs incurred to total estimated costs to be incurred. Losses onarrangements are recognized when known.

 

For multiple-element arrangements where we provide both software andservices, we defer the service fee, based on vendor-specific objective evidenceof fair value, and recognize the services as performed.

 

**Deferred Revenues**

** **

Deferred revenues include amounts paid by clients for revenues thathave not been recognized and generally result from billed, but deferred termand perpetual license revenues and services not yet performed. Deferredrevenues will be recognized on a monthly basis over the term of the agreement,the remaining economic life of the product, or when the services are performed.As we continue to increase our term license and transaction-based revenuesrelative to our perpetual licenses, we expect our deferred revenues tofluctuate since term license and transaction-based customers are billed andpaid ratably (usually either annually, monthly or quarterly). We do notconsider deferred revenue to be an indicator of future revenues.

 

**Internal Use Software**

** **

In accordance with Statement of Position 98-1, *Accounting for the Costs of Computer SoftwareDeveloped or Obtained for Internal Use*, we capitalize costsassociated with the implementation and integration of our trade managementplatform to our managed services operations, related to certain capitalizabletasks including the technical design, system configuration and testing phasesof the integration process. Judgment is involved in determining whichdevelopment tasks associated with the platform integration are capitalizablepursuant to SOP 98-1. We capitalized approximately $93,000 and $463,000 in thesecond quarters of 2003 and 2002, respectively, and $284,000 and $810,000 inthe six months ended June 30, 2003 and 2002, respectively. These costs areamortized as costs of managed services revenues over three years, andamortization commences upon the completion of the integration to the Vasteraplatform. We began amortizing these costs in the fourth quarter of 2002. Totalamortization expense in the three months and six months ended June 30, 2003 wasapproximately $97,000 and $220,000, respectively. Net capitalized costs on thebalance sheets as of June 30, 2003 and December 31, 2002 wereapproximately $1.6 million and $1.5 million, respectively.

 

**Goodwill and Intangible Assets**

** **

As of June 30, 2003, we had recorded goodwill and intangible assets ofapproximately $77.4 million related to our acquisitions.

 

Goodwill represents the excess of costs over the fair value of assetsof businesses acquired. We adopted the provisions of SFAS No. 142, *Goodwill and Other Intangible Assets,* asof January 1, 2002. Goodwill and intangible assets acquired in a purchasebusiness combination and determined to have an indefinite useful life are notamortized, but instead tested for impairment at least annually in accordancewith the provisions of SFAS No. 142. SFAS No. 142 also requires thatintangible assets with estimable useful lives be amortized over theirrespective estimated useful lives to their estimated residual values, andreviewed for impairment in accordance with SFAS No. 144, *Accounting for Impairment or Disposal of Long-LivedAssets*.

 

As of January 1, 2002, we had unamortized goodwill ofapproximately $62.2 million. Prior to January 1, 2002, goodwill wasamortized on a straight-line basis over its expected economic life, generallyfour or five years, and assessed for recoverability by determining whether theamortization of the goodwill balance over its remaining life could be recoveredthrough the undiscounted future operating cash flows of the acquired operation.

 

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On January 1, 2002, in accordance with SFAS No. 141, wereclassified our assembled workforce intangible assets to goodwill. Prior toJanuary 1, 2002, assembled workforce intangibles were amortized on astraight-line basis over two or three years. The value assigned to theassembled workforce in the acquisition of Ford’s global customs operation wasallocated to each country in which we acquired Ford’s global customsoperations, based upon the number of employees in that country. The related amortizationwas to be recorded over three years from the date we assumed Ford’s customsoperations in that country.

 

All other identifiable intangible assets are amortized on astraight-line basis over their expected economic lives, generally one to fiveyears. The value assigned to the Ford contract is being amortized as a discountto revenue over the minimum term of the contract. Beginning July 1, 2003, theamount allocated to the GE contract and customer relationship acquired in theacquisition of GE’s internal US customs operations will be amortized as adiscount to revenue over five years, the estimated useful life of the asset.Beginning July 1, 2003, the amount allocated to the acquired technology andknow-how intangible acquired in the acquisition of GE’s internal US customsoperations will be amortized on a straight-line basis over five years, theestimated useful life of the asset. In the aggregate, amortization ofintangible assets for the quarters ended June 30, 2003 and 2002 wasapproximately $707,000 and $740,000, respectively, and $1.4 million and $1.2million for the six months ended June 30, 2003 and 2002, respectively. In theaggregate, amortization of these identified intangibles is expected to beapproximately $2.8 million, $2.6 million, $1.2 million,$1.2 million, $885,000 and $100,000 in 2003, 2004, 2005, 2006, 2007, and2008, respectively.

 

The recoverability and useful lives of our intangible assets are basedon estimates and are susceptible to change. Although we believe our intangibleassets will be recoverable, changes in the economy, the business in which weoperate and our own relative performance could change the assumptions used toevaluate intangible asset recoverability. We continue to monitor theseassumptions and their effect on the estimated recoverability.

 

**Management’s Disclosure of Non-GAAP FinancialMeasures**

** **

From time to time, management makes public disclosures, other thanthrough our financial filings on Form 10-Q or Form 10-K, of certainfinancial measures such as pro forma earnings (loss) and EBITDA, as adjusted(as defined below), that are not considered GAAP financial measures. Only July24, 2003, we issued an earnings press release that was furnished as an exhibitto a Form 8-K filed the same day. This press release contains reconciliationsof pro forma earnings (loss) and EBITDA, as adjusted, to net loss.

 

To assess fully our financial operating results, management believesthat pro forma earnings (loss) is a useful way to measure our operatingperformance and liquidity, because it reflects more accurately our operatingperformance for the reporting period by excluding those charges associated withpast events that are not related to current operations or, in the case ofincome taxes, amounts that are not used to measure operating performance butrather are derived from it. The excluded intangible amortization expense isassociated with identifiable intangible assets from acquisitions. The excludedstock-based compensation pertains to deferred non-cash compensation chargesrecorded in connection with the initial public offering of our shares of commonstock and from acquisitions.

 

EBITDA, as adjusted, excludes intangible amortization expense,restructuring, stock-based compensation, income taxes, depreciation,amortization of revenue discount related to Ford contract, amortization ofcapitalized internal-use software costs, and other income, net. Management usesEBITDA, as adjusted, to measure and evaluate our operating performance andliquidity, because it reflects the resources available from the reportingperiod’s operations for operating and strategic opportunities including, amongothers, investing in the business, meeting financing obligations, makingstrategic acquisitions, and paying other cash obligations. Therefore,management believes EBITDA, as adjusted, is an appropriate measure to evaluateour operating performance and liquidity. These financial measures, however,should be considered in addition to, not as a substitute for or as beingsuperior to, operating net losses, cash flows, or other measures of financialperformance prepared in accordance with U.S. generally accepted accountingprinciples.

 

**Comparison of the Quarter Ended June 30, 2003to the Quarter Ended June 30, 2002**

** **

*Revenues*

* *

**Totalrevenues.** Total revenues increased 17% to approximately $21.5 million for thequarter ended June 30, 2003 from approximately $18.3 million for thequarter ended June 30, 2002.

 

**Managed services revenues.**  Managed services revenues increased 24% toapproximately $13.6 million for the quarter ended June 30, 2003 fromapproximately $11.0 million for the quarter ended June 30, 2002. For thequarter ended June 30, 2002, we

 

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derivedapproximately $1.0 million in revenue under our Ford U.S. global managedservices agreement related to transactions in excess of the quarterly minimum.In July 2002, we amended our agreement with Ford U.S. to provide forbilling Ford at a fixed annual rate instead of on a per transaction processedbasis; therefore, excess transactions are no longer billable. Excluding the$1.0 million revenue related to excess transaction billings to Ford for thequarter ended June 30, 2002, managed services revenue increased for the quarterended June 30, 2003 by 36% from the quarter ended June 30, 2002. We attributethis increase to the continued growth in our automotive and high-tech managedservices client base and expansion of our responsibilities with existingcustomers, primarily Ford, Lucent, and Nortel. Revenues derived from ourmanaged services agreements accounted for 63% of our total revenues for thequarter ended June 30, 2003, compared to 60% of our total revenues for thequarter ended June 30, 2002. We expect managed services revenues to account forapproximately 60% to 70% of our total revenues for the foreseeable future.

 

**Software revenues.**  Software revenues decreased 7% toapproximately $2.9 million for the quarter ended June 30, 2003 fromapproximately $3.1 million for the quarter ended June 30, 2002. Weattribute this decrease to the conversion of several customers to managedservices, the drop-off of revenue related to perpetual licenses sold in prioryears and maintenance cancellations. Revenues derived from our softwareagreements accounted for 14% of our total revenues for the quarter ended June30, 2003, compared to 17% of our total revenues for the quarter ended June 30,2002. We expect software revenues to account for approximately 10% to 15% ofour total revenues for the foreseeable future.

 

**Services revenues.**  Services revenues increased 19% toapproximately $5.0 million for the quarter ended June 30, 2003 fromapproximately $4.2 million for the quarter ended June 30, 2002. We attributethis increase to the variability in the demand for our services from ourcustomer base, the decline in services revenue in the quarter ended June 30,2002 resulting from closing few software deals in the first quarter of 2002,and the accelerated timing of certain software integration projects during thequarter ended June 30, 2003. Services revenues accounted for 23% of our totalrevenues for both the quarters ended June 30, 2003 and 2002. We expect servicesrevenues to continue to account for approximately 20% to 25% of our totalrevenues for the foreseeable future.

 

*Cost of Revenues*

* *

**Cost of managed services revenues.**  Cost of managed services revenues consistsof salaries and related expenses for our managed services organization,including payments to Ford for our use of Ford’s facilities, the costs ofleased employees, and the maintenance and expenses related to the acquiredtechnology, as well as the amortization of capitalized internal use softwarecosts related to the implementation and integration of our trade managementplatform to our managed services operation.

 

Cost of managed services revenues increased 39% to approximately$7.5 million for the quarter ended June 30, 2003 from approximately$5.4 million for the quarter ended June 30, 2002. This increase waslargely due to the growth of our managed services operations to support ourgrowing client base and our European expansion. Cost of managed servicesrevenues as a percentage of managed services revenues was 55% for the quarterended June 30, 2003 and 49% for the quarter ended June 30, 2002. This increaseas a percentage of managed services revenues resulted from our adding personneland incurring infrastructure costs related to our European expansion and the$1.0 million of non-recurring revenue related to the excess transaction billingto Ford for the quarter ended June 30, 2002. Over time, we expect to realizeproductivity improvements from our investment in our support infrastructure andthe leveraging of personnel in the performance of our managed servicesagreements. As we enter into large multi-year managed services agreements innew industry sectors or new geographic regions that may require significantinvestments in the related infrastructure, the costs associated with thesemanaged services agreements may be greater in the initial year than in thelater years when we realize productivity improvements from these infrastructureinvestments. Accordingly, we expect that our cost of managed services revenuesmay fluctuate on a quarterly or annual basis as a percentage of managedservices revenues.

 

**Cost of software revenues.**  Cost of software revenues includes royaltiesowed to third parties for technology products integrated into our softwareproducts, as well as the cost of salaries and related expenses for ourtechnical support organization.

 

Cost of software revenues increased 7% to approximately $712,000 forthe quarter ended June 30, 2003 from approximately $667,000 for thequarter ended June 30, 2002. This increase was largely due to our investment inour client support infrastructure. Cost of software revenues as a percentage ofsoftware revenues was 25% for the quarter ended June 30, 2003, compared to 21%for the quarter ended June 30, 2002. This increase as a percentage of softwarerevenues results from our additional investment in our client supportinfrastructure to support our new product offerings, as well as a reduction inour software revenues. We expect the cost of software revenues as a percentageof software revenues to remain in this approximate range for the foreseeablefuture, but this percentage may fluctuate in any given quarter or year.

 

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**Cost of services revenues.**  Cost of services revenues includes the costof salaries and related expenses for implementation, management consulting andtraining services provided to clients, as well as the cost of third parties wecontract with to provide either application consulting or implementationservices to our clients.

 

Cost of services revenues increased 11% to approximately $3.6 million forthe quarter ended June 30, 2003 from approximately $3.3 million for the quarterended June 30, 2002. This increase was largely due to the additional personnelcosts associated with the additional work completed in the quarter. Cost ofservices revenues as a percentage of services revenues was 73% and 79% for thequarters ended June 30, 2003 and 2002, respectively. This decrease isconsistent with the increase in revenue from the additional work completedduring the second quarter of 2003. We expect the cost of services revenues as apercentage of services revenues to be approximately 70% to 75% on an annualbasis, but this percentage may fluctuate outside this range in any givenquarter or year.

 

*Operating Expenses*

* *

**Sales and marketing.**  Sales and marketing expense consistsprimarily of salaries, commissions and bonuses earned by sales and marketingpersonnel, sales training events, public relations, advertising, trade showsand travel expenses related to both promotional events and direct sales efforts.

 

Sales and marketing expense decreased 29% to approximately$2.3 million for the quarter ended June 30, 2003 from approximately$3.3 million for the quarter ended June 30, 2002. This decrease wasprimarily due to a reduction in personnel and a reduction in promotionalexpenses. Sales and marketing expenses represented 11% of our total revenuesfor the quarter ended  June 30, 2003 and18% for the quarter ended June 30, 2002. We anticipate that sales and marketingexpenses will remain relatively stable as a percentage of total revenues forthe foreseeable future.

 

**Research and development.**  Research and development expense consistsprimarily of salaries, benefits, and equipment for software developers, qualityassurance personnel, program managers, and technical writers.

 

Research and development expense decreased 14% to approximately$3.0 million for the quarter ended June 30, 2003 from approximately$3.5 million for the quarter ended June 30, 2002. This decrease wasprimarily due to the transfer of some of our research and developmentactivities to geographies with lower costs of labor, a reduction in personnel,and a reduction in the number of internal and contract software developers andquality assurance personnel needed to support our product development andtesting activities. Research and development expenses represented 14% of ourtotal revenues for the quarter ended June 30, 2003 and 19% for the quarterended June 30, 2002. We believe that we must continue to invest in research anddevelopment in order to develop new products and services. We anticipate thatresearch and development expenses will continue to decrease as a percentage oftotal revenues for the foreseeable future.

 

**General and administrative.**  General and administrative expense consistsprimarily of salaries, benefits, and related costs for executive, finance,administrative, and information services personnel.

 

General and administrative expense increased 18% to approximately$2.7 million for the quarter ended June 30, 2003 from approximately$2.3 million for the quarter ended June 30, 2002. This increase resultedfrom the addition of personnel to support the growth of our business, legal,and professional fees relating to our international expansion, and increasedcosts associated with the new public company regulations. General andadministrative expenses represented 13% of our total revenues for both thequarters ended June 30, 2003 and 2002. We believe our general andadministrative expenses will decrease as a percentage of total revenues butwill remain relatively consistent in absolute dollars when compared to thequarter ended June 30, 2003.

 

**Depreciation.**  Depreciation expense increased 15% toapproximately $1.3 million for the quarter ended June 30, 2003 fromapproximately $1.1 million for the quarter ended June 30, 2002. Thisincrease resulted from the depreciation of fixed assets purchased to build theinfrastructure needed to support the growth of our business. We believe ourdepreciation expense will increase in absolute dollar amounts as we continue toinvest our infrastructure.

 

**Intangible amortization expense.**  Intangible amortization expense decreased 4%to approximately $707,000 for the quarter ended June 30, 2003 fromapproximately $740,000 for the quarter ended June 30, 2002. This decreaserelates primarily to the fluctuations in foreign currency rates and the relatedtranslations into US dollars.

 

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**Restructuring.**  The Company recorded approximately$2.0 million and $1.6 million of restructuring costs, respectively,during the second and third quarters of 2002. The Company reduced itsrestructuring reserve during the fourth quarter of 2002 by approximately$274,000, based on differences between actual costs incurred compared to theiroriginal estimates. Costs associated with the termination of employees totaledapproximately $1.1 million. Costs associated with the closing of redundantfacilities, the cancellation of certain contracts, and other non-personnelrelated actions totaled approximately $2.2 million. As ofDecember 31, 2002, the balance of the restructuring reserve wasapproximately $1.3 million. The Company paid approximately $146,000 ofthese costs in the second quarter of 2003 and $577,000 in the six months endedJune 30, 2003. As of June 30, 2003, the balance of the restructuring reservewas approximately $800,000. The Company expects to pay out the remainder of therestructuring reserve in 2003 and 2004.

 

**Stock-based compensation.**  We recorded deferred compensation ofapproximately $6.4 million in the last nine months of 1999 andapproximately $13.1 million in 2000. These amounts represent the aggregatedifference between the exercise price and the fair value for accountingpurposes of the underlying common stock at the date of grant. On March 29,2001, we recorded $465,000 of deferred compensation in connection with theunvested stock options that were assumed in connection with the Speedchainacquisition. These amounts are included as a component of stockholders’ equityand are being amortized on an accelerated basis over the applicable vestingperiod. For the quarters ended June 30, 2003 and 2002, we amortizedapproximately $275,000 and $710,000, respectively, of deferred compensation. Weexpect to amortize deferred compensation of approximately $941,000 and $45,000for the years ending December 31, 2003 and 2004, respectively. The amountof stock option compensation expense to be recorded in future periods coulddecrease if options for which accrued but unvested compensation has beenrecorded are forfeited.

 

In October 2002, we offered each employee an opportunity to cancelcertain stock options (the “Options Exchange”) in exchange for the right toreceive a future stock option grant for the same number of shares six monthsand one day from the date of cancellation with a strike price equal to themarket price on the new grant date. Options to purchase approximately 3.8million shares were cancelled pursuant to the Options Exchange. In April 2003,we issued replacement options to employees to purchase approximately 3.6million shares of common stock at an exercise price of $4.06 per share inexchange for the options previously canceled. The vesting schedule of thecanceled options remained in effect for the replacement options. We deferredthe issuance of annual option grants to employees during this six-month period,and accordingly, in April 2003, we issued additional options to purchase930,000 shares of common stock to these employees at an exercise price of $4.06per share. As of June 30, 2003, options to purchase approximately 8,538,000shares of common stock were outstanding.

 

**Other income (expenses), net.**  Other income (expenses), net fluctuates,based on the amount of cash balances available for investment, borrowings underour lines of credit, interest and other expenses related to our equipmentborrowings, and realized gains and losses on investments. Other income(expenses), net decreased to approximately $148,000 for the quarter ended June30, 2003 from approximately $228,000 for the quarter ended June 30, 2002. Thisdecrease resulted from lower interest rates and lower cash and investmentbalances.

 

**Income taxes.**  For the quarters ended June 30, 2003 and2002, the tax provision was comprised of state and foreign taxes. For thequarter ended June 30, 2003, the tax provision was greater than in previousquarters due to income-based withholding taxes incurred from foreign servicesrevenue and the disallowance of net operating loss carryforwards in certainstates where we do business. No provision for federal income taxes has beenrecorded for the quarters ended June 30, 2003 or 2002 due to our accumulatednet operating losses. We have recorded a valuation allowance for the fullamount of our net deferred tax assets as a result of the uncertaintysurrounding the realization of these future tax benefits.

 

As of December 31, 2002, we had net operating loss carry-forwards forfederal tax purposes of approximately $67.6 million. These losscarry-forwards are available to reduce future taxable income and begin toexpire in 2011. Under provisions of the Internal Revenue Code, certainsubstantial changes in our ownership have occurred, and as a result, our futureutilization of these net operating loss carryforwards that we accumulated priorto the change in ownership will be subject to annual limitations. We have alsogenerated foreign net operating losses of approximately $16.2 million thatare available for carryforward. We may generate additional net operating losscarry-forwards in the future.

 

**Comparison of the Six Months Ended June 30,2003 to the Six Months Ended June 30, 2002**

** **

*Revenues*

* *

**Total revenues.**  Total revenues increased 14% toapproximately $42.5 million for the six months ended June 30, 2003 fromapproximately $37.3 million for the six months ended June 30, 2002.

 

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**Managed services revenues.**  Managed services revenues increased 24% toapproximately $27.3 million for the six months ended June 30, 2003 from approximately$22.0 million for the six months ended June 30, 2002. For the six monthsended June 30, 2002, we derived approximately $2.5 million in revenue under ourFord U.S. global managed services agreement related to transactions in excessof the quarterly minimums. In July 2002, we amended our agreement withFord U.S. to provide for billing Ford at a fixed annual rate instead of on aper transaction processed basis; therefore, excess transactions are no longerbillable. Excluding the $2.5 million revenue related to excess transactionbillings to Ford for the six months ended June 30, 2002, managed servicesrevenue increased for the six months ended June 30, 2003 by 40% from the sixmonths ended June 30, 2002. We attribute this increase to the continued growthin our automotive and high-tech managed services client base and expansion ofour responsibilities with existing customers, primarily Ford, Lucent, andNortel. Revenues derived from our managed services agreements accounted for 64%of our total revenues for the six months ended June 30, 2003, compared to 59%of our total revenues for the six months ended June 30, 2002. We expect managedservices revenues to account for approximately 60% to 70% of our total revenuesfor the foreseeable future.

 

**Software revenues.**  Software revenues decreased 15% toapproximately $5.6 million for the six months ended June 30, 2003 fromapproximately $6.6 million for the six months ended June 30, 2002. Weattribute this decrease to the conversion of several customers to managedservices, the drop-off of revenue related to perpetual licenses sold in prioryears, and maintenance cancellations. Revenues derived from our softwareagreements accounted for 13% of our total revenues for the six months endedJune 30, 2003, compared to 18% of our total revenues for the six months endedJune 30, 2002. We expect software revenues to account for approximately 10% to15% of our total revenues for the foreseeable future.

 

**Services revenues.**  Services revenues increased 9% toapproximately $9.6 million for the six months ended June 30, 2003 fromapproximately $8.8 million for the six months ended June 30, 2002. We attributethis increase to the variability in the demand for our services from ourcustomer base, the decline in services revenue in the quarter ended June 30,2002 resulting from closing few software deals in the first quarter of 2002 andthe accelerated timing of certain software integration projects in the quarterended June 30, 2003. Services revenues accounted for 23% of our total revenuesfor both the six months ended June 30, 2003 and 2002. We expect servicesrevenues to continue to account for approximately 20% to 25% of our totalrevenues for the foreseeable future.

 

*Cost of Revenues*

* *

**Cost of managed services revenues.**  Cost of managed services revenues increased38% to approximately $14.9 million for the six months ended June 30, 2003from approximately $10.8 million for the six months ended June 30, 2002.This increase was largely due to the growth of our managed services operationsto support our growing client base and our European expansion. Cost of managedservices revenues as a percentage of managed services revenues was 55% for thesix months ended June 30, 2003 and 49% for the six months ended June 30, 2002.This increase as a percentage of managed services revenues resulted from ouradding personnel and incurring infrastructure costs related to our Europeanexpansion and the $2.5 million of non-recurring revenue related to the excesstransaction billing to Ford for the six months ended June 30, 2002. Over time,we expect to realize productivity improvements from our investment in oursupport infrastructure and the leveraging of personnel in the performance ofour managed services agreements. As we enter into large multi-year managedservices agreements in new industry sectors or new geographic regions that mayrequire significant investments in the related infrastructure, the costsassociated with these managed services agreements may be greater in the initialyear than in the later years when we realize productivity improvements fromthese infrastructure investments. Accordingly, we expect that our cost ofmanaged services revenues may fluctuate on a quarterly or annual basis as apercentage of managed services revenues.

 

**Cost of software revenues.**  Cost of software revenues increased 16% toapproximately $1.4 million for the six months ended June 30, 2003 fromapproximately $1.2 million for the six months ended June 30, 2002. Thisincrease was largely due to our investment in our client supportinfrastructure. Cost of software revenues as a percentage of software revenueswas 25% for the six months ended June 30, 2003, compared to 18% for the sixmonths ended June 30, 2002. This increase as a percentage of software revenuesresults from our additional investment in our client support infrastructure tosupport our new product offerings, as well as a reduction in our softwarerevenues. We expect the cost of software revenues as a percentage of softwarerevenues to remain in this approximate range for the foreseeable future, butthis percentage may fluctuate in any given quarter or year.

 

**Cost of services revenues.**  Cost of services revenues increased 5% toapproximately $7.0 million for the six months ended June 30, 2003 fromapproximately $6.7 million for the six months ended June 30, 2002. Thisincrease was largely due to the additional personnel costs associated with theadditional work completed in the three months ended June 30, 2003. Cost ofservices revenues as a percentage of services revenues was 73% and 76% for thesix months ended June 30, 2003 and 2002, respectively. We expect the cost ofservices revenues as a percentage of services revenues to be approximately 70%to 75% on an annual basis, but this percentage may fluctuate outside this rangein any given quarter or year.

 

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*Operating Expenses*

* *

**Sales and marketing.**  Sales and marketing expense decreased 31% toapproximately $4.5 million for the six months ended June 30, 2003 fromapproximately $6.6 million for the six months ended June 30, 2002. Thisdecrease was primarily due to a reduction in personnel and a reduction inpromotional expenses. Sales and marketing expenses represented 11% of our totalrevenues for the six months ended June 30, 2003 and 18% for the six monthsended June 30, 2002. We anticipate that sales and marketing expenses willremain relatively stable as a percentage of total revenues for the foreseeablefuture.

 

**Research and development.**  Research and development expense decreased19% to approximately $6.0 million for the six months ended June 30, 2003from approximately $7.4 million for the six months ended June 30, 2002.This decrease was primarily due to the transfer of some of our research anddevelopment activities to geographies with lower costs of labor, a reduction inpersonnel, and a reduction in the number of internal and contract softwaredevelopers and quality assurance personnel needed to support our productdevelopment and testing activities. Research and development expensesrepresented 14% of our total revenues for the six months ended June 30, 2003and 20% for the six months ended June 30, 2002. We believe that we mustcontinue to invest in research and development in order to develop new productsand services. We anticipate that research and development expenses willcontinue to decrease as a percentage of total revenues for the foreseeablefuture.

 

**General and administrative.**General andadministrative expense increased 13% to approximately $5.5 million for the sixmonths ended June 30, 2003 from approximately $4.9 million for the sixmonths ended June 30, 2002. This increase resulted from the addition ofpersonnel and technology infrastructure to support the growth of our business,legal and professional fees relating to our international expansion, andincreased costs associated with the new public company regulations. General andadministrative expenses represented 13% of our total revenues for both thequarters ended June 30, 2003 and 2002. We believe our general andadministrative expenses will decrease as a percentage of total revenues butwill remain relatively consistent in absolute dollars when compared to the sixmonths ended June 30, 2003.

 

**Depreciation.**  Depreciation expense increased 24% toapproximately $2.6 million for the six months ended June 30, 2003 fromapproximately $2.1 million for the six months ended June 30, 2002. Thisincrease resulted from the depreciation of fixed assets purchased to build theinfrastructure needed to support the growth of our business. We believe ourdepreciation expense will increase in absolute dollar amounts as we continue toinvest our infrastructure.

 

**Intangible amortization expense.**  Intangible amortization expense increased16% to approximately $1.4 million for the six months ended June 30, 2003 fromapproximately $1.2 million for the six months ended June 30, 2002. Thisincrease resulted from the full quarter effect of the amortization from theidentified intangible assets acquired in the three acquisitions completed inthe first quarter of 2002, offset slightly by a decrease in intangibleamortization expense due to the fluctuations in foreign currency rates and therelated translations into US dollars.

 

**Restructuring.**  The Company recorded approximately$2.0 million and $1.6 million of restructuring costs, respectively,during the second and third quarters of 2002. The Company reduced itsrestructuring reserve during the fourth quarter of 2002 by approximately$274,000, based on differences between actual costs incurred compared to theiroriginal estimates. Costs associated with the termination of employees totaledapproximately $1.1 million. Costs associated with the closing of redundantfacilities, the cancellation of certain contracts, and other non-personnelrelated actions totaled approximately $2.2 million. As ofDecember 31, 2002, the balance of the restructuring reserve wasapproximately $1.3 million. The Company paid approximately $146,000 ofthese costs in the second quarter of 2003 and $577,000 in the six months endedJune 30, 2003. As of June 30, 2003, the balance of the restructuring reservewas approximately $800,000. The Company expects to pay out the remainder of therestructuring reserve in 2003 and 2004.

 

**Stock-based compensation.**  We recorded deferred compensation ofapproximately $6.4 million in the last nine months of 1999 andapproximately $13.1 million in 2000. These amounts represent the aggregatedifference between the exercise price and the fair value for accountingpurposes of the underlying common stock at the date of grant. On March 29,2001, we recorded $465,000 of deferred compensation in connection with theunvested stock options that were assumed in connection with the Speedchainacquisition. These amounts are included as a component of stockholders’ equityand are being amortized on an accelerated basis over the applicable vestingperiod. For the six months ended June 30, 2003 and 2002, we amortizedapproximately $645,000 and $1.6 million, respectively, of deferredcompensation. We expect to amortize deferred compensation of approximately$941,000 and $45,000 for the years ending December 31, 2003 and 2004,respectively. The amount of stock option compensation expense to be recorded infuture periods could decrease if options for which accrued but unvestedcompensation has been recorded are forfeited.

 

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In October 2002, we offered each employee an opportunity to cancelcertain stock options (the “Options Exchange”) in exchange for the right toreceive a future stock option grant for the same number of shares six monthsand one day from the date of cancellation with a strike price equal to themarket price on the new grant date. Options to purchase approximately 3.8million shares were cancelled pursuant to the Options Exchange. In April 2003,we issued replacement options to employees to purchase approximately 3.6million shares of common stock at an exercise price of $4.06 per share inexchange for the options previously canceled. The vesting schedule of thecanceled options remained in effect for the replacement options. We deferredthe issuance of annual option grants to employees during this six-month period,and accordingly, in April 2003, we issued additional options to purchase930,000 shares of common stock to these employees at an exercise price of $4.06per share. As of June 30, 2003, options to purchase approximately 8,538,000shares of common stock were outstanding.

 

**Other income (expenses), net.**  Other income (expenses), net fluctuates,based on the amount of cash balances available for investment, borrowings underour lines of credit, interest and other expenses related to our equipmentborrowings, and realized gains and losses on investments. Other income(expenses), net decreased to approximately $336,000 for the six months endedJune 30, 2003 from approximately $533,000 for the six months ended June 30,2002. This decrease resulted from lower interest rates and lower cash andinvestment balances.

 

**Income taxes.**  For the quarters ended June 30, 2003 and2002, our tax provision was comprised of state and foreign taxes. For the sixmonths ended June 30, 2003, our tax provision was greater than in previousperiods due to income-based withholding taxes incurred from foreign servicesrevenue and the disallowance of net operating loss carryforwards in certainstates where we do business. No provision for federal income taxes has beenrecorded for the quarters ended June 30, 2003 or 2002 due to our accumulatednet operating losses. We have recorded a valuation allowance for the fullamount of our net deferred tax assets because of the uncertainty surroundingthe realization of these future tax benefits.

 

As of December 31, 2002, we had net operating loss carry-forwards forfederal tax purposes of approximately $67.6 million. These losscarry-forwards are available to reduce future taxable income and begin toexpire in 2011. Under provisions of the Internal Revenue Code, certainsubstantial changes in our ownership have occurred, and as a result, our futureutilization of these net operating loss carryforwards that we accumulated priorto the change in ownership will be subject to annual limitations. We have alsogenerated foreign net operating losses of approximately $16.2 million thatare available for carryforward. We may generate additional net operating losscarry-forwards in the future.

 

**Liquidity and Capital Resources**

 

We had cash and cash equivalents and short-term investments of$51.6 million as of June 30, 2003, a decrease of $5.3 million from$56.9 million as of December 31, 2002.

 

In July 2002, we refinanced $3.9 million of outstanding debtunder our former credit facility with a new facility from Comerica Bank. Theterm loan matures in June 2004 and bears interest at the bank’s prime rateplus 50 basis points (4.50% as of June 30, 2003). The balance outstanding underthe term loan was approximately $2.0 million as of June 30, 2003. We alsoobtained a secured revolving line of credit and an equipment line of creditwith Comerica Bank.

 

We may borrow up to $10 million under the revolving line ofcredit, with a $2.5 million sub-limit for the issuance of letters ofcredit. Advances under the revolving line of credit are limited to the lesserof $10 million or 80% of eligible accounts receivable, as defined in theloan agreement. The revolving line of credit bears interest at the bank’s primerate (4.00% as of June 30, 2003) and matures in July 2004. There was nooutstanding balance under the revolving line of credit as of June 30, 2003.

 

We may borrow up to $5 million under the equipment line of creditthat bears interest at the bank’s prime rate plus 50 basis points (4.50% as ofJune 30, 2003). The equipment line of credit has two interest-only payment periodsand matures in July 2005. In the first quarter of 2003, we borrowedapproximately $614,000 against the equipment line of credit. The outstandingbalance under the equipment line of credit was approximately $532,000 as ofJune 30, 2003. On July 30, 2003, we borrowed approximately $488,000 against ourequipment line of credit.

 

The terms of the revolving line of credit and equipment line of creditrequire us to comply with certain financial covenants, including, restrictionsand limitations on future indebtedness, sale of assets and material changes inour business. The financial covenants include a minimum modified quick ratio,as defined in the loan agreement, of 2.0 to 1.0 and a maximum ratio of totalliabilities to tangible net worth of 1.5 to 1.0. Under the most restrictive ofthese financial covenants, our quarterly pro forma loss cannot exceed$1.5 million. Through June 30, 2003, we were in compliance with thesecovenants and expect to be in compliance for the next 12 months.

 

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Pro forma income (loss) is defined in the loan agreement as net income,plus interest expense, taxes, non-cash charges (including depreciation,amortization, stock-based compensation, research and development related chargesand one-time restructuring charges), and cash restructuring charges (not toexceed $5.0 million in the aggregate), less interest income and anyone-time or non-recurring revenue.

 

We have various capital leases due over 36-month to 48-month repaymentperiods that are collateralized by our intellectual property. In March 2003, weobtained a new equipment leasing arrangement with a vendor for approximately$886,000. Amounts borrowed are due over 36 months. Total capital leaseobligations outstanding as of June 30, 2003, was approximately $878,000.

 

We reimburse Ford for certain expenses incurred by Ford for our use ofFord’s facilities, the costs of leased employees, and maintenance and expensesrelated to the acquired technology. We expect to pay approximately $450,000 infees to Ford each month for reimbursement of these expenses. For the quartersended June 30, 2003 and 2002, we paid Ford approximately $1.9 million and$1.4 million, respectively. For the six months ended June 30, 2003 and2002, we paid Ford approximately $3.9 million and $2.7 million, respectively.These payments increased beginning in December 2002, when we assumedresponsibility for managing Ford’s operations in Europe. However, we expectpayments to decrease in the future as we leverage our existing facilities andemployees and deploy our own technology.

 

Net cash used in operating activities totaled approximately $1.8million for the six months ended June 30, 2003, compared to $2.6 million forthe six months ended June 30, 2002. Net cash flows used in operating activitiesreflect the net losses of approximately $1.5 million and $6.7 million forthe six months ended June 30, 2003 and 2002, respectively, and were partiallyoffset by non-cash expenses relating to stock-based compensation, depreciationand intangible amortization expense, the provision for doubtful accounts,amortization of the revenue discount related to the Ford contract, andamortization of capitalized internal-use software costs. In addition, the netcash used in operating activities decreased for the six months ended June 30,2003 due to increases in accounts receivable, prepaid expenses and otherassets, and decreases in accounts payable and accrued expenses, partiallyoffset by cash provided by increases in accrued compensation and benefits anddeferred revenue.

 

Net cash used in investing activities was approximately $12.1 millionfor the six months ended June 30, 2003 compared to net cash provided byinvesting activities of approximately $5.1 million for the six months endedJune 30, 2002. This change is due to our investing activities that included ouracquisitions, additions of property and equipment, and purchases and sales ofshort-term investments. We anticipate that our capital expenditures will berelatively constant in the near term. We may also utilize our cash to acquireother companies.

 

Net cash provided by financing activities was approximately $1.2million and $4.4 million for the six months ended June 30, 2003 and 2002,respectively. This change is due to our financing activities that included thenet proceeds from the exercise of employee stock options, issuance of stock forthe employee stock purchase plan, proceeds from our equipment line of creditand principal payments on our debt.

 

We expect to pay approximately $2.5 million, $1.6 million, $490,000 and$80,000 on our term loan, equipment line of credit, and capital leaseobligations in 2003, 2004, 2005, and 2006, respectively. We will fund thesecommitments through our current cash resources and our future cash flow fromoperations.

 

We intend to continue investing in the expansion of our business,particularly in the area the build out of our global platform andinfrastructure. Our future liquidity and capital requirements will depend onnumerous factors, including:

 

•                  The costs andtiming of expansion of sales and marketing activities;

 

•                  The costs andtiming of expansion of our operating capabilities;

 

•                  The costs andtiming of product development efforts and the success of these developmentefforts;

 

•                  The extent towhich our existing and new products and services gain market acceptance;

 

•                  The level andtiming of revenues;

 

•                  The costsinvolved in maintaining and enforcing our intellectual property rights; and

 

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•                  Availableborrowings under line of credit and capital lease arrangements.

 

Accordingly,until we generate enough profit from our operations to fund these investmentsfully, our cash, cash equivalents, and short-term investments are likely tocontinue to decline. In addition, we may use cash resources to fundacquisitions of complementary businesses and technologies. We believe that ourcurrent cash resources will be sufficient to meet our working capital andcapital requirements for at least the next 12 months. Thereafter, we mayfind it necessary to obtain additional equity or debt financing. In the eventthat additional financing is required, we may not be able to raise it on termsacceptable to us, if at all.

 

**Recent Accounting Pronouncements**

** **

In November 2002, the EITF reached a Consensus on EITF IssueNo. 00-21, *Revenue Arrangements WithMultiple Deliverables,* on when and how to allocate revenue from thesale of products and services delivered separately in a bundled salesarrangement. The Consensus is effective prospectively for arrangements enteredinto in fiscal periods beginning after June 15, 2003. Companies, however,may elect to apply the Consensus to existing arrangements as well and to recordthe income-statement impact of the change as a cumulative effect of a change inaccounting principle. We are currently analyzing the impact of EITFNo. 00-21 on our financial statements. The adoption of this consensus isnot expected to have a material effect on our financial statements.

 

In January 2003, the FASB issued Interpretation No. 46, *Consolidation of Variable Interest Entities, aninterpretation of ARB No. 51*. This interpretation addresses theconsolidation by business enterprises of variable interest entities as definedin the interpretation. The interpretation applies immediately to variableinterest in variable interest entities created or obtained after January 31,2003. The interpretation is applied to the enterprise no later than the end ofthe first reporting period beginning after June 15, 2003. The interpretationrequires certain disclosures in financial statements issued after January 31,2003 if it is reasonably possible that we will consolidate or discloseinformation about variable interest entities when the interpretation becomeseffective. The adoption of this interpretation is not expected to have amaterial effect on our financial statements.

 

In March 2003, the Emerging Issues Task Force issued a preliminaryconsensus on EITF No. 01-08, *DeterminingWhether an Arrangement Contains a Lease*. This guidance is effectivefor arrangements entered into in fiscal periods beginning after May 28, 2003.EITF No. 01-08 discusses the criteria necessary to determine if an arrangementcontains a lease. The adoption of EITF No. 01-08 is not expected to have amaterial effect on our financial statements.

 

In May 2003, the FASB issued SFAS No. 150, *Accounting for Certain Financial Instruments with Characteristics ofboth Liabilities and Equity.*SFAS No. 150 establishes standards forhow an issuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity. SFAS No. 150 is effective forfinancial instruments entered into or modified after May 31, 2003, andotherwise is effective at the beginning of the first interim period beginningafter June 15, 2003. The adoption of SFAS No. 150 is not expected to have amaterial effect our financial statements.

 

**Risks Relating to Our Business**

** **

Before deciding to invest in us or to maintain or increase your investment,you should consider carefully the risks described below, in addition to theother information contained in this report and in our other filings with theSEC, including our subsequent reports on Forms 10-K, 10-Q, and 8-K. The risksand uncertainties described below are not the only ones facing us. Additionalrisks and uncertainties not presently known to us or that we currently deemimmaterial may also affect our business operations. If any of these risksactually occur, our business, financial condition or results of operationscould be seriously harmed. The market price for our common stock could decline,and you may lose all or part of your investment.

 

**We have a history of losses and expect toincur losses in the near future.**

** **

We incurred net losses of approximately $11.4 million,$45.8 million, $35.8 million, $10.5 million and$8.3 million in 2002, 2001, 2000, 1999, and 1998, respectively. Ouraccumulated deficit as of June 30, 2003 was approximately $184.0 million.We believe that the success of our business depends on our ability tosignificantly increase revenue and to limit increases in our operatingexpenses. If our revenues fail to grow at anticipated rates or our operatingexpenses increase without a corresponding increase in our revenues, or we failto adjust operating expense levels appropriately, we may not be able to achieveor maintain profitability, which would increase the possibility that the valueof your investment will decline.

 

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**Our inability to provide managed servicessuccessfully to existing and future clients would substantially reduce ourrevenues, increase our costs, hurt our reputation in our industry, andadversely affect our business.**

** **

As a critical element of our strategy, we intend to continue providingmanaged services to our current and future clients. These services range fromproviding operational management for a single global trade process to managinga client’s entire worldwide trade operation. We expect that, over time, therevenues we receive from providing managed services to these and future clientswill continue to represent the largest portion of our total revenues. Anyinability to perform our agreements with Ford, Lucent Technologies and NortelNetworks or to provide managed services successfully to our other clients wouldsignificantly reduce our revenues, increase our costs, hurt our reputation inour industry and adversely affect our business and results of operations.

 

**There exists a significant concentration ofour revenues among a few material customers.**

** **

In 2002, 2001, and 2000, we derived approximately 59%, 67%, and 38%,respectively, of our total revenues from our top five customers. For the sixmonths ended June 30, 2003 and 2002, we derived approximately 66% and 61%,respectively, of total revenues from our top five customers. In 2002, 2001, and2000, Ford accounted for 30%, 35%, and 17% of total revenues, respectively. Forthe six months ended June 30, 2003, Ford accounted for 30% of total revenues.In 2002, Lucent Technologies accounted for 11% of total revenues. For the sixmonths ended June 30, 2003, Lucent Technologies accounted for 15% of totalrevenues. We expect such customer concentration of revenues to exist for theforeseeable future. There were no other customers that accounted for greaterthan 10% of the Company’s revenue. As we continue to expand our relationshipswith existing managed services customers and as we continue to sign contractsof a large magnitude with new customers, each such relationship will be ofadded significance to us. Additionally, we expect that we will continue toderive a significant portion of our total revenues from Ford and such othercustomers in the near future. Certain of our agreements permit our customers toterminate for convenience after a specified period of time. We cannot assureyou that we will be able to maintain or renew these agreements. If any of theseevents occur, our results of operations and financial condition would beadversely affected.

 

**Certain of our customers operate inindustries that have been experiencing greater than normal difficulties in adeclining economy. If the industries of which these companies are a partcontinue to experience economic difficulties, our business would be adverselyaffected.**

** **

During the past few years, there has been a decline in the economies ofthe U.S. and other countries. In addition, some of our customers operate inindustries that have experienced greater difficulties than the overall economy.If these industries continue to experience difficulties, it could adverselyaffect our business and our ability to collect receivables from thesecustomers.

 

**Any restriction on our ability to accesscost-effectively and legally a foreign country’s rules and regulations that weincorporate into our global trade content, Global Content, or any failure toupdate our Global Content timely to include changes in such rules andregulations, may compromise the effectiveness of our solutions and adverselyimpact our revenues.**

** **

The success of our Global Trade Management solutions for our clientsdepends on our ability to obtain or access the complex rules and regulationspublished by foreign governments governing a particular country’s import andexport of goods. The foundation of our solutions, Global Content, is subject torapid change at the initiative of foreign governments based on factors beyondour control. Any changes in a country’s rules and regulations relating toglobal trade that we are unable to include in our Global Content library mayresult in dissatisfied clients and possible litigation. Moreover, to the extenta foreign government restricts our access to its rules and regulations, chargesa fee for such access or grants proprietary rights to such information to oneor more of our competitors, our solutions may not be useful to, or costefficient for, our current and future clients and our revenues could decrease.

 

**Fluctuations in our operating results and thecomposition of our revenues, particularly compared to the expectations ofmarket analysts and investors, may cause the price of our common stock todecline.**

** **

Our operating results have varied in the past and could fluctuatesignificantly in the future. We expect that our operating results will continueto vary in the future, based on a number of factors, including:

 

•                  The loss of asignificant customer;

 

•                  Therenegotiation of contract terms with one or more significant customers;

 

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•                  Fluctuations inthe demand for our products and services;

 

•                  Our ability toachieve targeted cost and expense reductions;

 

•                  Our ability, andthe associated timing, to convert our customers on to our technology platform;

 

•                  Price andsolution competition in our industry;

 

•                  Changes inimport/export laws;

 

•                  Changes ingeneral economic conditions that may adversely affect technology companies inour industry;

 

•                  The timing oforders and our ability to satisfy all contractual obligations in customercontracts;

 

•                  Variability inthe mix of our managed services, software, and consulting revenues; and

 

•                  Timing of newsolution introductions and enhancements to our TradeSphere and TradePrism.comsolutions.

 

Due to the foregoing factors, our annual or quarterly results ofoperations may not meet the expectations of securities analysts and investors,which may cause the price of our common stock to decline.

 

**Our ability to achieve or maintainprofitability will be constrained if we do not manage our rapid growtheffectively.**

** **

During the past three years, we have significantly increased ouremployee base to meet increasing demand for our client solutions. As we expandour operations, we expect to increase the size of our employee base. Ourmanagement and operations have been strained by this growth and will continueto be strained by our anticipated growth. To compete effectively and to managefuture growth, we must continue to improve our financial and managementcontrols, reporting systems and procedures on a timely basis. We must also expand,train, and manage our employee base. If we are not successful in managing ourgrowth, our ability to achieve and maintain profitability may be harmed.

 

**We may be unable to attract and retain keypersonnel, which would adversely affect our ability to develop and manage ourbusiness effectively.**

** **

Our future performance will depend largely on the efforts and abilitiesof our senior executives, key technical, professional services, sales andmarketing and managerial personnel. This dependence is greatly important to ourbusiness because personal relationships are a critical element of obtaining andmaintaining clients. Our success will depend on our ability to attract andretain these key employees in the future. The employment of our key personnel,including our executives, is at will. The market for such individuals isextremely competitive, and we may not find qualified replacements for personnelwho leave us. The loss of, or the inability to attract, any one or more of ourkey personnel may harm our ability to develop and manage our businesseffectively.

 

**If we are unable to obtain additional capitalas needed or obtain additional capital on unfavorable terms in the future, ouroperations and growth strategy may be adversely affected, and the market pricefor our common stock could decline.**

** **

Historically, we have financed our operations primarily through thesale of our equity securities. As of June 30, 2003, we had cash and cashequivalents of approximately $11.2 million plus short-term investments ofapproximately $40.5 million and an accumulated deficit of approximately$184.0 million. While we believe that our current cash resources will besufficient to meet our working capital needs and finance capital expendituresfor at least the next 12 months, we may need to raise additional debt orequity capital to fund expansion of our operations, to enhance our products andservices, or to acquire or invest in complementary products, services,businesses or technologies. If we raise additional funds through furtherissuances of convertible debt or equity securities, our existing stockholderscould suffer significant dilution, and any new equity securities we issue couldhave rights, preferences, and privileges superior to those of holders of ourcommon stock. Any debt financing secured by us in the future could involverestrictive covenants relating to our capital raising activities and otherfinancial and operational matters, which may make it more difficult for us toobtain additional capital and to pursue business opportunities, includingpotential acquisitions. In addition, we may not be able to obtain additionalfinancing on terms favorable to us, if at all. If adequate funds are notavailable on terms favorable to us, our operations and growth strategy may be adverselyaffected and the market price for our common stock could decline.

 

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**Our international operations and plannedexpansion expose us to business risks that could limit the effectiveness of ourgrowth strategy and cause our operating results to suffer.**

** **

We intend to continue to expand our international operationssubstantially and enter new international markets. This expansion will requiresignificant management attention and financial resources to translatesuccessfully our software products into various languages, to developcompliance expertise relating to international regulatory agencies and todevelop direct and indirect international sales and support channels. We face anumber of risks associated with conducting our business internationally thatcould negatively impact our operating results, including:

 

•                  Languagebarriers, conflicting international business practices and other difficultiesrelated to the management and administration of a global business;

 

•                  Longer salescycles associated with educating foreign clients about the benefits of ourproducts and services;

 

•                  Currencyfluctuations and exchange rates;

 

•                  Difficulty inrepatriating cash from certain foreign jurisdictions;

 

•                  Longer collectiontime from foreign clients;

 

•                  Multiple, andpossibly overlapping, tax structures and the burdens of complying with a widevariety of foreign laws;

 

•                  The need toconsider characteristics unique to technology systems used internationally; and

 

•                  Economic orpolitical instability in some international markets.

 

We may not succeed in our efforts or we may experience delays in theexecution of our plan to enter new international markets, establish, maintainor increase international demand for our solutions or expand our internationaloperations, which may harm our growth strategy and could cause our operatingresults to suffer.

 

**As we expand globally, we may establishoperations in countries that become politically or economically unstable, whichmay put the capital we have invested in such operations at a risk of loss andcause our business to be adversely affected.**

** **

We intend to continue expanding our operations and serving our existingclients internationally. As we do so, we may establish operations in certaincountries that may become politically or economically unstable. If a country inwhich we commence operations becomes politically or economically unstable, themoney and resources we have invested to establish such operations may be put atrisk of loss, and if such money and resources are lost, our business may beadversely affected.

 

**Our lengthy and variable sales cycle makes itdifficult for us to predict when or if sales will occur and, therefore, we mayexperience an unplanned shortfall in revenues.**

** **

Our solutions have a lengthy and unpredictable sales cycle thatcontributes to the uncertainty of our operating results. Clients typically viewthe purchase of our solutions as a significant and strategic decision. As aresult, clients and potential clients generally evaluate our solutions anddetermine their impact on existing infrastructure over a lengthy period oftime. Our sales cycle has averaged approximately six to nine months forsoftware sales and nine to 12 months for managed services agreements,depending on a particular client’s implementation requirements and whether theclient is new or is extending an existing implementation. The license of oursoftware products may be subject to delays if the client has lengthy internalbudgeting, approval, and evaluation processes. Additionally, in the currenteconomic environment, many companies have reduced their budgets for informationtechnology spending. If companies continue reducing the spending on informationtechnology assets, we may be subject to additional delays and correspondingreductions in sales of our software products. Additionally, we may incursignificant selling and marketing expenses during a client’s evaluation period,including the costs of developing a full proposal and completing a rapid proofof concept or custom demonstration, before the client engages us. Largerclients may purchase our solutions as a part of multiple simultaneouspurchasing decisions, which may result in additional unplanned administrativeprocessing and other delays. In addition, any prolonged decline in the demandfor technology products and services could reduce the market for our solutions,making sales more difficult. If

 

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revenuesforecasted from a specific client for a particular quarter are not realized orare delayed to another quarter, we may experience an unplanned shortfall inrevenues, which could adversely affect our operating results.

 

**Any loss of our licensed third-partytechnology may result in increased costs of, or delays in, providing oursolutions, which would harm our operating results.**

** **

We license technology from several companies on a non-exclusive basisthat we have integrated into our TradeSphere product suite, includingdevelopment tools and facilities from IBM (WebSphere and MQ Series) and Forte,which was acquired by Sun Microsystems. Our license with Sun Microsystemsexpires on December 31, 2005, and our license with IBM expires onJune 30, 2006. If we cannot renew these technology licenses, we likelywould face delays in the licensing of our TradeSphere products until equivalenttechnology, if any, is identified, licensed and integrated, and would adverselyaffect our operating results.

 

**If we interpret and analyze incorrectly the variouslaws and regulations contained in our Global Content, we may face costlyliability claims.**

** **

The foundation of our software solutions and managed services, GlobalContent, is a rules-based application that provides comprehensivemanagement of government trade regulations and programs acquired, interpreted,and updated by Vastera’s in-country trade experts. Because of the legalisticand complex nature of Global Content, our inability to interpret and analyzeaccurately the rules and regulations upon which our Global Content is based mayexpose us to liability claims from our clients in connection with our currentproducts and future products. Any provisions in our agreements with our clientsdesigned to limit our exposure to potential product liability claims and anyproduct liability insurance may not be adequate to protect us from such claimsunder our agreements. A successful product liability claim brought against uscould harm our financial condition. Even if unsuccessful, any product liabilityclaim could result in costly litigation and divert management’s attention andresources. In addition, the effective implementation of our products may dependupon the successful operation of third-party licensed products in conjunctionwith our products and, therefore, any undetected errors in these licensedproducts may prevent the implementation or impair the functionality of ourproducts, delay new product introductions, and harm our reputation.

 

**The market for our Global Trade Managementmanaged services offering is a nascent one, and if companies fail to adopt ourmanaged services offerings, our business will be adversely affected.**

** **

For most companies, Global Trade Management is a critical but non-corebusiness function. Because the market for third-party Global Trade Managementis a nascent one, many companies may be reluctant or unwilling to utilize athird-party service provider to manage their global trade, and will retainthese functions in-house. If companies fail to adopt managed service offerings,our business will be adversely affected.

 

**We may be unable to protect our proprietaryrights adequately, which could result in their unauthorized use by ourcompetitors and have an adverse impact on our revenues.**

** **

Our success depends on our ability to protect our proprietary rights.We rely primarily on:

 

•                  Confidentialityagreements with employees and third parties;

 

•                  Protectivecontractual provisions such as those contained in license agreements withconsultants, vendors, and clients, although we have not signed such agreementsin every case; and

 

•                  Copyright, tradesecret, and trademark laws.

 

Despite our efforts to protect our proprietary rights, unauthorizedparties may copy aspects of our products and obtain and use information weregard as proprietary. Other parties may breach confidentiality agreements andother protective contracts. We may not become aware of these breaches or haveadequate remedies available. We may need to litigate claims against thirdparties who infringe our intellectual property rights, which could be costly,time-consuming, and would divert management’s attention and resources.

 

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**Our patent protection strategy is indevelopment currently, and any inadequacy in the protection of our technologycould increase our operating costs.**

** **

We may also rely on patents to protect our proprietary rights in thefuture. Any patent strategy we attempt to implement may not be successful andcould harm our business by disclosing unpatentable trade secrets. The laws thatapply to the types of patents we may seek are evolving and are subject tochange. We presently have filed provisional patent applications in the UnitedStates. These applications may not result in patents or may take longer than weexpect to result in patents. We may also decide not to file patent applicationsin all the countries in which we operate or intend to operate. Our decision todo so may inhibit our ability to protect our proprietary rights in thosecountries. Even if we are issued patents, we cannot assure you that they willprovide us any meaningful protection or competitive advantage. If we try toenforce our patents, third parties may challenge our patents in court or beforethe United States Patent and Trademark Office. An unfavorable outcome in anysuch proceeding could require us to cease using the technology or to licenserights from prevailing third parties. We cannot assure you that any prevailingparty would offer us a license or that we could execute a license on terms thatare commercially acceptable to us, if at all. Developing and enforcing ourpatent protection strategy is likely to increase our operating costs.

 

**We may have to defend against intellectualproperty infringement claims, which could be expensive, and if we areunsuccessful, could result in substantial monetary liability and disrupt ourbusiness.**

** **

We cannot be certain that our solutions do not or will not infringevalid patents, copyrights, trademarks, or other intellectual property rightsheld by third parties, inside and outside the U.S. As a result, we may besubject to legal proceedings and claims from time to time relating to theintellectual property of others in the ordinary course of our business.

 

We may incur substantial expenses in defending against any third-partyinfringement claims, regardless of their merit. Successful infringement claimsagainst us may result in substantial monetary liability, may divertmanagement’s attention from our core business, and may disrupt our business. Inaddition, if we are unsuccessful in defending such claims, we may need toobtain a license to the technology, which may not be available on acceptableterms or at all.

 

**Any future acquisitions may be difficult tointegrate and disruptive to our operations. We may not realize the expectedbenefits from any such acquisitions, and if we cannot address the challengespresented by acquisitions, our operating results may be harmed.**

** **

In the past, we have acquired businesses to expand our operations ormarket presence, and we intend to continue our expansion by acquiring orinvesting in companies, assets or technologies that complement our business andoffer opportunities for growth. These transactions involve many risks andchallenges that we might not successfully overcome, including:

 

•                  Difficulties inassimilating technologies, products, personnel, and operations;

 

•                  Disruption ofour ongoing business and diversion of management’s attention from otherbusiness concerns;

 

•                  Risks ofentering markets in which we have no or limited prior experience;

 

•                  Issuances ofequity securities that may dilute your ownership interest in our common stock;

 

•                  Cash paymentsto, or the assumption of debt or other liabilities of, the companies weacquire; and

 

•                  Large write-offsrelated to goodwill and other intangible assets and other adverse auditconsequences.

 

**Your ability to influence corporate mattersmay be limited because our officers, directors, and affiliates will be able tocontrol, and Ford will be able to influence, matters requiring stockholderapproval and these parties may have interests that differ from yours.**

** **

As of June 30, 2003, our officers, directors, and affiliated entities,together with Ford, beneficially owned approximately 58.4% of the outstandingshares of our common stock. This concentration of ownership may delay, deter,or prevent acts that would result in a change of control, which in turn couldreduce the market price of our common stock. Accordingly, these stockholderscollectively may be able to control all matters requiring stockholder approvaland, thereby, our management and affairs. Ford

 

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beneficiallyowns approximately 19.4% of the outstanding shares of our common stock. As thesingle largest stockholder of Vastera, Ford may exercise significant influenceover corporate acts requiring stockholder approval, including a merger or saleof Vastera. Also, so long as Ford holds at least 5% of our common stock, it hasthe right to appoint a non-voting observer to our board of directors. Ourofficers, directors, and affiliated entities, together with Ford, may haveinterests that differ from your interests, and their decisions may negativelyimpact our future success.

 

**Because of provisions in our corporate charterand bylaws, Delaware law and Ford’s significant ownership position, othercompanies may have difficulty acquiring us, even if doing so would benefit ourstockholders.**

** **

Provisions in our certificate of incorporation, in our bylaws and underDelaware law could make it more difficult for other companies to acquire us,even if doing so would benefit our stockholders. Our certificate ofincorporation and bylaws contain the following provisions, among others, whichmay inhibit an acquisition of our company by a third party:

 

•                  a staggeredboard of directors, where stockholders elect only a minority of the board eachyear;

 

•                  advancenotification procedures for matters to be brought before stockholder meetings;

 

•                  a limitation onwho may call stockholder meetings; and

 

•                  a prohibition onstockholder action by written consent.

 

We are subject to provisions of Delaware law that prohibit us fromengaging in any business combination with any “interested stockholder,” meaninggenerally a stockholder who beneficially owns more than 15% of our stock, for aperiod of three years from the date this person became an interestedstockholder, unless various conditions are met, such as approval of thetransaction by our board. This could have the effect of delaying or preventinga change in control. Additionally, in connection with establishing ourstrategic relationship with Ford, Ford acquired 8,000,000 shares of our commonstock. Because of Ford’s significant holdings, other companies may be deterredfrom acquiring us, even if being acquired would be in the best interest of ourother stockholders.

 

## **Item 3:   Qualitativeand Quantitative Disclosures About Market Risk**

## ** **

We develop solutions in the United States and market them in NorthAmerica, and to a lesser extent, in Europe, Latin America, and the Asia-Pacificregions of the world. Our financial results could be affected by factors suchas changes in foreign currency exchange rates or weak economic conditions inforeign markets. With most of our sales being generated in U.S. dollars, astrengthening of the dollar could make our products less competitive in foreignmarkets.

 

Currently we do not use financial instruments to hedge operatingexpenses of our foreign subsidiaries. We intend to assess the need to utilizefinancial instruments to hedge currency exposures on an ongoing basis. Amountsoutstanding under our term loan and equipment line of credit arrangementsexpose us to interest rate risk if the prime rate increases. We hadapproximately $2.5 million in variable rate debt as of June 30, 2003. Ourinterest income is sensitive to changes in the general level of U.S. interestrates, particularly since the majority of our investments are in short-terminstruments. Due to the short-term nature of our investments, we believe thatthere is no material market risk. We do not hold or issue derivativesecurities, derivative commodity instruments, or other financial instrumentsfor trading purposes. Therefore, no quantitative tabular disclosures arerequired.

 

## **Item 4:   Controlsand Procedures**

## ** **

An evaluation was carried out under the supervision and with theparticipation of management, including our Chief Executive Officer and ChiefFinancial Officer, of the effectiveness of the design and operation of ourdisclosure controls and procedures (as defined in Rule 13a-14 and 15d-14under the Securities Exchange Act of 1934). Based upon that evaluation, theChief Executive Officer and Chief Financial Officer concluded that, as of theend of the period covered by this report, those disclosure controls andprocedures were adequate to ensure that information required to be disclosed byus in the reports that we file or submit under the Exchange Act is recorded,processed, summarized, and reported, within the time periods specified in theCommission’s rules and forms.

 

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There have been no changes in our internal controls over financialreporting that occurred during the second quarter of 2003 that have materiallyaffected, or are reasonably likely to materially affect, our internal controlsover financial reporting.

 

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# **PART II - OTHER INFORMATION**

# ** **

## **Item 1:          LegalProceedings**

## ** **

We are periodically a party to disputes arising from normal businessactivities. In the opinion of management, resolution of these matters will nothave a materially adverse effect upon our financial condition or our futureoperating results.

 

On March 14, 2001, Expeditors International ofWashington, Inc. and Expeditors Tradewin, L.L.C. (collectively“Expeditors”) filed suit against us in the United States District Court for theEastern District of Michigan, Southern Division primarily alleging that wemisappropriated certain of Expeditors’ trade secrets in connection with ouracquisition of Ford’s customs operations, by utilizing systems and businessprocesses that Expeditors assisted in developing for Ford and through ouremployee hiring practices. Trial in this matter is scheduled to commence inAugust 2003. In connection with our acquisition of Ford’s customs operations,Ford agreed to indemnify us for intellectual property infringement claims, andFord is currently indemnifying us in connection with this litigation.

 

## **Item 2:          Changes inSecurities and Use of Proceeds**

## ** **

We received net offering proceeds from our initial public offering inSeptember 2000 of approximately $86.1 million. As of June 30, 2003 we haveused approximately $54.1 million of the net proceeds from the initialpublic offering for general corporate purposes, principally working capital forour international acquisitions, increased domestic and international sales andmarketing expenditures, product development expenditures, expenditures relatedto the expansion of our consulting services organization, and capitalexpenditures made in the ordinary course of business. The remaining portions ofthe net proceeds have been used for working capital.

 

We issued 51,046 shares of common stock in the quarter ended June 30,2003 in connection with our acquisition of GE’s internal US customs operations.In issuing these shares, we relied on Section 4(2) of the Securities Act andRule 506 of Regulation D promulgated thereunder for exemptions from theregistration requirements of the Securities Act. The entity to which theseshares of common stock were issued to an accredited investor.

 

## **Item 3:          Defaults UponSenior Securities**

## ** **

None.

 

## **Item 4:          Submission ofMatters to a Vote of Security Holders**

## ** **

None.

 

## **Item 5:          OtherInformation**

## ** **

None.

 

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## **Item 6:          Exhibits andReports on Form 8-K**

 
| The following exhibits are included herein: |
|---------------------------------------------|
|                                        |   |   |
| (a)                                         |   | Exhibits. |
|                                        |   |   |
| 31.1                                        |   | Certification Pursuant to 18 U.S.C. Section  1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002,  by the Chief Executive Officer, dated August 13, 2003. |
|                                        |   |   |
| 31.2                                        |   | Certification Pursuant to 18 U.S.C. Section  1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002,  by the Chief Financial Officer, dated August 13, 2003. |
|                                        |   |   |
| 32.1                                        |   | Certification Pursuant to 18 U.S.C. Section  1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,  by the Chief Executive Officer, dated August 13, 2003. |
|                                        |   |   |
| 32.2                                        |   | Certification Pursuant to 18 U.S.C. Section  1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,  by the Chief Financial Officer, dated August 13, 2003. |
|                                        |   |   |
| (b)                                         |   | Reports on Form 8-K. |

 

On July 24, 2003, we filed a Form 8-K furnishing a press release thatannounced our financial results for the quarter ended June 30, 2003 andpresenting certain other information.

 

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**SIGNATURES**

** **

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized in Dulles, Virginia on August 13, 2003.

 

 
|   | VASTERA, INC. |
|--------|---------------|
|   |          |   |
|   | By:           | /s/ Maria Henry |   |
|   |          | Maria Henry, |
|   |          | Chief Financial Officer |
|   |          | (Principal Financial Officer) |
|   |          |   |
|   | By:           | /s/ Kevin M. Boyce |   |
|   |          | Kevin M. Boyce, |
|   |          | Vice President, Finance and  Corporate Controller |
|   |          | (Principal Accounting Officer) |
|        |               |  |  |  |

 

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**EXHIBITS**

** **
| 31.1   |   | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002, by the Chief Executive  Officer, dated August 13, 2003. |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                             |
| 31.2   |   | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002, by the Chief Financial  Officer, dated August 13, 2003. |
|   |   |                                                                                                                                                                             |
| 32.1   |   | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002, by the Chief Executive  Officer, dated August 13, 2003. |
|   |   |                                                                                                                                                                             |
| 32.2   |   | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002, by the Chief Financial  Officer, dated August 13, 2003. |

** **

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