**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM10-Q**

 

**ý****              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**Forthe Quarter Ended September 30, 2004**

 

**CommissionFile Number 000-31589**

 

**VASTERA, INC.**

(ExactName of Registrant as Specified in its Charter)

 
| **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 SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing 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 ý  No o

 

As of November 4, 2004 there were 42,260,253 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 - FINANCIALINFORMATION (UNAUDITED)**

#  

## **Item 1:                  **Financial Statements

##  

**VASTERA, INC.AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED BALANCE SHEETS**

 

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

 
| ** **                                                                                                                | ** ** | **September 30,  2004** | ** ** | **December 31, 2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| ** **                                                                                                                | ** ** | **(Unaudited)**         | ** ** | ** **                 | ** ** |
| **Assets**                                                                                                                | ** ** | ** **              | ** ** | ** **                 | ** ** |
| Current assets:                                                                                                           |       |                    |       |                       |       |
| Cash and cash equivalents                                                                                                 |       | $                       | 19,527     |                       | $          | 16,046 |   |
| Short-term investments                                                                                                    |       | 36,087                  |       | 40,402                     |       |
| Accounts receivable, net of allowance for  doubtful accounts of $1,111 and $994, respectively                             |       | 18,584                  |       | 17,599                     |       |
| Prepaid expenses and other current assets                                                                                 |       | 4,252                   |       | 4,212                      |       |
| Total current assets                                                                                                      |       | 78,450                  |       | 78,259                     |       |
| Property and equipment, net                                                                                               |       | 9,542                   |       | 10,806                     |       |
| Intangible assets, net                                                                                                    |       | 1,033                   |       | 1,863                      |       |
| Goodwill                                                                                                                  |       | 5,044                   |       | 5,044                      |       |
| Deposits and other assets                                                                                                 |       | 964                     |       | 1,292                      |       |
|                                                                                                                      |       |                    |       |                       |       |
| Total assets                                                                                                              |       | $                       | 95,033     |                       | $          | 97,264 |   |
|                                                                                                                      |       |                    |       |                       |       |
| **Liabilities and Stockholders’ Equity**                                                                             |       |                    |       |                       |       |
| Current liabilities:                                                                                                      |       |                    |       |                       |       |
| Line of credit and capital lease  obligations, current                                                                    |       | $                       | 745        |                       | $          | 1,867 |   |
| Accounts payable                                                                                                          |       | 916                     |       | 921                        |       |
| Accrued expenses                                                                                                          |       | 6,721                   |       | 5,260                      |       |
| Accrued compensation and benefits                                                                                         |       | 3,700                   |       | 3,452                      |       |
| Deferred revenue, current                                                                                                 |       | 11,220                  |       | 9,451                      |       |
| Total current liabilities                                                                                                 |       | 23,302                  |       | 20,951                     |       |
| Long-term liabilities:                                                                                                    |       |                    |       |                       |       |
| Line of credit and capital lease  obligations, net of current portion                                                     |       | 149                     |       | 698                        |       |
| Deferred revenue, net of current portion                                                                                  |       | 1,330                   |       | 2,393                      |       |
| Total liabilities                                                                                                         |       | 24,781                  |       | 24,042                     |       |
| Commitments and contingencies (See Note 6)                                                                                |       |                    |       |                       |       |
|                                                                                                                      |       |                    |       |                       |       |
| Stockholders’ equity:                                                                                                |       |                    |       |                       |       |
| Common stock, $0.01 par value; 100,000  shares authorized; 42,023 and 41,745 shares issued and outstanding,  respectively |       | 420                     |       | 417                        |       |
| Additional paid-in capital                                                                                                |       | 328,101                 |       | 327,234                    |       |
| Accumulated other comprehensive loss                                                                                      |       | (1,021                  | )          | (715                       | )          |
| Deferred compensation                                                                                                     |       | —                  |       | (46                        | )          |
| Accumulated deficit                                                                                                       |       | (257,248                | )          | (253,668                   | )          |
|                                                                                                                      |       |                    |       |                       |       |
| Total stockholders’ equity                                                                                           |       | 70,252                  |       | 73,222                     |       |
| Total liabilities and stockholders’ equity                                                                           |       | $                       | 95,033     |                       | $          | 97,264 |   |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

 

3

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**VASTERA, INC.AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

 

**(UNAUDITED)**

 

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

 
| ** **                                  | ** ** | **Three Months  Ended September 30,** | ** ** | **Nine Months  Ended September 30,** | ** ** |
|---------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                  | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Revenues:**                               | ** ** | ** **                            | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Managed services revenues                   |       | $                                     | 13,740     |                                 | $          | 14,084 |   | $ | 41,920 |   | $ | 41,343 |   |
| Software revenues                           |       | 2,639                                 |       | 2,936                                |       | 7,344 |   | 8,552 |   |
| Services revenues                           |       | 5,432                                 |       | 4,675                                |       | 14,664 |   | 14,268 |   |
| Total revenues                              |       | 21,811                                |       | 21,695                               |       | 63,928 |   | 64,163 |   |
|                                        |       |                                  |       |                                 |       |   |   |   |   |
| **Cost of revenues:**                       |       |                                  |       |                                 |       |   |   |   |   |
| Cost of managed services revenues           |       | 8,403                                 |       | 7,553                                |       | 24,557 |   | 22,488 |   |
| Cost of software revenues                   |       | 758                                   |       | 716                                  |       | 2,116 |   | 2,110 |   |
| Cost of services revenues                   |       | 3,828                                 |       | 3,421                                |       | 10,822 |   | 10,427 |   |
|                                        |       |                                  |       |                                 |       |   |   |   |   |
| **Operating expenses:**                     |       |                                  |       |                                 |       |   |   |   |   |
| Sales and marketing                         |       | 2,531                                 |       | 2,290                                |       | 7,461 |   | 6,836 |   |
| Research and development                    |       | 3,187                                 |       | 2,954                                |       | 9,211 |   | 8,990 |   |
| General and administrative                  |       | 2,922                                 |       | 2,663                                |       | 8,699 |   | 8,136 |   |
| Depreciation                                |       | 1,353                                 |       | 1,281                                |       | 4,065 |   | 3,845 |   |
| Intangible amortization expense             |       | 135                                   |       | 719                                  |       | 612 |   | 2,106 |   |
| Stock-based compensation                    |       | —                                |       | 189                                  |       | 46 |   | 834 |   |
| Total operating expenses                    |       | 10,128                                |       | 10,096                               |       | 30,094 |   | 30,747 |   |
|                                        |       |                                  |       |                                 |       |   |   |   |   |
| Loss from operations                        |       | (1,306                                | )          | (91                                  | )          | (3,661 | ) | (1,609 | ) |
| Other income, net                           |       | 168                                   |       | 112                                  |       | 364 |   | 448 |   |
| Loss before income taxes                    |       | (1,138                                | )          | 21                                   |       | (3,297 | ) | (1,161 | ) |
| Income taxes                                |       | (55                                   | )          | (150                                 | )          | (283 | ) | (458 | ) |
|                                        |       |                                  |       |                                 |       |   |   |   |   |
| Net loss                                    |       | $                                     | (1,193     | )                                    | $          | (129 | ) | $ | (3,580 | ) | $ | (1,619 | ) |
|                                        |       |                                  |       |                                 |       |   |   |   |   |
| Basic and diluted net loss per common share |       | $                                     | (0.03      | )                                    | $          | (0.00 | ) | $ | (0.09 | ) | $ | (0.04 | ) |
|                                        |       |                                  |       |                                 |       |   |   |   |   |
| Weighted-average common shares outstanding  |       | 42,009                                |       | 41,374                               |       | 41,834 |   | 40,944 |   |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

 

4

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**VASTERA, INC.AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS**

 

**(UNAUDITED)**

 

**(In thousands)**

 
| ** **                                                                                              | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                              | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| **Cash flows from operating activities:**                                                               |       |                                 |       |   |   |
| Net loss                                                                                                |       | $                                    | (3,580     | ) | $ | (1,619 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used in) operating activities:              |       |                                 |       |   |   |
| Stock-based compensation                                                                                |       | 46                                   |       | 834 |   |
| Depreciation and intangible amortization  expense                                                       |       | 4,677                                |       | 5,951 |   |
| Provision for allowance for doubtful  accounts                                                          |       | 454                                  |       | 171 |   |
| Amortization of revenue discounts related  to customer contracts                                        |       | 230                                  |       | 235 |   |
| Amortization of capitalized internal-use  software costs                                                |       | 545                                  |       | 335 |   |
| Asset disposal                                                                                          |       | 96                                   |       | — |   |
| Changes in operating assets and  liabilities:                                                           |       |                                 |       |   |   |
| Accounts receivable                                                                                     |       | (1,426                               | )          | (1,056 | ) |
| Prepaid expenses and other current assets                                                               |       | (146                                 | )          | (1,067 | ) |
| Deposits and other assets                                                                               |       | 449                                  |       | (602 | ) |
| Accounts payable and accrued expenses                                                                   |       | 1,368                                |       | (5,856 | ) |
| Accrued compensation and benefits                                                                       |       | 270                                  |       | 1,833 |   |
| Deferred revenue                                                                                        |       | 759                                  |       | (112 | ) |
| Net cash provided by (used in) operating  activities                                                    |       | 3,742                                |       | (953 | ) |
|                                                                                                    |       |                                 |       |   |   |
| **Cash flows from investing activities:**                                                               |       |                                 |       |   |   |
| Acquisition of subsidiaries                                                                             |       | —                               |       | (3,000 | ) |
| Net (purchases) sales of short-term  investments                                                        |       | 4,168                                |       | 457 |   |
| Acquisition of property and equipment                                                                   |       | (3,330                               | )          | (2,208 | ) |
| Net cash provided by (used in) investing  activities                                                    |       | 838                                  |       | (4,751 | ) |
|                                                                                                    |       |                                 |       |   |   |
| **Cash flows from financing activities:**                                                               |       |                                 |       |   |   |
| Proceeds from the exercise of stock options  and issuance of stock for the employee stock purchase plan |       | 870                                  |       | 3,147 |   |
| Principal payments on long-term debt                                                                    |       | (1,671                               | )          | (2,027 | ) |
| Proceeds from equipment line of credit                                                                  |       | —                               |       | 1,102 |   |
| Net cash provided by (used in) financing  activities                                                    |       | (801                                 | )          | 2,222 |   |
| Effect of foreign currency exchange rate  changes on cash and cash equivalents                          |       | (298                                 | )          | 180 |   |
| Net increase (decrease) in cash and cash  equivalents                                                   |       | 3,481                                |       | (3,302 | ) |
| Cash and cash equivalents, beginning of  period                                                         |       | 16,046                               |       | 23,696 |   |
| Cash and cash equivalents, end of period                                                                |       | $                                    | 19,527     |   | $ | 20,394 |   |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

 

5

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**VASTERA, INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS(Unaudited)**

 

### **1.**                                      Basis of Presentationand Nature of Business:

###  

The accompanying unaudited condensedconsolidated financial statements of Vastera, Inc. and its subsidiaries (“Vastera”the “Company,” “we,” or “us”) have been prepared on the same basis as auditedfinancial statements and include all adjustments, including all normalrecurring adjustments that are necessary for a fair presentation of thefinancial condition, results of operations, and cash flows for the interimperiods 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, 2004.  Allsignificant intercompany balances and transactions have been eliminated inconsolidation.  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 interimfinancial statements should be read in conjunction with the Company’s auditedconsolidated financial statements and notes thereto, as filed with the SEC withthe Company’s Annual Report on Form 10-K and other reports filed with theSEC.

 

Vastera is a leading provider of solutionsfor Global Trade Management and was incorporated in Virginia inNovember 1991 under the name Export Software International, Inc.  The Company reincorporated in Delaware inJuly 1996 and changed its name to Vastera, Inc. inJune 1997.  The Company’s principalsolutions offerings include software solutions, Trade Management Consulting,and Managed Services.  Managed Servicesrange from management of a client’s specific global trade function to providingcomplete management of a client’s global trade operations.  The Company has operations in the UnitedStates, Belgium, Brazil, Canada, China, France, Germany, Ireland, Japan,Mexico, the Netherlands, Poland, Spain, and the United Kingdom.

 

The Company’s operations are subject tocertain risks and uncertainties, including among others, uncertainties relatingto product development, rapidly changing technology, current and potentialcompetitors with greater financial, technological, production, and marketingresources, the potential loss of significant customers, dependence on keymanagement personnel, limited protection of intellectual property andproprietary rights, uncertainty of future profitability and possiblefluctuations in financial results.

 

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

###  

**Use of Estimates**

 

The preparation of the consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosures of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.  Estimates that are mostsusceptible to change are the Company’s estimates of collections of accountsreceivable and the estimated lives and the realization of its internal usesoftware and intangible assets.

 

**Revenue Recognition**

 

The Company’s revenues consist of managedservices revenues, software revenues, and services revenues.

 

*Managed Services Revenues*

* *

Managed services revenues are derived fromagreements that provide for transaction or services fees based on theperformance and delivery of the Company’s Managed Services solutions.  Managed Services solutions include theprocessing of the Company’s clients’ customs and shipment entries and theclassifying of 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 using a weighted-averagetransaction rate or the cumulative amount billable.  For those Managed Services transactionarrangements subject to annual minimums and for those arrangements where theamount billable for interim periods is limited to the pro-rata portion of theannual minimum, transactions processed in excess of the minimum in each periodare not billable, and, therefore, revenue is not recognized until the end ofthe related year.  Certain ManagedServices arrangements are based upon a fixed services fee.  Revenues associated with these arrangementsare recognized ratably over the term of the arrangement and limited to theamounts billable.  In addition, theCompany may receive annual gainsharing fees under certain Managed Servicesarrangements based on a percentage of the clients’ annual cost savings, asdefined in those Managed Services arrangements. These gainsharing fees are recognized when they become fixed anddeterminable.

 

6

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* *

*Software Revenues*

* *

Software revenues consist of term licenserevenues, perpetual software license revenues, and transaction-basedrevenues.  The Company recognizes revenuefrom the sale of software products in accordance with Statement of Position (“SOP”)97-2, Software Revenue Recognition.

 

Term license revenues are derived from termsoftware license arrangements in which the Company’s clients license itssoftware products and obtain the right to unspecified enhancements on awhen-and-if-available basis, ongoing support and content update services.  Content updates are significant and frequent.  Revenues are recognized ratably over thecontract term.  Term license arrangementstypically range from three to five years. To the extent the Company hosts the software for its customers, thehosting fee is recognized ratably over the contract period in conjunction withthe recognition of the license fee.

 

Perpetual software license revenues arederived from perpetual software license arrangements and related maintenancecontracts.  Maintenance contracts includethe right to unspecified enhancements on a when-and-if available basis, ongoingsupport, and content update services. The content updates provided under maintenance arrangements aresignificant and frequent, and, as a result, revenues from perpetual softwarelicense sales are recognized ratably over the estimated economic life of theproduct.  The Company has estimated thatthe life of the product is three years, which is consistent with the historicalperiods between major upgrades to the functionality and architecture of itsproducts.  Revenues from maintenancecontracts are recognized ratably over the contract term, which is typically oneyear.  To the extent the Company hoststhe software for its customers, the hosting fee is recognized ratably over thecontract period in conjunction with the recognition of the license fee.

 

Transaction-based revenues are derived fromarrangements that provide for transaction fees based on a client’s usage of theCompany’s software products.  Revenuesfrom the usage of its software products are recognized as transactions occur.

 

The Company recognizes revenues fromarrangements with resellers beginning when the software product is sold to theend user.  Any annual transactionminimums not sold by the reseller to the end customers are recognized as revenuesupon the expiration of the annual minimum period.

 

*Services Revenues*

* *

Services revenues are derived from softwareimplementation, Trade Management Consulting, and training services.  Services are performed on a time andmaterials basis or under fixed price arrangements.  Revenues on time and materials contracts arerecognized based on fixed billable rates for hours delivered, and revenues onfixed priced contracts and are recognized as the services are performed, usingthe percentage of completion method of accounting based on the ratio of costsincurred to total estimated costs to be incurred.  Losses on fixed price arrangements arerecognized when known.

 

For multiple-element arrangements where theCompany provides both software and services, the Company defers the servicefee, based on vendor-specific objective evidence, and recognize it as theservices are performed.

 

**Deferred Revenues**

 

Deferred revenues include amounts billed toclients for revenues that have not been recognized and generally result frombilled, but deferred license revenues and services not yet performed.  Deferred revenues are recognized over theterm of the agreement, the remaining economic life of the product, or when theservices are performed.

 

**Cost of Revenues**

 

Cost of revenues includes the cost of managedservices revenues, the cost of software revenues, and the cost of servicesrevenues.

 

Cost of managed services revenues consist ofthe cost of salaries and related expenses, reimbursed expenses to Ford for ourManaged Services organization, and the amortization of capitalized internal usesoftware costs related to the implementation and integration of the Company’strade management platform to the Managed Services operation.

 

Cost of software revenues includes royaltiesowed to third parties for technology products integrated into the Company’ssoftware products, as well as the cost of salaries and related expenses for thesoftware customer support organization.

 

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 partiescontracted to provide either implementation services or Trade ManagementConsulting to the Company’s clients.

 

7

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**Internal Use Software**

 

In accordance with SOP 98-1, *Accounting for the Costs of Computer SoftwareDeveloped or Obtained for Internal Use*, the Company capitalizescosts associated with the implementation and integration of its trademanagement platform to its Managed Services operations.  The Company capitalized approximately$253,000 and $111,000 of direct labor costs in the third quarters of 2004 and2003, respectively, and $619,000 and $395,000 in the nine months endedSeptember 30, 2004 and 2003, respectively, related to certain capitalizabletasks including the technical design, system configuration and testing phasesof the integration process.  Judgment isinvolved in determining which development tasks associated with the platformintegration are capitalizable pursuant to SOP 98-1.  These costs are amortized as costs of managedservices revenues over three years and amortization commences upon thecompletion of the integration to the Vastera platform.  Total amortization expense in the threemonths and nine months ended September 30, 2004 was approximately $209,000 and$545,000, respectively.  Totalamortization expense in the three months and nine months ended September 30,2003 was approximately $115,000 and $335,000, respectively.  Net capitalized costs as of September 30,2004 and December 31, 2003 was approximately $1.8 million and $1.7million, respectively.

 

**Concentrations of Credit Risk**

 

Financial instruments that potentiallysubject the Company to concentrations of credit risk consist primarily of cashequivalents, short-term investments, and accounts receivable.  The Company limits the amount of investmentexposure in any one financial instrument and does not have any foreign currencyinvestments.  The Company sells productsand services to customers across several industries throughout the worldwithout requiring collateral.  However,the Company routinely assesses the financial strength of its customers andmaintains allowances for anticipated losses.

 

As of September 30, 2004 and December 31,2003, Ford Motor Company accounted for 26% and 25%, respectively, of totalaccounts receivable.  As of September 30,2004 and December 31, 2003, Lucent Technologies accounted for 12% and 7%,respectively, of total accounts receivable.

 

**Net Loss Per Common Share**

 

Basic net loss per common share is computedby dividing net loss applicable to common stockholders by the weighted-averagenumber of common shares outstanding for the period.  Diluted net loss per common share includesthe potential dilution that would occur if securities or other contracts toissue common stock were exercised or converted into common stock.  As of September 30, 2004 andDecember 31, 2003, options to purchase approximately 7,645,000 and8,436,000 shares of common stock were outstanding, respectively.  Due to the anti-dilutive effect of theoptions, they have been excluded from the calculation of weighted-averageshares for diluted earnings per share. As a result, the basic and diluted loss per share amounts are identical.

 

**Comprehensive Income (Loss)**

 

As of September 30, 2004 andDecember 31, 2003, accumulated other comprehensive loss includesunrealized gains and losses on investments and foreign currency translationadjustments.  As of September 30, 2004 andDecember 31, 2003, accumulated net unrealized (loss) gain on available forsale investments was approximately $(40,000) and $107,000, respectively.  As of September 30, 2004 andDecember 31, 2003, accumulated foreign currency translation adjustment wasa loss of approximately $981,000 and $822,000, respectively.

 

**Goodwill and Intangible Assets**

 

Goodwill represents the excess of costs overfair value of assets of businesses acquired. Goodwill and intangible assets acquired in a purchase businesscombination and determined to have an indefinite useful life are not amortized,but instead tested for impairment at least annually in accordance with theprovisions of SFAS No. 142.  TheCompany’s assessment date is December 31 each year.  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*.

 

Intangible assets are amortized on astraight-line basis over their expected economic life, generally one to fiveyears.  The value assigned to the Fordand GE contracts in connection with the Ford and GE acquisitions are beingamortized as a discount to revenue over the minimum terms of the contracts.

 

**Stock Options**

 

The Company has adopted the disclosurerequirements of SFAS No. 123, *Accountingfor Stock-Based Compensation*. The

 

8

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Company applies Accounting Principles Board (“APB”) OpinionNo. 25, *Accounting for Stock Issued toEmployees*, and related interpretations in accounting for itsPlans.  No options with exercise pricesthat were less than fair value were granted during the nine months endedSeptember 30, 2004 and 2003.  The Companyhad deferred compensation balances from options issued prior to 2001.  The deferred compensation was recognized overthe vesting period of the related options using an accelerated method.  The Company recognized compensation expenseduring the first nine months of 2004 and 2003 of approximately $46,000 and$834,000, respectively.  As of September30, 2004, all deferred compensation has been recognized.

 

Had compensation expense for the Company’s1996 Plan, 2000 Plan and Employee Stock Purchase Plan been determined based onthe fair value at the grant dates for awards under the Plans consistent withthe method of SFAS No. 123, the Company’s net loss would have beenincreased to the pro forma amounts indicated below (in thousands, except pershare data).

 
| ** **                                                                                          | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                          | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                |       |                                  |       |                                 |       |   |   |   |   |
| Net loss applicable to common stockholders,  as reported                                            |       | $                                     | (1,193     | )                                    | $          | (129 | ) | $ | (3,580 | ) | $ | (1,619 | ) |
| Add: stock-based compensation included in  net loss, net of tax                                     |       | —                                |       | 189                                  |       | 46 |   | 834 |   |
| Deduct: stock-based compensation determined  under the fair value method for all awards, net of tax |       | (1,466                                | )          | (1,870                               | )          | (6,375 | ) | (13,510 | ) |
| Net loss, pro forma                                                                                 |       | $                                     | (2,659     | )                                    | $          | (1,810 | ) | $ | (9,909 | ) | $ | (14,295 | ) |
| Pro forma net loss per common share                                                                 |       | $                                     | (0.06      | )                                    | $          | (0.04 | ) | $ | (0.24 | ) | $ | (0.35 | ) |

 

**Income Taxes**

 

Deferred taxes are provided utilizing theasset and liability method as prescribed by SFAS No. 109, *Accounting for Income Taxes*, wherebydeferred tax assets are recognized for deductible temporary differences andoperating loss and tax credit carryforwards and deferred tax liabilities arerecognized for taxable temporary differences. Temporary differences are the differences between the reported amountsof assets and liabilities and their tax bases. Deferred tax assets and liabilities are adjusted for the effects ofchanges in tax laws and rates on the date of enactment.  Deferred tax assets are reduced by avaluation allowance when, in the opinion of management, it is more likely thannot that some portion or all of the deferred tax assets will not be realized.

 

### **3.**                                      Restructuring

###  

During 2002, the Company recordedrestructuring costs of approximately $1.1 million associated with thetermination of employees and approximately $2.2 million associated withthe closing of redundant facilities, the cancellation of certain contracts, andother non-personnel related actions.

 

As of September 30, 2004 andDecember 31, 2003, the balance of the restructuring reserve wasapproximately $22,000 and $112,000, respectively.  The Company paid approximately $30,000 and$137,000 of these costs during the third quarters of 2004 and 2003,respectively.  The Company paidapproximately $90,000 and $714,000 of these costs during the nine months endedSeptember 30, 2004 and 2003, respectively. The Company expects to pay out the remainder of the restructuringreserve in 2004.

 

### **4.**                                      Acquisitions

###  

On June 19, 2003, the Company acquiredGeneral Electric Company’s (“GE”) internal U.S. customs operations.  The Company also entered into a managedservices agreement under which Vastera will manage the U.S. customs operationsfor five of GE’s US divisions for a minimum term of 3 years.  The purchase method of accounting has beenapplied to this acquisition, and accordingly, the results of GE’s internal UScustoms operations are included in the Company’s operations beginningJuly 1, 2003, the effective date of the acquisition.

 

9

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In exchange for its internal US customsoperations, GE received $3.0 million in cash and 51,046 shares of the Company’scommon stock valued at approximately $312,000. The purchase price, including transaction costs of approximately$62,000, has been allocated based on fair values as follows (in thousands):

 
| ** **                            | ** ** | **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 amountallocated to the acquired technology and know-how intangible is being amortizedon a straight-line basis over five years, the estimated useful life of theasset.  Beginning July 1, 2003, theamount allocated to the GE contract and customer relationship is beingamortized as a discount to revenue over five years, the estimated useful lifeof the asset.

 

### **5.**                                      Long-Term Debt:

###  

**Lines of Credit**

 

The Company has a term loan, a securedrevolving line of credit (Line of Credit) and an equipment line of credit(Equipment Line of Credit) with Comerica Bank.

 

The Company paid the remaining term loanbalance during 2004.  The balance underthe term loan was zero and approximately $1.0 million as of September 30,2004 and December 31, 2003, respectively.

 

The Company may borrow up to$10.0 million under the Line of Credit, with a $2.5 million sub-limitfor the issuance of letters of credit. Advances under the Line of Credit are limited to the lesser of $10 millionor 80% of eligible accounts receivable, as defined in the loan agreement.  The Line of Credit bears interest at the bank’sprime rate (4.75% as of September 30, 2004). The Line of Credit matured in July 2004.  There were no outstanding balances under theLine of Credit as of December 31, 2003.

 

In the first and third quarters of 2003, theCompany borrowed approximately $614,000 and $488,000, respectively, against theEquipment Line of Credit.  Theavailability under the Equipment Line of Credit expired in July 2003.  Commencing on July 31, 2003, interestand principal began to be payable in monthly installments on all borrowingsmade under the Equipment Line of Credit.

 

In July 2004, the Company renewed  its existing Line of Credit for $10 million,with a $2.5 million sub-limit for the issuance of letters of credit, and a newequipment line of credit for $5 million with Comerica Bank.  The renewed Line of Credit will mature inJuly 2006 and the renewed equipment line of credit will mature three years fromthe date of the general equipment or software purchases.  The outstanding balance and current portionof balance under the Equipment Line of Credit was approximately $430,000 as ofSeptember 30, 2004, and $796,000 and $490,000, respectively, as ofDecember 31, 2003.  The renewedEquipment Line of Credit has two interest-only payment periods and bearsinterest at the bank’s prime rate plus 50 basis points (5.25% as of September30, 2004).

 

The terms of the renewed Line of Credit andthe renewed Equipment Line of Credit require the Company to comply with severalfinancial covenants, including restrictions and limitations on futureindebtedness, sale of assets and material changes in the Company’sbusiness.  Through September 30, 2004,the Company was in compliance with the covenants of the its credit facility.

 

**Capital Lease Obligations and Other**

 

The Company leases office equipment undervarious non-cancelable capital leases. Amounts borrowed under the equipment leasing arrangement are due over36- to 48-month repayment periods.  As ofSeptember 30, 2004 and December 31, 2003, capital lease obligationsoutstanding were approximately $464,000 and $764,000, respectively.  Approximately $315,000 and $372,000 of thecapital lease obligation balance was current as of September 30, 2004 andDecember 31, 2003, respectively. Property and equipment includes approximately $925,000 of equipmentunder capital lease arrangements at September 30, 2004 and December 31,2003.  Related accumulated depreciationwas approximately $478,000 and $247,000 at September 30, 2004 andDecember 31, 2003, respectively.

 

As of December 31, 2002, the Company hada note payable outstanding of approximately $120,000 due to a third party 

 

10

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issued in connection with a 2002 acquisition.  The Company repaid the loan inFebruary of 2003.  Interest accruedmonthly at an annual rate of approximately 6.5%.

 

### **6.**                                      Commitments andContingencies:

###  

The Company is periodically a party todisputes arising from normal business activities.  In the opinion of management, resolution ofthese matters will not have a materially adverse effect upon the financialcondition or future operating results of the Company.

 

On March 14, 2001, ExpeditorsInternational of Washington, Inc. and Expeditors Tradewin, L.L.C. (collectively“Expeditors”) filed suit against the Company in the United States DistrictCourt for the Eastern District of Michigan, Southern Division primarilyalleging that the Company misappropriated certain of Expeditors’ trade secretsin connection with its acquisition of Ford’s customs operations, by utilizingsystems and business processes that Expeditors assisted in developing for Fordand through its employee hiring practices. In connection with its acquisitionof Ford’s customs operations, Ford agreed to indemnify the Company forintellectual property infringement claims, and Ford indemnified the Company inconnection with this litigation. Although Ford is obligated to indemnify the Company of claims of intellectualproperty infringement arising from the property the Company acquired from it,Ford is not obligated to indemnify the Company for legal fees arising from anyclaims that pertained solely to the Company’s acts, upon which certain of theclaims asserted in this matter were based. Trial in this matter commenced on July 15, 2004.  On August 4, 2004, the jury found in favor ofVastera.  In October 2004, Expeditors,the Company, and Ms. Jennifer Sharkey, a Vastera employee named as aco-defendant, mutually agreed to waive all rights to an appeal in this matter.

 

In some of its software license arrangements,the Company has agreed to indemnify customers for any damages they sustain froma claim for intellectual property infringement. Additionally, subject to specified contractual limitations on amount,under our Managed Services agreements, the Company has agreed to indemnify itscustomers for any damages they sustain from the Company’s performance ofManaged Services in a non-compliant manner. Although management does not believe that the Company’s productsinfringe the intellectual property rights of any third party or that it isperforming services in a non-compliant manner, the Company cannot estimate ourmaximum liability exposure, because of the inherent uncertainty associated withany such claims and the varying nature of the indemnification levels to whichthe Company has agreed.

 

### **7.**                                      SegmentInformation:

###  

The Company has three reportable operatingsegments: managed services, software, and services.  The managed services segment generates revenuesfrom managed services transaction and service arrangements.  The software segment generates revenues fromterm license, perpetual license, and transaction license agreements of itsGlobal Trade Management solutions.  Theservices segment generates revenues by charging its customers forimplementation, management consulting and training services.

 

The Company evaluates the performance of eachsegment based on revenues and gross profit. The Company’s unallocated costs include corporate and other costs notallocated to the segments for management’s reporting purposes.

 

11

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The following table summarizes the Company’sthree segments (in thousands):

 
| ** **                 | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                 | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                 | ** ** | **(unaudited)**                       | ** ** | **(unaudited)**                      | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** |
| Revenues:                  |       |                                  |       |                                 |       |   |   |   |   |
| Managed services           |       | $                                     | 13,740     |                                 | $          | 14,084 |   | $ | 41,920 |   | $ | 41,343 |   |
| Software                   |       | 2,639                                 |       | 2,936                                |       | 7,344 |   | 8,552 |   |
| Services                   |       | 5,432                                 |       | 4,675                                |       | 14,664 |   | 14,268 |   |
| Total revenues             |       | 21,811                                |       | 21,695                               |       | 63,928 |   | 64,163 |   |
|                       |       |                                  |       |                                 |       |   |   |   |   |
| Gross Profit:              |       |                                  |       |                                 |       |   |   |   |   |
| Managed services           |       | 5,337                                 |       | 6,531                                |       | 17,363 |   | 18,855 |   |
| Software                   |       | 1,881                                 |       | 2,220                                |       | 5,228 |   | 6,442 |   |
| Services                   |       | 1,604                                 |       | 1,254                                |       | 3,842 |   | 3,841 |   |
| Gross profit               |       | 8,822                                 |       | 10,005                               |       | 26,433 |   | 29,138 |   |
|                       |       |                                  |       |                                 |       |   |   |   |   |
| Net loss:                  |       |                                  |       |                                 |       |   |   |   |   |
| Unallocated expense        |       | (10,128                               | )          | (10,096                              | )          | (30,094 | ) | (30,747 | ) |
| Interest income            |       | 182                                   |       | 158                                  |       | 480 |   | 591 |   |
| Interest and other expense |       | (14                                   | )          | (46                                  | )          | (116 | ) | (143 | ) |
| Income tax                 |       | (55                                   | )          | (150                                 | )          | (283 | ) | (458 | ) |
| Net loss                   |       | $                                     | (1,193     | )                                    | $          | (129 | ) | $ | (3,580 | ) | $ | (1,619 | ) |

 

**Geographic Information**

 

The Company sells its products and servicesthrough its offices in the United States, Brazil, Canada, Mexico, Germany,Japan, and the United Kingdom.  Informationregarding revenues and long-lived assets attributable to the United States andto all foreign countries is stated below. The geographic classification of product and services revenues was basedupon the location of the customer.  TheCompany’s product and services revenues were generated in the followinggeographic regions (in thousands):

 
| ** **                  | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                  | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                  | ** ** | **(unaudited)**                       | ** ** | **(unaudited)**                      | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** |
| United States               |       | $                                     | 16,414     |                                 | $          | 15,970 |   | $ | 48,522 |   | $ | 47,720 |   |
| Other North America         |       | 2,369                                 |       | 2,547                                |       | 6,864 |   | 7,253 |   |
| Europe                      |       | 1,927                                 |       | 1,876                                |       | 6,326 |   | 5,705 |   |
| Other international regions |       | 1,101                                 |       | 1,302                                |       | 2,216 |   | 3,485 |   |
| Total revenues              |       | $                                     | 21,811     |                                 | $          | 21,695 |   | $ | 63,928 |   | $ | 64,163 |   |

 

The Company’s tangible long-lived assets werelocated as follows (in thousands):

 
| ** **                    | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                    | ** ** | **(unaudited)**         | ** ** | ** **                  | ** ** |
| United States                 | ** ** | $                       | 8,045      |                        | $          | 9,590 | ** ** |
| Other North America           |       | 656                     |       | 826                         |       |
| Europe                        |       | 546                     |       | 202                         |       |
| Other international locations |       | 295                     |       | 188                         |       |
| Total long-lived assets       |       | $                       | 9,542      |                        | $          | 10,806 |   |

 

**Significant Customers**

 

For the quarters ended September 30, 2004 and2003, the Company derived approximately 60% and 65%, respectively, of its totalrevenues from the Company’s top five customers. For the nine months ended September 30, 2004 and 2003, the Companyderived approximately 63% and 66%, respectively, of its total revenues from theCompany’s top five customers.  For thequarters ended September 30, 2004 and 2003, Ford accounted for 30% of totalrevenues.  For the nine months endedSeptember 30, 2004 and 2003, Ford accounted for 30% of total revenues.  For the quarters ended September 30, 2004 and2003, Lucent accounted for 12% and 14% of total revenues respectively.  For the nine months ended September 30, 2004and 2003, Lucent accounted for 13% and 15% of

 

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total revenues respectively.

 

### **8.**                                      Transactions withFord Motor Company:

###  

On August 29, 2000, the Company acquiredFord’s global customs import operations and merged Ford’s global customs importoperations into its Managed Services operations.  Ford received 8,000,000 shares of the Company’scommon stock valued at approximately $79.2 million in consideration at thetime of the transaction.  As of September30, 2004, Ford owned 8,000,000 shares or approximately 19% of the Company.

 

In August 2000, the Company also enteredinto a Managed Services agreement under which Vastera manages Ford’s globaltrade import operations.  InJanuary 2001 and March 2001, the Company entered into ManagedServices agreements with Ford Mexico and Ford Canada, respectively.  In November 2002, the Company enteredinto a Managed Services agreement with Ford Europe to manage operations in the UnitedKingdom, Spain, Belgium, and Germany. The agreements with Ford have initially had minimum terms of four years.

 

In July 2002, the Company amended itsagreement with Ford U.S. to provide for billing Ford at a fixed annual rate of$11.8 million for the remaining life of the agreement, beginningJanuary 1, 2003.  Either party mayterminate this agreement for convenience commencing on August 1, 2004, afterproviding the non-terminating party one-year advance notice.  Commencing on August 1, 2005 and continuingthereafter, either party may terminate the agreement upon providing six-months’advance written notice. Ford U.S. has not informed the Company that they planto terminate the agreement.  The Companyis currently reviewing with Ford U.S. the scope of services it performs and theassociated fees charged for these services. As part of this review, effective June 1, 2004, the Company has agreedto reduce the managed services fees charged to Ford U.S. by approximately$500,000 on an annual basis.

 

For the quarters ended September 30, 2004 and2003, Ford accounted for 30%, of total revenues.  For the nine months ended September 30, 2004and 2003, Ford accounted for 30% of total revenues.  As of September 30, 2004 andDecember 31, 2003, Ford accounted for 26% and 25%, respectively, of totalaccounts receivable.

 

The Company reimburses Ford for expensesincurred by Ford for the use of its facilities, the costs of leased employees,and the maintenance and expenses related to the acquired technology.  For the quarters ended September 30, 2004 and2003, Ford charged the Company approximately $900,000 and $1.2 million,respectively.  For the nine months endedSeptember 30, 2004 and 2003, Ford charged the Company approximately $3.0million and $5.1 million, respectively. In 2003, these payments began to decrease as the Company began deployingits own technology in North America.

 

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

###  

In October 2002, the Company offeredeach eligible employee an opportunity to cancel certain of his or her stockoptions (the “Options Exchange”) in exchange for the right to receive a futurestock option grant for the same number of shares six months and one day fromthe date of cancellation with a strike price equal to the market price on thenew grant date.  Options to purchaseapproximately 3.8 million shares were cancelled pursuant to the OptionsExchange.  In April 2003, theCompany issued replacement options to employees to purchase approximately3.6 million shares of common stock at an exercise price of $4.06 per sharein exchange for the options previously canceled.  The vesting schedule of the canceledoptions remained in effect for the replacement options.  The Company deferred the issuance of annualoption grants to employees during this six-month period and accordingly, inApril 2003, the Company issued additional options to purchase 930,000shares of common stock to these employees at an exercise price of $4.06 pershare.

 

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The Company applies APB Opinion No. 25,Accounting for Stock Issued to Employees, and related interpretations inaccounting for it stock option plan.  TheCompany recorded deferred compensation cost of approximately $6.4 millionin the last nine months of 1999 and approximately $13.4 million in thefirst nine months of 2000.  OnMarch 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 deferred compensation amounts representthe aggregate difference between the exercise price and the fair value foraccounting purposes of the underlying shares of common stock at the date ofgrant.  This amount is included as acomponent of stockholders’ equity and is being amortized on an acceleratedbasis over the applicable vesting period. Stock-based compensation, which has been separately identified in theaccompanying condensed consolidated statement of operations, has not beenincluded in costs of revenues, sales and marketing, research and development,and general and administrative expense as indicated below (in thousands):

 
| ** **                        | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                        | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                        | ** ** | **(unaudited)**                       | ** ** | **(unaudited)**                      | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** |
| Cost of managed services revenues |       | $                                     | —     |                                 | $          | 5 |   | $ | 1 |   | $ | 23 |   |
| Cost of software revenues         |       | —                                |       | 1                                    |       | — |   | 4 |   |
| Cost of services revenues         |       | —                                |       | 26                                   |       | 6 |   | 117 |   |
| Sales and marketing               |       | —                                |       | 76                                   |       | 19 |   | 334 |   |
| Research and development          |       | —                                |       | 18                                   |       | 4 |   | 81 |   |
| General and administrative        |       | —                                |       | 63                                   |       | 16 |   | 275 |   |
| Total stock-based compensation    |       | $                                     | —     |                                 | $          | 189 |   | $ | 46 |   | $ | 834 |   |

 

### **10.**                               SupplementalInformation:

###  

# **Cash Flow Information**

#  

Cash paid for interest was approximately$79,000 and $120,000 for the nine months ended September 30, 2004 and 2003,respectively.  Noncash activities were asfollows (in thousands):

 
| ** **                                                                                                              | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                              | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| ** **                                                                                                              | ** ** | **(unaudited)**                      | ** ** | **(unaudited)** | ** ** |
| Increase in capital lease obligations                                                                                   |       | $                                    | —     |   | $ | 921 |   |
| Issuance of common stock and stock options  in acquisitions                                                             |       | —                               |       | 312 |   |
| Assumed liabilities, transaction costs and  other, net of tangible assets and deferred revenue acquired in acquisitions |       | —                               |       | (214 | ) |
|                                                                                                                         |            |                                      |            |  |  |  |  |

 

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##  

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

##  

*The following discussion and analysis of ourfinancial condition and results of operations should be read in conjunctionwith our condensed consolidated financial statements and related notesappearing elsewhere in this Report, which are deemed to be incorporated intothis section.  Some of the statements wemake in “Management’s Discussion and Analysis of Financial Condition andResults of Operations” and elsewhere in this Report constitute forward-lookingstatements within the meaning of Section 21E of the Securities ExchangeAct of 1934, as amended (the “Exchange Act”). These statements involve known and unknown risks, uncertainties andother factors that may cause our actual results, levels of activity,performance or achievements as expressed or implied by such forward-lookingstatements not to be achieved fully. These forward-looking statements relate to future events and our futurefinancial performance.  In some cases,you can identify forward-looking statements by words such as “may,” “should,” “expect,”“plan,” “anticipate,” “intend,” “believe,” “estimate,” “predict,” and “continue,”or the negative of such terms or other comparable words.  These statements are only predictions andincluded risks and uncertainties particularly those described in this Reportunder 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 leader in solutionsfor Global Trade Management.  We are aninternational company with a presence in 14 countries, serving an internationalclient base that utilizes our solutions to manage trade worldwide.  Our solutions have been designed to enableour clients to manage efficiently and effectively the information flowsassociated with the cross border movement of goods and comply with the myriadof rules and regulations to which global trade is subject.

 

Our solutions facilitate our clients’abilities to manage the complexities and inefficiencies inherent in globaltrading in a manner that allows them to capitalize on the large, highlyfragmented, and rapidly growing opportunity existing in the internationalmarket.  We have three major product andservices offerings, which are: TradeSphere Solutions; Trade ManagementConsulting; and Managed Services.  Thefoundation upon which our product and services offerings are based is ourcollection of proprietary processes, data, rules, and regulations, which wecall our Global Trade Content.

 

**Global Trade Content**is our proprietary rules-based application that provides comprehensivemanagement of trade regulations and programs and it functions as theinformation repository for our entire suite of Global Trade Managementsolutions.  **TradeSphere Solutions** is our suite of software solutions thathelps manage critical trade processes, and provides visibility into shipmentand carrier performance.  **Trade Management Consulting** is ourconsulting services offering that applies our global trade expertise and ourproprietary methodologies.  Ourconsulting services range from performing opportunity and complianceassessments to implementing detailed strategic analyses designed to improve aclient’s global trade practices.  **Managed Services** is our business processoutsourcing offering through which we combine our Global Trade Content, tradeexpertise, and technology to improve client regulatory compliance and reducetransaction processing costs.  We offerManaged Services to address all or a portion of a client’s global tradeoperations, ranging from one or more specific global trade functions toproviding a complete suite of Managed Services.

 

The potential market into which we offer ourproducts and services is an expansive one. Our product and services offerings, however, are new to their targetedaudience and the ultimate market size is difficult to quantify.  While our offerings are critical to a companyremaining compliant with import and export rules and regulations, generally ourofferings are not core to the business needs of a company.  This can often mean that the decision as towhether to purchase one of our solutions is predicated more on expected costsavings to be achieved by an entity than it is upon enhanced compliance.  In 2001 and 2002, our sales cycle averagedapproximately six to nine months for software sales and nine to 12 monthsfor Managed Services sales.  In 2003,however, we experienced a lengthening of these cycle times.

 

During the last seven quarters, weexperienced a significant slowing in the rate at which we added new business,reflected by an extended average sales cycle and sales of Managed Services andsoftware at lower than expected levels. Total revenues during this period demonstrated only modest growth,especially when compared to the revenue growth rates we experienced in 2001 and2002.  Total sales of Managed Servicesand software for 2003 and the first nine months of 2004 were lower thanexpected and considerably lower than what we achieved in the prior threeyears.  We expect that our total 2004revenues will be below our 2003 revenue level, and revenues in future periodsmay not increase above 2003 and 2004 levels until such time as we canaccelerate the rate of our sales growth. We also expect our revenues in 2005 will decrease when compared to 2004.

 

In 2003, we implemented several expensereduction activities to help offset the lack of aggregate revenue growth andachieve profitability targets.  Weexpected that these cost reduction actions would be short in duration.  Moreover, we expected to return to normalizedspending levels once new sales reached established targets.  We did not, however, achieve our anticipatedsales levels and, accordingly, the desired outcome was not achieved.  The expense reduction actions taken in 2003have slowed our progress in sales and marketing, product development andManaged Services operations.  To satisfycustomer expectations for product quality better, we increased spending onoperating expenses in 2004, primarily in research and development and sales andmarketing.  Additionally, to serve ourManaged Services customers better we increased spending on our Managed Servicesoperations in 2004, which resulted in a reduction in managed services grossmargins.  These increased investmentsreduced our cash generated from operations and increased our net losses.  We continually assess the level of investmentin our business and we expect to decrease our level of investments over time,consistent with the needs of our changing market.  We believe our level of investments in ourbusiness will be

 

15

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one of the contributing factors to when we become profitable andgenerate cash.

 

We expect the gross margin in our ManagedServices business to decline in the near term. The loss of the Visteon revenue in January 2005 will negatively impactour margin.  Over the longer term, weexpect to realize productivity improvements from our investment in ourinfrastructure.  As we enter into largemulti-year Managed Services agreements in new industry sectors or newgeographic regions that require significant investments in the relatedinfrastructure, the costs associated with these Managed Services agreements maybe greater in the initial year, and in certain circumstances exceed the revenuerecognized in the initial year, than in the later years, when we realizeproductivity improvements from these infrastructure investments.  There is offsetting pressure to theanticipated productivity benefits from price pressure in our marketplace. Inaddition, our large managed services customers expect to share in the costreductions achieved through our efficiency gains.  Consequently, the long-term gross margins ofour business are difficult to predict, but we expect them to be lower thanthose we anticipated when we first established our managed services businessmodel.

 

Our management team is currently reviewingthe level of investment we make in each of our product and services lines ofbusiness and geographic areas of presence. We are streamlining our product and services lines and consolidating andreorganizing our geographic locations and will continue doing so to align thelevel of our investments with the lower margin rates we anticipateachieving.  In doing so, we anticipateincurring costs associated with exiting contractual relationships andterminating personnel.  Althoughmanagement does not currently believe such costs will be material, we cannotyet quantify them or the effects these actions may have on future revenues.

 

In July 2004, Visteon Corporation notified usthat it will not renew its agreement for Managed Services when it expires onDecember 31, 2004.  We have providedoutsourced global trade management services to Visteon throughout North Americasince 2000.  Vastera and Visteon arecurrently working through a transition period. We expect to recognize 2004 revenues of approximately $6 millionassociated with the Visteon contract. Additionally, revenue derived from other large customer contracts maychange as we renew these contracts.  Weexpect our revenue in 2005 will decrease when compared to 2004.  We anticipate the amount of new businessclosed in 2004 will not offset the loss of the Visteon contract.  If we also fail to reduce the expenses of ourbusiness to match lower revenues, our net losses may increase and our cashflows could be negatively impacted.

 

**Relationship with Ford Motor Company**

 

On August 29, 2000, we acquired Ford’sglobal customs import operations and merged Ford’s global customs importoperations into our Managed Services operations.  Ford received 8,000,000 shares of our commonstock valued at approximately $79.2 million in consideration at the timeof the transaction.  As of September 30,2004, Ford owned 8,000,000 shares or approximately 19% of our common stock.

 

In August 2000, we also entered into aManaged Services agreement under which we manage Ford’s global trade importoperations.  In January 2001 andMarch 2001, we entered into Managed Services agreements with Ford Mexicoand Ford Canada, respectively.  In November 2002,we entered into a Managed Services agreement with Ford Europe to manageoperations in the United Kingdom, Spain, Belgium, and Germany.  The agreements with Ford have initially hadminimum terms of four years.  Ouragreement with Ford U.S. provides for billing Ford at a fixed annual rate of$11.8 million for the remaining life of the agreement, beginningJanuary 1, 2003.  Either party mayterminate this agreement for convenience commencing on August 1, 2004, afterproviding the non-terminating party one-year advance notice.  Commencing on August 1, 2005 and continuingthereafter, either party may terminate the agreement upon providing six-months’advance written notice.  Ford U.S. hasnot informed us they plan to terminate the agreement.

 

We are currently reviewing with Ford U.S. thescope of services we perform and the associated fees charged for theseservices.  As part of this review,effective June 1, 2004, we agreed to reduce the managed services fees chargedto Ford U.S. by approximately $500,000 on an annual basis.  Additionally, in September 2004, we agreedwith Ford to share some of the cost savings we obtain from achieving additionalefficiencies in our European operations. We have agreed with Ford that it shall obtain the benefit of such costsavings in the form of reduced managed services fees if and when any suchefficiencies are achieved.

 

For the quarters ended September 30, 2004 and2003, Ford accounted for 30%, of total revenues.  For the nine months ended September 30, 2004and 2003, Ford accounted for 30% of our total revenues.  As of September 30, 2004 andDecember 31, 2003, Ford accounted for 26% and 25%, respectively, of totalaccounts receivable.

 

We reimburse Ford for expenses incurred byFord for the use of its facilities, the costs of leased employees, and themaintenance and expenses related to the acquired technology.  For the quarters ended September 30, 2004 and2003, Ford charged us approximately $900,000 and $1.2 million,respectively.  For the nine months endedSeptember 30, 2004 and 2003, Ford charged us approximately $3.0 million and$5.1 million, respectively.  In 2003,these payments began to decrease as we began deploying our own

 

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technology in North America.

 

**Lucent**

 

In August 2001, we entered into afive-year agreement with Lucent Technologies to manage Lucent’s global tradeoperations in the United States. Subsequently, we expanded our relationship with Lucent by assumingresponsibility for administering and managing Lucent’s global trade operationsin other countries in North America, Europe, Brazil, and China.  For the quarters ended September 30, 2004 and2003, Lucent accounted for 12% and 14%, of total revenues respectively.  For the nine months ended September 30, 2004and 2003, Lucent accounted for 13% and 15%, of total revenues, respectively.

 

Lucent’s current agreement is transactionbased with minimums which step-down annually. Historically, Lucent’s transaction volumes have been below the minimumthreshold, and therefore our revenue from the Lucent contract has declined.  The annualized step-down from 2003 to 2004was approximately $2.2 million of revenue. In August 2004, and thereafter, Lucent will be able to terminatethe agreement for convenience by providing us with six months advancenotice.  We are in the process ofnegotiating an extension to the agreement.

 

**Acquisitions**

 

On June 19, 2003, we acquired GE’sinternal U.S. customs import operations. We also entered into a Managed Services agreement under which Vasterawill manage the U.S. customs import operations for five of GE’s U.S. divisionsfor a minimum term of three years.  GEmay terminate this agreement for convenience commencing on July 1, 2006, afterproviding the Company six months’ advance notice.  The results of GE’s internal U.S. customsimport operations have been included in our operations since July 1, 2003,the effective date of the acquisition. In exchange for its internal U.S. customs import operations, GE received$3.0 million in cash and 51,046 shares of our common stock, valued at approximately$312,000.  The purchase price, includingtransaction costs of approximately $62,000, totaled approximately$3.4 million.

 

**Critical Accounting Policies**

 

We consider our accounting policies relatedto revenue recognition, deferred revenues, internal use software and intangibleassets to be critical to our business operations and the understanding of ourresults of operations.  The impact andassociated risks related to these policies on our business operations arediscussed throughout this Management’s Discussion and Analysis of FinancialCondition and Results of Operations where such policies affect our reported andexpected financial results.  For asummary of significant accounting policies used in the preparation of ourconsolidated financial statements, see the Notes to our Consolidated FinancialStatements in Item 1 of this Report.  Ourpreparation of this Report requires us to make estimates and assumptions thataffect the reported amount of assets and liabilities, disclosure of contingentassets and liabilities at the date of our financial statements, and thereported amounts of revenue and expenses during the reporting period.  We cannot be sure that actual results willnot differ from those estimates.

 

***Sourceof Revenues and Revenue Recognition Policy***

 

*Managed Services Revenues*

 

Managed services revenues are derived fromagreements that provide for transaction or services fees based on theperformance and delivery of our Managed Services solutions.  Managed Services solutions include the processingof our clients’ customs and shipment 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 using a weighted-average transaction rate or thecumulative amount billable.  For thoseManaged Services transaction arrangements subject to annual minimums and forthose arrangements where the amount billable for interim periods is limited tothe pro-rata portion of the annual minimum, transactions processed in excess ofthe minimum in each period are not billable, and, therefore, revenue is notrecognized until the end of the related year. Certain Managed Services arrangements are based upon a fixed servicesfee.  Revenues associated with thesearrangements are recognized ratably over the term of the arrangement andlimited to the amounts billable.  Inaddition, we may receive annual gainsharing fees under certain Managed Servicesarrangements based on a percentage of the client’s annual cost savings, asdefined in those Managed Services arrangements. These gainsharing fees are recognized when they become fixed anddeterminable.  Managed Services transactionminimums and fixed service fees are typically billed monthly.

 

*Software Revenues*

 

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

 

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*Recognition*.

 

Term license revenues are derived from termsoftware license arrangements in which our clients license our software productsand obtain the right to unspecified enhancements on a when-and-if-availablebasis, ongoing support and content update services.  Content updates are significant andfrequent.  Revenues are recognizedratably over the contract term.  Termlicense arrangements typically range from three to five years.  To the extent we host the software for ourcustomers, the hosting fee is recognized ratably over the contract period inconjunction with the recognition of the license fee.  Term license fees are typically billedannually, quarterly or monthly.

 

Perpetual software license revenues arederived from perpetual software license arrangements and related maintenancecontracts.  Maintenance contracts includethe right to unspecified enhancements on a when-and-if available basis, ongoingsupport, and content update services. The content updates provided under maintenance arrangements aresignificant and frequent, and, as a result, revenues from perpetual softwarelicense sales are recognized ratably over the estimated economic life of theproduct.  We have estimated that the lifeof the product is three years, which is consistent with the historical periodsbetween major upgrades to the functionality and architecture of ourproducts.  Accordingly, we experience adrop-off in software revenues related to perpetual licenses at the end of thethree-year amortization period.  Revenuesfrom maintenance contracts are recognized ratably over the contract term,typically one year.  To the extent wehost the software for our customers, the hosting fee is recognized ratably overthe contract period in conjunction with the recognition of the license fee.

 

Transaction-based revenues are derived fromagreements that provide for transaction fees based on a client’s usage of oursoftware products.  Revenues from theusage of our software products are recognized as transactions occur.

 

We recognize revenues from arrangements withresellers beginning when the software product is sold to the end user.  Any annual transaction minimums not sold bythe reseller to the end customers are recognized as revenues upon theexpiration of the annual minimum period.

 

*Services Revenues*

 

Services revenues are derived fromimplementation, Trade Management Consulting, and training services.  Services are performed on a time andmaterials basis or under fixed price arrangements.  Revenues on time and materials contracts arebilled and recognized based on fixed billable rates for hours delivered, andrevenues on fixed priced contracts are recognized as the services areperformed, using the percentage of completion method of accounting based on theratio of costs incurred to total estimated costs to be incurred.  Losses on fixed price arrangements arerecognized when known.

 

For multiple-element arrangements where weprovide both software and software-related services, we defer the service fee,based on vendor-specific objective evidence of fair value, and recognize it asthe services are performed.

 

***InternalUse Software***

 

In accordance with Statement of Position98-1, *Accounting for the Costs of ComputerSoftware Developed 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 isinvolved in determining which development tasks associated with the platform integrationare capitalizable pursuant to SOP 98-1. These costs are amortized as costs of managed services revenues overthree years, and amortization commences upon the completion of the integrationto the Vastera platform.

 

***Goodwilland Intangible Assets***

 

In accordance with Statement of FinancialAccounting Standard (SFAS) No. 142, *Goodwilland Other Intangible Assets*, we prepare an annual assessment to testfor impairment of goodwill.  Ourassessment date is December 31st of each year.  The assessment requires us to compare thecarrying value of our reporting units to their fair values.  To the extent the carrying amount of areporting unit exceeds the fair value, we are required to compare the impliedfair value, as defined, of reporting unit goodwill with the carrying amount todetermine the amount of impairment.  Thefair value and the implied fair value, as defined, is determined for thereporting units taking into consideration many factors, such as currentperformance, future projections, and market conditions.

 

In accordance with SFAS No. 144, *Accounting for Impairment for or Disposal ofLong-Lived Assets*, purchased intangibles subject to amortization,are reviewed for impairment whenever events or changes in circumstancesindicate that the carrying amount of an asset may not be recoverable.  Recoverability is measured by a comparison ofthe carrying amount of an asset to the estimated undiscounted future cash flowsexpected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cashflows, an impairment charge is recognized by the amount by which the carryingamount of the asset exceeds the fair value of the asset.  The estimated undiscounted future cash flowsof an asset takes into consideration many factors, such as current performance,future projections, and market conditions.

 

**Management’s Disclosure of Non-GAAP Financial Measures**

 

From time to time, management makes publicdisclosures, other than in our SEC filings on Form 10-Q or Form 10-K,of certain financial measures such as pro forma earnings (loss) and EBITDA, asadjusted (as defined below), that are not considered

 

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GAAP financial measures.  On October 21, 2004, we issued an earningspress release and included it as an exhibit to a Form 8-K we filed withthe SEC the same day.  This press releasecontained reconciliations of pro forma earnings (loss) and EBITDA, as adjusted,to our reported net loss.

 

Management believes that pro forma earnings(loss) is a useful supplement to GAAP financial measures as it measures ouroperating performance and liquidity for the reporting period because itexcludes certain charges associated with past events that are not related tocurrent operations or that are not relevant to current operations and will not bein the foreseeable future.  Because wehave such a significant balance of net operating losses that we will be able tocarry forward and apply against future U.S. tax liabilities, we exclude incometaxes from the calculation of pro forma earnings (loss).  Although we do pay income taxes on a portionof the revenues we generate, the aggregate amount of such payments is notmaterial in relation to our net operating losses.  Until such time as we generate income fromoperations and have fully applied our net operating losses to future taxliabilities, which we do not expect to occur during the foreseeable future, webelieve that income taxes will not be a relevant element of our operatingperformance.  The excluded intangibleamortization expense and impairment of goodwill and intangibles are associatedwith identifiable intangible assets from prior acquisitions.  The excluded stock-based compensation expensepertains to deferred non-cash compensation charges recorded in connection withour initial public offering of common stock and from prior acquisitions.

 

EBITDA, as adjusted, excludes expensesrelated to amortization of intangible assets, restructuring charges, impairmentof goodwill and intangibles, stock-based compensation, income taxes,depreciation, amortization of revenue discounts related to customer contractsand amortization of capitalized internal-use software costs, and other income,net.  Management uses EBITDA, asadjusted, to measure and evaluate our operating performance and liquidity,because it reflects the resources available from the reporting period’soperations for operating and strategic opportunities.  These opportunities include investing in thebusiness, meeting financing obligations, making strategic acquisitions, andpaying other cash obligations. Therefore, management believes EBITDA, as adjusted, is an appropriatemeasure by which to evaluate our operating performance and liquidity.

 

Pro forma earning (loss) and EBITDA, asadjusted, however, should be considered in addition to, and not as a substitutefor or as being superior to, operating net losses, cash flows, or othermeasures of financial performance prepared in accordance with U.S. GAAP.

 

**Comparison of the Quarter Ended September 30, 2004 to the Quarter EndedSeptember 30, 2003**

 

***Revenues***
| ** **       | ** ** | ** **                                    | ** ** | ** **             | ** ** | ** **          | ** ** | ** **             | ** ** | ** **               | ** ** | ** **         | ** ** | **Future** | ** ** |
|------------------|------------|-----------------------------------------------|------------|------------------------|------------|---------------------|------------|------------------------|------------|--------------------------|------------|--------------------|------------|------------|------------|
| ** **       | ** ** | **For the  Three Months Ended September 30,** | ** ** | ** **             | ** ** | ** **          | ** ** | **Expected**           | ** ** |
| ** **       | ** ** | **2004**                                      | ** ** | **2003**               | ** ** | ** **          | ** ** | ** **             | ** ** | **% of**                 | ** ** |
| ** **       | ** ** | **Amount**                                    | ** ** | **Percent  of  Total** | ** ** | **Amount**          | ** ** | **Percent  of  Total** | ** ** | **Increase  (Decrease)** | ** ** | **Total  Revenue** | ** ** |
| ** **       | ** ** | **(in  thousands)**                           | ** ** | ** **             | ** ** | **(in  thousands)** | ** ** | ** **             | ** ** | **(in thousands)**       | ** ** | ** **         | ** ** |
|             |       |                                          |       |                   |       |                |       |                   |       |                     |       |               |       |       |       |
| Managed services |       | $                                             | 13,740     |                   | 63         | %                   | $          | 14,084                 |       | 65                       | %          | $                  | (344       | )          | (2         | )% | 65-70 | % |
| Software         |       | 2,639                                         |       | 12                     |       | 2,936               |       | 13                     |       | (297                     | )          | (10                | )          | 10-15      |       |
| Services         |       | 5,432                                         |       | 25                     |       | 4,675               |       | 22                     |       | 757                      |       | 16                 |       | 15-20      |       |
| Total revenues   |       | $                                             | 21,811     |                   | 100        | %                   | $          | 21,695                 |       | 100                      | %          | $                  | 116        |       | 1          | % |   |   |
|                  |            |                                               |            |                        |            |                     |            |                        |            |                          |            |                    |            |            |            |  |  |  |  |  |  |  |

 

***Managed servicesrevenues.*** We derive managed services revenues from agreements that provide fortransaction or service fees based on our performance of Managed Services.

 

The decrease in managed services revenues for the three months endedSeptember 30, 2004 from the three months ended September 30, 2003 primarilyresulted from the following:

 

•                  A reduction in revenue from the effect ofLucent and a few other contract transaction minimum step-downs in 2003 because,in some of our transaction-based managed service contracts, the minimum numberof guaranteed transactions declines over time. To the extent the minimum volumes step-down over time and the customertransaction volumes are below the minimum, our revenues decrease over that timeperiod: offset by;

 

•                  Other new business revenue from customercontracts signed since the third quarter of 2003.

 

Our top five Managed Services customersaccounted for 90% and 91% of our managed services revenues in the quarters endedSeptember 30, 2004 and 2003, respectively. Our non-US managed services revenues increased to $4.0 million in thethird quarter of 2004 from approximately $3.6 million recognized in the thirdquarter of 2003.  This increase resultedfrom new customer contracts in Europe. The favorable effect on revenues of changes in foreign currency exchangerates between the quarters ended September 30, 2004 and 2003was approximately$103,000.  We expect non-US managedservices revenues to continue to increase as a percentage of managed servicesrevenues in the future as we grow our international business.

 

In 2004, we expect revenues on a few of our customer contracts todecrease due to reductions in the base minimum fees associated with thestep-down in the minimum number of transactions in those contracts.  We estimate between approximately

 

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$2.0 million and $3.0 million of reduced revenues from thesecontracts in 2004 compared to 2003. Additionally, revenue derived from large customer contracts may changeas we renew these contracts.  If we failto maintain or expand the scope of services provided under these contracts, ourrevenues from these contracts will decrease. We also expect our revenues in 2005 will decrease when compared to2004.  We anticipate that the amount ofnew business closed in 2004 will not offset the loss of the Visteon contract.

 

***Software revenues.***  Software revenues consist of term licenserevenues, perpetual software license revenues, maintenance revenues, andtransaction-based revenues.

 

The decrease in revenues resulted primarily from the expiration of a$2.5 million annual license fee from a Japanese customer, the drop-off of fullyrecognized revenue from perpetual licenses sold in prior years, and maintenancecancellations.  These declines werepartially offset by an increase in software revenues from new customers.  Our top five software customers accounted for28% and 37% of our total software revenues during the three months endedSeptember 30, 2004 and 2003, respectively.

 

We expect 2004 software revenues to decrease compared to 2003 becausenew business will not offset the expiration of the $2.5 million per yearlicense fee in January 2004 from a Japanese customer and the drop-off of revenuesfrom perpetual licenses.

 

***Services revenues.***  We derive services revenues from theimplementation of software for our customers, management consulting, andtraining services.

 

Our services revenues fluctuate from quarter to quarter based on manyfactors, such as demand by our customers, the number of billable days in aquarter, utilization, and the number of new software contracts executed inrecent quarters.  Historically, less than30% of our services revenues have been derived from implementation servicesperformed in connection with new software license sales.  The increase in revenues was driven by ourTrade Management Consulting business, increased implementation project workfrom a few customers, and the recognition of approximately $300,000 of revenuethat had been deferred in prior quarters because we concluded the fees were notfixed or uncertainty existed regarding the collectibility of the fees.

 

Our five largest services customers accounted for 61% and 54% of ourservices revenues for the quarters ended September 30, 2004 and 2003,respectively.

 

Because the third quarter results were better than we anticipated, 2004services revenue will be higher than 2003 services revenue.

 

***Cost of Revenues***

 
| ** **             | ** ** | **For the Three Months Ended September 30,** | ** ** | ** **                             | ** ** | ** **         | ** ** |
|------------------------|------------|----------------------------------------------|------------|----------------------------------------|------------|--------------------|------------|
| ** **             | ** ** | **2004**                                     | ** ** | **2003**                               | ** ** | ** **         | ** ** | ** ** | ** ** |
| ** **             | ** ** | **Amount**                                   | ** ** | **Percent of  Segment  Revenues** | ** ** | **Amount**         | ** ** | **Percent of  Segment  Revenues** | ** ** | **Increase (Decrease)** | ** ** |
| ** **             | ** ** | **(in thousands)**                           | ** ** | ** **                             | ** ** | **(in thousands)** | ** ** | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| ** **             | ** ** | ** **                                   | ** ** | ** **                             | ** ** | ** **         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Managed services       |       | $                                            | 8,403      |                                   | 61         | %                  | $          | 7,553 |   | 54 | % | $ | 850 |   | 11 | % |
| Software               |       | 758                                          |       | 29                                     |       | 716                |       | 24 |   | 42 |   | 6 |   |
| Services               |       | 3,828                                        |       | 70                                     |       | 3,421              |       | 73 |   | 407 |   | 12 |   |
| Total cost of revenues |       | $                                            | 12,989     |                                   | 60         |               | $          | 11,690 |   | 54 |   | $ | 1,299 |   | 11 |   |
|                        |            |                                              |            |                                        |            |                    |            |  |  |  |  |  |  |  |  |  |  |  |

 

**Cost of managed services revenues.**  Cost of managed services revenues consist ofsalaries and related expenses, reimbursed expenses to Ford for our ManagedServices organization and amortization of capitalized internal use softwarecosts related to implementation and integration of our trade managementplatform to our Managed Services operation.

 

The cost increase in absolute dollars and as a percentage of managedservices revenues was largely due to the additional investment we have made inour Managed Services business and several new contracts with lower profitmargins than our earlier contracts and the effect on costs of changes inexchange rates between the quarters. These costs were partially offset by efficiencies we achieved in ourU.S. operations as we migrated from Ford’s technology systems to our own.  We expect the cost of managed services revenuesas a percentage of managed services revenues to increase on a quarterly basisfor the foreseeable future due to the Lucent transaction minimum step-down andthe loss of the Visteon contract.

 

**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 our softwarecustomer support organization.

 

The increase as a percentage of software revenues results from areduction in our software revenues.  Weexpect the cost of

 

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software revenues as a percentage of software revenues to be relativelyconstant in absolute dollars on a quarterly basis in the foreseeable future.

 

**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 partiescontracted to provide either implementation services or Trade ManagementConsulting to our clients.

 

From quarter to quarter as customer demand fluctuates, the cost ofservices revenues will fluctuate based on actions we take to align ourpersonnel capacity with demand, such as changes in our use of subcontractors,delays or accelerations of hiring personnel and the temporary deployment ofresources to or from other business segments. The increase in cost of services revenues over prior year is driven byan increase in personnel and other resource costs.

 

We expect the cost of services to fluctuate relative to servicesrevenues in 2004 on a quarterly basis, but remain relatively consistent on apercentage of services revenues basis for the year.

 

***OperatingExpenses***

 
| ** **                 | ** ** | **For the Three Months Ended September 30,** | ** ** | ** **                      | ** ** | ** **         | ** ** |
|----------------------------|------------|----------------------------------------------|------------|---------------------------------|------------|--------------------|------------|
| ** **                 | ** ** | **2004**                                     | ** ** | **2003**                        | ** ** | ** **         | ** ** | ** ** | ** ** |
| ** **                 | ** ** | **Amount**                                   | ** ** | **Percent of  Total  Revenues** | ** ** | **Amount**         | ** ** | **Percent of  Total  Revenues** | ** ** | **Increase (Decrease)** | ** ** |
| ** **                 | ** ** | **(in thousands)**                           | ** ** | ** **                      | ** ** | **(in thousands)** | ** ** | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
|                       |       |                                         |       |                            |       |               |       |   |   |   |   |   |   |
| Sales and marketing        |       | $                                            | 2,531      |                            | 12         | %                  | $          | 2,290 |   | 11 | % | $ | 241 |   | 11 | % |
| Research and development   |       | 3,187                                        |       | 15                              |       | 2,954              |       | 14 |   | 233 |   | 8 |   |
| General and administrative |       | 2,922                                        |       | 13                              |       | 2,663              |       | 12 |   | 259 |   | 10 |   |
| Depreciation               |       | 1,353                                        |       | 6                               |       | 1,281              |       | 6 |   | 72 |   | 6 |   |
|                            |            |                                              |            |                                 |            |                    |            |  |  |  |  |  |  |  |  |  |

 

**Sales and marketing.**  Sales and marketing expense consistsprimarily of salaries and commissions earned by sales and marketing personnel,public relations, trade shows and travel expenses related to both promotionalevents and direct sales efforts.

 

The increase in sales and marketing expense resulted from an increasein personnel expense, marketing programs, and bad debt expense.  We expect sales and marketing expense toremain constant in absolute dollars on a quarterly basis, and higher in 2004compared to 2003 due to the investment we made in 2004.

 

**Research and development.**  Research and development expense consistsprimarily of salaries, benefits, and equipment for personnel who develop andsupport software for external sale and use in our Managed Services business.

 

The increase in research and development costs was primarily from costsassociated with the use of subcontractors, which were not incurred in the priorperiod.  We anticipate research anddevelopment expense to be slightly higher in 2004 compared to 2003.

 

**General and administrative.**  General and administrative expense consistsprimarily of salaries, benefits, outside accounting, legal, insurance fees andrelated costs for executive, finance, legal, human resources, administrativeand information services personnel.

 

The increase in general and administrative expense resulted from anincrease in corporate insurance costs and an increase in the number ofaccounting and finance staff and work related to Sarbanes-Oxleycompliance.  We expect general andadministrative expense to increase slightly in 2004 compared to 2003 when wefurther expand our operations in Europe and Asia.

 

**Depreciation.**  The increase resulted from the depreciationof fixed assets we purchased to build the technology infrastructure needed tosupport our business.  Most of these newassets were acquired to build out our data center.  We expect our depreciation expense tocontinue increasing in absolute dollars in 2004 as we continue to invest in ourinfrastructure.  However, since we arecurrently investing in capital equipment and software at a level below ourcurrent depreciation level, we expect depreciation to decrease over time.

 

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| ** **                      | ** ** | **For the Three Months Ended September 30,** | ** ** | ** **                          | ** ** | ** **         | ** ** |
|---------------------------------|------------|----------------------------------------------|------------|-------------------------------------|------------|--------------------|------------|
| ** **                      | ** ** | **2004**                                     | ** ** | **2003**                            | ** ** | ** **         | ** ** | ** ** | ** ** |
| ** **                      | ** ** | **Amount**                                   | ** ** | **Percent of  Total  Revenue** | ** ** | **Amount**         | ** ** | **Percent of  Total  Revenue** | ** ** | **Decrease** | ** ** |
| ** **                      | ** ** | **(in thousands)**                           | ** ** | ** **                          | ** ** | **(in thousands)** | ** ** | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
|                            |       |                                         |       |                                |       |               |       |   |   |   |   |   |   |
| Intangible amortization expense |       | $                                            | 135        |                                | 1          | %                  | $          | 719 |   | 3 | % | (584 | ) | (81 | )% |
| Stock-based compensation        |       | —                                       |       | —                              |       | 189                |       | 1 |   | (189 | ) | (100 | ) |
|                                 |            |                                              |            |                                     |            |                    |            |  |  |  |  |  |  |  |  |  |

 

**Intangible amortization expense.**  During the fourth quarter of 2003, werecognized impairment charges of approximately $6.1 million related tointangible assets.  As a result,amortization expense has decreased significantly in 2004.

 

**Stock-based compensation.**  Our stock based compensation resulted fromoptions issued to employees prior to our initial public offering in 2000 withexercise prices less than fair value and from options issued to employees inconnection with our acquisition of Speedchain in 2001.  There was no stock based compensation duringthe quarter ended September 30, 2004 as prior amounts were amortized over therelated vesting period.

 

***Other Income(Expenses) and Income Taxes***

 
| ** **                   | ** ** | **For the Three Months Ended September   30,** | ** ** | ** **         | ** ** | ** **              |
|------------------------------|------------|-----------------------------------------------------|------------|--------------------|------------|-------------------------|
| ** **                   | ** ** | **2004**                                            | ** ** | **2003**           | ** ** | **Increase (Decrease)** | ** ** |
| ** **                   | ** ** | **(in thousands)**                                  | ** ** | **(in thousands)** | ** ** | **(in thousands)**      | ** ** | ** ** | ** ** |
|                         |       |                                                |       |               |       |                    |   |   |   |
| Other income (expenses), net |       | $                                                   | 168        |               | $          | 112                     |   | $ | 56 |   | 50 | % |
| Income taxes                 |       | (55                                                 | )          | (150               | )          | (95                     | ) | (63 | ) |
|                              |            |                                                     |            |                    |            |                         |  |  |  |  |  |  |

 

**Other income (expenses), net.**  Other income (expenses), net fluctuates basedon the amount of cash balances available for investment, borrowings under ourlines of credit, interest and other expenses related to our equipmentborrowings, and any realized gains and losses on investments.  The increase resulted primarily from higherinterest income and lower interest expense.

 

**Income taxes.**  For the three months ended September 30, 2004and 2003, our income tax provision was comprised of federal, state, and foreigntaxes.  The federal tax provisionrepresents alternative minimum tax that resulted from certain limitationsplaced on the utilization net operating losses under the alternative minimumtax system.  The state tax provisionconsists primarily of the Single Business Tax assessed in Michigan and othermiscellaneous franchise taxes.  We haverecorded a valuation allowance for the full amount of our net deferred taxassets, including the credit for the alternative minimum tax, as a result ofthe uncertainty surrounding the timing of the realization of these future taxbenefits.  The decrease in income taxexpense resulted primarily from lower federal taxes and withholding taxes inthe quarter than in prior year.  Income-basedwithholding taxes are derived from services provided to customers in certaingeographies outside of the United States.

 

**Comparison of the Nine Months Ended September 30, 2004 to the NineMonths Ended September 30, 2003**

** **

***Revenues***

 
| ** **       | ** ** | **For the Nine Months Ended September 30,** | ** ** | ** **            | ** ** | ** **         | ** ** |
|------------------|------------|---------------------------------------------|------------|-----------------------|------------|--------------------|------------|
| ** **       | ** ** | **2004**                                    | ** ** | **2003**              | ** ** | ** **         | ** ** | ** ** | ** ** |
| ** **       | ** ** | **Amount**                                  | ** ** | **Percent of  Total** | ** ** | **Amount**         | ** ** | **Percent of  Total** | ** ** | **Increase (Decrease)** | ** ** |
| ** **       | ** ** | **(in thousands)**                          | ** ** | ** **            | ** ** | **(in thousands)** | ** ** | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
|             |       |                                        |       |                  |       |               |       |   |   |   |   |   |   |
| Managed services |       | $                                           | 41,920     |                  | 66         | %                  | $          | 41,343 |   | 65 | % | $ | 577 |   | 1 | % |
| Software         |       | 7,344                                       |       | 11                    |       | 8,552              |       | 13 |   | (1,208 | ) | (14 | ) |
| Services         |       | 14,664                                      |       | 23                    |       | 14,268             |       | 22 |   | 396 |   | 3 |   |
| Total revenues   |       | $                                           | 63,928     |                  | 100        | %                  | $          | 64,163 |   | 100 | % | $ | (235 | ) | 0 | % |
|                  |            |                                             |            |                       |            |                    |            |  |  |  |  |  |  |  |  |  |  |

 

***Managed servicesrevenues.***

 

The increase in managed services revenuesfrom the nine months ended September 30, 2004 to the nine months endedSeptember 30, 2003 primarily resulted from the following:

 

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**•**                  Revenue from our new contract withGE, which began on July 1, 2003;

**•**                  Higher nonrecurringproject-based work in the first quarter of 2004;

**•**                  Other newbusiness revenue from customer contracts signed in 2003; primarily offset by

**•**                  A reduction inrevenue from the effect of Lucent and a few other contract transaction minimumstep-downs in 2003 because, in some of our transaction-based managed servicecontracts, the minimum number of guaranteed transactions declines overtime.  To the extent the minimum volumesstep-down over time and the customer transaction volumes are below the minimum,our revenues decrease over that time period.

 

Our top five Managed Services customersaccounted for 89% and 93% of our managed services revenues in the nine monthsended September 30, 2004 and 2003, respectively.  Our non-US managed services revenues increasedto $11.9 million in the nine months ended September 30, 2004 from approximately$10.5 million recognized in the nine months ended September 30, 2003.  This increase resulted from new customercontracts in Europe and Brazil.  Thefavorable effect on revenues of changes in foreign currency exchange ratesbetween the nine months ended September 30, 2004 and 2003 was approximately$534,000 of managed service revenues.  Weexpect non-US managed services revenues to continue to increase as a percentageof managed services revenues in the future.

 

***Software revenues.***

 

The decrease in revenues resulted primarilyfrom the expiration of a $2.5 million annual license fee from a Japanesecustomer, the drop-off of fully recognized revenue from perpetual licenses soldin prior years, and maintenance cancellations. These declines were partially offset by an increase in software revenuesfrom new customers.  Our top fivesoftware customers accounted for 22% and 38% of our total software revenuesduring the nine months ended September 30, 2004 and 2003, respectively.

 

***Services revenues.***

 

Our services revenues fluctuate from quarterto quarter based on many factors, such as demand by our customers, the numberof billable days in a quarter, utilization, and the number of new softwarecontracts executed in recent quarters. Historically, less than 30% of our services revenues have been derivedfrom implementation services performed in connection with new software licensesales.  The increase in revenues wasdriven by our Trade Management Consulting business and the recognition ofapproximately $300,000 of revenue that had been deferred in prior quartersbecause we concluded the fees were not fixed or uncertainty existed regardingthe collectibility of the fees.

 

Our five largest services customers accountedfor 55% and 57% of our services revenues in the nine months ended September 30,2004 and 2003, respectively.

 

***Cost of Revenues***

 
| ** **             | ** ** | **For the Nine Months Ended September 30,** | ** ** | ** **                             | ** ** | ** **         | ** ** |
|------------------------|------------|---------------------------------------------|------------|----------------------------------------|------------|--------------------|------------|
| ** **             | ** ** | **2004**                                    | ** ** | **2003**                               | ** ** | ** **         | ** ** | ** ** | ** ** |
| ** **             | ** ** | **Amount**                                  | ** ** | **Percent of  Segment  Revenues** | ** ** | **Amount**         | ** ** | **Percent of  Segment Revenues** | ** ** | **Increase (Decrease)** | ** ** |
| ** **             | ** ** | **(in thousands)**                          | ** ** | ** **                             | ** ** | **(in thousands)** | ** ** | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
|                   |       |                                        |       |                                   |       |               |       |   |   |   |   |   |   |
| Managed services       |       | $                                           | 24,557     |                                   | 59         | %                  | $          | 22,488 |   | 54 | % | $ | 2,069 |   | 9 | % |
| Software               |       | 2,116                                       |       | 29                                     |       | 2,110              |       | 25 |   | 6 |   | — |   |
| Services               |       | 10,822                                      |       | 74                                     |       | 10,427             |       | 73 |   | 395 |   | 4 |   |
| Total cost of revenues |       | $                                           | 37,495     |                                   | 59         |               | $          | 35,025 |   | 55 |   | $ | 2,470 |   | 7 |   |
|                        |            |                                             |            |                                        |            |                    |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Cost of managed services revenues.**

 

The cost increase in absolute dollars and asa percentage of managed services revenues was largely due to the additionalinvestment we have made in our Managed Service business and several newcontracts with lower profit margins than our earlier contracts and the effecton costs of changes in exchange rates between the quarters.  These costs were partially offset byefficiencies we achieved in our U.S. operations as we migrated from Ford’stechnology systems to our own.

** **

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** **

**Cost of software revenues.**

 

The increase as a percentage of software revenues results from areduction in our software revenues.

 

**Cost of services revenues.**

 

From quarter to quarter as customer demand fluctuates, the cost ofservices revenues will fluctuate based on actions we take to align ourpersonnel capacity with demand, such as changes in our use of subcontractors,delays or accelerations of hiring personnel and the temporary deployment ofresources to or from other business segments. The increase in cost of services revenues over prior year is driven byan increase in personnel and other resource costs.

 

***OperatingExpenses***

 
| ** **                 | ** ** | **For the Nine Months Ended September 30,** | ** ** | ** **                      | ** ** | ** **         | ** ** |
|----------------------------|------------|---------------------------------------------|------------|---------------------------------|------------|--------------------|------------|
| ** **                 | ** ** | **2004**                                    | ** ** | **2003**                        | ** ** | ** **         | ** ** | ** ** | ** ** |
| ** **                 | ** ** | **Amount**                                  | ** ** | **Percent of  Total  Revenues** | ** ** | **Amount**         | ** ** | **Percent of  Total  Revenues** | ** ** | **Increase (Decrease)** | ** ** |
| ** **                 | ** ** | **(in thousands)**                          | ** ** | ** **                      | ** ** | **(in thousands)** | ** ** | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
|                       |       |                                        |       |                            |       |               |       |   |   |   |   |   |   |
| Sales and marketing        |       | $                                           | 7,461      |                            | 12         | %                  | $          | 6,836 |   | 11 | % | $ | 625 |   | 9 | % |
| Research and development   |       | 9,211                                       |       | 14                              |       | 8,990              |       | 14 |   | 221 |   | 2 |   |
| General and administrative |       | 8,699                                       |       | 14                              |       | 8,136              |       | 13 |   | 563 |   | 7 |   |
| Depreciation               |       | 4,065                                       |       | 6                               |       | 3,845              |       | 6 |   | 220 |   | 6 |   |
|                            |            |                                             |            |                                 |            |                    |            |  |  |  |  |  |  |  |  |  |

 

**Sales and marketing.**

 

The increase in sales and marketing expenseprimarily resulted from an increase in bad debt expense and severance costsrelated to our former Vice President of Sales and Marketing.  Costs associated with marketing programs andpersonnel were also higher when compared to the same period in the prior year.

 

**Research and development.**

 

The increase in research and developmentcosts was primarily from costs associated with the use of technologyconsultants and subcontractors, partially offset by a decrease in headcount.

 

**General and administrative.**

 

The increase in general and administrativeexpense resulted from an increase in corporate insurance costs, an increase inthe number of accounting and finance staff and work related to Sarbanes-Oxleycompliance.

 

**Depreciation.**  The increase resulted from the depreciationof fixed assets we purchased to build the technology infrastructure needed tosupport our business.  Most of these newassets were acquired to build out our data center.

 
| ** **                      | ** ** | **For the Nine Months Ended June 30,** | ** ** | ** **                          | ** ** | ** **         | ** ** |
|---------------------------------|------------|----------------------------------------|------------|-------------------------------------|------------|--------------------|------------|
| ** **                      | ** ** | **2004**                               | ** ** | **2003**                            | ** ** | ** **         | ** ** | ** ** | ** ** |
| ** **                      | ** ** | **Amount**                             | ** ** | **Percent of  Total  Revenue** | ** ** | **Amount**         | ** ** | **Percent of  Total  Revenue** | ** ** | **Decrease** | ** ** |
| ** **                      | ** ** | **(in thousands)**                     | ** ** | ** **                          | ** ** | **(in thousands)** | ** ** | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| ** **                      | ** ** | ** **                             | ** ** | ** **                          | ** ** | ** **         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Intangible amortization expense |       | $                                      | 612        |                                | 1          | %                  | $          | 2,106 |   | 3 | % | $ | (1,494 | ) | (71 | )% |
| Stock-based compensation        |       | 46                                     |       | —                              |       | 834                |       | 1 |   | (788 | ) | (94 | ) |
|                                 |            |                                        |            |                                     |            |                    |            |  |  |  |  |  |  |  |  |  |

 

 

**Intangible amortization expense.**  During the fourth quarter of 2003, werecognized impairment charges of approximately $6.1 million related to intangibleassets.  As a result, amortizationexpense has decreased significantly in 2004.

 

**Stock-based compensation.**  Our stock based compensation resulted fromoptions issued to employees prior to our initial public offering in 2000 withexercise prices less than fair value and from options issued to employees inconnection with our acquisition of Speedchain in 2001.  The Company records stock based compensationon an accelerated basis.  Because we havenot issued options below market value in the past six months or acquiredoptions in connection with an acquisition since the Speedchain acquisition, theexpense incurred during the nine months

 

24

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ended September 30, 2004 was lower than the expense incurred during thenine months ended September 30, 2003. The deferred compensation balance was zero as of September 30, 2004.

 

***Other Income(Expenses) and Income Taxes***

 
| ** **                   | ** ** | **For the Nine Months Ended  September 30,** | ** ** | ** **         | ** ** | ** **              | ** ** |
|------------------------------|------------|----------------------------------------------|------------|--------------------|------------|-------------------------|------------|
| ** **                   | ** ** | **2004**                                     | ** ** | **2003**           | ** ** | **Increase (Decrease)** | ** ** |
| ** **                   | ** ** | **(in thousands)**                           | ** ** | **(in thousands)** | ** ** | **(in thousands)**      | ** ** | ** ** | ** ** |
| ** **                   | ** ** | ** **                                   | ** ** | ** **         | ** ** | ** **              | ** ** | ** ** | ** ** |
| Other income (expenses), net |       | $                                            | 364        |               | $          | 448                     |       | $ | (84 | ) | (19 | )% |
| Income taxes                 |       | (283                                         | )          | (458               | )          | (175                    | )          | (38 | ) |
|                              |            |                                              |            |                    |            |                         |            |  |  |  |  |  |

 

**Other income (expenses), net.**  Other income (expenses), net fluctuates basedon the amount of cash balances available for investment, borrowings under ourlines of credit, interest and other expenses related to our equipmentborrowings, and any realized gains and losses on investments.  The decrease resulted primarily from lowerinvestment interest rates.

 

**Income taxes.**  For the nine months ended September 30, 2004and 2003, our income tax provision was comprised of federal, state, and foreigntaxes.  The federal tax provisionrepresents alternative minimum tax that resulted from certain limitations placedon the utilization net operating losses under the alternative minimum taxsystem.  The state tax provision consistsprimarily of the Single Business Tax assessed in Michigan and othermiscellaneous franchise taxes.  We haverecorded a valuation allowance for the full amount of our net deferred taxassets, including the credit for the alternative minimum tax, as a result ofthe uncertainty surrounding the timing of the realization of these future taxbenefits.  The decrease in income taxexpense resulted primarily from lower withholding taxes in the quarter than inprior year.  Income-based withholdingtaxes are derived from services provided to customers in certain geographiesoutside of the United States.

 

**Liquidity and Capital Resources**

 

***Obligations***

 

*Lines of Credit*

 

We have a term loan, a secured revolving line of credit (Line ofCredit), and an equipment line of credit (Equipment Line of Credit) withComerica Bank.

 

We paid the remaining term loan balance during 2004.  The balance under the term loan was zero andapproximately $1.0 million as of September 30, 2004 and December 31, 2003,respectively.

 

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 revolvingline of credit are limited to the lesser of $10 million or 80% of eligibleaccounts receivable, as defined in the loan agreement.  The revolving line of credit bears interestat the bank’s prime rate (4.75% as of September 30, 2004) and matured inJuly 2004.  There was no outstandingbalance under the revolving line of credit as of September 30, 2004 andDecember 31, 2003.

 

In the first and third quarters of 2003, we borrowed approximately$614,000 and $488,000, respectively against the equipment line of credit.  The availability under the Equipment Line ofCredit expired in July 2003. Commencing on July 31, 2003, interest and principal began to bepayable in monthly installments on all borrowings made under the equipment lineof credit.

 

In July 2004, we renewed our existing Line ofCredit for $10 million, with a $2.5 million sub-limit for the issuance ofletters of credit, and a new equipment line of credit for $5 million withComerica Bank.  The renewed Line ofCredit will mature in July 2006 and the renewed equipment line of credit willmature three years from the date of the general equipment or softwarepurchases.  The outstanding balance andcurrent portion of balance under the Equipment Line of Credit was approximately$430,000 as of September 30, 2004, and $796,000 and $490,000, respectively asof December 31, 2003.  The EquipmentLine of Credit has two interest-only payment periods and bears interest at thebank’s prime rate plus 50 basis points (5.25% as of September 30, 2004).

 

The terms of the renewed Line of Credit andthe renewed Equipment Line of Credit require us to comply with severalfinancial covenants, including restrictions and limitations on futureindebtedness, sale of assets and material changes in our business.  Through September 30, 2004, we were incompliance with these covenants.

 

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*Leases*

 

We have various capital leases with 36-month to 48-month repaymentperiods.  In March 2003, we obtaineda new equipment leasing arrangement with a vendor for approximately$886,000.  Amounts borrowed are due over36 months.  Total capital leaseobligations outstanding as of September 30, 2004 and December 31, 2003,were approximately $464,000 and $764,000, respectively.

 

We lease various equipment and office space under operating leaseagreements expiring at various dates through 2013.  In addition to base rent, we are responsiblefor certain taxes, utilities, and maintenance costs.

 

*Guarantees*

 

In some of our software license arrangements, we have agreed toindemnify customers for any damages they sustain from a claim for intellectualproperty infringement.  Additionally,subject to specified contractual limitations on amount, under our Managed Servicesagreements, we have agreed to indemnify our customers for any damages theysustain from our performance of Managed Services in a non-compliantmanner.  Although we do not believe thatour products infringe the intellectual property rights of any third party orthat we are performing services in a non-compliant manner, we cannot estimateour maximum liability exposure, because of the inherent uncertainty associatedwith any such claims and the varying nature of the indemnification levels towhich we have agreed.

 

***Cash Flows***

 
| ** **                                                                 | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                 | ** ** | **2004**                                    | ** ** | **2003** | ** ** |
| ** **                                                                 | ** ** | **(in thousands)**                          | ** ** | **(in thousands)** | ** ** |
|                                                                       |       |                                        |       |   |   |
| Cash and cash equivalents and short-term  investments, end of period       |       | $                                           | 55,614     |   | $ | 53,050 |   |
| Cash and cash equivalents and short-term  investments, beginning of period |       | 56,448                                      |       | 56,957 |   |
| Net decrease in cash and cash equivalents  and short-term investments      |       | $                                           | (834       | ) | $ | (3,907 | ) |

 

The net decrease in cash and cash equivalents and short-terminvestments for the nine months ended September 30, 2004, compared to the ninemonths ended September 30, 2003, is primarily due to the following:

 

•                                       Improvedworking capital;

•                                       Lower debt payments, was partially offset by

•                                       Lower proceeds from our Employee StockPurchase Plan

•                                       Increased capital expenditures

•                                       No cash investments in acquisitions in 2004

 

##### ***Future Cash Investment Needs***

##### *** ***

We intend to continue investing in the expansion of our business,particularly to build out our global platform and infrastructure.  Additionally, we are spending more on ourManaged Services operations in 2004 than we did in 2003.  Our future liquidity and capital requirementswill depend on numerous factors, including:

 

•              The costs and timing of expansionof our sales and marketing activities;

•              The costs and timing of expansionof our operating capabilities;

•              The costs and timing of ourproduct development efforts and the success of those development efforts;

•              The extent to which our existingand new products and services gain market acceptance;

•              The level and timing of ourrevenues;

•              The costs involved in maintainingand enforcing our intellectual property rights; and

•              Available borrowings under line ofcredit and capital lease arrangements.

 

Accordingly, until we generate and sustainprofits from our operations to fund these investments fully, our cash, cashequivalents, and short-term investments are likely to continue to decline.  In addition, we may use cash resources tofund acquisitions of complementary businesses and technologies.  We believe that our current cash resourceswill be sufficient to meet our working capital and capital requirements for atleast the next 12 months. Thereafter, we may find it necessary to obtain additional equity or debtfinancing.  In the event that we needadditional financing, we may not be able to raise it on terms acceptable to us,if at all.

** **

**26**

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** **

**Risks Relating to Our Business**

** **

*Before deciding to invest in our Company orto maintain or increase your investment, you should consider carefully therisks described below, in addition to the other information contained in thisreport and in our other filings with the SEC, including our subsequent reportson Forms 10-K, 10-Q and 8-K.  The risksand uncertainties described below are not the only ones facing our**Company. Additional risks and uncertainties not currently known to us or that wecurrently deem immaterial may also affect our business operations.  If any of these risks actually occurs, ourbusiness, financial condition or results of operations could be seriously harmed.  In that event, the market price for ourcommon 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$71.2 million, $11.4 million, $45.8 million, $35.8 million,and $10.5 million in 2003, 2002, 2001, 2000, and 1999, respectively.  Our accumulated deficit as of September 30,2004 was approximately $257 million.  Webelieve that the success of our business depends on our ability to increaserevenues and to manage our operating expenses. If our revenues fail to grow at anticipated rates or our operatingexpenses are not properly managed, we may not be able to achieve or maintainprofitability, which would increase the possibility that the value of yourinvestment will decline.  Although wegenerated positive cash flows from operations in the nine months endedSeptember 30, 2004, in part because we reduced operating expenses, we cannotassure you that we can continue to generate positive cash flows, especially ifour revenues do not increase.  As ofSeptember 30, 2004, we had cash and short-term investments of $55.6 millioncompared to $56.4 as of December 31, 2003. This is likely to be insufficient to sustain our operations over thelong-term if we do not generate positive cash flow from operations over time.

 

**Our Managed Services business model isunproven, and our inability to provide Managed Services successfully toexisting and future clients would substantially reduce our revenues, increaseour costs, hurt our reputation in our industry, and adversely affect ourbusiness.**

 

The long-term success of our Managed Servicesbusiness is predicated on our ability to leverage our investment in ourtechnology and processes to lower our per transaction costs to the lowest levelpossible.  As a critical element of ourstrategy, we intend to continue providing Managed Services to our current andfuture clients.  These services rangefrom providing operational management for a single global trade process tomanaging a client’s entire worldwide trade operation.  We expect the revenues we receive fromproviding Managed Services to our current and future clients will continue torepresent the largest portion of our total revenues.  If we are unsuccessful in effectivelylowering our costs of delivery to acceptable levels, we may be unable toachieve a level of gross margin necessary to achieve and sustainprofitability.  Additionally, if we areunable to perform our obligations under our agreements with Ford, LucentTechnologies or Nortel Networks or to provide Managed Services successfully toour other clients, we would experience a significant reduction in our revenues,increases in our costs, and damage to our reputation, which would adverselyaffect our business and results of operations.

 

**Our revenues are concentrated among a fewcustomers.  Therefore, our businesssuccess is dependent on our maintaining good relationships with thesecustomers.**

 

In 2003, 2002, and 2001, we derivedapproximately 64%, 59%, and 67%, respectively, of our total revenues from ourtop five customers.  During the thirdquarters of 2004 and 2003, we derived approximately 60% and 65%, respectively,of our total revenues from our top five customers.  During the nine months ended September 30,2004 and 2003, we derived approximately 63% and 66%, respectively, of our totalrevenues from our top five customers. For the quarters ended September 30, 2004 and 2003, Ford accounted for30%, of total revenues.  For the ninemonths ended September 30, 2004 and 2003, Ford accounted for 30% of totalrevenues, respectively.  For the quartersended September 30, 2004 and 2003, Lucent accounted for 12% and 14%, of totalrevenues respectively.  For the ninemonths ended September 30, 2004 and 2003, Lucent accounted for 13% and 15% oftotal revenues, respectively.  We expectthis customer concentration to exist for the foreseeable future.  We had no other customer that accounted forgreater than 10% of our revenues for the periods noted.  As we continue to expand our relationshipswith existing Managed Services customers and if we continue to sign largecontracts with new customers, each such relationship will be of addedsignificance to us.  Additionally, if weare unable to sign contracts that generate significant revenues, this heavyconcentration of customers will persist, which could cause us to become evenmore dependent on each of our existing large customers.

 

We also expect to continue to derive asignificant portion of our total revenues from Ford, Lucent, and other largecustomers for at least the next several years. Some of our agreements permit a customer to terminate for convenienceafter a specified period of time.  Wecannot assure you that we will be able to maintain or renew theseagreements.  In July 2004, VisteonCorporation notified us that it will not renew its agreement for ManagedServices when it expires on December 31, 2004. If any other significantagreements do not renew, our results of operations and financial conditionwould be adversely affected.  If we failto maintain or expand the scope of services provided under these contracts, ourrevenues from these contracts will decrease. We expect that our total 2004 revenues will be below our 2003 revenuelevel, and revenues in future periods may not increase above 2003 and 2004levels until such time as we can accelerate the rate of our sales growth.  We also expect our revenues in 2005 willdecrease when compared to 2004.  If wealso fail to reduce the expenses of our business to match lower revenues, ournet losses may increase and our cash flows could be negatively impacted.

 

27

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**Our inability to renew existing ManagedServices contracts on substantially similar terms may cause revenues to declinewhich would have an adverse affect our business.**

 

Generally, our Managed Services agreementscontain a specified time period during which our customers have guaranteedminimum fixed levels of revenues to us. As these time periods expire, our customers have, and can be expected tocontinue, indicated their intent to negotiate new terms for the future.  Our inability to renew such contracts onfinancial terms substantially similar to the existing terms will cause ourrevenues to decline and may adversely affect our business.

 

**Some of our customers have been evolving orotherwise changing their business models. As these customers change their business models, their volumerequirements and level of service required from us may decline, and adverselyaffect our business.**

 

During the past few years, some of ourclients have changed their business models significantly by outsourcing variousbusiness functions or using contract manufacturers.  For example, in 2004, Nortel Networks announcedthat it intends to outsource its manufacturing operations to Flextronics InternationalLtd.  The effects of such changes in ourcustomers’ business models may include a reduction in transaction volumes, asimporting and exporting of goods and parts may now occur through third partycontract manufacturers and outsourcing companies.  If our customers’ transaction volumes declinesignificantly and we are unable to add the third-party contract manufacturersand outsourcing companies as customers, our revenues will decline, which wouldhave an adverse impact on our business.

 

**Any restriction on our ability to access aforeign country’s rules and regulations that we incorporate into our GlobalContent cost-effectively and legally, or any failure to update our GlobalContent timely to include changes in such rules and regulations, may compromisethe effectiveness of our solutions and adversely impact our customerrelationships and revenues.**

 

The success of our Global Trade Managementsolutions depends on our ability to obtain or access the complex rules andregulations published by foreign governments governing a particular country’simport and export of goods.  Thefoundation of our solutions, Global Content, is subject to rapid change at theinitiative of foreign governments based on factors beyond our control.  Any changes in a country’s rules andregulations relating to global trade that we are unable to include in ourGlobal Content library may result in dissatisfied clients and possiblelitigation.  Moreover, to the extent aforeign government restricts our access to its rules and regulations, charges afee for such access or grants proprietary rights to such information to one ormore of our competitors, our solutions may not be useful to, or cost efficientfor, our current and future clients and our revenues could decrease.

 

**Fluctuations in our operating results and thecomposition of our revenues, compared to the expectations of market analystsand investors, may cause the price of our common stock to decline.**

 

Our operating results have varied in the past and could fluctuatesignificantly in the future.  We expectthat our operating results will continue to vary in the future, based on anumber of factors, including:

 

•                                          Thepossible loss of a significant customer;

 

•                                          Thepossible renegotiation of contract terms with one or more significantcustomers;

 

•                                          Fluctuationsin the demand for our products and services;

 

•                                          Ourability, and the associated timing, to convert our customers to our technologyplatform;

 

•                                          Competitionin our industry;

 

•                                          Inabilityto deliver compliant solutions;

 

•                                          Changesin trade regulations;

 

•                                          Variabilityin the mix of our managed services, software, and consulting revenues; and

 

•                                          Timingof new solution introductions and enhancements to our TradeSphere andTradePrism.com solutions.

 

Several of these factors are outside ourcontrol.  Due to the foregoing factors,our annual or quarterly results of operations may not meet the expectations ofsecurities analysts and investors, which is likely to cause the price of ourcommon stock to decline.

 

**We have a new seniormanagement team that may not be able to develop and execute upon a successfulbusiness strategy.**

 

During the past 24 months, we have hiredthree new people into our executive management team, which includes the hiring

 

28

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of a new CEO within the past 12 months, and we replaced the individualoverseeing our Managed Services operations. This new management team is responsible for developing a plan tosignificantly increase sales, improving product quality, gaining marketacceptance of our Managed Services offerings, and expanding our globaloperations.  Our management team mustdevelop and execute upon a sound and appropriate strategy to grow revenues andachieve significant profitability.  Ifthe new management team is unable to develop a sound and appropriate strategy,or if it is unable to execute upon such a strategy, our business will be adverselyaffected.

 

**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 onthe efforts and abilities of our senior executives, key technical, professionalservices, sales and marketing and managerial personnel.  This dependence is extremely important to ourbusiness because personal relationships are a critical element of obtaining andmaintaining clients.  Also, we aredependent upon our technical personnel to enhance our technology platforms sothat our business remains competitive. Our success will depend on our ability to attract and retain these keyemployees in the future.  The market forsuch individuals is extremely competitive, and we may not find qualifiedreplacements for personnel who leave us. The loss of, or the inability to attract, any one or more of our keypersonnel may harm our ability to develop and manage our business effectively.

 

**Our international operations and anycontinued expansion may expose us to business risks that could limit theeffectiveness of our growth strategy, cause our operating results to suffer,and put some of our invested capital at risk of loss.**

 

We intend to continue to expand our currentinternational operations, entering into new international markets.  This expansion will require significantmanagement attention and financial resources to translate our software productsinto various languages successfully, to develop compliance expertise relatingto regulatory agencies in more countries and to develop direct and indirectinternational sales and support channels. We face a number of risks associated with conducting our businessinternationally that could negatively affect our operating results, including:

 

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

 

•                                          Longersales cycles associated with educating foreign clients about the benefits ofour products and services;

 

•                                          Currencyfluctuations and exchange rates;

 

•                                          Difficultyin repatriating cash from some foreign jurisdictions;

 

•                                          Longercollection time from foreign clients;

 

•                                          Multiple,and possibly overlapping, tax structures and the burdens of complying with awide variety of foreign laws;

 

•                                          Theneed to consider characteristics unique to technology systems usedinternationally; and

 

•                                          Economicor political 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.  Any of these difficultiesmay harm our growth strategy and could cause our operating results 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 these operations at a risk of loss andcause our business to be adversely affected.**

 

We intend to continue expanding ouroperations and serving our existing clients internationally.  As we do so, we may establish operations incountries that become politically or economically unstable.  If a country in which we commence operationsbecomes politically or economically unstable, the money and resources we haveinvested to establish such operations may be put at risk of loss, and if suchmoney and resources are lost, our business may be adversely affected.

 

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** **

**Our software products and Managed Servicesofferings are complex.  During the salescycle these offerings must be described and articulated to several individualsacross a customer’s organization before a final purchasing decision ismade.  Because of the significant numberof people with whom we must interact and the complexity of our software andManaged Services offerings, our sales cycle is lengthy and variable in nature,which makes it difficult for us to predict when or if sales will occur.  Therefore, we may experience an unexpectedshortfall in sales.**

 

Due to the inherent complexities associatedwith global trade and the myriad of rules and regulations governing globaltrade, our software and Managed Services solutions are very complex.  Additionally, many prospects face regulatorycompliance issues of which they are unaware prior to us performing any duediligence.  Because of the complexity ofour software and Managed Services offerings, and the regulatory issues manyprospects face during the sales cycle, our personnel must conduct in depthdiscussions and provide detailed explanations to several individuals across anorganization.  These people are oftenmembers of the finance, purchasing, customs, information technology, and legaldepartments of an organization. Moreover, these individuals typically view the purchase of our solutionsas an important, but not core decision. As a result, they generally evaluate our solutions and determine theirimpact on existing infrastructure over a lengthy period of time.  Because we must interact with, and educate somany distinct individuals during the sales cycle, revenues forecasted from aspecific client for a particular quarter may be delayed to anotherquarter.  Consequently, we may experiencean unexpected shortfall in sales, which could adversely affect our operatingresults.

 

**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 companieson a non-exclusive basis that we have integrated into our TradeSphere productsuite.  This technology includesdevelopment tools and facilities from IBM (WebSphere and MQ Series) and Forte,which was acquired by Sun Microsystems. Our license with Sun Microsystems expires on December 31, 2005, andour license with IBM expires on June 30, 2006.  If we cannot renew these technology licenses,we likely would face delays in the licensing of our TradeSphere products untilequivalent technology, if any, can be identified, licensed and integrated,which would adversely affect our operating results.

 

**If we interpret and analyze incorrectly thevarious laws and regulations contained in our Global Content or we perform ourManaged Services in a non-compliant manner, we may face costly liabilityclaims.**

 

The foundation of our software solutions andManaged Services, Global Content, is a rules-based application that providescomprehensive management of government trade regulations and programs that mustbe acquired, interpreted, and updated by our in-country trade experts.  Because of the legalistic and complex natureof Global Content, our inability to interpret and analyze accurately the rulesand regulations upon which our Global Content is based may expose us toliability claims from our clients in connection with our current products andfuture products.  Additionally, ourManaged Services customers view us as global trade experts.  If we perform our services in a manner thatdoes not comply with legal or regulatory requirements, our clients could facesevere penalties and they would seek recompense from us to make themwhole.  Any provisions in our agreementswith our clients designed to limit our exposure to potential product orservices liability claims may not be adequate to protect us from suchclaims.  A claim of product liability ora claim that our performance of Managed Services in a non-compliant mannerbrought against us successfully could harm our financial condition.  Even if unsuccessful, any claims could resultin costly litigation and divert management’s attention and resources.  Additionally, the effective implementation ofour products may depend upon the successful operation of third-party licensedproducts in conjunction with our products and, therefore, any undetected errorsin these licensed products may prevent the implementation or impair thefunctionality of our products, delay new product introductions, and harm ourreputation.

 

**The market for our Global Trade ManagementManaged Services and software offerings is a nascent one and the ultimatemarket size is difficult to quantify.  Ifcompanies fail to adopt our offerings, our business will be adversely affected.**

 

For most companies, Global Trade Managementis a critical but non-core business function. Because the market for third-party Global Trade Management is a nascentone, many companies may be reluctant or unwilling to utilize a third-partyservice provider to manage their global trade, and will retain these functionsin-house.  If companies fail to adoptmanaged service offerings, our business will be adversely affected.

 

**We are encountering competition from significantly larger companiesthat possess both greater financial resources and name recognition than wepossess.**

** **

Although we believe our solutions arecurrently competitive, the market in which we operate is characterized by earlyadopters and is rapidly evolving.  We maynot be able to maintain our competitive position against current and potentialcompetitors, especially those with significantly greater financial resources,name recognition, and other resources, such as international brokers, freightforwarders, logistics companies, and ERP software companies.

 

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**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 protectour proprietary rights.  We relyprimarily 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 ourproprietary rights, unauthorized parties may copy aspects of our products andobtain and use information we regard as proprietary.  Other parties may breach confidentialityagreements or other protective contracts. We may not become aware of these breaches or have adequate remediesavailable.  We may need to litigateclaims against third parties who infringe our intellectual property rights, whichcould be costly, time-consuming, and would divert management’s attention andresources.

 

**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 donot or will not infringe valid patents, copyrights, trademarks, or otherintellectual property rights held by third parties, inside and outside theU.S.  As a result, we may be subject tolegal proceedings and claims from time to time relating to the intellectualproperty of others in the ordinary course of our business.

 

We may incur substantial expenses indefending against any third-party infringement claims, regardless of theirmerit.  Successful infringement claimsagainst us may result in substantial monetary liability, may divert management’sattention from our core business, and may disrupt our business.  In addition, if we are unsuccessful indefending such claims, we may need to obtain a license to the technology, whichmay not be available on acceptable terms or at all.

 

**Any future acquisitions may be difficult to integrate and disruptive toour operations.  We may not realize theexpected benefits from any such acquisitions, and if we cannot address thechallenges presented by acquisitions, our operating results may be harmed.**

** **

In the past, we have acquired businesses toexpand our operations or market presence, and we intend to continue ourexpansion by acquiring or investing in companies, assets or technologies thatcomplement our business and offer opportunities for growth.  These transactions involve many risks andchallenges that we might not successfully overcome, including:

 

•                                          Difficultiesin assimilating technologies, products, personnel, and operations;

 

•                                          Disruptionof our ongoing business and diversion of management’s attention from otherbusiness concerns;

 

•                                          Risksof entering markets in which we have no or limited prior experience;

 

•                                          Issuancesof equity securities that may dilute your ownership interest in our commonstock;

 

•                                          Cashpayments to, or the assumption of debt or other liabilities of, the companieswe acquire; and

 

•                                          Write-offsrelated to goodwill and other intangible assets and other adverse accountingconsequences.

 

**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 September 30, 2004, our officers,directors, and affiliated entities, together with Ford, beneficially ownedapproximately 37% of the outstanding shares of our common stock.  This concentration of ownership may delay,deter, or prevent acts that would result in a change of control, which in turncould reduce the market price of our common stock.  Accordingly, these stockholders collectivelymay be able to control all matters requiring stockholder approval and, thereby,our management and affairs.  Fordbeneficially owns approximately 19% of the outstanding shares of our commonstock.  As the single largest stockholderof Vastera, Ford may exercise significant influence over corporate actsrequiring stockholder approval, including a merger or sale of Vastera.  Also, so long as Ford holds at least 5% ofour common stock, it has the right to appoint a non-voting observer to ourboard of 

 

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directors.  Our officers, directors,and affiliated entities, together with Ford, may have interests that differfrom your interests, and their decisions may negatively impact our futuresuccess.

** **

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

** **

We develop solutions in the United States andmarket them in North America, and to a lesser extent, in Europe, Latin America,and the Asia-Pacific region.  Ourfinancial results could be affected by factors such as changes in foreign currencyexchange rates or weak economic conditions in foreign markets.  With most of our sales being generated inU.S. dollars, a strengthening of the dollar could make our products lesscompetitive in foreign markets.  Wecurrently do not use financial instruments to hedge the operating expenses ofour foreign subsidiaries.  We intend toassess the need to utilize financial instruments to hedge currency exposures onan ongoing basis.

 

Amounts outstanding under our securedrevolving line of credit arrangement expose us to interest rate risk if the primerate increases.  We had approximately$430,000 in variable rate debt as of September 30, 2004.  Our interest income is sensitive to changesin U.S. interest rates, particularly since the majority of our investments arein short-term instruments.  Due to theshort-term nature of our investments, we believe that there is no material riskexposure.  We do not hold or issuederivative securities, derivative commodity instruments, or other financialinstruments for trading purposes. Therefore, no quantitative tabular disclosures are required.

 

**Item 4:   Controlsand Procedures**

** **

An evaluation was carried out under thesupervision and with the participation of management, including our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures (as defined inRules 13a-14 and 15d-14 under the Securities Exchange Act of 1934).  Based upon that evaluation, the ChiefExecutive Officer and Chief Financial Officer concluded that, as of the end ofthe period covered by this report, those disclosure controls and procedureswere adequate to ensure that information required to be disclosed by us in thereports that we file or submit under the Exchange Act is recorded, processed,summarized, and reported, within the time periods specified in the Commission’srules and forms.

 

There have been no changes in our internalcontrols over financial reporting that occurred during the third quarter of2004 that have materially affected, or are reasonably likely to materiallyaffect, our internal controls over financial reporting.

 

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# **PART II - OTHER INFORMATION**

# ** **

## **Item 1:**                                                          LegalProceedings

## ** **

We are periodically a party to disputesarising from normal business activities. In our opinion, resolution of these matters will not have a materiallyadverse effect upon our financial condition or our future operating results.

 

On March 14, 2001, Expeditors International of Washington, Inc.and Expeditors Tradewin, L.L.C. (collectively “Expeditors”) filed suit againstus in the United States District Court for the Eastern District of Michigan,Southern Division primarily alleging that we misappropriated certain ofExpeditors’ trade secrets in connection with our acquisition of Ford’s customsoperations, by utilizing systems and business processes that Expeditorsassisted in developing for Ford and through our employee hiring practices.  In connection with our acquisition of Ford’scustoms operations, Ford agreed to indemnify us for intellectual propertyinfringement claims, and Ford indemnified us in connection with thislitigation.  Although Ford is obligatedto indemnify us of claims of intellectual property infringement arising fromthe property we acquired from it, Ford is not obligated to indemnify us forlegal fees arising from any claims that pertained solely to our acts, uponwhich certain of the claims asserted in this matter were based. Trial in thismatter commenced on July 15, 2004.  OnAugust 4, 2004, the jury found in favor of Vastera.  In October 2004, Expeditors, the Company, andMs. Jennifer Sharkey, a Vastera employee named as a co-defendant, mutuallyagreed to waive all rights to an appeal in this matter.

 

In some of our software license arrangements, we have agreed toindemnify customers for any damages they sustain from a claim for intellectualproperty infringement.  Additionally,subject to specified contractual limitations on amount, under our ManagedServices agreements, we have agreed to indemnify our customers for any damagesthey sustain from our performance of Managed Services in a non-compliantmanner.  Although we do not believe thatour products infringe the intellectual property rights of any third party orthat we are performing services in a non-compliant manner, we cannot estimateour maximum liability exposure, because of the inherent uncertainty associatedwith any such claims and the varying nature of the indemnification levels towhich we have agreed.

 

## **Item 2:**                                                          UnregisteredSales of Equity Securities and Use of Proceeds

## ** **

None.

 

## **Item 3:**                                                          DefaultsUpon Senior Securities

## ** **

None.

 

## **Item 4:**                                                          Submissionof Matters to a Vote of Security Holders

## ** **

None.

 

## **Item 5:**                                                          OtherInformation

## ** **

None.

 

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## **Item 6:**                                                          Exhibitsand Reports on Form 8-K

 
| The following exhibits are included herein: |
|---------------------------------------------|
|                                        |   |   |
| 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 President and Chief Executive Officer,  dated November 8, 2004. |
|                                        |   |   |
| 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 November 8,  2004. |
|                                        |   |   |
| 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 President and Chief Executive Officer, dated November 8, 2004. |
|                                        |   |   |
| 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 November 8, 2004. |
|                                        |   |   |

 

**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized in Dulles,Virginia on November 8, 2004.

 
|   | 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) |

 

**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  President and Chief Executive Officer, dated November 8, 2004. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                      |
| 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 November 8, 2004.               |
|   |   |                                                                                                                                                                                                      |
| 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  President and Chief Executive Officer, dated November 8, 2004. |
|   |   |                                                                                                                                                                                                      |
| 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 November 8, 2004.               |

 

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