** **

**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-Q**

** **
| **(Mark One)**                                                                                                            |                                                                                                          |
|---------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------|
| ý                                                                                                                    | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**  |
| **For the Quarterly Period Ended September 30, 2003**                                                                     |
| **Or**                                                                                                                    |
| o                                                                                                                         | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
| **For the transition period  from       to       ** |

 

**CommissionFile Number 0-30881**

 

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**CLICKCOMMERCE, INC.**

(Exact name of registrant asspecified in its charter)

 

| **Delaware**

(State or other jurisdiction

of incorporation or organization)                                  |   | **36-4088644**

(I.R.S. Employer Identification Number) |
|----------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------|
|                                                                                                           |   |                                                    |
| **200 East Randolph Drive, 52nd Floor**

**Chicago, Illinois 60601**

(Address of principal executive offices) |
|                                                                                                           |   |                                                    |
| **(312) 482-9006**

(Registrant’s telephone number, including area code)                             |

 

**Securitiesregistered pursuant to Section 12(b) of the Act: None**

**Securitiesregistered pursuant to Section 12(g) of the Act:**

**CommonStock, par value $0.001 per share**

 

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                Indicate by check mark whetherthe registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes ý  No o

 

                Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Exchange ActRule 12b-2). Yes o  No ý

 

                As of November 4, 2003, therewere 8,336,643 shares of the registrant’s common shares outstanding.

 

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**CLICKCOMMERCE, INC.**

**INDEX**

 
|           |                                                                                                                                                               |   |
|----------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| **PART I.**    | **FINANCIAL INFORMATION**                                                                                                                                          |   |
|           |                                                                                                                                                               |   |
| Item 1.        | Financial Statements                                                                                                                                               |   |
|           |                                                                                                                                                               |   |
|           | Condensed  Consolidated Balance Sheets as of September 30, 2003 (unaudited) and  December 31, 2002                                                       |   |
|           |                                                                                                                                                               |   |
|           | Condensed  Consolidated Statements of Operations and Comprehensive Income (Loss) for the  three and nine months ended September 30, 2003 and 2002 (unaudited) |   |
|           |                                                                                                                                                               |   |
|           | Condensed  Consolidated Statements of Cash Flows for the nine months ended  September 30, 2003 and 2002 (unaudited)                                           |   |
|           |                                                                                                                                                               |   |
|           | Notes  to Condensed Consolidated Financial Statements (unaudited)                                                                                                  |   |
|           |                                                                                                                                                               |   |
| Item  2.       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                        |   |
|           |                                                                                                                                                               |   |
| Item  3.       | Quantitative  and Qualitative Disclosures About Market Risk                                                                                                        |   |
|           |                                                                                                                                                               |   |
| Item 4.        | Controls and Procedures                                                                                                                                            |   |
|           |                                                                                                                                                               |   |
| **PART II.**   | **OTHER INFORMATION**                                                                                                                                              |   |
|           |                                                                                                                                                               |   |
| Item 1.        | Legal Proceedings                                                                                                                                                  |   |
|           |                                                                                                                                                               |   |
| Item  2.       | Changes  in Securities and Use of Proceeds                                                                                                                         |   |
|           |                                                                                                                                                               |   |
| Item 3.        | Defaults Upon  Senior Securities                                                                                                                                   |   |
|           |                                                                                                                                                               |   |
| Item  4.       | Submission  of Matters to a Vote of Security Holders                                                                                                               |   |
|           |                                                                                                                                                               |   |
| Item 5.        | Other Information                                                                                                                                                  |   |
|           |                                                                                                                                                               |   |
| Item 6.        | Exhibits  and Reports on Form 8-K                                                                                                                             |   |
|           |                                                                                                                                                               |   |
| **SIGNATURES** |                                                                                                                                                               |

 

2

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**PARTI.  FINANCIAL INFORMATION**

 

**Item 1.  FinancialStatements**

 

**CLICK COMMERCE, INC.**

 

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Dollars inthousands, except per share data)**

 
|                                                                                                                                              |   | **September  30, 2003** |       | **December  31, 2002** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|------------|------------------------|--------|
|                                                                                                                                              |   | **(unaudited)**         | ** ** |                   |   |
| **ASSETS**                                                                                                                                        |   |                    |       |                   |   |
| Current assets:                                                                                                                                   |   |                    |       |                   |   |
| Cash and cash equivalents                                                                                                                         |   | $                       | 11,372     |                   | $      | 23,646 |   |
| Short-term investments                                                                                                                            |   | —                  |       | 10,367                 |   |
| Trade accounts receivable, net                                                                                                                    |   | 4,544                   |       | 4,912                  |   |
| Prepaids and other current assets                                                                                                                 |   | 1,051                   |       | 920                    |   |
| Total current assets                                                                                                                              |   | 16,967                  |       | 39,845                 |   |
| Property and equipment, net                                                                                                                       |   | 927                     |       | 2,333                  |   |
| Restricted cash                                                                                                                                   |   | 170                     |       | —                 |   |
| Goodwill and intangible assets                                                                                                                    |   | 426                     |       | —                 |   |
| Other assets                                                                                                                                      |   | 305                     |       | 104                    |   |
| Total assets                                                                                                                                      |   | $                       | 18,795     |                   | $      | 42,282 |   |
|                                                                                                                                              |   |                    |       |                   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                     |   |                    |       |                   |   |
| Current liabilities:                                                                                                                              |   |                    |       |                   |   |
| Accounts payable                                                                                                                                  |   | $                       | 855        |                   | $      | 504 |   |
| Billings in excess of revenues earned on contracts in progress                                                                                    |   | 428                     |       | 376                    |   |
| Deferred revenue                                                                                                                                  |   | 4,439                   |       | 3,774                  |   |
| Accrued compensation                                                                                                                              |   | 1,053                   |       | 727                    |   |
| Accrued expenses and other current liabilities                                                                                                    |   | 1,647                   |       | 1,408                  |   |
| Restructuring accrual                                                                                                                             |   | 225                     |       | 282                    |   |
| Current portion of capital lease obligations                                                                                                      |   | 264                     |       | 643                    |   |
| Total current liabilities                                                                                                                         |   | 8,911                   |       | 7,714                  |   |
| Capital lease obligations, less current portion                                                                                                   |   | —                  |       | 47                     |   |
| Accrued restructuring, long term                                                                                                                  |   | 97                      |       | —                 |   |
| Total liabilities                                                                                                                                 |   | 9,008                   |       | 7,761                  |   |
|                                                                                                                                              |   |                    |       |                   |   |
| Shareholders’ equity:                                                                                                                        |   |                    |       |                   |   |
| Preferred stock, $0.001 par value, 5,000,000 shares authorized, no  shares issued and outstanding                                                 |   | —                  |       | —                 |   |
| Common stock, $0.001 par value, 75,000,000 shares authorized;  8,165,707 and 8,121,850 shares issued; 8,136,643 and 8,092,786 shares  outstanding |   | 8                       |       | 8                      |   |
| Additional paid-in capital                                                                                                                        |   | 62,252                  |       | 82,532                 |   |
| Accumulated other comprehensive income                                                                                                            |   | 135                     |       | 148                    |   |
| Deferred compensation                                                                                                                             |   | (194                    | )          | (246                   | )      |
| Treasury stock, at cost—29,064 shares                                                                                                        |   | (117                    | )          | (117                   | )      |
| Accumulated deficit                                                                                                                               |   | (52,297                 | )          | (47,804                | )      |
| Total shareholders’ equity                                                                                                                   |   | 9,787                   |       | 34,521                 |   |
| Total liabilities and shareholders’ equity                                                                                                   |   | $                       | 18,795     |                   | $      | 42,282 |   |

 

The accompanying notes arean integral part of these condensed consolidated financial statements.

 

3

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**CLICKCOMMERCE, INC.**

 

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND**

## **COMPREHENSIVEINCOME (LOSS)**

**(Dollars inthousands, except per share data)**

**(Unaudited)**

** **
|                                                                                                                                                                                                                                                                                 |   | **Three  months ended September 30,** |   | **Nine  months ended September 30,** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------|--------|
|                                                                                                                                                                                                                                                                                 |   | **2003**                                   |   | **2002**                                  |   | **2003** |   | **2002** |   |
| Revenues                                                                                                                                                                                                                                                                             |   |                                       |   |                                      |   |   |   |   |   |
| Product license                                                                                                                                                                                                                                                                      |   | $                                          | 584    |                                      | $      | 214 |   | $ | 1,452 |   | $ | 1,530 |   |
| Subscription                                                                                                                                                                                                                                                                         |   | 571                                        |   | —                                    |   | 1,515 |   | — |   |
| Maintenance and hosting                                                                                                                                                                                                                                                              |   | 1,692                                      |   | 1,688                                     |   | 4,868 |   | 5,359 |   |
| Service                                                                                                                                                                                                                                                                              |   | 2,194                                      |   | 1,584                                     |   | 5,209 |   | 7,356 |   |
| Total revenues                                                                                                                                                                                                                                                                       |   | 5,041                                      |   | 3,486                                     |   | 13,044 |   | 14,245 |   |
| Cost of revenues                                                                                                                                                                                                                                                                     |   |                                       |   |                                      |   |   |   |   |   |
| Product                                                                                                                                                                                                                                                                              |   | 69                                         |   | 190                                       |   | 295 |   | 522 |   |
| Service (exclusive of $2 and $16 for the three months ended  September 30, 2003 and 2002, respectively, and $5 and $46 for the nine  months ended September 30, 2003 and 2002 respectively, reported below as  amortization of stock-based compensation)                   |   | 2,197                                      |   | 1,952                                     |   | 6,310 |   | 6,534 |   |
| Total cost of revenues                                                                                                                                                                                                                                                               |   | 2,266                                      |   | 2,142                                     |   | 6,605 |   | 7,056 |   |
| Gross profit                                                                                                                                                                                                                                                                         |   | 2,775                                      |   | 1,344                                     |   | 6,439 |   | 7,189 |   |
| Operating expenses:                                                                                                                                                                                                                                                                  |   |                                       |   |                                      |   |   |   |   |   |
| Sales and marketing (exclusive of $6 and $353 for the three months  ended September 30, 2003 and 2002, respectively, and $44 and $1,085 for  the nine months ended September 30, 2003 and 2002, respectively,  reported below as amortization of stock-based compensation) |   | 676                                        |   | 1,488                                     |   | 2,508 |   | 8,084 |   |
| Research and development (exclusive of $2 for the three months ended  September 30,  2002,  and $2 and $7 for the nine months ended  September 30, 2003 and 2002, respectively, reported below as  amortization of stock-based compensation)                     |   | 587                                        |   | 880                                       |   | 1,928 |   | 3,766 |   |
| General and administrative (exclusive of $14 for the three months  ended September 30, 2002,  and  $59 for the nine months ended September 30,  2002,  reported below as  amortization of stock-based compensation)                                         |   | 891                                        |   | 963                                       |   | 3,737 |   | 3,639 |   |
| Amortization of stock-based compensation                                                                                                                                                                                                                                             |   | 8                                          |   | 385                                       |   | 51 |   | 1,197 |   |
| Amortization of intangible assets                                                                                                                                                                                                                                                    |   | 40                                         |   | —                                    |   | 68 |   | — |   |
| Restructuring and other charges (recoveries)                                                                                                                                                                                                                                         |   | (983                                       | )      | —                                    |   | 2,959 |   | 1,213 |   |
| Total operating expenses                                                                                                                                                                                                                                                             |   | 1,219                                      |   | 3,716                                     |   | 11,251 |   | 17,899 |   |
| Operating income (loss)                                                                                                                                                                                                                                                              |   | 1,556                                      |   | (2,372                                    | )      | (4,812 | ) | (10,710 | ) |
| Interest income                                                                                                                                                                                                                                                                      |   | 23                                         |   | 199                                       |   | 281 |   | 633 |   |
| Interest expense                                                                                                                                                                                                                                                                     |   | (1                                         | )      | (26                                       | )      | (13 | ) | (58 | ) |
| Other income (expense)                                                                                                                                                                                                                                                               |   | (3                                         | )      | —                                    |   | 51 |   | — |   |
| Income (loss) before income taxes                                                                                                                                                                                                                                                    |   | 1,575                                      |   | (2,199                                    | )      | (4,493 | ) | (10,135 | ) |
| Income tax expense (benefit)                                                                                                                                                                                                                                                         |   | —                                     |   | —                                    |   | — |   | — |   |
| Net income (loss)                                                                                                                                                                                                                                                                    |   | $                                          | 1,575  |                                      | $      | (2,199 | ) | $ | (4,493 | ) | $ | (10,135 | ) |
| Basic net income (loss) per common share                                                                                                                                                                                                                                             |   | $                                          | 0.19   |                                      | $      | (0.27 | ) | $ | (0.55 | ) | $ | (1.26 | ) |
| Diluted net income (loss) per common share                                                                                                                                                                                                                                           |   | $                                          | 0.19   |                                      | $      | (0.27 | ) | $ | (0.55 | ) | $ | (1.26 | ) |
| Weighted average common shares outstanding—basic                                                                                                                                                                                                                                |   | 8,136,643                                  |   | 8,040,148                                 |   | 8,117,148 |   | 8,047,879 |   |
| Weighted average common shares outstanding—diluted                                                                                                                                                                                                                              |   | 8,186,102                                  |   | 8,040,148                                 |   | 8,117,148 |   | 8,047,879 |   |
| Comprehensive income (loss):                                                                                                                                                                                                                                                         |   |                                       |   |                                      |   |   |   |   |   |
| Net income (loss)                                                                                                                                                                                                                                                                    |   | $                                          | 1,575  |                                      | $      | (2,199 | ) | $ | (4,493 | ) | $ | (10,135 | ) |
| Foreign currency translation adjustment                                                                                                                                                                                                                                              |   | (9                                         | )      | 48                                        |   | (13 | ) | 93 |   |
| Comprehensive income (loss)                                                                                                                                                                                                                                                          |   | $                                          | 1,566  |                                      | $      | (2,151 | ) | $ | (4,506 | ) | $ | (10,042 | ) |

 

The accompanying notes arean integral part of these condensed consolidated financial statements.

 

4

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**CLICK COMMERCE, INC.**

 

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Dollars inthousands)**

**(Unaudited)**

 
|                                                                         |   | **Nine  months ended  September 30,** |   |
|------------------------------------------------------------------------------|--------|--------------------------------------------|--------|
|                                                                         |   | **2003**                                   |   | **2002** |   |
| **Cash flows from operating activities:**                                    |   |                                       |   |   |   |
| Net loss                                                                     |   | $                                          | (4,493 | ) | $ | (10,135 | ) |
| Adjustments to reconcile net loss to net cash used in operating  activities: |   |                                       |   |   |   |
| Amortization of stock-based compensation                                     |   | 51                                         |   | 1,197 |   |
| Depreciation and amortization                                                |   | 909                                        |   | 1,181 |   |
| Provision for doubtful accounts                                              |   | 89                                         |   | 312 |   |
| Amortization of deferred compensation                                        |   | —                                     |   | 184 |   |
| Restructuring and other charges, net of payments                             |   | 1,192                                      |   | 3 |   |
| Changes in operating assets and liabilities, net of effect of  acquisition   |   |                                       |   |   |   |
| Trade accounts receivable                                                    |   | 2,313                                      |   | 3,903 |   |
| Other current assets                                                         |   | 547                                        |   | 1,246 |   |
| Other assets                                                                 |   | 23                                         |   | 221 |   |
| Accounts payable                                                             |   | (491                                       | )      | (635 | ) |
| Billings in excess of revenues earned on contracts in progress               |   | 52                                         |   | (179 | ) |
| Deferred revenue                                                             |   | (970                                       | )      | 24 |   |
| Accrued compensation                                                         |   | (992                                       | )      | (504 | ) |
| Accrued expenses and other current liabilities                               |   | (79                                        | )      | (907 | ) |
| Net cash used in operating activities                                        |   | (1,849                                     | )      | (4,089 | ) |
|                                                                         |   |                                       |   |   |   |
| **Cash flows from investing activities:**                                    |   |                                       |   |   |   |
| Purchases of property and equipment                                          |   | (46                                        | )      | (331 | ) |
| Acquisition of Allegis, net of deal costs                                    |   | 176                                        |   | — |   |
| Redemptions (purchases) of short-term investments, net                       |   | 10,367                                     |   | (10,295 | ) |
| Purchase of long-term investments                                            |   | (200                                       | )      | — |   |
| Net cash provided by (used in) investing activities                          |   | 10,297                                     |   | (10,626 | ) |
|                                                                         |   |                                       |   |   |   |
| **Cash flows from financing activities:**                                    |   |                                       |   |   |   |
| Proceeds from exercise of stock options                                      |   | 62                                         |   | 32 |   |
| Purchase of treasury stock                                                   |   | —                                     |   | (111 | ) |
| Payment of special dividend                                                  |   | (20,342                                    | )      | — |   |
| Principal payments under capital lease obligations                           |   | (429                                       | )      | (636 | ) |
| Net cash used in financing activities                                        |   | (20,709                                    | )      | (715 | ) |
| Effect of foreign exchange rates on cash and cash equivalents                |   | (13                                        | )      | 93 |   |
| Net decrease in cash and cash equivalents                                    |   | (12,274                                    | )      | (15,337 | ) |
| Cash and cash equivalents at beginning of period                             |   | 23,646                                     |   | 40,677 |   |
| Cash and cash equivalents at end of period                                   |   | $                                          | 11,372 |   | $ | 25,340 |   |
|                                                                         |   |                                       |   |   |   |
| **Supplemental disclosures:**                                                |   |                                       |   |   |   |
| Interest paid                                                                |   | $                                          | 14     |   | $ | 58 |   |
| Income taxes paid                                                            |   | $                                          | — |   | $ | — |   |

 

The accompanying notes arean integral part of these condensed consolidated financial statements.

 

5

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**CLICK COMMERCE, INC.**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**1.             BASIS OFPRESENTATION**

 

                The unaudited condensedconsolidated financial statements include the accounts of Click Commerce, Inc.and its wholly owned subsidiaries (the “Company”) and reflect all adjustments(which are normal and recurring in nature) that, in the opinion of management,are necessary for a fair presentation of the interim periods presented. Theresults of operations for the interim periods presented are not necessarilyindicative of the results to be expected for any subsequent quarter or for theentire fiscal year ending December 31, 2003. Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been condensed or omitted in accordance with the Securities andExchange Commission’s rules and regulations. The unaudited condensedconsolidated financial statements and notes included herein should be read inconjunction with the Company’s audited consolidated financial statements andnotes included in the Company’s Annual Report on Form 10-K and otherdocuments that have been filed with the Securities and Exchange Commission.

 

                Certain prior year amounts havebeen reclassified to conform to the 2003 presentation.

 

**2.             SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

 

**Revenue and Cost Recognition**

 

                The Company recognizes productlicense revenue from licensing the rights to use its software on a perpetualbasis. Software licenses that are limited in duration are recognized assubscriptions. The Company generates service revenues from integrating itssoftware, performing needs analyses for customers and providing trainingservices. Maintenance and hosting revenues are generated under contracts thatprovide customers with maintenance, product support and hosting services. TheCompany recognizes revenue in accordance with Statement of Position (“SOP”)No. 97-2 *“Software Revenue Recognition”*as amended by SOP 98-9, *“Modification of SOP97-2, Software Revenue Recognition, with Respect to Certain Transactions.”*For those contracts that either do not contain a services component or thathave services which are not essential to the functionality of any other elementof the contract, software license revenue is recognized upon delivery of theCompany’s software provided that the fee is fixed and determinable, persuasiveevidence of an arrangement exists and collection of the resulting receivable isconsidered probable. Revenue from service contracts is typically recognized asthe services are performed. The revenue to be recognized from multiple-elementsoftware contracts is based on the fair value of each element. The Companyrecords deferred revenue on software contracts for which it has billed orcollected amounts, but for which the requirements for revenue recognition havenot been met.

 

                In accordance with EITFNo. 01-14, the Company characterizes the reimbursement of out-of-pocketexpenses from their customers as revenue, rather than as a reduction of therelated expense in the income statement.

 

                Revenue from contracts in whichthe Company’s services are essential to the functionality of the other elementsof the contract is recognized using the percentage-of-completion method undercontract accounting as services are performed or output milestones are reached,as the Company delivers, customizes and installs the software. The percentagecompleted is measured either by the percentage of labor hours incurred to datein relation to estimated total labor hours or in consideration of achievementof certain output milestones, depending on the specific nature of eachcontract. For arrangements in which percentage-of-completion accounting isused, the Company records cash receipts from customers and billed amounts duefrom customers in excess of recognized revenue as billings in excess ofrevenues earned on contracts in progress. The timing and amount of cash receiptsfrom customers can vary significantly depending on specific contract terms andcan therefore have a significant impact on the amount of billings in excess ofrevenues earned on contracts in progress at the end of any given period.

 

                Revenue from contractsrecognized under the percentage-of-completion method is presented as productrevenue to the extent that the underlying milestones are related to softwaredeliveries. To the extent that contract milestones relate to professionalservices, revenues are presented as service revenues. When hours of input areused as the basis for percentage complete, revenues of the arrangement arepresented as product revenue based on the percentage of product list pricedivided by total estimated project list price multiplied by the contract valueand are presented as services revenue based on the percentage of estimatedservices base line hours at list prices divided by total estimated project listprice multiplied by the contract value.

 

6

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                For software subscriptions, theCompany applies revenue recognition principles in accordance with the guidanceprovided by Staff Accounting Bulletin (SAB) No. 101, *“Revenue Recognition in Financial Statements.”*The arrangement fee related to multi-element arrangements should beallocated to the individual elements in accordance with EITF 00-21 based uponverifiable, objective evidence of the fair values of each accounting unit. TheCompany’s arrangements with customers generally include several elements,including (1) strategic consulting services, (2) set-up and softwaresubscription services, and (3) hosting services**.** All the elements of a software subscription are presented assubscription revenues. Total arrangement revenues and direct costs are deferreduntil customer acceptance has occurred and the software subscription servicebegins. Revenues and direct costs are then amortized ratably to income over thenoncancelable contractual term, which is normally 18 months.

 

                Maintenance service is soldseparately under contracts that are renewable annually and is provided only tocustomers who purchase maintenance. The Company recognizes maintenance servicerevenue ratably over the contract period, which is generally one year in length.Maintenance fees are generally billed annually in advance and are recorded asdeferred revenue. The Company also provides hosting services to its customersunder separate contracts with terms that are typically 18 months. TheCompany recognizes hosting services revenues ratably over the contract period,comprising a monthly hosting fee and an amortization of a one-time initialhosting services set-up fee that is required at the beginning of a new hostingcontract. For software license sales with bundled maintenance and hostingservices, the Company applies revenue recognition principles using the residualmethod pursuant to the requirements of Statement of Position (SOP) 97-2*, “Software Revenue Recognition,”* asamended by SOP 98-9, *“Software RevenueRecognition with Respect to Certain Transactions.”* Under theresidual method, revenue is recognized for delivered elements when acontractually stipulated annual renewal rate for maintenance is provided in thecontract with the customer; provided, however, that collection is deemedprobable and the fee is fixed and determinable. As part of the sales process,the Company may perform a needs analysis for the potential customer on a fixedfee basis. Revenue from needs analyses is recognized as the work is performed.Training revenue is recognized as the services are provided.

 

                Cost of product license revenueincludes production and shipping expenses, which are expensed as incurred, aswell as costs of licensing third party software incorporated into the Company’sproducts. These third party license costs are expensed as the products aredelivered.

 

                Cost of service revenue includessalaries and related expenses for professional services and technical supportpersonnel who provide development, customization and installation services tocustomers, as well as an allocation of data processing and overhead costs.Service costs under contracts for which the related services are accounted foras separate accounting units under the accounting rules are expensed asincurred. In situations where the services and software licenses cannot beaccounted for as separate accounting units, services are recognized on thepercentage complete basis along with the underlying software license. Whenservices are provided for subscription arrangements, the cost of such servicesare deferred and recognized ratably over the same period as the subscriptionrevenues.

 

**Cash, Cash Equivalents and Investments**

 

                The Company considers all highlyliquid investments with original maturity dates of three months or less to becash equivalents. Cash equivalents are carried at cost, which approximates fairmarket value. Short-term investments are classified as available-for-salesecurities and are recorded at market value. The Company’s long-terminvestments consist of investments in a long term equity fund.  The investment commitment under thelong-term equity fund totals $2 million and is payable pursuant to cashrequests from the fund.

 

**Reverse Stock Split**

 

                On September 4, 2002, theCompany effectuated a 1-for-5 reverse stock split of its common stock. On thatday, each five shares of outstanding common stock of the Company automaticallyconverted to one share of common stock. All share and per share amounts in theaccompanying condensed consolidated financial statements have beenretroactively restated to give effect to the September 4, 2002 reversestock split. The authorized shares of 75,000,000 and par value of $0.001 pershare for the Company’s common stock were not affected by the reverse stock split.

 

7

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**Stock-Based Compensation**

 

                The Company accounts for itsstock options in accordance with the provisions of Statement of FinancialAccounting Standards (“SFAS”) No. 123, *“Accountingfor Stock-Based Compensation,”* which permits entities torecognize as expense over the vesting period the fair value of all stock-basedawards on the date of grant. Alternatively, SFAS No. 123 also allowsentities to continue to apply the provisions of Accounting Principles BoardOpinion No. 25, *“Accounting for StockIssued to Employees”* (APB No. 25) and related interpretations.The Company continues to apply the provisions of APB 25 and provides the proforma disclosures required by SFAS No. 123, as amended by SFASNo. 148, *“Accounting for Stock-BasedCompensation—Transition and Disclosure, an amendment of FASB StatementNo. 123.”* Accordingly, the Company measures compensationexpense for its employee stock-based compensation using the intrinsicvalue method and discloses the pro forma effects on earnings had the fair valueof the options been expensed. As such, compensation expense would be recordedonly if the fair value of the underlying stock exceeded the exercise price onthe grant date. Accordingly, no compensation cost has been recognized on stockoptions for which the exercise price equaled the fair value at the date ofgrant. With respect to stock options granted at exercise prices less than theirdeemed fair value, the Company recorded deferred stock-basedcompensation. Such deferred stock-based compensation is amortized on astraight-line basis over the vesting period of each individual award. The fairvalue of equity instruments issued to non-employees is amortized and charged toexpense over the vesting period of the respective instruments.

 

                The fair value of each stockoption granted is estimated on the date of grant using the Black-Scholesoption-pricing model, with the following weighted average assumptions forboth the three and nine month periods ended September 30, 2003: expectedlife of 4.25 years, expected volatility of 147%, risk-free interest rate of2.7% and 0% dividend yield. The weighted average assumptions for both the threeand nine month periods ended September 30, 2002: expected life of4.25years, expected volatility of 99.4%; risk-free interest rate of 2.7% and 0%dividend yield.

 

                The Company has applied APBNo. 25 and related interpretations in accounting for the ClickCommerce, Inc. Stock Option and Stock Award Plan and the Directors’ StockOption and Stock Award Plan. Accordingly, no compensation cost has beenrecognized on stock options for which the exercise price equaled the fair valueat the date of grant. Had the Company determined compensation cost based on themethod required by SFAS No. 123, the Company’s net income (loss) and netincome (loss) per common share for the three and nine months endedSeptember 30, 2003 and 2002 would approximate the pro forma amounts below:

 

8

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|                                                                                                                                  |   | **Three  months ended September 30,** |   | **Nine  months ended September 30,** |   |
|---------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------|--------|
|                                                                                                                                  |   | **2003**                                   |   | **2002**                                  |   | **2003** |   | **2002** |   |
|                                                                                                                                  |   | **(in  thousands, except per share data)** |   |
| Net income (loss), as reported                                                                                                        |   | $                                          | 1,575  |                                      | $      | (2,199 | ) | $ | (4,493 | ) | $ | (10,135 | ) |
| Stock-based employee compensation expense included in the determination  of net income (loss) as reported, net of related tax effects |   | 8                                          |   | 76                                        |   | 51 |   | 270 |   |
| Total fair value method employee stock-based compensation expense,  net of related tax effects                                        |   | (462                                       | )      | (412                                      | )      | (880 | ) | (1,657 | ) |
| Pro forma net income (loss)                                                                                                           |   | $                                          | 1,121  |                                      | $      | (2,535 | ) | $ | (5,322 | ) | $ | (11,522 | ) |
| Basic income (loss) per share:                                                                                                        |   |                                       |   |                                      |   |   |   |   |   |
| As reported                                                                                                                           |   | $                                          | 0.19   |                                      | $      | (0.27 | ) | $ | (0.55 | ) | $ | (1.26 | ) |
| Pro forma                                                                                                                             |   | $                                          | 0.14   |                                      | $      | (0.32 | ) | $ | (0.66 | ) | $ | (1.43 | ) |
| Diluted income (loss) per share:                                                                                                      |   |                                       |   |                                      |   |   |   |   |   |
| As reported                                                                                                                           |   | 0.19                                       |   | $                                         | (0.27  | ) | $ | (0.55 | ) | $ | (1.26 | ) |
| Pro forma                                                                                                                             |   | $                                          | 0.14   |                                      | $      | (0.32 | ) | $ | (0.66 | ) | $ | (1.43 | ) |

 

**3.             NETINCOME (LOSS) PER SHARE**

 

Net income (loss) per share was computed as follows(in thousands, except per share amounts):

 
|                                                             |   | **Three  Months Ended** |   | **Nine  Months Ended**  |   |
|------------------------------------------------------------------|--------|-------------------------|--------|-------------------------|--------|
|                                                             |   | **September  30, 2003** |   | **September  30, 2002** |   | **September  30, 2003** |   | **September  30, 2002** |   |
| **Basic  income (loss) per share:**                              |   |                    |   |                    |   |   |   |   |   |
| Net income  (loss)                                               |   | $                       | 1,575  |                    | $      | (2,199 | ) | $ | (4,493 | ) | $ | (10,135 | ) |
| Weighted average  common shares outstanding                      |   | 8,137                   |   | 8,040                   |   | 8,117 |   | 8,048 |   |
| Per share amount                                                 |   | $                       | 0.19   |                    | $      | (0.27 | ) | $ | (0.55 | ) | $ | (1.26 | ) |
|                                                             |   |                    |   |                    |   |   |   |   |   |
| **Diluted  income (loss) per share:**                            |   |                    |   |                    |   |   |   |   |   |
| Net income  (loss)                                               |   | $                       | 1,575  |                    | $      | (2,199 | ) | $ | (4,493 | ) | $ | (10,135 | ) |
| Weighted average  common shares outstanding                      |   | 8,137                   |   | 8,040                   |   | 8,117 |   | 8,048 |   |
| Add: Effect of  dilutive securities — stock options         |   | 49                      |   | —                  |   | — |   | — |   |
| Diluted weighted  average and equivalent shares outstanding |   | 8,186                   |   | 8,040                   |   | 8,117 |   | 8,048 |   |
| Per share amount                                                 |   | 0.19                    |   | $                       | (0.27  | ) | (0.55 | ) | $ | (1.26 | ) |

 

Forthe quarter ended September 30, 2003, 230,343 shares of potentially dilutivesecurities were excluded from the computation of diluted earnings per sharebecause their inclusion would have been antidilutive.  In all other periods, all potentially dilutive securities wereexcluded from the loss per share calculation as their inclusion would have beenantidilutive.

 

**4.             BUSINESSCOMBINATION**

 

                On March 27, 2003, theCompany completed its acquisition of all of the capital stock of AllegisCorporation (“Allegis”), a privately-held California corporation engaged inlicensing partner relationship management software and providing professionalimplementation services, hosting, and maintenance services related to itssoftware, effective as of March 24, 2003. Results of Allegis’ operations havebeen included in the Company’s consolidated financial statements sinceMarch 24, 2003. Under the terms and conditions of the Agreement and Planof Merger, Allegis became a wholly-owned subsidiary of the Company, andthe holders of Allegis’ preferred stock received cash consideration in anaggregate amount of approximately $10,200. The Company funded the acquisitionusing available cash on hand. The acquisition of Allegis was expected tobroaden the Company’s installed base and product offerings and expand itsmarket share within the partner relationship management area, as well asachieve cost savings through elimination of redundant development efforts andadministrative functions.

 

9

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                The following unaudited proforma financial information for the three and nine months endedSeptember 30, 2003 and 2002 presents the consolidated operations of theCompany as if the Allegis acquisition had been made on January 1, 2002,after giving effect to certain pro forma adjustments as of the acquisitiondate. Under the provisions of SFAS No. 142, “*Goodwill and Other Intangible Assets”*goodwill acquired in transactions completed after June 30, 2001 isnot amortized. As the acquisition of Allegis occurred subsequent to that date,these pro forma results do not reflect any goodwill amortization expense. Theunaudited pro forma financial information is provided for informationalpurposes only, should not be construed to be indicative of the Company’sconsolidated results of operations had the acquisition of Allegis beenconsummated on this earlier date, and does not project the Company’s results ofoperations for any future period:

 
|                                          |   | **Three  months ended  September30,**      |   | **Nine  months ended  September 30,** |   |
|-----------------------------------------------|--------|--------------------------------------------|--------|--------------------------------------------|--------|
|                                          |   | **2003**                                   |   | **2002**                                   |   | **2003** |   | **2002** |   |
|                                          |   | **(in  thousands, except per share data)** |   |
| Revenues                                      |   | $                                          | 5,041  |                                       | $      | 6,900 |   | $ | 15,037 |   | $ | 23,133 |   |
| Net income (loss)                             |   | 1,575                                      |   | (4,542                                     | )      | (7,253 | ) | (18,671 | ) |
| Basic and diluted net income (loss) per share |   | 0.19                                       |   | (0.56                                      | )      | (0.89 | ) | (2.32 | ) |
|                                               |        |                                            |        |                                            |        |  |  |  |  |  |  |  |  |

 

**5.             STOCK-BASEDCOMPENSATION**

 

                Prior to its initial publicoffering, the Company granted certain stock options at exercise prices lessthan their deemed fair value; accordingly, the Company recorded deferredcompensation of $4,636,000. Such deferred compensation is amortized on astraight-line basis over the vesting period of each individual award, resultingin $8,000 and $76,000 of stock-based compensation expense for the threemonths ended September 30, 2003 and 2002, respectively. For the ninemonths ended September 30, 2003 and 2002, respectively, stock-basedcompensation expense was $51,000 and $270,000.

 

                In April 2000, the Companyissued a warrant to Accenture Ltd. (“Accenture”) to purchase up to 163,645shares of common stock at $61.11 per share. The warrant vested contingentlyupon the achievement of certain milestones, primarily the generation of licenserevenue for the Company, and was set to expire on April 20, 2004. Thewarrant contained a significant cash penalty for Accenture’s failure to meetthe agreed revenue target by the expiration date, and, accordingly, the fairvalue of the warrant was measured at the date of grant in accordance with EITFIssue No. 96-18 and SFAS No. 123, resulting in a fair value ofapproximately $5,000,000, which was determined using the Black-Scholesoption-pricing model. In the fourth quarter of 2002, the Company reachedan agreement with Accenture to cancel the warrant. For the three and ninemonths ended September 30, 2002, the Company recognized $309,000 and$927,000**,** respectively, in amortizationexpense related to the warrant.

 

**6.             RESTRUCTURING**

 

                During the second quarter of2003, the Company continued to execute its restructuring plan following theAllegis acquisition. As part of this plan, certain redundant costs wereeliminated. These actions resulted in the termination of approximately 15employees primarily across the professional services, support and research anddevelopment departments. All of these employees were terminated within thesecond quarter. The Company also consolidated office space and included anadditional restructuring charge for the remaining lease payments on theCompany’s excess office space located in Chicago and Boston. The restructuringcosts of $2,356,000 recorded during the first six months of 2003 are detailedbelow. In the third quarter of 2003, the Company reached a settlement with thelandlord for its vacant office space in Chicago that resulted from itsconsolidation efforts in the second quarter. This agreement resulted in the cancellation of the Company’s originallease obligation in exchange for a $900,000 cash payment. As of June 30, 2003,the total cost of this lease was estimated at $1,865,000 and was included inthe restructuring charge and accrual recorded during the second quarter.  Accordingly, the Company reversed $965,000of the restructuring accrual in the quarter ended September 30, 2003 as aresult of the lease settlement as well as $18,000 related to recoveries ofrestructured assets.  This reversalamount is presented as restructuring and other charges (recoveries) in thestatement of operations for the quarter ended September 30, 2003.

 

                In conjunction with its reviewof redundant costs structures, the Company also recorded a $1,586,000 assetimpairment charge during the quarter ended June 30, 2003. This charge relatedto leasehold improvements associated with the excess office leases, a redundantcomputer system and excess equipment totaling $1,004,000 and the write-off ofcertain third party software licenses related to products that had no projectedsales and no plans for further development in the amount of $582,000.

 

10

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                During the fourth quarter of2002, the Company performed an asset impairment analysis on its third partyprepaid licenses and other intangible assets. The Company evaluated theundiscounted future operating cash flows to determine whether these cash flowswill be sufficient to recover the carrying value of the related assets. TheCompany assessed that two of its third party prepaid license agreements hadimpaired values resulting from diminished maintenance contracts and slowsoftware sales on related products. The Company also determined that anacquired product line, purchased in the third quarter of 2001, had no futurevalue based on its assessment of no expected future sales and no further plansto develop this product line. Accordingly, the Company recorded an impairmentcharge of $1,043,000 during the fourth quarter of 2002.

 

                In the quarter endedJune 30, 2002, the Company determined that its cost structure exceeded thelevel suggested by its assessment of the Company’s then-current near-termrevenue opportunities and developed a plan to reduce its cost structure to alevel in line with current revenue opportunities, resulting in an $821,000restructuring charge. Included in this restructuring plan was the terminationof 51 employees across all areas of the Company and facilities related costsrepresenting the remaining lease payments for closing four regional offices.

 

                In conjunction with theJune 30, 2002 restructuring, the Company recorded a $451,000 assetimpairment charge. The write-down of assets, primarily computer equipment undercapital leases, was a direct result of the staffing reductions. The fair valueof the equipment included in the write-down was deemed to be $0 as the Companyhad no foreseeable use for the assets, most of which the Company was requiredto either return or purchase at the then fair market value upon expiration ofthe related leases.

 

                As of September 30, 2003,the majority of the Company’s restructuring accrual related to remaining leasecommitments on excess office space. Due to extended payment terms under theselease agreements, payments against the restructuring charge will be made throughthe quarter ending December 31, 2005.

 
|                                           |   | **Accrual at  December 31,  2002** |   | **Additional  restructuring  charges** |   | **Adjustments** |   | **2003 YTD  cash  payments** |   | **Balance at  September 30,  2003** |   |
|------------------------------------------------|--------|-----------------------------------------|--------|----------------------------------------|--------|-----------------|--------|------------------------------|--------|-------------------------------------|--------|
|                                           |   | **(in  thousands)**                     |   |
| Employee severance, benefits and related costs |   | $                                       | 252    |                                   | $      | 182             |   | $                            | — |                                | (312   | ) | $ | 122 |   |
| Facilities related costs                       |   |                                    |   | 2,144                                  |   | (965            | )      | (1,009                       | )      | 170                                 |   |
| Legal costs and other                          |   | 30                                      |   | 30                                     |   | —          |   | (30                          | )      | 30                                  |   |
| Total                                          |   | $                                       | 282    |                                   | $      | 2,356           |   | $                            | (965   | )                                   | $      | (1,351 | ) | $ | 322 |   |
|                                                |        |                                         |        |                                        |        |                 |        |                              |        |                                     |        |  |  |  |  |  |

 

**7.             SPECIALDIVIDEND**

 

                On May 1, 2003, the Companyannounced that its Board of Directors had declared a special cash dividend inthe amount of $2.50 per share of the Company’s common stock (“SpecialDividend”). The Special Dividend was paid on June 4, 2003 to stockholdersof record as of May 20, 2003. For Federal income tax purposes, the Companyexpects the Special Dividend to be treated as a “return of capital.” As areturn of capital, the Special Dividend would be either wholly tax-free ortaxable in part as capital gain, depending on each stockholder’s tax basis in theCompany’s common stock. As of May 20, 2003, the Company had 8,136,643 shares ofcommon stock outstanding, which resulted in a total Special Dividend payment ofapproximately $20,342,000.

 

11

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**Item 2.  Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

                The following discussion shouldbe read in conjunction with the Company’s condensed consolidated financialstatements and notes elsewhere in this quarterly report.

 

**Overview**

 

                Click Commerce, Inc. (the“Company”) is a provider of business-to-business partner relationshipmanagement software products and integration services that connect large,global manufacturing companies with their distribution channel partners. The Company’ssoftware products and integration services enable large companies toeffectively manage and engage in collaborative business-to-businessinteractions throughout their sell-side channels and processes. The Company’ssoftware uses the Internet to enable communication between a company and allparticipants in its network or chain of distribution who have a password and anInternet browser.

 

                The Company commenced operationson August 20, 1996. The Company implemented the first Click CommerceRelationship Manager in the second quarter of 1997. On June 30, 2000, theCompany completed an initial public offering (“IPO”) of common stock thatresulted in the issuance of 5,000,000 shares of common stock with an IPO priceof $10.00 per share (adjusted to 1,000,000 shares of common stock with a priceof $50.00 per share following the 1-for-5 reverse stock split that occurred onSeptember 4, 2002). The Company completed its acquisition of AllegisCorporation (“Allegis”) on March 24, 2003, which expanded the productofferings available to customers to include subscription licenses and hostingcapabilities.

 

                The Company’s revenue is derivedfrom sales of perpetual licenses or subscriptions of its software. The ClickCommerce software suite consists of the Partner Portal platform and eighteenbusiness applications. The Company’s revenue is also derived from services,including business consulting, implementation, maintenance, training andmanaged hosting services.

 

                Cost of product license revenuesinclude production and shipping expenses, which are expensed as incurred, aswell as costs of licensing third party software incorporated into or requiredby the Company’s products. These third party license costs are expensed as theproducts are delivered on perpetual licenses or as maintenance and subscriptionrevenues are recognized to the extent that the third party license costsrelates to those product offerings. Cost of service revenues include salariesand related expenses for professional services and technical support personnelwho provide customization and installation services, maintenance and hostingservices to customers, as well as an allocation of data processing and overheadcosts which are expensed as incurred.

 

                Operating expenses areclassified into five general categories: sales and marketing, research anddevelopment, general and administrative, amortization of stock-basedcompensation and amortization of intangible assets. Sales and marketingexpenses consist primarily of salaries and other related costs for sales andmarketing personnel, sales commissions, travel, public relations and marketingmaterials. Research and development expenses consist primarily of personnelcosts to support product development. General and administrative expensesconsist primarily of salaries and other related costs for executive management,finance and administrative employees, legal and accounting services, andcorporate liability insurance. Amortization of stock-based compensationrepresents the amortization over the related service period of the differencebetween the exercise price of options granted and the deemed fair market valueof the underlying common stock on the date of grant, as well as amortization ofthe warrant issued in connection with a joint marketing agreement withAccenture.  Since the Company reached anagreement with Accenture to cancel the warrant in the fourth quarter of 2002,no amortization expense of the warrant is reflected in the accompanyingstatements of operations for 2003.   Amortization of intangible assets representsamortization expense for certain customer relationships with definite usefullives, which was recorded in connection with the Allegis acquisition.

 

                The Company believes thatperiod-to-period comparisons of operating results should not be relied upon aspredictive of future performance. The Company’s prospects must be considered inlight of the risks, expenses and difficulties encountered by companies in new,rapidly evolving markets. The Company may not be successful in addressing suchrisks and difficulties.

 

12

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**Critical Accounting Policies**

 

                The Company’s consolidatedfinancial statements are prepared in accordance with accounting principlesgenerally accepted in the United States of America. As such, the Company makescertain estimates, judgments and assumptions that it believes are reasonablebased upon the information available. These estimates and assumptions affectthe reported amounts of assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during the periodspresented. The Company’s critical accounting policies include revenuerecognition and any resulting deferral of revenues and related costs, theestimation of credit losses on accounts receivable and the valuation ofdeferred tax assets. For a discussion of these critical accounting policies,see “Critical Accounting Policies and Estimates” in the Company’s Annual Reporton Form 10-K for the year ended December 31, 2002, filed with theSecurities and Exchange Commission.

 

13

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**Results of Operations**

 

                The following table sets forthselected unaudited financial data for the periods indicated in dollars and as apercentage of total revenue.

 
|                                         |   | **Three  Months Ended September 30,** |   | **Nine  Months Ended September 30,** |   |
|----------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                                         |   | **2003**                              |   | **2002**                             |   | **2003** |   | **2002** |   |
|                                         |   | **In 000’s**                     |   | **% of  Revenue**                    |   | **In 000’s** |   | **% of  Revenue** |   | **In 000’s** |   | **% of  Revenue** |   | **In 000’s** |   | **% of  Revenue** |   |
| Revenues                                     |   |                                  |   |                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Product license                              |   | 584                                   |   | 11.6                                 | %      | 214 |   | 6.1 | % | 1,452 |   | 11.2 | % | 1,530 |   | 10.7 | % |
| Subscription                                 |   | 571                                   |   | 11.3                                 | %      | — |   | 0.0 | % | 1,515 |   | 11.6 | % | — |   |   |   |
| Maintenance and hosting                      |   | 1,692                                 |   | 33.6                                 | %      | 1,688 |   | 48.4 | % | 4,868 |   | 37.3 | % | 5,359 |   | 37.6 | % |
| Service                                      |   | 2,194                                 |   | 43.5                                 | %      | 1,584 |   | 45.5 | % | 5,209 |   | 39.9 | % | 7,356 |   | 51.7 | % |
| Total                                        |   | 5,041                                 |   | 100.0                                | %      | 3,486 |   | 100 | % | 13,044 |   | 100 | % | 14,245 |   | 100 | % |
|                                         |   |                                  |   |                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of revenues                             |   |                                  |   |                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Product                                      |   | 69                                    |   | 1.4                                  | %      | 190 |   | 5.5 | % | 295 |   | 2.2 | % | 522 |   | 3.6 | % |
| Service (a)                                  |   | 2,197                                 |   | 43.6                                 | %      | 1,952 |   | 56.0 | % | 6,310 |   | 48.4 | % | 6,534 |   | 45.9 | % |
| Total cost of revenues                       |   | 2,266                                 |   | 45.0                                 | %      | 2,142 |   | 61.5 | % | 6,605 |   | 50.6 | % | 7,056 |   | 49.5 | % |
|                                         |   |                                  |   |                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross profit                                 |   | 2,775                                 |   | 55.0                                 | %      | 1,344 |   | 38.5 | % | 6,439 |   | 49.4 | % | 7,189 |   | 50.5 | % |
| Gross margin %                               |   | 55                                    | %      | 39                                   | %      | 49 | % | 50 | % |   |   |   |   |   |   |   |   |
| Operating expenses:                          |   |                                  |   |                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Sales and marketing (a)                      |   | 676                                   |   | 13.4                                 | %      | 1,488 |   | 42.7 | % | 2,508 |   | 19.2 | % | 8,084 |   | 56.8 | % |
| Research and development (a)            |   | 587                                   |   | 11.6                                 | %      | 880 |   | 25.2 | % | 1,928 |   | 14.8 | % | 3,766 |   | 26.4 | % |
| General and administrative (a)          |   | 891                                   |   | 17.7                                 | %      | 963 |   | 27.6 | % | 3,737 |   | 28.7 | % | 3,639 |   | 25.6 | % |
| Amortization of stock-based compensation     |   | 8                                     |   | 0.2                                  | %      | 385 |   | 11.0 | % | 51 |   | 0.4 | % | 1,197 |   | 8.4 | % |
| Amortization of intangible assets            |   | 40                                    |   | 0.8                                  | %      | — |   | 0.0 | % | 68 |   | 0.5 | % |   |   | 0.0 | % |
| Restructuring and other charges (recoveries) |   | (983                                  | )      | (19.5                                | )%     | — |   | 0.0 | % | 2,959 |   | 22.7 | % | 1,213 |   | 8.5 | % |
| Total operating expenses                     |   | 1,219                                 |   | 24.2                                 | %      | 3,716 |   | 106.5 | % | 11,251 |   | 86.3 | % | 17,899 |   | 125.7 | % |
|                                         |   |                                  |   |                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating income (loss)                      |   | 1,556                                 |   | 30.8                                 | %      | (2,372 | ) | (68.0 | )% | (4,812 | ) | (36.9 | )% | (10,710 | ) | (75.2 | )% |
| Other income                                 |   |                                  |   |                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest income                              |   | 23                                    |   | 0.5                                  | %      | 199 |   | 5.7 | % | 281 |   | 2.2 | % | 633 |   | 4.4 | % |
| Interest expense                             |   | (1                                    | )      | (0.0                                 | )%     | (26 | ) | (0.8 | )% | (13 | ) | (0.1 | )% | (58 | ) | (0.4 | )% |
| Other income (expense)                       |   | (3                                    | )      | (0.1                                 | )%     | — |   | 0.0 | % | 51 |   | 0.4 | % | — |   | 0.0 | % |
| Pretax income (loss)                         |   | 1,575                                 |   | 31.2                                 | %      | (2,199 | ) | (63.1 | )% | (4,493 | ) | (34.4 | )% | (10,135 | ) | (71.2 | )% |
| Tax provision                                |   | —                                |   |                                 |   | — |   |   |   | — |   |   |   | — |   |   |   |
| Net income (loss)                            |   | 1,575                                 |   | 31.2                                 | %      | (2,199 | ) | (63.1 | )% | (4,493 | ) | (34.4 | )% | (10,135 | ) | (71.2 | )% |
|                                              |        |                                       |        |                                      |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(a)                                  Exclusive ofamortization of stock-based compensation which is presented as a separatecaption.

 

14

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**Comparison of the three months ended September 30, 2003to the three months ended September 30, 2002**

 

*                Revenue*

 

                Total revenue increasedapproximately $1.6 million, or 44.6%, to $5.0 million for the three monthsended September 30, 2003 from $3.5 million for the three months ended September30, 2002. Product license revenue consists of revenue from separateproduct-only agreements and from agreements accounted for under apercentage-of-completion basis using product-related milestones. Productlicense revenue increased by $370,000, or 172.9%, as a result of an increase inthe number of new contracts  resultingfrom the acquisition of Allegis Corporation (“Allegis”) on March 24, 2003. TheCompany recorded $571,000 of subscription revenue during the three-month periodended September 30, 2003 as a result of the Allegis acquisition.  No subscription revenue was recorded duringthe comparable prior-year period. Maintenance and hosting revenue of $1.7 million remained relatively flatduring the third quarter of 2003, as compared to the third quarter of 2002.  Service revenue of $2.2 million, comprisingfees related to time and materials service contracts, training and needsanalyses, as well as agreements accounted for under a percentage completedbasis using hours of input or milestones that specifically relate tointegration and customization services, increased by $0.6 million, or 38.5%,over the prior -year quarter. The increase in service revenue was due primarilyto the addition of service revenue from the Allegis acquisition in the thirdquarter of 2003.**** In any period, service revenue from time andmaterials contracts is dependent, among other things, on license transactionsclosed during the current and preceding quarters and customer decisionsregarding implementations of licensed software.

 

                *Costof Revenue*

 

                Total cost of revenue increasedby $0.1 million, or 5.8%, to $2.3 million for the three months endedSeptember 30, 2003, as compared to the three-months endedSeptember 30, 2002. This cost of revenue increase is primarily a result ofthe increase in cost of services revenue during the third quarter of 2003.  Cost of product revenue during the thirdquarter of 2003 decreased by $0.1 million or 63.7% due to lower royalty feesfor licensed third party software that is embedded in the Company’s products orincorporated in the Company’s product offerings arising from lower productsales, as well as lower amortization of product packaging and other productcosts. Total cost of service revenue increased $0.2 million, or 12.6%, to $2.2million for the three months ended September 30, 2003, as compared to the sameperiod in 2002, due primarily to the increase in service personnel headcountand corresponding higher service revenue during the period as a result of theAllegis acquisition.  Gross profitmargins increased to 55% for the three months ended September 30, 2003,compared to 39% for the three months ended September 30, 2002. The grossmargin increase is due to higher margins on both product and services revenue.The increase in service margins is due to improved utilization rates for the professionalservices staff in the current quarter.

 

                *OperatingExpenses*

 

                *Salesand Marketing.*  Sales andmarketing expenses decreased by approximately $0.8 million, or 54.6%, to $0.7million for the three months ended September 30, 2003 from $1.5 millionfor the three months ended September 30, 2002. The decrease in sales andmarketing expense was primarily attributable to lower employee compensation andrelated costs due to a reduction in personnel and from lower discretionarymarketing spending.

 

                *Researchand Development.*  Researchand development expenses decreased by approximately $0.3 million, or 33.3%, to$0.6 million for the three months ended September 30, 2003, compared to$0.9 million for the comparable prior year three-month period. Thisdecrease was primarily attributable to lower third party contractor costs andreduction in salaries due to lower headcount. To date, all software developmentcosts have been expensed as incurred.

 

                *Generaland Administrative.*  Generaland administrative expenses decreased by approximately $70,000, or 7.5%, to$0.9 million for the three months ended September 30, 2003 from $1.0 millionfor the three months ended September 30, 2002.  The decrease is primarilyattributable to the reductions in overhead expenses achieved through theCompany’s cost reduction measures.

 

                *Amortizationof stock-based compensation.* Prior to its initial public offering, the Company granted certain stockoptions at exercise prices less than their deemed fair value; accordingly, theCompany recorded deferred compensation of $4.6 million. Such deferredcompensation is being amortized over the vesting periods of the applicableoptions, resulting in expense of $8,000 and $76,000 for the three months endedSeptember 30, 2003 and 2002, respectively. Additionally, the $5.0 million fairvalue of the warrant issued to Accenture in April 2000 was being amortized overthe vesting period of the warrant. As discussed above in “Overview”, theCompany reached an Agreement with Accenture in the fourth quarter of 2002 tocancel the warrant. The Company recognized no related amortization expense inthe three months ended September 30, 

 

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2003and $0.3 million in amortization expense in the three months ended September30, 2002.

 

*                Amortizationof intangible assets.*  Inthe quarter ended September 30, 2003, the Company recorded $40,000 inamortization of****customer relationship intangible assets****that were recorded as part of theAllegis acquisition**. **No such amortization was recordedin the comparable prior-year quarter.

 

                *Restructuringand other charges.*  In thequarter ended June 30, 2003, the Company continued to execute its restructuringplan following the Allegis acquisition. As part of this plan, certain redundantcosts were eliminated and a restructuring charge was recorded for excess leasecosts and severance and other benefit costs for the termination of 15employees.   In the third quarter of2003, the Company reached a settlement with the landlord for its vacant officespace in Chicago that resulted from its consolidation efforts in the secondquarter.  This agreement resulted in thecancellation of the Company’s original lease obligation in exchange for a$900,000 cash payment. As of June 30, 2003, the total cost of this lease wasestimated at $1,865,000 and was included in the restructuring charge andaccrual recorded during the second quarter. Accordingly, the Company reversed $965,000 of the restructuring accrualin the quarter ended September 30, 2003 as a result of the leasesettlement.  The Company also recorded arecovery of $18,000 during the third quarter of 2003 related to the sale ofimpaired assets that were no longer recorded on the Company’s books.

 

                *Incometax expense.*  The Companyrecorded no income tax expense or benefit for the three months endedSeptember 30, 2003 and 2002.

 

**Comparison of the nine months ended September 30, 2003to the nine months ended September 30, 2002**

 

                *Revenue*

 

                Total revenue decreasedapproximately $1.2 million, or 8.4%, to $13.0 million for the nine monthsended September 30, 2003 from $14.2 million for the nine months endedSeptember 30, 2002. Product license revenue consists of revenue fromseparate product-only agreements and from agreements accounted for under apercentage-of-completion basis using product-related milestones. Productlicense revenue decreased by $78,000, or 5%, as a result of a decrease in thenumber of new contracts and the average selling price of the current period’scontracts offset by additional license revenue resulting from the Allegisacquisition on March 24, 2003. The Company recorded $1.5 million ofsubscription revenue during the nine-month period ended September 30, 2003 as aresult of the Allegis acquisition.  Nosubscription revenue was recorded during the comparable prior-year period.  Maintenance and hosting revenue decreased by$0.5 million, or 9.2%, to $4.9 million for the nine months ended September 30,2003 from $5.4 million for the nine months ended September 30, 2002.  Maintenance and hosting revenue decreasedprimarily due to a decrease in contract renewals and lower average fees onexisting contracts.  Service revenue,comprised of fees related to time and materials service contracts, training andneeds analyses, as well as agreements accounted for under a percentagecompleted basis using hours of input or milestones that specifically relate tointegration and customization services, decreased by $2.1 million, or29.2%, to $5.2 million for the first nine months of 2003 from $7.3 million forthe comparable prior-year period.  Thedecrease in service revenue was due primarily to the completion of existing implementation service contracts in the prior yearand a trend toward smaller scoped projects in 2003.

 

                *Costof Revenue*

 

                Total cost of revenue decreasedapproximately $0.5 million, or 6.4%, to $6.6 million for the nine monthsended September 30, 2003 compared to $7.1 million for the nine monthsended September 30, 2002. This cost of revenue decrease is primarily aresult of lower third party contractor costs and employee compensation andrelated costs due to a reduction in project management personnel. Cost ofproduct revenue decreased by $0.2 million, or 43.5%, due to lower royaltyfees for licensed third party software that is embedded in the Company’sproducts or incorporated in the Company’s product offerings arising from lowerproduct sales, as well as lower amortization of product packaging and othercosts. Cost of service revenue decreased by $0.2, or 3.4%, to $6.3 million.  Gross profit margins decreased to 49% forthe nine months ended September 30, 2003, compared to 50% for the ninemonths ended September 30, 2002. The gross margin decrease is due to adecrease in product revenue as a percentage of total revenue as well as lowermargins on services revenue. The decrease in service margins is due to thefollowing reasons: the classification of project management overhead in cost ofservices after the first quarter of 2002 rather than general and administrativeexpenses as their allocation related to internal projects that were completedor discontinued in that quarter, lower average hourly rates, and a lowerutilization rate for the professional services staff.

 

                *OperatingExpenses*

 

                *Salesand Marketing.*  Sales andmarketing expenses decreased by approximately $5.6 million, or 69.0%, to 

 

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$2.5 millionfor the nine months ended September 30, 2003 from $8.1 million forthe nine months ended September 30, 2002. The decrease in sales and marketingexpense was primarily attributable to lower employee compensation and relatedcosts due to a reduction in personnel and discretionary marketing spending.

 

                *Researchand Development.*  Researchand development expenses decreased by approximately $1.8 million, or48.8%, to $1.9 million for the nine months ended September 30, 2003,compared to $3.8 million for the prior year nine-month period. Thisdecrease was primarily attributable to lower third party contractor costs,reduction in personnel, and discretionary spending. To date, all softwaredevelopment costs have been expensed as incurred.

 

                *Generaland Administrative.*  Generaland administrative expenses increased by approximately $0.1 million, or2.7%, to $3.7 million for the nine months ended September 30, 2003from $3.6 million for the nine months ended September 30, 2002. The increase is attributable to$0.7 million of non-recurring legal and consulting expenses related to theCompany’s consideration of an unsolicited acquisition proposal by one of itsinvestors and the payment of the June 4, 2003 $2.50 Special Dividend. Thisincrease was principally offset by a reduction in administrative and overheadcosts  as a result of the Company’srecent  cost reduction measures.

 

                *Amortizationof stock-based compensation.* Prior to its initial public offering, the Company granted certain stockoptions at exercise prices less than their deemed fair value; accordingly, theCompany recorded deferred compensation of $4.6 million. Such deferredcompensation is being amortized over the vesting periods of the applicableoptions, resulting in expense of $51,000 and $269,000 for the nine months endedSeptember 30, 2003 and 2002, respectively. Additionally, the$5.0 million fair value of the warrant issued to Accenture inApril 2000 was being amortized over the vesting period of the warrant. Asdiscussed above in “Overview,” the Company reached an Agreement with Accenturein the fourth quarter of 2002 to cancel the warrant. The Company recognized norelated amortization expense in the nine months ended September 30, 2003and recognized $0.9 million in amortization expense in the nine monthsended September 30, 2002.

 

*                Amortizationof intangible assets.*  Inthe nine-month period ended September 30, 2003, the Company recorded $68,000 inamortization of customer relationshipintangible assets that were recorded as part of****the Allegis acquisition**. **No such amortizationwas recorded in the comparable prior-year quarter.

 

                *Restructuringand other charges.*  In thequarter ended June 30, 2003, the Company continued to execute itsrestructuring plan following the Allegis acquisition. As part of this plan,certain redundant costs were eliminated and a restructuring charge of$2.3 million was recorded. The restructuring charge primarily related to$2.1 million of excess lease costs in two locations and severance andother benefit costs of $0.2 million for the termination of 15 employees aspart of the restructuring plan. In the third quarter of 2003, the Companyreached a settlement with the landlord for its vacant office space in Chicagothat resulted from its consolidation efforts in the second quarter.  This agreement resulted in the cancellationof the Company’s original lease obligation in exchange for a $900,000 cashpayment. As of June 30, 2003 the total cost of this lease was estimated at$1,865,000 and was included in the restructuring accrual recorded during thesecond quarter.  Accordingly, theCompany reversed $965,000 of the restructuring accrual in the quarter endedSeptember 30, 2003 as a result of the lease settlement.

 

                The company also recorded a$1.6 million asset impairment charge during the second quarter of 2003.This charge related to leasehold improvements associated with the excess officeleases, a redundant computer system and excess equipment totaling$1.0 million and the write-off of certain third party software licensesrelated to products that had no projected sales and no plans for furtherdevelopment in the amount of $0.6 million. The Company also recorded arecovery of $18,000 during the third quarter of 2003 related to the sale ofimpaired assets that were no longer recorded on the Company’s books.

 

                The restructuring and othercharges in the nine months ended September 30, 2002 included $0.7 millionof employee severance costs for 51 employees, other restructuring costs of$0.1 million and a $0.5 million asset impairment charge primarilyrelated to excess computer equipment.

 

                *Incometax expense.*  The Companyrecorded no income tax expense or benefit for the nine months endedSeptember 30, 2003 and 2002.

 

**Liquidity and Capital Resources**

 

                At September 30, 2003, theCompany had $11.4 million of cash and cash equivalents, consistingprimarily of the remaining proceeds from its initial public offering and afterthe payment of the $20.3 million Special Dividend. The Special 

 

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Dividendof $2.50 per share was declared on April 30, 2003 and payable onJune 4, 2003 to shareholders of record as of May 20, 2003.

 

                Net cash used in operatingactivities was $1.8 million for the nine months ended September 30,2003, consisting principally of net losses of $4.5 million for the period,a $1.0 million reduction in accrued compensation primarily attributable toamounts related to the Allegis acquisition and a decrease in deferred revenueof 1.0 million, net of deferred revenue associated with the Allegisacquisition.  The cash outflow duringthe period was partially offset by a collections of account receivable of $2.3million, restructuring and other charges totaling $1.2 million, anddepreciation and amortization of $1.0 million.

 

**                Netcash provided by investing activities was $10.3 million for the ninemonths ended September 30, 2003, consisting of the redemption of short-terminvestments to fund the Special Dividend of $10.4 million and the net cashacquired in the acquisition of Allegis of $176,000, offset partially bypurchases of property and equipment of $46,000 and the investment in along-term equity fund of $0.2 million. The Company’s investment commitment under the long-term equity fundtotals $2.0 million, which is payable pursuant to cash requests from the fund.**

 

**                Netcash used in financing activities was approximately $20.7 million for thenine months ended September 30, 2003, reflecting the payment of the$20.3 million Special Dividend on June 4, 2003 and $0.4 millionof capital lease payments offset partially by proceeds from stock optionexercises of $62,000.**

 

                In January 2000, theCompany obtained a letter of credit under a now-expired line of credit totaling$0.5 million to secure an office lease. This letter of credit declined by$0.1 million annually and had a balance of $0.2 million when it was drawn downin full as part of the settlement of the remaining lease obligations with thelandlord. As part of the Allegis acquisition, the Company assumed a letter ofcredit securing office space in San Francisco. The letter of credit expires onSeptember 30, 2005 and currently has a balance of $170,000. The Companyalso has an outstanding letter of credit for an original amount ofapproximately $820,686 in connection with an insurance premium financeagreement. The letter of credit declines on a monthly basis, beginning inNovember 2003, until it expires on September 24, 2004. As of September 30, 2003,the obligations related to the letter of credit were $603,845. These letters ofcredit were previously secured by the Company’s line of credit that expired onMarch 31, 2003. Beginning April 1, 2003, the Company secured theseletters of credit with cash funds that are being maintained in a separateaccount held by the respective financial institutions.

 

                In May 2002, the Companyannounced that its Board of Directors had authorized the repurchase of up to$5.0 million of its common stock in the open market. These shares may bepurchased pursuant to Rule 10b-18 under the Exchange Act from time to timein the public market or through privately negotiated transactions. The timingand amount of any repurchase will be at the discretion of the Company’smanagement. As of September 30, 2003, the Company had repurchased 29,064shares of its common stock at an average purchase price of $4.03 per share andat an aggregate cost of $117,239. No shares were repurchased during 2003.

 

                On August 30, 2002, at aspecial meeting of its shareholders, an amendment to the Company’s certificateof incorporation was approved in order to effectuate a reverse stock split ofthe Company’s common stock at a ratio between 1-for-2 and 1-for-5, as determinedby the Company’s Board of Directors. At a special meeting of the Board ofDirectors on August 30, 2002, the Board of Directors approved a 1-for-5reverse stock split of the Company’s common stock effective as ofSeptember 4, 2002, in order to improve the trading price for the commonstock and improve the likelihood that the Company will be allowed to maintainthe common stock’s listing on the NASDAQ National Market by satisfying theminimum bid requirement for continued listing on the NASDAQ National Market. Aspreviously disclosed by the Company on a Current Report on Form 8-K datedSeptember 4, 2002, the Company expected to and actually did receive onSeptember 9, 2002, a letter from NASDAQ informing the Company that theCompany had not satisfied the minimum bid price requirement for listing of itscommon stock and that it would be delisted on September 17, 2002. TheCompany appealed such notice on September 12, 2002, requesting a hearingbefore a listing qualification panel to review such delisting determination.Subsequently, NASDAQ informed the Company that it had evidenced compliance withthe bid price requirement for continued listing on the NASDAQ National Market.

 

                The Company may use cashresources to fund investments in complementary businesses or technologies orother purposes as determined by the Company. The Company believes that workingcapital will be sufficient to meet its working capital and operatingexpenditure requirements for at least the next twelve months. Although theCompany has no current plans to raise additional equity during the next twelvemonths and such plans are subject to business and market conditions, theCompany may consider raising additional capital as a result of a recentnotification of non-compliance with the NASDAQ National Market Rules requiringlisted companies to maintain at least $10 million of shareholders’ equity.  The Company reported $9.8 and $8.2 millionof equity as of September 30, 2003 and June 30, 2003, respectively. The Companymay find it 

 

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necessaryto obtain additional equity or debt financing, although the Company does notcurrently foresee a need for additional cash resources for long-term needs. Inthe event additional financing is required, the Company may not be able toraise it on acceptable terms or at all.

 

**Recent Accounting Pronouncements**

 

                In July 2002, the FASBissued SFAS No. 146. *“Accounting forCosts Associated with Exit or Disposal Activities.”* This statementrequired the recording of exit or disposal costs when they are incurred and canbe measured at fair value. A liability is incurred when an event obligates acompany to transfer or use assets (*i.e.*,when an event leaves the company little or no discretion to avoid transferringor using assets in the future). These costs will be subsequently adjusted forchanges in estimated cash flows. This statement is effective for exit ordisposal activities initiated after December 31, 2002. This statement doesnot impact the treatment of liabilities for exit and disposal costs previouslyrecorded prior to adoption. The adoption of this statement did not have amaterial impact on the Company.

 

                In December 2002, the FASBissued SFAS No. 148, *“Accounting forStock-Based Compensation—Transition and Disclosure, an amendment of FASBStatement No. 123.”* This statement amends FASB StatementNo. 123, “Accounting for Stock-Based Compensation,” to providealternative methods of transition for a voluntary change to the fair valuemethod of accounting for stock-based employee compensation. In addition,this statement amends the disclosure requirements of Statement No. 123 torequire prominent disclosures in both annual and interim financial statements.Certain of the disclosure modifications are required for fiscal years endingafter December 15, 2002 and are included in the notes to the condensedconsolidated financial statements included in this Form 10-Q.

 

In May 2003, the FASB’s Emerging Issues TaskForce reached consensus on EITF Issue No. 00-21, “Revenue Arrangements withMultiple Deliverables” (EITF 00-21). EITF 00-21’s criteria govern how to identify whether goods or servicesor both that are to be delivered separately in a bundled sales arrangementshould be accounted for separately. Specifically, the purpose of EITF 00-21 is to determine if separation isnecessary and, if so, how to measure and allocate the arrangementconsideration.  For publicly tradedcompanies, EITF 00-21 is applicable for revenue arrangements entered into inperiods beginning after June 15, 2003. Accordingly, the Company adopted EITF 00-21 on July 1, 2003 for all newrevenue arrangements. The adoption of EITF 00-21 did not have a significantimpact on the Company.

 

 

**                SafeHarbor Statement under the Private Securities Litigation Reform Act of 1995within the meaning of Section 21E of the Securities Exchange Act of 1934,as amended:**

 

                Statements in thisForm 10-Q that are not historical facts and refer to the Company’s futureprospects are “forward-looking statements” under the Private SecuritiesLitigation Reform Act of 1995. These forward-looking statements aregenerally identified by words such as “expect,” “anticipate,” “intend,”“believe,” “hope,” “assume,” “estimate” and other similar words andexpressions. The statements are subject to risks and uncertainties and actualresults may differ materially from those indicated by these forward-lookingstatements as a result of various factors, including but not limited to, theability of the Company to enter into strategic alliances with systemintegrators and business consultants, the extent of customer acceptance andutilization of the Company’s channel management solutions, the impact ofcompetitive products and services, the Company’s ability to develop new andenhanced versions of its products and services, the effect of economic andbusiness conditions, the volume and timing of customer contracts, and relatedapproval processes of capital and intellectual property spending of theCompany’s target customers, changes in technology, deployment delays or errorsassociated with the Company’s products, the ability of the Company to integrateacquired businesses or products and the Company’s ability to protect itsintellectual property rights. For a discussion of these and other risk factorsthat could affect the Company’s business, see “Risk Factors” in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2002,which is on file with the Securities and Exchange Commission.

 

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**Item 3.  Qualitativeand Quantitative Disclosures About Market Risk**

 

                The following discusses theCompany’s exposure to market risk related to changes in foreign currencyexchange rates and interest rates. This discussion contains forward-lookingstatements that are subject to risks and uncertainties. Actual results couldvary materially as a result of a number of factors including those set forth inPart I of the Company’s Annual Report on Form 10-K under “RiskFactors.”

 

*Foreign Currency Exchange Rate Risk*

 

                To date, nearly all of theCompany’s recognized revenues have been denominated in U.S. dollars andprimarily from customers in the United States and the exposure to foreigncurrency exchange rate changes has been immaterial. The Company expects,however, that future product license and professional services revenues mayalso be derived from international markets and may be denominated in thecurrency of the applicable market. As a result, operating results may becomesubject to significant fluctuations based on changes in the exchange rates ofcertain currencies in relation to the U.S. dollar. Furthermore, to the extentthe Company engages in international sales denominated in U.S. dollars, anincrease in the value of the U.S. dollar relative to foreign currencies couldmake the Company’s products less competitive in international markets. Althoughthe Company will continue to monitor its exposure to currency fluctuations,and, when appropriate, may use financial hedging techniques in the future tominimize the effect of these fluctuations, there is no assurance that exchangerate fluctuations will not adversely affect financial results in the future.

 

*Interest Rate Risk*

 

                As of September 30, 2003, theCompany had cash and cash equivalents of $11.4 million. Declines ininterest rates will reduce interest income from short-term investments. Basedupon the balance of cash and cash equivalents at September 30, 2003, achange in interest rates of 0.5% would cause a corresponding change in annualinterest income of less than $0.1 million.

 

**Item 4.  Controls andProcedures**

 

                The Company carried out an evaluation, under thesupervision and with the participation of its management,including its Chief Executive Officer and Chief Financial Officer, of the designand operation of the Company’s disclosure controls and procedures. Basedon this evaluation, the Company’s Chief Executive Officer and ChiefFinancial Officer concluded that, as of September 30, 2003, theCompany’s disclosure controls and procedures were effective to provide reasonable assurance that theinformation required to be disclosed by us in the reports filed or submittedunder the Securities Exchange Act of 1934 is recorded, processed, summarizedand reported within the time periods specified in the SEC’s rules and forms.

 

                There has been no change in the Company’s internalcontrols over financial reporting during the Company’s most recent fiscalquarter that has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal controls over financial reporting.

 

                The Company’s management, including the ChiefExecutive Officer and Chief Financial Officer, does not expect that itsdisclosure controls and procedures or internal control over financialreporting will prevent all error and all fraud. A control system, nomatter how well conceived and operated, can provide only reasonable, notabsolute, assurance that the objectives of the control system are met. Further,the design of a control system must reflect the fact that there are resourceconstraints, and the benefits of controls must be considered relative to theircosts. Because of the inherent limitations in all control systems, noevaluation of controls can provide absolute assurance that all control issuesand instances of fraud, if any, within the Company have been detected. Theseinherent limitations include the realities that judgments in decision-makingcan be faulty and that breakdowns can occur because of simple error or mistake.Additionally, controls can be circumvented by the individual acts of somepersons, by collusion of two or more people, or by management override of thecontrol. The design of any system of controls also is based in part uponcertain assumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions; over time, control may become inadequate becauseof changes in conditions, or the degree of compliance with the policies or proceduresmay deteriorate. Because of the inherent limitations in a cost-effectivecontrol system, misstatements due to error or fraud may occur and not bedetected.

 

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**PART II.  OTHERINFORMATION**

 

**Item1.  Legal Proceedings**

 

                There are no material legalproceedings to which the Company is a party or of which any of its property issubject.

 

**Item 2.  Changes inSecurities and Use of Proceeds**

 

                On June 26, 2000, theSecurities and Exchange Commission declared effective the Company’sRegistration Statement on Form S-1, File No. 333-30564, relating tothe initial public offering of the Company’s common stock, par value $.001 pershare. As of September 30, 2003, the Company had returned $20.3 millionto shareholders in a Special Dividend paid on June 4, 2003 to shareholdersof record as of May 20, 2003 and expended the balance of the remaining netproceeds for working capital and general corporate purposes since the initialpublic offering.

 

**Item 3.  Defaults UponSenior Securities**

 

                Not applicable.

 

**Item 4.  Submission ofMatters to a Vote of Security Holders**

 

                Not applicable.

 

**Item5.  Other Information**

 

                Not applicable.

 

**Item 6.  Exhibits andReports on Form 8-K**

 

**(a)           Exhibits**

 

                The following exhibits are filedas part of this Form 10-Q.

 
| **Exhibit****Number** |   | **Description**                                                                                                            |
|-----------------------|--------|----------------------------------------------------------------------------------------------------------------------------|
| 10.1                  |   | Sublease  Termination Agreement between Radian Guaranty Inc., and Click Commerce, Inc.,  dated as of August 29, 2003. |
| 31.1                  |   | Certification  of Michael W. Ferro, Jr. pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                         |
| 31.2                  |   | Certification  of Michael W. Nelson pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                             |
| 32.1                  |   | Certification  of Michael W. Ferro, Jr. pursuant to Section 906 of the Sarbanes-Oxley Act of  2002                         |
| 32.2                  |   | Certification  of Michael W. Nelson pursuant to Section 906 of the Sarbanes-Oxley Act of  2002                             |

 

**(b)****                                 ****Reports on Form 8-K**

 

                The Company filed a CurrentReport on Form 8-K, dated September 17, 2003, to report that it hadreceived a formal notice from the Nasdaq Stock Market, Inc. of itsdetermination that the Company did not comply with the minimum $10 millionstockholders’ equity requirement for continued listing on The NASDAQ NationalMarket.  The company also announced thatit would appeal this determination and had requested an oral hearing before aNasdaq Listing Qualifications Panel.

 

                The Company filed a CurrentReport on Form 8-K, dated October 24, 2003, to report the issuance ofa press release setting forth the Company’s third quarter 2003 earnings.

 

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**SIGNATURES**

 

                Pursuant to the requirements ofthe Securities and Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 
|                        | Click Commerce, Inc. |
|-----------------------------|----------------------|
| Date:  **November 4, 2003** |                 |
|                        |                 |
|                        | By:                  | /s/ Michael W. Nelson |
|                        |                 | Michael W. Nelson

*Vice President, Chief Financial Officer and  Treasurer*

*(Principal Financial and Accounting Officer)* |

 

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