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UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





---




FORM 10-Q





(Mark One)


| | x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. | 
| | - |  | ---------------------------------------------------------------------------------------- | 




For the quarterly period ended June 30, 2002





OR





| |  ̈ |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. | 
| | - |  | ----------------------------------------------------------------------------------------- | 




For the transition period from

to .





Commission file number: 0-27207





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VITRIA TECHNOLOGY, INC.


(Exact Name of Registrant as Specified in Its Charter)





Delaware

77-0386311(State or Other Jurisdiction of Incorporation or Organization)

(I.R.S. Employer Identification
No.)





945 Stewart Drive


Sunnyvale, California 94085


(408) 212-2700


(Address, including Zip Code, of Registrants Principal Executive Offices


and Registrants
Telephone Number, including Area Code)





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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes  x  No  ̈





The number of shares of
Vitrias common stock, $0.001 par value, outstanding as of July 31, 2002 was 130,451,218 shares.





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##### Table of Contents




VITRIA TECHNOLOGY, INC.





INDEX





PagePART I:    FINANCIAL INFORMATIONItem 1.

Condensed Consolidated Financial Statements and NotesCondensed Consolidated Balance Sheets at June 30, 2002 and December 31, 2001

3Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2002 and June 30, 2001

4Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and June 30, 2001

5Notes to the Condensed Consolidated Financial Statements

6Item 2:

Managements Discussion and Analysis of Financial Condition and Results of Operations

12Item 3:

Quantitative and Qualitative Disclosures About Market Risk

23PART II:    OTHER INFORMATIONItem 1:

Legal Proceedings

33Item 2:

Changes in Securities and Uses of Proceeds

33Item 3:

Defaults Upon Senior Securities

33Item 4:

Submission of Matters to a Vote of Security Holders

33Item 5:

Other Information

34Item 6:

Exhibits and Reports on Form 8-K

35Signature

36




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##### Table of Contents




PART I.    FINANCIAL INFORMATION





Item 1.Financial Statements





VITRIA TECHNOLOGY, INC.





CONDENSED CONSOLIDATED BALANCE SHEETS


(in thousands)





June 30, 2002


December 31, 2001(unaudited)


(Note 1)ASSETSCurrent Assets:Cash and cash equivalents

$
62,124


$
60,479Short-term investments


83,716



96,734Accounts receivable, net


17,245



37,215Other current assets


4,129



7,335Total current assets


167,214



201,763Restricted investments






18,325Property and equipment, net


12,015



14,000Intangible assets, net


2,021



2,752Goodwill






7,247Other assets


1,558



1,424Total assets

$
182,808


$
245,511LIABILITIES AND STOCKHOLDERS EQUITYCurrent Liabilities:Accounts payable

$
2,158


$
3,569Accrued payroll and related


10,824



13,232Other accrued liabilities


9,058



10,890Accrued restructuring expenses


14,910



Deferred revenue


20,577



27,309Total current liabilities


57,527



55,000Commitments and ContingenciesStockholders Equity:Common Stock


130



130Additional paid-in capital


273,217



271,596Unearned stock-based compensation


(938
)


(1,547
)Notes receivable from stockholders


(193
)


(193
)Accumulated other comprehensive income (loss)


443



(241
)Accumulated deficit


(147,378
)


(79,234
)Total stockholders equity


125,281



190,511Total liabilities and stockholders equity

$
182,808


$
245,511





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




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##### Table of Contents




VITRIA TECHNOLOGY, INC.





CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS


(In thousands, except per share amounts)


(unaudited)





Three Months Ended June
30,


Six Months Ended June
30,2002


2001


2002


2001Revenues:License

$
10,047


$
19,942


$
20,001


$
40,803Service and other


16,471



14,459



31,166



28,936Total revenues


26,518



34,401



51,167



69,739Cost of revenues:License


1,974



297



2,429



622Service and other


7,994



7,363



17,148



15,587Total cost of revenues


9,968



7,660



19,577



16,209Gross profit


16,550



26,741



31,590



53,530Operating expenses:Sales and marketing


19,460



26,106



45,159



50,314Research and development


8,717



11,027



18,225



20,809General and administrative


5,590



4,562



11,514



8,407Stock-based compensation


276



503



1,285



1,066Amortization of goodwill and intangible assets


213



1,103



731



1,103Impairment of goodwill


7,047







7,047



Restructuring costs


17,346







17,346



Acquired in-process research and development






1,500







1,500Total operating expenses


58,649



44,801



101,307



83,199Loss from operations


(42,099
)


(18,060
)


(69,717
)


(29,669
)Interest income


766



2,517



1,730



6,024Other income, net


563



338



240



201Net loss before income taxes


(40,770
)


(15,205
)


(67,747
)


(23,444
)Provision for income taxes


206



170



397



411Net loss

$
(40,976
)

$
(15,375
)

$
(68,144
)

$
(23,855
)Basic and diluted net loss per share

$
(0.32
)

$
(0.12
)

$
(0.53
)

$
(0.19
)Weighted average shares used in computing basic and diluted net loss per share


129,597



126,573



129,271



125,891





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




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##### Table of Contents




VITRIA TECHNOLOGY, INC.





CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


(in thousands)


(unaudited)





Six months ended June
30,2002


2001Operating activities:Net loss

$
(68,144
)

$
(23,855
)Adjustments to reconcile net loss to net cash used in operating activities:Amortization of goodwill and intangible assets


731



1,103Acquired in-process technology






1,500Impairment of goodwill


7,047



Loss on write-down of equity investments


164



(860
)Loss on disposal of fixed assets


451



400Depreciation


3,528



3,045Stock-based compensation


1,285



1,066Changes in assets & liabilities:Accounts receivable


19,970



12,320Other current assets


3,206



(1,197
)Other assets


(298
)


(125
)Accounts payable


(1,411
)


(595
)Accrued liabilities


(4,040
)


(2,688
)Accrued restructuring charges


14,910



Deferred revenue


(6,732
)


(15,317
)Net cash used in operating activities


(29,333
)


(25,203
)Investing activities:Acquisition of subsidiary, net of cash acquired






(8,869
)Purchases of property and equipment


(1,994
)


(3,911
)Purchases of investments


(89,995
)


(219,260
)Maturities of investments


121,226



165,143Proceeds from sales of equity investments






4,000Collection of note receivable






48Net cash provided by (used in) investing activities


29,237



(62,849
)Financing activities:Issuance of common stock, net


945



3,015Net cash provided by financing activities


945



3,015Effect of exchange rates on changes on cash and cash equivalents


796



(129
)Net increase (decrease) in cash and cash equivalents


1,645



(85,166
)Cash and cash equivalents at beginning of period


60,479



154,826Cash and cash equivalents at end of period

$
62,124


$
69,660





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




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##### Table of Contents




NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)





1)    Basis of
Presentation





The accompanying unaudited condensed consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim consolidated financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. In the opinion of the management of Vitria Technology, Inc., these
unaudited condensed consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, which we consider necessary to fairly state Vitrias financial position and the results of its operations and its
cash flows. The balance sheet at December 31, 2001 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for
complete financial statements. The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in Vitrias Annual Report on Form 10-K for the year ended
December 31, 2001. The results of Vitrias operations for any interim period are not necessarily indicative of the results of the operations for any other interim period or for a full fiscal year.





Certain prior period amounts have been reclassified to conform to the current period presentation. Such reclassifications did not change
the previously reported operating loss or net loss amounts.





2)    Net Loss Per Share





Basic net loss per share is calculated by dividing net loss by the weighted-average number of shares of common stock outstanding. Basic
net loss per share does not include shares subject to Vitrias right of repurchase, which lapses ratably over the related vesting term. Diluted net loss per share is calculated by dividing net loss by the weighted-average number of shares of
common stock outstanding plus shares of potential common stock. Shares of potential common stock are composed of shares of common stock subject to Vitrias right of repurchase and shares of common stock issuable upon the exercise of stock
options (using the treasury stock method). The calculation of diluted net loss per share excludes shares of potential common stock if their effect is anti-dilutive.





The following table sets forth the computation of basic and diluted net loss per share for the periods indicated (in thousands, except per share amounts):





Three months ended


Six months endedJune 30, 2002


June 30, 2001


June 30, 2002


June 30, 2001Numerator for basic and diluted net loss per share:Net loss

$
(40,976
)

$
(15,375
)

$
(68,144
)

$
(23,855
)Denominator for basic and diluted net loss per share:Weighted average shares of common stock outstanding


130,420



129,256



130,344



128,829Less shares subject to repurchase


(823
)


(2,683
)


(1,073
)


(2,938
)Denominator for basic and diluted net loss per share


129,597



126,573



129,271



125,891Basic and diluted net loss per share

$
(0.32
)

$
(0.12
)

$
(0.53
)

$
(0.19
)




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##### Table of Contents

The following table sets forth the weighted average potential shares of common stock that are not included in the diluted
net loss per share calculation above because to do so would be anti-dilutive for the periods indicated (in thousands):





Three months ended

Six months endedJune 30, 2002

June 30, 2001

June 30, 2002

June 30, 2001Weighted average effect of anti-dilutive securities:Employee stock options (using the Treasury stock Method)

779

4,842

6,147

5,724Common stock subject to repurchase agreements

823

2,683

1,073

2,938Total

1,602

7,525

7,220

8,662





3)    Comprehensive Loss





Comprehensive loss is comprised of net loss and other comprehensive income (loss) such as foreign currency translation gains (losses) and
unrealized gains (losses) on available-for-sale marketable securities. Vitrias total comprehensive loss was as follows (in thousands):





Three months ended


Six months endedJune 30, 2002


June 30, 2001


June 30, 2002


June 30, 2001Net loss

$
(40,976
)

$
(15,375
)

$
(68,144
)

$
(23,855
)Other comprehensive income (loss):Foreign currency translation adjustment


321



16



796



129Unrealized gain (loss) on securities


44



(37
)


(112
)


(103
)Comprehensive loss

$
(40,611
)

$
(15,396
)

$
(67,460
)

$
(23,829
)





4)    Stock-Based Compensation





Stock-based compensation is broken down as follows (in thousands):





Three months ended

Six months endedJune 30, 2002

June 30, 2001

June 30, 2002

June 30, 2001Cost of revenues

$
22

$
40

$
47

$
84Sales and marketing


102


192


575


406Research and development


100


180


214


381General and administrative


52


91


449


195Total stock-based compensation

$
276

$
503

$
1,285

$
1,066




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As a result of changes made to our management structure, we modified the stock option vesting terms of option grants made
to certain former key executives. In accordance with APB 25, Accounting for Stock Issued to Employees, we recorded an additional non-cash stock-based compensation expense of $695,000 as a result of these modifications in the quarter
ended March 31, 2002.





5)    Restricted investments





In June 2002, we entered into a new standby letter of credit, replacing the previous standby letters of credit that restricted certain of our investments from use in
operations for the purpose of securing three leased facilities whose leases extend, with varying expiration dates, through June 2013. The new standby letter of credit no longer requires such restriction therefore the investments were reclassified as
cash and cash equivalents or short-term investments at June 30, 2002.





6)    Derivative Financial Instruments





Vitria adopted Statement of Financial Accounting Standards No. 133, or SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities, as amended, on January 1, 2001, and its adoption has not had a material effect on our financial statements. SFAS 133 requires companies to recognize all of their derivative
instruments as either assets or liabilities in the balance sheet at fair value. The accounting for changes in the fair value (i.e., unrealized gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as
part of a hedging relationship and on the type of hedging relationship. Derivatives that are not hedges must be adjusted to fair value through current earnings.





To protect against possible changes in values of certain foreign currency denominated receivables, primarily resulting from sales outside the United States, we enter into foreign currency forward
contracts which qualify and are designated as fair value hedges. The gains and losses on these forward contracts as well as the offsetting losses and gains on the hedged receivables are recognized in current earnings. The effectiveness test for
these contracts is determined by using the forward-to-forward rate comparison for currency forward contracts, which makes same-currency hedges perfectly effective. In the three and six months ended June 30, 2002, we did not engage in any hedging
activities.





7)    Goodwill





During the quarter ended June 30, 2002, we made an adjustment to reduce the purchase price of XMLSolutions Corporation by $200,000. The reduction in purchase price was due
to revised estimates of acquisition related expenses. The adjustment to the purchase price reduced both goodwill and other accrued liabilities by $200,000, respectively. In addition, in accordance with SFAS 142, we transferred approximately $1.0
million of net assembled workforce to goodwill as of January 1, 2002. For comparative purposes we have made this reclassification in the balance sheet as of December 31, 2001.





Also during the quarter ended June 30, 2002, we performed an assessment of the carrying value of goodwill, which was recorded in connection with our acquisition of
XMLSolutions in April 2001. The assessment was performed because our market capitalization has declined significantly and because sustained negative economic conditions have impacted our operations and expected future revenues. Current economic
indicators suggest that these economic conditions may continue for the foreseeable future. We evaluated goodwill under the provisions of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, or
SFAS 142 (See Note 9). Goodwill was tested for impairment by calculating the fair value of Vitria as a whole based on our market capitalization at June 30, 2002 and comparing the




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fair value to the book value of Vitria, and then comparing the implied fair value of the goodwill to its
carrying value. As a result of the assessment, we recorded impairment charges of $7.0 million related to goodwill.





The following pro-forma financial information reflects consolidated results adjusted as if SFAS 142 had been adopted for all periods presented (in thousands, except per share amounts):





Three months ended


Six months ended


Twelve months endedJune 30, 2002


June 30, 2001


June 30, 2002


June 30, 2001


December 31, 2001Reported net loss

$
(40,976
)

$
(15,375
)

$
(68,144
)

$
(23,855
)

$
(53,622
)Add back: goodwill amortization (including assembled workforce)






859







859



2,083Adjusted net loss

$
(40,976
)

$
(14,516
)

$
(68,144
)

$
(22,996
)

$
(51,539
)Basic and diluted net loss per share:Reported net loss per share

$
(0.32
)

$
(0.12
)

$
(0.53
)

$
(0.19
)

$
(0.42
)Add back: goodwill amortization (including assembled workforce)






0.01







0.01



0.01Adjusted net loss per share

$
(0.32
)

$
(0.11
)

$
(0.53
)

$
(0.18
)

$
(0.41
)Weighted average share count


129,597



126,573



129,271



125,891



126,851





8)    Intangible Assets





Our acquisition of XMLSolutions Corporation in April 2001, which was accounted for as a purchase, resulted in intangible assets. At June
30, 2002 intangible assets consist of the following (in thousands):





Gross Carrying Amount June 30, 2002

Accumulated Amortization June 30, 2002


Net Carrying Amount June 30, 2002Developed Technology

$
2,500

$
(969
)

$
1,531Trademarks


800


(310
)


490Total

$
3,300

$
(1,279
)

$
2,021





In accordance with Statement of Financial Accounting Standards No.
144, Accounting for the Impairment of Disposal of Long-Lived Assets, the carrying values of our intangible assets are tested for impairment whenever events or changes in circumstances indicate that we may not be able to recover the
assets carrying amount. An analysis for impairment was conducted during the quarter ended June 30, 2002 due to sustained negative economic conditions that have impacted our operations. Intangible assets were tested for impairment by comparing the
undiscounted cash flows associated with the intangible assets to their carrying value. No impairment was identified for the intangible assets as a result of our assessment, as the undiscounted cash flows of the intangible assets exceeded their
carrying value.





SFAS 142 (See Note 9) requires that intangible assets that do not meet the criteria for
recognition apart from goodwill must be reclassified as of January 1, 2002. In accordance with SFAS 142, we transferred approximately




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$1.0 million of net assembled workforce to goodwill as of January 1, 2002. For comparative purposes we
have made this reclassification as of December 31, 2001.





9)    Recent Accounting Pronouncements





We adopted the Financial Accounting Standard Board, or FASB, Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets, or SFAS 142, on January 1, 2002. Under this pronouncement, goodwill and those intangible assets with indefinite lives are no longer amortized but rather are tested for impairment at least
annually and when events and circumstances indicate that their fair value has been reduced below carrying value (see Note 7 and 8). SFAS 142 also requires that goodwill be tested for impairment upon adoption. Furthermore, upon adoption,
approximately $1.0 million classified as assembled workforce was reclassified to goodwill. SFAS 142 requires that goodwill be tested for impairment at least annually after adoption using a two-step impairment analysis. In addition, certain
disclosures are required to be presented until all periods are accounted for in accordance with SFAS 142. Pro-forma financial information presented in Note 7 reflects consolidated results adjusted as if SFAS 142 had been adopted for all
periods presented.





In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets, or SFAS 144, which is effective for fiscal periods beginning after December 15, 2001 and interim periods within those fiscal years. SFAS 144 establishes an
accounting model for impairment or disposal of long-lived assets to be disposed of by sale. SFAS 144 was adopted by Vitria on January 1, 2002 and did not have a material impact on our results of operations, financial position or cash flows.





In November 2001, the staff of FASB issued Staff Announcement Topic No. D-103, Income Statement
Characterization of Reimbursements Received for Out of Pocket Expenses Incurred, or the Announcement. The Announcement requires companies to characterize reimbursements received for out of pocket expenses incurred as revenue in the income
statement. Vitria has adopted the Announcement beginning on January 1, 2002. Adjustments to prior period financial statements have not been made because the amounts have not been material. The Announcement has had no impact on gross profit or net
income but has minimally increased services revenue and cost of services revenue.





10)    Restructuring and Asset
Impairments





In April 2002, we announced a plan to reduce our cost structure. The plan was a combination of a
reduction in workforce of approximately 150 employees, or 17% of the existing workforce, consolidations of facilities in the United States and United Kingdom and fixed asset write-offs of leasehold improvements and equipment. The workforce reduction
affected all functional areas and was largely completed in the quarter ended June 30, 2002. As a result of the restructuring plan, we incurred a charge of $17.3 million in the quarter ended June 30, 2002. The restructuring charge included
approximately $2.4 million of severance related charges, $14.5 million of committed excess facilities payments, and $463,000 in fixed asset write-offs of leasehold improvements and equipment. The facilities consolidation charge was calculated using
our best estimates and was based upon the remaining future lease commitments for vacated facilities from the date of facility consolidation, net of estimated future sublease income. The estimated costs of vacating these leased facilities were based
on market information and trend analyses, including information obtained from independent real estate sources. We have engaged brokers to locate tenants to sublease these facilities. As of June 30, 2002, $14.7 million of lease termination costs, net
of anticipated sublease income, remains accrued and is expected to be fully utilized by fiscal 2013. In calculating the charge for facilities consolidation, certain assumptions were made with respect to the estimated time periods of vacancy and
sublease rates and opportunities. Actual future circumstances could be materially different from our estimates and accordingly, the actual total charges associated with the vacated facilities could be




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materially higher or lower than estimated. Adjustments to the facilities consolidation charges will be
made in future periods, if necessary, based upon then current actual events and circumstances.





As of June 30,
2002, $14.9 million of restructuring costs remained accrued for payment in future periods, as follows:





Facilities Consolidation


Severance


TotalTotal charges

$
14,983


$
2,363


$
17,346Cash payments


(477
)


(2,201
)


(2,678
)Fixed asset write-offs


(463
)






(463
)Reclassification of deferred rent


705







705Accrued at June 30, 2002

$
14,748


$
162


$
14,910





In the three months ended June 30, 2002 we also incurred a charge
to cost of license revenues for approximately $2.0 million related to a non-cancelable royalty agreement that will have no future utility to us. The charge resulted from the write-off of approximately $1.1 million of prepaid assets and the accrual
of approximately $900,000 relating to a remaining guaranteed future payment to be made in January 2003.





11)    Subsequent Events





In July 2002, our Board of Directors
announced a stock repurchase program under which we may repurchase up to an aggregate of five million shares of our common stock beginning on July 29, 2002. Under the program the repurchases will be made from time to time on the open market at
prevailing market prices or in negotiated transactions off the market. The repurchases will be funded from available working capital.





In August 2002, we reduced our workforce by approximately 135 employees, or 20%, to further streamline our cost structure. In the third quarter we will add to our restructuring charges to reflect the costs associated with
this reduction in workforce.




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Item 2:Managements Discussion and Analysis of Financial Condition and Results of Operations





The information in this discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 which are subject to the safe
harbor created by those sections. These forward-looking statements are generally identified by words such as expect, anticipate, intend, plan, believe, hope,
assume, estimate and other similar words and expressions. These forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially from those in the forward-looking statements,
including, without limitation, the risks outlined under Business Risks in this report on Form 10-Q. These business risks should be considered in evaluating our prospects and future financial performance. Although we believe that the
expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.





Overview





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In addition to providing the integration server, we offer integration solutions, known as collaborative applications. These applications are pre-built, configurable solutions for solving common
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out-of-the-box solutions for specific integration problems. For example, global straight through processing, or GSTP, is a problem that requires companies in the financial services industry to work together to reduce the time and cost of securities
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The BusinessWare integration server and our family of collaborative applications are currently licensed by more
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BusinessWare enables companies to automate business processes across the extended
enterprise and integrates the underlying information technology, or IT, systems that must work together to support these processes.





BusinessWare combines in a single solution the five elements that we believe are essential for ebusiness infrastructure software:





(1)  Business Process Management, or BPM: BPM provides control and coordination of business processes spanning a wide combination of systems,
people and corporate boundaries. It uses graphical process models to seamlessly define, automate and manage transactions and the




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##### Table of Contents

exchange of information between internal business applications, people and external trading partners.





(2)  Business-to-Business Integration, or B2Bi: B2Bi enables the secure and reliable completion of
transactions and the exchange of business information between customers and partners over the Internet to support collaborative processes. B2Bi helps companies manage their value chain interactions from end to end.





(3)  Enterprise Application Integration, or EAI: EAI enables the secure and reliable movement of information in
and out of internal business applications. By enabling internal applications to communicate with each other, EAI helps unify and improve extended enterprise processes.





(4)  Business Process Intelligence, or BPI: BPI provides real-time monitoring and analysis of running business processes thereby enabling
optimization of operational efficiency. Our two key BPI componentsProcess Analyzer and Business Cockpitcontinuously gather working business process data, analyze and visualize it in real time, and enable process owners to proactively
identify and respond to integration problems or opportunities as they occur.





(5)  Business Vocabulary Management, or BVM: BVM is our vocabulary-based approach to transformation that, we believe, substantially reduces the time and complexity of translating between different document formats. BVM
includes a comprehensive set of extended markup language, industry-specific vocabularies (words and meanings) and documents required to conduct business over the Internet. To address the specific needs of each industry, BVM provides packaged
vocabularies for various industries based on the specific business terms utilized within those industries.





Once
customers use BusinessWare to define their business process models and integrate the underlying IT systems, BusinessWare automatically controls the flow of information across the IT systems as specified by the process models. BusinessWare
continuously analyzes the customers business processes and can automatically change the processes in response to this analysis. This capability allows companies to transform the information flowing through their IT systems into
actionable intelligence that enables business managers to optimize their business operations.





We
derive revenues primarily from two sources: licenses, and services and other. Our products are typically licensed directly to customers for a perpetual term, with pricing based on the number of copies licensed, or systems or applications managed. We
record license revenues when a license agreement has been signed by both parties, the fee is fixed or determinable, collection of the fee is probable, and delivery of our product has occurred. For electronic transmissions, we consider our product to
have been delivered when the access code to download the software from the Internet has been provided to the customer.





Service and other revenues include product maintenance, consulting, training and government grants. Customers who license BusinessWare normally purchase maintenance contracts. These contracts provide unspecified software upgrades and
technical support over a specified term, which is typically twelve months. Maintenance contracts are usually paid in advance, and revenues from these contracts are recognized ratably over the term of the contract. A majority of our customers use
third-party system integrators to implement our products. Customers typically purchase additional consulting services from us to support their implementation activities. These consulting services are generally sold on a time and materials basis and
recognized as the services are performed. We also offer training services which are sold on a per student or per class basis and recognized as the classes are attended.




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We market our products through our direct sales force and augment our marketing
efforts through relationships with system integrators and technology vendors. To date, we have not experienced significant seasonality of revenue. We expect that future results may be affected by the fiscal or quarterly budget cycles of our
customers.





We recognized approximately 30% of our revenues from customers outside the United States in the three
months ended June 30, 2002 and 29% of our revenues from customers outside the United States in the six months ended June 30, 2002, compared to 21% in the three months ended June 30, 2001 and 16% in the six months ended June 30, 2001. For the next
quarter, we believe international revenues will remain at approximately the same percentage of total revenues as the three months ended June 30, 2002.





Sales to our ten largest customers accounted for 38% of total revenues in the three months ended June 30, 2002 and 33% of total revenues in the six months ended June 30, 2002. Sales to our ten largest
customers accounted for 36% of total revenues in the three months ended June 31, 2001 and 30% of total revenues in the six months ended June 30, 2001. However, no single customer accounted for more than 10% of total revenues in either the three or
six months ended June 30, 2002 or June 30, 2001. We expect that revenues from a limited number of customers will continue to account for a large percentage of total revenues in future quarters. Therefore, the loss or delay of individual orders could
have a significant impact on revenues. Our ability to attract new customers will depend on a variety of factors, including the reliability, security, scalability and the overall cost-effectiveness of our products.





Critical Accounting Policies





For discussion of our critical accounting policies please see Managements Discussion of Analysis and Financial Condition and Results of OperationsCritical Accounting Policies and Estimates in our annual report
on Form 10-K for the year ended December 31, 2001.




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Results of Operations





For the three and six months ended June 30, 2002





The following table sets forth the results of operations for the three and six months ended June 30, 2002, expressed as a percentage of total revenues.





Three Months Ended June
30,


Six Months Ended June
30,2002


2001


2002


2001RevenuesLicense

38%


58%


39%


59%Service and other

62%


42%


61%


41%Total revenues

100%


100%


100%


100%Cost of revenuesLicense

8%


1%


5%


1%Service and other

30%


21%


33%


22%Total cost of revenues

38%


22%


38%


23%Gross profit

62%


78%


62%


77%Operating expensesSales and marketing

73%


76%


88%


71%Research and development

33%


32%


36%


30%General and administrative

21%


13%


23%


12%Stock-based compensation

1%


2%


2%


2%Amortization of goodwill and intangible assets

1%


3%


1%


2%Impairment of goodwill

27%


0%


14%


0%Restructuring costs

65%


0%


34%


0%Acquired in-process research and development

0%


4%


0%


2%Total operating expenses

221%


130%


198%


119%Loss from operations

(159%
)

(52%
)

(136%
)

(42%
)Interest income

3%


7%


3%


9%Other income, net

2%


1%


1%


0%Net loss before income taxes

(154%
)

(44%
)

(132%
)

(33%
)Provision for income taxes

1%


0%


1%


1%Net loss

(155%
)

(44%
)

(133%
)

(34%
)




15




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Revenues





LICENSE.    License revenues decreased 50% to $10.0 million in the three months ended June 30, 2002 from $19.9 million in the three months ended June 30, 2001. License revenues
decreased 51% to $20.0 million in the six months ended June 30, 2002 from $40.8 million in the six months ended June 30, 2001. This decrease was the direct result of a decrease in the number of licenses sold, which has been caused by a general
slowdown in information technology spending in our target markets.





SERVICE AND
OTHER.    Service and other revenues increased 14% to $16.5 million in the three months ended June 30, 2002 from $14.5 million in the three months ended June 30, 2001. Service and other revenues increased 8% to $31.2 million in
the six months ended June 30, 2002 from $28.9 million in the six months ended June 30, 2001. The increases for both periods are due to an increase in support renewals in the current quarter due to more active sales efforts and an increase in
consulting revenue as our consulting organization expands its efforts to meet our customer needs, offset in part by a decrease in first year support revenues associated with our decrease in license revenues in the same periods, and a decrease in
training revenues due to the current economic trend which is curtailing many of our customers training budgets





Cost of
Revenues





LICENSE.    Cost of license revenues consists of royalty payments to third
parties for technology incorporated into our products. Cost of license revenues varies as it is dependent upon the third-party technology incorporated into our products and the buying patterns of our customers. As a percentage of license revenues,
cost of license revenues increased to 20% in the three months ended June 30, 2002 from 1% for the three months ended June 30, 2001. As a percentage of license revenues, cost of license revenues increased to 12% in the six months ended June 30, 2002
from 2% in the six months ended June 30, 2001. Both of these increases are primarily due to a charge of approximately $2.0 million associated with the write-off of a prepaid royalty related to a product that we do not expect to sell in the future.
For the next quarter we expect cost of license revenues to decrease in absolute dollars as a result of the charge recorded in the quarter ended June 30, 2002.





SERVICE AND OTHER.    Cost of service and other revenues consists of salaries, facility costs, travel expenses and third party consultant fees incurred in providing customer
support, training and implementation related services. Cost of service and other revenues was $8.0 million in the three months ended June 30, 2002, an increase of 9% over cost of service and other revenues of $7.4 million in the three months
ended June 30, 2001. This increase is primarily due to increased travel expenses incurred by our professional services group, related to increased consulting revenues in the current quarter. Cost of service and other revenues was $17.1 million in
the six months ended June 30, 2002, an increase of 10% over cost of service and other revenues of $15.6 million in the six months ended June 30, 2001. This increase is primarily due to increased travel expenses incurred by our professional services
group, related to increased consulting revenues in the current quarter and to higher salary costs over the same period a year ago. As a percentage of service and other revenues, these costs decreased 2% to 49% in the three months ended June 30, 2002
from 51% in the three months ended June 30, 2001. As a percentage of service and other revenues, these costs increased 1% to 55% in the six months ended June 30, 2002 from 54% in the six months ended June 30, 2001. These changes are essentially flat
due to increasing expenses at the same time that service and other revenues have increased. For the next quarter, we expect that cost of service and other revenues will remain consistent with previous periods in absolute dollars.





Operating Expenses





SALES AND MARKETING.    Sales and marketing expenses consist of salaries, commissions, field office expenses, travel and entertainment, and promotional expenses. During the three months ended June 30, 2002, sales
and marketing expenses were $19.5 million, a decrease of 25% over sales and marketing expenses of $26.1 million for




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the three months ended June 30, 2001. This decrease was primarily due to lower salary and related expenses as a result of our headcount reduction, lower commission costs due to reduced revenues
in the current year and lower marketing expenses due to cost containment efforts. During the six months ended June 30, 2002, sales and marketing expenses were $45.2 million, a decrease of 10% over sales and marketing expenses of $50.3 million for
the six months ended June 30, 2001. This decrease is primarily attributable to a decrease in commission expense due to reduced revenues in the current period and a decrease in marketing expenses due to our cost containment efforts, which were
partially offset by an increase in the use of outside consultants. As a percentage of revenues, sales and marketing expenses remained nearly flat, decreasing 3% to 73% in the three months ended June 30, 2002 from 76% in the three months ended June
30, 2001. This slight decrease is due to the fact that the decrease in our expenses from our cost containment efforts has been nearly offset by the decrease in our revenues. As a percentage of revenues, sales and marketing expenses increased 17% to
88% in the six months ended June 30, 2002 from 71% in the six months ended June 30, 2001. This increase in expense over the prior year is due to the fact that while costs have decreased significantly in absolute dollars, the decrease in expense has
been more than offset by a decrease in revenues over the same period. For the next quarter, we expect that sales and marketing expenses will decrease in absolute dollars as a result of the reduction in workforce and further efforts to control costs.





RESEARCH AND DEVELOPMENT.    Research and development expenses include costs associated with
the development of new products, enhancements to existing products, and quality assurance activities. These costs consist primarily of employee salaries, benefits, and the cost of consulting resources that supplement the internal development team.
Costs of developing software for external use that may have been eligible for capitalization have not been material and we have expensed all of these costs as incurred. During the three months ended June 30, 2002, research and development expenses
were $8.7 million, a decrease of 21% from research and development expenses of $11.0 million for the three months ended June 30, 2001. This decrease is mainly attributable to a decrease in salary and related expenses as a result of our headcount
reduction in April 2002, and a decrease in third party consulting expenses. During the six months ended June 30, 2002, research and development expenses were $18.2 million, a decrease of 12% over research and development expense of $20.8 million for
the six months ended June 30, 2001. This decrease is mainly attributable to a decrease in salary and related expenses as a result of headcount reduction and decreases in third party consulting expenses and travel expense due to our cost containment
efforts. As a percentage of total revenues, research and development expenses increased 1% to 33% in the three months ended June 30, 2002 from 32% in the three months ended June 30, 2001. This slight increase over the prior year is due to the fact
that while costs have decreased significantly in absolute dollars over the same period in the prior year, the decrease in expense has been more than offset by the relative decrease in revenue during the same period. As a percentage of total
revenues, research and development expense increased 6% to 36% in the six months ended June 30, 2002 from 30% in the six months ended June 30, 2001. This increase over the prior year is due to the fact that while costs have decreased significantly
in absolute dollars, the decrease in expense has been more than offset by the decrease in revenues. For the next quarter, we expect that research and development expenses will decrease in absolute dollars as a result of the reduction in workforce
and further efforts to control costs.





GENERAL AND ADMINISTRATIVE.    General and
administrative expenses consist of salaries for administrative, executive and finance personnel, information systems costs, outside professional service fees and our provision for doubtful accounts. During the three months ended June 30, 2002,
general and administrative expenses were $5.6 million, an increase of 23% over general and administrative expenses of $4.6 million for the three months ended June 30, 2001. During the six months ended June 30, 2002, general and administrative
expenses were $11.5 million, an increase of 37% over general and administrative expenses of $8.4 million for the six months ended June 30, 2001. These increases are primarily attributable to higher benefits costs as we switched to a new medical
insurance plan in 2002, an increase in outside consulting expenses associated with the implementation of internal systems and a decrease in sublease rental income. As a percentage of revenues, general and administrative expenses increased 8% to 21%
in the three months ended June 30, 2002 from 13% in the three months ended June 30, 2001. As a percentage of revenues, general and administrative expenses increased 11% to 23% in the six months ended June 30, 2002 from 12% in the six months ended
June 30, 2001. These increases as a percentage of revenues are due to both the increases in general and administrative expenses in absolute dollars as explained above as




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well as the decreases in revenues in the three and six months ended June 30, 2002 from the same periods in the prior year. For the next quarter, we expect that general and administrative expenses
will decrease in absolute dollars as a result of the reduction in workforce and further efforts to control costs.





STOCK-BASED COMPENSATION.    Stock-based compensation represents the difference between the exercise price and the deemed fair value of our common stock on the date certain stock options were granted or modified.
During the three months ended June 30, 2002, stock-based compensation was $276,000, a decrease of 45% over stock-based compensation of $503,000 for the three months ended June 30, 2001. During the six months ended June 30, 2002, stock-based
compensation was $1.3 million, an increase of 21% over stock-based compensation of $1.1 million for the six months ended June 30, 2001. As a result of changes in our top management structure, we modified the stock option vesting terms of option
grants made to certain key executives who left the company in the quarter ended March 31, 2002. In accordance with APB 25, Accounting for Stock Issued to Employees, we recorded $695,000 in additional non-cash stock-based compensation
expense in the three months ended March 31, 2002 as a result of these grant modifications. Stock-based compensation also includes the amortization of unearned employee stock-based compensation on options issued to employees which were exercised
prior to the Company filing its initial public offering in September 1999. This unearned employee stock-based compensation is being amortized over a five-year vesting period. We expect to recognize employee stock-based compensation expenses of
approximately $403,000 for the six months ending December 31, 2002, $447,000 for the year ending December 31, 2003 and $88,000 for the year ending December 31, 2004. This unearned compensation expense will be reduced in future periods to the extent
that options are terminated prior to vesting. The amount of compensation expense recorded for options that are cancelled prior to vesting will be credited to the income statement at the time of termination.





AMORTIZATION OF GOODWILL AND OTHER PURCHASED INTANGIBLE ASSETS.    We purchased XMLSolutions in April 2001 under the
purchase method of accounting which resulted in goodwill and intangible assets being recorded at the time of purchase. Goodwill associated with this purchase was amortized over its estimated life in 2001. However, in accordance with SFAS 142, as
referenced in Note 9, beginning January 1, 2002, we discontinued the amortization of goodwill. Amortization of other purchased intangible assets associated with the acquisition of XMLSolutions resulted in charges to earnings of $213,000 for the
three months ended June 30, 2002 and $731,000 for the six months ended June 30, 2002. There was no goodwill amortization in 2002. Amortization of goodwill and intangible assets was $1.1 million in the three months and six months ended June 30, 2001.
The purchased intangible assets will continue to be amortized over their estimated useful lives subject to periodic review for impairment.





IMPAIRMENT OF GOODWILL.    During the quarter ended June 30, 2002, we performed an assessment of the carrying values of our goodwill, which was recorded in connection with our acquisition of XMLSolutions
in April 2001. The assessment was performed because our market capitalization has declined significantly and because sustained negative economic conditions have impacted our operations and expected future revenues. Current economic indicators
suggest that these conditions will continue for the foreseeable future. We evaluated goodwill under the provisions of SFAS 142 (See Note 9). Goodwill was tested for impairment by calculating the fair value of Vitria as a whole, based on the market
capitalization at June 30, 2002, and comparing the fair value to the book value of Vitria, and then comparing the implied fair value of the goodwill with its carrying value. As a result of this assessment, we recorded impairment charges of $7.0
million related to goodwill.





INTANGIBLE ASSETS.    Our purchase of XMLSolutions Corporation
resulted in intangible assets. Intangible assets, which have a net carrying amount of approximately $2.0 million at June 30, 2002, include developed technology and trademarks. In accordance with Statement of Financial Accounting Standards No. 144,
Accounting for the Impairment of Disposal of Long-Lived Assets, the carrying values of our intangible assets are tested for impairment whenever events or changes in circumstances indicate that we may not be able to recover the assets
carrying amount. An analysis for impairment was conducted during the quarter ended June 30, 2002 due to sustained negative economic conditions that have impacted our operations. Intangible assets were tested for impairment by comparing the
undiscounted cash flows associated with the intangible assets to their carrying value. No impairment was identified for the intangible assets as a result of our assessment, as the undiscounted cash flows of the intangible assets exceeded their
carrying value. As required by SFAS 142, intangible assets that do not meet the criteria for recognition apart from goodwill must be reclassified. In accordance with SFAS 142, we transferred approximately $1.0 million of net assembled workforce to
goodwill as of January 1, 2002.




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RESTRUCTURING COSTS.    In April 2002, we announced a plan to
reduce our cost structure. The plan was a combination of a reduction in workforce of approximately 150 employees, or 17%, of the existing workforce, consolidations of facilities and fixed asset write-offs. The workforce reduction affected all
functional areas and was largely completed in the quarter ended June 30, 2002. As a result of the restructuring plan, we incurred a charge of $17.3 million in the quarter ended June 30, 2002. The restructuring charge included approximately $2.4
million of severance related amounts, $14.5 million of committed excess facilities, which were primarily related to lease expenses net of anticipated sublease income, and $463,000 in fixed asset write-offs. Accrued restructuring costs totaled $14.9
million at June 30, 2002. In August 2002, we reduced our workforce by approximately 135 employees, or 20%, to further streamline our cost structure. In the third quarter we will add to our restructuring charges to reflect the costs associated with
this reduction in workforce.





INTEREST AND OTHER INCOME, NET.    Interest and other income,
net, decreased by 53% to $1.3 million in the three months ended June 30, 2002 from $2.9 million in the three months ended June 30, 2001. Interest and other income, net, decreased by 68% to $2.0 million in the six months ended June 30, 2002 from $6.2
million in the six months ended June 30, 2001. The decrease in both periods is primarily attributable to lower interest income earned from our short-term investments due to lower interest rates on investments and lower cash and investment balances
in the three and six months ended June 30, 2002.





Provision for Income Taxes





We recorded an income tax provision of $206,000 and $397,000, respectively, for the three-month and six- month periods ended June 30, 2002. The provision relates to
income taxes currently payable on income generated in non-U.S. tax jurisdictions, state income taxes, and foreign withholding taxes incurred on software license revenue. We recorded an income tax provision of $170,000 and $411,000, respectively, for
the three-month and six-month periods ended June 30, 2001. The 2001 provision relates to income taxes payable on income generated in non-U.S. jurisdictions, state income taxes, and foreign withholding taxes incurred on software license revenue.





Liquidity and Capital Resources





As of June 30, 2002, we had $62.1 million in cash and cash equivalents, $83.7 million in short-term investments, and $109.7 million in working capital with no outstanding long-term debt, compared to
$60.5 million in cash and cash equivalents, $96.7 million in short-term investments and $146.8 million in working capital with no outstanding long term debt at December 31, 2001.





Net cash used in operating activities was $29.3 million for the six months ended June 30, 2002 and was primarily due to our net loss, an increase in accrued restructuring
expenses, a decrease in deferred revenue and accrued liabilities, offset by a decrease in accounts receivable, and an impairment of goodwill, a non-cash item. Net cash used in operating activities was $25.2 million for the six months ended June 30,
2001, primarily due to our net loss and a decrease in deferred revenues, partially offset by a decrease in accounts receivable.




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Net cash provided by investing activities was $29.2 million in the six months
ended June 30, 2002 and was primarily due to maturities of investments, partially offset by purchases of fixed assets and purchases of investments. Net cash used in investing activities was $62.8 million in the six months ended June 30, 2001,
primarily due to purchases of investments and the acquisition of XMLSolutions, partially offset by maturities of investments.





Net cash provided by financing activities was $945,000 in the six months ended June 30, 2002. Net cash provided by financing activities was $3.0 million in the six months ended June 30, 2001. Net cash provided by financing activities
for both periods was primarily from the issuance of common stock.





During the six months ended June 30, 2002 our
net accounts receivable decreased $20.0 million from $37.2 million at December 31, 2001 to $17.2 million at June 30, 2002. The reason for the decline was due to strong collections as well as lower revenues in the six months ended June 30, 2002. Both
of these factors are likely to reduce our future cash flows for at least the next quarter. At June 30, 2002 our gross accounts receivable balance is $19.0 million with an allowance for doubtful accounts of $1.7 million.





During the six months ended June 30, 2002, our deferred revenue balance decreased $6.7 million from $27.3 million at December 31, 2001 to
$20.6 million at June 30, 2002. The primary reason for this decline is lower than anticipated license revenues, which reduced our first year support billings.





Contractual Cash Obligations





At June 30, 2002, we had
operating lease commitments of approximately $37.7 million, payable through 2013 as noted in the table below.





Year ending December 31,

2007 and Thereafter

Total Minimum Lease Payment2002

2003

2004

2005

2006Operating Leases

$
4,690

$
8,537

$
6,801

$
6,565

$
4,695

$
6,327

$
37,615





Off-Balance Sheet Arrangements





At June 30, 2002, Vitria did not have any off-balance sheet arrangements or relationships with unconsolidated entities or financial
partnerships, such as entities often referred to as structured finance or special purpose entities, which are typically established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.





Stock Repurchase Program





In July 2002, our Board of Directors announced a stock repurchase program under which we may repurchase up to an aggregate of five million shares of our common stock
beginning on July 29, 2002. Under the program the repurchases will be made from time to time on the open market at prevailing market prices or in negotiated transactions off the market. The repurchases will be funded from available working capital.





Operating Capital and Capital Expenditure Requirements




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Estimated future uses of cash over the next twelve months are primarily to fund
operations and to a lesser extent to fund capital expenditures. For the next twelve months, we expect to fund these uses from available cash balances, cash generated from operations, if any, and interest on available cash balances. Our ability to
generate cash from operations is dependent upon our ability to sell our products and services and generate revenue, as well as our ability to manage our operating costs. In turn, our ability to sell our products is dependent upon both the economic
climate and the competitive factors of the marketplace in which we operate.





In the past, we have invested
significantly in our operations. For the next quarter, we expect that operating expenses will decrease in absolute dollars as a result of the reduction in workforce and continued efforts to control costs. However, we anticipate that operating
expenses and planned capital expenditures will continue to constitute a material use of our cash resources. We believe that our available cash and cash equivalents will be sufficient to meet our working capital and operating expense requirements for
at least the next twelve months. At some point in the future we may require additional funds to support our working capital and operating expense requirements or for other purposes and may seek to raise these additional funds through public or
private debt or equity financings. If we need to seek additional financing, there is no assurance that this additional financing will be available, or if available, will be on reasonable terms and not dilutive to our stockholders.





We have a limited operating history that makes it difficult to predict future operating results. We believe our success
requires expanding our customer base and continuing to enhance our BusinessWare products. Subject to a number of factors, some of which are difficult to project, such as the timing of the improvement of both the U.S. economy and of information
technology spending in our target markets, we expect to reach profitability sometime during fiscal 2003. Our revenues, operating results and cash flows depend upon the volume and timing of customer orders and payments and the date of product
delivery. Historically, a substantial portion of revenues in a given quarter have been recorded in the third month of that quarter, with a concentration of these revenues in the last two weeks of the third month. We expect this trend to continue
and, therefore, any failure or delay in the closing of orders would have a material adverse effect on our quarterly operating results and cash flows. Since our operating expenses are based on anticipated revenues and because a high percentage of
these expenses are relatively fixed, a delay in the recognition of revenue from one or more license transactions could cause significant variations in operating results from quarter to quarter and cause unexpected results. Revenues from contracts
that do not meet our revenue recognition policy requirements for which we have been paid or have a valid receivable are recorded as deferred revenues. While a portion of our revenues each quarter is recognized from deferred revenue, our quarterly
performance will depend primarily upon entering into new contracts to generate revenues for that quarter. New contracts may not result in revenue during the quarter in which the contract was signed, and we may not be able to predict accurately when
revenues from these contracts will be recognized. Our future operating results and cash flows will depend on many factors, including the following:





| |  |  | size and timing of customer orders and product and service delivery;
| | - |  | --------------------------------------------------------------------




| |  |  | level of demand for our professional services;
| | - |  | ----------------------------------------------




| |  |  | changes in the mix of our products and services;
| | - |  | ------------------------------------------------




| |  |  | ability to protect our intellectual property;
| | - |  | ---------------------------------------------




| |  |  | actions taken by our competitors, including new product introductions and pricing changes;
| | - |  | ------------------------------------------------------------------------------------------




| |  |  | costs of maintaining and expanding our operations;
| | - |  | --------------------------------------------------




| |  |  | introduction of new products;
| | - |  | -----------------------------




| |  |  | timing of our development and release of new and enhanced products;
| | - |  | -------------------------------------------------------------------




| |  |  | costs and timing of hiring qualified personnel;
| | - |  | -----------------------------------------------




| |  |  | success in maintaining and enhancing existing relationships and developing new relationships with system integrators;
| | - |  | ---------------------------------------------------------------------------------------------------------------------




| |  |  | technological changes in our markets, including changes in standards for computer and networking software and hardware;
| | - |  | -----------------------------------------------------------------------------------------------------------------------




| |  |  | deferrals of customer orders in anticipation of product enhancements or new products;
| | - |  | -------------------------------------------------------------------------------------

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| |  |  | delays in our ability to recognize revenue as a result of the decision by our customers to postpone software delivery, or because of changes in the timing of
when delivery of products or services is completed;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | customer budget cycles and changes in these budget cycles;
| | - |  | ----------------------------------------------------------




| |  |  | external economic conditions;
| | - |  | -----------------------------




| |  |  | availability of customer funds for software purchases given external economic factors;
| | - |  | --------------------------------------------------------------------------------------




| |  |  | costs related to acquisition of technologies or businesses;
| | - |  | -----------------------------------------------------------




| |  |  | ability to successfully integrate acquisitions;
| | - |  | -----------------------------------------------




| |  |  | changes in strategy and capability of our competitors; and
| | - |  | ----------------------------------------------------------




| |  |  | liquidity and timeliness of payments from international customers.
| | - |  | ------------------------------------------------------------------




As a result of these factors, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as
indications of future performance. It is likely that in some future quarter our operating results will be below the expectations of public market analysts and investors. In this event, the price of our common stock would likely decline.




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Item 3.Quantitative and Qualitative Disclosure About Market Risk





In the normal
course of business, the financial position of Vitria is routinely subjected to a variety of risks, including market risk associated with interest rate movements and collectibility of accounts receivable. We regularly assess these risks and have
established policies and business practices to protect against the adverse effects of these and other potential exposures. As a result, we do not anticipate material losses in these areas. As we expand our operations internationally, we will also
become subject to risks associated with currency rate movements on non-U.S. dollar denominated assets and liabilities.





We are exposed to interest rate risk on our investments of cash, cash equivalents and marketable debt securities. The primary objective of our investment activities is to preserve principal while at the same time maximizing yields
without significantly increasing risk. To achieve this objective, we invest in highly liquid and high quality debt securities. To minimize the exposure due to adverse shifts in interest rates, we invest in short-term securities with maturities of
less than one year. If a one percentage point change in interest rates were to have occurred on June 30, 2002 or June 30, 2001, such a change would not have had a material effect on the fair value of our investment portfolio as of that date. Due to
the nature of our short-term investments, we have concluded that we do not have a material financial market risk exposure.





Business
Risks





Since our short operating history makes it difficult to evaluate our prospects, our future financial performance may
disappoint securities analysts or investors and result in a decline in our stock price.





We were incorporated
in October 1994. Until November 1997, we were engaged primarily in research and development of our initial product. We licensed our first product in November 1997. Because of our limited operating history, we have limited insight into trends that
may emerge in our market and affect our business. The revenue and income potential of our market are unproven. As a result of our limited operating history, we have limited financial data that you can use to evaluate our business. You must consider
our prospects in light of the risks, expenses and challenges we might encounter because we are in the early stages of development in a new and rapidly evolving market.





Although we have in the past reported net income, we cannot guarantee we will do so in the future.





We have incurred substantial losses since inception as we funded the development of our products and the growth of our organization. We have an accumulated deficit of $147.4 million as of June 30,
2002. We intend to continue investing selectively in sales, marketing and research and development. As a result, we are likely to report future operating losses and cannot guarantee we will report net income in the future.





Our operating results fluctuate significantly and an unanticipated decline in revenue may disappoint securities analysts or investors and result in a decline
in our stock price.





Although we have had significant revenue growth in the past, we may not be able to grow
our revenues or match prior growth rates and prospective investors should not use past results to predict future operating margins or results. Our quarterly operating results have fluctuated significantly in the past and may vary significantly in
the future. If our operating results are below the expectations of securities analysts or investors, our stock price is likely to decline. Period-to-period comparisons of our historical results of operations are not necessarily a good predictor of
our future performance.





Our revenues and operating results depend upon the volume and timing of customer orders
and payments and the date of product delivery. Historically, a substantial portion of revenues in a given quarter have been recorded in the third month of that quarter, with a concentration of these revenues in the last two weeks of the third month.
We expect




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this trend to continue and, therefore, any failure or delay in the closing of orders would have a material adverse effect on our quarterly
operating results. Since our operating expenses are based on anticipated revenues and because a high percentage of these expenses are relatively fixed, a delay in the recognition of revenue from one or more license transactions could cause
significant variations in operating results from quarter to quarter and cause unexpected results.





Our quarterly
results will depend primarily upon entering into new or follow-on contracts to generate revenues for that quarter. New contracts may not result in revenue in the quarter in which the contract was signed, and we may not be able to predict accurately
when revenues from these contracts will be recognized. Our operating results are also dependent upon our ability to manage our cost structure.





If we are unable to maintain our Nasdaq National Market listing, the liquidity of our common stock would be seriously limited.





Since June 28, 2002, our stock has had minimum closing bid prices of less than $1.00 per share on a number of trading days, which is the minimum bid price requirement for continued listing with the
Nasdaq National Market. If we fail to comply with the minimum bid price requirement for 30 straight days, we will receive a deficiency notice from the Nasdaq National Market. We will then have 90 calendar days to reestablish compliance with that
requirement. To reestablish compliance, our minimum closing bid price must be more than $1.00 per share for 10 consecutive trading days. If we do not reestablish compliance with this requirement during the 90-day period, Nasdaq will commence
delisting proceedings and we may be delisted from the Nasdaq National Market. Our shares will continue to trade on Nasdaq National Market unless and until the delisting proceedings have commenced and been completed and the Nasdaq National Market has
made a determination to delist us. In the event our shares are delisted from the Nasdaq National Market, we will attempt to have our common stock traded on the Nasdaq Small Cap Market. If our common stock is delisted, it could seriously limit the
liquidity of our common stock and would limit our potential to raise future capital through sale of our common stock, which could seriously harm our business. If we are unable to maintain our Nasdaq National Market listing, our ability to attract
and retain employees may be impaired.





Our product may not achieve market acceptance, which could cause our revenues to decline.





Deployment of our product requires interoperability with a variety of software applications and systems and,
in some cases, the ability to process a high number of transactions per second. If our product fails to satisfy these demanding technological objectives, our customers will be dissatisfied and we may be unable to generate future sales. Failure to
establish a significant base of customer references will significantly reduce our ability to license our product to additional customers.





Our revenues will likely decline if we do not develop and maintain successful relationships with system integrators.





System integrators install and deploy our products and those of our competitors, and perform custom integration of systems and applications. Some system integrators engage in joint marketing and sales
efforts with us. If these relationships fail, we will have to devote substantially more resources to the sales and marketing, and implementation and support of our product than we would otherwise have to, and our efforts may not be as effective as
those of the system integrators. In many cases, these parties have extensive relationships with our existing and potential customers and influence the decisions of these customers. We rely upon these firms for recommendations of our product during
the evaluation stage of the purchasing process, as well as for implementation and customer support services. A number of our competitors have strong relationships with these system integrators and, as a result, these system integrators may recommend
competitors products and services. In addition, a number of our competitors have relationships with a greater number of these system integrators and, therefore, have access to a broader base of enterprise customers. Our failure to establish or
maintain these relationships would significantly harm our ability to license and successfully implement our software product. In addition, we rely on the industry expertise and reach of these firms. Therefore, this failure would also harm our
ability to develop industry-specific products. We are currently investing, and plan to continue to invest, significant resources to develop and maintain these relationships. Our




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operating results could be adversely affected if these efforts do not generate license and service revenues necessary to offset this investment.





We may suffer product deployment delays, a lower quality of customer service and increased expenses if sufficient system integrator
implementation teams are not available.





System integrators help our customers install and deploy our product.
These system integrators are not contractually required to implement our product, and competition for these resources may preclude us from obtaining sufficient resources to provide the necessary implementation services to support our needs. If the
number of installations of our product exceeds our access to the resources provided by these system integrators, we will be required to provide these services internally, which would significantly limit our ability to meet our customers
implementation needs and increase our expenses. In addition, we cannot control the level and quality of service provided by our current and future implementation partners.





Because a small number of customers have in the past accounted for a substantial portion of our revenues, our revenues could decline due to the loss or delay of a single customer order.





Sales to our ten largest customers accounted for 38% of total revenues in the six months ended June 30, 2002.
Our license agreements do not generally provide for ongoing license payments. Therefore, we expect that revenues from a limited number of customers will continue to account for a significant percentage of total revenues in future quarters. Our
ability to attract new customers will depend on a variety of factors, including the reliability, security, scalability, breadth and depth of our products, and cost-effectiveness of our products. The loss or delay of individual orders could have a
significant impact on revenues and operating results. Our failure to add new customers that make significant purchases of our product and services would reduce our future revenues.





Our sales are concentrated in the telecommunications, manufacturing, financial services, energy, insurance and healthcare industries, and if our customers in these markets decrease their information
technology spending, or we fail to penetrate other industries, our revenues may decline.





We expect to
continue to direct our sales and marketing efforts toward companies in the telecommunications, manufacturing, financial services, energy, insurance and healthcare industries. Given the high degree of competition and the rapidly changing environment
in these industries, there is no assurance that we will be able to continue sales in these industries at current levels. In addition, we intend to market our product in new vertical markets. Customers in these new vertical markets are likely to have
different requirements and may require us to change our product design or features, sales methods, support capabilities or pricing policies. If we fail to successfully address these new vertical markets we may experience decreased sales in future
periods.





During the fourth quarter of 2000, companies in the telecommunications industry began sharply decreasing
their capital expenditures as the U.S. economy contracted. This decrease in spending and the overall contraction in the U.S. economy negatively impacted our revenues in 2001 and the six months ended June 30, 2002, and may continue to negatively
impact our revenues for the foreseeable future.





Failure of our current or potential small to mid-sized customers to receive necessary
funding could harm our business.





Some of our customers include small to mid-size companies. Most privately
and publicly held small to mid-size companies require outside cash sources to continue operations. To the extent additional funding is less available for small to mid-sized companies as a result of a stock market decline, a downturn in the U.S.
economy or other factors, demand for our products may decline significantly, thereby reducing our sales. On sales we do generate from small to mid-size companies, we may need to defer recognizing revenue until payment is received.




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The downturn in the U.S. economy may continue to cause a decline in capital allocations, thus
reducing our revenue and affecting our accounts receivable.





The downturn in the U.S. economy may cause a
further decline in capital allocations for software purchases. The delay in capital expenditures may cause a decrease in sales, may cause an increase in our accounts receivable and may make collection of license and support payments from our
customers more difficult. In addition, if our customers seek protection from creditors through formal bankruptcy filings, we may experience an increase in delinquent accounts receivable.





Our markets are highly competitive and, if we do not compete effectively, we may suffer price reductions, reduced gross margins and loss of market share.





The market for our product is intensely competitive, evolving and subject to rapid technological change. The intensity of competition is
expected to increase in the future. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any one of which could significantly reduce our future revenues. Our current competitors include:





B2Bi and EAI Vendors.    We face direct and indirect competition from vendors offering
Business-to-Business Integration, or B2Bi, and Enterprise Application Integration, or EAI, as well as other aspects of our products. Some of these vendors include BEA, IBM Corporation, IONA, Microsoft Corporation, Mercator
Software, Peregrine Systems, Sybase, SeeBeyond Technology, Tibco Software, and webMethods. In the future, some of these companies may expand their products to enhance existing, or to provide, business process management and business process
intelligence functionality. Additionally, in this fast-growing market, these or other competitors may merge to attempt the creation of a more competitive entity, or one that offers a broader solution than we provide.





Process Automation and Workflow Vendors.    We face direct and indirect competition from vendor offering
process automation and/or workflow as well as other aspects of our products. Some of these vendors include Savvion, Fuego, and Intalio. In the future, some of these companies may expand their products to enhance existing, or to provide EAI, and B2Bi
functionality. Additionally, in the fast-growing market, these or other competitors may merge to attempt the creation of a more competitive entity, or one that offers a broader solution that we provide.





Internal IT Departments.    In-house information technology departments of potential customers have
developed or may develop systems that provide for some or all of the functionality of our products. We expect that internally developed application integration and process automation efforts will continue to be a principal source of competition for
the foreseeable future. In particular, it can be difficult to sell our product to a potential customer whose internal development group has already made large investments in and progress towards completion of systems that our product is intended to
replace.





Other Software Vendors.    We also face or may soon face direct and indirect
competition from major enterprise software developers that offer integration products as a complement to their other enterprise software products. Some of these vendors include Oracle, PeopleSoft, and SAP AG.





Many of our competitors have more resources and broader customer relationships than we do. In addition, many of these competitors have
extensive knowledge of our industry. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to offer a single solution and increase the ability of their products to
address customer needs.





Although we believe that our solutions generally compete favorably with respect to these
factors, our market is relatively new and is evolving rapidly. We may not be able to maintain our competitive position against current and potential competitors, especially those with significantly greater resources.




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We experience long and variable sales cycles, which could have a negative impact on our results of
operations for any given quarter.





Our product is often used by our customers to deploy mission-critical
solutions used throughout their organization. Customers generally consider a wide range of issues before committing to purchase our products, including product benefits, ability to operate with existing and future computer systems, ability to
accommodate increased transaction volume and product reliability. Many customers will be addressing these issues for the first time. As a result, we or other parties, including system integrators, must educate potential customers on the use and
benefits of our product and services. In addition, the purchase of our products generally involves a significant commitment of capital and other resources by a customer. This commitment often requires significant technical review, assessment of
competitive products, and approval at a number of management levels within the customers organization. Because of these issues, our sales cycle has ranged from two to nine months and is difficult to predict for any particular license
transaction. In addition, the downturn in the U.S. economy has caused some customers to increase budgetary controls or require additional management approvals within the customers organization prior to committing to significant capital
purchases, either of which could result in an increased sales cycle.





The cost and difficulty in implementing our product could
significantly harm our reputation with customers, diminishing our ability to license additional products to our customers.





Our products are often purchased as part of large projects undertaken by our customers. These projects are complex, time consuming and expensive. Failure by customers to successfully deploy our products, or the failure by us or
third-party consultants to ensure customer satisfaction, could damage our reputation with existing and future customers and reduce future revenues. In many cases, our customers must interact with, modify, or replace significant elements of their
existing computer systems. The costs of our product and services represent only a portion of the related hardware, software, development, training and consulting costs. The significant involvement of third parties, including system integrators,
reduces the control we have over the implementation of our products and the quality of customer service provided to organizations which license our software.





If we are not successful in continuing to develop industry specific solutions based on our products, our ability to increase future revenues could be harmed.





We have developed and intend to continue to develop solutions based on BusinessWare which incorporate business processes, connectivity and document transformations specific
to the needs of particular industries, including telecommunications, manufacturing, financial services, energy, insurance and healthcare industries. This presents technical and sales challenges and requires collaboration with third parties,
including system integrators and standard organizations, and the commitment of significant resources. If we are not successful in developing these targeted solutions or these solutions do not achieve market acceptance, our ability to increase future
revenues could be harmed.





If our new VCA products are not commercially successful, our revenues may decline.





The market for our family of VCA products may not develop as quickly or broadly as we anticipate. Our future prospects could be
harmed and our revenues could decline if our family of VCA products do not achieve market acceptance and commercial success.





If we
are not successful in selling products in specific industries, our ability to increase future revenues may be harmed.





We have developed and intend to continue to develop products for specific industries, including telecommunications, healthcare, insurance, manufacturing, financial services and energy. Specific industries may experience economic
downturns or regulatory changes that may result in delayed spending decisions by customers or require changes to our products. We may be unable to meet the needs of specific industries or adapt our products to




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the changing needs of specific industries. If our products are not accepted in specific industries, our ability to increase future revenues
could be harmed.





Our operating results are substantially dependent on license revenues from essentially one product and our business
could be materially harmed by factors that adversely affect the pricing and demand for our product.





Since
1998, a substantial portion of our total revenues has been, derived from the license of our BusinessWare product and for applications for that product. Accordingly, our future operating results will depend on the demand for BusinessWare by future
customers, including new and enhanced releases that are subsequently introduced. If our competitors release new products that are superior to BusinessWare in performance or price, or we fail to enhance BusinessWare and introduce new products in a
timely manner, demand for our product may decline. A decline in demand for BusinessWare as a result of competition, technological change or other factors would significantly reduce our revenues.





If our product does not operate with the many hardware and software platforms used by our customers, our business may fail.





We currently serve a customer base with a wide variety of constantly changing hardware, packaged software applications and networking platforms. If our products fail to
gain broad market acceptance, due to their inability to support a variety of these platforms, our operating results may suffer. Our business depends, among others, on the following factors:





| |  |  | our ability to integrate our product with multiple platforms and existing, or legacy, systems and to modify our product as new versions of packaged applications
are introduced;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | the portability of our products, particularly the number of operating systems and databases that our products can source or target;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------




| |  |  | our ability to anticipate and support new standards, especially Internet standards;
| | - |  | -----------------------------------------------------------------------------------




| |  |  | the integration of additional software modules under development with our existing products; and
| | - |  | ------------------------------------------------------------------------------------------------




| |  |  | our management of software being developed by third parties for our customers or use with our products.
| | - |  | -------------------------------------------------------------------------------------------------------




If we fail to introduce new versions and releases of our products in a timely manner, our revenues may decline.





We may fail to introduce or deliver new products on a timely basis, if at all. In the past, we have experienced delays in the commencement
of commercial shipments of our BusinessWare products. To date, these delays have not had a material impact on our revenues. If new releases or products are delayed or do not achieve market acceptance, we could experience a delay or loss of revenues
and cause customer dissatisfaction. In addition, customers may delay purchases of our products in anticipation of future releases. If customers defer material orders in anticipation of new releases or new product introductions, our revenues may
decline.





Our products rely on third-party programming tools and applications. If we lose access to these tools and applications, or
are unable to modify our products in response to changes in these tools and applications, our revenues could decline.





Our programs utilize Java programming technology provided by Sun Microsystems. We also depend upon access to the interfaces, known as APIs, used for communication between external software products and packaged
application software. Our access to APIs of third-party applications are controlled by the providers of these applications. If the application provider denies or delays our access to APIs, our business may be harmed. Some application providers may
become competitors or establish alliances with our competitors, increasing the likelihood that we would not be granted access to their APIs. We also license technology related to the connectivity of our product to third-party database and other
applications and we incorporate some third-party technology into our product offerings. Loss of the ability to use this technology, delays in upgrades, failure of these third parties to support these




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technologies, or other difficulties with our third-party technology partners could lead to delays in product shipment and could cause our
revenues to decline.





We could suffer losses and negative publicity if new versions and releases of our products contain errors or
defects.





Our products and their interactions with customers software applications and IT systems are
complex and, accordingly, there may be undetected errors or failures when products are introduced or as new versions are released. We have in the past discovered software errors in our new releases and new products after their introduction which has
resulted in additional research and development expenses. To date, these additional expenses have not been material. We may in the future discover errors in new releases or new products after the commencement of commercial shipments. Since many
customers are using our product for mission- critical business operations, any of these occurrences could seriously harm our business and generate negative publicity.





If we fail to develop the management system and infrastructure to support our growth, our ability to market and sell our products and develop new products may be harmed.





We must plan and manage our growth effectively in order to offer our products and services and achieve revenue growth and profitability in
a rapidly evolving market. For us to effectively manage our growth, we must continue to do the following:





| |  |  | install new management and information control systems; and
| | - |  | -----------------------------------------------------------




| |  |  | expand, train and motivate our workforce.
| | - |  | -----------------------------------------




In particular, we continue to add new software systems to complement and enhance our existing accounting, human resource and sales and marketing software systems. If we fail to install these software
systems in an efficient and timely manner, or if the new systems fail to adequately support our level of operations, then we could incur substantial additional expenses to remedy these failures.





If we do not keep pace with technological change, our products may be rendered obsolete and our operating results may suffer.





Our industry is characterized by very rapid technological change, frequent new product introductions and enhancements, changes in customer demands and evolving
industry standards. Our existing products will be rendered obsolete if we fail to introduce new products or product enhancements that meet new customer demands, support new standards or integrate with new or upgraded versions of packaged
applications. We have also found that the technological life cycle of our product is difficult to estimate. We believe that we must continue to enhance our current product while we concurrently develop and introduce new products that anticipate
emerging technology standards and keep pace with competitive and technological developments. Failure to do so will harm our ability to compete. As a result, we are required to continue to make substantial product development investments.





If we fail to attract and retain qualified personnel, our ability to compete will be harmed.





We depend on the continued service of our key technical, sales and senior management personnel. None of these persons are bound by an
employment agreement. The loss of senior management or other key research, development, sales and marketing personnel could have a material adverse effect on our future operating results. In particular, Dr. JoMei Chang, our President and Chief
Executive Officer, and Dr. M. Dale Skeen, our Chief Technology Officer, would be difficult to replace.




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In addition, we must attract, retain and motivate highly skilled employees. We
face significant competition for individuals with the skills required to develop, market and support our products and services. We cannot be sure that we will be able to recruit and retain sufficient numbers of these highly skilled employees.





We depend on the increasing use of the Internet and on the growth of electronic commerce. If the use of the Internet and electronic
commerce does not grow as anticipated, our revenues could decline and our business will be seriously harmed.





We depend on the increased acceptance and use of the Internet as a medium for electronic commerce and the adoption by businesses of ebusiness solutions. Rapid growth in the use of the Internet is a recent occurrence. As a result,
acceptance and use may not continue to develop at historical rates and a sufficiently broad base of business customers may not adopt or continue to use the Internet as a medium of commerce. Demand and market acceptance for recently introduced
services and products over the Internet are subject to a high level of uncertainty, and there exist few proven services and products.





Our future results may depend significantly on the use of our electronic commerce platform in electronic marketplaces.





We have entered into agreements with licensees who are forming networks that will be powered by our business-to-business electronic commerce platform. These networks have been recently formed and are
at an early stage of development. There is no guarantee regarding the level of activity of different companies in these networks, the effectiveness of the interaction among companies using our business-to-business electronic commerce platform and of
the attractiveness of offerings of our competitors. If these networks are not successful, our business, operating results and financial position could be affected.





If we fail to adequately protect our proprietary rights, we may lose these rights and our business may be seriously harmed.





We depend upon our ability to develop and protect our proprietary technology and intellectual property rights to distinguish our products from our competitors
products. The use by others of our proprietary rights could materially harm our business. We rely on a combination of copyright, patent, trademark and trade secret laws, as well as confidentiality agreements and licensing arrangements, to establish
and protect our proprietary rights. Despite our efforts to protect our proprietary rights, existing laws afford only limited protection. Attempts may be made to copy or reverse engineer aspects of our products or to obtain and use information that
we regard as proprietary. Accordingly, there can be no assurance that we will be able to protect our proprietary rights against unauthorized third-party copying or use. Furthermore, policing the unauthorized use of our products is difficult, and
expensive litigation may be necessary in the future to enforce our intellectual property rights.





If our source code is released to
our customers, our ability to protect our proprietary rights could be jeopardized and our revenues could decline.





Some of our license agreements require us to place the source code for our products in escrow. These agreements generally provide these customers with a limited, non-exclusive license to use this code if:





| |  |  | we fail to provide the product or maintenance and support;
| | - |  | ----------------------------------------------------------




| |  |  | we cease to do business without a successor; or
| | - |  | -----------------------------------------------




| |  |  | there is a bankruptcy proceeding by or against Vitria.
| | - |  | ------------------------------------------------------




Our revenues could decline and our business could be seriously harmed if customers were granted this access.




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Our products could infringe the intellectual property rights of others causing costly litigation and
the loss of significant rights.





Software developers in our market will increasingly be subject to
infringement claims as the number of products in different software industry segments overlap. Any claims, with or without merit, could be time-consuming, result in costly litigation, prevent product shipment or cause delays, or require us to enter
into royalty or licensing agreements, any of which could harm our business. Patent litigation in particular has complex technical issues and inherent uncertainties. In the event an infringement claim against us is successful and we cannot obtain a
license on acceptable terms or license a substitute technology or redesign our product to avoid infringement, our business would be harmed. Furthermore, former employers of our current and future employees may assert that our employees have
improperly disclosed to us or are using confidential or proprietary information.





We may not successfully enter international markets
or generate significant product revenues abroad, which could result in slower revenue growth and harm our business.





We have opened international offices in countries including Australia, Brazil, Canada, France, Germany, Japan, Korea, Italy, Singapore, Spain, Sweden, Switzerland, Taiwan, and the United Kingdom, and may establish additional
international offices. There are a number of challenges to establishing operations outside of the United States and we may be unable to successfully generate significant international revenues. If we fail to successfully establish our products in
international markets, we could experience slower revenue growth and our business could be harmed. It may be difficult to protect our intellectual property in certain international jurisdictions.





We may not be able to efficiently integrate the operations of our acquisitions which may harm our business.





We may make additional acquisitions of, or significant investments in, businesses that offer complementary products, services, technologies or market access. If we are to
realize the anticipated benefits of these acquisitions, the operations of these companies must be integrated and combined efficiently. Customer relationships and strategic partnerships may be disrupted during the integration process which could
result in lost sales and lost customers, and could harm our business. We may also incur significant expenses during the integration process. In addition, the dedication of management resources to integration may detract attention from our day-to-day
business. The successful integration of any acquisition will also depend in part on the retention of key personnel. There can be no assurance that the integration process will be successful or that the anticipated benefits of any business
integration will be fully realized. Achieving the benefits of any acquisition will depend in part on our ability to continue to successfully develop and sell our products and integrate new technologies to develop new products and product features,
in a timely and efficient manner. If we are not successful in these efforts, our business may be harmed.





Failure to raise additional
capital or generate the significant capital necessary to expand our operations and invest in new products could reduce our ability to compete and result in lower revenues.





We may need to raise additional funds, and we cannot be certain that we will be able to obtain additional financing on favorable terms, or at all. If we need additional
capital and cannot raise it on acceptable terms, we may not be able to, among other things:





| |  |  | develop or enhance our products and services;
| | - |  | ---------------------------------------------




| |  |  | acquire technologies, products or businesses;
| | - |  | ---------------------------------------------




| |  |  | expand operations, in the United States or internationally;
| | - |  | -----------------------------------------------------------




| |  |  | hire, train and retain employees; or
| | - |  | ------------------------------------




| |  |  | respond to competitive pressures or unanticipated capital requirements.
| | - |  | -----------------------------------------------------------------------




Our failure to do any of these things could result in lower revenues and could seriously harm our business.




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We are at risk of securities class action litigation due to our expected stock price volatility.





In the past, securities class action litigation has often been brought against a company following a decline
in the market price of its securities. This risk is especially acute for us because technology companies have experienced greater than average stock price volatility in recent years and, as a result, have been subject to, on average, a greater
number of securities class action claims than companies in other industries. In November 2001, Vitria and certain of our officers and directors were named as defendants in a class action stockholder complaint. This litigation could result in
substantial costs and divert managements attention and resources, and could harm our business. See Item 1 Legal Proceedings for more information regarding this litigation.





We have implemented anti-takeover provisions which could discourage or prevent a takeover, even if an acquisition would be beneficial to our stockholders.





Provisions of our amended and restated certificate of incorporation and bylaws, as well as provisions of Delaware law, could make it more
difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. These provisions include:





| |  |  | establishment of a classified Board of Directors of directors requiring that not all members of the Board of Directors may be elected at one time;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | authorizing the issuance of blank check preferred stock that could be issued by our Board of Directors to increase the number of outstanding shares
and thwart a takeover attempt;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | prohibiting cumulative voting in the election of directors, which would otherwise allow less than a majority of stockholders to elect director candidates;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | limitations on the ability of stockholders to call special meetings of stockholders;
| | - |  | ------------------------------------------------------------------------------------




| |  |  | prohibiting stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | establishing advance notice requirements for nominations for election to the Board of Directors or for proposing matters that can be acted upon by stockholders
at stockholder meetings.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




In addition, Section 203 of the Delaware General Corporations Law and the terms of our stock
option plans may discourage, delay or prevent a change in control of Vitria.




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PART II





OTHER INFORMATION





Item
1.Legal Proceedings.





In November 2001, Vitria and certain of its officers and
directors were named as defendants in a class action shareholder complaint filed in the United States District Court for the Southern District of New York, and captioned Kideys, et al., v. Vitria Technology, Inc., et al., Case No. 01-CV-10092. The
plaintiffs allege that Vitria, certain of our officers and directors and the underwriters of our initial public offering, or IPO, violated the federal securities laws because Vitrias IPO registration statement and prospectus contained untrue
statements of material fact or omitted material facts regarding the compensation to be received by, and the stock allocation practices of, the IPO underwriters. The plaintiffs seek unspecified monetary damages and other relief. Similar complaints
were filed in the same court beginning in January 2001 against numerous public companies that first sold their common stock publicly since the mid-1990s.





On August 8, 2001, all of these IPO-related lawsuits were consolidated for pretrial purposes before United States Judge Shira Scheindlin of the Southern District of New York. Judge Scheindlin held an
initial case management conference on September 7, 2001, at which time she ordered, among other things, that the time for all defendants to respond to any complaint be postponed until further order of the Court. Thus, neither Vitria nor any of our
officers or directors has been required to answer the complaint, and no discovery has been served on Vitria.





In
accordance with Judge Scheindlins orders at further status conferences in March and April 2002, appointed lead plaintiffs counsel filed amended, consolidated complaints in these IPO-related lawsuits on April 19, 2002. Defendants then
filed a global motion to dismiss the IPO-related lawsuits on July 15, 2002, as to which the Court does not expect to issue a decision unit at least November 2002. We believe that this lawsuit is without merit and intend to defend against it
vigorously.





Vitria is currently a party to various legal actions arising out of the normal course of business,
none of which is expected to harm Vitrias financial position, cash flows or results of operations.





Item
2.Changes in Securities and Use of Proceeds.





None.





Item 3.Defaults Upon Senior Securities.





None.





Item 4.Submission of Matters to a Vote of Security Holders.





The annual meeting of
stockholders of Vitria Technology, Inc. was held on May 17, 2002 for the purpose of:





(1)  electing one director to our board of directors to serve until the 2005 annual meeting of stockholders;





(2)  to ratify the selection of Ernst & Young LLP as our independent auditors for the fiscal year ending December 31, 2002; and





(3)  to transact such other business as may properly come before the meeting or any adjournment or postponement thereof.




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Proxies for the meeting were solicited pursuant to Section 14(a) of the
Securities Exchange Act of 1934, as amended, and there was no solicitation in opposition of managements solicitations. The final vote on the proposals were recorded as follows:





Proposal 1:





Election
of a director for a three-year term expiring at the 2005 annual meeting:





Nominee

For

WithheldJoMei Chang, Ph.D.

101,783,158

8,630,834





Proposal 2:





The selection of Ernst & Young LLP as our independent auditors for the fiscal year ending December 31, 2002 was ratified by the following vote:





For

Against

Abstain110,101,724

287,061

25,207





Item 5.Other Information.





None.




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Item 6.Exhibits and Reports on Form 8-K.





a)  Exhibits





99.1

Certification of Chief Executive Officer and Chief Financial Officer.





b)  Reports on Form 8-K





No reports on Form 8-K were filed during the quarter ended June 30, 2002.




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SIGNATURES





Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.





VITRIA TECHNOLOGY, INC.By:

/s/    GRAHAM SMITHGraham Smith Senior Vice
President, Chief Financial Officer and Secretary





Date: August 14, 2002




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