##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 FORM 10-Q
 Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934
 
 (Mark One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
 For the quarterly period ended September 30, 2006
 OR
 o
    
    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 
Incorporation or Organization)
    
    (I.R.S. Employer
Identification No.)
 945 Stewart Drive
Sunnyvale, California 94085
(408) 212-2700
(Address, including Zip Code, of Registrants Principal Executive Offices
and Registrants Telephone Number, including Area Code)
 
 þ o
  o þ o
 o þ




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##### 



VITRIA TECHNOLOGY, INC.
TABLE OF CONTENTS
 PagePART I: FINANCIAL INFORMATIONItem 1.      Financial Statements (unaudited)Condensed Consolidated Balance Sheets at September 30, 2006 and December 31, 2005
    
    
    3Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2006 and 2005
    
    
    4Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2006 and 2005
    
    
    5Notes to the Condensed Consolidated Financial StatementsItem 2: Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    18Item 3: Quantitative and Qualitative Disclosures About Market Risk
    
    
    31Item 4: Controls and Procedures
    
    
    32PART II: OTHER INFORMATIONItem 1: Legal Proceedings
    
    
    34Item 1A: Risk Factors
    
    
    34Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    41Item 3: Defaults Upon Senior Securities
    
    
    41Item 4: Submission of Matters to a Vote of Security Holders
    
    
    41Item 5: Other Information
    
    
    41Item 6: Exhibits
    
    
    41Signatures
    
    
    43EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 ITEM 1. Financial Statements
  
    September 30,
    
    
    December 31,2006
    
    
    2005AssetsCurrent Assets:Cash and cash equivalents
    
    $
    34,497
    
    
    $
    26,503Short-term investments
    
    
    16,407
    
    
    
    34,979Accounts receivable, net
    
    
    11,715
    
    
    
    7,846Other current assets
    
    
    1,451
    
    
    
    2,181Total current assets
    
    
    64,070
    
    
    
    71,509Property and equipment, net
    
    
    891
    
    
    
    1,136Other assets
    
    
    993
    
    
    
    743Total assets
    
    $
    65,954
    
    
    $
    73,388Liabilities and Stockholders EquityCurrent Liabilities:Accounts payable
    
    $
    929
    
    
    $
    1,051Accrued compensation
    
    
    2,635
    
    
    
    3,059Other accrued liabilities
    
    
    3,613
    
    
    
    4,184Accrued restructuring expenses
    
    
    2,297
    
    
    
    3,460Deferred revenue
    
    
    10,851
    
    
    
    10,242Total current liabilities
    
    
    20,325
    
    
    
    21,996Long-Term Liabilities:Accrued restructuring expenses
    
    
    3,698
    
    
    
    3,960Other long-term liabilities
    
    
    1,012
    
    
    
    1,330Total long-term liabilities
    
    
    4,710
    
    
    
    5,290Commitments and ContingenciesStockholders Equity:Common Stock: $0.001 par value; 150,000
shares authorized; 34,262 shares outstanding
at September 30, 2006 and 33,709 shares
outstanding at December 31, 2005,
respectively
    
    
    34
    
    
    
    34Additional paid-in capital
    
    
    277,967
    
    
    
    275,857Accumulated other comprehensive income
    
    
    410
    
    
    
    515Accumulated deficit
    
    
    (236,996
    )
    
    
    (229,808
    )Treasury stock, at cost
    
    
    (496
    )
    
    
    (496
    )Total stockholders equity
    
    
    40,919
    
    
    
    46,102Total liabilities and stockholders equity
    
    $
    65,954
    
    
    $
    73,388
  3




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##### Table of Contents



Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Revenue:License
    
    $
    5,616
    
    
    $
    3,929
    
    
    $
    10,838
    
    
    $
    11,497Service and other
    
    
    8,978
    
    
    
    9,559
    
    
    
    25,636
    
    
    
    30,882Total revenue
    
    
    14,594
    
    
    
    13,488
    
    
    
    36,474
    
    
    
    42,379Cost of revenue:License
    
    
    107
    
    
    
    797
    
    
    
    336
    
    
    
    1,204Service and other
    
    
    3,365
    
    
    
    4,711
    
    
    
    10,929
    
    
    
    15,685Total cost of revenue
    
    
    3,472
    
    
    
    5,508
    
    
    
    11,265
    
    
    
    16,889Gross profit
    
    
    11,122
    
    
    
    7,980
    
    
    
    25,209
    
    
    
    25,490Operating expenses:Sales and marketing
    
    
    3,983
    
    
    
    4,806
    
    
    
    12,421
    
    
    
    14,679Research and development
    
    
    3,994
    
    
    
    3,878
    
    
    
    12,590
    
    
    
    13,256General and administrative
    
    
    3,184
    
    
    
    1,644
    
    
    
    8,369
    
    
    
    8,199Restructuring charges
    
    
    (121
    )
    
    
    38
    
    
    
    974
    
    
    
    645Total operating expenses
    
    
    11,040
    
    
    
    10,366
    
    
    
    34,354
    
    
    
    36,779Income (loss) from operations
    
    
    82
    
    
    
    (2,386
    )
    
    
    (9,145
    )
    
    
    (11,289
    )Interest income
    
    
    622
    
    
    
    526
    
    
    
    1,782
    
    
    
    1,398Other income, net
    
    
    24
    
    
    
    30
    
    
    
    261
    
    
    
    (263
    )Income (loss) before income taxes
    
    
    728
    
    
    
    (1,830
    )
    
    
    (7,102
    )
    
    
    (10,154
    )Provision for income taxes
    
    
    47
    
    
    
    55
    
    
    
    86
    
    
    
    157Net income (loss)
    
    $
    681
    
    
    $
    (1,885
    )
    
    $
    (7,188
    )
    
    $
    (10,311
    )Basic net income (loss) per share
    
    $
    0.02
    
    
    $
    (0.06
    )
    
    $
    (0.21
    )
    
    $
    (0.31
    )Diluted net income (loss) per share
    
    $
    0.02
    
    
    $
    (0.06
    )
    
    $
    (0.21
    )
    
    $
    (0.31
    )Weighted average shares used in calculatingBasic net income (loss) per share
    
    
    33,575
    
    
    
    33,524
    
    
    
    33,593
    
    
    
    33,459Diluted net income (loss) per share
    
    
    33,590
    
    
    
    33,524
    
    
    
    33,593
    
    
    
    33,459
  4




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Nine Months EndedSeptember 30,2006
    
    
    2005Operating activities:Net income (loss)
    
    $
    (7,188
    )
    
    $
    (10,311
    )Adjustments to reconcile net income (loss) to net cash
used in operating activities:Loss on disposal of fixed assets
    
    
    
    
    
    
    26Depreciation
    
    
    408
    
    
    
    895Stock-based compensation
    
    
    2,026
    
    
    
    105Provision for doubtful accounts
    
    
    (175
    )
    
    
    (146
    )Changes in assets & liabilities:Accounts receivable
    
    
    (3,694
    )
    
    
    534Other current assets
    
    
    730
    
    
    
    (608
    )Other assets
    
    
    (250
    )
    
    
    124Accounts payable
    
    
    (122
    )
    
    
    (321
    )Accrued liabilities
    
    
    (893
    )
    
    
    947Accrued restructuring charges
    
    
    (1,425
    )
    
    
    (4,537
    )Deferred revenue
    
    
    609
    
    
    
    136Other long term liabilities
    
    
    (310
    )
    
    
    736Net cash used in operating activities
    
    
    (10,284
    )
    
    
    (12,420
    )Investing activities:Purchases of property and equipment
    
    
    (158
    )
    
    
    (1,149
    )Purchases of investments
    
    
    (18,777
    )
    
    
    (52,995
    )Maturities of investments
    
    
    37,400
    
    
    
    61,389Net cash provided by investing activities
    
    
    18,465
    
    
    
    7,245Financing activities:Issuance of common stock, net
    
    
    84
    
    
    
    267Reduction of lease payable
    
    
    (109
    )
    
    
    (166
    )Net cash (used in) provided by financing activities
    
    
    (25
    )
    
    
    101Effect of exchange rates
    
    
    (162
    )
    
    
    107Net increase in cash and cash equivalents
    
    
    7,994
    
    
    
    (4,967
    )Cash and cash equivalents at beginning of period
    
    
    26,503
    
    
    
    32,106Cash and cash equivalents at end of period
    
    $
    34,497
    
    
    $
    27,139Supplemental disclosures of cash flow information:Income taxes paid
    
    $
    251
    
    
    $
    233Interest paid
    
    $
    5
    
    
    $
    14
  5




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##### Table of Contents



NOTE 1. Basis of Presentation
 Basis of Presentation
    NOTE 2. Recent Accounting Pronouncements
 Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109
 Considering
the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements
 NOTE 3. Summary of Significant Accounting Policies
 Stock-based Compensation
 Accounting for
Stock-Based Compensation Accounting
for Stock Issued to Employees
  6




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##### Table of Contents



Revenue Recognition
 Software Revenue Recognition
 Accounting for Performance of Construction Type and Certain Production Type
Contracts .
 .
  Accounts Receivable
  7




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##### Table of Contents



.
  Restructuring Charges
  Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an
Activity Accounting for Costs Associated
with Exit or Disposal Activity
   Deferred tax valuation allowance
  8




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##### Table of Contents



NOTE 4. Net Income (Loss) per Share
   Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Numerator for basic and diluted net income/(loss) per share:Net income/(loss)
    
    $
    681
    
    
    $
    (1,885
    )
    
    $
    (7,188
    )
    
    $
    (10,311
    )Shares used to compute basic net income/(loss) per share
    
    
    33,575
    
    
    
    33,524
    
    
    
    33,593
    
    
    
    33,459Shares used to compute diluted net income/(loss) per share
    
    
    33,590
    
    
    
    33,524
    
    
    
    33,593
    
    
    
    33,459Basic net income (loss) per share
    
    $
    0.02
    
    
    $
    (0.06
    )
    
    $
    (0.21
    )
    
    $
    (0.31
    )Diluted net income (loss) per share
    
    $
    0.02
    
    
    $
    (0.06
    )
    
    $
    (0.21
    )
    
    $
    (0.31
    )
  Nine months endedSeptember 30,2006
    
    
    2005Effect of anti-dilutive securties:Employee stock options (using the treasury stock method)
    
    
    4
    
    
    
    148Unvested restricted stock
    
    
    548
    
    
    
    Total
    
    
    552
    
    
    
    148
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##### Table of Contents



NOTE 5. Comprehensive Income (Loss)
  Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Net Income (Loss)
    
    $
    681
    
    
    $
    (1,885
    )
    
    $
    (7,188
    )
    
    $
    (10,311
    )Other comprehensive income (loss):Foreign currency translation adjustment
    
    
    (113
    )
    
    
    74
    
    
    
    (156
    )
    
    
    52Unrealized gain on securities
    
    
    23
    
    
    
    0
    
    
    
    51
    
    
    
    50Comprehensive income (loss)
    
    $
    591
    
    
    $
    (1,811
    )
    
    $
    (7,293
    )
    
    $
    (10,209
    )
  September 30,
    
    
    December 31,2006
    
    
    2005Foreign currency translation adjustment
    
    $
    405
    
    
    
    561Unrealized loss on securities
    
    
    5
    
    
    
    (46
    )Total accumlated other comprehensive gain
    
    $
    410
    
    
    $
    515
 NOTE 6. Stock Benefit Plans and Stock-Based Compensation
 Stock Benefit Plans
  1999 Employee Stock Purchase Plan
  Equity Incentive Plans
   10




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##### Table of Contents



Nine Months Ended September 30, 2006Weighted AverageOptions
    
    
    Exercise PriceOutstanding as of December 31, 2005
    
    
    5,775
    
    
    $
    6.11Granted
    
    
    240
    
    
    
    2.88Exercised
    
    
    (2
    )
    
    
    0.65Canceled
    
    
    (1,041
    )
    
    
    5.93Outstanding at end of period
    
    
    4,972
    
    
    $
    5.99Options exercisable at end of period
    
    
    3,435
    
    
    $
    7.19
 Nine Months Ended September 30, 2006Weighted AverageRestricted Stock Awards
    
    
    Exercise PriceOutstanding as of December 31, 2005
    
    
    100
    
    
    $
    3.42Awarded
    
    
    558
    
    
    
    2.70Released
    
    
    (75
    )
    
    
    3.10Forfeited
    
    
    (35
    )
    
    
    2.69Outstanding awards at end of period
    
    
    548
    
    
    $
    2.78
 11




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##### Table of Contents



Weighted
    
    
    Weighted
    
    
    
    
    
    
    WeightedNumber
    
    
    average
    
    
    average
    
    
    
    
    
    
    averageoutstanding at
    
    
    remaining
    
    
    exercise
    
    
    Exercisable as of
    
    
    exerciseRange of exercise prices
    
    September 30, 2006
    
    
    contractual term
    
    
    price
    
    
    September 30, 2006
    
    
    price$1.04 - $2.95
    
    
    556,296
    
    
    
    8.82
    
    
    $
    2.80
    
    
    
    129,592
    
    
    $
    2.72$2.99 - $3.04
    
    
    528,807
    
    
    
    7.61
    
    
    
    3.02
    
    
    
    279,161
    
    
    
    3.02$3.09 - $3.41
    
    
    384,700
    
    
    
    8.11
    
    
    
    3.30
    
    
    
    182,028
    
    
    
    3.31$3.42 - $3.42
    
    
    622,000
    
    
    
    8.52
    
    
    
    3.42
    
    
    
    218,208
    
    
    
    3.42$3.43 - $4.59
    
    
    227,596
    
    
    
    7.58
    
    
    
    3.78
    
    
    
    139,175
    
    
    
    3.88$4.60 - $4.60
    
    
    600,000
    
    
    
    4.40
    
    
    
    4.60
    
    
    
    529,165
    
    
    
    4.60$4.65 - $7.92
    
    
    452,070
    
    
    
    6.38
    
    
    
    4.75
    
    
    
    357,419
    
    
    
    4.74$8.00 - $8.00
    
    
    758,250
    
    
    
    2.78
    
    
    
    8.00
    
    
    
    758,250
    
    
    
    8.00$8.12 - $10.00
    
    
    199,552
    
    
    
    3.83
    
    
    
    9.40
    
    
    
    199,449
    
    
    
    9.40$12.04 - $188.00
    
    
    642,776
    
    
    
    5.04
    
    
    
    14.84
    
    
    
    642,258
    
    
    
    14.83$1.04 - $188.00
    
    
    4,972,047
    
    
    
    6.18
    
    
    $
    5.99
    
    
    
    3,434,705
    
    
    $
    7.19
 Stock-based compensation
  Three months ended September 30,
    
    
    Nine months ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(SFAS 123(R))
    
    
    (APB 25)
    
    
    (SFAS 123(R))
    
    
    (APB 25)Employee stock-based compensation in:Cost of revenue: service and other
    
    $
    88
    
    
    $
    
    
    
    $
    207
    
    
    $
    Research and development
    
    
    309
    
    
    
    
    
    
    
    547
    
    
    
    Sales and marketing
    
    
    304
    
    
    
    
    
    
    
    689
    
    
    
    General and administrative
    
    
    221
    
    
    
    22
    
    
    
    583
    
    
    
    105Total employee stock-based compensation:
    
    $
    922
    
    
    $
    22
    
    
    $
    2,026
    
    
    $
    105
 12




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##### Table of Contents



Three months ended September 30,
    
    
    Nine months ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Net income (loss) (2)
    
    $
    681
    
    
    $
    (1,885
    )
    
    $
    (7,188
    )
    
    $
    (10,311
    )Add: stock-based compensation included in reported net income (loss)
    
    
    922
    
    
    
    22
    
    
    
    2,026
    
    
    
    105Deduct: total stock based compensation expense determined under
fair value based method for all awards (1)
    
    
    (922
    )
    
    
    (218
    )
    
    
    (2,026
    )
    
    
    (1,758
    )Pro forma net income (loss)
    
    $
    681
    
    
    $
    (2,081
    )
    
    $
    (7,188
    )
    
    $
    (11,964
    )Basic and diluted net income (loss) per share (2)
    
    $
    0.02
    
    
    $
    (0.06
    )
    
    $
    (0.21
    )
    
    $
    (0.31
    )Pro forma basic and diluted net income (loss) per share (3)
    
    $
    0.02
    
    
    $
    (0.06
    )
    
    $
    (0.21
    )
    
    $
    (0.36
    )Weighted-average shares used in calculationBasic net income (loss) per share
    
    
    33,575
    
    
    
    33,524
    
    
    
    33,593
    
    
    
    33,459Diluted net income (loss) per share
    
    
    33,590
    
    
    
    33,524
    
    
    
    33,593
    
    
    
    33,459
 
 (1)
    
    Stock-based compensation expense prior to 2006 is calculated based on the pro forma
application of SFAS 123.(2)
    
    Net loss and net loss per share prior to 2006 did not include stock-based
compensation expense for employee stock-based awards under SFAS 123 because we had not
adopted the recognition provisions of SFAS 123.(3)
    
    Net loss and net loss per share prior to 2006 represents pro forma information based
on SFAS 123. Fair Value Disclosure
  Stock option plan
    
    ESPP
    
    Stock option plan
    
    ESPPThree months ended
    
    Nine months endedSeptember 30,
    
    September 30,2006
    
    2005
    
    2006
    
    2005
    
    2006
    
    2005
    
    2006
    
    2005Expected term (in
years)
    
    
    6.25
    
    
    
    2.0
    
    
    
    1.0
    
    
    
    2.0
    
    
    
    6.25
    
    
    
    2.0
    
    
    
    1.0
    
    
    
    1.0Expected Volatility
    
    
    95
    %
    
    
    66
    %
    
    
    43
    %
    
    
    77
    %
    
    
    80
    %
    
    
    66
    %
    
    
    43
    %
    
    
    91
    %Dividend yield
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Risk free interest rate
    
    
    4.60
    %
    
    
    4.18
    %
    
    
    5.21
    %
    
    
    2.70
    %
    
    
    4.86
    %
    
    
    3.95
    %
    
    
    5.21
    %
    
    
    2.73
    %Forfeiture rate
    
    
    8.86
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8.86
    %
    
    
    
    
    
    
    
    
    
    
    
 13




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NOTE 7. Restructuring, Impairments and Other Charges
     Facilities Consolidation
    
    
    Severance
    
    
    TotalBalance at December 31, 2003
    
    $
    18,482
    
    
    $
    330
    
    
    $
    18,812Cash Payments
    
    
    (6,295
    )
    
    
    (330
    )
    
    
    (6,625
    )Facility adjustments
    
    
    1,236
    
    
    
    
    
    
    
    1,236Balance at December 31, 2004
    
    
    13,423
    
    
    
    
    
    
    
    13,423Cash Payments
    
    
    (6,400
    )
    
    
    
    
    
    
    (6,400
    )Facility adjustments
    
    
    397
    
    
    
    
    
    
    
    397Balance at December 31, 2005
    
    
    7,420
    
    
    
    
    
    
    
    7,420Cash Payments
    
    
    (2,399
    )
    
    
    
    
    
    
    (2,399
    )Facility adjustments
    
    
    974
    
    
    
    
    
    
    
    974Balance at September 30, 2006
    
    $
    5,995
    
    
    $
    
    
    
    $
    5,995
   14




---



##### Table of Contents



Total2011 and
    
    
    Estimated2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    Thereafter
    
    
    Net PaymentsUndiscounted future lease payments and estimated
operating costs for restructured facilities
    
    $
    637
    
    
    $
    2,191
    
    
    $
    931
    
    
    $
    931
    
    
    $
    931
    
    
    $
    2,278
    
    
    $
    7,899Less: contractual future sublease income
    
    
    (161
    )
    
    
    (512
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (673
    )Gross estimated future payments
    
    $
    476
    
    
    $
    1,679
    
    
    $
    931
    
    
    $
    931
    
    
    $
    931
    
    
    $
    2,278
    
    
    $
    7,226Less: Discount factor due to fair value treatment of
facilities restructured in 2003
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,231
    )Net future payments on restructured facilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    5,995
  NOTE 8. Deferred Revenue
  NOTE 9. Related Party Transactions
   15




---



##### Table of Contents



Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2006
    
    2005
    
    2006
    
    2005Revenue from QilinSoft LLC
    
    $
    74
    
    
    $
    50
    
    
    $
    222
    
    
    $
    150R&D and Consulting
expense incurred with
QilinSoft LLC
    
    $
    533
    
    
    $
    1,000
    
    
    $
    2,278
    
    
    $
    2,000
 As of September 30,
    
    As of December 31,2006
    
    2005Trade Accounts Receviable and
accruals with QilinSoft LLC
    
    $
    
    
    
    $
    300Trade Accounts Payable and
accruals with QilinSoft LLC
    
    $
    255
    
    
    $
    441
  NOTE 10. Credit Facilities with Silicon Valley Bank
    NOTE 11. Segment Information
   16




---



##### Table of Contents



NOTE 12. Cash, Cash Equivalents and Short-term Investments
  As of September 30, 2006
    
    
    As of December 31, 2005Carrying
    
    
    Unrealized
    
    
    Unrealized
    
    
    Estimated
    
    
    Carrying
    
    
    Unrealized
    
    
    Unrealized
    
    
    EstimatedValue
    
    
    Gains
    
    
    Losses
    
    
    Fair Value
    
    
    Value
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueCash
    
    $
    10,546
    
    
    $
    
    
    
    $
    
    
    
    $
    10,546
    
    
    $
    7,679
    
    
    $
    
    
    
    $
    
    
    
    $
    7,679Money market funds
    
    
    1,027
    
    
    
    
    
    
    
    
    
    
    
    1,027
    
    
    
    1,285
    
    
    
    
    
    
    
    
    
    
    
    1,285Government securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    800
    
    
    
    
    
    
    
    
    
    
    
    800Commercial paper
    
    
    22,921
    
    
    
    3
    
    
    
    
    
    
    
    22,924
    
    
    
    16,739
    
    
    
    
    
    
    
    
    
    
    
    16,739Total cash equivalents
    
    
    23,948
    
    
    
    3
    
    
    
    
    
    
    
    23,951
    
    
    
    18,824
    
    
    
    
    
    
    
    
    
    
    
    18,824Total cash and cash equivalents
    
    
    34,494
    
    
    
    3
    
    
    
    
    
    
    
    34,497
    
    
    
    26,503
    
    
    
    
    
    
    
    
    
    
    
    26,503Government securities
    
    
    8,084
    
    
    
    
    
    
    
    (1
    )
    
    
    8,083
    
    
    
    13,754
    
    
    
    
    
    
    
    (23
    )
    
    
    13,731Corporate bonds
    
    
    928
    
    
    
    2
    
    
    
    
    
    
    
    930
    
    
    
    13,794
    
    
    
    
    
    
    
    (26
    )
    
    
    13,768Commercial paper
    
    
    7,393
    
    
    
    1
    
    
    
    
    
    
    
    7,394
    
    
    
    7,477
    
    
    
    3
    
    
    
    
    
    
    
    7,480Total short-term investments
    
    
    16,405
    
    
    
    3
    
    
    
    (1
    )
    
    
    16,407
    
    
    
    35,024
    
    
    
    3
    
    
    
    (49
    )
    
    
    34,979Total cash, cash equivalents,
and short-term investments
    
    $
    50,899
    
    
    $
    6
    
    
    $
    (1
    )
    
    $
    50,904
    
    
    $
    61,527
    
    
    $
    3
    
    
    $
    (49
    )
    
    $
    61,482
 NOTE 13. Going-Private Transaction
   17




---



##### Table of Contents



Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2006
    
    
    2006Directors Fees
    
    $
    62
    
    
    $
    108Consulting
    
    
    500
    
    
    
    500Legal
    
    
    300
    
    
    
    393Total Transaction Related Costs
    
    $
    862
    
    
    $
    1,001
 
 ITEM 2 MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  Overview
      Going-Private Transaction
 18
    Table of Contents  Product Overview
 BusinessWare
 BusinessWare
  §
    
    Process automation§
    
    Management of human workflow§
    
    Message transport and routing§
    
    Data transformation and vocabulary management§
    
    Web services integration and orchestration§
    
    Enterprise Service Bus (ESB)§
    
    Other SOA integration capabilities§
    
    Compatibility with specific data transport protocols§
    
    Tools for building custom connectors§
    
    Various pre-built services for business process integration§
    
    Modeling environment for development§
    
    Solution life cycle management
 19
    Table of Contents  §
    
    Connectors for various packaged software applications (e.g., SAP, Siebel, Oracle
Applications, Peoplesoft) and databases (e.g., Oracle, Microsoft SQL Server, Sybase,
DB2)§
    
    Connectors for various technology standards and transport protocols (e.g., Java
Messaging Service, WebSphere MQ, IBM CICS)§
    
    Specialized data transformation and validation products (e.g., HIPAA, HL7, SWIFT)§
    
    Business process monitoring and analysis§
    
    EDI and various other business-to-business integration standards
 BusinessWare BusinessWare
 §
    
    Order Accelerator This process application, initially released in March 2004,
automates business processes across a telecommunications service providers existing
systems and is designed to provide faster, more cost-effective, and more accurate order
management. Order Accelerator includes pre-built business processes and other content
based on the Telemanagement Forums eTOM (Enhanced Telecom Operations Map) standard.§
    
    Resolution Accelerator- This process application, initially released in June 2005,
manages the resolution of business process exceptions. Such exceptions occur when
automated business transactions are diverted from their normal process path due to
incomplete or erroneous data, specific business policies, or factors external to the
process. Resolution Accelerator provides capabilities to automatically fix many
problems, guide manual resolution of other problems, and reinsert affected transactions
back into the normal process flow. While a majority of our sales to date of this
product have been to the telecommunications sector, it is applicable to other sectors as
well. We released an enhanced version of Resolution Accelerator in April 2006.§
    
    Smart Claims This process application for health insurance payers was initially
released in late 2003. Smart Claims augments existing claims processing systems by
applying automated business rules to reduce off-line manual processing, by intelligently
routing claims between different systems, and by providing a unified view of the claims
processing
lifecycle across multiple systems. Potential benefits to Smart Claims customers include
fewer delays in claims processing and payment, reduced errors, faster changes to claims
processing logic, and faster response to customer and partner inquiries.§
    
    Smart Gateway- This process application manages the intake, splitting, validation,
transformation, aggregation, and routing of health insurance claims and other electronic
business documents exchanged with multiple external parties. By consolidating multiple
document exchange processes into a single electronic document gateway, this product
can reduce operational complexity and costs, increase visibility within a complex
document exchange process, and make the automated business logic governing these
processes easier to implement, manage and modify. Vitria released the first part of
this solution in December 2005 and released the complete product in June 2006.
    20
    Table of Contents    CRITICAL ACCOUNTING POLICIES
   
    
    Revenue Recognition
    
    Allowances for Doubtful Accounts
    
    Restructuring Costs
  Share-Based Payment
    21
    Table of Contents     22
    Table of Contents  RESULTS OF OPERATIONS
 For the three and nine months ended September 30, 2006 and September 30, 2005
  Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2006
    
    2005
    
    2006
    
    2005Revenue
License
    
    
    38
    %
    
    
    29
    %
    
    
    30
    %
    
    
    27
    %Service and other
    
    
    62
    %
    
    
    71
    %
    
    
    70
    %
    
    
    73
    %Total revenue
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %Cost of revenue
License
    
    
    1
    %
    
    
    6
    %
    
    
    1
    %
    
    
    3
    %Service and other
    
    
    23
    %
    
    
    35
    %
    
    
    30
    %
    
    
    37
    %Total cost of revenue
    
    
    24
    %
    
    
    41
    %
    
    
    31
    %
    
    
    40
    %Gross profit
    
    
    76
    %
    
    
    59
    %
    
    
    69
    %
    
    
    60
    %Operating expenses
Sales and marketing
    
    
    27
    %
    
    
    36
    %
    
    
    34
    %
    
    
    35
    %Research and development
    
    
    27
    %
    
    
    29
    %
    
    
    35
    %
    
    
    31
    %General and administrative
    
    
    22
    %
    
    
    12
    %
    
    
    23
    %
    
    
    19
    %Restructuring
    
    
    (1
    %)
    
    
    0
    %
    
    
    3
    %
    
    
    2
    %Total operating expenses
    
    
    75
    %
    
    
    77
    %
    
    
    94
    %
    
    
    87
    %Income (loss) from operations
    
    
    1
    %
    
    
    (18
    %)
    
    
    (25
    %)
    
    
    (27
    %)Interest income
    
    
    4
    %
    
    
    4
    %
    
    
    5
    %
    
    
    3
    %Other income (expense), net
    
    
    0
    %
    
    
    0
    %
    
    
    1
    %
    
    
    (1
    %)Net income (loss) before income taxes
    
    
    5
    %
    
    
    (14
    %)
    
    
    (19
    %)
    
    
    (25
    %)Provision for income taxes
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Net Income (loss)
    
    
    5
    %
    
    
    (14
    %)
    
    
    (19
    %)
    
    
    (25
    %)
 Revenue
    23
    Table of Contents  License
  Service and other
 Cost of Revenue
 License.
  Service and other
 24
    Table of Contents  Operating Expenses
 Sales and marketing
   Research and development.
   General and administrative
 25
    Table of Contents  Restructuring charges.
     26
    Table of Contents  Interest income and other income (expense), net.
  Stock-based Compensation .
   Three months ended September 30,
    
    
    Nine months ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(SFAS 123(R))
    
    
    (APB 25)
    
    
    (SFAS 123(R))
    
    
    (APB 25)Employee stock-based compensation in:Cost of revenue: service and other
    
    $
    88
    
    
    $
    
    
    
    $
    207
    
    
    $
    Research and development
    
    
    309
    
    
    
    
    
    
    
    547
    
    
    
    Sales and marketing
    
    
    304
    
    
    
    
    
    
    
    689
    
    
    
    General and administrative
    
    
    221
    
    
    
    22
    
    
    
    583
    
    
    
    105Total employee stock-based
compensation:
    
    $
    922
    
    
    $
    22
    
    
    $
    2,026
    
    
    $
    105
 Provision for Income Taxes
 Accounting for Income Taxes in Interim Periods, an
interpretation of APB Opinion No. 28
 27
    Table of Contents  LIQUIDITY AND CAPITAL RESOURCES
 September 30, 2006
    
    December 31, 2005
    
    Change
    
    Percent ChangeCash, cash equivalents and short-term investments
    
    $
    50,904
    
    
    $
    61,482
    
    
    $
    (10,578
    )
    
    
    -17
    %Working capital
    
    $
    43,745
    
    
    $
    49,513
    
    
    $
    (5,768
    )
    
    
    -12
    %Stockholders equity
    
    $
    40,919
    
    
    $
    46,102
    
    
    $
    (5,183
    )
    
    
    -11
    %
      Contractual Cash Obligations and Commitments
  Off-Balance Sheet Arrangements
  Credit Facilities with Silicon Valley Bank
   28
    Table of Contents  Operating Capital and Capital Expenditure Requirements
    
    
    size and timing of customer orders and product and service delivery;
    
    level of demand for our professional services;
    
    changes in the mix of our products and services;
    
    ability to protect our intellectual property;
    
    actions taken by our competitors, including new product introductions and pricing changes;
    
    costs of maintaining and expanding our operations;
    
    timing of the development and release of new products or enhanced products;
    
    costs and timing of hiring qualified personnel;
 29
    Table of Contents  
    
    success in maintaining and enhancing existing relationships and developing new
relationships with system integrators;
    
    technological changes in our markets, including changes in standards for computer and
networking software and hardware;
    
    deferrals of customer orders in anticipation of product enhancements or new products;
    
    delays in our ability to recognize revenue as a result of the decision by our
customers to postpone software delivery, or because of changes in the timing of when
delivery of products or services is completed;
    
    customer budget cycles and changes in these budget cycles;
    
    external economic conditions;
    
    availability of customer funds for software purchases given external economic factors;
    
    costs related to acquisition of technologies or businesses;
    
    ability to successfully integrate acquisitions;
    
    changes in strategy and capability of our competitors; and
    
    liquidity and timeliness of payments from international customers.
  Related Party Transactions
   30
    Table of Contents  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2006
    
    2005
    
    2006
    
    2005Revenue from QilinSoft LLC
    
    $
    74
    
    
    $
    50
    
    
    $
    222
    
    
    $
    150R&D and Consulting
expense incurred with
QilinSoft LLC
    
    $
    533
    
    
    $
    1,000
    
    
    $
    2,278
    
    
    $
    2,000
 As of September 30,
    
    As of December 31,2006
    
    2005Trade Accounts Receivable and
accruals with QilinSoft LLC
    
    $
    
    
    
    $
    300Trade Accounts Payable and
accruals with QilinSoft LLC
    
    $
    255
    
    
    $
    441
  
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
 Interest Rate Risk
      31
    Table of Contents    2006
    
    
    
    
    
    
    2005Weighted
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    AverageFair Value
    
    
    Interest Rate
    
    
    Fair Value
    
    
    Interest RateCash and cash equivalents
    
    $
    34,497
    
    
    
    0.60
    %
    
    $
    27,139
    
    
    
    0.63
    %Short-term investments
    
    
    16,407
    
    
    
    8.36
    %
    
    
    38,113
    
    
    
    3.81
    %Total cash and investment securities
    
    $
    50,904
    
    
    
    
    
    
    $
    65,252
 Foreign Exchange Risk
    
 ITEM 4. CONTROLS AND PROCEDURES
 Disclosure controls and procedures
   32




---



##### Table of Contents



Vitria didnt have adequate staffing to perform needed reviews.
 Documentation supporting our control assessment was not adequate
 Internal controls over our subsidiary in Japan were not proven to be effective as of December
31, 2005.
  Changes in Internal Control over Financial Reporting
  33




---



##### Table of Contents



PART II. OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
 In re Vitria Technology, Inc. IPO Securities Litigation
    Wilbanks v. Vitria, et al. Schachter v.
Skeen, et al.
 
 ITEM 1A. RISK FACTORS
 If the proposed merger with Innovation Technology Group, Inc. is not completed, our business could
be harmed and our stock price could decline.
 34
    Table of Contents    The fact that there is a merger pending could harm our business, revenue and results of operations.
   
    
    the diversion of management and employee attention and the unavoidable disruption to our relationships with customers and
vendors may detract from our ability to grow revenues and minimize costs;
 
    
    we have and will continue to incur significant expenses related to the Merger prior to its closing; and
 
    
    we may be unable to respond effectively to competitive pressures, industry developments and future opportunities.
  Purported stockholder class action complaints have been filed against Vitria Technology and members
of our board of directors challenging the Merger, and an unfavorable judgment or ruling in these
lawsuits could prevent or delay the consummation of the Merger, result in substantial costs or
both.
 Wilbanks v. Vitria, et al. Schachter v.
Skeen, et al.
  Our operating results fluctuate significantly and an unanticipated decline in revenue may
result in a decline in our stock price and may disappoint securities analysts or investors, and may
also harm our relationship with our customers.
 35




---



##### Table of Contents



We have incurred substantial operating losses since inception and we cannot guarantee that we will
become profitable in the future.
  Our operating results are substantially dependent on license revenue from BusinessWare and our
business could be materially harmed by factors that adversely affect the pricing and demand for BusinessWare.
 BusinessWare BusinessWare BusinessWare BusinessWare BusinessWare
 Failure to raise additional capital or generate the significant capital necessary to expand our
operations and invest in new products could reduce our ability to compete and result in lower
revenue.
  
    
    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
 36




---



##### Table of Contents




    
    respond to competitive pressures or unanticipated capital requirements.
  The reluctance of companies to make significant expenditures on information technology could reduce
demand for our products and cause our revenue to decline.
  We experience long and variable sales cycles, which could have a negative impact on our results of
operations for any given quarter.
  Because a small number of customers have in the past accounted for a substantial portion of our
revenue, our revenue could decline due to the loss or delay of a single customer order.
  If we are not successful in developing industry specific pre-built process applications based on
our business process integration platform, our ability to increase future revenue could be harmed.
   Our products may not achieve market acceptance, which could cause our revenue to decline.
 37




---



##### Table of Contents



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 cost and difficulty in implementing our product could significantly harm our reputation with
customers, diminishing our ability to license additional products to our customers.
   If our products do not operate with the many hardware and software platforms used by our customers,
our business may fail.
  38




---



##### Table of Contents




    
    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 those related to
service-oriented integration, other types of integration, and business process
management;
    
    the integration of additional software modules under development with our existing products; and
    
    our management of software being developed by third parties for our customers or use with our products.
 If we fail to introduce new versions and releases of our products in a timely manner, our revenue
may decline.
 BusinessWare
 Our products rely on third-party programming tools and applications. If we lose access to these
tools and applications, or are unable to modify our products in response to changes in these tools
and applications, our revenue could decline.
  The use of Open Source Software in our products may expose us to additional risks and harm our
intellectual property our intellectual property position.
  We could suffer losses and negative publicity if new versions and releases of our products contain
errors or defects.
 39
    Table of Contents    If we fail to attract and retain qualified personnel, our ability to compete will be harmed.
  If we fail to adequately protect our proprietary rights, we may lose these rights and our business
may be seriously harmed.
  Our products could infringe the intellectual property rights of others causing costly litigation
and the loss of significant rights.
  Our significant international operations may fail to generate significant product revenue or
contribute to our drive toward profitability, which could result in slower revenue growth and harm
our business.
  We are at risk of securities class action litigation due to our expected stock price volatility.
  We have implemented anti-takeover provisions which could discourage or prevent a takeover, even if
an acquisition would be beneficial to our stockholders.
 40




---



##### Table of Contents




    
    establishment of a classified Board of Directors requiring that not all members of
the Board of Directors may be elected at one time;
    
    authorizing the issuance of blank check preferred stock that could be issued by our
Board of Directors to increase the number of outstanding shares and thwart a takeover
attempt;
    
    prohibiting cumulative voting in the election of directors, which would otherwise
allow less than a majority of stockholders to elect director candidates;
    
    limitations on the ability of stockholders to call special meetings of stockholders;
    
    prohibiting stockholder action by written consent, thereby requiring all stockholder
actions to be taken at a meeting of our stockholders; and
    
    establishing advance notice requirements for nominations for election to the Board of
Directors or for proposing matters that can be acted upon by stockholders at stockholder
meetings.
 
 ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 ITEM 3. Defaults Upon Senior Securities
  
 ITEM 4. Submission of Matters to a Vote of Security Holders
  
 ITEM 5. Other Information
  
 ITEM 6. Exhibits
  Exhibit 2.1(1)
    
    Agreement and Plan of Merger, dated as of September 20, 2006, among Innovation Technology Group, Inc., a
Delaware corporation, (Parent), ITG Acquisition, Inc., a Delaware corporation and wholly owned subsidiary of
Parent, and Vitria Technology, Inc., a Delaware corporation.Exhibit 10.36(2)
    
    Letter Agreement, by and between Vitria Technology, Inc. and Michael D. Perry.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.
 41




---



##### Table of Contents



Exhibit 32.1
    
    Certification of Chief Executive Financial 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. *
 
 *
    
    The certifications attached as Exhibits 32.1 and 32.2 accompany this Quarterly Report on Form
10-Q, are not deemed filed with the Securities and Exchange Commission and are not to be
incorporated by reference into any filing of Vitria Technology, Inc. under the Securities Act of
1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after
the date of this Form 10-Q, irrespective of any general incorporation language contained in such
filing.(1)
    
    Filed as Exhibit 2.1 to our Current Report on Form 8-K, filed on September 22, 2006,
and incorporated herein by reference. (Schedules and exhibits omitted pursuant to Item
601(b)(2) of Regulation S-K. The Company agrees to furnish supplementally a copy of any
omitted schedule or exhibit to the SEC upon request.)(2)
    
    Filed as Exhibit 10.36 to our Current Report on Form 8-K, filed on September 27, 2006,
and incorporated herein by reference. 42




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SIGNATURES
  Vitria Technology, Inc.Date:   November 9, 2006
    By:
    /s/  MICHAEL D. PERRYMichael D. PerrySenior Vice President and Chief Financial Officer 43




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##### Table of Contents



Exhibit 2.1(1)
    
    Agreement and Plan of Merger, dated as of September 20, 2006, among Innovation
Technology Group, Inc., a Delaware corporation, (Parent), ITG Acquisition,
Inc., a Delaware corporation and wholly owned subsidiary of Parent, and Vitria
Technology, Inc., a Delaware corporation.Exhibit 10.36(2)
    
    Letter Agreement, by and between Vitria Technology, Inc. and Michael D. Perry.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 Financial 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. *
 
 *
    
    The certifications attached as Exhibits 32.1 and 32.2 accompany this Quarterly Report on
Form 10-Q, are not deemed filed with the Securities and Exchange Commission and are not to be
incorporated by reference into any filing of Vitria Technology, Inc. under the Securities Act
of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before
or after the date of this Form 10-Q, irrespective of any general incorporation language
contained in such filing.(1)
    
    Filed as Exhibit 2.1 to our Current Report on Form 8-K, filed on September 22, 2006,
and incorporated herein by reference. (Schedules and exhibits omitted pursuant to Item
601(b)(2) of Regulation S-K. The Company agrees to furnish supplementally a copy of any
omitted schedule or exhibit to the SEC upon request.)(2)
    
    Filed as Exhibit 10.36 to our Current Report on Form 8-K, filed on September 27, 2006,
and incorporated herein by reference. 44