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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
   FORM 10-Q
 
 (Mark One) [X]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.For the quarterly period ended March 31, 2004OR[  ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
 For the transition period from ____________ to ____________. Commission file number: 0-27207 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 94086
(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 [X] No [  ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes [X] No [  ] The number of shares of Vitrias common stock, $0.001 par value,
outstanding as of April 30, 2004 was 32,938,501 shares. 1




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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, 2004 and December 31, 2003
    
    
    3Condensed Consolidated Statements of Operations for the three months ended March 31, 2004
and 2003
    
    
    4Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2004
and 2003
    
    
    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
    
    
    27Item 4: Controls and Procedures
    
    
    35PART II: OTHER INFORMATIONItem 1: Legal Proceedings
    
    
    36Item 2:
Changes in Securities, Uses of Proceeds and Issuer Purchases of
Equity Securities
    
    
    36Item 3: Defaults Upon Senior Securities
    
    
    36Item 4: Submission of Matters to a Vote of Security Holders
    
    
    36Item 5: Other Information
    
    
    36Item 6: Exhibits and Reports on Form 8-K
    
    
    37Signature
    
    
    38EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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PART I. FINANCIAL INFORMATION 
 ITEM 1. Financial Statements Vitria Technology, Inc.
Condensed Consolidated Balance Sheets
(In thousands) March 31,
    
    December 31,2004
    
    2003(unaudited)
    
    (Note 1)AssetsCurrent Assets:Cash and cash equivalents
    
    $
    8,849
    
    
    $
    8,782Short-term investments
    
    
    82,113
    
    
    
    82,754Accounts receivable, net
    
    
    10,855
    
    
    
    15,471Other current assets
    
    
    3,290
    
    
    
    3,568Total current assets
    
    
    105,107
    
    
    
    110,575Property and equipment, net
    
    
    2,177
    
    
    
    2,805Other assets
    
    
    733
    
    
    
    745Total assets
    
    $
    108,017
    
    
    $
    114,125Liabilities and Stockholders EquityCurrent Liabilities:Accounts payable
    
    $
    2,111
    
    
    $
    1,837Accrued compensation
    
    
    3,542
    
    
    
    3,743Other accrued liabilities
    
    
    3,550
    
    
    
    3,783Accrued restructuring expenses
    
    
    6,071
    
    
    
    6,831Deferred revenue
    
    
    16,314
    
    
    
    13,864Total current liabilities
    
    
    31,588
    
    
    
    30,058Long-Term Liabilities:Accrued restructuring expenses
    
    
    10,693
    
    
    
    11,980Other long-term liabilities
    
    
    115
    
    
    
    131Total long-term liabilities
    
    
    10,808
    
    
    
    12,111Commitments and ContingenciesStockholders Equity:Common Stock
    
    
    33
    
    
    
    33Additional paid-in capital
    
    
    274,104
    
    
    
    273,854Unearned stock-based compensation
    
    
    (38
    )
    
    
    (79
    )Notes receivable from stockholders
    
    
    (125
    )
    
    
    (193
    )Accumulated other comprehensive income
    
    
    587
    
    
    
    635Accumulated deficit
    
    
    (208,444
    )
    
    
    (201,798
    )Treasury stock, at cost
    
    
    (496
    )
    
    
    (496
    )Total stockholders equity
    
    
    65,621
    
    
    
    71,956Total liabilities and stockholders equity
    
    $
    108,017
    
    
    $
    114,125
 The accompanying notes are an integral part of these condensed consolidated financial statements. 3




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Vitria Technology, Inc.
Condensed Consolidated Statement of Operations
(In thousands, except per share amounts)
(unaudited) Three Months EndedMarch 31,2004
    
    2003RevenuesLicense
    
    $
    3,391
    
    
    $
    10,549Service and other
    
    
    10,858
    
    
    
    12,056Total revenues
    
    
    14,249
    
    
    
    22,605Cost of revenuesLicense
    
    
    198
    
    
    
    94Service and other
    
    
    6,088
    
    
    
    7,015Total cost of revenues
    
    
    6,286
    
    
    
    7,109Gross profit
    
    
    7,963
    
    
    
    15,496Operating expensesSales and marketing
    
    
    6,567
    
    
    
    13,020Research and development
    
    
    4,656
    
    
    
    5,271General and administrative
    
    
    3,282
    
    
    
    3,899Stock-based compensation
    
    
    41
    
    
    
    153Restructuring charges
    
    
    54
    
    
    
    14,008Total operating expenses
    
    
    14,600
    
    
    
    36,351Loss from operations
    
    
    (6,637
    )
    
    
    (20,855
    )Interest income
    
    
    251
    
    
    
    422Other income (expense), net
    
    
    (140
    )
    
    
    (217
    )Net loss before income taxes
    
    
    (6,526
    )
    
    
    (20,650
    )Provision for income taxes
    
    
    120
    
    
    
    65Net loss
    
    $
    (6,646
    )
    
    $
    (20,715
    )Basic and diluted net loss per share
    
    $
    (0.20
    )
    
    $
    (0.64
    )Weighted average shares used in
calculating basic
and diluted net loss per share
    
    
    32,816
    
    
    
    32,530
 The accompanying notes are an integral part of these condensed consolidated financial statements. 4




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Vitria Technology, Inc.Condensed Consolidated Statements of Cash Flows
(In thousands)
(unaudited) Three Months EndedMarch 31,2004
    
    2003Operating activities:Net loss
    
    $
    (6,646
    )
    
    $
    (20,715
    )Adjustments to reconcile net loss to net cash
used in operating activities:Loss on write-down of equity investments
    
    
    
    
    
    
    300Loss on disposal of fixed assets
    
    
    
    
    
    
    2,380Forgiveness of note receivable
    
    
    74
    
    
    
    Depreciation
    
    
    645
    
    
    
    1,539Stock-based compensation
    
    
    41
    
    
    
    153Changes in assets & liabilities:Accounts receivable
    
    
    4,616
    
    
    
    (6,980
    )Other current assets
    
    
    265
    
    
    
    63Other assets
    
    
    12
    
    
    
    (22
    )Accounts payable
    
    
    274
    
    
    
    (140
    )Accrued liabilities
    
    
    (434
    )
    
    
    (2,645
    )Accrued restructuring charges
    
    
    (2,047
    )
    
    
    9,754Deferred revenue
    
    
    2,450
    
    
    
    1,736Other long term liabilities
    
    
    (16
    )
    
    
    (721
    )Net cash used in operating activities
    
    
    (766
    )
    
    
    (15,298
    )Investing activities:Purchases of property and equipment
    
    
    (17
    )
    
    
    (264
    )Purchases of investments
    
    
    (8,000
    )
    
    
    (16,550
    )Maturities of investments
    
    
    8,642
    
    
    
    18,000Net cash provided by investing activities
    
    
    625
    
    
    
    1,186Financing activities:Issuance of common stock, net
    
    
    257
    
    
    
    (1
    )Net cash
provided by (used in) financing activities
    
    
    257
    
    
    
    (1
    )Effect of exchange rates on changes on cash and cash equivalents
    
    
    (49
    )
    
    
    201Net increase (decrease) in cash and cash equivalents
    
    
    67
    
    
    
    (13,912
    )Cash and cash equivalents at beginning of period
    
    
    8,782
    
    
    
    42,427Cash and cash equivalents at end of period
    
    $
    8,849
    
    
    $
    28,515
 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
have been prepared in accordance with generally accepted accounting principles
for interim consolidated financial information and with the instructions for
Form 10-Q and Article 10 of Regulation S-X. In the opinion of the management
of Vitria Technology, Inc., these unaudited condensed consolidated financial
statements include all adjustments, consisting only of normal recurring
adjustments, which we consider necessary to fairly state Vitrias financial
position and the results of its operations and its cash flows. The balance
sheet at December 31, 2003 has been derived from the audited consolidated
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. The accompanying condensed consolidated financial
statements should be read in conjunction with the financial statements and
notes thereto included in Vitrias Annual Report on Form 10-K for the year
ended December 31, 2003. The results of Vitrias operations for any interim
period are not necessarily indicative of the results of the operations for any
other interim period or for a full fiscal year. Stock-based compensation Vitria accounts for stock-based employee compensation arrangements using
the intrinsic value method in accordance with the provisions of Accounting
Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued to
Employees,as amended by FASB Interpretation No. 44, Accounting for Certain
Transactions Involving Stock Compensation, issued by the Financial Accounting
Standards Board, and complies with the disclosure provisions of Statement of
Financial Accounting Standards No. 123 (SFAS 123), Accounting for Stock-Based
Compensationand SFAS No. 148, Accounting for Stock-based Compensation 
Transition and Disclosure. Unearned compensation is amortized and expensed in
accordance with Financial Accounting Standards Board Interpretation No. 28
using the multiple option approach. Under APB 25 and related interpretations, unearned compensation is based
on the difference, on the date of the grant, between the fair value of Vitrias
common stock and the exercise price. Under APB 25, no compensation expense is
recognized in Vitrias financial statements when the exercise price of Vitrias
employee stock options equals the market price of the underlying stock on the
date of grant. Vitria has elected to follow APB 25 because the alternative fair
value accounting provided for under SFAS 123 requires the use of option
valuation models that were not developed for use in valuing employee stock
options. 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 our
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 in the table below
was estimated using the Black-Scholes option-pricing model and the following
weighted-average assumptions: 6




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Stock optionplans
    
    ESPPThree months ended March 31,2004
    
    2003
    
    2004
    
    2003Risk-free interest rate
    
    
    3.00
    %
    
    
    3.23
    %
    
    
    3.14
    %
    
    
    3.63
    %Expected Lives (in years)
    
    
    3
    
    
    
    3
    
    
    
    1
    
    
    
    1Dividend yield
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Expected volatility
    
    
    126
    %
    
    
    82
    %
    
    
    138
    %
    
    
    145
    %
 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.
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 do 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 (collectively options). 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,
    
    March 31,2004
    
    2003Net loss, as reported
    
    $
    (6,646
    )
    
    $
    (20,715
    )Add: stock-based employee compensation expense included
in reported net loss
    
    
    41
    
    
    
    153Deduct: total stock-based compensation expense determined
under the fair value based method for all awards
    
    
    (2,086
    )
    
    
    41Pro forma net loss
    
    $
    (8,691
    )
    
    $
    (20,521
    )Net loss per share as reported
    
    $
    (0.20
    )
    
    $
    (0.64
    )Pro forma net loss per share
    
    $
    (0.26
    )
    
    $
    (0.63
    )Total shares used in calculation
    
    
    32,816
    
    
    
    32,530
 During
the three months ended March 31, 2003, stock-based compensation
expense determined under the fair value based method resulted in a positive
number in the above table, or a reduction in expense. This is the result of
adjustments to reverse previously recognized stock-based compensation expense
on employee options forfeited prior to the employee earning the award.
Forfeitures refer to awards that do not vest because service or employment
requirements are not met. In accordance with SFAS 123, we based our initial
estimate of stock-based compensation expense on the total number of options
granted. Adjustments are made in the period of forfeiture to reverse
previously recognized stock-based compensation expense associated with the
unearned portion of a forfeited award. 7




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Because the determination of fair value of all options granted prior to
the time we became a public entity excludes volatility factors, the above
results may not be representative of future periods. 2) Net Loss Per Share Basic net loss per share is calculated by dividing net loss by the
weighted-average number of shares of common stock outstanding. Basic net loss
per share does not include shares subject to Vitrias right of repurchase,
which lapses ratably over the related vesting term. Diluted net loss per share
is calculated by dividing net loss by the weighted-average number of shares of
common stock outstanding plus shares of potential common stock. Shares of
potential common stock are composed of shares of common stock subject to
Vitrias right of repurchase and shares of common stock issuable upon the
exercise of stock options (using the treasury stock method). The calculation of
diluted net loss per share excludes shares of potential common stock if their
effect is anti-dilutive. The following table sets forth the computation of basic and diluted net
loss per share for the periods indicated (in thousands, except per share
amounts). All share amounts in the following table have been restated for all
periods presented to reflect the reverse stock split which occurred during the
second quarter of 2003 (see Note 7). Three Months EndedMarch 31,
    
    March 31,2004
    
    2003Numerator for basic and diluted net loss per share:Net loss
    
    $
    (6,646
    )
    
    $
    (20,715
    )Denominator for basic and diluted net loss per share:Weighted average shares of common stock
outstanding
    
    
    32,820
    
    
    
    32,606Less shares subject to repurchase
    
    
    (4
    )
    
    
    (76
    )Denominator for basic and diluted net loss per share
    
    
    32,816
    
    
    
    32,530Basic and diluted net loss per share
    
    $
    (0.20
    )
    
    $
    (0.64
    )
 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,
    
    March 31,2004
    
    2003Weighted average effect of anti-dilutive securities:Employee stock options (using the treasury stock
method)
    
    
    1,688
    
    
    
    55Common stock subject to repurchase agreements
    
    
    4
    
    
    
    76Total
    
    
    1,692
    
    
    
    131
 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,
    
    March 31,2004
    
    2003Net loss
    
    $
    (6,646
    )
    
    $
    (20,715
    )Other comprehensive income (loss):Foreign currency translation adjustment
    
    
    (49
    )
    
    
    201Unrealized (loss) on securities
    
    
    1
    
    
    
    (15
    )Comprehensive loss
    
    $
    (6,694
    )
    
    $
    (20,529
    )
 The components of accumulated other comprehensive loss are as follows (in
thousands): March 31,
    
    December 31,2004
    
    2003Foreign currency translation
    
    $
    584
    
    
    $
    633Unrealized gain on marketable debt securities
    
    
    3
    
    
    
    2Total accumulated other comprehensive gain
    
    $
    587
    
    
    $
    635
 4) Stock-Based Compensation Stock-based compensation is broken down as follows (in thousands): Three Months EndedMarch 31,
    
    March 31,2004
    
    2003Cost of revenues
    
    $
    15
    
    
    $
    56Sales and marketing
    
    
    15
    
    
    
    56Research and development
    
    
    8
    
    
    
    29General and administrative
    
    
    3
    
    
    
    12Total stock-based compensation
    
    $
    41
    
    
    $
    153
 9




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5) Restructuring, Impairments and Other Charges In
the year ended December 31, 2002 we initiated actions to reduce our
cost structure due to sustained negative economic conditions that have impacted
our operations and resulted in lower than anticipated revenues. In April and
August 2002 we reduced our workforce and consolidated our facilities. The
restructuring actions in 2002 resulted in a reduction in workforce of
approximately 285 employees or 33% of Vitrias workforce measured as of the
beginning of 2002 and affected all departments. Facilities in the United
States and United Kingdom were consolidated and related leasehold improvement
and equipment were written off. As a result of the restructuring actions, a
charge of $19.5 million in the year ended December 31, 2002 was incurred. The
restructuring charge included approximately $4.2 million of severance related
charges and $15.4 million of committed excess facilities payments, which
included $463,000 for the write-off of leasehold improvements and equipment in
vacated buildings. In the year ended December 31, 2003, we initiated actions to further
reduce our cost structure. The restructuring actions in 2003 resulted in a
reduction in workforce of approximately 120 employees or 22% of our workforce
measured as of the beginning of 2003 and affected all departments. The plan
was a combination of a reduction in workforce, consolidations of facilities in
the United States and United Kingdom and the associated disposal of leasehold
improvements and equipment. The severance related charges consist of one-time
termination benefits recognized and measured at fair value at the date the plan
was communicated to the employees. The excess facilities payments were
measured at fair value as of the cease-use date of the facilities using a
discount rate of 6% per annum. The leasehold improvements and equipment
write-offs, which were associated with vacating the excess facilities, were
based on net book value as of the date of abandonment. As a result of the
restructuring actions, a charge of $16.1 million in the year ended December 31,
2003 was incurred. The restructuring charge included approximately $2.9
million of severance related charges and $9.8 million of committed excess
facilities payments, $2.2 million in write-offs of leasehold improvements and
equipment and $1.0 million for changes in sublease income assumptions for
facilities restructured in both 2002 and 2003. In addition we incurred
$180,000 in accretion charges in 2003 and $54,000 in accretion charge in the
first quarter of 2004 related to the fair value treatment for the facilities we
restructured in 2003, in accordance with Statement of Financial Accounting
Standard No. 146 (SFAS 146), Accounting for Costs Associated with Exit or
Disposal Activities. There were no other restructuring charges or adjustments
in the first quarter of 2004. As of March 31, 2004, $16.8 million related to
facility closures remains accrued from all of the restructuring actions. The facilities consolidation charges for all of our restructuring actions
were calculated using our 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 several sublease agreements. 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 our
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. The total accrued liability for lease termination costs of $16.8 million
at March 31, 2004 is net of $5.0 million of estimated sublease income. The
portion of this liability related to restructuring actions taken in 2003 is
discounted at fair value as required by SFAS 146, which was adopted by us in
2003, and is included in the table below: 10




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Facilitiesconsolidation
    
    Severance
    
    TotalFiscal 2002 restructuring
    
    $
    15,358
    
    
    $
    4,158
    
    
    $
    19,516Cash payments
    
    
    (2,592
    )
    
    
    (4,014
    )
    
    
    (6,606
    )Fixed asset writeoffs
    
    
    (463
    )
    
    
    
    
    
    
    (463
    )Reclassification 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 asset writeoffs
    
    
    (2,247
    )
    
    
    
    
    
    
    (2,247
    )Facility adjustments
    
    
    1,229
    
    
    
    
    
    
    
    1,229Severance
    
    
    
    
    
    
    330
    
    
    
    330Balance at December 31, 2003
    
    
    18,482
    
    
    
    330
    
    
    
    18,812Cash payments
    
    
    (1,772
    )
    
    
    (330
    )
    
    
    (2,102
    )Facility adjustments
    
    
    54
    
    
    
    
    
    
    
    54Balance at March 31, 2004
    
    $
    16,764
    
    
    $
    
    
    
    $
    16,764
 At March 31, 2004, $6.1 million related to the restructuring activities
remained in current liabilities and $10.7 million remained in long-term
liabilities. Future lease payments for restructured facilities totaling $16.8
million will be made through 2013. 6) Related Party Transactions In
December 2003, we sold our interest in our China operations to
ChiLin LLC. ChiLin is owned and controlled by Dr. JoMei Chang, a
director and a significant stockholder, and Dr. Dale Skeen, a
director and our interim Chief
Executive Officer and Chief Technology Officer, the spouse of Dr. Chang and a
significant stockholder. Vitria and ChiLin also entered into a license agreement whereby ChiLin
received a royalty-bearing license to distribute Vitria products in China. In
addition, Vitria and ChiLin executed a development agreement pursuant to which
ChiLin will perform development work and other fee-bearing services for Vitria.
During the first quarter of 2004, ChiLin paid Vitria royalty license fees of
$100,000 and Vitria paid ChiLin $174,000 for development work performed in the
first quarter of 2004. 7) Reverse Stock Split On May 19, 2003, our Board of Directors approved a one-for-four reverse
split of our common stock. The reverse split was approved by Vitria
stockholders on May 16, 2003 and implemented on May 27, 2003. Each four shares
of our outstanding common stock automatically converted into one share of
common stock. 11




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All share and per share amounts have been restated for all periods
presented to reflect this reverse stock split. In addition, the number of
authorized shares of common stock was reduced from 600 million to 150 million
shares. 12




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##### Table of Contents



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 is a leading provider of business process integration software and
services for corporations in healthcare, telecommunications, finance,
manufacturing and other markets. Our software automates business processes
across multiple existing systems, people and trading partners in order to
reduce operating costs, enhance revenues and improve customer service. To
accomplish this, we develop and deliver the Vitria:BusinessWare® business
process integration software platform together with packaged applications and
best practices content. These applications and content are designed to quickly
and effectively solve industry-specific business problems such as healthcare
claims lifecycle management, straight-through processing in capital markets,
and order management for telecommunications and manufacturing. Our flagship Vitria:BusinessWare integration platform uses graphically
modeled business process logic as the foundation for orchestrating complex
interactions between dissimilar software applications, Web services,
individuals, and trading partners over corporate networks and the Internet. By
automating and measuring previously fragmented business processes from start to
finish, our products and services are designed to:  
    
    Reduce personnel costs, improve customer service, and
speed time-to-revenue capture by automating manual processes
between systems, people and partners;
    
    Enhance visibility into business operations by measuring
business performance as it crosses different systems, departments,
customers and partners;
    
    Enforce industry and company-specific best practices and
government regulatory requirements with automated business logic,
rules and workflows, and
    
    Ensure greater consistency, accuracy and accessibility of
corporate-wide data on customers and products. We derive revenues primarily from two sources: licenses, and services and
other. Our products are typically licensed directly to customers for a
perpetual term, with pricing based on the number of copies licensed, or systems
or applications managed. Service and other revenues include product
maintenance, consulting and training. Customers who license Vitria:BusinessWare
normally purchase maintenance contracts. These contracts provide unspecified
software upgrades and technical support over a specified term, which is
typically twelve months. A majority of our customers use third-party system
integrators to implement our products. Customers typically purchase additional
consulting services from us to support their implementation activities. We also
offer training classes for our customers and system integrators. We market our
products through our direct sales force and augment our marketing efforts
through relationships with system integrators and technology vendors. Our
revenues to date have been derived primarily from accounts in the United
States. We have international sales offices in Australia, Brazil, Canada,
France, Germany, Italy, Japan, Korea, Mexico, Singapore, Spain and the United
Kingdom. Over the last three years, the marketplace in which Vitria competes has
become increasingly competitive as more companies are offering products in our
general markets. Additionally, over the same period increased competition has
caused a steady decline in the average purchase price of our products. While
we have taken measures in 2002 and 2003 to reduce our overall cost structure to
better match lower revenues, we must develop additional products to create
revenue growth. Accordingly, we are developing a suite of products targeted to
reduce specific components of our customers administrative costs. While the
success of our efforts cannot be predicted, we feel that our future revenue and
margin growth will be dependent upon successfully selling these products. Industry-Specific Products Vitrias Business Process Integration Software While each Vitria customer has unique aspects of their business processes
and existing application environment, there are many common business and
technical elements to recurring business integration problems that lend
themselves to a more standardized, repeatable approach. Pre-building certain
applications and components is designed to satisfy customers desire for faster
time-to-value, lower cost of implementation, and leveraging industry best
practices. Pre-built applications and best practices content can include: 13




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
    
    business process models;
    
    business rules for automated decision-making;
    
    human task automation (workflow);
    
    operational real-time dashboards and on-demand historical reporting;
    
    exception handling rules and workflows;
    
    data translations and validation rules;
    
    application connectors; and
    
    third-party applications and components. Because these components are built on our general-purpose
Vitria:BusinessWare integration platform, each is configurable to meet
customers unique business and technology requirements. Vitria combines technology leadership with industry domain expertise in
healthcare, telecommunications, finance and manufacturing to automate and
streamline strategic business processes across systems, people and trading
partners. Using pre-built applications, content, platform and in conjunction
with services to deliver business process integration solutions that preserve
and extend a companys existing technology investments, Vitrias applications
are designed to provide real-time visibility and streamlined control over
processes and data to reduce costs, increase revenues, improve customer
experience, and ensure regulatory compliance. Vitria has developed years of intellectual property around automating
industry-specific business processes in our target markets that can be either
pre-packaged in software applications that run on the Vitria:BusinessWare
platform, or used by Vitrias client services teams to more rapidly implement
and configure applications. This focus on business processes allows Vitria to
concentrate our product development and marketing efforts on demonstrating the
measurable business value of process integration to business executives, in
addition to demonstrating the technical value of our platform to information
technology professionals. Examples of Vitrias packaged applications include:  
    
    Vitria:SmartClaims: a packaged application designed to improve
a healthcare payers automation of claims processing.
Vitria:SmartClaims augments a payers legacy claims processing
systems with automated business rules, processes and human workflows
to prevent, automatically resolve, and expedite the resolution of
issues that prevent full automation of each claims payment decision.
Vitria:SmartClaims improves business agility by empowering business
users to quickly and directly automate new policies with intuitive
business rules.
    
    Vitria:OrderAccelerator: a packaged software application that
automates business processes across a telecommunications service
providers existing systems for more cost-efficient and accurate
order management. Vitria:OrderAccelerator includes pre-built
business processes and content based on the Telemanagement Forums
eTOM (Enhanced Telecom Operations Map) as well as best practices
Vitria has incorporated from successful implementations with its
telecom customers.
    
    Vitria:SmartResponse: a packaged application designed to reduce
healthcare insurers medical management administrative costs by
automating the processes and decision logic by which physicians and
hospitals submit requests for medical service authorizations and
referrals, and by which insurers receive, decide and respond to those
requests.
    
    CleanOrder: a package of pre-built content for manufacturing
companies to quickly achieve consolidated order management.
CleanOrder intelligently manages customer orders across multiple
existing systems, 14




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trading partners and internal organizations, resulting in a
single-point order and fulfillment management system without the risk
and cost of big-budget Enterprise Resource Planning (ERP)
implementations.
    
    Accenture Straight Through Processing (STP) Integration
Platform, powered by Vitria: a package of pre-built content
co-designed and co-marketed with Accenture to enable efficient,
end-to-end transaction processing automation for broker/dealers,
asset managers and custodians in order to reduce exception processing
costs, reduce trade correction costs, and manage operational risks in
real time.
    
    SWIFT Management: a package of pre-built content to allow banks
and brokerages to automatically generate messages that are compliant
with the ever-changing requirements of the SWIFT financial network,
convert between formats and repair failed trades in order to cut
operational costs and optimize operations. Vitrias BusinessWare Platform Vitria:BusinessWare unifies the five elements that we believe are
essential for business process integration software, all in a single platform:  (1)
    
    Business Process Management, or BPM: BPM manages the steps of a
cross-functional business process to ensure optimal completion of the
process (e.g., from submission of a healthcare claim by a care
provider to the remittance of payment by an insurer). It uses
graphical business process models together with automated human
workflows to define, automate and orchestrate transactions and the
exchange of information between internal business applications,
people and external trading partners.(2)
    
    Business Analysis and Monitoring, or BAM: BAM provides both
historic and real-time monitoring and analysis of business processes,
providing greater visibility and business intelligence needed to
optimize operational efficiency. Our two key BAM components, Cockpit
and Analyzer, are designed to continuously gather business process
data across applications, human workflows and trading partner
interactions; analyze and visualize this data in real time; and
enable business executives and process owners to identify and respond
to both business and integration problems or opportunities as they
occur.(3)
    
    Business Vocabulary Management, or BVM: BVM is comprised of
content and tools that enable the flexible, scalable management of
translations between industry-specific and application-specific data
formats and meanings (vocabularies) as represented in electronic
transactions between businesses (e.g. via Electronic Data
Interchange, or EDI, or eXtensible Markup Language, or XML), and
between a companys internal applications. BVM uses automated
exception handling, business rules-based validation and advanced data
transformation designed to ensure that differences in how data is
represented does not interfere with successful completion of a
business transaction (e.g. fulfilling a customers order, processing
a healthcare claim, or settling a financial transaction). To address
the specific needs of each industry, BVM provides packaged
vocabularies for various industries based on the specific business
terms used within those industries.(4)
    
    Business-to-Business Integration, or B2B: B2B enables the
secure and reliable completion of transactions and the exchange of
business information between customers and partners over the Internet
to support collaborative business processes. Combined with BPM and
BAM, B2B helps companies manage their value chain interactions from
end to end as an integrated part of their larger business processes.(5)
    
    Enterprise Application Integration, or EAI: EAI enables the
secure and reliable movement of 15




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information in and out of internal business applications. By
enabling internal applications to communicate with one another, EAI
helps unify and improve enterprise processes while maximizing the
value of a companys application investments. Companies may use
Vitria:BusinessWares BPM, BAM and BVM capabilities to control
business processes on top of industry-standard methods of
transporting data from application to application (such as Web
services and Java Messaging Service) or third-party EAI
infrastructures. Vitria:BusinessWare allows customers to solve their business problems
using graphical models rather than developing custom programs. Instead of
writing new software programs, business managers can create visual diagrams of
business processes, called process models, using a point-and-click user
interface. Vitria:BusinessWare then translates these process models into
software programs that automate the flow of information across a companys
underlying IT systems. Once customers use Vitria:BusinessWare to define their business process
models and integrate the underlying IT systems, people and partners,
Vitria:BusinessWare automatically controls the flow of information across the
IT systems as specified by the process models. Vitria:BusinessWare continuously
analyzes the customers business processes and can automatically change the
processes in response to this analysis. This capability allows companies to
transform the information flowing through their IT systems into actionable
intelligence that enables business managers to optimize their business
operations. 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, revenues 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 revenues from software licenses to end users for
Vitria:BusinessWare and other products and related services, which include
maintenance and support, consulting and training services. In accordance with
the provisions of Statement of Position 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,
the product is considered 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 the 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 revenue is deferred until sufficient objective
evidence exists or all elements have been delivered. We treat all arrangements
with payment terms longer than normal not to be fixed or determinable. Our
normal payment terms currently range from net 30 days to net 90 days for
domestic and international customers, respectively. Revenue is generally
deferred for those agreements which exceed our normal payment terms and are
therefore 16




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assessed as not being fixed or determinable. Revenue under these
agreements is recognized as payments become due unless collectibility concerns
exist, in which case revenue is deferred until payments are received. Our
assessment of collectibility is particularly critical in determining whether
revenue should be recognized in the current market environment. If
collectibility is not considered probable, revenue is recognized when the fee
is collected. Revenue on arrangements with customers who are not the ultimate
users, primarily third-party systems integrators, is not recognized until
evidence of a sell-through arrangement to an end user has been received. Service and other revenues include product maintenance, consulting, and
training. Customers who license Vitria:BusinessWare normally purchase
maintenance contracts. These contracts provide unspecified software upgrades
and technical support over a specified term, which is typically twelve months.
Maintenance contracts are usually paid in advance, and revenues from these
contracts are recognized ratably over the term of the contract. A majority of
our customers use third-party system integrators to implement our products.
Customers typically purchase additional consulting services from us to support
their implementation activities. These consulting services are generally sold
on a time and materials basis and recognized as the services are performed. We
also offer training services which are sold on a per student or per class basis
and recognized as the classes are attended. Payments received in advance of revenue recognition are recorded as
deferred revenue. When the 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 the software product, both the product license revenue and
consulting services revenue are recognized in accordance with the provision of
Statement of Position 81-1, Accounting for Performance of Construction Type and
Certain Production Type Contracts.We recognize revenue from these
arrangements using the percentage of completion method based on cost inputs
and, therefore, both product license and consulting services revenue are
recognized as work progresses. These arrangements have not been common and,
therefore, the significant majority of our license revenue in the past three
years has been recognized under SOP 97-2, as amended. 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 collectibility issue exists with respect to a specific
receivable, we record an allowance to reduce that receivable to the amount that
we believe is collectible. In addition, we record an allowance on the
remainder of our receivables that are still in good standing based on our past
write off experience. If the financial condition of our customers were to
deteriorate in the future, resulting in an impairment of their ability to make
payments, additional allowances may be required. Restructuring Charges We recorded $19.5 million in restructuring charges related to the
realignment of our business operations in 2002. During 2003, we recorded an
additional $16.1 million of restructuring charges related to the realignment of
our business operations. In the first quarter of 2004 we did not incur any
restructuring charges except for accretion charges related to the fair value
treatment for the facilities we restructured in 2003, in accordance with SFAS
146. As of March 31, 2004, we have $16.8 million in accrued restructuring
expenses, consisting entirely of future lease payments which will be paid out
through 2013. 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 17




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sublease income we are likely to receive and the timing of finding a
tenant has been obtained from third party experts and are 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. 18




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RESULTS OF OPERATIONS
For the three months ended March 31, 2004 and 2003 The following table sets forth the results of operations for the three
months ended March 31, 2004 and 2003, expressed as a percentage of total
revenues. Three Months EndedMarch 31,2004
    
    2003Revenues:License
    
    
    24
    %
    
    
    47
    %Service and other
    
    
    76
    %
    
    
    53
    %Total revenues
    
    
    100
    %
    
    
    100
    %Cost of revenues:License
    
    
    1
    %
    
    
    0
    %Service and other
    
    
    43
    %
    
    
    31
    %Total cost of revenues
    
    
    44
    %
    
    
    31
    %Gross profit
    
    
    56
    %
    
    
    69
    %Operating expenses:Sales and marketing
    
    
    46
    %
    
    
    58
    %Research and development
    
    
    33
    %
    
    
    23
    %General and administrative
    
    
    23
    %
    
    
    17
    %Stock-based compensation
    
    
    0
    %
    
    
    1
    %Restructuring charges
    
    
    0
    %
    
    
    62
    %Total operating expenses
    
    
    102
    %
    
    
    161
    %Loss from operations
    
    
    (46
    %)
    
    
    (92
    %)Interest income
    
    
    2
    %
    
    
    2
    %Other income (expense), net
    
    
    (1
    %)
    
    
    (1
    %)Net loss before income taxes
    
    
    (45
    %)
    
    
    (91
    %)Provision for income taxes
    
    
    1
    %
    
    
    0
    %Net loss
    
    
    (46
    %)
    
    
    (91
    %)
 Revenues In the three months ended March 31, 2004, our revenues from customers
outside the United States increased to 43% compared to 26% in the three months
ended March 31, 2003 as our U.S. license revenues decreased significantly from
the prior period. To date, we have not experienced significant seasonality of
revenue. We expect that future results may be affected by the fiscal or
quarterly budget cycles of our customers. Sales to our ten largest customers accounted for 35% of total revenues in
the three months ended March 31, 2004 and 51% of total revenues in the three
months ended March 31, 2003. No single customer accounted for more 19




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than 10% of total revenues in the three months ended March 31, 2004. Two
customers accounted for 19% and 13% of our total revenues in the three months
ended March 31, 2003. We expect that revenues from a limited number of
customers will continue to account for a large percentage of total revenues in
future quarters. Therefore, the loss or delay of individual orders could have
a significant impact on revenues. Our ability to attract new customers will
depend on a variety of factors, including the reliability, security,
scalability and the overall cost-effectiveness of our products. License.License revenues decreased 68% from $10.5 million in the three
months ended March 31, 2003 to $3.4 million in the three months ended March 31,
2004. This decrease was due to fewer total orders and a decrease in our
average deal size. The decrease in our average deal size was due to downward
pricing pressure on our base Vitria:Businessware software offering. The
maturation of the market in which we compete has resulted in fewer total orders
as competition has increased for a smaller pool of potential buyers. The
general slowdown in information technology spending in our target markets due
to slow U.S. economic growth has made it more difficult for us to grow our
revenues. Service and other.The level of service revenue is impacted by the number
and size of license deals in a given period. Support for the first year is
purchased as part of each license deal. Most of our consulting project revenue
and customer training revenue is also affected by the size and number of
license deals. Service and other revenue also includes support renewals, which
is dependent upon our installed license base. Service and other revenues
decreased 10% from $12.1 million in the three months ended March 31, 2003 to
$10.9 million in the three months ended March 31, 2004. Consulting revenue
decreased significantly primarily due to a
delay in obtaining final sign off on consulting services of
approximately $900,000 in the three months ended March 31, 2004. We had already received payment for these
services at March 31, 2004. However, the signoff was not received
until April 2, 2004 therefore the revenue will be recognized in
the second quarter of fiscal 2004. First year support decreased slightly, related
to our decrease in license revenue. Both of these declines were partially offset by an
increase in support renewals from customers who had purchased our products in
previous years. Cost of Revenues License.Cost of license revenues consists of royalty payments to third
parties for technology incorporated into our products. Fluctuations in cost of
license is generally due to the buying patterns of our customers, as cost of
license revenues is dependent upon which products our customers purchase, and
which of those purchased products have third-party technology incorporated into
them. Cost of license revenues increased 110% from $94,000 in the three months
ended March 31, 2003 to $198,000 in the three months ended March 31, 2004.
This fluctuation as well as future fluctuations in cost of license revenues are
due to increases or decreases in sales of those particular products which
incorporate third-party technology. Service and other. Cost of service and other revenues consists of
salaries, facility costs, travel expenses and third party consultant fees
incurred in providing customer support, training and implementation related
services. Cost of service and other revenues decreased 13% from $7.0 million
in the three months ended March 31, 2003 to $6.1 million in the three months
ended March 31, 2004. This decrease is primarily due to a decrease of $117,000
in salary and benefit expenses arising from our workforce reductions in 2003
and associated decreases of approximately $359,000 in facility costs related to
the headcount reductions, as well as reduced travel expenses of $240,000 due to
fewer consulting projects in the first quarter of 2004. For the next quarter,
we expect that cost of service and other will decrease slightly as a result of
further efforts to control costs. Operating Expenses Sales and marketing. Sales and marketing expenses consist of salaries,
commissions, field office expenses, travel and entertainment, and promotional
expenses. Sales and marketing expenses decreased 50% from $13.0 million in the
three months ended March 31, 2003 to $6.6 million in the three months ended
March 31, 2004. This decrease was primarily due to decreases in salary and
benefit expenses of $2.8 million and reduced travel expenses of $613,000 due to
our workforce reduction in the first quarter of 2003, lower external consulting
expenses of $777,000 20




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due to cost containment efforts, lower commission expenses of $694,000 due to
lower revenues in the three months ended March 31, 2004, as well as related
decreases in most other expense areas as a result of our cost containment
efforts. For the next quarter, we expect that sales and marketing expenses
will remain flat compared to the quarter ended March 31, 2004. 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 12% from $5.3 million in the three months ended March 31, 2003 to
$4.7 million in the three months ended March 31, 2004. This decrease was
primarily due to a decrease of $200,000 in salary expenses arising from our
workforce reduction in the first quarter of 2003 and reduced facilities costs
of $298,000 due to our facilities restructuring in the first quarter of 2003 as
well as related decreases in most other expense areas as a result of our cost
containment efforts. For the next quarter, we expect that research and
development expenses will remain flat compared to the quarter ended March 31,
2004. General and administrative. General and administrative expenses consist
of salaries for administrative, executive and finance personnel, information
systems costs, outside professional service fees and our provision for doubtful
accounts. General and administrative expenses decreased 16% from $3.9 million
in the three months ended March 31, 2003 to $3.3 million in the three months
ended March 31, 2004. This decrease was primarily attributable to a decrease
of $189,000 in salaries and benefit expenses as a result of our workforce
reduction in the first quarter of 2003 and related decreases in most other
expense areas as a result of our cost containment efforts. For the next
quarter, we expect that general and administrative expenses will
increase slightly
compared to the quarter ended March 31, 2004 due to increasing
costs of complying with the Sarbanes-Oxley Act. Stock-based compensation.Total stock-based compensation expenses were
$41,000 for the three months ended March 31, 2004 and $153,000 for the three
months ended March 31, 2003. Stock-based compensation includes the
amortization of unearned employee stock-based compensation on options issued to
employees prior to Vitria completing its initial public offering in September
1999 and is being amortized over a five-year vesting period. We expect to
recognize employee stock-based compensation expenses of approximately $38,000
for the remaining nine months of 2004. This unearned compensation expense will
be reduced in future periods to the extent that options are terminated prior to
vesting. Restructuring charges.In the year ended December 31, 2002 Vitria
initiated actions to reduce our cost structure due to sustained negative
economic conditions that have impacted our operations and resulted in lower
than anticipated revenues. In April and August 2002 we reduced our workforce
and consolidated our facilities. The restructuring actions in 2002 resulted
in a reduction in workforce of approximately 285 employees or 33% of Vitrias
workforce measured as of the beginning of 2002 and affected all departments.
Facilities in the United States and United Kingdom were consolidated and
related leasehold improvement and equipment were written off. As a result of
the restructuring actions, a charge of $19.5 million in the year ended December
31, 2002 was incurred. The restructuring charge included approximately $4.2
million of severance related charges and $15.4 million of committed excess
facilities payments, which included $463,000 for the write-off of leasehold
improvements and equipment in vacated buildings. In the year ended December 31, 2003, we initiated actions to further
reduce our cost structure. The restructuring actions in 2003 resulted in a
reduction in workforce of approximately 120 employees or 22% of our workforce
measured as of the beginning of 2003 and affected all departments. The plan
was a combination of a reduction in workforce, consolidations of facilities in
the United States and United Kingdom and the associated disposal of leasehold
improvements and equipment. The severance related charges consist of one-time
termination benefits recognized and measured at fair value at the date the plan
was communicated to the employees. The excess facilities payments were
measured at fair value as of the cease-use date of the facilities using a
discount rate of 6% per 21




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annum. The leasehold improvements and equipment write-offs, which were
associated with vacating the excess facilities, were based on net book value as
of the date of abandonment. As a result of the restructuring actions, a charge
of $16.1 million in the year ended December 31, 2003 was incurred. The
restructuring charge included approximately $2.9 million of severance related
charges and $9.8 million of committed excess facilities payments, $2.2 million
in write-offs of leasehold improvements and equipment and $1.0 million for
changes in sublease income assumptions for facilities restructured in both 2002
and 2003. In addition we incurred $180,000 in accretion charges in 2003 and
$54,000 in accretion charge in the first quarter of 2004 related to the fair
value treatment for the facilities we restructured in 2003, in accordance with
Statement of Financial Accounting Standard No. 146 (SFAS 146), Accounting for
Costs Associated with Exit or Disposal Activities. There were no other
restructuring charges or adjustments in the first quarter of 2004. As of March
31, 2004, $16.8 million related to facility closures remains accrued from all
of the restructuring actions. The total accrued liability for lease termination costs of $16.8 million
at March 31, 2004 is net of $5.0 million of estimated sublease income. A
portion of this liability is based on the fair value treatment required by SFAS
146, which we adopted as of January 31, 2003. The facilities consolidation charges for all of our restructuring actions
were calculated using our 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 several sublease agreements. 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 our 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 (expense), net, decreased 46%, from $205,000 in the three months ended
March 31, 2003 to $111,000 in the three months ended March 31, 2004. The
decrease is primarily attributable to lower interest income due to lower cash
and investment balances, offset by an increase in foreign currency exchange
gain. Provision for income taxes We recorded an income tax provision of $120,000 and $65,000 for the
three-month periods ended March 31, 2004 and 2003, respectively. Income tax
provisions in both periods presented relate to income taxes currently payable
on income generated in non-U.S. tax jurisdictions, state income taxes, and
foreign withholding taxes incurred on software license revenue. 22




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Liquidity and Capital Resources Three Months EndedMarch 31,
    
    Percent2004
    
    2003
    
    Change(in thousands)Net cash used in operating activities
    
    $
    (766
    )
    
    $
    (15,298
    )
    
    
    (95
    %)Net cash provided by (used in) investing activities
    
    
    625
    
    
    
    1,186
    
    
    
    (47
    %)Net cash provided by (used in) financing activities
    
    
    257
    
    
    
    (1
    )
    
    
    (25,800
    %)
 As
of March 31, 2004, we had approximately $91.0 million in
cash, cash equivalents and short term investments, $31.6 million
in short term liabilities and $10.8 million in long term
liabilities. Net cash used in operating activities decreased $14.5 million, or 95%, in
the three months ended March 31, 2004 compared to the three months ended March
31, 2003. This decrease was primarily due to a decrease in our net loss as we
reduced our expenses over the prior year, a decrease in our accounts receivable
balances as we collected more cash than the prior year, offset by a decrease in
accrued restructuring balance as we paid down our restructuring liabilities. Net cash provided by investing activities decreased $561,000, or 47%, in
the three months ended March 31, 2004 compared to the three months ended March
31, 2003. This decrease in the current period was primarily due to
the fact that the net
maturities of our investments (maturities minus purchases) were less in the
first quarter of 2004 than in the first quarter of 2003. Net cash provided by (used in) financing activities increased $258,000, in
the three months ended March 31, 2004 as compared to the three months ended
March 31, 2003. Net cash provided by (used in) financing activities in both
the current and prior periods was primarily from the issuance of common stock. During the three months ended March 31, 2004, our net accounts receivable
balance decreased $4.6 million from $15.5 million at December 31, 2003 to $10.9
million at March 31, 2004. The reason for the decrease was that cash was
collected on most of the invoices that were due. An additional contributing
factor for the decline in the receivable balance was the decrease in revenues
during the first quarter as compared to the prior quarter. At March 31, 2004,
our gross accounts receivable balance is $11.3 million with an allowance for
doubtful accounts of $421,000 which is essentially unchanged from the allowance
balance at December 31, 2003. During the three months ended March 31, 2004, our deferred revenue balance
increased $2.4 million from $13.9 million at December 31, 2003 to $16.3 million
at March 31, 2004. The primary reason for this increase in deferred revenue is
an increase in support renewals. Contractual Cash Obligations and Commitments At March 31, 2004, we had contractual obligations and commercial
commitments of approximately $24.1 million as shown in the table below. The
table below excludes obligations related to accounts payable and accrued
liabilities incurred in the ordinary course of business. 23




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Payments due by periodLess than
    
    
    
    
    
    
    
    
    
    More thanContractual Obligations
    
    Total
    
    1 year
    
    1-3 years
    
    3-5 years
    
    5 years(in thousands)Capital Lease Obligations
    
    $
    147
    
    
    $
    95
    
    
    $
    52
    
    
    $
    
    
    
    $
    Operating Lease Obligations
    
    
    23,847
    
    
    
    5,516
    
    
    
    10,447
    
    
    
    3,716
    
    
    
    4,168Long-term Sublease Deposits
    
    
    62
    
    
    
    
    
    
    
    62
    
    
    
    
    
    
    
    Total
    
    $
    24,056
    
    
    $
    5,611
    
    
    $
    10,561
    
    
    $
    3,716
    
    
    $
    4,168
 Operating lease commitments shown above, which are net of contractual
sublease agreements, include $19.6 million of operating lease commitments under
leases for vacated facilities which were recorded as accrued restructuring
expenses in the accompanying balance sheet as of March 31, 2004. This $19.6
million lease commitment is net of $2.3 million in contractual sublease income.
We do not have any material commercial
commitments under lines of credit, standby lines of credit, standby repurchase
obligations or other such arrangements, except as disclosed below in the
section entitled Credit Facilities with Silicon Valley Bank. Off-Balance Sheet Arrangements At March 31, 2004, Vitria did not have any off-balance sheet arrangements
or relationships with unconsolidated entities or financial partnerships, such
as entities often referred to as structured finance or special purpose
entities, which are typically established for the purpose of facilitating
off-balance sheet arrangements or other contractually narrow or limited
purposes. Credit Facilities with Silicon Valley Bank We have a $15.0 million revolving line of credit agreement with Silicon
Valley Bank. Interest on outstanding borrowings accrues at the banks prime
rate of interest. The facility is secured by all of Vitrias assets. The
agreement includes restrictive covenants which require us to maintain, among
other things, minimum cash, cash equivalents, and short-term investments
balance of $80.0 million. As part of this $80.0 million balance, the agreement
also requires us to maintain a minimum balance of $25.0 million in investments
which are invested 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. As of March 31, 2004, 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 $8.8 million related to certain office leases at March
31, 2004. Operating Capital and Capital Expenditure Requirements Estimated future uses of cash over the next twelve months are primarily to
fund operations and to a lesser extent to fund capital expenditures. For the
next twelve months, we expect to fund these uses from available cash balances,
cash generated from operations, if any, and interest on available cash and
investment balances. Our ability to generate cash from operations is dependent
upon our ability to sell our products and services and generate revenue, 24




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as well as our ability to manage our operating costs. In turn, our
ability to sell our products is dependent upon both the economic climate and
the competitive factors of the marketplace in which we operate. In the past, we have invested significantly in our operations. We intend
to continue to invest selectively in sales, marketing, and research and
development. In addition, 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 in the
current year to be approximately $1.0 million. In addition, we may utilize
cash resources to fund acquisitions or investments in other businesses,
technologies or products lines. 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 and
may seek to raise these additional funds through public or private debt or
equity financings. If we need to seek additional financing, there is no
assurance that this additional financing will be available, or if available,
will be on reasonable terms and not dilutive to our stockholders. We believe our success requires expanding our customer base and continuing
to enhance our Vitria:BusinessWare products. Our revenues, operating results
and cash flows depend upon the volume and timing of customer orders and
payments and the date of product delivery. Historically, a substantial portion
of revenues in a given quarter have been recorded in the third month of that
quarter, with a concentration of these revenues in the last two weeks of the
third month. We expect this trend to continue and, therefore, any failure or
delay in the closing of orders would have a material adverse effect on our
quarterly operating results and cash flows. Since our operating expenses are
based on anticipated revenues and because a high percentage of these expenses
are relatively fixed, a delay in the recognition of revenue from one or more
license transactions could cause significant variations in operating results
from quarter to quarter and cause unexpected results. Revenues from contracts
that do not meet our revenue recognition policy requirements for which we have
been paid or have a valid receivable are recorded as deferred revenues. While a
portion of our revenues each quarter is recognized from deferred revenue, our
quarterly performance will depend primarily upon entering into new contracts to
generate revenues for that quarter. New contracts may not result in revenue
during the quarter in which the contract was signed, and we may not be able to
predict accurately when revenues from these contracts will be recognized. Our
future operating results and cash flows will depend on many factors, including
the following:  
    
    size and timing of customer orders and product and service delivery;
    
    level of demand for our professional services;
    
    changes in the mix of our products and services;
    
    ability to protect our intellectual property;
    
    actions taken by our competitors, including new product introductions and pricing changes;
    
    costs of maintaining our operations;
    
    introduction of new products;
    
    timing of our development and release of new and enhanced products;
    
    costs and timing of hiring qualified personnel;
    
    success in maintaining and enhancing existing relationships and
developing new relationships with system integrators; 25




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
    
    technological changes in our markets, including changes in
standards for computer and networking software and hardware;
    
    deferrals of customer orders in anticipation of product
enhancements or new products;
    
    delays in our ability to recognize revenue as a result of the
decision by our customers to postpone software delivery, or because
of changes in the timing of when delivery of products or services is
completed;
    
    customer budget cycles and changes in these budget cycles;
    
    external economic conditions;
    
    availability of customer funds for software purchases given external economic factors;
    
    costs related to acquisition of technologies or businesses;
    
    ability to successfully integrate acquisitions;
    
    changes in strategy and capability of our competitors; and
    
    liquidity and timeliness of payments from international customers. As a result of these factors, we believe that period-to-period comparisons
of our results of operations are not necessarily meaningful and should not be
relied upon as indications of future performance. It is likely that in some
future quarter our operating results will be below the expectations of public
market analysts and investors. In this event, the price of our common stock
would likely decline. Related Party Transactions In December 2003, Vitria sold its interest in its China operations to
ChiLin LLC. ChiLin is owned and controlled by Dr. JoMei Chang, a
director and
a significant stockholder, and Dr. Dale Skeen, a director and
our interim Chief Executive
Officer and Chief Technology Officer, the spouse of Dr. Chang and a significant
stockholder. Vitria and ChiLin also entered into a license agreement whereby ChiLin
received a royalty-bearing license to distribute Vitria products in China. In
addition, Vitria and ChiLin executed a development agreement pursuant to which
ChiLin will perform development work and other fee-bearing services for Vitria.
During the first quarter of 2004, ChiLin paid Vitria royalty license fees
of $100,000 and Vitria paid ChiLin $174,000 for development work performed in
the first quarter of 2004. 26




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK 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 under the caption Risks Associated with
Vitrias Business and Future Operating Results. 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 gains and losses at March 31,
2004 were not material. We have no cash flow exposure due to rate changes for cash equivalents and
cash 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, 2004. Table of investment securities (in thousands) as of March 31: 2004
    
    
    
    
    
    2003Weighted Average
    
    
    
    
    
    Weighted AverageFair Value
    
    Interest Rate
    
    Fair Value
    
    Interest RateCash and cash equivalents
    
    $
    8,849
    
    
    
    0.72
    %
    
    $
    28,515
    
    
    
    1.25
    %Short-term investments
    
    
    82,113
    
    
    
    1.15
    %
    
    
    73,971
    
    
    
    1.71
    %Total cash and investment securities
    
    $
    90,962
    
    
    
    
    
    
    $
    102,486
 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 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 27




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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, 2004. RISKS ASSOCIATED WITH VITRIAS BUSINESS AND FUTURE OPERATING RESULTS Our operating results fluctuate significantly and an unanticipated decline in
revenue may disappoint securities analysts or investors and result in a decline
in our stock price. Our quarterly operating results have fluctuated significantly in the past
and may vary significantly in the future. If our operating results are below
the expectations of securities analysts or investors, our stock price is likely
to decline. Period-to-period comparisons of our historical results of
operations are not necessarily a good predictor of our future performance. Our revenues and operating results depend upon the volume and timing of
customer orders and payments and the date of product delivery. Historically, a
substantial portion of revenues in a given quarter have been recorded in the
third month of that quarter, with a concentration of these revenues in the last
two weeks of the third month. We expect this trend to continue and, therefore,
any failure or delay in the closing of orders would have a material adverse
effect on our quarterly operating results. Since our operating expenses are
based on anticipated revenues and because a high percentage of these expenses
are relatively fixed, a delay in the recognition of revenue from one or more
license transactions could cause significant variations in operating results
from quarter to quarter and cause unexpected results. Our quarterly results depend primarily upon entering into new or follow-on
contracts to generate revenues for that quarter. New contracts may not result
in revenue in the quarter in which the contract was signed, and we may not be
able to predict accurately when revenues from these contracts will be
recognized. Our operating results are also dependent upon our ability to
manage our cost structure. 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 $208.4 million as of March 31, 2004. Since the
beginning of 2002, we have reduced our workforce by a total of 405 employees
and consolidated certain facilities as part of our restructuring plan. As a
result of these actions, we incurred a restructuring charge of $19.5 million in
2002 and $16.1 million in 2003. Despite these recent measures in order to
remain competitive we intend to continue investing selectively 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 revenues from
essentially one product, Vitria:BusinessWare product and our business could be
materially harmed by factors that adversely affect the pricing and demand for
Vitria:BusinessWare. Since 1998, a majority of our total revenues has been, and is expected to
be, derived from the license of our Vitria:BusinessWare product and for
applications built using that product. Accordingly, our future operating
results will depend on the demand for Vitria:BusinessWare 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:BusinessWare in performance or price, or we fail to enhance
Vitria:BusinessWare and introduce new products in a timely manner, demand for
our product may decline. A decline in demand for Vitria:BusinessWare as a
result of 28




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competition, technological change or other factors would significantly
reduce our revenues. We experienced a decrease in our average deal size in
2003 and in the first quarter of 2004 due to downward pricing pressure on our
base Vitria:Businessware software offering. The maturation of the market in
which we compete has resulted in fewer total orders as competition has
increased for a smaller pool of potential buyers. The general slowdown in
information technology spending in our target markets due to slow U.S. economic
growth has also made it more difficult to grow our revenues. Failure to raise additional capital or generate the significant capital
necessary to expand our operations and invest in new products could reduce our
ability to compete and result in lower revenues. During the three months ended March 31, 2004, we had a net loss of $6.6
million and our operating activities used $766,000 of cash. As of March 31,
2004, we had approximately $91.0 million in cash and cash equivalents and
short-term investments, $31.6 million in short-term liabilities, and $10.8 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
    
    respond to competitive pressures or unanticipated capital requirements. Our failure to do any of these things could result in lower revenues and
could seriously harm our business. The challenging economic environment in the United States and abroad, and
especially the continued reluctance of companies to make significant
expenditures on information technology, could reduce demand for our products
and cause our revenues to continue to decline. The downturn in the U.S. and the world economy may cause a further decline
in capital allocations for software purchases. The delay in capital
expenditures may cause a decrease in sales, may cause an increase in our
accounts receivable and may make collection of license and support payments
from our customers more difficult. Over approximately the past two years, we
have experienced a general slow-down in the level of capital spending by some
of our customers due to the general economic downturn, which has resulted in
lower revenues. This slow-down in capital spending, if sustained in future
periods, could result in reduced sales or the postponement of sales to our
customers. 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 revenues, diminished margin
levels, and could impair our operating results in future periods. 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. 29




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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. In addition, the downturn in the U.S. economy has caused some
customers to increase budgetary controls or require additional management
approvals within the customers organization prior to committing to significant
capital purchases, either of which could result in an increased sales cycle. Because a small number of customers have in the past accounted for a
substantial portion of our revenues, our revenues could decline due to the loss
or delay of a single customer order. Our ten largest transactions accounted for 35% of total revenues in the
three months ended March 31, 2004. Our license agreements do not generally
provide for ongoing license payments. Therefore, we expect that revenues from a
limited number of customers will continue to account for a significant
percentage of total revenues in future quarters. Our ability to attract new
customers will depend on a variety of factors, including the reliability,
security, scalability, breadth and depth of our products, and
cost-effectiveness of our products. The loss or delay of individual orders
could have a significant impact on revenues and operating results. Our failure
to add new customers that make significant purchases of our product and
services would reduce our future revenues. If we are not successful in developing industry specific solutions based on
Vitria:BusinessWare, our ability to increase future revenues could be harmed. We have developed and intend to continue to develop solutions based on
Vitria:BusinessWare which incorporate business processes, connectivity and
document transformations specific to the needs of particular industries,
including the healthcare, telecommunications, financial services and
manufacturing industries. This presents technical and sales challenges and
requires collaboration with third parties, including system integrators and
standard organizations, and the commitment of significant resources. 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 solutions or
these solutions do not achieve market acceptance, our ability to increase
future revenues could be harmed. To date we have concentrated our sales and marketing efforts toward
companies in the healthcare, telecommunications, financial services and
manufacturing industries. Customers in these new vertical markets are likely
to have different requirements and may require us to change our product design
or features, sales methods, support capabilities or pricing policies. If we
fail to successfully address these new vertical markets we may experience
decreased sales in future periods. Our products may not achieve market acceptance, which could cause our revenues
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. 30




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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 is intensely competitive, evolving and subject
to rapid technological change. The intensity of competition is expected to
increase in the future. Increased competition is likely to result in price
reductions, reduced gross margins and loss of market share, any one of which
could significantly reduce our future revenues. Our current and potential
competitors include ADP, Ascential Software, BEA, CCMS, CSC, IBM Corporation,
IONA, Landacorp, McKesson, MedDecision, Microsoft Corporation, Netik,
Pegasystems, ProxyMed, Quovadx, SeeBeyond Technology, SunGard, Sybase, TIBCO
Software, TriZetto, ViPS, WebMD, 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 products 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 also face or may soon face direct and indirect
competition from major enterprise software developers that offer integration
products as a complement to their other enterprise software products. These
companies may also modify their applications to be more easily integrated with
other applications through web services or other means. Some of these vendors
include Oracle, PeopleSoft, Siebel Systems 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. Our revenues will likely decline if we do not develop and maintain successful
relationships with system integrators. System integrators install and deploy our products and those of our
competitors, and perform custom integration of systems and applications. Some
system integrators engage in joint marketing and sales efforts with us. If
these relationships fail, we will have to devote substantially more resources
to the sales and marketing, and implementation and support of our product than
we would otherwise have to, and our efforts may not be as effective as those of
the system integrators. In many cases, these parties have extensive
relationships with our existing and potential customers and influence the
decisions of these customers. We rely upon these firms for recommendations of
our product during the evaluation stage of the purchasing process, as well as
for implementation and customer support services. A number of our competitors
have strong relationships with these system integrators and, as a result, these
system integrators may recommend competitors products and services. In
addition, a number of our competitors have relationships with a greater number
of these system integrators and, therefore, have access to a broader base of
enterprise customers. Our failure to establish or maintain these relationships
would significantly harm our ability to license and successfully implement our
software product. In addition, we rely on the industry expertise and reach of
these firms. Therefore, this failure would also harm our ability to develop
industry-specific products. We are currently investing, and plan to continue to
invest, significant resources to develop and maintain these relationships. Our
operating results could be harmed if these efforts do not generate license and
service revenues necessary to offset this investment. 31




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The cost and difficulty in implementing our product could significantly harm
our reputation with customers, diminishing our ability to license additional
products to our customers. Our products are often purchased as part of large projects undertaken by
our customers. These projects are complex, time consuming and expensive.
Failure by customers to successfully deploy our products, or the failure by us
or third-party consultants to ensure customer satisfaction, could damage our
reputation with existing and future customers and reduce future revenues. In
many cases, our customers must interact with, modify, or replace significant
elements of their existing computer systems. The costs of our 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 revenues may decline. We may fail to introduce or deliver new products on a timely basis, if at
all. In the past, we have experienced delays in the commencement of commercial
shipments of our Vitria:BusinessWare products. To date, these delays have not
had a material impact on our revenues. If new releases or products are delayed
or do not achieve market acceptance, we could experience a delay or loss of
revenues and cause customer dissatisfaction. In addition, customers may delay
purchases of our products in anticipation of future releases. If customers
defer material orders in anticipation of new releases or new product
introductions, our revenues may decline. Our products rely on third-party programming tools and applications. If we lose
access to these tools and applications, or are unable to modify our products in
response to changes in these tools and applications, our revenues could
decline. Our programs utilize Java programming technology provided by Sun
Microsystems. We also depend upon access to the interfaces, known as APIs,
used for communication between external software products and packaged
application software. Our access to APIs of third-party applications are
controlled by the providers of these applications. If the application provider
denies or delays our access to APIs, our business may be harmed. Some
application providers may become competitors or establish alliances with our
competitors, increasing the likelihood that we would not be granted access to
their APIs. We also license technology related to the connectivity of our
product to third-party database and other applications and we incorporate some
third-party technology into our product offerings. Loss of the ability to use
this technology, delays in upgrades, failure of these third parties to 32




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support these technologies, or other difficulties with our third-party
technology partners could lead to delays in product shipment and could cause
our revenues to decline. We could suffer losses and negative publicity if new versions and releases of
our products contain errors or defects. Our products and their interactions with customers software applications
and IT systems are complex and, accordingly, there may be undetected errors or
failures when products are introduced or as new versions are released. We have
in the past discovered software errors in our new releases and new products
after their introduction which has resulted in additional research and
development expenses. To date, these additional expenses have not been
material. We may in the future discover errors in new releases or new products
after the commencement of commercial shipments. Since many customers are using
our 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 persons are bound by an employment
agreement. The loss of senior management or other key research, development,
sales and marketing personnel could have a material adverse effect on our
future operating results. In 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 competitors products. The use by others of our proprietary rights could
materially harm our business. We rely on a combination of copyright, patent,
trademark and trade secret laws, as well as confidentiality agreements and
licensing arrangements, to establish and protect our proprietary rights.
Despite our efforts to protect our proprietary rights, existing laws afford
only limited protection. Attempts may be made to copy or reverse engineer
aspects of our products or to obtain and use information that we regard as
proprietary. Accordingly, there can be no assurance that we will be able to
protect our proprietary rights against unauthorized third party copying or use.
Furthermore, policing the unauthorized use of our products is difficult, and
expensive litigation may be necessary in the future to enforce our intellectual
property rights. Our products could infringe the intellectual property rights of others causing
costly litigation and the loss of significant rights. Software developers in our market will increasingly be subject to
infringement claims as the number of products in different software industry
segments overlap. Any claims, with or without merit, could be time-consuming,
result in costly litigation, prevent product shipment or cause delays, or
require us to enter into royalty or licensing agreements, any of which could
harm our business. Patent litigation in particular has complex technical issues
and inherent uncertainties. In the event an infringement claim against us is
successful and we cannot obtain a license on acceptable terms or license a
substitute technology or redesign our product to avoid infringement, our
business would be harmed. Furthermore, former employers of our current and
future employees may assert that our employees have improperly disclosed to us
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Our significant international operations may fail to generate significant
product revenues or contribute to our drive toward profitability, which could
result in slower revenue growth and harm our business. We
maintain international offices in countries including Australia,
Brazil, Canada, France, Germany, Italy, Japan, Korea, Mexico,
Singapore, Spain and The United Kingdom, and may establish additional
international offices. During the three months ended March 31, 2004, 43% of our
revenue was derived from international markets. There are a number of
challenges to establishing operations outside of the United States and we may
be unable to successfully generate significant international revenues. If we
fail to successfully establish our products in international markets, we could
experience slower revenue growth and our business could be harmed. It may be
difficult to protect our intellectual property in certain international
jurisdictions. We 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 Part II Item 1 Legal Proceedings for more
information regarding this litigation. We have implemented anti-takeover provisions which could discourage or prevent
a takeover, even if an acquisition would be beneficial to our stockholders. Provisions of our amended and restated certificate of incorporation and
bylaws, as well as provisions of Delaware law, could make it more difficult for
a third party to acquire us, even if doing so would be beneficial to our
stockholders. These provisions include:  
    
    establishment of a classified Board of Directors 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 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 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, 2004, our executive officers, directors
and their affiliates beneficially own approximately 37% 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. 
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Item 4. CONTROLS AND PROCEDURES Evaluation of disclosure controls and procedures. Based on their
evaluation as of March 31, 2004, our chief executive officer and chief
financial officer have concluded that, our disclosure controls and procedures
(as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act
of 1934, as amended) were sufficiently effective to ensure that the information
required to be disclosed by us in this Quarterly Report on Form 10-Q was
recorded, processed, summarized and reported within the time periods specified
in Securities and Exchange Commission rules and forms. Changes in internal controls. There were no changes in our internal
controls over financial reporting during our first fiscal quarter that have
materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting. Limitations on the effectiveness of controls.Our management, including
our chief executive officer and chief financial officer, does not expect that
our control systems will prevent all error and all fraud. A control system, no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within Vitria have been detected. These
inherent limitations include the realities that judgments in decision-making
can be faulty, and that breakdowns can occur because of simple error or
mistake. Additionally, controls can be circumvented by the individual acts of
some persons, by collusion of two or more people or by management override of
the control. The design of any system of controls also is based in part upon
certain assumptions about the likelihood of future events, and there can be no
assurance that any design will succeed in achieving its stated goals under all
potential future conditions. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur
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PART II
OTHER 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, and captioned
Kideys, et al., v. Vitria Technology, Inc., et al., Case No. 01-CV-10092. The
plaintiffs allege that Vitria, certain of our officers and directors and the
underwriters of our initial public offering (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
beginning in January 2001 against numerous public companies that first sold
their common stock since the mid-1990s. All of these IPO-related 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. On February 19, 2003, Judge
Scheindlin issued a ruling denying in part and granting in part the Defendants
motions to dismiss. On June 18, 2003, Vitrias Board of Directors approved a
resolution 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 issuer defendants. Under the terms of the
settlement, the plaintiff class will dismiss with prejudice all claims against
Vitria and our current and former directors and officers, and Vitria will
assign to the plaintiff class or its designee certain claims that Vitria may
have against the underwriters of our IPO. 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-related lawsuits, the plaintiffs will be entitled to recover the
difference between the actual recovery and $1.0 billion from the insurers for
the Issuers. Although Vitria has approved this settlement proposal in
principle, it remains subject to a number of procedural conditions, as well as
formal approval by the court. If approved, there will be no cash or other
payment from Vitria to the plaintiff class or any other parties. With the exception of the above lawsuit, we are not currently party to any
other material pending legal proceedings, except routine legal proceedings
arising in the ordinary course of and incidental to our business. We do not
believe that these other proceedings, individually or collectively, will harm
our business. 
 Item 2. Changes in
Securities, Use of Proceeds and Issuer Purchases of Equity Securities None. 
 Item 3. Defaults Upon Senior Securities None. 
 Item 4. Submission of Matters to a Vote of Security Holders None. 
 Item 5. Other Information  Consistent with Section 10A(i)(2) of the Securities Exchange
Act of 1934, as added by Section 202 of the Sarbanes-Oxley Act of
2002, Vitria is responsible for disclosing the nature of the
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approved by our Audit Committee during a quarter to be performed by
Ernst & Young LLP, our independent auditor. Non-audit services are
services other than those provided by Ernst & Young LLP in connection
with an audit or a review of Vitrias financial statements. During the
quarter ended March 31, 2004 our Audit Committee did not approve any
non-audit services to be performed by Ernst & Young LLP. 
 Item 6. Exhibits and Reports on Form 8-K a) Exhibits 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.*
    b) Reports on Form 8-K  Vitria filed a Current Report on Form 8-K, dated January 29, 2004, on
January 29, 2004, reporting under Item 12. Disclosure of Results of
Operations and Financial Condition, its result for the three months ended
December 31, 2003. 37




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized. Vitria Technology, Inc.Date: May 7, 2004
    
    By:
    
    /s/ JEFFREY J. BAIRSTOWJeffrey J. BairstowChief Financial Officer
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EXHIBIT INDEX Exhibits No.
    
    DescriptionExhibit 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.*