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UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





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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 March 31, 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 April 30, 2002 was 130,581,334 shares.





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VITRIA TECHNOLOGY, INC.





INDEX





PagePART I:    FINANCIAL INFORMATIONItem 1.

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

3Condensed Consolidated Statements of Operations for the three months ended March 31, 2002 and March 31, 2001

4Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2002 and March 31, 2002

5Notes to the Condensed Consolidated Financial Statements

6Item 2:

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

10Item 3:

Quantitative and Qualitative Disclosures About Market Risk

19PART II:    OTHER INFORMATIONItem 1:

Legal Proceedings

29Item 2:

Changes in Securities and Uses of Proceeds

29Item 3:

Defaults Upon Senior Securities

29Item 4:

Submission of Matters to a Vote of Security Holders

29Item 5:

Other Information

29Item 6:

Exhibits and Reports on Form 8-K

30Signature

31




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PART I.    FINANCIAL INFORMATION





Item 1.Financial Statements





VITRIA TECHNOLOGY, INC.





CONDENSED CONSOLIDATED BALANCE SHEETS


(in thousands)





March 31, 2002


December 31, 2001(unaudited)


(Note 1)ASSETSCurrent Assets:Cash and cash equivalents

$
48,140


$
60,479Short-term investments


98,952



96,734Accounts receivable, net


16,656



37,215Other current assets


7,506



7,335Total current assets


171,254



201,763Restricted investments


17,356



18,325Property and equipment, net


13,094



14,000Intangible assets, net


2,234



3,779Goodwill


7,247



6,220Other assets


1,572



1,424Total assets

$
212,757


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

$
2,627


$
3,569Accrued payroll and related


12,026



13,232Other accrued liabilities


9,649



10,890Deferred revenue


23,541



27,309Total current liabilities


47,843



55,000Commitments and ContingenciesStockholders Equity:Common Stock


130



130Additional paid-in capital


272,529



271,596Unearned stock-based compensation


(1,227
)


(1,547
)Notes receivable from stockholders


(193
)


(193
)Accumulated other comprehensive income (loss)


77



(241
)Accumulated deficit


(106,402
)


(79,234
)Total stockholders equity


164,914



190,511Total liabilities and stockholders equity

$
212,757


$
245,511





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




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VITRIA TECHNOLOGY, INC.





CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS


(In thousands, except per share amounts)


(unaudited)





Three Months Ended March 31,2002


2001Revenues:License

$
9,954


$
20,861Service and other


14,695



14,477Total revenues


24,649



35,338Cost of revenues:License


455



325Service and other


9,154



8,224Total cost of revenues


9,609



8,549Gross profit


15,040



26,789Operating expenses:Sales and marketing


25,699



24,208Research and development


9,508



9,782General and administrative


5,924



3,845Stock-based compensation


1,009



563Amortization of intangible assets


518



Total operating expenses


42,658



38,398Loss from operations


(27,618
)


(11,609
)Interest income


964



3,507Other expenses, net


(323
)


(138
)Net loss before income taxes


(26,977
)


(8,240
)Provision for income taxes


191



240Net loss

$
(27,168
)

$
(8,480
)Basic and diluted net loss per share

$
(0.21
)

$
(0.07
)Weighted average shares used in calculating basicand diluted net loss per share


128,945



125,208











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




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VITRIA TECHNOLOGY, INC.





CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


(in thousands)


(unaudited)





Three months endedMarch 31,2002


2001Operating activities:Net loss

$
(27,168
)

$
(8,480
)Adjustments to reconcile net loss to net cash used in operating activities:Amortization of intangible assets


518



Loss on write-down of equity investments


39



Depreciation


1,759



1,366Stock-based compensation


1,009



681Changes in assets & liabilities:Accounts receivable


20,559



4,723Other current assets


(171
)


(3,561
)Other assets


(187
)


(123
)Accounts payable


(942
)


2,781Accrued liabilities


(2,447
)


244Deferred revenue


(3,768
)


(3,202
)Net cash used in operating activities


(10,799
)


(5,571
)Investing activities:Purchases of property and equipment


(853
)


(2,748
)Purchases of investments


(71,194
)


(101,028
)Maturities of investments


69,788



80,062Net cash used in investing activities


(2,259
)


(23,714
)Financing activities:Issuance of common stock, net


244



269Net cash provided by financing activities


244



269Effect of exchange rates on changes on cash and cash equivalents


475



(113
)Net decrease in cash and cash equivalents


(12,339
)


(29,129
)Cash and cash equivalents at beginning of period


60,479



154,826Cash and cash equivalents at end of period

$
48,140


$
125,697








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




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VITRIA TECHNOLOGY, INC.





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 loss per share is calculated by dividing net loss by the weighted-average number of shares of common stock outstanding. Basic loss per share does not include shares subject to
Vitrias right of repurchase, which lapses ratably over the related vesting term. Diluted 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 endedMarch 31, 2002


March 31, 2001Numerator for basic and diluted net loss per share:Net loss

$
(27,168
)

$
(8,480
)Denominator for basic and diluted net loss per share:Weighted average shares available to common stock


130,268



128,400Less weighted shares subject to repurchase


(1,323
)


(3,192
)Denominator for basic and diluted net loss per share


128,945



125,208Basic and diluted net loss per share

$
(0.21
)

$
(0.07
)





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):




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VITRIA TECHNOLOGY, INC.





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)(Continued)










March 31, 2002

March 31, 2001Weighted average effect of anti-dilutive securities:Employee stock options (using the Treasury stock method)

11,030

6,923Common stock subject to repurchase agreements

1,323

3,192Total

12,353

10,115





3)    Comprehensive Loss





Comprehensive loss is comprised of net loss and other comprehensive earnings 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 endedMarch 31, 2002


March 31, 2001Net loss

$
(27,168
)

$
(8,480
)Other comprehensive income (loss):Foreign currency translation adjustment


475



(113
)Unrealized gain (loss) on securities


(157
)


66Comprehensive loss

$
(26,850
)

$
(8,527
)





4)    Stock-Based Compensation





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





Three months endedMarch 31, 2002

March 31, 2001Cost of revenues

$
25

$
45Sales and marketing


473


215Research and development


114


203General and administrative


397


100Total stock-based compensation

$
1,009

$
563





As a result of changes made to our management structure in the current period, 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 period ended March 31, 2002.




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VITRIA TECHNOLOGY, INC.





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)(Continued)







5)    Derivative Financial Instruments





Vitria adopted Statement of Financial Accounting Standards, 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 months ended March 31, 2002, we did not engage in any hedging activities.





6)    Goodwill and Other Intangible Assets





The Company adopted FASB
Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, or SFAS 142, on January 1, 2002. At the time of adoption, we were required to evaluate our existing goodwill and intangible assets and
make any necessary reclassifications in order to comply with the new criteria in SFAS 142. In addition, certain disclosures are required to be presented until all periods are accounted for in accordance with SFAS 142. However, as Vitria acquired
XMLSolutions in April, 2001, reconciliation between reported net loss and net loss adjusted for amortization of goodwill is not applicable for the period ended March 31, 2002.





7)    Recent Accounting Pronouncements





In August 2001, the Financial Accounting Standards Board 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 the Financial Accounting Standards Board issued an announcement on the topic of 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. The Announcement should be applied in
financial reporting periods beginning after December 15, 2001 and comparative financial statements for prior periods should be reclassified to comply with the guidance in this announcement. We have adopted the Announcement beginning on January 1,
2002. The Announcement has had no impact on gross margin or net income but has minimally increased services revenue and cost of services revenue.




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VITRIA TECHNOLOGY, INC.





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)(Continued)







8)    Subsequent Events





In April, 2002 we reduced our workforce by approximately 20% in order to reduce costs after lower than expected revenues for the period ending March 31, 2002. In the second quarter
we expect to take a restructuring charge to reflect the costs associated with this layoff as well as to account for the change in our usage of certain real estate facilities in the United States and Europe.




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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





We are a leading provider of innovative integration solutions. We develop and deliver software products and services that
are designed to allow corporations to more easily enable and manage complex interactions between their computer systems internally, as well as externally with their business partners, suppliers and customers. Our flagship product, the BusinessWare ® integration server, is a flexible and easily configurable software platform that is designed
to enable incompatible computer systems to exchange information automatically and in real time, without human intervention, over corporate networks and the Internet. This eliminates manual entry of information into multiple systems, and eliminates
the need to manually exchange information with customers, suppliers and business partners.





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 recurring integration problems by managing collaborative processes within and across
enterprises. The Vitria Collaborative Applications, or VCA, family of products is built on and leverages our integration server, BusinessWare, and provides 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 trading. To enable this activity, complex processes that manage the flow of information
between investment managers, brokers/dealers and custodian banks to support securities trading, allocation and settlement must be automated. The VCA for GSTP includes these pre-defined business processes in an out-of-the-box solution and offers
financial services companies the ability to identify and eliminate bottlenecks and errors, reduce cycle times, track order status and better manage risk.





The BusinessWare integration server and our family of collaborative applications are currently licensed by more than 500 companies worldwide in diverse industries such as telecommunications, healthcare, manufacturing,
energy, financial services and insurance. We sell our products through a direct sales force and through alliances with leading software vendors and systems integrators.





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




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(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, or XML, -based, 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 this 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 28% of our revenues from customers outside the United States in both the three months ended March 31, 2002 and
the three months ended March 31, 2001. For the next quarter, we believe international revenues will remain at approximately the same percentage of total revenues.





Sales to our ten largest customers accounted for 38% of total revenues in the three months ended March 31, 2002 and 35% of total revenues in the three months ended March 31, 2001.
However, no single customer accounted for more than 10% of total revenues in the three months ended March 31, 2002 or in the three months ended March 31, 2001. While our dependence on any single customer has been declining over the past three years,
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 months ended March 31, 2002





The following table sets forth the results of
operations for the three months ended March 31, 2002, expressed as a percentage of total revenues.





Three Months Ended March 31,2002


2001RevenuesLicense

40
%

59
%Service and other

60
%

41
%Total revenues

100
%

100
%Cost of revenuesLicense

2
%

1
%Service and other

37
%

23
%Total cost of revenues

39
%

24
%Gross profit

61
%

76
%Operating expensesSales and marketing

104
%

68
%Research and development

39
%

28
%General and administrative

24
%

11
%Stock-based compensation

4
%

2
%Amortization of intangible assets

2
%

0
%Total operating expenses

173
%

109
%Loss from operations

(112
%)

(33
%)Other income, net

3
%

10
%Net loss before income taxes

(109
%)

(23
%)Provision for income taxes

1
%

1
%Net loss

(110
%)

(24
%)




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Revenues





LICENSE.    License revenues decreased 52% to $10.0 million in the three months ended March 31, 2002 from $20.9 million in the three months ended March 31, 2001. This decrease was the direct
result of a decrease in the number of licenses caused by a general slowdown in information technology spending in our target markets.





SERVICE AND OTHER.    Service and other revenues increased 2% to $14.7 million in the three months ended March 31, 2002 from $14.5 million in the three months ended March 31, 2001. Service and other revenues were
essentially flat when compared to the quarter ended March 31, 2001. First year support decreased over the prior year due to the decline in license revenue. Training revenue also declined in the current period due to economic trends which curtailed
many of our customers training budgets. These declines were offset by an increase in consulting revenue.





Cost of Revenues





LICENSE.    Cost of license revenues consists of royalty payments to third parties for technology incorporated into our
products. As a percentage of license revenues, cost of license revenues increased to 5% in the three months ended March 31, 2002 from 1% for the three months ended March 31, 2001. Measured as a percentage of license sales, the cost of royalties for
third-party products has remained 5% or less over the past three years. 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. We expect the cost of
license revenues to increase as revenue increases. However, as a percentage of license revenues, we do not expect any significant variation in the cost of license revenues from that of the past year.





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 $9.2 million in the three months ended March 31, 2002, an increase of 11% over cost of service and other
revenues of $8.2 million in the three months ended March 31, 2001. The increase in the current quarter was the result of an increase in salary costs due to increased headcount compared to the same quarter a year ago, offset by a decrease in the use
of outside consultants, and a decrease in external recruiting expenditures. As a percentage of service and other revenues, these costs increased 5% to 62% in the three months ended March 31, 2002 from 57% in the three months ended March 31, 2001.
This increase is mainly due to headcount related costs, while service and other revenue remained at approximately the same level. For the next quarter, we expect that cost of service and other revenues will decrease 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 March 31, 2002, sales and
marketing expenses were $25.7 million, an increase of 6% over sales and marketing expenses of $24.2 million for the three months ended March 31, 2001. The increase was primarily due to higher salary expenses as a result of increased headcount and an
increase in the use of outside consultants. The increase was partially offset by decreased commission expense. As a percentage of revenue, sales and marketing expenses increased 36% to 104% in the three months ended March 31, 2002 from 68% in the
three months ended March 31, 2001. This increase as a percentage of revenues is primarily due to a decrease in revenues in the three months ended March 31, 2002. For the next quarter, we expect that sales and marketing expenses will decrease in
absolute dollars.




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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 March 31, 2002,
research and development expenses were $9.5 million, a decrease of 3% from research and development expenses of $9.8 million for the three months ended March 31, 2001. All costs remained essentially flat compared to the same quarter in the prior
year as headcount remained flat and we kept other research and development expenses in line accordingly. As a percentage of total revenues, research and development expenses increased 11% to 39% in the three months ended March 31, 2002 from 28% in
the three months ended March 31, 2001. This increase is primarily due to the decrease in revenues in the three months ended March 31, 2002 while costs remained essentially flat. For the next quarter, we expect that research and development expenses
will decrease in absolute dollars.





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 March 31, 2002, general and administrative
expenses were $5.9 million, an increase of 54% over general and administrative expenses of $3.8 million for the three months ended March 31, 2001. The increase is primarily attributable to higher salary expenses as a result of increased headcount,
an increase in outside consulting expense associated with the implementation of internal systems, and a decrease in sublease rental income. As a percentage of revenue, general and administrative expenses increased to 24% in the three months ended
March 31, 2002 from 11% in the three months ended March 31, 2001. This increase is due to both the 54% increase in general and administrative expenses as explained above as well as the 30% decrease in revenues in the three months ended March 31,
2002 from the same period in the prior year. For the next quarter, we expect that general and administrative expenses will decrease in absolute dollars.





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 March 31, 2002, stock-based compensation was $1.0 million, an increase of 79% over stock-based compensation of $563,000 for the three months ended March 31, 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 Vitria 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 current period 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 Vitrias initial public offering in September 1999. This unearned employee stock-based compensation is being amortized over a five-year vesting period. We expect to record employee
stock-based compensation expenses of approximately $276,000, $218,000, and $186,000 for the periods ending June 30, 2002, September 30, 2002, and December 31, 2002, respectively. This unearned compensation expense will be reduced in future periods
to the extent that options are terminated prior to vesting.





AMORTIZATION OF PURCHASED
INTANGIBLES.    Amortization of purchased intangible assets associated with the acquisition of XML Solutions in April, 2001 resulted in charges to earnings of $518,000 for the three months ended March 31, 2002. There was no
amortization of intangible assets in the three months ended March 31, 2001. The purchased intangible assets will continue to be amortized over their estimated useful lives. Goodwill associated with this purchase was amortized over its estimated
useful life in 2001. However, in accordance with SFAS 141 and 142, as referenced in Note 7, beginning January 1, 2002, goodwill is no longer being amortized but will be subject to a test of impairment at least annually.





INTEREST AND OTHER INCOME, NET.    Interest and other income, net, decreased by 81% to $641,000 in the three months ended March 31,
2002 from $3.4 million in the three months ended March 31, 2001. The decrease is




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primarily attributable to lower interest income earned from our short-term investments due to lower interest rates on
investments and lower cash balances in the three months ended March 31, 2002.





Provision for Income Taxes





We recorded an income tax provision of $191,000 in the three-month period ended March 31, 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 $240,000 for the three-month period ended March 31, 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 March 31, 2002, we had $48.1 million in cash and
cash equivalents, $99.0 million in short-term investments, and $123.4 million in working capital with no outstanding long-term debt, compared to $125.7 million in cash and cash equivalents, $90.6 million in short-term investments and $188.3
million in working capital with no outstanding long term debt at March 31, 2001.





Net cash used in operating activities was
$10.8 million for the three months ended March 31, 2002 and was primarily due to net loss for the quarter, a decrease in deferred revenue and accrued liabilities, offset by a decrease in accounts receivable. Net cash used in operating activities was
$5.6 million for the three months ended March 31, 2001, primarily due to our net loss, partially offset by a decrease in accounts receivable.





Net cash used in investing activities was $2.3 million in the three months ended March 31, 2002 and was primarily due to purchases of fixed assets and purchases of investments, partially offset by maturities of
investments. Net cash used in investing activities was $23.7 million in the three months ended March 31, 2001, primarily due to purchasing investments, partially offset by maturities of investments.





Net cash provided by financing activities was $244,000 in the three months ended March 31, 2002. Net cash provided by financing activities was $269,000
in the three months ended March 31, 2001. Net cash provided by financing activities for both periods was primarily from the issuance of common stock.





During the three months ended March 31, 2002 our net accounts receivable decreased $20.5 million from $37.2 million at December 31, 2001 to $16.7 million at March 31, 2002. The reason for the decline was due to very
strong collections as well as lowered revenues in the quarter ended March 31, 2002. Both of these factors will reduce our future cash flows for at least the next quarter. At March 31, 2002 our gross accounts receivable balance is $19.8 million with
an allowance for doubtful accounts of $3.1 million, which is approximately 16% of our gross accounts receivable balance. We believe that this is an adequate provision for doubtful accounts and that the net accounts receivables balance of $16.7
million represents a fully realizable amount.





During the three months ended March 31, 2002, our deferred revenue balance
decreased $3.8 million from $27.3 million at December 31, 2001 to $23.5 million at March 31, 2002. The primary reasons for this decline are lower than anticipated license revenues in the current quarter, which reduced our first year support
billings, as well as lower than expected support renewals during the quarter from customers who initially did business with us in 2000 and 2001 but who are no longer in business in 2002.





Contractual Cash Obligations





At March 31, 2002, we had
operating lease commitments of approximately $37.4 million, payable through 2013 as noted in the table below.




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Total MinimumYear ending March 31,

2007 and Thereafter2002

2003

2004

2005

2006


Lease PaymentOperating Leases

$
6,186

$
8,154

$
6,729

$
6,472

$
4,621

$
5,274

$
37,436





Off-Balance Sheet Arrangements





At March 31, 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.





Operating Capital and Capital Expenditure Requirements





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
and decline slightly as a percentage of planned revenue. 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. We intend to continue to invest selectively in sales, marketing and research and
development and expect to incur operating losses through the third quarter of 2002. 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:




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| |  |  | 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;
| | - |  | -------------------------------------------------------------------------------------




| |  |  | 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 March 31, 2002 or March 31, 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 available to stockholders, 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 $106.4 million as of March 31, 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




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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. 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.





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 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.




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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 three months ended March 31, 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 three months ended March 31, 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.





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




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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, Mercator Software, Microsoft, 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 new, process automation and real-time analysis functionality. Additionally, in this fast-changing 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.





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.





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.







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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 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 majority of our total revenues has been, and is expected to be, 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 fails to gain broad market acceptance, due to their inability to




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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 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.




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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.





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.




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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.





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 intend to
establish additional international offices. There are a number of challenges to establishing operations outside of the United




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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 acquired XMLSolutions Corporation in April 2001. 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.





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:




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| |  |  | 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. However, Judge Scheindlin does not expect
the defendants to file motions to dismiss the amended, consolidated complaints until at least summer 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.





None.





Item 5.Other Information.





None.




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





a)  Exhibits





b)  Reports on Form 8-K





No reports on Form 8-K were filed during the quarter ended March 31, 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: May 14, 2002




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