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  **UNITED STATES SECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549****FORM 10-Q**   þ **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934******For the quarterly period ended September 30, 2005******or,**   o **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934******For the transition period from                      to**                    ****Commission file number 0-27012****Insignia Solutions plc****(Exact name of Registrant as specified in its charter)**   **England and Wales** **Not applicable**(State or other jurisdiction of (I.R.S. employer identificationincorporation or organization) number)    **41300 Christy Street** **Mercury Park, Wycombe Lane****Fremont** **Wooburn Green****California 94538** **High Wycombe, Bucks HP10 0HH****United States of America** **United Kingdom****(510) 360-3700** **(44) 1628-539500****(Address and telephone number of principal executive offices and principal places of business)**Indicate by check mark whether the registrant: (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes þ No oIndicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 ofthe Exchange Act). Yes o No þIndicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes Yes o No þAs of November 30, 2005, there were 42,503,025 of the registrant’s ordinary shares, £0.20 eachnominal value, outstanding.  
 

**INSIGNIA SOLUTIONS PLC**       **Page No.** **PART 1 — FINANCIAL INFORMATION**         **Item 1. Financial Statements:**  3      Condensed Consolidated Balance Sheets at September 30, 2005 and December 31, 2004 (unaudited)  3      Condensed Consolidated Statements of Operations for the three and nine months endedSeptember 30, 2005 and 2004 (unaudited)  4      Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2005and 2004 (unaudited)  5      Notes to Condensed Consolidated Financial Statements (unaudited)  6      **Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations**  16      **Item 3. Quantitative and Qualitative Disclosures About Market Risk**  38      **Item 4. Controls and Procedures**  38      **PART II — OTHER INFORMATION**         **Item 1. Legal Proceedings**  40      **Item 2. Unregistered Sales of Equity Securities and Use of Proceeds**  40      **Item 3. Defaults Upon Senior Securities**  40      **Item 4. Submission of Matters to a Vote of Security Holders**  40      **Item 5. Other Information**  42      **Item 6. Exhibits**  42      **Signature**  44  EXHIBIT 10.06 EXHIBIT 31.01 EXHIBIT 31.02 EXHIBIT 32.01 EXHIBIT 32.02
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**PART I — FINANCIAL INFORMATION****Item 1. Financial Statements****INSIGNIA SOLUTIONS PLC****CONDENSED CONSOLIDATED BALANCE SHEETS****(unaudited, amounts in thousands, except share and per share amounts)**           **September 30,**  **December 31,**   **2005**  **2004** **ASSETS**        Current assets:        Cash and cash equivalents $25  $902 Restricted cash  50   50 Accounts receivable, net of allowances of $175 and $0, respectively  922   175 Other receivables  5   241 Tax receivable  124   322 Prepaid expenses  309   456        Total current assets  1,435   2,146 Property and equipment, net  86   140 Intangible assets, net  2,193   — Goodwill  503   — Investment in affiliate  —   68 Other assets  236   233          $4,453  $2,587                 **LIABILITIES AND SHAREHOLDERS’ EQUITY**        Current liabilities:        Accounts payable $1,149  $241 Accrued liabilities  1,154   995 Notes payable  40   — Deferred revenue  97   10        Total current liabilities  2,440   1,246 Notes payable net of current portion  164   —        Total liabilities  2,604   1,246                 Commitments and contingencies (Note 6)                 Shareholders’ equity:        Preferred shares, £0.20 par value: 3,000,000 shares authorized; noshares issued  —   — Ordinary shares, £0.20 par value: 75,000,000 shares authorized;42,503,025 and 35,722,205 shares issued and outstanding in 2005and 2004, respectively  14,496   11,939 Additional paid-in capital  66,574   64,459 Ordinary share subscription  712   — Accumulated deficit  (79,472)  (74,596)Other accumulated comprehensive loss  (461)  (461)       Total shareholders’ equity  1,849   1,341          $4,453  $2,587        The accompanying notes are an integral part of these condensed consolidated financial statements
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**INSIGNIA SOLUTIONS PLC****CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS****(unaudited, amounts in thousands, except per share amounts)**                   **Three months ended**  **Nine months ended**   **September 30,**  **September 30,**   **2005**  **2004**  **2005**  **2004** Net revenues:                License $464  $100  $1,381  $521 Service  338   7   617   12                               Total net revenues  802   107   1,998   533                               Cost of net revenues:                License  42   —   125   28 Service  150   —   166   —                               Total cost of net revenues  192   —   291   28                               Gross profit  610   107   1,707   505                               Operating expenses:                Sales and marketing  608   578   1,937   1,923 Research and development  553   654   2,144   2,126 General and administrative  753   603   2,237   1,864 Amortization of intangible assets  97   —   207   —              Total operating expenses  2,011   1,835   6,525   5,913                               Operating loss  (1,401)  (1,728)  (4,818)  (5,408)                 Interest income (expense), net  2   4   (40)  6 Other income (expense), net  17   (3)  23   248                               Loss before income taxes  (1,382)  (1,727)  (4,835)  (5,154)                 Provision for (benefit from) income taxes  5   2   41   (211)                              Net loss  (1,387)  (1,729)  (4,876)  (4,943)                 Accretion of dividend on subsidiary preferred stock  (54)  —   (54)  — Deemed dividend related to beneficial conversionfeature of subsidiary preferred stock  (196)  —   (611)  —                               Net loss attributable to ordinary shareholders $(1,637) $(1,729) $(5,541) $(4,943)                              Net loss per share:                Basic and diluted $(0.04) $(0.06) $(0.13) $(0.17)                              Weighted average shares and share equivalents:                Basic and diluted  42,495   29,384   41,475   29,081              The accompanying notes are an integral part of these condensed consolidated financial statements.
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**INSIGNIA SOLUTIONS PLC****CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS****(unaudited, amounts in thousands)**           **Nine months ended**   **September 30,**   **2005**  **2004** Cash flows from operating activities:        Net loss $(4,876) $(4,943)Adjustments to reconcile net loss to net cash used in operating activities:        Depreciation  82   77 Amortization of intangible assets  207   — Allowance for doubtful accounts  175   — Non-cash charge for warrants, shares and stock options  64   353 Equity in net loss of affiliate  68   40 Gain on saleof product line  —   (302)Loss ondisposal of property and equipment  6   —Net changes in assets and liabilities, net of acquired assets and liabilities:        Accounts receivable  (781)  (439)Other receivables  248   (225)Tax receivable  203   (38)Prepaid royalties  —   2,185 Prepaid expenses  158   152 Other noncurrent assets  (3)  (3)Accounts payable  827   (74)Accrued liabilities  20   (318)Deferred revenue  (134)  (627)       Net cash used in operating activities  (3,736)  (4,162)                Cash flows from investing activities:        Purchases of property and equipment  (14)  (67)Investment in affiliate  —   (75)Acquisition of Mi4e, net of cash acquired  149   — Increase in restricted cash  —   (30)Proceeds from sale of property and equipment  4   —        Net cash provided by (used in) investing activities  139   (172)       Cash flows from financing activities:        Proceeds from issuance of shares, net  2,235   1,604 Proceeds from exercise of warrants  —   389 Proceeds from exercise of stock options and employee stock purchases  114   606 Proceeds from notes payable  425   — Repayment of notes payable  (54)  —        Net cash provided by financing activities  2,720   2,599        Net decrease in cash and cash equivalents  (877)  (1,735)Cash and cash equivalents at beginning of the period  902   2,212        Cash and cash equivalents at end of the period $25  $477                 Supplemental non-cash investing and financing activities:        Non-cash issuance of shares for acquired business $2,749  $—        Non-cash issuance of shares upon conversion of notes payable $275  $—        The accompanying notes are an integral part of these condensed consolidated financial statements.
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**INSIGNIA SOLUTIONS PLC****NOTES TO CONDENSED CONSOLIDATED****FINANCIAL STATEMENTS****(unaudited)****Note 1. Basis of presentation**The accompanying unaudited condensed consolidated financial statements of Insignia Solutions plc(“Insignia”, “us”, “our”, “we”, the “Registrant” or the “Company”) have been prepared in accordancewith accounting principles generally accepted in the United States of America for interim financialinformation and pursuant to the instructions to Form 10-Q. The unaudited interim financialstatements have been prepared on the same basis as the annual financial statements and, in theopinion of management, reflect all adjustments, consisting of normal recurring adjustments,considered necessary for a fair presentation. Interim results are not necessarily indicative ofresults for a full year. These unaudited condensed consolidated financial statements and notesshould be read in conjunction with Insignia’s audited consolidated financial statements for theyear ended December 31, 2004 and footnotes thereto, included in Insignia’s Annual Report on Form10-K and Insignia’s audited consolidated financial statements for the six months ended June 30,2005 included in the Registration Statement on Form S-1, as amended, as filed with the Securitiesand Exchange Commission on October 13, 2005 (the “2005 S-1 Registration Statement”).During the past 24 months, we have incurred an aggregate loss from operations and negativeoperating cash flows of $13.8 million and $12.0 million, respectively. As part of our strategy forongoing funding, on February 10, 2005, we entered into a securities subscription agreement (the“2005 Fusion Capital securities subscription agreement”) with Fusion Capital Fund II, LLC (“FusionCapital”). Pursuant to the 2005 Fusion Capital securities subscription agreement, Fusion Capitalhas agreed to purchase on each trading day after the commencement of funding, $20,000 of ourAmerican Depository Shares (“ADSs”), representing ordinaryshares of Insignia, for an aggregate ofup to $12 million over a 30-month period, subject to earlier termination at our discretion. Thecommencement of funding under the 2005 Fusion Capital securities subscription agreement is subjectto certain conditions, including the declaration of effectiveness by the Securities and ExchangeCommission of a registration statement covering the sale of the ADSs issued to Fusion Capital underthe 2005 Fusion Capital securities subscription agreement. The 2005 S-1 Registration Statement,which covers the sale of the ADSs to be issued to Fusion Capital under the 2005 Fusion Capitalsecurities subscription agreement, was declared effective by the Securities and Exchange Commissionon October 25, 2005. Fusion Capital may not purchase shares under the 2005 Fusion Capitalsecurities subscription agreement if Fusion Capital, together with its affiliates, wouldbeneficially own more than 9.9% of our shares outstanding at the time of the purchase by FusionCapital. Currently, Fusion Capital beneficially owns approximately 9.9% of our shares. Inaddition, Fusion Capital is not required to purchase shares if the market price is less than $0.40per share during any trading day. Any delay in the commencement of funding under the FusionCapital securities subscription agreement could jeopardize our business.By instituting cost cutting measures through consolidating our global research and developmentactivities, increasing revenue streams, collecting current outstanding receivables and subject tothe commencement of funding under the Fusion Capital securities subscription agreement we believewe should be able to meet our operating and capital requirements.The failure to raise additional funds, if needed, on a timely basis and on sufficiently favorableterms could have a material adverse effect on our business, operating results and financialcondition. Insignia’s liquidity may also be adversely affected in the future by factors such as aninability to borrow without collateral, availability of capital financing and continued operatinglosses. The accompanying unaudited condensed consolidated financial statements do not include anyadjustments that might result from the outcome of this uncertainty.
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CurrencyWe follow accounting principles generally accepted in the United States of America. We conduct ourbusiness in U.S. dollars, Euros and British pounds sterling, and since March 16, 2005, also inSwedish Krona. All amounts included in the financial statements and in the notes herein are in U.S.dollars unless designated “£’’, in which case they are in British pounds sterling.**Note 2. Net loss per share**Net loss per share is presented on a basic and diluted basis, and is computed by dividing our netloss attributable to ordinary shareholders by the weighted average number of ordinary shares andordinary equivalent shares outstanding during the period. Ordinary equivalent shares consist ofwarrants and stock options that have a dilutive effect (using the treasury stock method). Under thebasic method of calculating net loss per share, ordinary equivalent shares are excluded from thecomputation. Under the diluted method of calculating net loss per share, ordinary equivalent shareswere excluded from the computation because their effect was anti-dilutive, due to our net loss.The calculation of basic and diluted net loss per share is as follows:                   **(in thousands, except per share data)**   **Three months ended**  **Nine months ended**   **September 30,**  **September 30,**   **2005**  **2004**  **2005**  **2004** Numerator — basic and diluted:                Net loss attributable to ordinary shareholders $(1,637) $(1,729) $(5,541) $(4,943)             Denominator of basic and diluted:                Weighted average number of ordinary shares outstanding  42,495   29,384   41,475   29,081              Basic and diluted net loss per share $(0.04) $(0.06) $(0.13) $(0.17)             Options to purchase 4,136,506 and 4,440,113 shares of ordinary shares and warrants to purchase10,047,336 and 1,143,844 ordinary shares were outstanding at September 30, 2005 and 2004,respectively, but were not included in the computation of diluted net loss per share as the effectwould be anti-dilutive.**Note 3. Stock-based compensation**Insignia accounts for stock-based employee compensation using the intrinsic value method underAccounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, and relatedinterpretations and complies with the disclosure provisions of Statement of Financial AccountingStandards No. 148, “Accounting for Stock-Based Compensation, Transition and Disclosure — anAmendment of FASB Statement No.123”. The following tableillustrates the effect on our net loss attributable to ordinaryshareholders andnet loss per share if we had applied the fair value recognition provisions of Statement ofFinancial Accounting Standards No.123 (“SFAS 123”), “Accounting for Stock-Based Compensation” tostock-based compensation.                   **(in thousands, exceptper share data)**  **Three months ended**  **Nine months ended**   **September 30,**  **September 30,**   **2005**  **2004**  **2005**  **2004** Net loss attributable to ordinary shareholders — as reported $(1,637) $(1,729) $(5,541) $(4,943)Less stock-based compensation expense determined under fairvalue based method  (12)  (144)  (113)  (534)             Net lossattributable to ordinary shareholders — pro forma $(1,649) $(1,873) $(5,654) $(5,477)             Basic and diluted net loss per share — as reported $(0.04) $(0.06) $(0.13) $(0.17)Basic and diluted net loss per share — pro forma $(0.04) $(0.06) $(0.14) $(0.19)
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In accordance with the disclosure provisions of SFAS 123, the fair value of employee stock optionsgranted during the three and nine months ended September 30, 2005 and 2004 was estimated at thedate of grant using the Black-Scholes model and the following assumptions:                   **Three months ended** **Nine months ended**  **September 30,** **September 30,**  **2005** **2004** **2005** **2004**Stock Options:                Volatility range  276 – 277%   155 – 274%  104 – 277%   139 – 274%Risk-free interest rate range  3.83 – 4.42%  2.39 – 3.77%  3.83 – 4.43%  1.11 – 4.07%Dividend yield  0%  0%  0%  0%Expected life (years)  4   4   4   4 Employee Stock Purchase Plan:                Volatility range  —   66%  84%  66 – 198% Risk-free interest rate range  —   1.25%  2.93%  1.13 – 1.25% Dividend yield  0%  0%  0%  0%Expected life (years)  0.5   0.5   0.5   0.5 **Note 4. New accounting pronouncements**In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards No. 123 (revised 2004) “Share-Based Payment” (“SFAS 123R”), a revision to SFAS123. SFAS 123R addresses all forms of share-based payment (“SBP”) awards, including shares issuedunder our 1995 Incentive Stock Option Plan (“Purchase Plan”), stock options, restricted stock,restricted stock units and stock appreciation rights. SFAS 123R will require Insignia to recordcompensation expense in its consolidated statement of operations for SBP awards based on the fairvalue of the SBP awards. Under SFAS 123R, restricted stock and restricted stock units willgenerally be valued by reference to the market value of freely tradable shares of the Company’sordinary shares. Stock options, stock appreciation rights and shares issued under the Purchase Planwill generally be valued at fair value determined through an option valuation model, such as alattice model or the Black-Scholes model (the model that Insignia currently uses for its footnotedisclosure). SFAS 123R is effective for annual periods beginning after June 15, 2005 and,accordingly, Insignia must adopt the new accounting provisions effective January 1, 2006. TheCompany will adopt the provisions of SFAS 123R using a modified prospective application. Under amodified prospective application, SFAS 123R will apply to new awards and to awards that areoutstanding on the effective date and are subsequently modified or cancelled. Compensation expensefor outstanding awards for which the requisite service had not been rendered as of the effectivedate will be recognized over the remaining service period using the compensation cost calculatedfor pro forma disclosure purposes under SFAS 123. Insignia is in the process of determining how thenew method of valuing stock-based compensation as prescribed in SFAS 123R will be applied tovaluing share-based awards granted after the effective date and the impact the recognition ofcompensation expense related to such awards will have on its consolidated financial statements.In June 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections, areplacement of APB Opinion No. 20, Accounting Changes, and Statement No. 3, Reporting AccountingChanges in Interim Financial Statements” (“SFAS 154”). SFAS 154 will require companies to accountfor and apply changes in accounting principles retrospectively to prior periods’ financialstatements, instead of recording a cumulative effect adjustment within the period of the change,unless it is impracticable to determine the effects of the change to each period being presented.SFAS 154 is effective for accounting changes made in annual periods beginning after December 15,2005 and, accordingly, we must adopt the new accounting provisions effective January 1, 2006. We donot expect the adoption of SFAS 154 to have a material effect on our financial position, results ofoperations or cash flows.
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**Note 5. Mi4e Acquisition**On March 16, 2005, we acquired 100% of the capital stock of Mi4e Device Management AB (“Mi4e”), aprivate company headquartered in Stockholm, Sweden. The consideration paid in the transaction was2,969,692 ADSs, and another 989,896 ADSs are issuable on March 31, 2006, subject to potentialoffset for breach of representations, warranties and covenants. In addition, up to a maximum of700,000 Euros is payable in cash in a potential earn-out based on a percentage of future revenuecollected from sales of existing Mi4e products. As of September 30, 2005, $109,000 had been earnedand accrued for in the accompanying consolidated balance sheet. Mi4e develops, markets and supportssoftware technologies that enable mobile operators and phone manufacturers to update firmware ofmobile devices using standards over-the-air data networks. Its main product, a Device ManagementServer (“DMS”) is a mobile device management infrastructure solution for mobile operators thatsupport the Open Mobile Alliance (“OMA”) Client Provisioning Specification.The initial purchase price of approximately $3.0 million consisted of 3,959,588 ordinary shares(including the shares issuable in March 2006) with a value of approximately $2,749,000 andacquisition costs of approximately $267,000. The fair value of Insignia’s ordinary shares wasdetermined using an average value of $0.6943 per share, which was the average closing price ofInsignia’s ordinary shares three days before and after the measurement date of February 10, 2005.The shares issuable in March 2006 have been recorded as an ordinary share subscription on thecondensed consolidated balance sheet. Any earn-out amounts payable by Insignia to Mi4e’sshareholders will be recorded as additional purchase price and an increase to goodwill, but suchamounts are not included in the initial purchase price.The initial purchase price is allocated as follows (in thousands):**Allocation of Purchase Price:**     Tangible assets acquired $497 Liabilities assumed  (275)Goodwill(a)  394 Customer relationships(b)  900 Technology (c)  1,500     Total purchase price $3,016      (a) Goodwill represents the excess of the purchase price over the fair value of the net assetsacquired and liabilities assumed. (b) Customer relationships will be amortized over 10 years, the period of time Insignia estimatesit will benefit from the acquired customer relationship. (c) Technology will be amortized over 5 years, the period of time Insignia estimates it willbenefit from the technology acquired.In performing the purchase price allocation of acquired intangible assets, Insignia considered itsintention for future use of the assets, analysis of historical financial performance and estimatesof future performance of Mi4e’s products, among other factors. The amounts allocated to theintangible assets were determined through established valuation techniques established in thetechnology industry. Insignia determined the fair values of
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the above intangible technology assets using the “residual income” method, and for the customerrelationships the “income approach” method was used.The excess of the purchase price over the fair value of the identifiable tangible and intangiblenet assets acquired and liabilities assumed of $394,000 was assigned to goodwill. In accordancewith SFAS No. 142 “Goodwill and Other Intangible Assets” (“SFAS 142”), goodwill will not beamortized but will be tested for impairment at least annually. This amount is not deductible fortax purposes.The following table presents unaudited summarized combined results of operation of Insignia andMi4e, on a pro forma basis, as though the companies had been combined as of the beginning of eachperiod presented after giving effect to certain purchase accounting adjustments. The operatingresults of Mi4e have been included in Insignia’s condensed consolidated financial statements afterMarch 16, 2005, the date of acquisition. The following unaudited pro forma amounts are inthousands, except the per share amounts.                   Three months ended Nine months ended  September 30, September 30,  2005 2004 2005 2004Net revenues $802  $161  $2,211  $836                  Net loss attributable to ordinary shareholders $(1,637) $(1,789) $(5,702) $(5,418)Net loss per share — Basic and diluted $(0.04) $(0.05) $(0.14) $(0.16)The above unaudited pro forma summarized results of operations are intended for informationalpurposes only and, in the opinion of management, are neither indicative of the results ofoperations of Insignia had the acquisition actually taken place as of the beginning of the periodspresented, nor indicative of Insignia’s future results of operations. In addition, the aboveunaudited pro forma summarized results of operations do not include potential cost savings fromoperating efficiencies or synergies that may result from Insignia’s acquisition of Mi4e.**Note 6. Commitments and Contingencies**Insignia indemnifies its officers and directors for certain events or occurrences, subject tocertain limits, while the officer is or was serving at our request in such capacity. The term ofthe indemnification period is for the officer’s or director’s lifetime. The maximum amount ofpotential future indemnification is unlimited; however we do have a Director and Officer InsurancePolicy that limits our exposure and enables us to recover a portion of any future amounts paid. Asa result of the insurance policy coverage, we believe the fair value of these indemnificationagreements is minimal.In our sales agreements, we typically agree to indemnify our customers for any expenses orliability resulting from claimed infringements of patents, trademarks or copyrights of thirdparties. The terms of these indemnification provisions are generally perpetual any time after theexecution of the agreement. The maximum amount of potential future indemnification is unlimited. Todate we have not paid any amounts to settle claims or defend lawsuits.Insignia, on a limited basis, has granted price protection. The terms of these agreements aregenerally perpetual. We have not recorded any liabilities for these potential future paymentseither because they are not probable or not determinable.Insignia warrants its software products against defects in material and workmanship under normaluse and service for a period of ninety days. There is no warranty accrual recorded becausepotential future payments either are not probable or we have yet to incur the expense.
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**Note 7. Segment reporting and long-lived assets**Insignia operates in a single industry segment, providing software technologies that enable mobileoperators and phone manufacturers to update the firmware of mobile devices using standardover-the-air data networks. In the third quarter of 2004, one customer accounted for 93% of totalrevenues. In the three months ended September 30, 2005, one Swedish company accounted for 38% oftotal revenues, and two European companies accounted for 27% of total revenues. In the nine monthsended September 30, 2004, five customers accounted for 95% of our total revenues, and in the firstnine months of 2005 four customers accounted for 53% of total revenues with the largest customeraccounting for 15% of total revenues. No other customers accounted for 10% or more of Insignia’stotal revenues during the three or nine months ended September 30, 2005 and 2004. Sales tocustomers outside the United States, derived mainly from customers in Europe, the Middle East, Asiaand Africa, represented approximately 93% and 85% of total revenues in the three and nine monthsended September 30, 2005, respectively, and approximately 100% and 72% of total revenues in thethree and nine months ended September 30, 2004, respectively. Revenue is attributed to countriesbased on customer location.As of September 30, 2005, the majority of our long-lived assets are located outside the UnitedStates, principally in the United Kingdom and Sweden. All of our net intangible assets($2,193,000), goodwill ($503,000) and other non-current assets ($236,000) are located outside theUnited States. $23,000 of our net fixed assets are located outside the United States. At December31, 2004, substantially all of our long-lived assets were located in the United States.**Note 8. Equity transactions and warrants**On October 17, 2002, we entered into a securities subscription agreement (the “2002 Fusion CapitalAgreement”) with Fusion Capital, pursuant to which Fusion Capital agreed to purchase, on eachtrading day following the effectiveness of a registration statement covering the ADSs to bepurchased by Fusion Capital, $10,000 of our ADSs up to an aggregate of $6.0 million over a periodof 30 months. The purchase price of the ADSs was based on a formula based on the market price atthe time of each purchase. In 2004, we sold 3,100,060 shares to Fusion Capital for aggregateproceeds of $1.5 million, net of transaction costs, under the 2002 Fusion Capital securitiessubscription agreement. During 2003, we issued and sold to Fusion Capital 3,380,132 ADSs resultingin proceeds of $1.9 million, net of transaction costs, under the2002 Fusion Capital securitiessubscription agreement. During January 2005, we sold 299,007 ADSs for $200,000 under the 2002Fusion Capital agreement. As of December 31, 2004, new ordinary shares of 6,480,192 were purchasedunder the Fusion Capital securities subscription agreement for a total of $3.6 million, net ofissuance costs. Of this amount, $190,000 was recorded as an other receivable on the consolidatedbalance sheet at December 31, 2004 as payment was not received until January 2005.Under the terms of the 2002 Fusion Capital Agreement, we issued to Fusion Capital one redeemablewarrant for ADSs representing 1,000,000 ordinary shares, and one non-redeemable warrant for ADSsrepresenting 1,000,000 ordinary shares. The exercise price per share of each warrant was the U.S.dollar equivalent of 20.5 pence. Each warrant expires on September 30, 2007. The fair value ofthe warrants was estimated at $544,000 on the date of grant using the Black-Scholes pricing modelwith the following assumption: no dividend yield; risk-free rate of 2.5%; volatility of 101%; andexpected life of five years. The fair value of the warrants have been expensed in other expenseentirely in the year-ended December 31, 2002. Unless an event of default (including termination ofthe agreement) occurs under the 2002 Fusion Capital Agreement, the shares issuable upon exercise ofthese warrants must be held by Fusion Capital until 30 months from the date of the 2002 FusionCapital Agreement or the date the agreement is terminated. Upon Fusion Capital’s exercise of thesewarrants in 2003, we issued Fusion Capital 2,000,000 ADSs for a total of $668,000, net of issuancecosts. On February 9, 2005, Insignia and Fusion Capital entered into a mutual terminationagreement pursuant to which the 2002 Fusion Capital Agreement was terminated. As a result of thistermination, the 2,000,000 shares issued
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on exercise of the warrants in connection with the 2002 securities subscription agreement may beresold by Fusion Capital under the Company’s existing registration statement.On October 18, 2004, Insignia closed two equity financing transactions in which we raised over $2.3million, net of transaction costs. We closed a private placement financing with certaininstitutional and other accredited investors pursuant to which we issued and sold 3,208,499 newlyissued ADSs and warrants to purchase 802,127 ADSs, for a total purchase price of approximately $1.5million, or $1.3 million net of transaction costs. The shares were priced at $0.48 per share, andthe warrants have an exercise price of $1.06 per share. The warrants may be exercised any timeafter the date that is six months after the closing of the private placement until the earlier ofApril 18, 2010 or a change of control of Insignia. We also issued warrants to purchase an aggregateof 204,597 ADSs to the two principals of Nash Fitzwilliams Ltd. as compensation for NashFitzwilliams Ltd’s services as placement agent. The warrants issued to the Nash Fitzwilliams’ Ltd’sprincipals have the same exercise price and terms as the warrants issued to the investors in theprivate placement. In addition, in July 2005, we issued to each of the investors in the private placementfinancing a warrant (each a “penalty warrant”) to purchase ADSs equal to 6% of the sharespurchased by each investor at the closing of the financing. The exercise price for the penaltywarrants is $1.11 per share. The exercise price for the penalty warrants is $1.11 per share. We have filed a resaleregistration statement with the Securities and Exchange Commission for the purpose of registeringthe resale of the shares, and the shares underlying the warrants, issued in the private placement.Additionally, under a previously executed securities subscription agreement, we sold to FusionCapital 2,500,000 shares of newly issued ADSs at a purchase price of $0.40 per share, resulting inproceeds of approximately $1.0 million, net of transaction costs. As of October 18, 2004, we hadsold an aggregate of $3.152 million of Insignia’s ADSs (out of a total potential issuance of $6million under the securities subscription agreement) to Fusion Capital.On February 9, 2005, Insignia sold to Fusion Capital 3,220,801 ADSs at a purchase price of $0.40per share, resulting in proceeds of approximately $1.3 million. These shares were issued to FusionCapital in a private placement, and are registered under the 2005 S-1Registration Statement.On February 10, 2005, Insignia entered into the 2005 Fusion Capital securities subscriptionagreement with Fusion Capital to sell up to an aggregate of $12 million in ADSs to Fusion Capitalover a period of 30 months. The shares will be priced based on a market-based formula at the timeof purchase. The commencement of funding under the 2005 Fusion Capital securities subscriptionagreement is subject to certain conditions, including the declaration of effectiveness by theSecurities and Exchange Commission of a registration statement covering the ADSs to be purchased byFusion Capital under the 2005 Fusion Capital securities subscription agreement. The 2005 S-1Registration Statement, which covered the sale of the ADSs to be issued to Fusion Capital underthe 2005 Fusion Capital securities subscription agreement, was declared effective by the Securitiesand Exchange Commission on October 25, 2005. In addition, Fusion Capital may not purchase sharesunder the 2005 Fusion Capital securities subscription agreement if Fusion Capital, together withits affiliates, would beneficially own more than 9.9% of our shares outstanding at the time of thepurchase by Fusion Capital. Currently, Fusion Capital beneficially owns approximately 9.9% of ourshares. In addition, Fusion Capital shall not have the right nor be obligated to subscribe for anyADSs on any trading days that the purchase price of our ADSs (as defined in the 2005 Fusion Capitalsecurities subscription agreement) falls below $0.40 at any time during thetrading day. The purchase price of our ADSs had been $0.40 or above $0.40 from October 25, 2005, thedate when the 2005 S-1 Registration Statement was declared effective, until November 2, 2005.However, the purchase price of our ADSs has been less than $0.40 between November 3, 2005 throughDecember 8, 2005 at some point during each such trading day. Accordingly, our ability to obtainfunding under the 2005 Fusion Capital securities subscription agreement is dependent on the tradingprice of our ADSs increasing to at or above $0.40 per ADS. Any delay in the commencement offunding under the 2005 Fusion Capital securities subscription agreement or in obtaining otherfunding could jeopardize Insignia’s business. As a commitment fee for this facility, we issued toFusion
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Capital warrants for 2,000,000 ADSs exercisable at the greater of £0.205 or $0.40 per share and for2,000,000 ADSs exercisable at £0.205 per share. These warrants are exercisable immediately andexpire on February 28, 2010.On March 16, 2005, we closed our acquisition of Mi4e, a private company headquartered in Stockholm,Sweden. The consideration paid in the transaction was 2,969,692 ADSs representing ordinary sharesand another 989,896 ADSs are issuable on March 31, 2006, subject to potential offset for breach ofrepresentations, warranties and covenants.In June 2005, the Company issued convertible notes to three shareholders in exchange for a bridgefinancing of $275,000. These notes were converted into Series A Preferred Stock of our wholly-ownedsubsidiary, Insignia Solutions, Inc. (our “Subsidiary”) on June 30, 2005, as described below. Inconsideration of this bridge financing, the Company accrued loan fees in the form of 45,833 ADSsand warrants to purchase an aggregate of 45,833 ADSs at an exercise price of $0.58 per share wereissued. The 45,833 ADSs were valued at a market value of $25,200 and the warrants had a fairvalue, calculated using the Black-Scholes model, of approximately $17,000. These warrants areexercisable on December 21, 2005 and expire on June 30, 2010.On June 30, 2005 and July 5, 2005, we and our Subsidiary entered into securities subscriptionagreements with Fusion Capital and other investors. Pursuant to these subscription agreements, wecompleted a closing for an aggregate of $1,000,000 on June 30, 2005 (including exchange of the$275,000 bridge notes issued in June 2005), and we completed a second closing on July 5, 2005 foran additional $440,400. Pursuant to these subscription agreements, our Subsidiary issued its SeriesA Preferred Stock, no par value per share, to the investors. This preferred stock isnon-redeemable. The shares of preferred stock (plus all accrued and unpaid dividends thereon) heldby each investor are exchangeable for ADSs (i) at any time at the election of such investor, (ii)automatically upon written notice by us to such investor in the event that the sale price of theADSs on the Nasdaq SmallCap Market is greater than $1.50 per share for a period of ten consecutivetrading days, and certain other conditions are met, and (iii) automatically to the extent anyshares of the preferred stock have not been exchanged prior to June 30, 2007. The preferred stockwill accrue dividends at a rate of 15% per year compounded annually until June 30, 2007, at whichtime no further dividends will accrue, and are payable in the form of additional ADSs. Includingaccruable dividends, the shares of preferred stock issued on June 30, 2005, together with theadditional shares issued on July 5, 2005, will be exchangeable for 3,306,251 and 1,456,075 ADSs,respectively, at an initial purchase price of $0.40 per ADS. As of September 30, 2005,approximately $54,000 has been accrued for the value of the 15% dividend in the accompanyingconsolidated statements of operations. Pursuant to the subscription agreements, we also issued tothe investors on June 30, 2005 and July 5, 2005, warrants to purchase an aggregate of 2,500,000 and1,101,000 ADSs, respectively, at an exercise price per share equal to the greater of $0.50 or theU.S. Dollar equivalent of 20.5 U.K. pence. These warrants are immediately exercisable and expire onJune 30, 2010. We also entered into registration rights agreements with the investors pursuant towhich we agreed to file a registration statement with the Securities and Exchange Commissioncovering the resale of (i) the ADSs issued to the investors upon exchange of the Preferred Stockunder their subscription agreements and (ii) the ADSs issuable upon exercise of their warrants. Inconnection with the July 5, 2005 closing of the private placement, we also issued warrants topurchase an aggregate of 77,070 ADSs to Anthony Fitzgerald and Next Level Capital, Inc. ascompensation for services as placement agents, on substantially similar terms as the warrantsissued to the investors in such private placement. The 2005 S-1 Registration Statement, whichcovers the resale of the ADSs issued to the investors upon exchange of the preferred stock undertheir subscription agreements and the ADSs issuable upon exercise of the warrants issued to theinvestors, Anthony Fitzgerald and Next Level Capital, Inc. in the private placement was declaredeffective by the Securities and Exchange Commission on October 25, 2005.The issuance of the Series A Preferred Stock of our Subsidiary resulted in a beneficial conversionfeature, calculated in accordance with EITF No. 00-27, “Application of Issue No. 98-5, Accountingfor Convertible Securities with Beneficial Conversion Features of Contingently AdjustableConversion Ratios to Certain
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Convertible Instruments” based upon the conversion price of the preferred stock into ADSs, and thefair value of the ADSs at the date of issue. Accordingly, the warrants issued as of June 30, 2005were valued at $585,000, using a Black-Scholes model and the Company recognized $415,000 as acharge to additional paid-in-capital to account for the deemed dividend on the preferred stock, asof the issuance date, which represented the amount of the proceeds allocated to the preferredstock. The warrants issued as of July 5, 2005 (excluding the warrants issued to the placementagents in such closing) were valued at $244,000, using a Black-Scholes model and the Companyrecognized $196,000 as a charge to additional paid-in-capital to account for the deemed dividend onthe preferred stock, as of the issuance date, which represented the amount of the proceedsallocated to the preferred stock. The amount of the deemed dividend related to the beneficialconversion feature was recorded upon the issuance of the preferred stock, as the preferred stockcan be converted to ADSs by the holder at any time.The following table summarizes the warrant activity during the nine months ended September 30,2005.           Warrants outstanding Warrants outstanding  and exercisable exercise priceBalance, December 31, 2004  2,130,911  $0.92-$5.00          Granted  7,916,425   0.37-$1.11(1)Exercised  —   —        Balance, September 30, 2005  10,047,336  $0.37 - $5.00(1)        (1) 2,000,000 of the warrants are exercisable at £0.205 ($0.37 as of September 30, 2005),2,000,000 at the greater of £0.205 or $0.40 and 3,036,403 of the warrants are exercisable at the greater of£0.205 or $0.50.**Note 9. Related party transaction**On March 16, 2005, we closed our acquisition of Mi4e. The consideration paid in the transaction was2,969,692 ADSs representing ordinary shares and another 989,896 ADSs issuable on March 31, 2006,subject to potential offset for breach of representations, warranties and covenants. In addition upto a maximum of 700,000 Euros is payable in cash in a potential earn out based on a percentage offuture revenue collected from sales of existing Mi4e products. As of September 30, 2005, $109,000of this earn-out was earned and accrued for in accrued liabilities in the accompanying consolidatedbalance sheet. Anders Furehed, our senior vice president of European operations, was an indirect50% shareholder of Mi4e and thus received 1,484,846 ADSs on the closing of the acquisition.**Note 10. Notes payable**In connection with the March 16, 2005 acquisition of Mi4e, Insignia assumed two notes payable. Thelargest note is to ALMI Företags Partner (“ALMI”) and is referred to as a “regional developmentloan”. The total loan amount in Swedish Krona (“SEK”) was SEK 700,000 or approximately $90,000.This note is to be repaid by February 28, 2007 in quarterly installments of approximately SEK54,000 or approximately $7,000. The interest rate on this note from July 1, 2005 is 8.75% perannum. As of September 30, 2005, the outstanding balance of the ALMI note was approximately SEK285,000 or approximately $37,000. This loan is secured by a chattel mortgage in the amount of SEK700,000 or approximately $90,000.In addition to the ALMI note payable, there is a note payable from Skandinaviska Enskilda Banken(“SEB”). The total note amount was SEK 300,000 or approximately $39,000. The interest rate on theSEB note is
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approximately 6.75% per annum. As of September 30, 2005, the outstanding balance was approximatelySEK 133,000 or approximately $17,000. This note is to be repaid by January 2007 in monthlyinstallments of approximately SEK 8,000 or approximately $1,000. This loan is secured by a chattelmortgage in the amount of SEK 500,000 or approximately $64,000.We also have a line of credit of SEK 200,000 or approximately $25,500 with SEB. As of September30, 2005, there was no balance outstanding under this line. There is a commitment fee of 1.5% perannum on this line of credit and the borrowings bear interest at the rate of 5% per annum.On November 4, 2005, we issued a promissory note to Fusion Capital in the amount of $450,000 inconnection with a loan by Fusion Capital to Insignia in the amount of $150,0000 on September 22,2005 and $300,000 on November 4, 2005. The annual interest rate of the loan is 17% on theoutstanding balance computed on a basis of a 360-day year and the number of actual days lapsed.The maturity date of the loan is January 1, 2007.**Note 11. Share and nominal value**At our general meeting of shareholders held on September 30, 2005, our shareholders approvedan increase of 35,000,000 ordinary shares to our authorized share capital and a reduction of thenominal value of our ordinary shares from 20 pence per share to 1 pence per share. The reduction inthe nominal value of our ordinary shares will become effective once the order of the English HighCourt confirming it is registered with the U.K. Registrar of Companies, which we expect to becompleted by the end of January 2006. The increase in our authorized share capital is conditionalupon the reduction of the nominal value of our ordinary shares becoming effective.**Note 12. Subsequent Events**Silicon Valley Bank LoanOn October 3, 2005, Insignia entered into a Loan and Security Agreement with Silicon Valley Bankpursuant to which Insignia may request that Silicon Valley Bank finance certain eligible accountsreceivable (each, a “financed receivable”) by extending credit to Insignia in an amount equal to80% of such financed receivable (subject to certain adjustments). Accounts receivable arecurrently our most readily available collateral. The aggregate amount of financed receivablesoutstanding at any time may not exceed $1,250,000. On the maximum receivables of $1,250,000, wecan borrow up to $1,000,000. Insignia must pay a finance charge on each financed receivable inthe amount equal to (i) 2% plus the greater of 6.5% or Silicon Valley Bank’s most recentlyannounced prime rate, (ii) divided by 360, (iii) multiplied by the number of days each suchfinanced receivable is outstanding and (iv) multiplied by the total outstanding gross face amountfor such financed receivable. As security for the loan, Insignia granted Silicon Valley Bank afirst priority security interest in substantially all its assets, including intellectual property.Upon execution of the Loan and Security Agreement, Insignia paid Silicon Valley Bank anon-refundable facility fee of $15,000. The Loan and Security Agreement terminates on October 2,2006, and all obligations outstanding thereunder are due and payable on that date.Fusion Capital LoanOn November 4, 2005, we issued a promissory note to Fusion Capital in the amount of $450,000 inconnection with a loan by Fusion Capital to Insignia in the amount of $150,000 on September 22,2005 and $300,000 on November 4, 2005. The annual interest rate of the loan is 17% on theoutstanding balance computed on a basis of a 360-day year and the number of actual days lapsed.The maturity date of the loan is January 1, 2007. In connection with the loan, we issued toFusion Capital a warrant to purchase 562,500 ADSs at a purchase price per share equal to thegreater of the U.S. Dollar equivalent of 20.5 UK pence or U.S. $0.60, calculated upon exercise ofsuch warrant. The warrant is exercisable immediately and expires on November 3, 2010.
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**Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations**The following discussion and analysis should be read in conjunction with the unaudited condensedconsolidated financial statements and notes thereto included in Part I — Item 1 of this Form 10-Qand the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” setforth in Insignia’s Form 10-K for the year ended December 31, 2004 (the “Form 10-K”) filed with theSecurities and Exchange Commission.*This Form 10-Q contains forward-looking statements regarding future events and our future resultsthat are subject to the safe harbors created under the Securities Act of 1933, as amended (the“Securities Act”) and the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Wordssuch as “anticipates,” “believes,” “expects,” “future,” and “intends,” and similar expressions areused to identify forward-looking statements. These forward-looking statements concern matters whichinclude, but are not limited to, the revenue model and market for our products, its features,benefits and advantages of our international operations and sales, gross margins, spending levels,the availability of licenses to third-party proprietary rights, business and sales strategies,matters relating to proprietary rights, competition, exchange rate fluctuations and our liquidityand capital needs. These and other statements regarding matters that are not historical areforward-looking statements. These matters involve risks and uncertainties that could cause actualresults to differ materially from those in the forward-looking statements. Factors that could causeor contribute to such differences in results and outcomes include without limitation thosediscussed below under the caption “Risk Factors” as well as those discussed elsewhere in thisReport. Readers are cautioned not to place undue reliance on these forward-looking statements,which reflect management’s analysis only as of the date hereof. We assume no obligation to updatethese forward-looking statements to reflect actual results or changes in factors or assumptionsaffecting such forward-looking statements.*
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The following table sets forth the unaudited condensed consolidated results of operations as apercentage of total revenues for the three- and nine-month periods ended September 30, 2005 and2004.                   Three months ended  Nine months ended   September 30,  September 30,   2005  2004  2005  2004 Net revenues:                License  57.9 %  93.5 %  69.1 %  97.7 %Service  42.1 %  6.5 %  30.9 %  2.3 %                              Total net revenues  100.0 %  100.0 %  100.0 %  100.0 %                              Cost of net revenues:                License  5.2 %  0.0 %  6.3 %  5.3 %Service  18.7 %  0.0 %  8.3 %  0.0 %                              Total cost of net revenues  23.9 %  0.0 %  14.6 %  5.3 %                              Gross margin  76.1 %  100.0 %  85.4 %  94.7 %                              Operating expenses:                Sales and marketing  75.8 %  540.2 %  96.9 %  360.6 %Research and development  69.0 %  611.2 %  107.3 %  399.1 %General and administrative  93.9 %  563.6 %  112.0 %  349.7 %Amortization of intangible assets  12.1 %  0.0 %  10.4 %  0.0 %                              Total operating expenses  250.7 %  1,715.0 %  326.6 %  1,109.4 %                              Operating loss  (174.7  )%  (1,615.0  )%  (241.1  )%  (1,014.6  )%Interest income (expense), net  0.2 %  3.7 %  (2.0)  %  1.1 %Other income(expense), net  2.1 %  (2.8 )%  1.2 %  46.5 %                              Loss before income taxes  (172.3  )%  (1,614.0  )%  (242.0  )%  (967.0  )%Provision (benefit) for incometaxes  0.6 %  1.9 %  2.1 %  (39.6  )%                              Net loss  (172.9  )%  (1,615.9  )%  (244.0  )%  (927.4  )%             **Overview**We commenced operations in 1986, and currently develop, market and support software technologiesthat enable mobile operators and phone manufacturers to update the firmware of mobile devices usingstandard over-the-air data networks. Before 2003, our principal product line was the JeodeTMplatform, based on our Embedded Virtual Machine (“EVM”TM) technology.During 2001, we began development of a range of products (“Secure System Provisioning” or “SSP”products) for the mobile phone and wireless operator industry. These SSP products build on ourposition as a Virtual Machine (“VM”) supplier for manufacturers of mobile devices and allowwireless operators and phone manufacturers to reduce customer care and software recall costs aswell as increase subscriber revenue by deploying new mobile services based on dynamicallyprovisional capabilities. With the sale of our JVM product
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line in April 2003, our sole product line then consisted of our SSP product. We shipped our firstSSP product in December 2003, and in October 2004 we launched our Open Management Client (“OMC”)product.On March 16, 2005, we closed our acquisition of Mi4e Device Management AB (“Mi4e”), a privatecompany headquartered in Stockholm, Sweden. The consideration paid in the transaction was 2,969,692American depositary shares (ADSs) representing ordinary shares, and another 989,896 ADSs areissuable on March 31, 2006, subject to potential offset for breach of representations, warrantiesand covenants. In addition, up to a maximum of 700,000 Euros is payable in a potential earn-outbased on a percentage of future revenue collected from sales of existing Mi4e products. As ofSeptember 30, 2005, $109,000 was earned and accrued for in the accompanying consolidated balancesheet. Mi4e develops, markets and supports software technologies that enable mobile operators andphone manufacturers to update firmware of mobile devices using standards over-the-air datanetworks. Its main product, a Device Management Server (“DMS”), is a mobile device managementinfrastructure solution for mobile operators that support the Open Mobile Alliance (“OMA”) ClientProvisioning Specification. DMS was first deployed at Telstra in Australia in 2000 and has sincebeen deployed at more than ten carriers around the world. By integrating the Mi4e capabilities withexisting Insignia applications, our strategy is to deliver comprehensive solutions across multiplegenerations of technology and therefore resolve firmware update and compatibility issues forcurrent and future users who require over-the-air repair.Currently we primarily offer the SSP, DMS and OMC product lines. Our revenues from these productsare derived from: **•** initial licensing fees  **•** royalties paid based on volume of users  **•** support and maintenance fees  **•** trial and installation  **•** subscription fees for hosting services  **•** engineering servicesOur operations outside of the United States are primarily in the United Kingdom and Sweden, wherepart of our research and development operations and our European sales activities are located. Wesell our products directly to operators, distributors and original equipment manufacturers(“OEMs”). Our revenues from customers outside the United States are derived primarily from Europeand Asia and are generally affected by the same factors as our revenues from customers in theUnited States. The operating expenses of our operations outside the United States are mostlyincurred in Europe and relate to our research and development and European sales activities. Suchexpenses consist primarily of ongoing fixed costs and consequently do not fluctuate in directproportion to revenues. Our revenues and expenses outside the United States can fluctuate fromperiod to period based on movements in currency exchange rates. Historically, movements in currencyexchange rates have not had a material effect on our revenues and expenses.We operate with the U.S. dollar as our functional currency, with a majority of revenues andoperating expenses denominated in Euros, U.S. dollars, British pounds sterling and Swedish Krona.Exchange rate fluctuations against the dollar can cause U.K. and Swedish expenses, which aretranslated into dollars for financial statement reporting purposes, to vary from period-to-period.**Critical Accounting Policies and Estimates**The condensed consolidated financial statements are prepared in accordance with accountingprinciples generally accepted in the United States of America. Certain of our accounting policiesrequire the application of
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significant judgment by management in selecting the appropriate assumptions for calculatingfinancial estimates. These estimates affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the dates of the financial statements and thereported amounts of revenues and expenses during the reporting periods. By their nature, thesejudgments are subject to an inherent degree of uncertainty. The most significant estimates andassumptions relate to revenue recognition, the adequacy of allowances for doubtful accounts,long-lived assets, the valuation allowance on deferred tax assets,and business combinations. Actual amounts could differ from these estimates.***Revenue recognition***We recognize revenue in accordance with Statement of Position No. 97-2 (“SOP 97-2”), “SoftwareRevenue Recognition”, and Statement of Position No. 98-9, “Modification of SOP No. 97-2.” TheseStatements of Position require that four basic criteria must be met before revenue can berecognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or servicesrendered; (3) the fee is fixed or determinable; and (4) collectibility is probable. Determinationof criteria (3) and (4) are based on management’s judgments regarding the fixed nature of the feecharged for services rendered and products delivered and the collectibility of those fees. Shouldchanges in conditions cause management to determine these criteria are not met for certain futuretransactions, revenue recognized for any reporting period could be adversely affected.At the time of the transaction, we assess whether the fee associated with our revenue transactionis fixed or determinable and whether or not collection is probable. We assess whether the fee isfixed or determinable based on the payment terms associated with the transaction. If a significantportion of a fee is due after the normal payment terms, which are 30 to 90 days from invoice date,we account for the fee as not being fixed or determinable. In these cases, we recognize revenue onthe earlier of due date or the date on which cash is collected.We assess collectibility based on a number of factors, including past transaction history with thecustomer and the credit-worthiness of the customer. We do not request collateral from ourcustomers. If we determine that collection of a fee is not probable, we will defer the fee andrecognize revenue at the time collection becomes probable, which is generally upon receipt of cash.For all sales, we use either a signed license agreement or a binding purchase order (primarily formaintenance renewals) as evidence of an arrangement.For arrangements with multiple obligations (for example, undelivered maintenance and support), wewill allocate revenue to each component of the arrangement using the residual value method based onthe fair value of the undelivered elements, which is specific to us. This means that we will deferrevenue from the arrangement fee equivalent to the fair value of the undelivered elements. Fairvalue for the ongoing maintenance and support obligation is based upon separate sales of renewalsto other customers or upon renewal rates quoted in the contracts. Fair value of services, such astraining or consulting, is based upon separate sales by us of these services to other customers.Our arrangements do not generally include acceptance clauses. However, if an arrangement includesan acceptance provision, acceptance occurs upon the earlier of receipt of written customeracceptance or expiration of the acceptance period.We recognize revenue for maintenance and hosting services ratably over the contract term. Ourtraining and consulting services are billed based on hourly rates, and we will generally recognizerevenue as these services are performed. However, at the time of entering into a transaction, wewill assess whether or not any services included within the arrangement require us to performsignificant work either to alter the underlying software or to build additional complex interfacesso that the software performs as the customer requests. If these services
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are included as part of an arrangement, we recognize the entire fee using the percentage ofcompletion method. We estimate the percentage of completion based on our estimate of the totalcosts estimated to complete the project as a percentage of the costs incurred to date and theestimated costs to complete.***Accounts receivable and allowance for doubtful accounts***We perform ongoing credit evaluations of our customers and will adjust credit limits based uponpayment history and the customer’s current creditworthiness, as determined by our review of theircurrent credit information. We continuously monitor collections and payments from our customers andmaintain an allowance for doubtful accounts based upon historical experience and any specificcustomer collection issues that we have identified. While such credit losses have historically beenwithin expectations and the allowance established, credit loss rates may increase. Since ouraccounts receivable are concentrated in a relatively few number of customers, a significant changein the liquidity or financial position of any one of these customers could have a material adverseimpact on the collectibility of accounts receivables and future operating results.The preparation of financial statements requires us to make estimates of the uncollectibility ofour accounts receivables. We specifically analyze accounts receivable and analyze historical baddebts, customer concentrations, customer creditworthiness, current economic trends and changes inour customer payment terms when evaluating the adequacy of the allowance for doubtful accounts.***Long-LivedAssets***Weperiodically review our property and equipment and identifiableintangible assets for possible impairment whenever facts andcircumstances indicate that the carrying amount may not be fullyrecoverable. Assumptions and estimates used in the evaluation ofimpairment may affect the carrying value of long-lived assets, whichcould result  in impairment charges in future periods. Significantassumptions and estimates include the projected cash flows based uponestimated revenue and expense growth rates and the discount rateapplied to expected cash flows. In addition, our depreciation andamortization policies reflect judgments on the estimated useful livesof assets.***DeferredTaxes***Wecurrently have significant deferred tax assets, which are subject toperiodic recoverability assessments. We record a valuation allowanceto reduce our deferred tax assets to the amount that we believe to bemore likely than not realizable. We have recorded a valuationallowance in an amount equal to the net deferred tax assets toreflect uncertainty regarding future realization of these assetsbased on past performance and the likelihood of realization of ourdeferred tax assets.***BusinessCombinations***Inaccordance with the provisions of Statement of Financial AccountingStandards No. 141, “Business Combinations”, thepurchase price of an acquired company is allocated between theintangible assets and the net tangible assets of the acquiredbusiness with the residual of the purchase price recorded asgoodwill. Our future operating performance will be impacted by thefuture amortization of these acquired intangible assets and potentialimpairment charges related to goodwill if indicators of potentialimpairment exist. As a result of business acquisitions, theallocation of the purchase price to goodwill and intangible assetscould have a significant impact on our future operating results. Theallocation of the purchase price of the acquired companies togoodwill and intangible assets requires us to make significantestimates and assumptions, including estimates of future cash flowsexpected to be generated by the acquired assets and the appropriatediscount rate for these cash flows. Should conditions be differentfrom management’s current estimates, material write-downs ofintangible assets or goodwill may be required, which would adverselyaffect our operating results.Inaccordance with the provisions of Statement of Financial AccountingStandards No. 142, “Goodwill and Other IntangibleAssets”, we assess goodwill and intangible assets withindefinite lives for impairment at least annually, or more frequentlyif events and changes in circumstances suggest that the carryingamount may not be recoverable. To the extent the carrying amount exceeds its fair value, an impairment charge to operations isrecorded. At September 30, 2005, the carrying value of goodwillwas $503,000.**Results of Operations*****Revenues***