##### Table of Contents



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 June 30, 2004 OR [   ]           TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934. For the transition period from ____________ to ____________.
 Commission file number: 0-27207 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
[   ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [X] No
[   ] The number of shares of Vitrias common stock, $0.001 par value,
outstanding as of June 30, 2004 was 33,292,089 shares. 1




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##### Table of Contents



VITRIA TECHNOLOGY, INC. Index
    
    PagePART I: FINANCIAL INFORMATIONItem 1. Condensed Consolidated Financial Statements and NotesCondensed Consolidated Balance Sheets at June 30, 2004 and December 31, 2003
    
    
    3Condensed Consolidated Statements of Operations for the three months and six months ended June 30, 2004 and 2003
    
    
    4Condensed Consolidated Statements of Cash Flows for the six months ended June 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
    
    
    14Item 3: Quantitative and Qualitative Disclosures About Market Risk
    
    
    29Item 4: Controls and Procedures
    
    
    36PART II: OTHER INFORMATIONItem 1: Legal Proceedings
    
    
    38Item 2: Changes in Securities, Uses of Proceeds and Issuer Purchases of Equity Securities
    
    
    39Item 3: Defaults Upon Senior Securities
    
    
    39Item 4: Submission of Matters to a Vote of Security Holders
    
    
    39Item 5: Other Information
    
    
    39Item 6: Exhibits and Reports on Form 8-K
    
    
    39Signature
    
    
    40EXHIBIT 10.24EXHIBIT 10.25EXHIBIT 10.26EXHIBIT 10.27EXHIBIT 10.28EXHIBIT 10.29EXHIBIT 10.30EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
 2




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PART I. FINANCIAL INFORMATION 
 ITEM 1. Financial Statements Vitria Technology, Inc. 
   June 30,
    
    December 31,2004
    
    2003(unaudited)
    
    (Note 1)AssetsCurrent Assets:Cash and cash equivalents
    
    $
    57,001
    
    
    $
    8,782Short-term investments
    
    
    28,182
    
    
    
    82,754Accounts receivable, net
    
    
    9,161
    
    
    
    15,471Other current assets
    
    
    3,068
    
    
    
    3,568Total current assets
    
    
    97,412
    
    
    
    110,575Property and equipment, net
    
    
    1,805
    
    
    
    2,805Other assets
    
    
    713
    
    
    
    745Total assets
    
    $
    99,930
    
    
    $
    114,125Liabilities and Stockholders EquityCurrent Liabilities:Accounts payable
    
    $
    2,182
    
    
    $
    1,837Accrued compensation
    
    
    3,631
    
    
    
    3,743Other accrued liabilities
    
    
    3,427
    
    
    
    3,783Accrued restructuring expenses
    
    
    5,806
    
    
    
    6,831Deferred revenue
    
    
    15,366
    
    
    
    13,864Total current liabilities
    
    
    30,412
    
    
    
    30,058Long-Term Liabilities:Accrued restructuring expenses
    
    
    9,900
    
    
    
    11,980Other long-term liabilities
    
    
    104
    
    
    
    131Total long-term liabilities
    
    
    10,004
    
    
    
    12,111Commitments and ContingenciesStockholders Equity:Common Stock
    
    
    33
    
    
    
    33Additional paid-in capital
    
    
    274,796
    
    
    
    273,854Unearned stock-based compensation
    
    
    (9
    )
    
    
    (79
    )Notes receivable from stockholders
    
    
    (125
    )
    
    
    (193
    )Accumulated other comprehensive income
    
    
    422
    
    
    
    635Accumulated deficit
    
    
    (215,107
    )
    
    
    (201,798
    )Treasury stock, at cost
    
    
    (496
    )
    
    
    (496
    )Total stockholders equity
    
    
    59,514
    
    
    
    71,956Total liabilities and stockholders equity
    
    $
    99,930
    
    
    $
    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
June 30,
    
    Six Months Ended
June 30,2004
    
    2003
    
    2004
    
    2003Revenues:License
    
    $
    1,874
    
    
    $
    4,192
    
    
    $
    5,265
    
    
    $
    14,741Service and other
    
    
    11,831
    
    
    
    13,867
    
    
    
    22,689
    
    
    
    25,923Total revenues
    
    
    13,705
    
    
    
    18,059
    
    
    
    27,954
    
    
    
    40,664Cost of revenues:License
    
    
    126
    
    
    
    207
    
    
    
    324
    
    
    
    301Service and other
    
    
    5,912
    
    
    
    5,643
    
    
    
    12,000
    
    
    
    12,658Total cost of revenues
    
    
    6,038
    
    
    
    5,850
    
    
    
    12,324
    
    
    
    12,959Gross profit
    
    
    7,667
    
    
    
    12,209
    
    
    
    15,630
    
    
    
    27,705Operating expenses:Sales and marketing
    
    
    5,790
    
    
    
    10,178
    
    
    
    12,357
    
    
    
    23,198Research and development
    
    
    4,205
    
    
    
    4,414
    
    
    
    8,861
    
    
    
    9,685General and administrative
    
    
    3,577
    
    
    
    3,417
    
    
    
    6,859
    
    
    
    7,316Stock-based compensation
    
    
    302
    
    
    
    126
    
    
    
    343
    
    
    
    279Restructuring charges
    
    
    570
    
    
    
    337
    
    
    
    624
    
    
    
    14,345Total operating expenses
    
    
    14,444
    
    
    
    18,472
    
    
    
    29,044
    
    
    
    54,823Loss from operations
    
    
    (6,777
    )
    
    
    (6,263
    )
    
    
    (13,414
    )
    
    
    (27,118
    )Interest income
    
    
    252
    
    
    
    344
    
    
    
    503
    
    
    
    766Other income (expenses), net
    
    
    36
    
    
    
    118
    
    
    
    (104
    )
    
    
    (99
    )Net loss before income taxes
    
    
    (6,489
    )
    
    
    (5,801
    )
    
    
    (13,015
    )
    
    
    (26,451
    )Provision for income taxes
    
    
    174
    
    
    
    202
    
    
    
    294
    
    
    
    267Net loss
    
    $
    (6,663
    )
    
    $
    (6,003
    )
    
    $
    (13,309
    )
    
    $
    (26,718
    )Basic and diluted net loss per share
    
    $
    (0.20
    )
    
    $
    (0.18
    )
    
    $
    (0.40
    )
    
    $
    (0.82
    )Weighted average shares used in computing basic
and diluted net loss per share
    
    
    32,966
    
    
    
    32,598
    
    
    
    32,891
    
    
    
    32,564
 The accompanying notes are an integral part of these condensed consolidated financial statements. 4




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Vitria Technology, Inc. 
    Six Months EndedJune 30,2004
    
    2003Operating activities:Net loss
    
    $
    (13,309
    )
    
    $
    (26,718
    )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
    
    
    18
    
    
    
    2,371Forgiveness of note receivable
    
    
    74
    
    
    
    Depreciation
    
    
    1,120
    
    
    
    2,756Stock-based compensation
    
    
    343
    
    
    
    279Provision for doubtful accounts
    
    
    41
    
    
    
    Changes in assets & liabilities:Accounts receivable
    
    
    6,269
    
    
    
    4,265Other current assets
    
    
    487
    
    
    
    (61
    )Other assets
    
    
    32
    
    
    
    (38
    )Accounts payable
    
    
    345
    
    
    
    (866
    )Accrued liabilities
    
    
    (468
    )
    
    
    (4,613
    )Accrued restructuring charges
    
    
    (3,105
    )
    
    
    7,174Deferred revenue
    
    
    1,502
    
    
    
    2,564Other long term liabilities
    
    
    (27
    )
    
    
    (716
    )Net cash used in operating activities
    
    
    (6,678
    )
    
    
    (13,303
    )Investing activities:Purchases of property and equipment
    
    
    (138
    )
    
    
    (265
    )Purchases of investments
    
    
    (19,367
    )
    
    
    (59,923
    )Maturities of investments
    
    
    73,885
    
    
    
    52,296Net cash provided by (used in) investing activities
    
    
    54,380
    
    
    
    (7,892
    )Financing activities:Issuance of common stock, net
    
    
    676
    
    
    
    136Net cash provided by financing activities
    
    
    676
    
    
    
    136Effect of exchange rates on changes on cash and cash equivalents
    
    
    (159
    )
    
    
    126Net increase (decrease) in cash and cash equivalents
    
    
    48,219
    
    
    
    (20,933
    )Cash and cash equivalents at beginning of period
    
    
    8,782
    
    
    
    42,427Cash and cash equivalents at end of period
    
    $
    57,001
    
    
    $
    21,494
 The accompanying notes are an integral part of these condensed consolidated financial statements. 5




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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1) Basis of Presentation The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
for interim consolidated financial information and with the instructions for
Form 10-Q and Article 10 of Regulation S-X. In the opinion of the management
of Vitria Technology, Inc., these unaudited condensed consolidated financial
statements include all adjustments, consisting only of normal recurring
adjustments, which we consider necessary to fairly state Vitrias financial
position and the results of its operations and its cash flows. The balance
sheet at December 31, 2003 has been derived from the audited consolidated
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. The accompanying condensed consolidated financial
statements should be read in conjunction with the financial statements and
notes thereto included in Vitrias Annual Report on Form 10-K for the year
ended December 31, 2003. The results of Vitrias operations for any interim
period are not necessarily indicative of the results of the operations for any
other interim period or for a full fiscal year. Stock-based compensation Vitria accounts for stock-based employee compensation arrangements using
the intrinsic value method in accordance with the provisions of Accounting
Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued to
Employees,as amended by FASB Interpretation No. 44, Accounting for Certain
Transactions Involving Stock Compensation, issued by the Financial Accounting
Standards Board, and complies with the disclosure provisions of Statement of
Financial Accounting Standards No. 123 (SFAS 123), Accounting for Stock-Based
Compensationand SFAS No. 148, Accounting for Stock-based Compensation 
Transition and Disclosure. Unearned compensation is amortized and expensed in
accordance with Financial Accounting Standards Board Interpretation No. 28
using the multiple option approach. Under APB 25 and related interpretations, unearned compensation is based
on the difference, on the date of the grant, between the fair value of Vitrias
common stock and the exercise price. Under APB 25, no compensation expense is
recognized in Vitrias financial statements when the exercise price of Vitrias
employee stock options equals the market price of the underlying stock on the
date of grant. Vitria has elected to follow APB 25 because the alternative fair
value accounting provided for under SFAS 123 requires the use of option
valuation models that were not developed for use in valuing employee stock
options. Pro forma information regarding net loss and net loss per share is
required by SFAS 123. This information is required to be determined as if we
had accounted for our employee stock options (including shares issued under our
Employee Stock Purchase Plan, collectively called stock based awards), under
the fair value method of that statement. The fair value of our stock-based awards to employees in the table below
was estimated using the Black-Scholes option-pricing model and the following
weighted-average assumptions: Three months ended,
    
    Six months ended,June 30,
    
    June 30,
    
    June 30,
    
    June 30,
    
    June 30,
    
    June 30,
    
    June 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003
    
    2004
    
    2003
    
    2004
    
    2003Stock option plans
    
    ESPP
    
    Stock option plans
    
    ESPPRisk-free interest rate
    
    
    3.29
    %
    
    
    3.02
    %
    
    
    3.14
    %
    
    
    3.58
    %
    
    
    3.23
    %
    
    
    3.20
    %
    
    
    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
    
    
    123
    %
    
    
    134
    %
    
    
    138
    %
    
    
    144
    %
    
    
    124
    %
    
    
    134
    %
    
    
    138
    %
    
    
    144
    %
 6




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The Black-Scholes option-pricing model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are
fully transferable. Option valuation models require the input of highly
subjective assumptions, including the expected volatility of the stock price.
Because our stock based awards have characteristics significantly different
from those of traded options and because changes in the subjective input
assumptions can materially affect the fair value estimates, in the opinion of
management, the existing models do not necessarily provide a reliable single
measure of the fair value of our stock based awards. The following table illustrates the effect on net loss and loss per share
if we had applied the fair value recognition provisions of SFAS 123 to employee
stock-based compensation, including shares issued under our stock option plans
and Employee Stock Purchase Plan (collectively options). For purposes of pro
forma disclosures, the estimated fair value of the options is assumed to be
amortized to expense over the options vesting periods and the amortization of
deferred compensation, as calculated under the intrinsic value method, has been
added back. Pro forma information follows (in thousands, except per share
amounts): Three months ended,
    
    Six months ended,June 30,
    
    June 30,
    
    June 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net loss, as reported
    
    $
    (6,663
    )
    
    $
    (6,003
    )
    
    $
    (13,309
    )
    
    $
    (26,718
    )Add: stock-based employee compensation expense included
in reported net loss
    
    
    29
    
    
    
    126
    
    
    
    70
    
    
    
    279Deduct: total stock-based compensation expense determined
under the fair value based method for all awards
    
    
    (103
    )
    
    
    (443
    )
    
    
    1,988
    
    
    
    (365
    )Pro forma net loss
    
    $
    (6,531
    )
    
    $
    (5,434
    )
    
    $
    (15,227
    )
    
    $
    (26,074
    )Net loss per share as reported
    
    $
    (0.20
    )
    
    $
    (0.18
    )
    
    $
    (0.40
    )
    
    $
    (0.82
    )Pro forma net loss per share
    
    $
    (0.20
    )
    
    $
    (0.17
    )
    
    $
    (0.46
    )
    
    $
    (0.80
    )Total shares used in calculation
    
    
    32,966
    
    
    
    32,598
    
    
    
    32,891
    
    
    
    32,564
 During
the three months and six months ended June 30, 2004 and the six
months ended June 30, 2003, stock-based compensation
expense determined under the fair value based method resulted in a positive
number in the above table, or a reduction in expense. This is the result of
adjustments to reverse previously recognized stock-based compensation expense
on employee options forfeited prior to the employee earning the award.
Forfeitures refer to awards that do not vest because service or employment
requirements are not met. In accordance with SFAS 123, we based our initial
estimate of stock-based compensation expense on the total number of options
granted. Adjustments are made in the period of forfeiture to reverse
previously recognized stock-based compensation expense associated with the
unearned portion of a forfeited award. 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
    
    Six months endedJune 30,
    
    June 30,
    
    June 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Numerator for basic and diluted net loss per share:Net loss
    
    $
    (6,663
    )
    
    $
    (6,003
    )
    
    $
    (13,309
    )
    
    $
    (26,718
    )Denominator for basic and diluted net loss per
share:Weighted average shares of common stock
outstanding
    
    
    32,967
    
    
    
    32,650
    
    
    
    32,894
    
    
    
    32,628Less shares subject to repurchase
    
    
    (1
    )
    
    
    (52
    )
    
    
    (3
    )
    
    
    (64
    )Denominator for basic and diluted net loss per
share
    
    
    32,966
    
    
    
    32,598
    
    
    
    32,891
    
    
    
    32,564Basic and diluted net loss per share
    
    $
    (0.20
    )
    
    $
    (0.18
    )
    
    $
    (0.40
    )
    
    $
    (0.82
    )
 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
    
    Six months endedJune 30,
    
    June 30,
    
    June 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Weighted average effect of anti-dilutive securities:Employee stock options (using the treasury stock
method)
    
    
    140
    
    
    
    279
    
    
    
    785
    
    
    
    116Common stock subject to repurchase agreements
    
    
    1
    
    
    
    52
    
    
    
    3
    
    
    
    64Total
    
    
    141
    
    
    
    331
    
    
    
    788
    
    
    
    180
 3) Comprehensive Loss 8




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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
    
    Six months endedJune 30,
    
    June 30,
    
    June 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net loss
    
    $
    (6,663
    )
    
    $
    (6,003
    )
    
    $
    (13,309
    )
    
    $
    (26,718
    )Other comprehensive income (loss):Foreign currency translation adjustment
    
    
    (110
    )
    
    
    (75
    )
    
    
    (159
    )
    
    
    126Unrealized loss on securities
    
    
    (54
    )
    
    
    (57
    )
    
    
    (53
    )
    
    
    (72
    )Comprehensive loss
    
    $
    (6,827
    )
    
    $
    (6,135
    )
    
    $
    (13,521
    )
    
    $
    (26,664
    )
 The components of accumulated other comprehensive loss are as follows (in
thousands): June 30,
    
    December 31,2004
    
    2003Foreign currency translation
    
    $
    474
    
    
    $
    633Unrealized gain (loss) on marketable debt
securities
    
    
    (52
    )
    
    
    2Total accumulated other comprehensive gain
    
    $
    422
    
    
    $
    635
  4)
    
    Stock-Based Compensation  Stock-based compensation is broken down as follows (in thousands): Three months ended
    
    Six months endedJune 30,
    
    June 30,
    
    June 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Cost of revenues
    
    $
    73
    
    
    $
    10
    
    
    $
    76
    
    
    $
    22Sales and marketing
    
    
    54
    
    
    
    46
    
    
    
    69
    
    
    
    102Research and development
    
    
    67
    
    
    
    46
    
    
    
    82
    
    
    
    102General and administrative
    
    
    108
    
    
    
    24
    
    
    
    116
    
    
    
    53Total stock-based compensation
    
    $
    302
    
    
    $
    126
    
    
    $
    343
    
    
    $
    279
 5) Restructuring, Impairments and Other Charges In the year ended December 31, 2002 we initiated actions to reduce our
cost structure due to sustained negative economic conditions that have impacted
our operations and resulted in lower than anticipated revenues. In 9




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April and August 2002 we reduced our workforce and consolidated our
facilities. The restructuring actions in 2002 resulted in a reduction in
workforce of approximately 285 employees or 33% of Vitrias workforce measured
as of the beginning of 2002 and affected all departments. Facilities in the
United States and United Kingdom were consolidated and related leasehold
improvement and equipment were written off. As a result of the restructuring
actions, a charge of $19.5 million in the year ended December 31, 2002 was
incurred. The restructuring charge included approximately $4.2 million of
severance related charges and $15.4 million of committed excess facilities
payments, which included $463,000 for the write-off of leasehold improvements
and equipment in vacated buildings. In the year ended December 31, 2003, we initiated actions to further
reduce our cost structure. The restructuring actions in 2003 resulted in a
reduction in workforce of approximately 120 employees or 22% of our workforce
measured as of the beginning of 2003 and affected all departments. The plan
was a combination of a reduction in workforce, consolidations of facilities in
the United States and United Kingdom and the associated disposal of leasehold
improvements and equipment. The severance related charges consist of one-time
termination benefits recognized and measured at fair value at the date the plan
was communicated to the employees. The excess facilities payments were
measured at fair value as of the cease-use date of the facilities using a
discount rate of 6% per annum. The leasehold improvements and equipment
write-offs, which were associated with vacating the excess facilities, were
based on net book value as of the date of abandonment. As a result of the
restructuring actions, a charge of $16.1 million in the year ended December 31,
2003 was incurred. The restructuring charge included approximately $2.9
million of severance related charges and $9.8 million of committed excess
facilities payments, $2.2 million in write-offs of leasehold improvements and
equipment and $1.0 million for changes in sublease income assumptions for
facilities restructured in both 2002 and 2003. In addition we incurred
$180,000 in accretion charges in 2003. In the first quarter of 2004, there were no restructuring charges or
adjustments other than $54,000 in accretion charges related to the fair value
treatment for the facilities we restructured in 2003, in accordance with
Statement of Financial Accounting Standard No. 146 (SFAS 146), Accounting for
Costs Associated with Exit or Disposal Activities. In the second quarter of 2004, we made some adjustments to our sublease
assumptions in light of current market conditions on facilities we restructured
in 2003, resulting in a net charge to restructuring of $516,000. In addition,
we incurred an accretion charge of $54,000 in the second quarter. As of June
30, 2004, $15.7 million related to facility closures remains accrued from all
of our restructuring actions. The facilities consolidation charges for all of our restructuring actions
were calculated using our best estimates and were based upon the remaining
future lease commitments for vacated facilities from the date of facility
consolidation, net of estimated future sublease income. We have engaged
brokers to locate tenants to sublease all of the excess facilities and, to
date, have signed several sublease agreements. The estimated costs of
vacating these leased facilities were based on market information and trend
analyses, including information obtained from third-party real estate sources.
Our ability to generate estimated sublease income is highly dependent upon the
existing economic conditions, particularly lease market conditions in certain
geographies, at the time the sublease arrangements are negotiated with third
parties. While the amount we have accrued is our best estimate, these
estimates are subject to change and may require routine adjustment as
conditions change through the implementation period. If macroeconomic
conditions related to the commercial real estate market continue to worsen, we
may be required to increase our estimated cost to exit certain facilities. The total accrued liability for lease termination costs of $15.7 million
at June 30, 2004 is net of $4.6 million of estimated sublease income. The
portion of this liability related to restructuring actions taken in 2003 is
discounted at fair value as required by SFAS 146, which was adopted by us in
2003, and is included in the table below: 10




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Facilitiesconsolidation
    
    Severance
    
    TotalFiscal 2002 restructuring
    
    $
    15,358
    
    
    $
    4,158
    
    
    $
    19,516Cash payments
    
    
    (2,592
    )
    
    
    (4,014
    )
    
    
    (6,606
    )Fixed asset writeoffs
    
    
    (463
    )
    
    
    
    
    
    
    (463
    )Reclassification of deferred rent
    
    
    747
    
    
    
    
    
    
    
    747Balance at December 31, 2002
    
    
    13,050
    
    
    
    144
    
    
    
    13,194Fiscal 2003 restructuring
    
    
    12,077
    
    
    
    2,477
    
    
    
    14,554Cash payments
    
    
    (5,627
    )
    
    
    (2,621
    )
    
    
    (8,248
    )Fixed asset writeoffs
    
    
    (2,247
    )
    
    
    
    
    
    
    (2,247
    )Facility adjustments and accretion
    
    
    1,229
    
    
    
    
    
    
    
    1,229Severance
    
    
    
    
    
    
    330
    
    
    
    330Balance at December 31, 2003
    
    
    18,482
    
    
    
    330
    
    
    
    18,812Cash payments
    
    
    (3,400
    )
    
    
    (330
    )
    
    
    (3,730
    )Facility adjustments and accretion
    
    
    624
    
    
    
    
    
    
    
    624Balance at June 30, 2004
    
    $
    15,706
    
    
    $
    
    
    
    $
    15,706
 At June 30, 2004, $5.8 million related to the restructuring activities
remained in current liabilities and $9.9 million remained in long-term
liabilities. Future lease payments for restructured facilities (which
for the 2003 restructuring actions are discounted at
fair value under FAS 146 and net of estimated future sublease income) totaling
$15.7 million will be made through 2013. 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 executed a development agreement
pursuant to which QilinSoft will perform development work and other fee-bearing
services for Vitria. During the first quarter of 2004, QilinSoft paid Vitria royalty license
fees of $100,000. During the second quarter of 2004 Vitria paid QilinSoft
$174,000 for development work performed in the first quarter of 2004. At June
30, 2004, Vitria owed QilinSoft $127,000 for development work performed in the
second quarter of 2004. At June 30, 2004 QilinSoft owed Vitria $5,700 for
professional services performed by Vitria in the second quarter of 2004. 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 a
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 June 30, 3004, we had not borrowed against this line of
credit. In connection with the line of credit agreement, we have
outstanding letters of credit of approximately $8.8 million
related to certain office leases at June 30, 2004. 8) Reverse Stock Split On
May 19, 2003, our Board of Directors approved a one-for-four reverse split of our common stock.
The reverse split was approved by Vitria stockholders on May 16,
2003 and implemented on May 27, 2003. Each four shares of our outstanding common stock
automatically converted into one share of common stock. 11




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##### Table of Contents



ITEM 2: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS The information in this discussion contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934 which are subject to the safe harbor
created by those sections. These forward-looking statements are generally
identified by words such as expect, anticipate, intend, plan,
believe, hope, assume, estimate and other similar words and
expressions. These forward-looking statements involve risks and uncertainties
that could cause our actual results to differ materially from those in the
forward-looking statements, including, without limitation, the risks outlined
under Business Risks in this quarterly report on Form 10-Q. These business
risks should be considered in evaluating our prospects and future financial
performance. Although we believe that the expectations reflected in the
forward-looking statements are reasonable, we cannot guarantee future results,
levels of activity, performance or achievements. Overview Vitria is a leading provider of business process integration software and
services for corporations in healthcare, telecommunications, finance,
manufacturing and other markets. Our software automates business processes
across multiple existing systems, people and trading partners in order to
reduce operating costs, enhance revenues and improve customer service. To
accomplish this, we develop and deliver the Vitria:BusinessWare® business
process integration software platform together with packaged applications and
best practices content. These applications and content are designed to quickly
and effectively solve industry-specific business problems such as healthcare
claims lifecycle management, straight-through processing in capital markets,
and order management for telecommunications and manufacturing. Our flagship Vitria:BusinessWare integration platform uses graphically
modeled business process logic as the foundation for orchestrating complex
interactions between dissimilar software applications, Web services,
individuals, and trading partners over corporate networks and the Internet. By
automating and measuring previously fragmented business processes from start to
finish, our products and services are designed to:  
    
    Reduce personnel costs, improve customer service, and
speed time-to-revenue capture by automating manual processes
between systems, people and partners;
    
    Enhance visibility into business operations by measuring
business performance as it crosses different systems, departments,
customers and partners;
    
    Enforce industry and company-specific best practices and
government regulatory requirements with automated business logic,
rules and workflows, and
    
    Ensure greater consistency, accuracy and accessibility of
corporate-wide data on customers and products. We derive revenues primarily from two sources: licenses, and services and
other. Our products are typically licensed directly to customers for a
perpetual term, with pricing based on the number of copies licensed, or systems
or applications managed. Service and other revenues include product
maintenance, consulting and training. Customers who license Vitria:BusinessWare
normally purchase maintenance contracts. These contracts provide unspecified
software upgrades and technical support over a specified term, which is
typically twelve months. A majority of our customers use third-party system
integrators to implement our products. Customers typically purchase additional
consulting services from us to support their implementation activities. We also
offer training classes for our customers and system integrators. We market our
products through our direct sales force and augment our marketing efforts
through relationships with system integrators and technology vendors. A
majority of our revenues to date have been 12




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derived from accounts in the United
States. We have international sales offices in Australia, 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. 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, platform and in conjunction
with services to deliver business process integration solutions that preserve
and extend a companys existing technology investments, Vitrias applications
are designed to provide real-time visibility and streamlined control over
processes and data to reduce costs, increase revenues, improve customer
experience, and ensure regulatory compliance. Vitria has developed years of intellectual property around automating
industry-specific business processes in our target markets that can be either
pre-packaged in software applications that run on the Vitria:BusinessWare
platform, or used by Vitrias client services teams to more rapidly
implement and configure applications. This focus on business processes allows
Vitria to concentrate our product development and marketing efforts on
demonstrating the measurable business value of process integration to business
executives, in addition to demonstrating the technical value of our platform to
information technology professionals. Examples of Vitrias packaged
applications include: 13




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
    
    Vitria:SmartClaims: a packaged application designed to improve
a healthcare payers automation of claims processing.
Vitria:SmartClaims augments a payers legacy claims processing
systems with automated business rules, processes and human workflows
to prevent, automatically resolve, and expedite the resolution of
issues that prevent full automation of each claims payment decision.
Vitria:SmartClaims improves business agility by empowering business
users to quickly and directly automate new policies with intuitive
business rules.
    
    Vitria:OrderAccelerator: a packaged software application that
automates business processes across a telecommunications service
providers existing systems for more cost-efficient and accurate
order management. Vitria:OrderAccelerator includes pre-built
business processes and content based on the Telemanagement Forums
eTOM (Enhanced Telecom Operations Map) as well as best practices
Vitria has incorporated from successful implementations with its
telecom customers.
    
    Vitria:SmartResponse: a packaged application designed to reduce
healthcare insurers medical management administrative costs by
automating the processes and decision logic by which physicians and
hospitals submit requests for medical service authorizations and
referrals, and by which insurers receive, decide and respond to those
requests.
    
    CleanOrder: a package of pre-built 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, powered by Vitria: a package of pre-built content
co-designed and co-marketed with Accenture to enable efficient,
end-to-end transaction processing automation for broker/dealers,
asset managers and custodians in order to reduce exception processing
costs, reduce trade correction costs, and manage operational risks in
real time.
    
    SWIFT Management: a package of pre-built 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 cut operational costs and optimize
operations. Vitrias BusinessWare Platform Vitria:BusinessWare unifies the five elements that we believe are
essential for business process integration software, all in a single platform:  (1)
    
    Business Process Management, or BPM: BPM manages the steps of a
cross-functional business process to ensure optimal completion of the
process (e.g., from submission of a healthcare claim by a care
provider to the remittance of payment by an insurer). It uses
graphical business process models together with automated human
workflows to define, automate and orchestrate transactions and the
exchange of information between internal business applications,
people and external trading partners.(2)
    
    Business Analysis and Monitoring, or BAM: BAM provides both
historic and real-time monitoring and analysis of business processes,
providing greater visibility and business intelligence needed to
optimize operational efficiency. Our two key BAM components, Cockpit
and Analyzer, are designed to continuously gather business process
data across applications, human workflows and trading partner
interactions; analyze and visualize this data in real time; and
enable business executives and 14




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process owners to identify and respond
to both business and integration problems or opportunities as they
occur.(3)
    
    Business Vocabulary Management, or BVM: BVM is comprised of
content and tools that enable the flexible, scalable management of
translations between industry-specific and application-specific data
formats and meanings (vocabularies) as represented in electronic
transactions between businesses (e.g. via Electronic Data
Interchange, or EDI, or eXtensible Markup Language, or XML), and
between a companys internal applications. BVM uses automated
exception handling, business rules-based validation and advanced data
transformation designed to ensure that differences in how data is
represented does not interfere with successful completion of a
business transaction (e.g. fulfilling a customers order, processing
a healthcare claim, or settling a financial transaction). To address
the specific needs of each industry, BVM provides packaged
vocabularies for various industries based on the specific business
terms used within those industries.(4)
    
    Business-to-Business Integration, or B2B: B2B enables the
secure and reliable completion of transactions and the exchange of
business information between customers and partners over the Internet
to support collaborative business processes. Combined with BPM and
BAM, B2B helps companies manage their value chain interactions from
end to end as an integrated part of their larger business processes.(5)
    
    Enterprise Application Integration, or EAI: EAI enables the
secure and reliable movement of 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 15




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that are believed to be reasonable under the circumstances, the results of
which form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or
conditions. We believe the following critical accounting policies affect the more
significant judgments and estimates used in the preparation of our consolidated
financial statements. Revenue Recognition We derive revenues from software licenses to end users for
Vitria:BusinessWare and other products and related services, which include
maintenance and support, consulting and training services. In accordance with
the provisions of Statement of Position 97-2, Software Revenue Recognition, as
amended, we record revenue from software licenses when a license agreement is
signed by both parties, the fee is fixed or determinable, collection of the fee
is probable and delivery of the product has occurred. For electronic delivery,
the product is considered to have been delivered when the access code to
download the software from the Internet has been provided to the customer. If
an element of the agreement has not been delivered, revenue for the element is
deferred based on vendor-specific objective evidence of fair value. If
vendor-specific objective evidence of fair value does not exist for the
undelivered element, all revenue is deferred until sufficient objective
evidence exists or all elements have been delivered. We 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 third-party systems integrators, is not recognized until
evidence of a sell-through arrangement to an end user has been received. Service and other revenues include product maintenance, consulting, and
training. Customers who license Vitria:BusinessWare normally purchase
maintenance contracts. These contracts provide unspecified software upgrades
and technical support over a specified term, which is typically twelve months.
Maintenance contracts are usually paid in advance, and revenues from these
contracts are recognized ratably over the term of the contract. A majority of
our customers use third-party system integrators to implement our products.
Customers typically purchase additional consulting services from us to support
their implementation activities. These consulting services are generally sold
on a time and materials basis and recognized as the services are performed. We
also offer training services which are sold on a per student or per class basis
and recognized as the classes are attended. Payments received in advance of revenue recognition are recorded as
deferred revenue. When the software license arrangement requires us to provide
consulting services for significant production, customization or modification
of the software, or when the customer considers these services essential to the
functionality of the software product, both the product license revenue and
consulting services revenue are recognized in accordance with the
provisions of
Statement of Position 81-1, Accounting for Performance of Construction Type and
Certain Production Type Contracts.We recognize revenue from these
arrangements using the percentage of completion method based on cost inputs
and, therefore, both product license and consulting services revenue are
recognized as
work progresses. These arrangements have not been common and, therefore,
the significant majority of our license revenue in the past three years has
been recognized under SOP 97-2, as amended. Allowance for Doubtful Accounts We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers to deliver required payments to
us. When we believe a collectibility issue exists with respect to a specific 16




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receivable, we record an allowance to reduce that receivable to the amount that
we believe is collectible. In addition, we record an allowance on the
remainder of our receivables that are still in good standing based on our past
write off experience. If the financial condition of our customers were to
deteriorate in the future, resulting in an impairment of their ability to make
payments, additional allowances may be required. Restructuring Charges We recorded $19.5 million in restructuring charges related to the
realignment of our business operations in 2002. During 2003, we recorded an
additional $16.1 million of restructuring charges related to the realignment of
our business operations. In the first six months of 2004 we incurred charges
of $516,000 related to changes in our sublease assumptions on facilities we
restructured and accretion charges of $108,000 related to the fair value
treatment for the facilities we restructured in 2003, in accordance with SFAS
146. As of June 30, 2004, we have $15.7 million in accrued restructuring
expenses, consisting entirely of future lease payments net of estimated
sublease income which will be paid out through 2013. Only costs resulting from a restructuring plan that are not associated
with, or that do not benefit activities that will be continued, are eligible
for recognition as liabilities at the commitment date. These charges represent
expenses incurred in connection with certain cost reduction programs that we
have undertaken, and consist primarily of the cost of involuntary termination
benefits and remaining contractual lease payments and other costs associated
with closed facilities net of anticipated sublease income. Information
regarding sublease income estimates for the amount of sublease income we are
likely to receive and the timing of finding a tenant has been obtained from
third party experts and are based on prevailing market rates. The charges for facility closure costs require the extensive use of
estimates, including estimates and assumptions related to future maintenance
costs, our ability to secure sub-tenants and anticipated sublease income to be
received in the future. If we fail to make accurate estimates or to complete
planned activities in a timely manner, we might record additional charges or
reverse previous charges in the future. Such additional charges or reversals
will be recorded to the restructuring charges line in our statement of
operations in the period in which additional information becomes available to
indicate our estimates should be adjusted. Since April 2002, we have revised
our sublease income estimates at least semi-annually due to significant
downward trends in the real estate markets in the United States and in the
United Kingdom. RESULTS OF OPERATIONS
For the three and six months ended June 30, 2004 and June 30, 2003 17




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The following table sets forth the results of operations for the three and
six months ended June 30, 2004 and 2003, expressed as a percentage of total
revenues. Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003RevenuesLicense
    
    
    14
    %
    
    
    23
    %
    
    
    19
    %
    
    
    36
    %Service and other
    
    
    86
    %
    
    
    77
    %
    
    
    81
    %
    
    
    64
    %Total revenues
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %Cost of revenuesLicense
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %Service and other
    
    
    43
    %
    
    
    31
    %
    
    
    43
    %
    
    
    31
    %Total cost of revenues
    
    
    44
    %
    
    
    32
    %
    
    
    44
    %
    
    
    32
    %Gross profit
    
    
    56
    %
    
    
    68
    %
    
    
    56
    %
    
    
    68
    %Operating expensesSales and marketing
    
    
    42
    %
    
    
    56
    %
    
    
    44
    %
    
    
    57
    %Research and development
    
    
    31
    %
    
    
    24
    %
    
    
    32
    %
    
    
    24
    %General and administrative
    
    
    26
    %
    
    
    19
    %
    
    
    25
    %
    
    
    18
    %Amortization of stock-based compensation
    
    
    2
    %
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %Restructuring charges
    
    
    4
    %
    
    
    2
    %
    
    
    2
    %
    
    
    35
    %Total operating expenses
    
    
    105
    %
    
    
    102
    %
    
    
    104
    %
    
    
    135
    %Loss from operations
    
    
    (49
    %)
    
    
    (34
    %)
    
    
    (48
    %)
    
    
    (67
    %)Interest income
    
    
    2
    %
    
    
    2
    %
    
    
    2
    %
    
    
    2
    %Other income (expenses), net
    
    
    0
    %
    
    
    1
    %
    
    
    0
    %
    
    
    
    %Net loss before income taxes
    
    
    (47
    %)
    
    
    (31
    %)
    
    
    (46
    %)
    
    
    (65
    %)Provision for income taxes
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %Net loss
    
    
    (48
    %)
    
    
    (32
    %)
    
    
    (47
    %)
    
    
    (66
    %)
 Revenues We recognized approximately 45% of our revenues from customers outside the
United States in the three months ended June 30, 2004 and 44% of our revenues
from customers outside the United States in the six months ended June 30, 2004,
compared to 43% in the three months ended June 30, 2003 and 33% in the six
months ended June 30, 2003. To date, we have not experienced significant
seasonality of revenue. We expect that future results may be affected by the
fiscal or quarterly budget cycles of our customers. 18




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Sales to ten customers accounted for 35% of total revenues in the three
months ended June 30, 2004 and 33% of total revenues in the six months ended
June 30, 2004. Sales to ten customers accounted for 35% of total revenues in
the three months ended June 30, 2003 and 37% of total revenues in the six
months ended June 30, 2003. No single customer accounted for more than 10% of
total revenues in the three and six months ended June 30, 2004. No customer
accounted for more than 10% of total revenues in the three months ended June
30, 2003 and one customer accounted for 11% of total revenues in the six months
ended June 30, 2003. We expect that revenues from a limited number of
customers will continue to account for a large percentage of total revenues in
future quarters. Therefore, the loss or delay of individual orders could have
a significant impact on revenues. Our ability to attract new customers will
depend on a variety of factors, including the reliability, security,
scalability and the overall cost-effectiveness of our products. License.License revenues decreased 55% from $4.2 million in the three
months ended June 30, 2003 to $1.9 million in the three months ended June 30,
2004. License revenues decreased 64% from $14.7 million in the six months
ended June 30, 2003 to $5.3 million in the six months ended June 30, 2004.
These decreases were due to fewer total orders and a decrease in our average
deal size. The decrease in our average deal size was due to downward pricing
pressure on our base Vitria:Businessware software offering. The maturation of
the market in which we compete has resulted in fewer total orders as
competition has increased for a smaller pool of potential buyers. The general
slowdown in information technology spending in our target markets due to slow
U.S. economic growth has made it more difficult for us to grow our revenues. Service and other.The level of service revenue is impacted by the number
and size of license deals in a given period. Support for the first year is
purchased as part of each license deal. Most of our consulting project revenue
and customer training revenue is also affected by the size and number of
license deals. Service and other revenue also includes support renewals, which
is dependent upon our installed license base. Service and other revenues
decreased 15% from $13.9 million in the three months ended June 30, 2003 to
$11.8 million in the three months ended June 30, 2004. Service and other
revenues decreased 12% from $25.9 million in the six months ended June 30, 2003
to $22.7 million in the six months ended June 30, 2004. Consulting revenue
decreased between 2003 and 2004 due to both a decline in the number
and scope of consulting projects and to the deferral of approximately
$1.2 million in consulting revenue at June 30, 2004 due to
the need to obtain final signoff on a consulting project. Payment
from the customer for work done on this project had been received as
of June 30, 2004. First year support
decreased slightly in both periods, related to our decrease in license revenue.
This decrease in first year support was partially offset by an increase in support renewals from
customers who had purchased our products in previous years. Cost of Revenues License.Cost of license revenues consists of royalty payments to third
parties for technology incorporated into our products. Fluctuations in cost of
license is generally due to the buying patterns of our customers, as cost of
license revenues is dependent upon which products our customers purchase, and
which of those purchased products have third-party technology incorporated into
them. Cost of license revenues decreased 39% from $207,000 in the three months
ended June 30, 2003 to $126,000 in the three months ended June 30, 2004.
Cost of license revenues increased 8% from $301,000 in the six months ended
June 30, 2003 to $324,000 in the six months ended June 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 5% from $5.6 million in
the three months ended June 30, 2003 to $5.9 million in the three months ended
June 30, 2004. This minor increase was primarily due to a $259,000 increase in
external consulting expense. Cost of service and other revenues decreased 5%
from $12.7 million in the six months ended June 30, 2003 to $12.0 million in
the six months ended June 30, 2004. This decrease was primarily due to reduced
facilities costs of $474,000 as a result of our restructuring in the first
quarter of 2003, reduced salary and benefit 19




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expense of $381,000 for lower headcount, reduced travel expense of
$366,000 as a result of lower professional services revenue, offset by an
increase of $281,000 in external consulting expense. For the next quarter,
we expect that cost of revenues will remain flat compared to the quarter ended
June 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 43% from $10.2 million in the
three months ended June 30, 2003 to $5.8 million in the three months ended June
30, 2004. This decrease was primarily due to decreases in salary and benefit
expenses of $2.1 million, reduced travel expenses of $276,000, lower commission
expense of $743,000 due to lower revenues, 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 $23.2 million in the six months ended
June 30, 2003 to $12.4 million in the six months ended June 30, 2004. This
decrease was primarily due to lower salary and benefit expenses of $4.9
million, reduced travel expenses of $889,000, lower external consulting expense
of $793,000 due to cost containment efforts, lower commission expense of $1.4
million due to lower revenues, as well as related decreases in most other
expense areas as a result of our continuous cost containment efforts. For the
next quarter, we expect that sales and marketing expenses will remain flat
compared to the quarter ended June 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
decreased 5% from $4.4 million in the three months ended June 30, 2003 to $4.2
million in the three months ended June 30, 2004. This minor decrease of
$200,000 is primarily due to reduced facilities costs and depreciation expense
as a result our cost containment efforts. Research and development expenses
decreased 9% from $9.7 million in the six months ended June 30, 2003 to $8.9
million in the six months ended June 30, 2004. This decrease was primarily due
to reduced facilities costs of $431,000 as a result of our restructuring in the
first quarter of 2003, and lower depreciation expense of $575,000 as more of
our fixed assets have become fully depreciated and no significant purchases of
fixed assets have been made in 2004 due to our cost
containment efforts. For the next quarter, we expect that research and
development expenses will remain flat compared to the quarter ended June 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 increased 5% from $3.4 million
in the three months ended June 30, 2003 to $3.6 million in the three months
ended June 30, 2004. This minor increase was primarily attributable to an
increase of $672,000 in salaries and benefits expenses primarily for
compensation paid to certain executive officers who left Vitria in quarter
ended June 30, 2004, offset by a $186,000 decrease in equipment related
expenses and a $203,000 decrease in insurance and tax expense, as well as
related decreases in most other expense areas as a result of our cost
containment efforts. General and administrative expenses decreased 6% from
$7.3 million in the six months ended June 30, 2003 to $6.9 million in the six
months ended June 30, 2004. This decrease was primarily attributable to lower
equipment and related expenses of $255,000 and lower insurance and tax expenses
of $489,000 as a result of our cost containment efforts, reduced
facilities costs of $240,000 as a result of our restructuring in the first
quarter of 2003, offset by an increase in salaries and benefits expenses of
$483,000 for compensation paid to certain executive officers who left Vitria in
the quarter ended June 30, 2004. For the next quarter, we expect that general
and administrative expenses will decrease slightly compared to the quarter
ended June 30, 2004. Stock-based compensation.Total stock-based compensation expenses were
$302,000 for the three months ended June 30, 2004 and $126,000 for the three
months ended June 30, 2003. Total stock-based compensation expenses were
$343,000 for the six months ended June 30, 2004 and $279,000 for the six months
ended June 30, 20




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2003. Stock-based compensation includes the amortization of unearned
employee stock-based compensation on options issued to employees prior to
Vitria completing its initial public offering in September 1999 and is being
amortized over a five-year vesting period. We expect to recognize employee
stock-based compensation expenses of approximately $10,000 for the remaining
six months of 2004 for the amortization of these options. This unearned
compensation expense will be reduced in future periods to the extent that
options are terminated prior to vesting. In the quarter ended June 30, 2004,
we recorded $29,000 for amortization of unearned employee stock-based
compensation, $206,000 in non-cash stock-based compensation expense for stock
grants issued to our employees and $67,000 in non-cash stock-based compensation
expense as a result of vesting modifications made to option grants for certain
executive officers who left Vitria during the quarter ended June 30, 2004. Restructuring charges.In the year ended December 31, 2002 Vitria
initiated actions to reduce our cost structure due to sustained negative
economic conditions that have impacted our operations and resulted in lower
than anticipated revenues. In April and August 2002 we reduced our workforce
and consolidated our facilities. The restructuring actions in 2002 resulted
in a reduction in workforce of approximately 285 employees or 33% of Vitrias
workforce measured as of the beginning of 2002 and affected all departments.
Facilities in the United States and United Kingdom were consolidated and
related leasehold improvement and equipment were written off. As a result of
the restructuring actions, a charge of $19.5 million in the year ended December
31, 2002 was incurred. The restructuring charge included approximately $4.2
million of severance related charges and $15.4 million of committed excess
facilities payments, which included $463,000 for the write-off of leasehold
improvements and equipment in vacated buildings. In the year ended December 31, 2003, we initiated actions to further
reduce our cost structure. The restructuring actions in 2003 resulted in a
reduction in workforce of approximately 120 employees or 22% of our workforce
measured as of the beginning of 2003 and affected all departments. The plan
was a combination of a reduction in workforce, consolidations of facilities in
the United States and United Kingdom and the associated disposal of leasehold
improvements and equipment. The severance related charges consist of one-time
termination benefits recognized and measured at fair value at the date the plan
was communicated to the employees. The excess facilities payments were
measured at fair value as of the cease-use date of the facilities using a
discount rate of 6% per annum. The leasehold improvements and equipment
write-offs, which were associated with vacating the excess facilities, were
based on net book value as of the date of abandonment. As a result of the
restructuring actions, a charge of $16.1 million in the year ended December 31,
2003 was incurred. The restructuring charge included approximately $2.9
million of severance related charges and $9.8 million of committed excess
facilities payments, $2.2 million in write-offs of leasehold improvements and
equipment and $1.0 million for changes in sublease income assumptions for
facilities restructured in both 2002 and 2003. In addition we incurred
$180,000 in 2003 in accretion charges related to the facilities we
restructured in 2003. In the first quarter of 2004, there were no restructuring charges or
adjustments other than $54,000 in accretion charges related to the fair value
treatment for the facilities we restructured in 2003, in accordance with
Statement of Financial Accounting Standard No. 146 (SFAS 146), Accounting for
Costs Associated with Exit or Disposal Activities. In the second quarter of 2004, we made some adjustments to our sublease
assumptions in light of current market conditions for facilities we restructured
in 2003, resulting in a net charge to restructuring charges of $516,000. In addition,
we incurred accretion charge of $54,000 in the second quarter. As of June 30,
2004, $15.7 million related to facility closures remains accrued from all of
our restructuring actions. The total accrued liability for lease termination costs of $15.7 million
at June 30, 2004 is net of $4.6 million of estimated sublease income. A
portion of this liability, a discounted amount of the total estimated
cash payments, is based on the fair value treatment required by SFAS
146, which we adopted as of January 31, 2003. 21




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The facilities consolidation charges for all of our restructuring actions
were calculated using our best estimates and were based upon the remaining
future lease commitments for vacated facilities from the date of facility
consolidation, net of estimated future sublease income. We have engaged
brokers to locate tenants to sublease all of the excess facilities and, to
date, have signed several sublease agreements. The estimated costs of
vacating these leased facilities were based on market information and trend
analyses, including information obtained from third-party real estate sources.
Our ability to generate estimated sublease income is highly dependent upon the
existing economic conditions, particularly lease market conditions in certain
geographies, at the time the sublease arrangements are negotiated with third
parties. While the amount we have accrued is our best estimate, these
estimates are subject to change and may require routine adjustment as
conditions change through the implementation period. If macroeconomic
conditions related to the commercial real estate market continue to worsen, we
may be required to increase our estimated cost to exit certain facilities. Interest income and other income (expense), net.Interest and other
income (expense), net, decreased 38%, from $462,000 in the three months ended
June 30, 2003 to $288,000 in the three months ended June 30, 2004. The
decrease is primarily attributable to lower interest income due to lower cash
and investment balances, as well as a decrease in foreign currency exchange
gain. Interest and other income (expense), net, decreased 40%, from $667,000
in the six months ended June 30, 2003 to $399,000 in the six months ended June
30, 2004. The decrease is primarily attributable to lower interest income due
to lower cash and investment balances. Provision for income taxes We recorded an income tax provision of $174,000 and $294,000 for the
three-month and six-month periods ended June 30, 2004. We recorded an income
tax provision of $202,000 and $267,000 for the three-month and six-month
periods ended June 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. Liquidity and Capital Resources Six Months EndedJune 30,Percent2004
    
    2003
    
    Change(in thousands)Net cash used in operating activities
    
    $
    (6,678
    )
    
    $
    (13,303
    )
    
    
    (50
    %)Net cash provided by (used in) investing activities
    
    
    54,380
    
    
    
    (7,892
    )
    
    
    789
    %Net cash provided by financing activities
    
    
    676
    
    
    
    136
    
    
    
    397
    %
 As of June 30, 2004, we had approximately $85.2 million of cash, cash
equivalents and short term investments, $30.4 million in short term liabilities
and $10.0 million in long term liabilities. Net cash used in operating activities decreased $6.6 million, or 50%, in
the six months ended June 30, 2004 compared to the six months ended June 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 accrued restructuring 22




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liability. We continue to pay out cash
for facilities we restructured in 2002 and 2003. In the first six months of
2004, our cash payments for restructured facility leases totaled $3.4 million. Net cash provided by investing activities increased $62.3 million in the six months ended June 30, 2004 compared to the six months ended
June 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 $540,000 in
the six months ended June 30, 2004 as compared to the six months ended June 30,
2003. Net cash provided by financing activities in both the current and prior
periods was primarily from the issuance of common stock. During the six months ended June 30, 2004, our net accounts receivable
balance decreased $6.3 million from $15.5 million at December 31, 2003 to $9.2
million at June 30, 2004. The reason for the decrease was that cash was
collected on most of the invoices that were due. An additional contributing
factor for the decline in the receivable balance was the decrease in revenues
during the first six months of 2004 as compared to prior periods. At June 30,
2004, our gross accounts receivable balance is $9.7 million with an allowance
for doubtful accounts of $571,000. During the six months ended June 30, 2004, our deferred revenue balance
increased $1.5 million from $13.9 million at December 31, 2003 to $15.4 million
at June 30, 2004. The primary reasons for this increase in deferred revenue
are an increase of $2.0 million in deferred renewals and a $1.2 million increase
in deferred professional services revenue due to the need to obtain final
sign off on a consulting project. This increase is offset by a
$1.0 million decrease in deferred first-year support revenue, which is due to
the decrease in license revenue over the prior period. Contractual Cash Obligations and Commitments At June 30, 2004, we had contractual obligations and commercial
commitments of approximately $22.8 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
    
    $
    121
    
    
    $
    94
    
    
    $
    27
    
    
    $
    
    
    
    $
    Operating Lease Obligations
    
    
    22,339
    
    
    
    3,772
    
    
    
    10,744
    
    
    
    3,697
    
    
    
    4,126Purchase Obligations
    
    
    306
    
    
    
    306
    
    
    
    
    
    
    
    
    
    
    
    Long-term Sublease Deposits
    
    
    77
    
    
    
    
    
    
    
    21
    
    
    
    56
    
    
    
    Total
    
    $
    22,843
    
    
    $
    4,172
    
    
    $
    10,792
    
    
    $
    3,753
    
    
    $
    4,126
 Operating lease commitments shown above, which are net of contractual
sublease agreements, include $17.8 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 June 30, 2004.
This $17.8 million 23




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undiscounted lease commitment is net of $2.5 million in
contractual sublease income. We do not have any material commercial
commitments under lines of credit, standby lines of credit, standby repurchase
obligations or other such arrangements, except as disclosed below in the
section entitled Credit Facilities with Silicon Valley Bank. Off-Balance Sheet Arrangements At June 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 our this agreement on June 11, 2004 and reduced the
line of credit with from $15.0 million to $12.0 million. The modification
requires us to maintain a 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 June 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 $8.8 million related to certain
office leases at June 30, 2004. Operating Capital and Capital Expenditure Requirements Estimated future uses of cash over the next twelve months are primarily to
fund operations and to a lesser extent to fund capital expenditures. For the
next twelve months, we expect to fund these uses from available cash balances,
cash generated from operations, if any, and interest on available cash and
investment balances. Our ability to generate cash from operations is dependent
upon our ability to sell our products and services and generate revenue, 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 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. 24




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We believe our success requires expanding our customer base and continuing
to enhance our Vitria:BusinessWare products. Our revenues, operating results
and cash flows depend upon the volume and timing of customer orders and
payments and the date of product delivery. Historically, a substantial portion
of revenues in a given quarter have been recorded in the third month of that
quarter, with a concentration of these revenues in the last two weeks of the
third month. We expect this trend to continue and, therefore, any failure or
delay in the closing of orders would have a material adverse effect on our
quarterly operating results and cash flows. Since our operating expenses are
based on anticipated revenues and because a high percentage of these expenses
are relatively fixed, a delay in the recognition of revenue from one or more
license transactions could cause significant variations in operating results
from quarter to quarter and cause unexpected results. Revenues from contracts
that do not meet our revenue recognition policy requirements for which we have
been paid or have a valid receivable are recorded as deferred revenues. While a
portion of our revenues each quarter is recognized from deferred revenue, our
quarterly performance will depend primarily upon entering into new contracts to
generate revenues for that quarter. New contracts may not result in revenue
during the quarter in which the contract was signed, and we may not be able to
predict accurately when revenues from these contracts will be recognized. Our
future operating results and cash flows will depend on many factors, including
the following:  
    
    size and timing of customer orders and product and service delivery;
    
    level of demand for our professional services;
    
    changes in the mix of our products and services;
    
    ability to protect our intellectual property;
    
    actions taken by our competitors, including new product introductions and pricing changes;
    
    costs of maintaining our operations;
    
    introduction of new products;
    
    timing of our development and release of new and enhanced products;
    
    costs and timing of hiring qualified personnel;
    
    success in maintaining and enhancing existing relationships and
developing new relationships with system integrators;
    
    technological changes in our markets, including changes in
standards for computer and networking software and hardware;
    
    deferrals of customer orders in anticipation of product
enhancements or new products;
    
    delays in our ability to recognize revenue as a result of the
decision by our customers to postpone software delivery, or because
of changes in the timing of when delivery of products or services is
completed;
    
    customer budget cycles and changes in these budget cycles;
    
    external economic conditions;
    
    availability of customer funds for software purchases given external economic factors; 25




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
    
    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. 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 first quarter of 2004, QilinSoft paid Vitria
royalty license fees of $100,000. During the second quarter of 2004, Vitria
paid QilinSoft $174,000 for development work performed in the first quarter of
2004. At June 30, 2004, Vitria owed QilinSoft $127,000 for development work
performed in the second quarter of 2004. At June 30, 2004 QilinSoft owed
Vitria $5,700 for professional services performed by Vitria in the second
quarter of 2004. 26




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The following discussion about our risk management activities includes
forward-looking statements that involve risks and uncertainties. Actual
results could differ materially from those projected in the forward-looking
statements for the reasons described under the caption Risks Associated with
Vitrias Business and Future Operating Results. Interest Rate Risk Our exposure to market risk for changes in interest rates relates to our
investment portfolio, which consists of short-term money market instruments and
debt securities with maturities between 90 days and one year. We do not use
derivative financial instruments in our investment portfolio. We place our
investments with high credit quality issuers and, by policy, we limit the
amount of credit exposure to any one issuer. We mitigate default risk by investing in high credit quality securities
and by monitoring the credit rating of investment issuers. The portfolio
includes only marketable securities with active secondary or resale markets to
ensure portfolio liquidity. These securities are generally classified as
available for sale, and consequently, are recorded on the balance sheet at fair
value with unrealized gains or losses reported, as a separate component of
stockholders equity, net of tax. Unrealized gains and losses at June 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 June
30, 2004. Table of investment securities (in thousands) as of June 30: 2004
    
    
    
    
    
    2003Weighted Average
    
    
    
    
    
    Weighted AverageFair Value
    
    Interest Rate
    
    Fair Value
    
    Interest RateCash and cash equivalents
    
    $
    57,001
    
    
    
    0.35
    %
    
    $
    21,494
    
    
    
    1.06
    %Short-term investments
    
    
    28,182
    
    
    
    1.31
    %
    
    
    82,991
    
    
    
    1.60
    %Total cash and investment securities
    
    $
    85,183
    
    
    
    
    
    
    $
    104,485
 Foreign Exchange Risk As a global concern, we face exposure to adverse movements in foreign
currency exchange rates. These exposures may change over time as business
practices evolve and could have a material adverse impact on our financial
position and results of operations. Historically, our primary exposures have
related to non-U.S. dollar-denominated currencies, customer receivables, and
inter-company receivables or payables with our foreign subsidiaries.
Additionally, we provide funding to our foreign subsidiaries in Europe, Asia
Pacific and Latin America. In order to reduce the effect of foreign currency fluctuations, from time
to time, we utilize foreign currency forward exchange contracts (forward
contracts) to hedge certain foreign currency transaction exposures outstanding
during the period. The gains and losses on the forward contracts help to
mitigate the gains and losses on our outstanding foreign currency transactions.
We do not enter into forward contracts for trading purposes. All foreign 27




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currency transactions and all outstanding forward contracts are
marked-to-market at the end of the period with unrealized gains and losses
included in other income, net. We had no outstanding forward contracts as of June 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 for that quarter. New contracts may not result
in revenue in the quarter in which the contract was signed, and we may not be
able to predict accurately when revenues from these contracts will be
recognized. Our operating results are also dependent upon our ability to
manage our cost structure. We have incurred substantial operating losses since inception and we cannot
guarantee that we will become profitable in the future. We have incurred substantial losses since inception as we funded the
development of our products and the growth of our organization. We have an
accumulated deficit of $215.1 million as of June 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 recent measures in order to remain
competitive we intend to continue investing selectively in sales, marketing and
research and development. As a result, we may report future operating losses
and cannot guarantee whether we will report net income in the future. Our operating results are substantially dependent on license revenues from
essentially one product, Vitria:BusinessWare product and our business could be
materially harmed by factors that adversely affect the pricing and demand for
Vitria:BusinessWare. Since 1998, a majority of our total revenues has been, and is expected to
be, derived from the license of our Vitria:BusinessWare product and for
applications built using that product. Accordingly, our future operating
results will depend on the demand for Vitria:BusinessWare by existing and
future customers, including new and enhanced releases that are subsequently
introduced. If our competitors release new products that are superior to
Vitria:BusinessWare in performance or price, or we fail to enhance
Vitria:BusinessWare and introduce new products in a timely manner, demand for
our product may decline. A decline in demand for Vitria:BusinessWare as a
result of 28




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competition, technological change or other factors would significantly
reduce our revenues. We experienced a decrease in our average deal size in
2003 and in the first two quarters of 2004 due to downward pricing pressure on
our base Vitria:Businessware software offering. The maturation of the market in
which we compete has resulted in fewer total orders as competition has
increased for a smaller pool of potential buyers. The general slowdown in
information technology spending in our target markets due to slow U.S. economic
growth has also made it more difficult to grow our revenues. Failure to raise additional capital or generate the significant capital
necessary to expand our operations and invest in new products could reduce our
ability to compete and result in lower revenues. During the six months ended June 30, 2004, we had a net loss of $13.3
million and our operating activities used $6.7 million of cash. As of June 30,
2004, we had approximately $85.2 million in cash and cash equivalents and
short-term investments, $30.4 million in short term liabilities and $10.0
million in long-term liabilities. We may need to raise additional funds, and
we cannot be certain that we will be able to obtain additional financing on
favorable terms, or at all. If we need additional capital and cannot raise it
on acceptable terms, we may not be able to, among other things:  
    
    develop or enhance our products and services;
    
    acquire technologies, products or businesses;
    
    expand operations, in the United States or internationally;
    
    hire, train and retain employees; or
    
    respond to competitive pressures or unanticipated capital requirements.
    
    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 abroad, and
especially the continued reluctance of companies to make significant
expenditures on information technology, could reduce demand for our products
and cause our revenues to continue to decline. The
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 two years, we
have experienced a general slow-down in the level of capital spending by some
of our customers due to the general economic downturn, which has resulted in
lower revenues. This slow-down in capital spending, if sustained in future
periods, could result in reduced sales or the postponement of sales to our
customers. There can be no assurance that the level of spending on information
technology in general, or on business integration software by our customers and
potential customers, will increase or remain at current levels in future
periods. Lower spending on information technology could result in reduced
license sales to our customers, reduced overall revenues, diminished margin
levels, and could impair our operating results in future periods. We experience long and variable sales cycles, which could have a negative
impact on our results of operations for any given quarter. Our products are often used by our customers to deploy mission-critical
solutions used throughout their organization. Customers generally consider a
wide range of issues before committing to purchase our products, including
product benefits, ability to operate with existing and future computer systems,
ability to accommodate 29




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increased transaction volume and product reliability. Many customers will
be addressing these issues for the first time. As a result, we or other
parties, including system integrators, must educate potential customers on the
use and benefits of our product and services. In addition, the purchase of our
products generally involves a significant commitment of capital and other
resources by a customer. This commitment often requires significant technical
review, assessment of competitive products, and approval at a number of
management levels within the customers organization. Because of these issues,
our sales cycle has ranged from six to nine months, and in some cases even
longer, and it is very difficult to predict whether and when any particular
license transaction might be completed. In addition, the downturn in the U.S.
economy has caused some customers to increase budgetary controls or require
additional management approvals within the customers organization prior to
committing to significant capital purchases, either of which could result in an
increased sales cycle. Because a small number of customers have in the past accounted for a
substantial portion of our revenues, our revenues could decline due to the loss
or delay of a single customer order. Sales to ten customers accounted for 35% and 33% of total revenues in the
three and six months ended June 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
standard organizations, and the commitment of significant resources. Specific
industries may experience economic downturns or regulatory changes that may
result in delayed spending decisions by customers or require changes to our
products. If we are not successful in developing these targeted 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. 30




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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 install and deploy our products and those of our
competitors, and perform custom integration of systems and applications. Some
system integrators engage in joint marketing and sales efforts with us. If
these relationships fail, we will have to devote substantially more resources
to the sales and marketing, and implementation and support of our product than
we would otherwise have to, and our efforts may not be as effective as those of
the system integrators. In many cases, these parties have extensive
relationships with our existing and potential customers and influence the
decisions of these customers. We rely upon these firms for recommendations of
our product during the evaluation stage of the purchasing process, as well as
for implementation and customer support services. A number of our competitors
have strong relationships with these system integrators and, as a result, these
system integrators may recommend competitors products and services. In
addition, a number of our competitors have relationships with a greater number
of these system integrators and, therefore, have access to a broader base of
enterprise customers. Our failure to establish or maintain these relationships
would significantly harm our ability to license and successfully implement our
software product. In addition, we rely on the industry expertise and reach of
these firms. Therefore, this failure would also harm our ability to develop
industry-specific products. We are currently investing, and plan to continue to
invest, significant resources to develop and maintain these relationships. Our
operating results could be harmed if these efforts do not generate license and
service revenues necessary to offset this investment. 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. 31




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Our products are often purchased as part of large projects undertaken by
our customers. These projects are complex, time consuming and expensive.
Failure by customers to successfully deploy our products, or the failure by us
or third-party consultants to ensure customer satisfaction, could damage our
reputation with existing and future customers and reduce future revenues. In
many cases, our customers must interact with, modify, or replace significant
elements of their existing computer systems. The costs of our products and
services represent only a portion of the related hardware, software,
development, training and consulting costs. The significant involvement of
third parties, including system integrators, reduces the control we have over
the implementation of our products and the quality of customer service provided
to organizations which license our software. If our products do not operate with the many hardware and software platforms
used by our customers, our business may fail. We currently serve a customer base with a wide variety of constantly
changing hardware, packaged software applications and networking platforms. If
our products fail to gain broad market acceptance, due to their inability to
support a variety of these platforms, our operating results may suffer. Our
business depends, among others, on the following factors:  
    
    our ability to integrate our product with multiple platforms
and existing, or legacy, systems and to modify our products as new
versions of packaged applications are introduced;
    
    the portability of our products, particularly the number of
operating systems and databases that our products can source or
target;
    
    our ability to anticipate and support new standards, especially Internet standards;
    
    the integration of additional software modules under development with our existing products; and
    
    our management of software being developed by third parties for
our customers or use with our products. If we fail to introduce new versions and releases of our products in a timely
manner, our revenues may decline. We may fail to introduce or deliver new products on a timely basis, if at
all. In the past, we have experienced delays in the commencement of commercial
shipments of our Vitria:BusinessWare products. To date, these delays have not
had a material impact on our revenues. If new releases or products are delayed
or do not achieve market acceptance, we could experience a delay or loss of
revenues and cause customer dissatisfaction. In addition, customers may delay
purchases of our products in anticipation of future releases. If customers
defer material orders in anticipation of new releases or new product
introductions, our revenues may decline. Our products rely on third-party programming tools and applications. If we lose
access to these tools and applications, or are unable to modify our products in
response to changes in these tools and applications, our revenues could
decline. Our programs utilize Java programming technology provided by Sun
Microsystems. We also depend upon access to the interfaces, known as APIs,
used for communication between external software products and packaged
application software. Our access to APIs of third-party applications are
controlled by the providers of these applications. If the application provider
denies or delays our access to APIs, our business may be harmed. Some
application providers may become competitors or establish alliances with our
competitors, increasing the likelihood that we would not be granted access to
their APIs. We also license technology related to the connectivity of our
product to third-party database and other applications and we incorporate some
third-party technology into our product offerings. Loss of the ability to use
this technology, delays in upgrades, failure of these third parties to 32




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support these technologies, or other difficulties with our third-party
technology partners could lead to delays in product shipment and could cause
our revenues to decline. We could suffer losses and negative publicity if new versions and releases of
our products contain errors or defects. Our products and their interactions with customers software applications
and IT systems are complex and, accordingly, there may be undetected errors or
failures when products are introduced or as new versions are released. We have
in the past discovered software errors in our new releases and new products
after their introduction which has resulted in additional research and
development expenses. To date, these additional expenses have not been
material. We may in the future discover errors in new releases or new products
after the commencement of commercial shipments. Since many customers are using
our products for mission-critical business operations, any of these occurrences
could seriously harm our business and generate negative publicity. If we fail to attract and retain qualified personnel, our ability to compete
will be harmed. We depend on the continued service of our key technical, sales and senior
management personnel. None of these persons are bound by an employment
agreement. The loss of senior management or other key research, development,
sales and marketing personnel could have a material adverse effect on our
future operating results. In addition, we must attract, retain and motivate
highly skilled employees. We face significant competition for individuals with
the skills required to develop, market and support our products and services.
We cannot assure that we will be able to recruit and retain sufficient numbers
of these highly skilled employees. If we fail to adequately protect our proprietary rights, we may lose these
rights and our business may be seriously harmed. We depend upon our ability to develop and protect our proprietary
technology and intellectual property rights to distinguish our products from
our competitors products. The use by others of our proprietary rights could
materially harm our business. We rely on a combination of copyright, patent,
trademark and trade secret laws, as well as confidentiality agreements and
licensing arrangements, to establish and protect our proprietary rights.
Despite our efforts to protect our proprietary rights, existing laws afford
only limited protection. Attempts may be made to copy or reverse engineer
aspects of our products or to obtain and use information that we regard as
proprietary. Accordingly, there can be no assurance that we will be able to
protect our proprietary rights against unauthorized third party copying or use.
Furthermore, policing the unauthorized use of our products is difficult, and
expensive litigation may be necessary in the future to enforce our intellectual
property rights. Our products could infringe the intellectual property rights of others causing
costly litigation and the loss of significant rights. Software developers in our market will increasingly be subject to
infringement claims as the number of products in different software industry
segments overlap. Any claims, with or without merit, could be time-consuming,
result in costly litigation, prevent product shipment or cause delays, or
require us to enter into royalty or licensing agreements, any of which could
harm our business. Patent litigation in particular has complex technical issues
and inherent uncertainties. In the event an infringement claim against us is
successful and we cannot obtain a license on acceptable terms or license a
substitute technology or redesign our product to avoid infringement, our
business would be harmed. Furthermore, former employers of our current and
future employees may assert that our employees have improperly disclosed to us
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. 33




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We maintain international offices in countries including Australia,
Canada, France, Germany, Italy, Japan, Korea, Singapore, Spain and the United
Kingdom and may establish additional international offices. During the first
six 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. In the past, securities class action litigation has often been brought
against a company following a decline in the market price of its securities.
This risk is especially acute for us because technology companies have
experienced greater than average stock price volatility in recent years and, as
a result, have been subject to, on average, a greater number of securities
class action claims than companies in other industries. In November 2001,
Vitria and certain of our officers and directors were named as defendants in a
class action shareholder complaint. This litigation could result in
substantial costs and divert managements attention and resources, and could
seriously harm our business. See Part II Item 1 Legal Proceedings for more
information regarding this litigation. We have implemented anti-takeover provisions which could discourage or prevent
a takeover, even if an acquisition would be beneficial to our stockholders. Provisions of our amended and restated certificate of incorporation and
bylaws, as well as provisions of Delaware law, could make it more difficult for
a third party to acquire us, even if doing so would be beneficial to our
stockholders. These provisions include:  
    
    establishment of a classified Board of Directors requiring that
not all members of the Board of Directors may be elected at one time;
    
    authorizing the issuance of blank check preferred stock that
could be issued by our Board of Directors of directors to increase
the number of outstanding shares and thwart a takeover attempt;
    
    prohibiting cumulative voting in the election of directors,
which would otherwise allow less than a majority of stockholders to
elect director candidates;
    
    limitations on the ability of stockholders to call special
meetings of stockholders;
    
    prohibiting stockholder action by written consent, thereby
requiring all stockholder actions to be taken at a meeting of our
stockholders; and
    
    establishing advance notice requirements for nominations for
election to the Board of Directors of directors or for proposing
matters that can be acted upon by stockholders at stockholder
meetings Section 203 of the Delaware General Corporations Law and the terms of our
stock option plans may also discourage, delay or prevent a change in control of
Vitria. In addition, as of June 30, 2004, our executive officers, directors
and their affiliates beneficially own approximately 38% 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 34




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Evaluation of disclosure controls and procedures. Based on their
evaluation as of June 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 first fiscal quarter that have
materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting. Limitations on the effectiveness of controls.Our management, including
our chief executive officer and chief financial officer, does not expect that
our control systems will prevent all error and all fraud. A control system, no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within Vitria have been detected. These
inherent limitations include the realities that judgments in decision-making
can be faulty, and that breakdowns can occur because of simple error or
mistake. Additionally, controls can be circumvented by the individual acts of
some persons, by collusion of two or more people or by management override of
the control. The design of any system of controls also is based in part upon
certain assumptions about the likelihood of future events, and there can be no
assurance that any design will succeed in achieving its stated goals under all
potential future conditions. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur
and not be detected. 35




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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. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities None. 
 Item 3. Defaults Upon Senior Securities None. 
 Item 4. Submission of Matters to a Vote of Security Holders The annual meeting of stockholders of Vitria Technology, Inc was held on
May 21, 2004 for the purpose of: 36




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(1)
    
    electing two directors to our board of directors to serve until
2007 annual meeting of stockholders;(2)
    
    to ratify the selection of Ernst & Young LLP as our independent
auditors for the fiscal year ending December 31, 2004; and(3)
    
    to transact such other business as may properly come before the
meeting or any adjournment or postponement thereof. Proxies for the meeting were solicited pursuant to Section 14(a) of the
Securities Exchange Act of 1934, as amended, and there was no solicitation in
opposition of managements solicitations. The final vote on the proposals were
recorded as follows: Proposal 1: Election of two directors for three-year terms expiring at the 2007 annual
meeting: Nominee
    
    For
    
    WithheldRobert M. Halperin
    
    27,087,593
    
    4,264,533John L. Walecka
    
    30,713,029
    
    639,097
 Proposal 2: The selection of Ernst & Young LLP as our independent auditors for the
fiscal year ending December 31, 2004 was ratified by the following vote: For
    
    Against
    
    
    Abstain31,319,474
    
    30,970
    
    
    1,682
 
 Item 5. Other Information  Consistent with Section 10A(i)(2) of the Securities Exchange Act of 1934,
as added by Section 202 of the Sarbanes-Oxley Act of 2002, Vitria is
responsible for disclosing the nature of the non-audit services approved
by our Audit Committee during a quarter to be performed by Ernst & Young
LLP, our independent auditor. Non-audit services are services other than
those provided by Ernst & Young LLP in connection with an audit or a
review of Vitrias financial statements. During the quarter ended June
30, 2004 our Audit Committee did not approve any non-audit services to be
performed by Ernst & Young LLP. 
 Item 6. Exhibits and Reports on Form 8-K  a)
    
    Exhibits Exhibit 10.24
    
    Third Loan Modification Agreement by and between Silicon Valley
Bank and Vitria, dated June 11, 2004.Exhibit 10.25
    
    Separation Agreement, by and between Jeffrey Bairstow and Vitria, dated April 27, 2004.Exhibit 10.26
    
    Separation Agreement, by and between Gary Velasquez and Vitria, dated June 10, 2004.
 37




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Exhibit 10.27
    
    Separation Agreement, by and between James Guthrie and Vitria, dated May 11, 2004.Exhibit 10.28
    
    Separation Agreement, by and between Thomas Pianko and Vitria, dated April 7, 2004.Exhibit 10.29
    
    Separation Agreement, by and
between Sonja Wilkerson and Vitria dated July 14, 2004.Exhibit 10.30
    
    Confirmation Agreement, by and
between Jo Mei Chang, Dale Skeen and Vitria dated April 22, 2004.Exhibit 31.1
    
    Certification of Chief Executive Officer as required by Rule
13a-14(a) of the Securities Exchange Act of 1934, as amended.Exhibit 31.2
    
    Certification of Chief Financial Officer as required by Rule
13a-14(a) of the Securities Exchange Act of 1934, as amended.Exhibit 32.1
    
    Certification of Chief Executive Officer as required by Rule
13a-14(b) of the Securities Exchange Act of 1934, as amended.*Exhibit 32.2
    
    Certification of Chief Financial Officer as required by Rule
13a-14(b) of the Securities Exchange Act of 1934, as amended.*
   *
    
    The certifications attached as Exhibits 32.1 and 32.2 accompany this
Quarterly Report on Form 10-Q, are not deemed filed with the Securities
and Exchange Commission and are not to be incorporated by reference into
an filing of Vitria Technology, Inc. under the Securities Act of 1933, as
amended, or the Securities Exchange Act of 1934, as amended, whether made
before or after the date of this Form 10-Q, irrespective of any general
incorporation language contained in such filing.  b)
    
    Reports on Form 8-K Vitria filed a Current Report on Form 8-K, dated April 7, 2004, on
April 7, 2004, reporting under Item 12. Disclosure of Results of
Operations and Financial Condition, its preliminary results for the three
months ended March 31, 2004. Vitria filed a Current Report on Form 8-K, dated April 21, 2004, on
April 22, 2004, reporting under Item 12. Disclosure of Results of
Operations and Financial Condition, its results for the three months
ended March 31, 2004. Vitria filed a Current Report on Form 8-K, dated June 14, 2004, on
June 15, 2004, reporting under Item 10, Amendments to the Registrants
Code of Ethics, or Waiver of a Provision of the Code of Ethics, the
sale of Vitrias operations in the Peoples Republic of China to QiLinSoft
LLC, an entity owned by JoMei Chang, Ph.D., a current director and
Vitrias former Chief Executive Officer and M. Dale Skeen, Ph.D., a
director and Vitrias acting Chief Executive Officer and Chief Technology
Officer and certain agreements with QiLinSoft LLC. 38




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##### Table of Contents



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: August 6, 2004
    
    By:
    
    /s/ MICHAEL D. PERRYMichael D. PerrySenior Vice President and Chief Financial Officer
 39




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##### Table of Contents



EXHIBIT INDEX


Exhibit 10.24
    
    Third Loan Modification Agreement by and between Silicon Valley
Bank and Vitria, dated June 11, 2004.Exhibit 10.25
    
    Separation Agreement, by and between Jeffrey Bairstow and Vitria, dated April 27, 2004.Exhibit 10.26
    
    Separation Agreement, by and between Gary Velasquez and Vitria, dated June 10, 2004.Exhibit 10.27
    
    Separation Agreement, by and between James Guthrie and Vitria, dated May 11, 2004.Exhibit 10.28
    
    Separation Agreement, by and between Thomas Pianko and Vitria, dated April 7, 2004.Exhibit 10.29
    
    Separation Agreement, by and
between Sonja Wilkerson and Vitria dated July 14, 2004.Exhibit 10.30
    
    Confirmation Agreement, by and
between Jo Mei Chang, Dale Skeen and Vitria dated April 22, 2004.Exhibit 31.1
    
    Certification of Chief Executive Officer as required by Rule
13a-14(a) of the Securities Exchange Act of 1934, as amended.Exhibit 31.2
    
    Certification of Chief Financial Officer as required by Rule
13a-14(a) of the Securities Exchange Act of 1934, as amended.Exhibit 32.1
    
    Certification of Chief Executive Officer as required by Rule
13a-14(b) of the Securities Exchange Act of 1934, as amended.*Exhibit 32.2
    
    Certification of Chief Financial Officer as required by Rule
13a-14(b) of the Securities Exchange Act of 1934, as amended.*   *
    
    The certifications attached as Exhibits 32.1 and 32.2 accompany this
Quarterly Report on Form 10-Q, are not deemed filed with the Securities
and Exchange Commission and are not to be incorporated by reference into
an filing of Vitria Technology, Inc. under the Securities Act of 1933, as
amended, or the Securities Exchange Act of 1934, as amended, whether made
before or after the date of this Form 10-Q, irrespective of any general
incorporation language contained in such filing. 40