---

---

UNITED STATES


SECURITIES AND
EXCHANGE COMMISSION


Washington, D.C. 20549





---




Form 10-Q





|x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ---------------------------------------------------------------------------------------




| | For the quarterly period ended September 30, 2001.
| | --------------------------------------------------




| ̈ |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ----------------------------------------------------------------------------------------




| | For the transition period from
 to
| | ----------------------------------

Commission File Number 000-30293





---




EMBARCADERO TECHNOLOGIES, INC.


(Exact Name of Registrant as Specified in Its Charter)





Delaware

68-0310015(State or other jurisdiction of incorporation or
organization)

(I.R.S. Employer Identification No.)





425 MARKET STREET, SUITE 425


SAN FRANCISCO, CA 94105


(415) 834-3131


(Address of
principal executive offices)





---




Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12
months (or for shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.


x Yes  ̈ No





The number of shares outstanding of the Registrants Common Stock as of October 31, 2001 was 27,152,583.





---

---




EMBARCADERO TECHNOLOGIES, INC.





INDEX





PagePART I.     FINANCIAL INFORMATIONITEM 1.

FINANCIAL STATEMENTSCondensed Consolidated Balance Sheets as of September 30, 2001 and December 31, 2000


3Condensed Consolidated Statements of Operations for the three and nine months ended      September 30, 2001 and 2000


4Condensed Consolidated Statements of Cash Flows for the nine months ended September 30,      2001 and 2000


5Notes to Condensed Consolidated Financial Statements


6ITEM 2.

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


9ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK


24PART II.     OTHER INFORMATIONITEM 6.

EXHIBITS AND REPORTS ON FORM 8-K


25SIGNATURE


26




2


---




PART I





FINANCIAL INFORMATION





ITEM 1.    FINANCIAL
STATEMENTS





EMBARCADERO TECHNOLOGIES, INC.





CONDENSED CONSOLIDATED BALANCE SHEETS


(in thousands, except par value)


(unaudited)





September 30, 2001

December 31, 2000ASSETSCurrent Assets:Cash and cash equivalents


$40,708




$34,745Trade accounts receivable, net


5,802




6,622Prepaid and other current assets


2,038




3,408Total
current assets


48,548




44,775Property and equipment, net


3,252




3,299Goodwill and other intangible assets, net


20,242




20,522Deferred income taxes


1,117




1,117Other assets


201




264Total
assets


$73,360




$69,977LIABILITIES AND STOCKHOLDERS EQUITYCurrent Liabilities:Accounts payable and accrued liabilities


$   5,836




$   4,797Deferred revenue


8,928




7,939Deferred income taxes


181




980Total
current liabilities


14,945




13,716Stockholders Equity:Common stock, $0.001 par value


27




27Additional paid-in capital


71,553




70,949Accumulated other comprehensive income


116




Deferred stock-based compensation


(3,353
)



(6,886
)Accumulated deficit


(9,928
)



(7,829
)Total
stockholders equity


58,415




56,261Total
liabilities and stockholders equity


$73,360




$69,977





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




3


---




EMBARCADERO TECHNOLOGIES, INC.





CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS


(in thousands, except per share data)


(unaudited)





Three Months Ended September 30,

Nine Months Ended September 30,2001

2000

2001

2000Revenues:License

$  6,123


$  7,640


$25,064


$19,562Maintenance

4,950


3,211


14,299


8,252Total revenues

11,073


10,851


39,363


27,814Cost of revenues:License:License, other

136


150


550


445Amortization of acquired technology

231





635


Total license

367


150


1,185


445Maintenance:Maintenance, other

517


313


1,675


913Amortization of non-cash stock-based compensation

3


6


10


29Total maintenance

520


319


1,685


942Total cost of revenues

887


469


2,870


1,387Gross profit

10,186


10,382


36,493


26,427Operating expenses:Research and development:Research and development, other

3,915


2,790


10,811


6,640Amortization of non-cash stock-based compensation

29


77


110


279Total research and development

3,944


2,867


10,921


6,919Sales and marketing:Sales and marketing, other

5,022


3,106


15,146


8,216Amortization of non-cash stock-based compensation

352


716


1,259


2,821Total sales and marketing

5,374


3,822


16,405


11,037General and administrative:General and administrative, other

945


866


2,918


2,439Amortization of non-cash stock-based compensation

600


1,219


2,156


5,038Total general and administrative

1,545


2,085


5,074


7,477Amortization of goodwill and other intangible assets

1,405





4,215


Lease related impairment loss

1,490





1,490


Total operating expenses

13,758


8,774


38,105


25,433Income (loss) from operations

(3,572
)

1,608


(1,612
)

994Other income, net

271


651


810


1,181Expenses related to proposed public offering







(350
)

Income (loss) before income taxes

(3,031
)

2,259


(1,152
)

2,175Benefit from (provision for) income taxes

887


(1,517
)

(947
)

(3,972
)Income (loss) before share in affiliated company loss

(2,414
)

742


(2,099
)

(1,797
)Share in loss of affiliated company




(65
)




(230
)Net income (loss)

(2,414
)

677


(2,099
)

(2,027
)Deemed preferred stock dividend










(1,218
)Net income (loss) available to common stockholders

$  (2,414
)

$     677


$  (2,099
)

$  (3,245
)Basic and Diluted Net Income (Loss) Per Share Available to Common Stockholders:Basic

$    (0.09
)

$    0.03


$    (0.08
)

$    (0.13
)Diluted

$    (0.09
)

$    0.02


$    (0.08
)

$    (0.13
)Weighted Average Shares Used in Per Share Calculation:Basic

27,130


26,613


27,078


24,376Diluted

27,130


28,011


27,078


24,376





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




4


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EMBARCADERO TECHNOLOGIES, INC.





CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


(in thousands)


(unaudited)





Nine Months Ended September 30,2001

2000Cash Flows from Operating Activities:Net loss

$  (2,099
)

$  (2,027
)Adjustments to reconcile net loss to net cash provided by operating activities:Depreciation and amortization

1,111


427Provision for doubtful accounts

15


Amortization of acquired technology

635


Amortization of goodwill and other intangible assets

4,215


Amortization of deferred stock-based compensation

3,533


8,167Share in loss of affiliated company




230Loss on disposal of property and equipment

170


36Deferred income taxes, net

(799
)

274Lease related impairment loss

1,490


Changes in assets and liabilities:Trade
accounts receivable

805


(4,328
)Prepaid
expenses and other assets

1,525


(1,534
)Accounts
payable and accrued liabilities

(115
)

3,061Deferred
revenue

989


2,266Net cash provided by
operating activities

11,475


6,572Cash Flows from Investing Activities:Purchase of property and equipment

(1,570
)

(1,308
)Purchase of technology

(4,662
)

Net cash used in
investing activities

(6,232
)

(1,308
)Cash Flows from Financing Activities:Proceeds from issuance of preferred stock




1,828Proceeds from issuance of common stock




43,034Proceeds from exercise of stock options

679


172Payments for repurchase of common stock

(75
)

Payments on notes payable to stockholders




(1,000
)Net cash provided by
financing activities

604


44,034Effect of exchange rate changes on cash

116


Net increase in cash and cash equivalents

5,963


49,298Cash and cash equivalents at beginning of period

34,745


1,804Cash and cash equivalents at end of period

$40,708


$51,102Supplemental Non-cash Investing and Financing Activities:Deferred stock-based compensation

$       


$   6,759Exercise of common stock options for notes receivable

$       


$       458Conversion of preferred stock to common stock

$       


$   1,828








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




5


---




EMBARCADERO TECHNOLOGIES, INC.





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)





NOTE 1THE COMPANY AND BASIS OF PRESENTATION





Embarcadero Technologies, Inc. (the Company) was incorporated in California on July 23, 1993 and reincorporated in Delaware on February 15, 2000. The Company provides
software products that enable organizations to build and manage e-business applications and their underlying databases. The Companys suite of products allows customers to manage the database life cycle, which is the process of creating,
deploying and enhancing databases in response to evolving business and software application requirements. By simplifying the management of the database life cycle, the Companys products allow organizations to rapidly develop and ensure the
availability of e-business applications.





The Company markets its
software and related maintenance services directly through telesales and field sales organizations in the United States, Canada and the United Kingdom, and indirectly through independent distributors in Australia, Latin America and Japan.





The accompanying unaudited condensed consolidated financial
statements reflect all adjustments, which, in the opinion of the Company, are necessary for a fair presentation of the results for the interim periods presented. All such adjustments are normal recurring adjustments. These financial statements have
been prepared in accordance with generally accepted accounting principles related to interim financial statements and the applicable rules of the Securities and Exchange Commission. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete financial statements. The balance sheet at December 31, 2000 was derived from audited financial statements, but it does not include all disclosures required by generally
accepted accounting principles.





The financial statements and
related disclosures have been prepared with the presumption that users of the interim financial information have read or have access to the audited financial statements for the preceding fiscal year. Accordingly, these financial statements should be
read in conjunction with the audited financial statements and the related notes thereto contained in the Companys Annual Report on Form 10-K for the year ended December 31, 2000 filed on March 20, 2001.





Operating results for the three and nine months ended September 30, 2001 are not necessarily indicative
of the results that may be expected for the full year ending December 31, 2001 or for any future period. Further, the preparation of condensed consolidated financial statements requires management to make estimates and assumptions that affect the
recorded amounts reported therein. A change in facts or circumstances surrounding the estimates could result in a change to the estimates and impact future operating results.





Recent Accounting Pronouncements





In October 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, which supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of and the accounting and reporting provisions of Accounting
Principles Board (APB) No. 30, Reporting the Results of Operations- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. SFAS No. 144
addresses financial accounting and reporting for the impairment or disposal of long-lived assets and is effective for fiscal years beginning after December 15, 2001 as well as interim periods within those fiscal years. The Company is currently
reviewing this statement to determine its effect on its Companys financial position and results of operation.




6


---




EMBARCADERO TECHNOLOGIES, INC.





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)


(unaudited)





In September 2001, the FASB issued two
statements, SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 addresses financial accounting and reporting for business combinations and amends APB No. 16 Business
Combinations. All business combinations in the scope of this Statement are to be accounted for using one method, the purchase method. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets
and supersedes APB No. 17, Intangible Assets. It changes the accounting for goodwill from an amortization method to an impairment only approach. The Company will cease the amortization of goodwill that was recorded in past business
combinations on December 31, 2001, as required by SFAS No. 142. The Company is still evaluating how the adoption of these pronouncements will impact its financial statements.





In September 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS 133
establishes new standards of accounting and reporting for derivative instruments and hedging activities and was adopted by the Company on January 1, 2001. SFAS 133 requires that all derivatives be recognized at fair value in the statement of
financial position, and that the corresponding gains or losses be reported either in the statement of operations or as a component of comprehensive income, depending on the type of hedging relationship that exists. The adoption of SFAS 133 did not
have a material impact on the Companys financial position and results of operations.





NOTE 2RELATED-PARTY
TRANSACTIONS





During the three and nine months ended September
30, 2000, the Company had software product and maintenance revenue from its then affiliated company, Embarcadero Europe Ltd. (EEL), totaling $808,000 and $2.0 million, respectively. In October 2000, the Company acquired the remaining ownership in
EEL. Accordingly, the results of EELs operations for the three and nine months ended September 30, 2001 are included in the Companys consolidated results of operations.





NOTE 3OTHER COMPREHENSIVE INCOME





Accumulated other comprehensive income consists of changes in accumulated foreign currency translation adjustments during the period. For both the three and nine months ended
September 30, 2001, other comprehensive income amounted to approximately $116,000. No such amounts existed in the three and nine months ended September 30, 2000.





NOTE 4LEASE RELATED IMPAIRMENT LOSS





During the third quarter, we recorded a provision for an impairment loss of $1.5 million related to office leases in San Francisco and Boston. The impairment loss consists of
approximately $1 million in contractual obligations under the facilities leases, net of estimated sub-lease income from the projected date of abandonment to the end of the lease term. The remaining $500,000 consists of write-downs to leasehold
improvements and other assets attributable to the abandoned space, as well as other expenses related to securing the sublease arrangements.




7


---




EMBARCADERO TECHNOLOGIES, INC.





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)


(unaudited)





NOTE 5EARNINGS PER SHARE





Basic net income (loss) per common share excludes the effect of potentially dilutive securities and is
computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted net income (loss) per share reflects the potential dilution of securities by including stock
options in the weighted average number of common shares outstanding for a period, if dilutive.





A reconciliation of the numerator and denominator used in the calculation of historical basic and diluted net income (loss) per share is as follows (in thousands, except per share
data):





Three Months Ended September 30,

Nine Months Ended September 30,2001

2000

2001

2000Historical net income (loss) available to common stockholders per      share, basic and
diluted:Numerator for net income (loss) available to common
               stockholders, basic and diluted

$  (2,414
)

$       677

$  (2,099
)

$  (3,245
)Denominator for basic net income (loss) per share:Weighted average common shares outstanding

27,130


26,613

27,078


24,376Net income (loss) per share, basic

$     (0.09
)

$     0.03

$     (0.08
)

$     (0.13
)Denominator for diluted net income (loss) per share:Weighted average common shares outstanding

27,130


26,613

27,078


24,376Effect of dilutive securitiescommon stock options




1,398




Weighted average common and common equivalent shares

27,130


28,011

27,078


24,376Net income (loss) available to common stockholders per share,      diluted


$     (0.09
)

$     0.02

$     (0.08
)

$     (0.13
)Anti-dilutive securities not included in net income (loss) available to      common
stockholders per share calculationcommon stock      options

2,123




1,679


3,463





In connection with
the sale of 253,893 shares of Series A convertible preferred stock at a price below the deemed fair market value, the Company recognized a non-cash charge (deemed preferred stock dividend) against earnings attributable to common stockholders of
approximately $1.2 million in the nine months ended September 30, 2000. There was no such deemed preferred stock dividend in nine months ended September 30, 2001.




8


---




|ITEM 2. |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- |  | -------------------------------------------------------------------------------------




The following
discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included in this Form 10-Q and with our managements discussion
and analysis included in the Companys Annual Report on Form 10-K for the year ended December 31, 2000, filed on March 20, 2001.





This report contains forward-looking statements within the meaning of the federal securities laws that relate to future events or our future financial performance. In some cases,
you can identify forward-looking statements by terminology such as may, will, should, expect, plan, anticipate, believe, estimate, predict,
intend, potential or continue or the negative of these terms or other comparable terminology. Such statements are only predictions. Risks and uncertainties and the occurrence of other events could cause actual
results to differ materially from these predictions. The factors discussed below under Factors That May Affect Future Results should be considered carefully in evaluating Embarcadero and its business. Although we believe that the
expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and
completeness of these statements. We are under no duty to update any of the forward-looking statements after the date of this report or to conform these statements to actual results.





Overview





We provide software products that enable organizations to build and manage e-business applications and their underlying databases. Our suite of products allows customers to manage
the database life cycle, which is the process of creating, deploying and enhancing databases in response to evolving business and software application requirements. By simplifying the management of the database life cycle, our products allow
organizations to rapidly develop and ensure the availability of critical e-business applications.





We were incorporated in California as Client Worx, Inc. in July 1993 and changed our name to Embarcadero Technologies, Inc. in October 1993. We reincorporated in Delaware in
February 2000. At our inception, we focused on developing and marketing software for use with Sybase and Microsoft SQL Server databases. In December 1993, we introduced Rapid SQL for Sybase and Microsoft SQL Server database development. In July
1994, we introduced DBArtisan for the administration of Sybase and Microsoft SQL Server databases. In September 1996, we released ER/Studio, our database design solution, which was our first product to offer support for IBM DB2 Universal Database,
Informix and Oracle, as well as Sybase and Microsoft SQL Server.





The success of ER/Studios multi-vendor support led us to add support for other major databases to our other products. We added Oracle support to DBArtisan in April 1997 and
to Rapid SQL in January 1998. We added support for IBM DB2 Universal Database to both products in mid-1998. In 1998, we also began to enhance our products with add-ons and companion products. In October 1998, we offered our first standalone
companion product, ER/Studio Viewer, which complemented the ER/Studio product. In April 1999, we introduced DBArtisan Schema Manager as a standalone companion product and changed the product name to DBArtisan Change Manager in January 2000. In
October 2000, we introduced DBArtisan Job Scheduler, designed to simplify database administration by enabling database professionals to automate their scheduling tasks and manage them from a single, easy-to-use graphical console. We introduced
PL/SQL Debugger and SQL Profiler add-ons to extend the functionality of Rapid SQL and DBArtisan in January 2000. During the first quarter of 2001, we introduced Performance Center and SQL Tuner; both products help improve the availability and
performance of databases. Two new products were introduced during the third quarter of 2001, Data Voyager, a data management and editing product, and Repository for ER/Studio, which supports enterprise level modeling collaboration.




9


---




During the fourth quarter of 2000,
we completed three acquisitions: Embarcadero Europe Ltd., Advanced Software Technologies, Inc. and EngineeringPerformance, Inc. Embarcadero Europe Ltd. serves as our sales and marketing office for Europe, the Middle East and Africa. In connection
with our acquisition of Advanced Software Technologies, Inc., we introduced GDPro (recently renamed Describe), an application design product.





Sources of Revenue and Revenue Recognition Policy





Total revenues consist primarily of revenues earned under software license agreements and maintenance agreements. Revenues from software license agreements are recognized upon
shipment, provided that a signed contract exists, the fee is fixed or determinable and collection of the resulting receivable is probable. We recognize revenues from maintenance fees, including amounts allocated from product revenues for ongoing
customer support and product updates and upgrades, ratably over the period of the maintenance contract. Payments for maintenance fees are generally made in advance and are non-refundable.





For contracts with multiple obligations (e.g., deliverable products and maintenance), revenues are
allocated to each undelivered component of the contract based on objective evidence of its fair value, which is specific to the Company. We recognize revenues allocated when the criteria for revenue recognition set forth above are met.





We market our software and related maintenance services directly through our
telesales and field sales organizations in the United States, Canada and the United Kingdom, and indirectly through our distribution partners worldwide. We intend to expand our international sales activities in an effort to increase revenues from
foreign sales. To date, our primary international distributor has been our wholly-owned subsidiary, Embarcadero Europe Ltd.




10


---




Results of Operations





The following table sets forth, for the periods indicated, the percentage relationship of certain items
from the Companys condensed consolidated statement of operations to total revenues:





Three Months Ended September 30,

Nine Months Ended September 30,2001

2000

2001

2000Revenues:License

55.3
%

70.4
%

63.7
%

70.3
%Maintenance

44.7
%

29.6
%

36.3
%

29.7
%Total revenues

100.0
%

100.0
%

100.0
%

100.0
%Cost of revenues:License:License, other

1.2
%

1.4
%

1.4
%

1.6
%Amortization of acquired technology

2.1
%




1.6
%

Total license

3.3
%

1.4
%

3.0
%

1.6
%Maintenance:Maintenance, other

4.7
%

2.9
%

4.3
%

3.3
%Amortization of non-cash stock-based compensation





0.1
%




0.1
%Total maintenance

4.7
%

3.0
%

4.3
%

3.4
%Total cost of
revenues

8.0
%

4.4
%

7.3
%

5.0
%Gross profit

92.0
%

95.6
%

92.7
%

95.0
%Operating expenses:Research and development:Research and development, other

35.3
%

25.7
%

27.4
%

23.9
%Amortization of non-cash stock-based compensation


0.3
%

0.7
%

0.3
%

1.0
%Total research and
development

35.6
%

26.4
%

27.7
%

24.9
%Sales and marketing:Sales and marketing, other

45.3
%

28.6
%

38.5
%

29.5
%Amortization of non-cash stock-based compensation


3.2
%

6.6
%

3.2
%

10.1
%Total sales and
marketing

48.5
%

35.2
%

41.7
%

39.6
%General and administrative:General and administrative, other

8.5
%

8.0
%

7.4
%

8.8
%Amortization of non-cash stock-based compensation


5.4
%

11.2
%

5.5
%

18.1
%Total general and
administrative

13.9
%

19.2
%

12.9
%

26.9
%Amortization of goodwill and other intangible assets

12.7
%




10.7
%

Lease related impairment loss

13.5
%




3.8
%

Total operating
expenses

124.2
%

80.8
%

96.8
%

91.4
%Income (loss) from operations

(32.2
)%

14.8
%

(4.1
)%

3.6
%Other income, net

2.4
%

6.0
%

2.1
%

4.2
%Expenses related to proposed public offering







(0.9
)%

Income (loss) before income taxes

(29.8
)%

20.8
%

(2.9
)%

7.8
%Benefit from (provision for) income taxes

8.0
%

(14.0
)%

(2.4
)%

(14.3
)%Income (loss) before share in affiliated company loss

(21.8
)%

6.8
%

(5.3
)%

(6.5
)%Share in loss of affiliated company




(0.6
)%




(0.8
)%Net income (loss)

(21.8
)%

6.2
%

(5.3
)%

(7.3
)%Deemed preferred stock dividend










(4.4
)%Net income (loss)
available to common stockholders

(21.8
)%

6.2
%

(5.3
)%

(11.7
)%




11


---




Three and Nine Months Ended September 30, 2001 and September 30, 2000





| | Revenues
| | --------




Three Months Ended September 30,

Nine Months Ended September 30,2001

2000

2001

2000(in thousands)Revenues:License

$   6,123

$   7,640

$25,064

$19,562Maintenance

4,950

3,211

14,299

8,252Total
revenues

$11,073

$10,851

$39,363

$27,814





Total
Revenues.    Total revenues for the three and nine months ended September 30, 2001 were $11.1 million and $39.4 million, respectively, representing increases of 2.0% and 41.5% from the comparable periods of 2000.





License.    License revenues for
the three and nine months ended September 30, 2001 were $6.1 million and $25.1 million, respectively, representing a decrease of 19.9% and an increase of 28.1% from the comparable periods of 2000. The decrease in license revenues for the three
months was primarily the result of cautious IT spending due to weakening global economic conditions, aggravated by the September 11, 2001 terrorist attacks. The increase in license revenues for the nine-month period was due to greater market
acceptance of our products, greater breadth of product offerings and an increase in sales staff.





Maintenance.    Maintenance revenues for the three and nine months ended September 30, 2001 were $5.0 million and $14.3 million, respectively,
representing increases of 54.2% and 73.3% from the comparable periods of 2000. The increases were due to a cumulative increase in the number of licenses sold and a corresponding increase in our installed customer base and maintenance renewals.





| | Cost of Revenues
| | ----------------




Three Months Ended September 30,

Nine Months Ended September 30,2001

2000

2001

2000(in thousands)Cost of revenues:License:License,
other

$136

$150

$    550

$    445Amortization of acquired technology

231



635

Total license

367

150

1,185

445Maintenance:Maintenance, other

517

313

1,675

913Amortization of non-cash stock-based compensation

3

6

10

29Total maintenance

520

319

1,685

942Total cost of
revenues

$887

$469

$2,870

$1,387





License.    Cost of license revenues consists primarily of amortization of acquired technology, royalties, product media and packaging, shipping fees and
duplication expenses. Cost of license revenues was $367,000 and $1.2 million for the three and nine months ended September 30, 2001, respectively, representing increases of 144.7% and 166.3% from the comparable periods of 2000. The increase in
absolute dollars from 2000 to 2001




12


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was due to amortization of acquired technology that was purchased in the fourth quarter of 2000 and an increase in royalties attributable to the number of licenses sold. Cost of license revenues
represented 3.3% and 3.0% of license revenues in the three and nine months ending September 30, 2001, respectively, compared to 1.4% and 1.6% for the comparable periods of 2000. Excluding amortization of acquired technology, as a percentage of
license revenue cost of license was 1.2% and 1.4% for the three and nine months ended September 30, 2001 and 1.4% and 1.6% for the comparable periods of 2000. Cost of license revenues as a percentage of license revenues may vary in the future
depending on the mix of internally developed versus externally licensed products and product components.





Maintenance.    Cost of maintenance revenues consists primarily of customer support personnel and related expenses, including payroll, employee benefits
and non-cash stock-based compensation. Cost of maintenance revenues was $520,000 and $1.7 million for the three and nine months ended September 30, 2001, respectively, representing increases of 63.0% and 78.9% from the comparable periods of 2000.
Cost of maintenance revenues represented 4.7% and 4.3% of maintenance revenues in the three and nine months ended September 30, 2001, respectively, and 3.0% and 3.4% for the comparable periods of 2000. The increase in absolute dollars from 2000 to
2001 was due primarily to an increase in the number of customer support personnel hired to service our expanding worldwide customer base and the associated increase in overhead allocation. The increase in customer support personnel is due to hiring
as well as the inclusion of personnel absorbed through acquisitions in the fourth quarter of 2000. We expect that cost of maintenance revenues will likely increase in absolute dollars in future periods as we hire more support personnel.





| | Operating Expenses
| | ------------------




| | Research and Development
| | ------------------------




Three Months Ended September 30,

Nine Months Ended September 30,2001

2000

2001

2000(in thousands)Research and development:Research and development, other

$3,915

$2,790

$10,811

$6,640Amortization of non-cash stock-based compensation

29

77

110

279Total
research and development

$3,944

$2,867

$10,921

$6,919





Research and
development expenses consist primarily of personnel and related expenses, including payroll, employee benefits and non-cash stock-based compensation, as well as expenses related to outside software development contractors. Research and development
expenses for the three and nine months ended September 30, 2001 were $3.9 million and $10.9 million, respectively, representing increases of 37.6% and 57.8% from the comparable periods of 2000. As a percentage of total revenues, research and
development expenses were 35.6% and 27.7% for the three and nine months ended September 30, 2001, respectively, and 26.4% and 24.9% for the comparable periods of 2000. The increase in absolute dollars and as a percentage of revenue from 2000 to 2001
was due primarily to an increase in the number of personnel in our research and development organization, both domestically and in our research and development facility in Canada, and the associated increase in overhead allocation. The increase in
personnel is due to hiring as well as the inclusion of personnel absorbed through acquisitions in the fourth quarter of 2000. We expect research and development expenses to increase in absolute dollars in future periods as additional development
personnel are hired and as we expand our product development activities.




13


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| | Sales and Marketing
| | -------------------




Three Months Ended September 30,

Nine Months Ended September 30,2001

2000

2001

2000(in thousands)Sales and marketing:Sales and marketing, other

$5,022

$3,106

$15,146

$   8,216Amortization of non-cash stock-based compensation

352

716

1,259

2,821Total
sales and marketing

$5,374

$3,822

$16,405

$11,037





Sales and marketing
expenses consist primarily of salaries, commissions earned by sales personnel, non-cash stock-based compensation, trade shows, travel and other marketing communication costs, such as advertising and other marketing programs. Sales and marketing
expenses for the three and nine months ended September 30, 2001 were $5.4 million and $16.4 million, respectively, representing increases of 40.6% and 48.6% from the comparable periods in 2000. As a percentage of total revenues, sales and marketing
expenses were 48.5% and 41.7% for the three and nine months ended September 30, 2001, respectively, and 35.2% and 39.6% for the comparable periods of 2000. Excluding non-cash stock-based compensation, sales and marketing expenses as a percentage of
total revenues were 45.3% and 38.5% for the three and nine months ended September 30, 2001, respectively, and 28.6% and 29.5% for the comparable periods of 2000. The increase in absolute dollars from 2000 to 2001 was due to an increase in headcount
and related expenses, increased commissions based on sales volume, costs associated with the expansion of the field sales organization and expanded marketing programs. We have invested, and we plan to continue to invest, resources to expand our
sales and marketing efforts. As a result, we expect sales and marketing expenses to increase in absolute dollars in future periods.





| | General and Administrative
| | --------------------------




Three Months Ended September 30,

Nine Months Ended September 30,2001

2000

2001

2000(in thousands)General and administrative:General and administrative, other

$    945

$    866

$2,918

$2,439Amortization of non-cash stock-based compensation

600

1,219

2,156

5,038Total
general and administrative

$1,545

$2,085

$5,074

$7,477





General and
administrative expenses consist primarily of non-cash stock-based compensation, salaries and related personnel expenses and general operating expenses. General and administrative expenses for the three and nine months ended September 30, 2001 were
$1.5 million and $5.1 million, respectively, representing decreases of 25.9% and 32.1% from the comparable periods of 2000. As a percentage of total revenues, general and administrative expenses were 13.9% and 12.9% for the three and nine months
ended September 30, 2001, respectively, and 19.2% and 26.9% for the comparable periods of 2000. The decrease in absolute dollars and as a percentage of revenue from 2000 to 2001 was primarily due to a decrease in non-cash stock-based compensation.
Excluding non-cash stock based compensation, general and administrative expenses as a percentage of total revenues were 8.5% and 7.4% for the three and nine months ended September 30, 2001, respectively, and 8.0% and 8.8% for the comparable periods
of 2000. We expect other general and administrative expenses to continue to increase in absolute dollars as we expand our administrative staff and facilities to support larger operations and as we incur additional expenses associated with being a
public company.




14


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Amortization of Goodwill and
Other Intangible Assets.    In connection with the acquisitions of Advanced Software Technologies, Inc., EngineeringPerformance, Inc., and the remaining 56% of Embarcadero Europe Ltd., we recorded $21.4 million of goodwill
and other intangible assets in the fourth quarter of 2000. The total amortization expense related to these costs in the three and nine months ended September 30, 2001 was $1.6 million and $4.9 million, respectively. Approximately $635,000 of this
amortization expense was recorded as cost of license revenue in the nine months ended September 30, 2001. The remaining $4.2 million of expense was recorded as an operating expense. These assets will be amortized over their useful lives, ranging
from two to four years. We had no such amortization expense in the three and nine months ended September 30, 2000.





Lease Related Impairment Loss.    During the third quarter, we recorded a provision for an impairment loss of $1.5 million related to office leases in
San Francisco and Boston; management has decided to abandon and sublease these office spaces in order to streamline operations. The impairment loss consists of approximately $1 million in contractual obligations under the facilities leases, net of
estimated sub-lease income from the projected date of abandonment to the end of the lease term. The remaining $500,000 consists of write-downs to leasehold improvements and other assets attributable to the abandoned space, as well as other expenses
related to securing the sublease arrangements.





Benefit from
(Provision for) Income Taxes.    Benefit from (provision for) income taxes for the three and nine months ended September 30, 2001 was $887,000 and $(1.5) million, respectively. The decrease in the effective tax rate before
non-cash stock-based compensation and amortization of goodwill from 2000 to 2001 is the result of tax exempt interest income and an increased research and development tax credit resulting from a corresponding increase in qualified research and
development expenses.





Liquidity and Capital Resources





We have funded our business to date from cash generated by our operations and proceeds from sales of
equity. In April 2000, we completed our initial public offering of common stock, generating net proceeds to us of approximately $43.0 million. As of September 30, 2001, we had cash and cash equivalents of $40.7 million.





Net cash provided by operating activities for the nine months ended September 30,
2001 and 2000 was $11.5 million and $6.6 million, respectively. The increase was primarily due to changes in operating assets and liabilities as well as a net increase in non-cash depreciation and amortization expenses.





Net cash used in investing activities for the nine months ended September 30, 2001
and 2000 was $6.2 million and $1.3 million, respectively. In both periods, cash used in investing activities included purchases of computer equipment, software, leasehold improvements, fixtures and furniture. Additionally, in the nine months ended
September 30, 2001, $4.6 million was used to acquire technology. There was no such use of cash in the nine months ended September 30, 2000.





Net cash provided by financing activities in the nine months ended September 30, 2001 and 2000 was $600,000 and $44.0 million, respectively. In the nine
months ended September 30, 2001 cash flow from financing activities came primarily from the exercise of stock options under the Companys stock option plan. Net cash provided by financing activities in the nine months ended September 30, 2000
came predominately from $43.0 million in net proceeds from the Companys initial public offering of common stock and to a lesser extent from the proceeds from the sale of the Companys Series A preferred stock and the exercise of stock
options under the Companys stock option plan.





We have a $2
million revolving credit facility with a bank that bears interest at the prime rate and expires on May 31, 2002. We have not drawn on this credit facility and accordingly have no balance outstanding. Our credit facility requires us to maintain
various quarterly financial covenants including covenants related to our tangible net worth and total liabilities. We are in compliance with all of the financial covenants under the facility.




15


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We believe that our existing cash
balances and cash equivalents and cash from operations will be sufficient to finance our operations through at least the next 12 months. If additional financing is needed, there can be no assurance that such financing will be available to us on
commercially reasonable terms, or at all.





Impact of Recently Issued Accounting Standards





In October 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of and the accounting and reporting provisions of Accounting Principles Board (APB) No. 30, Reporting the Results of OperationsReporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and is effective for fiscal years beginning
after December 15, 2001, and interim periods within those fiscal years. The Company is currently reviewing this statement to determine its effect on its Companys financial position and results of operation.





In September 2001, the FASB issued two statements, SFAS No. 141, Business
Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 addresses financial accounting and reporting for business combinations and amends APB No. 16 Business Combinations. All business
combinations in the scope of this Statement are to be accounted for using one method, the purchase method. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB No. 17,
Intangible Assets. It changes the accounting for goodwill from an amortization method to an impairment only approach. The Company will cease the amortization of goodwill that was recorded in past business combinations on December 31,
2001, as required by SFAS No. 142. The Company is still evaluating how the adoption of these pronouncements will impact its financial statements.





In September 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS 133 establishes new standards
of accounting and reporting for derivative instruments and hedging activities and was adopted by the Company on January 1, 2001. SFAS 133 requires that all derivatives be recognized at fair value in the statement of financial position, and that the
corresponding gains or losses be reported either in the statement of operations or as a component of comprehensive income, depending on the type of hedging relationship that exists. The adoption of SFAS 133 did not have a material impact on the
Companys financial position and results of operations.




16


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FACTORS THAT MAY AFFECT FUTURE RESULTS





In addition to other information in this report, the following factors should be considered carefully
in evaluating the Company. The risks and uncertainties described below are not the only ones facing the Company. Additional risks and uncertainties that we are unaware of or currently deem immaterial may also become important factors that may harm
our business.





Our quarterly operating results may fluctuate in future periods, and, as a result, our stock price may
fluctuate or decline.





Our growth rates may not be sustainable
and you should not use our past performance to predict future results. We believe that quarter-to-quarter comparisons of our historical results of operations are not indicative of our future performance. Our revenues and operating results may vary
significantly from quarter to quarter due to a number of factors, including the factors discussed below under the captions:





| |  |  | Large sales of our products and maintenance involve a lengthy sales cycle, which could cause delays in recognizing revenue or the failure to obtain revenue;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | The impact of changes in global economic conditions on our customers may cause us to fail to meet expectations, which would negatively impact the price of our
stock;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Our operating results would be harmed if the database industry is in a downward cycle;
| | - |  | ----------------------------------------------------------------------------------------




| |  |  | We expect to incur increases in our operating expenses in the foreseeable future, which may affect our profitability;
| | - |  | -----------------------------------------------------------------------------------------------------------------------




| |  |  | Acquisitions of companies or technologies may result in disruptions to our business;
| | - |  | --------------------------------------------------------------------------------------




| |  |  | If we are not able to enhance our existing products to adapt to rapid technological change, or we introduce new products that do not achieve market acceptance, our
revenue and earnings may suffer and we may experience loss of market share;  and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | We may lose market share and be required to reduce prices as a result of competition from existing competitors, independent software vendors and manufacturers of
compatible software.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Seasonal variations in orders for our products also contribute to fluctuations
in our quarterly operating results. These fluctuations are likely to cause corresponding volatility in our stock price, particularly if our operating results vary from analysts expectations.





If sales of DBArtisan fall, our revenues and income may decline.





A large portion of our revenues currently comes from sales of our DBArtisan product. For the nine months ended September 30, 2001 and for the years ended
December 31, 2000, 1999 and 1998, DBArtisan accounted for approximately 38.5%, 46.6%, 48.3% and 56.3%, respectively, of our domestic license revenues. We expect that sales of DBArtisan will continue to represent a substantial portion of our license
revenues for the foreseeable future. In addition, most of our customers initiate a relationship with us by purchasing DBArtisan. If demand for DBArtisan declines due to competition, technological change or other factors, our revenues and income may
decline significantly.





If we do not continue to add new customers, we will not be able to sustain or increase our revenues.





Our license arrangements do not generally provide for
substantial ongoing license or maintenance payments. Therefore, our future revenue growth depends on our continued success in attracting new customers or expanding our relationships with existing customers. Our ability to attract new customers and
expand our relationships with existing customers will depend on a variety of factors, including the performance, quality, breadth and depth of




17


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our current and future products and maintenance. Our failure to add new customers or to expand our relationships with existing customers would reduce our future revenues.





Large sales of our products and maintenance involve a lengthy sales cycle, which could cause delays in recognizing revenue or the failure to
obtain revenue.





In the past year, large sales of our products
and maintenance to individual customers have increased. These large sales typically involve sales cycles from 6 months to 12 months, which is considerably longer than our historical sales cycle. This lengthy sales cycle is due to the need to educate
and convince prospective customers of the value of our products and services and to gain approval from a variety of constituencies within a prospective customer, including key management personnel. The timing of our revenues has become more
difficult to forecast because of this lengthy sales cycle for large sales. We may expend substantial funds and effort to negotiate these sales with prospective customers, but then be delayed in concluding, or be unable to conclude, sales of our
products and maintenance. Any delay in, or failure to complete, sales in a particular period would reduce our revenues in that period, as well as subsequent periods over which revenues for the sale may be recognized. If our sales cycle unexpectedly
lengthens in general or for one or more large sales, it could negatively affect the timing of our revenues and our revenue growth and may cause our revenues and operating results to vary significantly from period to period. If we were to experience
a delay on a large order, it could harm our ability to meet our forecasts for a given period.





The impact of changes in
global economic conditions on our customers may cause us to fail to meet expectations, which would negatively impact the price of our stock.





Our operating results can vary significantly based upon the impact of changes in global and domestic economic conditions on our customers. The domestic and
economic environment in 2001 is more uncertain than in recent periods. Additionally, the September 11, 2001 terrorist attacks in New York City, Washington, D.C. and Pennsylvania, and the United States military response, has further affected
the economic environment. At the time of the attacks, capital investment by businesses, particularly investments in new technology, had been experiencing substantial weakness. This weakness was aggravated by the September 11 attacks. Economic and a
political uncertainty resulting from the attacks and the U.S. military response could result in further decline in new technology investments. The effects of these actions could cause customers to defer or reconsider purchasing products or services
if they experience a downturn in their business or if there is a downturn in the general economy. Such events could have a material adverse effect on our business.





Our operating results would be harmed if the database industry is in a downward cycle.





The markets into which we sell our products are cyclical and are subject to general economic conditions. The database industry is subject to significant
downturns in connection with, or in anticipation of, declines in general economic conditions. For example, a number of companies that sell the database platforms that our products support, including Oracle Corporation, have reduced or failed to meet
analysts revenue and earnings expectations. In addition, we believe that the recent economic downturn has had an impact on capital spending in the database market.





We are uncertain as to how long and how deep the current downturn may be in the database market. Any continued or further slowdowns in the
database market or in general economic conditions would likely result in a reduction in demand for our products and would harm our business.





If we cannot manage our expansion effectively, our rate of growth and income may decline.





We have recently experienced a period of significant expansion in our operations, both through internal growth as well as through acquisitions of companies in the United Kingdom,
Colorado and Canada. This growth has placed, and will continue to place, a strain on our management, administrative, operational and financial




18


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infrastructure and we may not be able to effectively manage our growth in the future. To support our expanding operations, we have increased the number of our full-time employees from 57 as of
December 31, 1998, to 105 as of December 31, 1999, 268 as of December 31, 2000 and 293 as of September 30, 2001. We expect to hire additional employees to manage our expanding operations. Our ability to manage growth requires that we continue to
improve our operational, financial and management controls and procedures. If we are unable to manage this growth effectively, our rate of growth and our income may decline.





We expect to incur increases in our operating expenses in the foreseeable future, which may affect our profitability.





We intend to increase our operating expenses for the foreseeable future as we continue to increase our sales and marketing, research and
development activities and customer support operations. In connection with these expanded operations, we will need to increase our revenues. However, we will incur these increased expenses before we realize any increased revenues related to this
spending. If these efforts do not increase revenues, our profitability may decline.





The expansion of our international
operations exposes us to risks.





One aspect of our growth
strategy is to expand our international operations. For example, in the fourth quarter of 2000, we acquired companies with operations in the United Kingdom and Canada. As a result, we could face a number of risks from our expanding international
operations, including:





| |  |  | staffing and managing foreign operations;
| | - |  | -----------------------------------------




| |  |  | increased financial accounting and reporting complexities;
| | - |  | ----------------------------------------------------------




| |  |  | potentially adverse tax consequences;
| | - |  | -------------------------------------




| |  |  | the loss of revenues and net income resulting from currency fluctuations;
| | - |  | -------------------------------------------------------------------------




| |  |  | compliance with a wide variety of complex foreign laws and treaties;
| | - |  | --------------------------------------------------------------------




| |  |  | reduced protection for intellectual property rights in some countries;
| | - |  | ----------------------------------------------------------------------




| |  |  | licenses, tariffs and other trade barriers;
| | - |  | -------------------------------------------




| |  |  | longer sales and payment cycles; and
| | - |  | ------------------------------------




| |  |  | costs and difficulties of customizing products for foreign countries.
| | - |  | ---------------------------------------------------------------------




Further expansion of our international operations may require significant management attention and financial resources and may place
burdens on our management, administrative, operational and financial infrastructure. Our possible investments in establishing facilities in other countries may not produce desired levels of revenue or profitability.





Our proprietary rights may be inadequately protected and infringement claims or independent development of competing technologies could harm
our competitive position.





We rely on copyright and trademark
laws, trade secrets, confidentiality procedures and contractual provisions to establish and protect our proprietary rights. We also enter into confidentiality agreements with employees and consultants and attempt to restrict access to proprietary
information on a need-to-know basis. Despite such precautions, unauthorized third parties may be able to copy aspects of our products or obtain and use information that we consider as proprietary.





We license our software products primarily under shrink-wrap licenses included as part of product
packaging. Shrink-wrap licenses are not negotiated with or signed by individual licensees and purport to take




19


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effect upon the opening of the product package or downloading of the product from the Internet. These measures afford only limited protection. Policing unauthorized use of our products is
difficult and we are unable to determine the extent to which piracy of our software exists. In addition, the laws of some foreign countries do not protect our proprietary rights as well as United States laws.





We may have to enter into litigation to enforce our intellectual property rights or to determine the
validity and scope of the proprietary rights of others with respect to our rights. Litigation is generally very expensive and can divert the attention of management from daily operations. Accordingly, any intellectual property litigation could
disrupt our operations and harm our operating results.





We are not
aware of any case in which we are infringing the proprietary rights of others. However, third parties may bring infringement claims against us. Any such claim is likely to be time consuming and costly to defend, could cause product delays and could
force us to enter into unfavorable royalty or license agreements with third parties. A successful infringement claim against us could require us to enter into a license or royalty agreement with the claimant or develop alternative technology.
However, we may not be able to negotiate favorable license or royalty agreements, if any, in connection with such claims and we may fail to develop alternative technology on a timely basis. Accordingly, a successful product infringement claim
against us could harm our business and operating results.





If our products do not perform as expected, we may lose
customers, our costs will increase and revenues may be delayed or lost.





Computer software such as ours often contains undetected errors and may contain design flaws. Errors may be found in current versions, new versions or enhancements of our products
after we make commercial shipments. If our software contains undetected errors, performs unreliably, or if we otherwise fail to meet our customers expectations, we may suffer:





| |  |  | loss of revenues, market share or customers;
| | - |  | --------------------------------------------




| |  |  | negative publicity and harm to our reputation;
| | - |  | ----------------------------------------------




| |  |  | diversion of research and development and management resources;
| | - |  | ---------------------------------------------------------------




| |  |  | increased maintenance and warranty costs;
| | - |  | -----------------------------------------




| |  |  | legal actions by customers against us; and
| | - |  | ------------------------------------------




| |  |  | increased insurance costs.
| | - |  | --------------------------




Acquisitions of companies or technologies may result in disruptions to our business.





In the fourth quarter of 2000, we acquired Embarcadero Europe Ltd., based in Maidenhead, United Kingdom, Advanced Software Technologies, Inc., based in Littleton, Colorado and
EngineeringPerformance, Inc., based in Toronto, Canada. To realize the benefits of these recent acquisitions, we must successfully integrate these operations into our existing operations. This integration has required and will continue to require
significant time and resources to manage. If we are unable to successfully integrate with our existing operations these and any other businesses, products or technologies that we acquire, we may not receive the intended benefits of such acquisitions
and the revenue and operating results of the combined company may decline. In addition, acquisitions may subject us to unanticipated liabilities or risks. We may continue to make additional strategic acquisitions of companies, products or
technologies as necessary in order to implement our business strategy. Any acquisition may temporarily disrupt our operations and divert managements attention from day-to-day operations.





While we financed our recent acquisitions primarily with working capital, we may incur debt or issue
equity securities to finance future acquisitions. The issuance of equity securities for any acquisition could be




20


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substantially dilutive to our stockholders. In addition, our profitability may suffer due to acquisition-related expenses or amortization costs for acquired goodwill and other intangible assets.





If we are not able to enhance our existing products to adapt to rapid technological change, or we introduce new products
that do not achieve market acceptance, our revenue and earnings may suffer and we may experience loss of market share.





The market for our products is characterized by rapid technological change, frequent product introductions and enhancements, uncertain product life cycles and changes in customer
demands and industry standards. Our success depends on our ability to continue to:





| |  |  | enhance our current products;
| | - |  | -----------------------------




| |  |  | introduce new products that keep pace with technological developments;
| | - |  | ----------------------------------------------------------------------




| |  |  | satisfy increasingly complicated customer requirements;
| | - |  | -------------------------------------------------------




| |  |  | integrate our products with multiple database platforms; and
| | - |  | ------------------------------------------------------------




| |  |  | modify our products as database platforms change.
| | - |  | -------------------------------------------------




However, due to the nature of computing environments and the performance demanded by customers for database management software, new products and product
enhancements could require longer development and testing periods than we currently anticipate. Moreover, if we develop new products that do not achieve market acceptance, we may not be able to recoup development and marketing expenses, which could
harm our operating results.





The introduction of new technologies
and the emergence of new industry standards may render our existing products obsolete and unmarketable. Delays in the general availability of new releases or problems in the installation or implementation of new releases could harm our business and
operating results. We may not be successful in developing and marketing, on a timely and cost-effective basis, new products or new product enhancements that respond to technological change, evolving industry standards or customer requirements. Our
failure to do so would render our products obsolete and could harm our ability to compete. In addition, our products and product enhancements may not achieve market acceptance.





If we are not able to attract and retain qualified personnel, our business will not be able to grow.





Our success depends on the continued service of our executive officers and other key administrative, sales and marketing, research and development and
support personnel. None of our executive officers or key employees is bound by an employment agreement for any specific term and we do not maintain any key person life insurance policies. If we lose the services of one or more of our executive
officers or key employees, or if one or more of them decide to join a competitor or otherwise compete directly or indirectly with us, our business could be seriously harmed.





Our business will not be able to grow if we cannot attract, retain and motivate qualified personnel. Despite the economic downturn,
competition for qualified employees remains intense and we may not be able to attract, assimilate or retain highly qualified personnel in the future. There has in the past been and there may in the future be a shortage of personnel that possess the
technical background necessary to sell, support and develop our products effectively. Some of our current employees and those that we seek to hire may be subject to non-competition or non-solicitation covenants that could further limit our ability
to attract or retain qualified personnel.




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We may lose market share and be required to reduce prices as a result of competition from
our existing competitors, independent software vendors and manufacturers of compatible software.





The market for our products is highly competitive, dynamic and subject to rapidly changing technology. We compete primarily against other providers of application design and
database management utilities, which include Computer Associates, Quest Software, BMC Software, Rational Software and other independent software vendors. Our products also compete with products offered by database software manufacturers, including
Oracle, Microsoft and IBM. Some of these competing products are provided at no charge to their customers. We expect that companies such as Oracle, Microsoft and IBM will continue to develop and incorporate into their products applications which
compete with our products and may take advantage of their substantial technical, financial, marketing and distribution resources in those efforts. We may not be able to compete effectively with those products or efforts, which could significantly
harm our business and operating results. In addition, if the market for application design and database management products continues to grow, some of our competitors may increase their focus on offering software directly competitive with ours,
whether by internal development, external development or acquisition. Our competitors may also attempt to keep us from integrating our software with theirs, making it more difficult for our customers to adopt our software. If such increased
competition were to result in resistance to integration of our software with the software of these competitors, our business would be harmed. Further, if a single database platform were to gain a considerably larger share of the database market than
other database platforms, we would lose our multi-platform competitive advantage and our sales would suffer. Many of our competitors have longer operating histories, substantially greater financial, technical, marketing and other resources, and
greater name recognition than we do. They also may be able to respond more quickly than we can to changes in technology or customer requirements. Competition could seriously impede our ability to sell additional products on acceptable terms. Our
competitors may:





| |  |  | develop and market new technologies that render our products obsolete, unmarketable or otherwise less competitive;
| | - |  | ------------------------------------------------------------------------------------------------------------------




| |  |  | make strategic acquisitions or establish cooperative relationships among themselves or with other companies, thereby enhancing the functionality of their products; or
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | establish or strengthen cooperative relationships with channel or strategic partners which limit our ability to sell or to co-market products through these channels.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------




Competitive pressures could reduce our market
share, reduce customer orders, reduce gross margins or require us to reduce our prices, any of which would harm our operating results.





We may be required to change our revenue recognition policies based on changing implementation guidelines and interpretations, which may cause our revenues and operating results to fluctuate unexpectedly.





In recent years, software revenue recognition rules have been under heavy review and
interpretation by various accounting authoritative and regulatory bodies, including the American Institute for Certified Public Accountants and the Financial Accounting Standards Board. These reviews and interpretations have resulted in significant
changes in the practices and standards for recognizing revenues in software companies. The rapid pace of change in these standards could result in significantly different standards in the future. We may have to change our methods of revenue
recognition to comply with new standards, and any such change could cause deferment of revenue recognized in current periods to subsequent periods or accelerated recognition of deferred revenue to current periods, either of which could cause
shortfalls in meeting securities analysts and investors expectations in any period. Any such shortfalls could have an adverse impact on our stock price.




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We are susceptible to business interruptions that could harm our business.





Our operations are vulnerable to damage or interruption from
computer viruses, human error, natural disasters, telecommunications failures, intentional acts of vandalism and similar events. In particular, our corporate headquarters are located in San Francisco, which is known for seismic activity. Although we
have a disaster recovery plan for critical data and business applications, this does not provide assurance that we would not suffer a business interruption. A significant business interruption would result in losses or damages incurred by us and
would harm our business. Our business interruption insurance may not be adequate to compensate us for losses that might occur.





Insiders have substantial control over us, which could limit others ability to influence the outcome of key transactions.





Our executive officers and directors, in the aggregate, beneficially hold 32.3% of our outstanding common stock. These stockholders, if acting together, can
influence significantly all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions.





We expect the price of our common stock to remain volatile, making it difficult for our stockholders to predict the return on their investment.





Since our initial public offering, the market price of our common stock has
fluctuated significantly in response to a number of factors, some of which are beyond our control, including:





| |  |  | global and domestic economic conditions;
| | - |  | ----------------------------------------




| |  |  | quarterly variations in our operating results;
| | - |  | ----------------------------------------------




| |  |  | changes in financial estimates by securities analysts;
| | - |  | ------------------------------------------------------




| |  |  | changes in market valuation of software and Internet companies;
| | - |  | ---------------------------------------------------------------




| |  |  | announcements that we or our competitors make related to significant contracts, acquisitions, capital commitments, strategic partnerships or product introductions or
enhancements;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | additions or departures of key personnel;
| | - |  | -----------------------------------------




| |  |  | stock market price and volume fluctuations, which are particularly volatile among securities of software and Internet companies; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------




| |  |  | sales of significant amounts of our common stock or other securities in the open market.
| | - |  | ----------------------------------------------------------------------------------------




The market for technology and Internet-related companies has experienced extreme volatility that often has been unrelated to the
operating performance of particular companies. These fluctuations may adversely affect the trading price of our common stock, regardless of our actual operating performance.





Provisions of our charter and bylaws and Delaware law could deter takeover attempts that might be beneficial to our stockholders.





Provisions of our amended and restated certificate of incorporation and bylaws as well as Delaware law
could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. We are subject to the provisions of Delaware law, which restrict business combinations with interested stockholders, which may
have the effect of inhibiting a non-negotiated merger or other business combinations.




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ITEM 3.    
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





Foreign Exchange Risk





Currently, the majority of our sales and expenses are
denominated in U.S. dollars and, as a result, we have not experienced significant currency related gains or losses to date.





As sales by our wholly-owned subsidiary, Embarcadero Europe Ltd., increase, we will be exposed to greater volatility in fluctuations of the pound sterling, the Euro and potentially
other currencies as well. We used hedging contracts in the nine months ended September 30, 2001 to hedge our foreign-currency fluctuation risks. We do not use derivative financial instruments for speculative trading purposes.




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PART II





OTHER INFORMATION





ITEM 6.    
EXHIBITS AND REPORTS ON FORM 8-K





(a)  Exhibits:





| | None
| | ----




(b)  Reports on Form 8-K:





| | None
| | ----



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SIGNATURES





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





| | EM | BARCADERO TECHNOLOGIES, INC.
| | -- | ----------------------------




| | /s/    RAJ SABHLOK
| | ------------------

| | By | :
| | -- | -

| | Raj Sabhlok
| | -----------

| | Senior Vice President of Finance and
| | ------------------------------------

| | Corporate Development
| | ---------------------




Date: November 9, 2001




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