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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 September 30, 2004 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)   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 o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes x  No o The number of shares of Vitrias common stock, $0.001 par value,
outstanding as of September 30, 2004 was 33,381,991 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 September 30, 2004 and December
31, 2003
    
    
    3Condensed Consolidated Statements of Operations for the three months and nine months
ended September 30, 2004 and 2003
    
    
    4Condensed Consolidated Statements of Cash Flows for the nine months
ended September 30, 2004 and 2003
    
    
    5Notes to the Condensed Consolidated Financial Statements
    
    
    6Item 2: Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    12Item 3: Quantitative and Qualitative Disclosures About Market Risk
    
    
    29Item 4: Controls and Procedures
    
    
    36PART II: OTHER INFORMATIONItem 1: Legal Proceedings
    
    
    38Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    38Item 3: Defaults Upon Senior Securities
    
    
    38Item 4: Submission of Matters to a Vote of Security Holders
    
    
    38Item 5: Other Information
    
    
    39Item 6: Exhibits
    
    
    39Signature
    
    
    40EXHIBIT 10.32EXHIBIT 10.33EXHIBIT 10.34EXHIBIT 10.35EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
 2




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PART I. FINANCIAL INFORMATION 
 ITEM 1. Financial Statements Vitria Technology, Inc. 
 
 September 30,
    
    December 31,2004
    
    2003(unaudited)
    
    (Note 1)AssetsCurrent Assets:Cash and cash equivalents
    
    $
    36,007
    
    
    $
    8,782Short-term investments
    
    
    45,751
    
    
    
    82,754Accounts receivable, net
    
    
    8,501
    
    
    
    15,471Other current assets
    
    
    2,771
    
    
    
    3,568Total current assets
    
    
    93,030
    
    
    
    110,575Property and equipment, net
    
    
    1,370
    
    
    
    2,805Other assets
    
    
    651
    
    
    
    745Total assets
    
    $
    95,051
    
    
    $
    114,125Liabilities and Stockholders EquityCurrent Liabilities:Accounts payable
    
    $
    2,638
    
    
    $
    1,837Accrued compensation
    
    
    4,123
    
    
    
    3,743Other accrued liabilities
    
    
    3,320
    
    
    
    3,783Accrued restructuring expenses
    
    
    6,092
    
    
    
    6,831Deferred revenue
    
    
    12,503
    
    
    
    13,864Total current liabilities
    
    
    28,676
    
    
    
    30,058Long-Term Liabilities:Accrued restructuring expenses
    
    
    8,213
    
    
    
    11,980Other long-term liabilities
    
    
    86
    
    
    
    131Total long-term liabilities
    
    
    8,299
    
    
    
    12,111Commitments and ContingenciesStockholders Equity:Common Stock
    
    
    33
    
    
    
    33Additional paid-in capital
    
    
    275,195
    
    
    
    273,854Unearned stock-based compensation
    
    
    (4
    )
    
    
    (79
    )Notes
receivable from employees
    
    
    
    
    
    
    (193
    )Accumulated other comprehensive income
    
    
    507
    
    
    
    635Accumulated deficit
    
    
    (217,159
    )
    
    
    (201,798
    )Treasury stock, at cost
    
    
    (496
    )
    
    
    (496
    )Total stockholders equity
    
    
    58,076
    
    
    
    71,956Total liabilities and stockholders equity
    
    $
    95,051
    
    
    $
    114,125
 The accompanying notes are an integral part of these condensed consolidated financial statements. 3




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Vitria Technology, Inc. 
 
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Revenues:License
    
    $
    3,066
    
    
    $
    7,084
    
    
    $
    8,331
    
    
    $
    21,825Service and other
    
    
    13,234
    
    
    
    11,690
    
    
    
    35,923
    
    
    
    37,613Total revenues
    
    
    16,300
    
    
    
    18,774
    
    
    
    44,254
    
    
    
    59,438Cost of revenues:License
    
    
    227
    
    
    
    175
    
    
    
    551
    
    
    
    476Service and other
    
    
    5,900
    
    
    
    5,753
    
    
    
    17,900
    
    
    
    18,411Total cost of revenues
    
    
    6,127
    
    
    
    5,928
    
    
    
    18,451
    
    
    
    18,887Gross profit
    
    
    10,173
    
    
    
    12,846
    
    
    
    25,803
    
    
    
    40,551Operating expenses:Sales and marketing
    
    
    4,672
    
    
    
    8,738
    
    
    
    17,029
    
    
    
    31,936Research and development
    
    
    4,388
    
    
    
    4,207
    
    
    
    13,249
    
    
    
    13,892General and administrative
    
    
    3,121
    
    
    
    3,120
    
    
    
    9,980
    
    
    
    10,436Stock-based compensation
    
    
    6
    
    
    
    83
    
    
    
    349
    
    
    
    362Restructuring
    
    
    173
    
    
    
    503
    
    
    
    797
    
    
    
    14,848Total operating expenses
    
    
    12,360
    
    
    
    16,651
    
    
    
    41,404
    
    
    
    71,474Loss from operations
    
    
    (2,187
    )
    
    
    (3,805
    )
    
    
    (15,601
    )
    
    
    (30,923
    )Interest income
    
    
    277
    
    
    
    251
    
    
    
    780
    
    
    
    1,017Other income (expense), net
    
    
    79
    
    
    
    72
    
    
    
    (25
    )
    
    
    (27
    )Net loss before income taxes
    
    
    (1,831
    )
    
    
    (3,482
    )
    
    
    (14,846
    )
    
    
    (29,933
    )Provision for income taxes
    
    
    221
    
    
    
    251
    
    
    
    515
    
    
    
    518Net loss
    
    $
    (2,052
    )
    
    $
    (3,733
    )
    
    $
    (15,361
    )
    
    $
    (30,451
    )Basic and diluted net loss per share
    
    $
    (0.06
    )
    
    $
    (0.11
    )
    
    $
    (0.47
    )
    
    $
    (0.93
    )Weighted average shares used in computing basic
and diluted net loss per share
    
    
    33,196
    
    
    
    32,644
    
    
    
    32,993
    
    
    
    32,591
 The accompanying notes are an integral part of these condensed consolidated financial statements. 4




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Vitria Technology, Inc. 
 
 Nine Months EndedSeptember 30,2004
    
    2003Operating activities:Net loss
    
    $
    (15,361
    )
    
    $
    (30,451
    )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
    
    
    37
    
    
    
    2,369Forgiveness
of note receivable from employees
    
    
    193
    
    
    
    Depreciation
    
    
    1,550
    
    
    
    3,782Stock-based compensation
    
    
    349
    
    
    
    362Recoveries of doubtful accounts
    
    
    (155
    )
    
    
    Changes in assets & liabilities:Accounts receivable
    
    
    7,124
    
    
    
    2,381Other current assets
    
    
    790
    
    
    
    277Other assets
    
    
    94
    
    
    
    253Accounts payable
    
    
    801
    
    
    
    (268
    )Accrued liabilities
    
    
    (83
    )
    
    
    (5,667
    )Accrued restructuring charges
    
    
    (4,506
    )
    
    
    5,880Deferred revenue
    
    
    (1,361
    )
    
    
    455Other long term liabilities
    
    
    (45
    )
    
    
    (756
    )Net cash used in operating activities
    
    
    (10,573
    )
    
    
    (21,083
    )Investing activities:Purchases of property and equipment
    
    
    (152
    )
    
    
    (584
    )Purchases of investments
    
    
    (48,587
    )
    
    
    (90,060
    )Maturities of investments
    
    
    85,540
    
    
    
    86,325Net cash provided by (used in) investing activities
    
    
    36,801
    
    
    
    (4,319
    )Financing activities:Issuance of common stock, net
    
    
    1,075
    
    
    
    155Net cash provided by financing activities
    
    
    1,075
    
    
    
    155Effect of exchange rates on changes on cash and cash equivalents
    
    
    (78
    )
    
    
    98Net increase (decrease) in cash and cash equivalents
    
    
    27,225
    
    
    
    (25,149
    )Cash and cash equivalents at beginning of period
    
    
    8,782
    
    
    
    42,427Cash and cash equivalents at end of period
    
    $
    36,007
    
    
    $
    17,278
 The accompanying notes are an integral part of these condensed consolidated financial statements. 5




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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1) Basis of Presentation The accompanying unaudited condensed consolidated financial statements
include the accounts of Vitria Technology, Inc (the Company or Vitria) and
its wholly owned subsidiaries. These unaudited financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
and with the rules and regulations of the Securities and Exchange Commission.
Certain information and footnote disclosures normally included in consolidated
financial statements have been condensed or omitted in accordance with the
rules and regulations of the Securities and Exchange Commission. As a result,
these financial statements should be read in conjunction with the audited
financial statements and notes thereto included in our Annual Report on Form
10-K for the year ended December 31, 2003. In
the opinion of Vitrias management, these unaudited condensed
consolidated financial statements include all the adjustments necessary to
fairly state our financial position and the results of our operations and cash
flows. The results of our operations for any interim period are not
necessarily indicative of the results of the operations for any other interim
period or for a full fiscal year. The balance sheet at December 31, 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. Stock-based compensation We account for stock-based employee compensation arrangements using the
intrinsic value method in accordance with Accounting Principles Board Opinion
No. 25 (APB 25), Accounting for Stock Issued to Employees. In addition, we
have adopted the disclosure provisions of Statement of Financial Accounting
Standards (SFAS) No. 123 (SFAS 123), Accounting for Stock-Based Compensation
and SFAS No. 148, Accounting for Stock-based Compensation  Transition and
Disclosure. We amortize and expense unearned stock-based compensation 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, we do not recognize any
compensation expense on the date of grant if the exercise price of our employee
stock options equals the market price of the underlying stock. 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 to be disclosed by SFAS 123. Under SFAS 123, this information is
required to be calculated 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. 6




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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: Three Months Ended,
    
    Nine Months Ended,September 30
    
    September 30,2004
    
    2003
    
    2004
    
    2003
    
    2004
    
    2003
    
    2004
    
    2003Stock option plans
    
    ESPP
    
    Stock option plans
    
    ESPPRisk-free interest rate
    
    
    3.92
    %
    
    
    2.99
    %
    
    
    3.08
    %
    
    
    3.49
    %
    
    
    3.32
    %
    
    
    3.02
    %
    
    
    3.14
    %
    
    
    3.58
    %Expected
Lives (in years)
    
    
    3
    
    
    
    3
    
    
    
    2
    
    
    
    1
    
    
    
    3
    
    
    
    3
    
    
    
    2
    
    
    
    1Dividend yield
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Expected volatility
    
    
    121
    %
    
    
    131
    %
    
    
    137
    %
    
    
    143
    %
    
    
    123
    %
    
    
    125
    %
    
    
    138
    %
    
    
    144
    %
 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 may not necessarily provide a reliable single
measure of the fair value of our stock based awards. The following table illustrates the effect on net loss and loss per share
if we had applied the fair value recognition provisions of SFAS 123 to employee
stock-based compensation, including shares issued under our stock option plans
and Employee Stock Purchase Plan. For purposes of pro forma disclosures, the
estimated fair value of the options is assumed to be amortized to expense over
the options vesting periods and the amortization of deferred compensation, as
calculated under the intrinsic value method, has been added back. Pro forma
information follows (in thousands, except per share amounts): Three Months Ended,
    
    Nine Months Ended,September 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net loss, as reported
    
    $
    (2,052
    )
    
    $
    (3,733
    )
    
    $
    (15,361
    )
    
    $
    (30,451
    )Add: stock-based employee compensation expense included in
reported net loss, net of applicable tax effects
    
    
    6
    
    
    
    83
    
    
    
    349
    
    
    
    362Deduct: total stock-based compensation expense determined
under the fair value based method for all awards, net of
applicable tax effects
    
    
    (1,221
    )
    
    
    (1,283
    )
    
    
    (3,196
    )
    
    
    (921
    )Pro forma net loss
    
    $
    (3,267
    )
    
    $
    (4,933
    )
    
    $
    (18,208
    )
    
    $
    (31,010
    )Net loss per share as reported
    
    $
    (0.06
    )
    
    $
    (0.11
    )
    
    $
    (0.47
    )
    
    $
    (0.93
    )Pro forma net loss per share
    
    $
    (0.10
    )
    
    $
    (0.15
    )
    
    $
    (0.55
    )
    
    $
    (0.95
    )Total shares used in calculation
    
    
    33,196
    
    
    
    32,644
    
    
    
    32,993
    
    
    
    32,591
 In the table above, in accordance with SFAS 123, we based our estimate of
stock-based compensation expense on the total number of options granted.
Adjustments have been made to reverse previously recognized stock-based
compensation expense associated with the unearned portion of any forfeited
awards. Forfeiture refers to awards that do not vest because services or
employment requirements are not met. 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. 7




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2) Net Loss Per Share Basic net loss per share is calculated by dividing net loss by the
weighted-average number of shares of common stock outstanding. Basic net loss
per share does not include shares subject to Vitrias right of repurchase,
which lapses ratably over the related vesting term. Diluted net loss per share
is calculated by dividing net loss by the weighted-average number of shares of
common stock outstanding plus shares of potential common stock. Shares of
potential common stock are composed of shares of common stock subject to
Vitrias right of repurchase and shares of common stock issuable upon the
exercise of stock options (using the treasury stock method). The calculation of
diluted net loss per share excludes shares of potential common stock if their
effect is anti-dilutive. The following table sets forth the computation of basic and diluted net
loss per share for the periods indicated (in thousands, except per share
amounts). Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Numerator for basic and diluted net loss per share:Net loss
    
    $
    (2,052
    )
    
    $
    (3,733
    )
    
    $
    (15,361
    )
    
    $
    (30,451
    )Denominator for basic and diluted net loss per
share:Weighted average shares of common stock
outstanding
    
    
    33,196
    
    
    
    32,675
    
    
    
    32,995
    
    
    
    32,644Less shares subject to repurchase
    
    
    0
    
    
    
    (31
    )
    
    
    (2
    )
    
    
    (53
    )Denominator for basic and diluted net loss per
share
    
    
    33,196
    
    
    
    32,644
    
    
    
    32,993
    
    
    
    32,591Basic and diluted net loss per share
    
    $
    (0.06
    )
    
    $
    (0.11
    )
    
    $
    (0.47
    )
    
    $
    (0.93
    )
 The following table sets forth the weighted average potential shares of
common stock that are not included in the diluted net loss per share
calculation above because to do so would be anti-dilutive for the periods
indicated (in thousands): Three Months ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Weighted average effect of anti-dilutive securities:Employee stock options (using the treasury stock
method)
    
    
    12
    
    
    
    548
    
    
    
    365
    
    
    
    239Common stock subject to repurchase agreements
    
    
    0
    
    
    
    31
    
    
    
    2
    
    
    
    53Total
    
    
    12
    
    
    
    579
    
    
    
    367
    
    
    
    292
 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 Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net loss
    
    $
    (2,052
    )
    
    $
    (3,733
    )
    
    $
    (15,361
    )
    
    $
    (30,451
    )Other comprehensive income (loss):Foreign currency translation
adjustment
    
    
    81
    
    
    
    (28
    )
    
    
    (78
    )
    
    
    (60
    )Unrealized gain (loss) on
securities
    
    
    5
    
    
    
    12
    
    
    
    (50
    )
    
    
    98Comprehensive loss
    
    $
    (1,966
    )
    
    $
    (3,749
    )
    
    $
    (15,489
    )
    
    $
    (30,413
    )
 The components of accumulated other comprehensive loss are as follows (in
thousands): September 30,
    
    December 31,2004
    
    2003Foreign currency translation
    
    $
    555
    
    
    $
    633Unrealized gain (loss) on marketable debt securities
    
    
    (48
    )
    
    
    2Total accumulated other comprehensive gain
    
    $
    507
    
    
    $
    635
 4) Stock-Based Compensation Stock-based compensation is broken down as follows (in thousands): Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Cost of revenues
    
    $
    1
    
    
    $
    7
    
    
    $
    77
    
    
    $
    29Sales and marketing
    
    
    2
    
    
    
    31
    
    
    
    71
    
    
    
    133Research and development
    
    
    2
    
    
    
    30
    
    
    
    84
    
    
    
    132General and administrative
    
    
    1
    
    
    
    15
    
    
    
    117
    
    
    
    68Total stock-based compensation
    
    $
    6
    
    
    $
    83
    
    
    $
    349
    
    
    $
    362
 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 by reducing our workforce and consolidating our facilities. In
2002 we reduced our workforce across all departments by approximately 285
employees, a 33% reduction as measured from the beginning of 2002. Facilities
in the United States and United Kingdom were consolidated and related leasehold
improvement and equipment were written off. The restructuring charge included
approximately $4.2 million of severance related charges and $15.3 million of
committed excess facilities payments, which included $463,000 for the write-off
of leasehold improvements and equipment in vacated buildings, in
accordance with Emerging Issues Task Force (EITF) 94-3,
Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (Including Certain Costs Incurred in
a Restructuring). As a result of
our restructuring actions, we incurred a total charge of $19.5 million in the
year ended December 31, 2002. In the year ended December 31, 2003, we acted to further reduce our cost
structure. We reduced our workforce across all departments by approximately
120 employees, a 22% reduction as measured from the beginning of 2003. We also
consolidated facilities in the United States and United Kingdom and disposed of
associated leasehold improvements and equipment. The excess facilities payments
were measured at fair value as of the cease-use date of the facilities as
required under Statement of Financial Accounting Standard No. 146 (SFAS 146),
Accounting for Costs Associated with Exit or Disposal Activities. As a result
of these restructuring actions, we incurred a charge of $16.1 million in the
year ended December 31, 2003. The restructuring charge included approximately
$2.9 million of severance related charges and $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. As a result of the fair value
treatment for the excess facilities payments, we incurred $180,000 in accretion
charges in 2003. Accretion charges are adjustments in expense related
to the fair value treatment for the facilities we restructured in
2003 under SFAS 146. During the nine months ended
September 30, 2004, restructuring charges totaled $797,000 and were
related to the facilities we restructured in 2002 and 2003. Of this
amount, $516,000 was due to adjustments we made to our sublease
assumptions in the second quarter of 2004 for buildings we had
restructured in the United Kingdom. The remainder of our
restructuring expense during the first nine months of 2004 was due to
accretion charges. As of September 30, 2004,
$14.3 million remains accrued from all of our restructuring actions,
of which $6.0 million is in current liabilities and $8.2 million is
in long-term liabilities. The portion of this liability related to
restructuring actions taken in 2003 is discounted at fair value as
required by SFAS 146, adopted by us as of January 31, 2003. The total
accrued liability of $14.3 million is comprised entirely of lease
termination costs and is net of $4.6 million of estimated sublease
income. Undiscounted contractual future sublease income related to
our restructured buildings is $2.3 million at September 30, 2004. 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 and accretion
    
    
    1,229
    
    
    
    
    
    
    
    1,229Severance
    
    
    
    
    
    
    330
    
    
    
    330Balance at December 31, 2003
    
    
    18,482
    
    
    
    330
    
    
    
    18,812Cash payments
    
    
    (4,974
    )
    
    
    (330
    )
    
    
    (5,304
    )Facility adjustments and accretion
    
    
    797
    
    
    
    
    
    
    
    797Balance at September 30, 2004
    
    $
    14,305
    
    
    $
    
    
    
    $
    14,305
 The facilities consolidation charges for all of our restructuring actions
were calculated using our best estimates at each respective reporting period
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. 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 which indicates that our estimates should
be adjusted. 6) Related Party Transactions In December 2003, we sold our interest in our China operations to
QilinSoft LLC (formerly referred to as ChiLin LLC). QilinSoft is owned and
controlled by Dr. JoMei Chang, a director and a significant stockholder, and
Dr. Dale Skeen, a director and our interim Chief Executive Officer and Chief
Technology Officer, the spouse of Dr. Chang and a significant stockholder. Vitria and QilinSoft also entered into a license agreement whereby
QilinSoft received a royalty-bearing license to distribute Vitria products in
China. In addition, Vitria and QilinSoft have entered into a development
agreement pursuant to which QilinSoft will perform development work and other
fee-bearing services for Vitria. During
the three months ended September 30, 2004, we recorded royalty
license income of $25,000 from QilinSoft, in Other
income (expense), net. During the third quarter of 2004, we incurred
charges of $176,000 for development work performed by QilinSoft, which was
recorded in Research and development expense. During
the nine months ended September 30, 2004, we recorded royalty license
income of $75,000 from QilinSoft in Other income (expense), net.
During the first three quarters of 2004, we incurred charges of $351,000
for development work performed by QilinSoft, which was recorded in Research and
development expense. At
September 30, 2004, we owed QilinSoft $59,000 for development work
performed in the third quarter of 2004. At September 30, 2004
QilinSoft owed us $26,000 for professional services performed by
Vitria in the third quarter of 2004. 11




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##### Table of Contents



7) Credit Facilities with Silicon Valley Bank We entered into a Loan and Security Agreement with Silicon Valley Bank,
dated June 28, 2002, for the purpose of establishing a revolving line of
credit. We modified this agreement on June 11, 2004 and reduced the line of
credit from $15.0 million to $12.0 million. The modification requires us to
maintain minimum cash, cash equivalents, and short-term investments balance of
$30.0 million. The agreement also requires us to maintain our primary
depository and operating accounts with Silicon Valley Bank and invest all of
our investments through Silicon Valley Bank. The line of credit serves as
collateral for letters of credit and other commitments, even though these items
do not constitute draws on the line of credit. Available advances under the
line of credit are reduced by the amount of outstanding letters of credit and
other commitments. Interest on outstanding borrowings on the line of credit
accrues at the banks prime rate of interest. The agreement is secured by all
of Vitrias assets. As of September 30, 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 $6.0 million related to certain office leases at
September 30, 2004. 8) Stock Grant In the quarter ended June 30, 2004, we issued a stock grant to all Vitria
employees. Each person who was a non-executive employee on the date of the
grant received 250 shares of Vitria common stock. The fair market value of our
common stock at the date of the grant was $2.88 per share. This stock grant
resulted in stock based compensation expense of $207,000 in the quarter ended
June 30, 2004. 9) Notes Receivable Prior
to our initial public offering, a number of employees were granted
five year loans in order to enable them to purchase our stock prior
to the initial public offering. The notes were interest bearing and
accrued interest at 4% per year. The terms of the notes required that
the notes be paid back within five years of issuance or upon the
termination of employment, whichever occurred earlier. The notes
receivable from employees have been fully paid off as of September 30, 2004. 10) 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. All share information has been restated to reflect the effects
of the reverse split. 
 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 12




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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 to be deployed 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. Many of our customers use third-party system integrators to implement
our products. Customers typically purchase additional consulting services from
us to support their implementation activities. 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. A majority of our revenues to date
have been derived from accounts in the United States. We have international
sales offices in  Canada, France, Germany, Italy, Japan, Korea,
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 over the last three years to reduce our overall cost
structure to better match lower revenues, we must develop additional products
to create revenue growth. Accordingly, we are developing 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. 13




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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:  
    
    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, and platforms and in conjunction
with services to deliver business process integration capabilities 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. 14




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
    
    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 and field-built content for
manufacturing companies to quickly achieve consolidated order
management. CleanOrder intelligently manages customer orders across
multiple existing systems, 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: a package of platform plus pre-built content 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 and field-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 reduce 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. 15




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(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 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. 16




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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. When contracts
contain multiple elements wherein vendor specific objective evidence
exists for all undelivered elements, we account for the delivered
elements in accordance with the Residual Method of
accounting prescribed by AICPA Statements of Position 98-9
Modification of SOP 97-2, Software Revenue Recognition with
Respect to Certain Transactions (SOP 98-9). We consider 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 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 resellers, is not recognized until
evidence of a sell-through arrangement to an end user has been received.
Payments received in advance of revenue recognition are recorded as deferred
revenue. 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 at the beginning of the contract term
and revenues from these contracts are recognized ratably over the term of the
contract. Future maintenance contracts, where the term has not yet started and
we have not yet received payment but we have received the customers purchase
order and have invoiced the customer, are recorded as deferred revenue and accounts receivable. Many
of our customers use third-party system integrators to implement our
products. Those customers who use third party system integrators
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. Other customers engage us directly as the
prime contractor to develop new applications for them on our
BusinessWare platform. These consulting services are generally sold on a fixed fee
basis and recognized using the completed contract or percentage of
completion method of accounting as set forth in SOP 81-1, Accounting
for Performance of Construction-Type and Certain Production-Type
Contracts, as applicable. Under the percentage of completion method, we
measure progress towards completion using labor hours as input
measures. Training services are sold on a per student or per class basis and
recognized as the classes are attended. Allowances and Reserves 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. During the nine months ended September 30, 2004 we incurred
charges of $516,000 related to changes in our sublease assumptions on
facilities we restructured and accretion charges of $281,000 related to the
fair value treatment for the facilities we restructured in 2003, in accordance
with SFAS 146. As of September 30, 2004, we have $14.3 million in
accrued restructuring expenses, consisting entirely of future lease
payments net of estimated sublease income, which will be paid through 2013. 17




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Only costs resulting from a restructuring plan that are not associated
with, or that do not benefit activities that will be continued, are eligible
for recognition as liabilities at the commitment date. These charges represent
expenses incurred in connection with certain cost reduction programs that we
have undertaken, and consist primarily of the cost of involuntary termination
benefits and remaining contractual lease payments and other costs associated
with closed facilities net of anticipated sublease income. Information
regarding sublease income estimates for the amount of sublease income we are
likely to receive and the timing of finding a tenant has been obtained from
third party experts and is based on prevailing market rates. The charges for facility closure costs require the extensive use of
estimates, including estimates and assumptions related to future maintenance
costs, our ability to secure sub-tenants and anticipated sublease income to be
received in the future. If we fail to make accurate estimates or to complete
planned activities in a timely manner, we might record additional charges or
reverse previous charges in the future. Such additional charges or reversals
will be recorded to the restructuring charges line in our statement of
operations in the period in which additional information becomes available to
indicate our estimates should be adjusted. Since April 2002, we have revised
our sublease income estimates at least semi-annually due to significant
downward trends in the real estate markets in the United States and in the
United Kingdom. 18




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RESULTS OF OPERATIONS For the three and nine months ended September 30, 2004 and September 30, 2003 The following table sets forth the results of operations for the three and
nine months ended September 30, 2004 and 2003, expressed as a percentage of
total revenues. Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003RevenuesLicense
    
    
    19
    %
    
    
    38
    %
    
    
    19
    %
    
    
    37
    %Service and other
    
    
    81
    %
    
    
    62
    %
    
    
    81
    %
    
    
    63
    %Total revenues
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %Cost of revenuesLicense
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %Service and other
    
    
    36
    %
    
    
    31
    %
    
    
    40
    %
    
    
    31
    %Total cost of revenues
    
    
    37
    %
    
    
    32
    %
    
    
    41
    %
    
    
    32
    %Gross profit
    
    
    63
    %
    
    
    68
    %
    
    
    59
    %
    
    
    68
    %Operating expensesSales and marketing
    
    
    29
    %
    
    
    47
    %
    
    
    38
    %
    
    
    54
    %Research and development
    
    
    27
    %
    
    
    22
    %
    
    
    30
    %
    
    
    23
    %General and administrative
    
    
    19
    %
    
    
    17
    %
    
    
    23
    %
    
    
    17
    %Amortization of stock-based compensation
    
    
    0
    %
    
    
    0
    %
    
    
    1
    %
    
    
    1
    %Restructuring charges
    
    
    1
    %
    
    
    3
    %
    
    
    2
    %
    
    
    25
    %Total operating expenses
    
    
    76
    %
    
    
    89
    %
    
    
    94
    %
    
    
    120
    %Loss from operations
    
    
    (13
    %)
    
    
    (21
    %)
    
    
    (35
    %)
    
    
    (52
    %)Interest income
    
    
    2
    %
    
    
    1
    %
    
    
    2
    %
    
    
    2
    %Other income (expenses), net
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Net loss before income taxes
    
    
    (11
    %)
    
    
    (20
    %)
    
    
    (33
    %)
    
    
    (50
    %)Provision for income taxes
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %Net loss
    
    
    (12
    %)
    
    
    (21
    %)
    
    
    (34
    %)
    
    
    (51
    %)
 Revenues Revenues from sales that originate outside of the United States comprise a
significant percentage of our total revenues. We recognized approximately 46%
of our revenues from customers outside the United States in the three months
ended September 30, 2004 and 44% of our revenues from customers outside the
United States in the nine months ended September 30, 2004, compared to 40% in
the three months ended September 30, 2003 and 36% in the nine months ended
September 30, 2003. 19




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##### Table of Contents



A small number of customers account for a substantial percentage of our
total revenues. Revenues from our top ten customers and customers who
accounted for more than 10% of our total revenues are summarized in the table
below: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Percentage of revenues from top ten customers
    
    
    49
    %
    
    
    42
    %
    
    
    37
    %
    
    
    37
    %Number of customers who account for more
than 10% of total revenues
    
    
    0
    
    
    
    1
    
    
    
    0
    
    
    
    0Percentage of revenues from customers who
accounted for more than 10% of total
revenues
    
    
    
    
    
    
    18
    %
    
    
    
    
    
    
    
 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 of these customers or the delay of individual orders from
these customers 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. To date, we have not experienced significant seasonality of
revenues. License.License revenues are dependent on both the number of sales in a
period as well as the amount of license revenue recognized from each individual
sale in a particular period, both of which can vary significantly from period
to period. Over the past several years, we have had a significant decrease in
our license revenues due to the maturation of the market
in which we compete, which has resulted in downward pricing pressure and fewer
total orders as competition has increased for a smaller pool of potential
buyers. License revenues decreased 57% from $7.1 million in the three months ended
September 30, 2003 to $3.1 million in the three months ended September 30,
2004. This decrease was primarily due to fewer total sales during this period.
Average license revenues recognized per sale remained fairly constant in these
two periods mainly due to a few large sales which we recognized in the current
quarter.     License revenues decreased 62% from $21.8 million in the nine months
ended September 30, 2003 to $8.3 million in the nine months ended September 30,
2004. This decrease was due to fewer total sales during the current period
and less significantly due to a decrease in the average license revenue per
sale. The general slowdown in information technology spending in our target
markets has also made it more difficult for us to grow our revenues. Service and other.Service revenue is impacted by the number and size of
license sales in a given period. Support for the first year is
typically purchased as part of each license sale. Our consulting project revenue and customer
training revenue is also affected by the size and number of license sales.
Service and other revenue also includes support renewals, which is dependent
upon our customers satisfaction with and continued use of our products.
Service and other revenues increased 13% from $11.7 million in the three months
ended September 30, 2003 to $13.2 million in the three months ended September
30, 2004. This quarter over quarter increase of approximately $1.5 million was
primarily due to our ability to recognize $1.2 million in consulting revenue
from work performed in the first and second quarters of 2004 which had been
deferred due to the need to obtain written customer acceptance on the
project. Written customer acceptance was received during the third quarter of 2004 and accordingly we were
able to recognize the consulting revenue in the third quarter. The remainder
of the difference was due to increases in consulting and in support renewals,
partially offset by a decrease in first year support.
Service and other revenues decreased 4% from $37.6 million in the nine
months ended September 30, 2003 to $35.9 million in the nine months ended
September 30, 2004. This decrease of approximately $1.7 million was mainly due
to a decrease in first year support of $1.1 million, which is directly related
to our decrease in license revenue from the prior
year. The remainder of the difference was due to small decreases in our
training and consulting revenues, partially offset by an increase in support
renewals. 20




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##### Table of Contents



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 30% from $175,000 in the three months
ended September 30, 2003 to $227,000 in the three months ended September 30,
2004. Cost of license revenues increased 16% from $476,000 in the nine
months ended September 30, 2003 to $551,000 in the nine months ended September
30, 2004. These fluctuations 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 increased 3% from $5.8 million in
the three months ended September 30, 2003 to $5.9 million in the three months
ended September 30, 2004. This small increase was primarily due to increases
in external consultants costs of $253,000, partially offset by decreases in
salaries and benefits of $130,000 due to changes in staffing in our
Professional Services department. Cost of service and other revenues decreased
3% from $18.4 million in the nine months ended September 30, 2003 to $17.9
million in the nine months ended September 30, 2004. This decrease was
primarily due to a decrease in salaries and benefits of $510,000 due to changes
in staffing in our Professional Services department, decreases in travel
related expenses of $384,000 related to our lower consulting revenue, and
decreases in facility related expenses of $943,000 due to our facilities
restructuring in 2003, offset by increases in external consultant costs of
$534,000 and higher use of our Professional Services staff in other departments
in the company. For the next quarter, we expect that cost of revenues will
increase slightly compared to the quarter ended September 30, 2004. 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 47% from $8.7 million in the
three months ended September 30, 2003 to $4.7 million in the three months ended
September 30, 2004. This decrease was primarily due to decreases in salary and
benefit expenses of $2.6 million, reduced travel expenses of $289,000, lower
commission expense of $418,000 due to lower sales, as well as related decreases
in most other expense areas as a result of our cost containment efforts. Sales
and marketing expenses decreased 47% from $31.9 million in the nine months
ended September 30, 2003 to $17.0 million in the nine months ended September
30, 2004. This decrease was primarily due to lower salary and benefit expenses
of $7.5 million, reduced travel expenses of $1.2 million, lower external
consulting expense of $623,000, lower commission expense of $1.9 million due to
lower sales, and decreased depreciation expenses of $652,000 as well as related
decreases in most other expense areas as a result of our cost containment
efforts. The reduction in depreciation expense is due to the fact that more of
our fixed assets have become fully depreciated and no significant purchases of
fixed assets have been made in 2004. For the next quarter, we expect that sales
and marketing expenses will increase compared to the quarter ended September
30, 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
increased 4% from $4.2 million in the three months ended September 30, 2003 to
$4.4 million in the three months ended September 30, 2004. This small
increase of $181,000 is primarily attributable to an increase of $295,000 in
salaries and benefits and an increase of $174,000 for external consultants due
to moving some of our development work to India and China, offset by a
reduction in recruiting expenses of $73,000 and a $189,000 21




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reduction in depreciation costs, as well as decreases in most other areas due
to our cost containment efforts. Research and development expenses decreased
5% from $13.9 million in the nine months ended September 30, 2003 to $13.2
million in the nine months ended September 30, 2004. This decrease was
primarily due to reduced facilities costs of $457,000 as a result of our
restructuring in the first quarter of 2003 and lower rates on leases renewed in
2004, and lower depreciation expense of $764,000 offset by an increase of
$285,000 in salaries and benefits for compensation paid to certain executive
officers who left Vitria in the quarter ended June 30, 2004. The reduction in
depreciation expense is due to the fact that more of our fixed assets have
become fully depreciated and no significant purchases of fixed assets have been
made in 2004. For the next quarter, we expect that research and development
expenses will increase compared to the quarter ended September 30, 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 remained at $3.1 million for
both the three months ended September 30, 2003 and 2004. While our expenses
remained flat, there were some offsetting increases and decreases in expenses.
We incurred an increase of $203,000 in salaries and benefits expenses, an
increase of $127,000 for external consultant costs related to compliance with
the Sarbanes-Oxely Act, an increase of $145,000 in equipment related expenses,
and an increase in executive recruiting fees of $114,000. These increases were offset by a $142,000 decrease
in legal settlement fees, a decrease in depreciation expense of $122,000 as
fewer fixed assets purchases have been made in 2004, a reduction in facilities
costs of $197,000 which was the result of lower lease rate renewals in 2004, a
decrease in bad debt expense of $194,000 as our accounts receivable balances
decreased significantly from the prior year, and other cost containment
efforts. General and administrative expenses decreased 4% from $10.4 million
in the nine months ended September 30, 2003 to $10.0 million in the nine months
ended September 30, 2004. This small decrease was primarily attributable to
lower depreciation expenses of $421,000 due to fewer fixed assets purchases in
2004, reduced facilities costs of $186,000 as a result of our restructuring in
the first quarter of 2003, lower rates on leases renewed in 2004, and lower
insurance expenses of $534,000, offset by an increase in salaries and benefits
expense of $686,000 primarily for compensation paid to former
executive officers who
left Vitria in the second quarter of 2004. For the next quarter, we expect
that general and administrative expenses will increase slightly compared to the
quarter ended September 30, 2004. Stock-based compensation.Total stock-based compensation expenses were
$6,000 for the three months ended September 30, 2004 and $83,000 for the three
months ended September 30, 2003. Total stock-based compensation expenses were
$349,000 for the nine months ended September 30, 2004 and $362,000 for the nine
months ended September 30, 2003. Stock-based compensation expense 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 has been amortized over a five-year vesting period, which ended
September 30, 2004. In addition, stock based compensation expense includes
expense for options originally issued below fair market value on the date of
the grant, expense for stock grants issued to our employees, and expense for
modifications of stock options which result in a benefit to the employee.
Unearned compensation expense will be reduced in future periods to the extent
that options are terminated prior to vesting. We expect to recognize employee
stock-based compensation expense related to employee options of approximately
$4,000 for the remaining three months of 2004. In the quarter ended September
30, 2004, we recorded $5,000 for amortization of unearned employee stock-based
compensation related to employee options, and $1,000 in non-cash stock-based
compensation expense for stock grants issued to our employees. In the nine
months ended September 30, 2004, we recorded $75,000 for amortization of
unearned employee stock-based compensation, $207,000 for stock grants
issued to our employees and $67,000 as a result of vesting
modifications made to option grants for former executive officers who left
Vitria during the second quarter of 2004. Restructuring
charges.In the year ended December 31, 2002 we initiated actions to reduce our cost structure by reducing our workforce and
consolidating our facilities. In 2002 we reduced our workforce across all
departments by approximately 285 employees, a 33% reduction in staff as
measured from the beginning of 2002. Facilities in the United 22




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States and United Kingdom were consolidated and related leasehold
improvement and equipment were written off. The restructuring charge
included approximately $4.2 million of severance related charges and $15.3
million of committed excess facilities payments, which included $463,000 for
the write-off of leasehold improvements and equipment in vacated
buildings, in
accordance with Emerging Issues Task Force (EITF) 94-3,
Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (Including Certain Costs Incurred in
a Restructuring). As
a result of our restructuring actions, we incurred a charge of $19.5 million in
the year ended December 31, 2002. In the year ended December 31, 2003, we acted to further reduce our cost
structure. We reduced our workforce across all departments by approximately
120 employees, a 22% reduction in staff as measured from the beginning of 2003.
We also consolidated facilities in the United States and United Kingdom and
disposed of associated leasehold improvements and equipment. The excess
facilities payments were measured at fair value as of the cease-use date of the
facilities as required under Statement of Financial Accounting Standard No. 146
(SFAS 146), Accounting for Costs Associated with Exit or Disposal Activities.
As a result of the restructuring actions, we incurred a charge of $16.1
million in the year ended December 31, 2003. The restructuring charge included
approximately $2.9 million of severance related charges and $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. As a result of
the fair value treatment for the excess facilities payments, we incurred
$180,000 in 2003 in accretion charges related to the facilities we restructured
in 2003. Accretion charges are adjustments in expense related
to the fair value treatment for the facilities we restructured in
2003 under SFAS 146. During the nine months ended
September 30, 2004, restructuring charges totaled $797,000 and were
related to the facilities we restructured in 2002 and 2003. Of this
amount, $516,000 was due to adjustments we made to our sublease
assumptions in the second quarter of 2004 for buildings we had
restructured in the United Kingdom. The remainder of our
restructuring expense during the first nine months of 2004 was due to
accretion charges. As of September 30, 2004,
$14.3 million remains accrued from all of our restructuring actions
of which $6.0 million is in current liabilities and $8.2 million is
in long-term liabilities. The portion of this liability related to
restructuring actions taken in 2003 is discounted at fair value as
required by SFAS 146, adopted by us as of January 31, 2003. The total
accrued liability of $14.3 million is comprised entirely of lease
termination costs and is net of $4.6 million of estimated sublease
income. Undiscounted contractual future sublease income related to
our restructured buildings is $2.3 million at September 30, 2004. The facilities consolidation charges for all of our restructuring actions
were calculated using our best estimates at each respective reporting period
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. Such additional charges or reversals will be recorded to the
restructuring charges line in our 23




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statement of operations in the period in which additional information
becomes available which indicates that our estimates should be adjusted. Interest income and other income (expense), net.Interest and other
income (expense), net, increased 10%, from $323,000 in the three months ended
September 30, 2003 to $356,000 in the three months ended September 30, 2004 due
primarily to increased interest income. This small increase is due to higher
interest rates, offset by lower cash and investment balances in the third
quarter of 2004 as compared to the third quarter of 2003. During this period,
we had higher cash and investment balances but were earning interest at a lower
rate than in 2003. Interest and other income (expense), net, decreased 24% from $990,000
in the nine months ended September 30, 2003 to $755,000 in the nine months
ended September 30, 2004. This decrease is primarily attributable to lower
interest income, due to lower cash and investment balances, offset by a very
small change in interest rates on a year to date basis over this period of
time. Provision for income taxes We
recorded an income tax provision of $221,000 and $515,000 for the
three-month and nine month periods ended September 30, 2004. We recorded an
income tax provision of $251,000 and $518,000 for the three-month and nine-month
periods ended September 30, 2003. Income tax provisions in the 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. Because we cannot determine that it is more likely than not that the
deferred tax assets, primarily related to net operating loss carryovers, will
be utilized in the future, we have provided a reserve against deferred tax
assets in all periods presented. Liquidity and Capital Resources Nine Months EndedSeptember 30,
    
    Percent2004
    
    2003
    
    Change(in thousands)Net cash used in operating activities
    
    $
    (10,573
    )
    
    $
    (21,083
    )
    
    
    (50
    %)Net cash provided by (used in) investing activities
    
    
    36,801
    
    
    
    (4,319
    )
    
    
    952
    %Net cash provided by financing activities
    
    
    1,075
    
    
    
    155
    
    
    
    594
    %
 As of September 30, 2004, we had approximately $81.8 million of cash, cash
equivalents and short-term investments, $28.7 million in short term liabilities
and $8.3 million in long term liabilities. Net cash used in operating activities decreased $10.5 million, or 50%, in
the nine months ended September 30, 2004 compared to the nine months ended
September 30, 2003. This decrease was primarily due to a decrease in our net
loss as we reduced our expenses over the prior period. This decrease was
offset by a decrease in our accounts receivable balance due to lower
revenues in
2004, a decrease in our compensation liability as a result of our
restructuring in 2003, and a decrease in our restructuring liability as we paid
down our leasehold liabilities. We will continue to pay out cash for 24




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facilities we restructured in 2002 and 2003 until 2013. In the first nine
months of 2004, our cash payments for restructured facility leases totaled $5.0
million. Net cash provided by investing activities increased $41.1 million in the
nine months ended September 30, 2004 compared to the nine months ended
September 30, 2003. This increase in the current period is due to the fact
that we sold more short-term investments than we purchased, as compared to the
prior period when we purchased more short-term investments than we sold.
Toward the end of the second quarter of 2004, many of our investments matured
and were temporarily placed into money market funds as we consolidated all of
our investments under one investment management company. These cash
equivalents were re-invested in the early part of the third quarter of 2004 in
short-term investments with higher interest rates than money market funds. Net cash provided by financing activities increased $920,000 in the nine
months ended September 30, 2004 as compared to the nine months ended September
30, 2003. Net cash provided by financing activities in both the current and
prior periods was primarily from the issuance of common stock due to
exercises of employee stock options. During the nine months ended September 30, 2004, our net accounts
receivable balance decreased $7.0 million from $15.5 million at December 31,
2003 to $8.5 million at September 30, 2004. The decrease is primarily
attributable to increased cash collection during the period combined with the
decrease in revenues during the first nine months of 2004 as compared to prior
periods. At September 30, 2004, our gross accounts receivable balance was $8.7
million with an allowance for doubtful accounts of $243,000. During the nine months ended September 30, 2004, our deferred revenue
balance decreased $1.4 million from $13.9 million at December
31, 2003 to $12.5 million at September 30, 2004. The primary reason for this
decrease is a $1.3 million decline in our deferred support revenue balance.
Deferred support, which represents customers first year support on new license
deals, is directly related to our license revenue, which has declined in the
current year as compared to the prior year. Contractual Cash Obligations and Commitments At September 30, 2004, we had contractual obligations and commercial
commitments of approximately $21.8 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. Payments due by periodLess than
    
    
    
    
    
    
    
    
    
    More thanContractual Obligations
    
    Total
    
    1 year
    
    1-3 years
    
    3-5 years
    
    5 years(in thousands)Capital Lease Obligations
    
    $
    95
    
    
    $
    86
    
    
    $
    9
    
    
    $
    
    
    
    $
    Operating Lease Obligations
    
    
    20,990
    
    
    
    2,317
    
    
    
    10,879
    
    
    
    3,688
    
    
    
    4,106Purchase Obligations
    
    
    689
    
    
    
    689
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    21,774
    
    
    $
    3,092
    
    
    $
    10,888
    
    
    $
    3,688
    
    
    $
    4,106
 Operating lease commitments shown above, which are net of contractual
sublease agreements, include $16.9 million in undiscounted operating
lease commitments under leases for vacated facilities which were recorded as
accrued restructuring expenses in the accompanying balance sheet as of
September 30, 2004. This $16.9 million undiscounted 25




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lease commitment is net of $2.3 million in undiscounted 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 September 30, 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
entered into a Loan and Security Agreement with Silicon Valley Bank,
dated June 28, 2002, for the purpose of establishing a revolving line of credit.
We modified this agreement on June 11, 2004 and reduced the line of credit
from $15.0 million to $12.0 million. The modification requires us to maintain
minimum cash, cash equivalents, and short-term investments balance of $30.0
million. The agreement also requires us to maintain our primary depository and
operating accounts with Silicon Valley Bank and invest all of our investments
through Silicon Valley Bank. The line of credit serves as collateral for
letters of credit and other commitments, even though these items do not
constitute draws on the line of credit. Available advances under the line of
credit are reduced by the amount of outstanding letters of credit and other
commitments. Interest on outstanding borrowings on the line of credit accrues
at the banks prime rate of interest. The agreement is secured by all of
Vitrias assets. As of September 30, 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 $6.0 million related to certain office leases at
September 30, 2004. Stock Grant In the quarter ended June 30, 2004, we issued a stock grant to all Vitria
employees. Each person who was a non-executive employee on the date of the
grant received 250 shares of Vitria common stock. The fair market value of our
common stock at the date of the grant was $2.88 per share. This stock grant
resulted in stock based compensation expense of $207,000, which was
recorded in
the quarter ended June 30, 2004. Operating Capital and Capital Expenditure Requirements Our use of cash over the next twelve months will be 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, 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 for the
remainder of the current year to be less than $500,000. 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 the next twelve months. If we do
not achieve profitability, at some point in the future we may require 26




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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, and developing new
products for
our customers. 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 could
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;
    
    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; 27




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
    
    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
QilinSoft LLC. QilinSoft 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 QilinSoft also entered into a license agreement whereby
QilinSoft received a royalty-bearing license to distribute Vitria products in
China. In addition, Vitria and QilinSoft executed a development agreement
pursuant to which QilinSoft will perform development work and other fee-bearing
services for Vitria. During
the three months ended September 30, 2004, we recorded royalty
license income of $25,000 from QilinSoft, in Other
income (expense), net. During the third quarter of 2004, we incurred
charges of $176,000 for development work performed by QilinSoft, which was
recorded in Research and development expense. During
the
nine months ended September 30, 2004, we recorded royalty license
income of $75,000 from QilinSoft in Other income (expense), net.
During the first three quarters of 2004, we incurred charges of $351,000
for development work performed by QilinSoft, which was recorded in Research and
development expense. At
September 30, 2004, we owed QilinSoft $59,000 for development work
performed in the third quarter of 2004. At September 30, 2004
QilinSoft owed us $26,000 for professional services performed by
Vitria in the third quarter of 2004. 28




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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, these securities 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 September 30,
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
September 30, 2004. Table of investment securities (in thousands) as of September 30: 2004
    
    
    
    
    
    2003Weighted Average
    
    
    
    
    
    Weighted AverageFair Value
    
    Interest Rate
    
    Fair Value
    
    Interest RateCash and cash equivalents
    
    $
    36,007
    
    
    
    0.34
    %
    
    $
    17,278
    
    
    
    1.02
    %Short-term investments
    
    
    45,751
    
    
    
    1.44
    %
    
    
    79,111
    
    
    
    1.41
    %Total cash and investment securities
    
    $
    81,758
    
    
    
    
    
    
    $
    96,389
 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
currency 29




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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 September 30, 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. New contracts may not result
in revenue in the quarter in which the contract is 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 $217.2 million as of September 30, 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 restructuring charges of $19.5 million in
2002 and $16.1 million in 2003. Despite these 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
our core product, Vitria:BusinessWare, and related products developed
for certain vertical markets. Our business could be materially harmed by
factors that adversely affect the pricing and demand for Vitria:BusinessWare
and these related products. 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 competition, technological 30




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change or other factors would significantly reduce our revenues. 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. In
addition, the general slowdown in information technology spending in our target
markets due to slow 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 nine months ended September 30, 2004, we had a net loss of
$15.4 million and our operating activities used $10.6 million of cash. As of
September 30, 2004, we had approximately $81.8 million in cash, cash
equivalents and short-term investments, $28.7 million in short term liabilities
and $8.3 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;
    
    respond to competitive pressures or unanticipated capital requirements;
    
    have sufficient funds for day to day operations. 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 especially the
continued reluctance of companies to make significant expenditures on
information technology, could reduce demand for our products and cause our
revenues to decline. The worldwide slowdown in the enterprise software market 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 three 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. As a result, 31




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we or other parties, including system resellers and 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 economic environment 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. Sales
to our largest ten customers accounted for 49% and 37% of total
revenues in the three and nine months ended September 30, 2004, respectively.
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 products based on
Vitria:BusinessWare, our ability to increase future revenues could be harmed. We have developed and intend to continue to develop products 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
standards organizations, and the commitment of significant resources. Specific
industries may experience economic downturns or regulatory changes that may
result in delayed spending decisions by customers or require changes to our
products. If we are not successful in developing these targeted products or
these products 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. 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. 32




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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, Clear Technology, CSC,
FileNet, GXS, 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 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 products
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 may, at the option of the customer, 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 might have to devote
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 some cases, these parties have
extensive relationships with our existing and potential customers and influence
the decisions of these customers. We rely upon these firms to recommend 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
existing relationships with these system integrators and, as a result, these
system integrators may recommend competitors products and
services instead of ours. In
addition, some of our competitors have relationships with a greater number of
these system integrators and, therefore, have access to a broader base of
enterprise customers. If we fail to establish or maintain relationships with
system integrators, our ability to license and successfully implement our
software products and our ability to develop industry specific products could
be harmed. 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, 33




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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 for 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 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 34




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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
or are using confidential or proprietary information. 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
Canada, France, Germany, Italy, Japan, Korea, Singapore, Spain and the United
Kingdom and may establish additional international offices. During the first
nine months of 2004, 44% 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. 35




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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 to increase
the number of outstanding shares and thwart a takeover attempt;
    
    prohibiting cumulative voting in the election of directors,
which would otherwise allow less than a majority of stockholders to
elect director candidates;
    
    limitations on the ability of stockholders to call special
meetings of stockholders;
    
    prohibiting stockholder action by written consent, thereby
requiring all stockholder actions to be taken at a meeting of our
stockholders; and
    
    establishing advance notice requirements for nominations for
election to the Board of Directors  or for proposing
matters that can be acted upon by stockholders at stockholder
meetings Section 203 of the Delaware General Corporations Law and the terms of our
stock option plans may also discourage, delay or prevent a change in control of
Vitria. In addition, as of September 30, 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. 
 Item 4. CONTROLS AND PROCEDURES Evaluation of disclosure controls and procedures. Based on their
evaluation as of September 30, 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 third fiscal quarter that have
materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting. Subsequent Event.Subsequent to September 30, 2004, Vitria management
identified a deficiency in an internal control related to our Information
Technology (IT) systems. Our IT systems lost power on October 29, 2004, which
resulted from the failure to replace a battery in an uninterruptible power
supply system that had been previously reported as malfunctioning during a
preventive maintenance inspection. This power failure in turn caused our data
back-up server to fail. The company was therefore unable to back up much of
its data for several days. During the period of power and backup failure none
of our data was lost, and this system failure did not result in a misstatement
of our financial statements. However, because the accuracy and completeness of
our financial information depends on the capability of our IT systems to record
and preserve our data, management concluded this failure constituted a material
weakness in our internal control structure. The failed battery and backup
server was replaced with new equipment, a full backup was completed on November
9, 2004 and our process of making regularly scheduled backups was resumed.
We believe that these actions, coupled with changes in the IT organization,
have corrected this material weakness and should prevent a future back-up
failure. We continue to review our controls with respect to IT systems and we
may make other changes in these controls. 36




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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
and not be detected. 37




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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 the 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. In October 2002, Vitrias officers and directors were
dismissed without prejudice pursuant to a stipulated dismissal and tolling
agreement with the plaintiffs. On February 19, 2003, Judge Scheindlin issued
a ruling denying in part and granting in part the Defendants motions to
dismiss. In June 2003, Vitrias Board of Directors approved a resolution
tentatively accepting a settlement offer from the plaintiffs according to the
terms and conditions of a comprehensive Memorandum of Understanding negotiated
between the plaintiffs and the 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. In June 2004, Vitria executed a final settlement agreement with
the plaintiffs consistent with the terms of the Memorandum of Understanding.
The settlement is still subject to a number of conditions, including action by
the Court certifying a class action for settlement purposes and formally
approving the settlement. The underwriters have opposed both the certification
of the class and the judicial approval of the settlement. 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. None. 
 Item 3. Defaults Upon Senior Securities None. 
 Item 4. Submission of Matters to Vote of Security Holders None. 38




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Item 5. Other Information QiLinSoft LLC Marketing Agreement On
November 4, 2004, we entered into a Marketing Agreement with QiLinSoft LLC pursuant to which the parties
agreed to provide each other with limited sales assistance and sales and marketing information. This agreement
is contained in Exhibit 10.32 on this Form 10Q. For further information regarding our relationship with
QiLinSoft LLC see Note 6, Related Parties
Transactions, contained in Part I, Item 1 of this
Form 10Q. 
 Item 6. Exhibits a) Exhibits Exhibit 10.32
    
    Marketing Agreement between
QilinSoft, LLC and Vitria dated November 4, 2004.Exhibit 10.33
    
    Form of Stock Option Agreement.Exhibit 10.34
    
    Form of Stock Option Grant Notice.Exhibit 10.35
    
    Form of Stock Award Notice and Agreement.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 certification 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 Vitira 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. 39




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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: November 9, 2004
    
    By:    /s/ MICHAEL D. PERRYMichael D. PerrySenior Vice President and Chief Financial Officer
 40




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EXHIBIT INDEX Exhibit 10.32
    
    Marketing Agreement between
QilinSoft, LLC and Vitria dated November 4, 2004.Exhibit 10.33
    
    Form of
Stock Option Agreement.Exhibit 10.34
    
    Form of
Stock Option Grant Notice.Exhibit 10.35
    
    Form of
Stock Award Notice and Agreement.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 certification 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 Vitira 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. 41