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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   FORM 10-Q
 
 (Mark One) þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934.
 For the quarterly period ended March 31, 2005 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934.
 For the transition period from ____________ to ____________. Commission file number: 0-27207 VITRIA TECHNOLOGY, INC. (Exact Name of Registrant as Specified in Its Charter)
 Delaware
    
    77-0386311(State or Other Jurisdiction of
    
    (I.R.S. EmployerIncorporation or Organization)
    
    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)   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 þ No o Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange
Act Rule 12b-2). Yes þ No o The number of shares of Vitrias common stock, $0.001 par value, outstanding as of March 31,
2005 was 33,441,503 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, 2005 and December 31, 2004
    
    
    3Condensed Consolidated Statements of Operations for the three months
ended March 31, 2005 and 2004
    
    
    4Condensed Consolidated Statements of Cash Flows for the three months
ended March 31, 2005 and 2004
    
    
    5Notes to the Condensed Consolidated Financial Statements
    
    
    6Item 2: Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13Item 3: Quantitative and Qualitative Disclosures About Market Risk
    
    
    25Item 4: Controls and Procedures
    
    
    32PART II: OTHER INFORMATIONItem 1: Legal Proceedings
    
    
    34Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    34Item 3: Defaults Upon Senior Securities
    
    
    34Item 4: Submission of Matters to a Vote of Security Holders
    
    
    34Item 5: Other Information
    
    
    35Item 6: Exhibits
    
    
    35Signature
    
    
    36EXHIBIT 10.40EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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PART I. FINANCIAL INFORMATION 
 ITEM 1. Financial Statements Vitria Technology, Inc. 
   March 31,
    
    
    December 31,2005
    
    
    2004(unaudited)
    
    
    (Note 1)AssetsCurrent Assets:Cash and cash equivalents
    
    $
    31,426
    
    
    $
    32,106Short-term investments
    
    
    41,167
    
    
    
    46,457Accounts receivable, net
    
    
    15,018
    
    
    
    10,529Other current assets
    
    
    2,328
    
    
    
    1,880Total current assets
    
    
    89,939
    
    
    
    90,972Property and equipment, net
    
    
    1,075
    
    
    
    1,053Other assets
    
    
    810
    
    
    
    872Total assets
    
    $
    91,824
    
    
    $
    92,897Liabilities and Stockholders EquityCurrent Liabilities:Accounts payable
    
    $
    1,334
    
    
    $
    1,777Accrued compensation
    
    
    3,883
    
    
    
    4,186Other accrued liabilities
    
    
    3,722
    
    
    
    4,086Accrued restructuring expenses
    
    
    5,938
    
    
    
    6,091Deferred revenue
    
    
    15,033
    
    
    
    11,082Total current liabilities
    
    
    29,910
    
    
    
    27,222Long-Term Liabilities:Accrued restructuring expenses
    
    
    5,593
    
    
    
    7,332Other long-term liabilities
    
    
    1,094
    
    
    
    750Total long-term liabilities
    
    
    6,687
    
    
    
    8,082Commitments and Contingencies (Note) 7Stockholders Equity:Common Stock
    
    
    34
    
    
    
    33Additional paid-in capital
    
    
    275,773
    
    
    
    275,366Unearned stock-based compensation
    
    
    (335
    )
    
    
    Accumulated other comprehensive income
    
    
    360
    
    
    
    382Accumulated deficit
    
    
    (220,109
    )
    
    
    (217,692
    )Treasury stock, at cost
    
    
    (496
    )
    
    
    (496
    )Total stockholders equity
    
    
    55,227
    
    
    
    57,593Total liabilities and stockholders equity
    
    $
    91,824
    
    
    $
    92,897
 The accompanying notes are an integral part of these condensed consolidated financial statements. 3




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Vitria Technology, Inc. 
    Three Months EndedMarch 31,2005
    
    
    2004Revenue:License
    
    $
    5,422
    
    
    $
    3,391Service and other
    
    
    11,123
    
    
    
    10,858Total revenue
    
    
    16,545
    
    
    
    14,249Cost of revenue:License
    
    
    121
    
    
    
    198Service and other
    
    
    5,682
    
    
    
    6,088Total cost of revenue
    
    
    5,803
    
    
    
    6,286Gross profit
    
    
    10,742
    
    
    
    7,963Operating expenses:Sales and marketing
    
    
    4,973
    
    
    
    6,567Research and development
    
    
    4,542
    
    
    
    4,656General and administrative
    
    
    3,637
    
    
    
    3,282Stock-based compensation
    
    
    62
    
    
    
    41Restructuring
    
    
    136
    
    
    
    54Total operating expenses
    
    
    13,350
    
    
    
    14,600Loss from operations
    
    
    (2,608
    )
    
    
    (6,637
    )Interest income
    
    
    389
    
    
    
    251Other income (expense), net
    
    
    (151
    )
    
    
    (140
    )Net loss before income taxes
    
    
    (2,370
    )
    
    
    (6,526
    )Provision for income taxes
    
    
    47
    
    
    
    120Net loss
    
    $
    (2,417
    )
    
    $
    (6,646
    )Basic and diluted net loss per share
    
    $
    (0.07
    )
    
    $
    (0.20
    )Weighted average shares used in computing basic
and diluted net loss per share
    
    
    33,373
    
    
    
    32,816
 The accompanying notes are an integral part of these condensed consolidated financial statements. 4




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Vitria Technology, Inc. 
    Three Months EndedMarch 31,2005
    
    
    2004Operating activities:Net loss
    
    $
    (2,417
    )
    
    $
    (6,646
    )Adjustments to reconcile net loss to net cash
used in operating activities:Forgiveness of note receivable from employees
    
    
    
    
    
    
    74Depreciation
    
    
    333
    
    
    
    645Stock-based compensation
    
    
    62
    
    
    
    41Provision for doubtful accounts
    
    
    148
    
    
    
    Changes in assets & liabilities:Accounts receivable
    
    
    (4,637
    )
    
    
    4,616Other current assets
    
    
    (448
    )
    
    
    265Other assets
    
    
    62
    
    
    
    12Accounts payable
    
    
    (443
    )
    
    
    274Accrued liabilities
    
    
    (667
    )
    
    
    (434
    )Accrued restructuring charges
    
    
    (1,892
    )
    
    
    (2,047
    )Deferred revenue
    
    
    3,951
    
    
    
    2,450Other long term liabilities
    
    
    344
    
    
    
    (16
    )Net cash used in operating activities
    
    
    (5,604
    )
    
    
    (766
    )Investing activities:Purchases of property and equipment
    
    
    (355
    )
    
    
    (17
    )Purchases of investments
    
    
    (8,052
    )
    
    
    (8,000
    )Maturities of investments
    
    
    13,356
    
    
    
    8,642Net cash provided by investing activities
    
    
    4,949
    
    
    
    625Financing activities:Issuance of common stock, net
    
    
    11
    
    
    
    257Net cash provided by financing activities
    
    
    11
    
    
    
    257Effect of exchange rates on changes on cash and cash equivalents
    
    
    (36
    )
    
    
    (49
    )Net increase (decrease) in cash and cash equivalents
    
    
    (680
    )
    
    
    67Cash and cash equivalents at beginning of period
    
    
    32,106
    
    
    
    8,782Cash and cash equivalents at end of period
    
    $
    31,426
    
    
    $
    8,849Supplemental disclosures of cash flow information:Income taxes paid
    
    $
    106
    
    
    $
    250Interest paid
    
    $
    9
    
    
    $
    5
 The accompanying notes are an integral part of these condensed consolidated financial statements. 5




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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1) Basis of Presentation The accompanying unaudited condensed consolidated financial statements include the accounts of
Vitria Technology, Inc. (the Company or Vitria) and its subsidiaries. These unaudited
financial statements have been prepared in accordance with accounting principles generally accepted
in the United States and with the rules and regulations of the Securities and Exchange Commission.
Certain information and footnote disclosures normally included in consolidated financial statements
have been condensed or omitted in accordance with the rules and regulations of the Securities and
Exchange Commission. As a result, these financial statements should be read in conjunction with
the audited financial statements and notes thereto included in our Annual Report on Form 10-K for
the year ended December 31, 2004. In the opinion of Vitrias management, these unaudited condensed consolidated financial
statements include all the adjustments necessary to fairly state our financial position and the
results of our operations and cash flows. The results of our 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. The balance sheet at December 31, 2004 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. Stock-based compensation We currently account for stock-based employee compensation arrangements using the intrinsic
value method in accordance with the provisions of Accounting Principles Board Opinion (APB) 25,
Accounting for Stock Issued to Employeesand Financial Accounting Standards Board Interpretation
(FIN) 44, Accounting for Certain Transactions Involving Stock Compensation, and comply with the
disclosure provisions of Statement of Financial Standards (SFAS) 123, Accounting for Stock-Based
Compensationand SFAS 148, Accounting for Stock-based Compensation  Transition and Disclosure.
Under APB 25 and related interpretations compensation is based on the difference, if any, on the
date of the grant between the fair value of our stock and the exercise price. Unearned compensation
is amortized and expensed in accordance with FIN 28, Accounting for Stock Appreciation Rights and
Other Stock Option or Award Plan,using the multiple option approach. We account for stock-based
compensation issued to non-employees in accordance with the provisions of SFAS 123 and Emerging
Issued Task Force (EITF) 96-18, Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services. In December 2004, the Financial Accounting Standard Board (FASB) issued SFAS 123(R),
Share-Based Payment, which replaces SFAS 123, Accounting for Stock-Based Compensation, and
supersedes APB Opinion 25, Accounting for Stock Issued to Employees. SFAS 123(R) requires
compensation costs relating to share-based payment transactions be recognized in financial
statements. The pro forma disclosure previously permitted under SFAS 123 will no longer be an
acceptable alternative to recognition of expenses in the financial statements. We are required to
adopt SFAS 123(R) starting in the first fiscal quarter of 2006. We expect the adoption of SFAS
123(R) will have a material adverse impact on our net income and net income per share. We are
currently in the process of evaluating the extent of such impact. We currently follow APB Opinion 25 and related interpretations in accounting for our employee
stock options because, as discussed below, the alternative fair value accounting provided for under
SFAS 123 requires the use of option 6




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valuation models that were not developed for use in valuing employee stock options. Under APB
Opinion 25, because the exercise price of our employee stock options equals the market price of the
underlying stock on the date of grant, no compensation expense is recognized in our financial
statements. Pro forma information regarding net loss and net loss per share is required by SFAS 123. This
information is required to be determined as if we had accounted for our employee stock options
(including shares issued under the Employee Stock Purchase Plan, collectively called stock based
awards), under the fair value method of that statement. The fair value of our stock based awards to employees was estimated using the following
weighted-average assumptions: Three Months Ended,March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Stock option plans
    
    
    ESPPRisk-free interest rate
    
    
    3.96
    %
    
    
    3.00
    %
    
    
    2.73
    %
    
    
    3.14
    %Expected Lives (in years)
    
    
    3
    
    
    
    3
    
    
    
    1
    
    
    
    1Dividend yield
    
    
    0
    
    
    
    0
    %
    
    
    0
    
    
    
    0
    %Expected volatility
    
    
    64
    %
    
    
    126
    %
    
    
    91
    %
    
    
    138
    %
 The Black-Scholes option-pricing model was developed for use in estimating the fair value
of traded options that have no vesting restrictions and are fully transferable. Option valuation
models require the input of highly subjective assumptions, including the expected volatility of the
stock price. We use a third party analysis to assist in developing volatility and expected life of
stock options. The volatility and expected life of the stock options is based upon historical and
other economic data trended into the future. Because our stock based awards have characteristics
significantly different from those of traded options and because changes in the subjective input
assumptions can materially affect the fair value estimates, in the opinion of management, the
existing models may not necessarily provide a reliable single measure of the fair value of our
stock based awards. The following table illustrates the effect on net loss and loss per share if we had applied
the fair value recognition provisions of SFAS 123 to employee stock-based compensation, including
shares issued under our stock option plans and Employee Stock Purchase Plan. For purposes of pro
forma disclosures, the estimated fair value of the options is assumed to be amortized to expense
over the options vesting periods and the amortization of deferred compensation, as calculated
under the intrinsic value method, has been added back. Pro forma information follows (in
thousands, except per share amounts): Three Months Ended,March 31,2005
    
    
    2004Net loss, as reported
    
    $
    (2,417
    )
    
    $
    (6,646
    )Add: stock-based employee compensation expense included
in reported net loss
    
    
    62
    
    
    
    41Deduct: total stock-based compensation expense determined
under the fair value based method for all awards
    
    
    (1,002
    )
    
    
    (2,086
    )
 7




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Three Months Ended,March 31,2005
    
    
    2004Pro forma net loss
    
    $
    (3,357
    )
    
    $
    (8,691
    )Net loss per share as reported
    
    $
    (0.07
    )
    
    $
    (0.20
    )Pro forma net loss per share
    
    $
    (0.10
    )
    
    $
    (0.26
    )Total shares used in calculation
    
    $
    33,373
    
    
    $
    32,816
 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. 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 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. For any
period in which a net loss is reported, diluted net loss per share equals basic net loss per share. 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 31,2005
    
    
    2004Numerator for basic and diluted net loss per share:Net loss
    
    $
    (2,417
    )
    
    $
    (6,646
    )Denominator for basic and diluted net loss per share:Weighted average shares of common stock
Outstanding
    
    
    33,373
    
    
    
    32,820Less shares subject to repurchase
    
    
    0
    
    
    
    (4
    )Denominator for basic and diluted net loss per share
    
    
    33,373
    
    
    
    32,816Basic and diluted net loss per share
    
    $
    (0.07
    )
    
    $
    (0.20
    )
 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 EndedMarch 31,2005
    
    
    2004Weighted average effect of anti-dilutive securities:Employee stock options (using the treasury stock method)
    
    
    297
    
    
    
    1,688Common stock subject to repurchase agreements
    
    
    0
    
    
    
    4Total
    
    
    297
    
    
    
    1,692
 8




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3) Comprehensive Loss Comprehensive loss is comprised of net loss and other comprehensive income (loss) such as
foreign currency translation gains and losses and unrealized gains or losses on available-for-sale
marketable securities. Vitrias total comprehensive loss was as follows (in thousands): Three Months EndedMarch 31,2005
    
    
    2004Net loss
    
    $
    (2,417
    )
    
    $
    (6,646
    )Other comprehensive income (loss):Foreign currency translation adjustment
    
    
    (36
    )
    
    
    (49
    )Unrealized gain (loss) on securities
    
    
    14
    
    
    
    1Comprehensive loss
    
    $
    (2,439
    )
    
    $
    (6,694
    )
 The components of accumulated other comprehensive losses are as follows (in thousands): March 31,
    
    
    December 31,2005
    
    
    2004Foreign currency translation adjustments
    
    $
    451
    
    
    $
    487Unrealized gain (loss) on marketable debt
securities
    
    
    (91
    )
    
    
    (105
    )Total accumulated other comprehensive gain
    
    $
    360
    
    
    $
    382
 4) Stock-Based Compensation Total stock based compensation expenses were $62,000 and $41,000 for the three months ended
March 31, 2005 and 2004 respectively. In the quarter ended March 31, 2005, we issued a restricted
stock award. The expense related to this stock award is being recognized over a four year period
as service is rendered. We recorded $7,000 in stock-based compensation expense in the quarter ended
March 31, 2005 related to this award. In addition, we recorded $55,000 in stock-based compensation
expense for a stock award granted to a former member of our Board of Directors. In the three months
ended March 31, 2004, our stock-based compensation consisted solely of the amortization of unearned
employee stock-based compensation on options issued to employees prior to our initial public
offering in September 1999. Stock-based compensation is broken down as follows (in thousands): 9




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Three Months EndedMarch 31,2005
    
    
    2004Cost of revenue
    
    $
    
    
    
    $
    15Sales and marketing
    
    
    
    
    
    
    15Research and development
    
    
    
    
    
    
    8General and administrative
    
    
    62
    
    
    
    3Total stock-based compensation
    
    $
    62
    
    
    $
    41
 5) Restructuring, Impairments and Other Charges In 2002 we initiated actions to reduce our cost structure due to sustained negative economic
conditions that impacted our operations and resulted in lower than anticipated revenue. The plan
was a combination of a reduction in workforce of approximately 285 employees, consolidations of
facilities in the United States and United Kingdom and the related disposal of leasehold
improvements and equipment. As a result of these restructuring actions, we incurred a charge of
$19.5 million in the year ended December 31, 2002. The restructuring charge included approximately
$4.2 million of severance related charges and $15.3 million of committed excess facilities
payments, which included $463,000 for the write-off of leasehold improvements and equipment in
vacated facilities. In 2003 we initiated actions to further reduce our cost structure. The plan was a combination
of a reduction in workforce of approximately 100 employees, consolidations of facilities in the
United States and United Kingdom and the related disposal of leasehold improvements and equipment.
As a result of these restructuring actions, we incurred a charge of $16.1 million in the year ended
December 31, 2003. The restructuring charge included approximately $2.9 million of severance
related charges and $13.0 million of committed excess facilities charges, which included $2.2
million for the write-off of leasehold improvements and equipment in vacated facilities. The
charge also included $180,000 in accretion charges related to the fair value treatment for the
facilities we restructured in 2003, in accordance with SFAS 146, Accounting for Costs Associated
with Exit or Disposal Activities. During 2004, we incurred $1.1 million in restructuring costs. These costs consisted of
accretion expense due to the fair value treatments for those leases restructured in 2003 under SFAS
146 and adjustments we made to our estimates for future sublease income and other assumption of
future costs, which we revise periodically based on current market conditions. In the quarter ended March 31, 2005, we incurred $136,000 in restructuring costs. These costs
consisted of accretion expense due to the fair value treatments for those leases restructured in
2003 under SFAS 146 and adjustments we made to our estimates for future sublease income and other
assumption of future costs, which we revise periodically based on current market conditions. As of March 31, 2005, $11.5 million related to facility closures remains accrued from all of
our restructuring actions net of $2.3 million of estimated future sublease income and $2.1 million
of contractual future sublease income. A portion of this liability is based on the fair value
treatment required by SFAS 146, which we adopted as of January 1, 2003. In the three months ended
March 31, 2005, we reclassified $467,000 from accrued restructuring to accrued rent to account for
rent expense in periods prior to restructurings for which our landlord has not yet billed us,
resulting in an increase in rent expense of $125,000 during the first quarter of 2005, representing
the difference between the $467,000 gross rent expense and the present valued amount of $342,000
that was previously included in accrued restructuring. 10




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Facilitiesconsolidation
    
    
    Severance
    
    
    TotalFiscal 2002 restructuring
    
    $
    15,358
    
    
    $
    4,158
    
    
    $
    19,516Cash payments
    
    
    (2,592
    )
    
    
    (4,014
    )
    
    
    (6,606
    )Fixed assets write-offs
    
    
    (463
    )
    
    
    
    
    
    
    (463
    )Reclassifications of deferred rent
    
    
    747
    
    
    
    
    
    
    
    747Balance at December 31, 2002
    
    
    13,050
    
    
    
    144
    
    
    
    13,194Fiscal 2003 restructuring
    
    
    12,077
    
    
    
    2,477
    
    
    
    14,554Cash payments
    
    
    (5,627
    )
    
    
    (2,621
    )
    
    
    (8,248
    )Fixed assets write-offs
    
    

    (2,247
    )
    
    
    
    
    
    
    (2,247
    )Facilities adjustment and accretion
    
    
    1,229
    
    
    
    
    
    
    
    1,229Severance
    
    
    
    
    
    
    330
    
    
    
    330Balance at December 31, 2003
    
    
    18,482
    
    
    
    330
    
    
    
    18,812Cash payments
    
    
    (6,295
    )
    
    
    (330
    )
    
    
    (6,625
    )Facility adjustments and accretion
    
    
    1,236
    
    
    
    
    
    
    
    1,236Balance at December 31, 2004
    
    
    13,423
    
    
    
    
    
    
    
    13,423Cash payments
    
    
    (1,686
    )
    
    
    
    
    
    
    (1,686
    )Facility adjustments and accretion
    
    
    136
    
    
    
    
    
    
    
    136Reclassifications of accrued rent
    
    
    (342
    )
    
    
    
    
    
    
    (342
    )Balance at March 31, 2005
    
    $
    11,531
    
    
    $
    
    
    
    $
    11,531
 The facilities consolidation charges for all of our restructuring actions were calculated
using managements best estimates and were based upon the remaining future lease commitments for
vacated facilities from the date of facility consolidation, net of estimated future sublease
income. We have engaged brokers to locate tenants to sublease all of the excess facilities and, to
date, have signed sublease agreements for two of the four remaining buildings. The estimated
costs of vacating these leased facilities were based on market information and trend analyses,
including information obtained from third-party real estate sources. Our ability to generate
estimated sublease income is highly dependent upon the existing economic conditions, particularly
lease market conditions in certain geographies, at the time the sublease arrangements are
negotiated with third parties. While the amount we have accrued is the best estimate, these
estimates are subject to change and may require routine adjustment as conditions change through the
implementation period. If macroeconomic conditions related to the commercial real estate market
worsen, we may be required to increase our estimated cost to exit certain facilities. 6) Deferred Revenue Deferred revenue is comprised primarily of deferred maintenance, consulting and training
revenue. Deferred maintenance revenue is not recorded until it has been supported by a formal
commitment to pay or until it has been collected. Deferred maintenance is recognized in the
consolidated statement of operations over the term of the arrangement, which is most commonly
twelve months but can be as long as 18 or 24 months. Consulting and training revenue are generally
recognized as the services are performed. Long term deferred revenue is part of other long-term
liabilities on our Consolidated Balance Sheets and totaled $904,000 as of March 31, 2005 and
$673,000 as of December 31, 2004. Total deferred revenue was $16.1 million at March 31, 2005 and
$11.8 million at December 31, 2004. 11




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7) Related Party Transactions In December 2003, we sold our interest in our China operations to QilinSoft LLC (formerly
referred to as ChiLin LLC). QilinSoft is owned and controlled by Dr. JoMei Chang, a director and a
significant stockholder, and Dr. Dale Skeen, a director and our Chief Executive Officer and Chief
Technology Officer, the spouse of Dr. Chang and a significant stockholder. At the time of the sale, Vitria and QilinSoft entered into a license agreement whereby
QilinSoft received a royalty-bearing license to distribute our products in China. In addition,
Vitria and QilinSoft executed a development agreement in December 2003 pursuant to which QilinSoft
performs development work and other fee-bearing services for us. In April 2004, Dr. Chang and Dr.
Skeen entered into a confirmation agreement with us confirming the nature of their involvement
and/or investment in QilinSoft including obligations with respect to non-solicitation and hiring of
our employees and non-competition with Vitria. In July 2004, we entered into a professional
services agreement with QilinSoft pursuant to which QilinSoft may order professional services from
us. In November 2004, we entered into a two year marketing agreement with QilinSoft governing the
marketing and sales relationship between the parties. During the first quarter of 2005, we recorded revenue of $50,000 from QilinSoft and incurred
charges of $419,000 for development work performed by QilinSoft, recorded in research and
development expense. At March 31, 2005, we owed QilinSoft $113,000 for development work performed in the first
quarter of 2005 and due by April 30, 2005 and we had no outstanding receivable balances due from
QilinSoft. 8) Credit Facilities with Silicon Valley Bank We entered into a Loan and Security Agreement with Silicon Valley Bank, dated June 28, 2002,
for the purpose of establishing a revolving line of credit. We modified this agreement on June 11,
2004 and reduced the line of credit from $15.0 million to $12.0 million. The modification requires
us to maintain minimum cash, cash equivalents, and short-term investments balance of $30.0 million.
The agreement also requires us to maintain our primary depository and operating accounts with
Silicon Valley Bank and invest all of our investments through Silicon Valley Bank. The line of
credit serves as collateral for letters of credit and other commitments, even though these items do
not constitute draws on the line of credit. Available advances under the line of credit are
reduced by the amount of outstanding letters of credit and other commitments. Interest on
outstanding borrowings on the line of credit accrues at the banks prime rate of interest. The
agreement is secured by all of Vitrias assets. As of March 31, 2005, we have not borrowed against this line of credit. In connection with
the line of credit agreement, we have outstanding letters of credit of approximately $5.5 million
related to certain office leases at March 31, 2005. Fees related to the outstanding letters of
credit totaled $12,000 and $16,000 for the three months ended March 31, 2005 and 2004,
respectively. 9) Segment Information We provide business process integration software and services to businesses around the world.
Since managements primary form of internal reporting is aligned with the offering of these
software products and services, we believe that we have operated in one segment during each of the
two quarters ended March 31, 2005 and 2004. We sell our products primarily to healthcare and
insurance, telecommunications, manufacturing, and finance industries in the United States and in
foreign countries through our direct sales personnel, resellers and system integrators. During the first quarter of 2005, we had one customer which accounted for 24% of our revenue
and, as of March 31, 2005, this customer accounted for 31% of our accounts receivable balance. No
other customer accounted for more than 12




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10% of our revenue during the first quarter of 2005, or more
than 10% of our accounts receivable balance as of March 31, 2005. 
 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 quarterly 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 Vitria provides business process integration software and services for corporations in
healthcare and insurance, telecommunications, manufacturing, finance and other industries. Our
software products orchestrate interactions between isolated software systems, automate manual
process steps, facilitate both manual and automated resolution of process exceptions and manage
data exchanges between companies. Our software products also provide operational staff and
managers with real-time and historical views of individual transactions as well as of large-scale
processes spanning multiple systems and organizations. Our customers use our software products to pursue new revenue opportunities, cut operating
costs, reduce process cycle times, decrease process errors, improve customer service, increase
supply chain efficiencies and more easily adapt their business processes to changing requirements
and conditions. Our strategy is to help our customers manage complex business processes, particularly those
that require enterprise-class reliability from their underlying software infrastructure. These
targeted business processes typically use multiple software applications, involve a series of steps
occurring over a period of time, include both system-to-system interactions and manual workflow and
require end-to-end visibility. Our experience is that such process requirements are most common in
Global 2000 companies in healthcare and insurance, telecommunications, manufacturing and finance,
although we have customers in other industries as well. We execute our strategy in two ways. First, we offer a software platform for business process
integration. Customers use our platform to create and deploy process and integration content (such
as process models and data transformations) to meet their unique needs. Second, we offer pre-built
process applications with our platform to support selected business processes in specific
industries. By providing Vitria-built content based on industry standards and best practices, our
applications are designed to reduce customer implementation time while providing an adaptable
business process integration framework for meeting future needs. Product Overview Vitria:BusinessWareis our business process integration platform and flagship
product. It uses graphically modeled business process and integration logic as the foundation for
orchestrating complex interactions among dissimilar software applications, databases, web services,
people, and companies over corporate networks and the Internet. Our platform is typically used by
information technology professionals to support complex business processes like order 13




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management
and fulfillment, securities trades and insurance claims processing, supply chain management, and
customer service. Vitria:BusinessWareincludes a business process integration server and various options that
extend the servers capabilities. Some of these optional products enable connectivity to specific
software applications, databases, and protocols. Other options provide additional capabilities for
data transformation, process analysis and visualization, and trading partner management. Our business process integration platform products have faced increasing competition over the
past few years. We expect the intensity of our competition in platform sales to further increase
as market adoption of lower-level integration technologies like messaging, transformation, and web
services continue to shift towards evolving industry standards supported by a broad range of
software vendors. Consequently, we expect our pre-built process applications product line to be our primary
source of revenue growth in the years ahead. By combining the power and flexibility of the
Vitria:BusinessWareplatform with pre-built content, we believe that our pre-built process
applications can command higher prices and offer us a more diverse revenue composition than our
platform sales alone. In 2005, we plan to increase investment in our pre-built process applications product line and
bring several new applications to market, increase sales of our existing pre-built process
applications, bring new pre-built process applications to market successfully, enhance our platform
products, improve execution in sales and marketing, expand our strategic alliances to increase our
revenue opportunities and renew enterprise license agreements with some of our most important
customers. In addition, we plan to selectively invest in Research and Development and Sales and
Marketing in order to strengthen our future growth, while at the same time, contain overall costs
in order to reduce our net cash outflow. CRITICAL ACCOUNTING POLICIES Our discussion and analysis of our financial condition and results of operations are based
upon our consolidated financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States. The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenue and expenses, and related disclosures. We evaluate our estimates, on an
on-going basis, including those related to revenue recognition, allowances for doubtful accounts
and restructuring charges. We base our estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the results of which form
the basis for making judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these estimates under
different assumptions or conditions. We believe the following critical accounting policies affect the more significant judgments
and estimates used in the preparation of our consolidated financial statements. Revenue Recognition We derive our revenue from sales of software licenses and related services. In accordance
with the provisions of Statement of Position (SOP) 97-2, Software Revenue Recognition, as
amended, we record revenue from software licenses when a license agreement is signed by both
parties, the fee is fixed or determinable, collection of the fee is probable and delivery of the
product has occurred. For electronic delivery, we consider our software products to have been
delivered when the access code to download the software from the Internet has been provided to the
customer. If an element of the agreement has not been delivered, revenue for that element is
deferred based on vendor-specific objective evidence of fair value. If vendor-specific objective
evidence of fair value does not exist for the undelivered element, all 14




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revenue is deferred until
sufficient objective evidence exists or all elements have been delivered. We treat all
arrangements with payment terms longer than normal as having fees that are not fixed or
determinable. Our normal payment terms currently range from net 30 days to net 90 days and are
determined in a deal by deal basis. We defer
revenue for those agreements that exceed our normal payment terms and are therefore assessed
as not being fixed or determinable. Revenue under these agreements is recognized as payments
become due unless collectability concerns exist, in which case revenue is deferred until payments
are received. Our assessment of collectability is particularly critical in determining whether
revenue should be recognized in the current market environment. Fees derived from arrangements
with resellers are not recognized until evidence of a sell-through arrangement to an end user has
been received. Service revenue includes product maintenance, consulting and training. Customers who license
our software products normally purchase maintenance services. These maintenance 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 revenue from these contracts
are recognized ratably over the term of the contract. Many 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 either sold on a
time and materials or fixed fee basis and recognized as the services are performed. We also offer
training services which are sold on a per student or per-class basis. Fees from training services
are recognized as classes are attended by customers. Payments received in advance of revenue recognition are recorded as deferred revenue. In the
event that a software license arrangement requires us to provide consulting services for
significant production, customization or modification of the software, or when the customer
considers these services essential to the functionality of our software product, both the product
license revenue and consulting services revenue would be recognized in accordance with the
provision of SOP 81-1, Accounting for Performance of Construction Type and Certain Production Type
Contracts.In such event, we would recognize revenue from such arrangements using the percentage
of completion method and, therefore, both the product license and consulting services revenue would
be recognized as work progresses, using hours worked as input measures. Allowance for Doubtful Accounts We maintain allowances for doubtful accounts for estimated losses resulting from the inability
of our customers to deliver required payments to us. When we believe a collectability issue exists
with respect to a specific receivable, we record an allowance to reduce that receivable to the
amount that we believe is collectible. Accounts 180 days past due are typically fully reserved.
In addition, we record an allowance on the remainder of our receivables that are still in good
standing. When determining this allowance, we consider the probability of recoverability based on
our past experience, taking into account current collection trends that are expected to continue,
as well as general economic factors. From this, we develop an allowance provision based on the
percentage likelihood that our aged receivables will not be collected.Historically, our actual
losses have been consistent with our provisions. Customer accounts receivable balances are written
off against the allowance for doubtful accounts when they are deemed uncollectible. Unexpected future events or significant future changes in trends could have a material impact
on our future allowance provisions. If the financial condition of our individual customers were to
deteriorate in the future, or general economic conditions were to deteriorate and affect our
customers ability to pay, our allowance expense could increase and have a material impact on our
future statements of operations and cash flows. Restructuring Charges We recorded $16.1 million in restructuring charges related to the realignment of our business
operations in 2003 and $19.5 million in restructuring charges in 2002. 15




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We recorded $136,000 in restructuring charges related to the realignment of our business
operations in 2005. These costs consisted of accretion expense due to the fair value treatments
for those leases restructured in 2003 under SFAS 146 and adjustments we made to our estimates for future sublease income and other
assumption of future costs, which we revise periodically based on current market conditions. As of March 31, 2005, we have $11.5 million in accrued restructuring expenses consisting
entirely of lease payments for facilities we restructured in 2003 and 2002. In the three months
ended March 31, 2005, we reclassified $467,000 from accrued restructuring to accrued rent to
account for rent expense in periods prior to restructurings for which our landlord has not yet
billed us, resulting in an increase in rent expense of $125,000 during the first quarter of 2005,
representing the difference between the $467,000 gross rent expense and the present valued amount
of $342,000 that was previously included in accrued restructuring. Only costs resulting from a restructuring plan that are not associated with, or that do not
benefit activities that will be continued, are eligible for recognition as liabilities at the
commitment date. These charges represent expenses incurred in connection with certain cost
reduction programs that we have undertaken and consist primarily of the cost of involuntary
termination benefits and remaining contractual lease payments and other costs associated with
closed facilities net of anticipated sublease income. Information regarding sublease income
estimates for the amount of sublease income we are likely to receive and the timing of finding a
tenant has been obtained from third party experts and is based on prevailing market rates. The charges for facility closure costs require the extensive use of estimates, including
estimates and assumptions related to future maintenance costs, our ability to secure sub-tenants
and anticipated sublease income to be received in the future. If we fail to make accurate
estimates or to complete planned activities in a timely manner, we might record additional charges
or reverse previous charges in the future. Such additional charges or reversals will be recorded
to the restructuring charges line in our statement of operations in the period in which additional
information becomes available to indicate our estimates should be adjusted. Since April 2002, we
have revised our sublease income estimates at least semi-annually due to significant downward
trends in the real estate markets in the United States and in the United Kingdom. RESULTS OF OPERATIONS For the three months ended March 31, 2005 and March 31, 2004 16




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The following table sets forth the results of operations for the three months ended March 31,
2005 and 2004, expressed as a percentage of total revenue. Three Months EndedMarch 31,2005
    
    
    2004RevenueLicense
    
    
    33
    %
    
    
    24
    %Service and other
    
    
    67
    %
    
    
    76
    %Total revenue
    
    
    100
    %
    
    
    100
    %Cost of revenueLicense
    
    
    1
    %
    
    
    1
    %Service and other
    
    
    34
    %
    
    
    43
    %Total cost of revenue
    
    
    35
    %
    
    
    44
    %Gross profit
    
    
    65
    %
    
    
    56
    %Operating expensesSales and marketing
    
    
    30
    %
    
    
    46
    %Research and development
    
    
    28
    %
    
    
    33
    %General and administrative
    
    
    22
    %
    
    
    23
    %Amortization of stock-based compensation
    
    
    0
    %
    
    
    0
    %Restructuring charges
    
    
    1
    %
    
    
    0
    %Total operating expenses
    
    
    81
    %
    
    
    102
    %Loss from operations
    
    
    (16
    %)
    
    
    (46
    %)Interest income
    
    
    2
    %
    
    
    2
    %Other income (expenses), net
    
    
    (1
    %)
    
    
    (1
    %)Net loss before income taxes
    
    
    (15
    %)
    
    
    (45
    %)Provision for income taxes
    
    
    0
    %
    
    
    1
    %Net loss
    
    
    (15
    %)
    
    
    (46
    %)
 Revenue Total revenue, which is comprised of license revenue and service revenue, increased 16% from
$14.3 million in the three months ended March 31, 2004 to $16.5 million in the three months ended
March 31, 2005. License. The license revenue that we recognize in any given period is directly related to the
number and size of our license orders. A few large license orders usually comprise a large
percentage of our sales and as such our average license order size fluctuates significantly from
period to period. Due to the rapidly changing business environment, we expect that we will
continue to see fluctuations in the size of our average license order. 17




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License revenue increased 60% from $3.4 million in the three months ended March 31, 2004 to
$5.4 million in the three months ended March 31, 2005. For the first quarter of 2005, we
experienced flat license order volume while our average license order size increased 75% compared
to the first quarter of 2004. The increase in the size of our average license order in the first
quarter of 2005 as compared to the first quarter of 2004 was due to one large license order which
accounted for approximately 69% of all orders in the current quarter. Service and other. The level of service revenue is affected by the number and size of license
sales in a given period. Customers typically purchase maintenance for the first year as part of
each license sale. Most of our consulting revenue and customer training revenue is also affected
by the size and number of license deals. Service and other revenue includes revenue from support
renewals, which are dependent upon our installed license base. Service revenue increased 2% from
$10.9 million in the three months ended March 31, 2004 to $11.1 million in the three months ended
March 31, 2005. Consulting revenue increased by $328,000, but was offset by a decline in training
revenue of $360,000. First year support revenue decreased by $352,000 but was offset by an
increase in maintenance renewal revenue of $562,000 from customers who had licensed our products in
previous years. Revenue from sales that originate outside of the United States comprises a significant
percentage of our total revenue. We recognized approximately 39% of our revenue from customers
outside the United States in the three months ended March 31, 2005, compared to 43% in the three
months ended March 31, 2004. Revenue from our top ten customers accounted for 51% and 35% of our
total revenue in the first quarter of 2005 and 2004 respectively. A small number of customers account for a substantial percentage of our total revenue.
During the first quarter of 2005, we had one customer which accounted for 24% of our revenue
and, as of March 31, 2005 this customer accounted for 31% of our accounts receivable balance. No
other customer accounted for more than 10% of our revenue during the first quarter of 2005 and
2004, or more than 10% of accounts receivable balance as of March 31, 2005 and 2004. We expect that revenue from a limited number of customers will continue to account for a large
percentage of total revenue in future quarters. Cost of Revenue License. Cost of license revenue consists of royalty payments to third parties for technology
incorporated into our product. Fluctuations in cost of license revenue is generally due to the
buying patterns of our customers, as cost of license revenue is dependent upon which products our
customers purchase and which of those purchased products have third-party technology incorporated
into them.Cost of license revenue decreased 39% from $198,000 in the three months ended March
31, 2004 to $121,000 in the three months ended March 31, 2005. This decrease in cost of license
revenue was primarily due to a decrease in license sales of royalty bearing products during the
three months ended March 31, 2005. Future fluctuations in cost of license revenue is dependent upon increases or decreases in
sales of those particular products which incorporate third-party technology. Service and other. Cost of service and other revenue consists of salaries, facility costs,
travel expenses and third- party consultant fees incurred in providing customer support, training
and implementation services. Cost of service and other revenue decreased 7% from $6.1 million in
the three months ended March 31, 2004 to $5.7 million in the three months ended March 31, 2005.
This decrease was primarily due to lower headcount from staffing changes in our Professional
Services department which reduced salary and related expenses by $623,000. These reductions were
offset by increased external consultant expenses of $196,000. For the next quarter, we expect that
cost of revenue will increase slightly compared to the quarter ended March 31, 2005 due to an
increase in external consultant costs. 18




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Operating Expenses Sales and Marketing. Sales and marketing expenses consist of salaries, commissions, field
office expenses, travel, entertainment and promotional expenses. Sales and marketing expenses
decreased 24% from $6.6 million in the three months ended March 31, 2004 to $5.0 million in the
three months ended March 31, 2005. This decrease was primarily due to lower headcount that
reduced salary and related expenses by $879,000, and drove a reduction in depreciation and
occupancy expenses of $331,000. In addition, commission expense declined $242,000 in the current
quarter compared to the same quarter of the prior year due to unusually high commission costs in
the first quarter of 2004. For the next quarter, we expect that sales and marketing expenses will
increase slightly compared to the first quarter of 2005 due to slightly higher commission 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. Research and development expenses decreased 2% from
$4.7 million in the three months ended March 31, 2004 to $4.5 million in the three month ended
March 31, 2005. This decrease was primarily due to a reduction in the use of our Professional
Services staff by our Engineering department for collaborative development projects. For the next quarter, we expect that research and development expenses will remain flat
compared to the quarter ended March 31, 2005. General and Administrative. General and administrative expenses consist of salaries for
administrative, executive and finance personnel, outside professional service fees, information
systems costs and our provision for doubtful accounts. General and administrative expenses
increased 11% from $3.3 million in the three months ended March 31, 2004 to $3.6 million in the
three months ended March 31, 2005. The slight increase was primarily due to an increase in our bad
debt expense of $153,000 and an increase of $224,000 for work necessary to comply with the
Sarbanes-Oxley Act of 2002. For the next quarter, we expect that general and administrative expenses will remain
approximately the same as the quarter ended March 31, 2005. Stock-based compensation.Total stock based compensation expenses were $62,000 and $41,000
for the three months ended March 31, 2005 and 2004 respectively. In the quarter ended March 31,
2005, we issued a restricted stock award. The expense related to this stock award is being
recognized over a four year period as service is rendered. We recorded $7,000 in stock-based
compensation expense in the quarter ended March 31, 2005 related to this award. In addition, we
recorded $55,000 in stock-based compensation expense for a stock award granted to a former member
of our Board of Directors. In the three months ended March 31, 2004, our stock-based compensation
consisted solely of the amortization of unearned employee stock-based compensation on options
issued to employees prior to our initial public offering in September 1999. Restructuring charges. In 2002 we initiated actions to reduce our cost structure due to
sustained negative economic conditions that impacted our operations and resulted in lower than
anticipated revenue. The plan was a combination of a reduction in workforce of approximately 285
employees, consolidations of facilities in the United States and United Kingdom and the related
disposal of leasehold improvements and equipment. As a result of these restructuring actions, we
incurred a charge of $19.5 million in the year ended December 31, 2002. The restructuring charge
included approximately $4.2 million of severance related charges and $15.3 million of committed
excess facilities payments, which included $463,000 for the write-off of leasehold improvements and
equipment in vacated facilities. In 2003 we initiated actions to further reduce our cost structure. The plan was a combination
of a reduction in workforce of approximately 100 employees, consolidations of facilities in the
United States and United Kingdom and the 19




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related disposal of leasehold improvements and equipment. As a result of these restructuring
actions, we incurred a charge of $16.1 million in the year ended December 31, 2003. The
restructuring charge included approximately $2.9 million of severance related charges and $13.0
million of committed excess facilities charges, which included $2.2 million for the write-off of
leasehold improvements and equipment in vacated facilities. The charge also included $180,000 in
accretion charges related to the fair value treatment for the facilities we restructured in 2003,
in accordance with SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities. In the year ended December 31, 2004, we incurred $1.1 million in restructuring costs. These
costs consisted of accretion expense due to the fair value treatments for those leases restructured
in 2003 under SFAS 146 and adjustments we made to our estimates for future sublease income and
other assumption of future costs, which we revise periodically based on current market conditions. In the quarter ended March 31, 2005, we incurred $136,000 in restructuring costs as compared
to $54,000 in the quarter ended March 31, 2004. These costs consisted of accretion expense due to
the fair value treatments for those leases restructured in 2003 under SFAS 146 and adjustments we
made to our estimates for future sublease income and other assumption of future costs, which we
revise periodically based on current market conditions. As of March 31, 2005, $11.5 million related to facility closures remains accrued from all of
our restructuring actions net of $2.3 million of estimated future sublease income and $2.1 of
contractual future sublease income. A portion of this liability is based on the fair value
treatment required by SFAS 146, which we adopted as of January 1, 2003. The facilities consolidation charges for all of our restructuring actions were calculated
using managements best estimates and were based upon the remaining future lease commitments for
vacated facilities from the date of facility consolidation, net of estimated future sublease
income. We have engaged brokers to locate tenants to sublease all of the excess facilities and, to
date, have signed sublease agreements for two of the four remaining buildings. The estimated
costs of vacating these leased facilities were based on market information and trend analyses,
including information obtained from third-party real estate sources. Our ability to generate
estimated sublease income is highly dependent upon the existing economic conditions, particularly
lease market conditions in certain geographies, at the time the sublease arrangements are
negotiated with third parties. While the amount we have accrued is the best estimate, these
estimates are subject to change and may require routine adjustment as conditions change through the
implementation period. If macroeconomic conditions related to the commercial real estate market
continue to worsen, we may be required to increase our estimated cost to exit certain facilities. Interest income and other income (expense), net.Interest and other income, increased (net)
from $111,000 in the three months ended March 31, 2004 to $238,000 in the three months ended March
31, 2005. This increase is primarily attributable to higher interest income due to higher interest
rate and a decrease in foreign currency exchange loss. Provision for income taxes We recorded provision for income taxes of $47,000 and $120,000 for the three months ended
March 31, 2005 and 2004, respectively. Income tax provisions in all periods presented relate to
income taxes currently payable on income generated in non-U.S. tax jurisdictions. Based on the cumulative pre-tax losses that we have sustained, we have recorded a deferred tax
asset at both March 31, 2005 and March 31, 2004. Because we cannot determine that it is more
likely than not that we will be able to utilize the deferred tax asset in the future, we have also
recorded a valuation allowance in an amount equal to our net deferred tax assets as of March 31,
2005 and March 31, 2004. On October 22, 2004, the American Jobs Creation Act was signed into law. The American Jobs
Creation Act creates a temporary incentive for U.S. corporations to repatriate accumulated income
earned abroad by providing an 85% 20




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dividends received deduction for certain dividends from controlled foreign corporations. The
deduction is subject to a number of limitations and uncertainty remains as to how to interpret
numerous provisions of the American Jobs Creation Act. As such, we are not yet in a position to
decide on whether, and to what extent, we might repatriate foreign earnings that have not yet been
remitted to the United States. Liquidity and Capital Resources For the three months ended
    
    
    Percent ChangeMarch 31,
    
    
    2005 vs.2005
    
    
    2004
    
    
    2004(in thousands)Cash, cash equivalents and short- term investments
    
    $
    72,593
    
    
    $
    90,962
    
    
    
    (20
    %)Short-term liabilities
    
    
    29,910
    
    
    
    31,588
    
    
    
    (5
    %)Long-term liabilities
    
    
    6,687
    
    
    
    10,808
    
    
    
    (38
    %)Net cash used in operating activities
    
    
    (5,604
    )
    
    
    (766
    )
    
    
    632
    %Net cash provided by investing activities
    
    
    4,949
    
    
    
    625
    
    
    
    692
    %Net cash provided by financing activities
    
    
    11
    
    
    
    257
    
    
    
    (96
    %)
 The current source of our cash and investment balances is primarily cash receipts from
customers, as we do not have any outstanding debt and our interest income is not significant. The
downward trend in our revenue has affected our cash flows and contributed to a negative cash flow
from operations in each quarter in 2004 and in the first quarter of 2005. The decline in our cash
and investment balances is summarized in the table below: Three Months Ended March 31,2005
    
    
    2004Beginning cash and investment balances
    
    $
    78,563
    
    
    $
    91,536Cash receipts from customers
    
    
    15,793
    
    
    
    21,641Miscellaneous cash receipts
    
    
    239
    
    
    
    1,733Investment income
    
    
    389
    
    
    
    252Cash payments to vendors and employees
    
    
    (22,391
    )
    
    
    (24,200
    )Ending cash and investment balances
    
    $
    72,593
    
    
    $
    90,962Net decrease in cash and investment balances
    
    $
    (5,970
    )
    
    $
    (574
    )Payments to suppliers in excess of cash
receipts from customers
    
    $
    (6,598
    )
    
    $
    (2,559
    )
 Cash, cash equivalents and short term investments were $91.0 million at March 31, 2004
compared to $72.6 21




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million at March 31, 2005, a decrease of $18.4 million. Our cash and investment balances
declined $6.0 million during the quarter ended March 31, 2005 compared to a decline of $574,000 in
the quarter ended March 31, 2004. The decrease the first quarter of 2004 was unusually low
primarily due to higher than average cash collections against delinquent receivable which were
approximately $7.0 million higher than the other three quarters of 2004. The main reason for the decline in our cash and investment balances in the table above was
that our total cash payments to vendors and employees was greater than our total cash receipts from
customers. Payments to employees and suppliers exceeded our cash receipts from customers in each
quarter of 2004 and this net payment outflow ranged from $2.5 million to $6.4 million per quarter
in 2004. In the quarter ended March 31, 2005, payments to employees and suppliers exceeded our
cash receipts from customers by $6.6 million, compared to the quarter ended March 31, 2004, when
payments to employees and suppliers exceeded our cash receipts from customers by $2.6 million.
This was primarily due to the unusually high cash receipts received and slight higher cash outflows
during the quarter ended March 31, 2004 compared to the quarter ended March 31, 2005. Net cash used in operating activities increased by $4.9 million in the three months ended
March 31, 2005 compared to the three months ended March 31, 2004. The primary reason for this
increase was the change in our trade receivable balance. During the first quarter of 2005, our
trade receivable balance increased $4.7 million due to a large sale which was recorded in this
quarter but was not scheduled for collection until the second quarter of 2005. In the first
quarter of 2004, our trade receivable balance decreased $4.6 million due to increased collection
efforts which brought in more cash and lowered our trade receivable balance. Net cash payments of
$1.5 million made in the first quarter of 2005 for leases restructured in previous years is not
included in net income for the three months ended March 31, 2005 as it has already been expensed in
previous years. During the first quarter of 2005, our net accounts receivable balance increased
$4.5 million from $10.5 million at December 31, 2004 to $15.0 million at March 31, 2005. This is
due to $4.0 million, or 24%, of total revenue recognized in the quarter ended March 31, 2005 which
was attributable to a sale to one customer whose payment to us was not due until April 2005. At
March 31, 2005, our gross accounts receivable balance was $15.7 million with an allowance for
doubtful accounts of $700,000. Net cash provided by investing activities increased $4.3 million for the quarter ended March
31, 2005 compared to the quarter ended March 31, 2004. This increase was mainly due to the fact
that we sold at maturity $5.3 million more in short term investments than we purchased in the first
quarter of 2005 to fund operating losses of $2.4 million and cash payments for restructured leases
of approximately $1.5 million. Net cash provided by financing activities decreased $246,000 for the quarter ended March 31,
2005 compared to the quarter ended March 31, 2004. This decrease was due to a decrease in stock
option exercises over the prior year. For the quarter ended March 31, 2005, our total deferred revenue balance, which includes long
term deferred revenue in the amount of $904,000 included in other long term liabilities in our
consolidated balance sheets, increased $4.4 million from $11.8 million at December 31, 2004 to
$16.2 million at March 31, 2005. This increase is due primarily due to an increase in support
renewals of $4.1 million. Contractual Cash Obligations and Commitments As of March 31, 2005, there was no material change in our long-term debt obligations, capital
lease obligations, operating lease obligations, purchase obligations, or any other long-term
liabilities reflected on our condensed consolidated balance sheets as compare to such obligations
and liabilities as of December 31, 2004. Off-Balance Sheet Arrangements At March 31, 2005 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 22




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are typically established for the purpose of facilitating off-balance sheet arrangements or other
contractually narrow or limited purposes. Credit Facilities with Silicon Valley Bank We entered into a Loan and Security Agreement with Silicon Valley Bank dated June 28, 2002 for
the purpose of establishing a revolving line of credit. We modified this agreement on June 11,
2004 and reduced the line of credit from $15.0 million to $12.0 million. The modification requires
us to maintain minimum cash, cash equivalents, and short-term investments balance of $30.0 million.
The agreement also requires us to maintain our primary depository and operating accounts with
Silicon Valley Bank and invest all of our investments through Silicon Valley Bank. The line of
credit serves as collateral for letters of credit and other commitments, even though these items do
not constitute draws on the line of credit. Available advances under the line of credit are
reduced by the amount of outstanding letters of credit and other commitments. Interest on
outstanding borrowings on the line of credit accrues at the banks prime rate of interest. The
agreement is secured by all of Vitrias assets. As of March 31, 2005, we had not borrowed against this line of credit. In connection with the
line of credit agreement, we have outstanding letters of credit of approximately $5.5 million
related to certain office leases at March 31, 2005. Fees related to the outstanding letters of
credit totaled $12,000 and $16,000 for the three months ended March 31, 2005 and 2004,
respectively. 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 cash generated from operations, interest generated from cash and investment
balances and cash and investment 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 in the marketplace in which we operate. In the past, we have invested significantly in our operations. We plan to selectively invest
in Research and Development and Sales and Marketing in 2005 to strengthen our future growth and at
the same time, contain overall costs in order to reduce our net cash outflow. For the next year,
we anticipate that operating expenses and planned capital expenditures will continue to constitute
a material use of our cash resources. We expect our capital expenditures for the next nine months
to be approximately $900,000. We believe that our available cash, cash equivalents and short-term
investments 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 such as
funding acquisitions or investments in other businesses. If such funds are needed, we 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 believe our success requires expanding our customer base and continuing to enhance our
Vitria:BusinessWareproducts. Our revenue, 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 revenue in a given quarter has been recorded in the third month of that
quarter, with a concentration of this revenue 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 revenue 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. Fees that do not meet our revenue recognition policy requirements for which we have been
paid or 23




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have a valid receivable are recorded as deferred revenue. While a portion of our revenue in
each quarter is recognized from deferred revenue, our quarterly performance will depend primarily
upon entering into new contracts to generate revenue 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 revenue 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;
    timing of the development and release of new products or 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 24




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quarter our operating results may be below the expectations of public market analysts and
investors. In this event, the price of our common stock would likely decline. Related Party Transactions In December 2003, we sold our interest in our China operations to QilinSoft LLC (formerly
referred to as ChiLin LLC). QilinSoft is owned and controlled by Dr. JoMei Chang, a director and a
significant stockholder, and Dr. Dale Skeen, a director and our Chief Executive Officer and Chief
Technology Officer, the spouse of Dr. Chang and a significant stockholder. At the time of the sale, Vitria and QilinSoft entered into a license agreement whereby
QilinSoft received a royalty-bearing license to distribute our products in China. In addition,
Vitria and QilinSoft executed a development agreement in
December 2003 pursuant to which QilinSoft performs development work and other fee-bearing services for us. In April 2004, Dr. Chang and
Dr. Skeen entered into a confirmation agreement with us confirming the nature of their involvement
and/or investment in QilinSoft including obligations with respect to non-solicitation and hiring of
our employees and non-competition with Vitria. In July 2004, we entered into a professional
services agreement with QilinSoft pursuant to which QilinSoft may order professional services from
us. In November 2004, we entered into a two year marketing agreement with QilinSoft governing the
marketing and sales relationship between the parties. During the first quarter of 2005, we recorded revenue of $50,000 from QilinSoft and incurred
charges of $419,000 for development work performed by QilinSoft, recorded in research and
development expense. At March 31, 2005, we owed QilinSoft $113,000 for development work performed in the first
quarter of 2005 and due by April 30, 2005 and we had no outstanding receivable balances due from
Qilinsoft. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Interest Rate Risk Our exposure to market risk for changes in interest rates relates to our investment portfolio,
which consists of short-term money market instruments and debt securities with maturities between
90 days and one year. We do not use derivative financial instruments in our investment portfolio.
We place our investments with high credit quality issuers and, by policy, we limit the amount of
credit exposure to any one issuer. We mitigate default risk by investing in high credit quality securities and by monitoring the
credit rating of investment issuers. The portfolio includes only marketable securities with active
secondary or resale markets to ensure portfolio liquidity. These securities are generally
classified as available for sale, and consequently, are recorded on the balance sheet at fair value
with unrealized gains or losses reported, as a separate component of stockholders equity, net of
tax. Unrealized loss was $91,000 at March 31, 2005, and unrealized gain was not material at March
31, 2004. We do not have cash flow exposure due to rate changes for cash equivalents and short-term
investments as all of these investments are at fixed interest rates. There has been no material change in our interest rate exposure since March 31, 2005. The table below presents the principal amount of related weighted average interest rates for
our investment portfolio. Short-term investments are all in fixed rate instruments and have
maturities of one year or less. Cash equivalent consist of money market funds and short-term
investments which have an original maturity date of 90 days or less from the time of purchase. 25




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Table of investment securities (in thousands) as of March 31: 
 2005Average
    
    
    
    
    
    
    2004Weighted Average
    
    
    
    
    
    
    Weighted AverageFair Value
    
    
    Interest Rate
    
    
    Fair Value
    
    
    Interest RateCash and cash equivalent
    
    $
    31,426
    
    
    
    0.35
    %
    
    $
    8,849
    
    
    
    0.36
    %Short-term investments
    
    
    41,167
    
    
    
    2.66
    %
    
    
    82,113
    
    
    
    1.24
    %Total cash and
investment securities
    
    $
    72,593
    
    
    
    
    
    
    $
    90,962
 Foreign Exchange Risk As a global concern, we face exposure to adverse movements in foreign currency exchange rates.
These exposures may change over time as business practices evolve and could have a material
adverse impact on our financial position and results of operations. Historically, our primary
exposures have related to non-U.S. dollar-denominated currencies, customer receivables, and
inter-company receivables or payables with our foreign subsidiaries. Additionally, we periodically
provide funding to our foreign subsidiaries in Europe, Asia Pacific and Latin America. In order to reduce the effect of foreign currency fluctuations, from time to time, we utilize
foreign currency forward exchange contracts (forward contracts) to hedge certain foreign currency
transaction exposures outstanding during the period. The gains and losses on the forward contracts
help to mitigate the gains and losses on our outstanding foreign currency transactions. We do not
enter into forward contracts for trading purposes. All foreign currency transactions and all
outstanding forward contracts are marked-to-market at the end of the period with unrealized gains
and losses included in other income, net. We had no outstanding forward contracts as of March 31, 2005 and did not enter into any
forward contracts during the three months ended March 31, 2005. RISKS ASSOCIATED WITH VITRIAS BUSINESS AND FUTURE OPERATING RESULTS We operate in a rapidly changing environment that involves a number of risks, some of which
are beyond our control. The following discussion about our risk management activities includes
forward-looking statements that involve risks and uncertainties. Actual results could differ
materially from those projected in the forward-looking statements for the reasons described below. Our operating results fluctuate significantly and an unanticipated decline in revenue may result in
a decline in our stock price and may disappoint securities analysts or investors, and may also harm
our relationship with our customers. 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 revenue 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 revenue in a
given quarter has been recorded in the third month of that quarter, with a concentration of this
revenue in the last two weeks of the third month. We expect this trend 26




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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 revenue 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 depend primarily upon entering into new or follow-on contracts to
generate revenue 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 revenue from these
contracts will be recognized. Our operating results are also dependent upon our ability to manage
our cost structure. We have incurred substantial operating losses since inception and we cannot guarantee that we will
become profitable 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 $220.1 million as of
March 31, 2005. Since the beginning of 2002, we have reduced our workforce and consolidated
certain facilities as part of our restructuring plan. As a result of these actions, we incurred a
year to date charge of $136,000 in 2005, $1.1 million in 2004, $16.1 million in 2003, and $19.5
million in 2002. Despite these measures in order to remain competitive we intend to continue
investing in sales, marketing and research and development. As a result, we may report future
operating losses and cannot guarantee whether we will report net income in the future. Our operating results are substantially dependent on license and support revenue from
Vitria:BusinessWareand our business could be materially harmed by factors that adversely affect
the pricing and demand forVitria:BusinessWare. Since 1998, a majority of our total revenue has been, and is expected to be, derived from the
license and support of our Vitria:BusinessWareproduct and for applications built for that product.
Accordingly, our future operating results will depend on the demand for Vitria:BusinessWareand
support by existing and future customers, including new and enhanced releases that are subsequently
introduced. If our competitors release new products that are superior to Vitria:BusinessWarein
performance or price, or we fail to enhance Vitria:BusinessWareand introduce new products in a
timely manner, demand for our product may decline. A decline in demand for Vitria:BusinessWareas a
result of competition, technological change or other factors would significantly reduce our
revenue. 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
revenue. During the first quarter of 2005, we had a net loss of $2.4 million and our operating
activities used $5.6 million of cash. As of March 31, 2005, we had approximately $72.6 million in
cash and cash equivalents and short-term investments, $60.0 million in working capital, $29.9
million in short-term liabilities, and $6.7 million in long-term liabilities. 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 27




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
    respond to competitive pressures or unanticipated capital requirements. Our failure to do any of these things could result in lower revenue and could seriously harm
our business. The continued reluctance of companies to make significant expenditures on information technology
could reduce demand for our products and cause our revenue to decline. There can be no assurance that the level of spending on information technology in general, or
on business integration software by our customers and potential customers, will increase or remain
at current levels in future periods. Lower spending on information technology could result in
reduced license sales to our customers, reduced overall revenue, diminished margin levels, and
could impair our operating results in future periods. Any general 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. A general slow-down
in capital spending, if sustained in future periods, could result in reduced sales or the
postponement of sales to our customers. We experience long and variable sales cycles, which could have a negative impact on our
results of operations for any given quarter. Our products are 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 six to nine months, and in some cases even longer, and it is very difficult to
predict whether and when any particular license transaction might be completed. Because a small number of customers have in the past accounted for a substantial portion of our
revenue, our revenue could decline due to the loss or delay of a single customer order. Sales to our ten largest customers accounted for 51% of total revenue in the three months
ended March 31, 2005 and one customer accounted for 24% of total revenue. Our license agreements
do not generally provide for ongoing license payments. Therefore, we expect that revenue from a
limited number of customers will continue to account for a significant percentage of total revenue
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 the
cost-effectiveness of our products. The loss or delay of individual orders could have a
significant impact on revenue and operating results. Our failure to add new customers that make
significant purchases of our product and services would reduce our future revenue If we are not successful in developing industry specific pre-built process applications based on
Vitria:BusinessWare, our ability to increase future revenue could be harmed. We have developed and intend to continue to develop pre-built process applications based on
Vitria:BusinessWarewhich incorporate business processes, connectivity and document transformations
specific to the needs of particular industries, including healthcare and insurance,
telecommunications, manufacturing, finance and other industries. This presents technical and sales
challenges and requires collaboration with third parties, including system integrators and
standards organizations, and the commitment of significant resources. Specific industries may
experience economic downturns or regulatory changes that may result in delayed spending decisions
by customers or require changes to our products. If we are not successful in developing these
targeted pre-built process applications or these pre-built process applications do not achieve
market acceptance, our ability to increase future revenue could be harmed. 28




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To date we have concentrated our sales and marketing efforts toward companies in the
healthcare and insurance, financial services, telecommunication and other vertical markets.
Customers in these 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 the needs of these vertical markets we may experience decreased
sales in future periods. Our products may not achieve market acceptance, which could cause our revenue to decline. Deployment of our products 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 products fail 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 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 products and solutions 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 revenue. Our current and
potential competitors include, BEA, Fiarano, FileNet, Fuego, IBM Corporation, Intalio, Microsoft
Corporation, Oracle/Peoplesoft, PolarLake, SAP, Savvion, SeeBeyond Technology, Sonic Software,
Sungard, TIBCO Software, Telcordia, TriZetto, webMethods and others. In the future, some of these
companies may expand their products to provide or enhance existing business process management,
business analysis and monitoring, and business vocabulary management functionality, as well as
integration solutions for specific business problems. 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. In addition, 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. Finally, we face direct and indirect competition from major enterprise
software developers that offer integration products as a complement to their other enterprise
software products. These companies may also modify their applications to be more easily integrated
with other applications through web services or other means. Some of these companies include
Oracle/PeopleSoft and SAP AG. Many of our competitors have more resources and broader customer and partner 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. 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 revenue. In many
cases, our customers must interact with, modify, or replace significant elements of 29




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their existing computer systems. The cost of our products 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 our products do 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 products 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 revenue
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 Vitria:BusinessWare
products. To date, these delays have not had a material impact on our revenue. If new releases or
products are delayed or do not achieve market acceptance, we could experience a delay or loss of
revenue 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 revenue 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 revenue 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 revenue to
decline. We could suffer losses and negative publicity if new versions and releases of our products contain
errors or defects. 30




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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 that have 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 products for mission-critical business operations, any of these
occurrences could seriously harm our business and generate negative publicity. 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 employees 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 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 assure that we will be able to
recruit and retain sufficient numbers of these highly skilled employees. 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 competitors 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. Our products could infringe the intellectual property rights of others causing costly litigation
and the loss of significant rights. Software developers in our market are increasingly being 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 involves 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. Our significant international operations may fail to generate significant product revenue or
contribute to our drive toward profitability, which could result in slower revenue growth and harm
our business. We have international presence in Australia, Canada, France, Germany, Italy, Japan, Korea,
Singapore, Spain and the United Kingdom. During the first quarter of 2005, 39% of our revenue was
derived from international markets. There are a number of challenges to establishing and
maintaining operations outside of the United States and we may be unable to continue to generate
significant international revenue. If we fail to successfully establish or maintain our products in
international markets, we could experience slower revenue growth and our business could be harmed.
In addition, it also may be difficult to protect our intellectual property in certain international
jurisdictions. 31




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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 shareholder complaint. This
litigation could result in substantial costs and divert managements attention and resources, and
could seriously harm our business. See Item 1 of Part II 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 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. Section 203 of the Delaware General Corporations Law and the terms of our stock option plans
may also discourage, delay or prevent a change in control of Vitria. In addition, as of March 31,
2005, our executive officers, directors and their affiliates beneficially own approximately 35% of
our outstanding common stock. This could have the effect of delaying or preventing a change of
control of Vitria and may make some transactions difficult or impossible without the support of
these stockholders. 
 Item 4. CONTROLS AND PROCEDURES Evaluation of disclosure controls and procedures. We maintain disclosure controls and
procedures as this term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, or
the Exchange Act. Our disclosure controls and procedures are designed to provide reasonable, not
absolute, assurance that the objectives of our control system are met to ensure that information
required to be disclosed by us in reports that we file under the Exchange Act is recorded,
processed, summarized, and reported within the time periods specified in Securities and Exchange
Commission rules and forms, and that such information is accumulated and communicated to our
management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), as
appropriate, to allow timely decisions regarding required 32




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disclosure. In designing disclosure controls and procedures, our management has necessarily
applied its judgment in evaluating the costs versus the benefits of the possible disclosure
controls and procedures. The design of any disclosure controls and procedures also is based in part
upon certain assumptions about the likelihood of future events, but there can be no assurance that
any design will succeed in achieving its stated goal under all potential future conditions. A material weakness is a control deficiency, or combination of control deficiencies, that
results in more than a remote likelihood that a material misstatement of the annual or interim
financial statements will not be prevented or detected. As of December 31, 2004, our assessment of
the effectiveness of our internal control over financial reporting identified the following
deficiencies: our review and supervision procedures over the recording of activity at our Japanese
subsidiary were inadequate in that (a) there was no documented evidence of certain levels of local
review of revenue recognition calculations nor documentation of points to be considered; (b) there
was a lack of segregation of duties at this subsidiary due to small headcount; and (c) certain
procedures carried out by external consultants were not adequately tested and reviewed. Taken
together, these deficiencies constitute a material weakness in our system of internal controls over
financial reporting as of December 31, 2004. We have taken actions to remediate this material
weakness. This material weakness is discussed in our Annual Report on Form 10-K for the year ended
December 31, 2004. Under supervision of Vitria management, we performed an evaluation of the effectiveness of the
design and operation of our disclosure controls and procedures as of March 31, 2005. Due to the
material weakness discussed above, our CEO and CFO have concluded that our disclosure controls and
procedures were not effective in providing reasonable assurance that
the objectives of our control
system were met as of March 31, 2005. Changes in internal controls.During the first quarter of 2005, we implemented or began
implementing the following remediation steps to address the material weakness discussed above:
performing all revenue recognition duties for our subsidiary at our corporate offices and
realigning all revenue recognition duties, such that accounting for our subsidiary reports directly
into our corporate offices. We expect to complete the implementation of these remedial
measures by June 30, 2005 and once fully implemented, we expect that future tests of internal
controls over the Japanese location will determine that the control is operating effectively. Except as discussed above, there were no changes in our internal controls over financial
reporting that occurred in the first quarter of 2005 that have materially affected or are
reasonably likely to affect, our internal controls over financial reporting. 33




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PART IIOTHER INFORMATION 
 Item 1. Legal Proceedings In November 2001, Vitria and certain of our 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, now captioned In re Vitria Technology, Inc. IPO Securities Litigation, Case
No. 01-CV-10092. In the amended complaint, the plaintiffs allege that Vitria, certain of our
officers and directors, and the underwriters of our initial public offering (IPO) violated 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 against
hundreds of public companies, (the Issuers) that first sold their common stock since the mid-1990s,
(the IPO Lawsuits). The IPO Lawsuits were consolidated for pretrial purposes before United States Judge Shira
Scheindlin of the Southern District of New York. Defendants filed a global motion to dismiss the
IPO-related lawsuits on July 15, 2002. In October 2002, Vitrias officers and directors were
dismissed without prejudice pursuant to a stipulated dismissal and tolling agreement with the
plaintiffs. On February 19, 2003, Judge Scheindlin issued a ruling denying in part and granting in
part the Defendants motions to dismiss. In June 2003, Vitrias Board of Directors approved a resolution tentatively accepting a
settlement offer from the plaintiffs according to the terms and conditions of a comprehensive
Memorandum of Understanding negotiated between the plaintiffs and the Issuers. Under the terms of
the settlement, the plaintiff class will dismiss with prejudice all claims against the Issuers,
including Vitria and our current and former directors and officers, and the Issuers will assign to
the plaintiff class or its designee certain claims that they may have against the IPO underwriters.
In addition, the tentative settlement guarantees that, in the event that the plaintiffs recover
less than $1.0 billion in settlement or judgment against the underwriter defendants in the IPO
Lawsuits, the plaintiffs will be entitled to recover the difference between the actual recovery and
$1.0 billion from the insurers for the Issuers. In June 2004, Vitria executed a final settlement
agreement with the plaintiffs consistent with the terms of the Memorandum of Understanding. The
settlement is still subject to a number of conditions, including action by the Court certifying a
class action for settlement purposes and formally approving the settlement. The underwriters have
opposed both the certification of the class and the judicial approval of the settlement. On
February 15, 2005, the Court issued a decision certifying a class action for settlement purposes
and granting preliminary approval of the settlement subject to modification of certain bar orders
contemplated by the settlement. In addition, the settlement is still subject to statutory notice
requirement as well as final judicial approval. 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds None. 
 Item 3. Defaults Upon Senior Securities None. 
 Item 4. Submission of Matters to Vote of Security Holders None 34




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Item 5. Other Information None. 
 Item 6. Exhibits Exhibit 10.37(1)
    
    Form of Restricted Stock Award Agreement.Exhibit 10.38(2)
    
    Form of Restricted Stock Award Grant Notice.Exhibit 10.39(3)
    
    Offer Letter, by and between Jim Davis and Vitria, dated February 25, 2005.Exhibit 10.40
    
    Employment agreement, as amended by and between Paul Taylor and Vitria, dated June 16, 2004.Exhibit 31.1
    
    Certification of Chief Executive Officer as required by Rule 13a-14(a) of the
Securities Exchange Act of 1934, as amended.Exhibit 31.2
    
    Certification of Chief Financial Officer as required by Rule 13a-14(a) of the
Securities Exchange Act of 1934, as amended.Exhibit 32.1
    
    Certification of Chief Executive Officer as required by Rule 13a-14(b) of the
Securities Exchange Act of 1934, as amended. *Exhibit 32.2
    
    Certification of Chief Financial Officer as required by Rule 13a-14(b) of the
Securities Exchange Act of 1934, as amended.*
   (1)
    Filed as Exhibit 10.36 to our Current Report on Form 8-K, dated February 25, 2005 and filed
on March 8, 2005, and incorporated herein by reference.(2)
    Filed as Exhibit 10.37 to our Current Report on Form 8-K, dated February 25, 2005 and filed
on March 8, 2005, and incorporated herein by reference.(3)
    Filed as Exhibit 10.38 to our Current Report on Form 8-K, dated February 25, 2005 and filed
on March 8, 2005, and incorporated herein by reference.  *
    The certification attached as Exhibits 32.1 and 32.2 accompany this Quarterly
Report on Form 10-Q, are not deemed filed with the Security and Exchange Commission and
are not to be incorporated by reference into any filing of Vitria Technology, Inc. under
the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as
amended, whether made before or after the date of this Form 10-Q, irrespective of any
general incorporation language contained in such filing. 35




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SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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 on May 9, 2005. VITRIA TECHNOLOGY, INC. Date: May 9, 2005
    
    By:     /s/ Michael D. PerryMichael D. PerrySenior Vice President and Chief Financial Officer
 36




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EXHIBIT INDEX Exhibit 10.37(1)
    
    Form of Restricted Stock Award Agreement.Exhibit 10.38(2)
    
    Form of Restricted Stock Award Grant Notice.Exhibit 10.39(3)
    
    Offer Letter, by and between Jim Davis and Vitria, dated February 25, 2005.Exhibit 10.40
    
    Employment agreement, as amended by and between Paul Taylor and Vitria, dated June 16,
2004.Exhibit 31.1
    
    Certification of Chief Executive Officer as required by Rule 13a-14(a) of the
Securities Exchange Act of 1934, as amended.Exhibit 31.2
    
    Certification of Chief Financial Officer as required by Rule 13a-14(a) of the
Securities Exchange Act of 1934, as amended.Exhibit 32.1
    
    Certification of Chief Executive Officer as required by Rule 13a-14(b) of the
Securities Exchange Act of 1934, as amended. *Exhibit 32.2
    
    Certification of Chief Financial Officer as required by Rule 13a-14(b) of the
Securities Exchange Act of 1934, as amended.*
   (1)
    Filed as Exhibit 10.36 to our Current Report on Form 8-K, dated February 25, 2005 and filed
on March 8, 2005, and incorporated herein by reference.  (2)
    Filed as Exhibit 10.37 to our Current Report on Form 8-K, dated February 25, 2005 and filed
on March 8, 2005, and incorporated herein by reference.  (3)
    Filed as Exhibit 10.38 to our Current Report on Form 8-K, dated February 25, 2005 and filed
on March 8, 2005, and incorporated herein by reference.  *
    The certification attached as Exhibits 32.1 and 32.2 accompany this Quarterly
Report on Form 10-Q, are not deemed filed with the Security and Exchange Commission and
are not to be incorporated by reference into any filing of Vitria Technology, Inc. under
the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as
amended, whether made before or after the date of this Form 10-Q, irrespective of any
general incorporation language contained in such filing. 37