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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

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



For the quarterly period ended June 30, 2004



OR



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



For the transition period from            to



Commission file number: 000-31409



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MOTIVE, INC.

(Exact Name of Registrant as Specified in its
Charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 74-2834515                          
|(State or Other Jurisdiction of Incorporation or Organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|12515 Research Boulevard, Building 5 Austin, Texas             |  | 78759-2220                          
|(Address of principal executive offices)                       |  | (Zip code)                          



(512) 339-8335

Registrants telephone number, including area code



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Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ̈Yes    x  No



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange
Act). ̈Yes    x  No



As of June 30, 2004, there were 25,597,912 outstanding shares of the common
stock of Motive, Inc.



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##### Table of Contents

MOTIVE, INC.

FORM 10-Q QUARTERLY REPORT

QUARTERLY PERIOD ENDED JUNE 30, 2004



TABLE OF CONTENTS



PART I  FINANCIAL INFORMATION



|        |  |                                                                                       |  |                                                                                                                                                                                                   |  |  
|------- |  | ------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -
|Item 1. |  | Financial Statements                                                                  |  |                                                                                                                                                                                                  
|        |  |                                                                                       |  | Consolidated Condensed Balance Sheets at June 30, 2004 (unaudited) and December 31, 2003                                                                                                          |  | 3
|        |  |                                                                                       |  | Consolidated Condensed Statements of Operations for the three months ended June 30, 2004 (unaudited) and 2003 (unaudited) and the six months ended June 30, 2004 (unaudited) and 2003 (unaudited) |  | 4
|        |  |                                                                                       |  | Consolidated Condensed Statements of Cash Flows for the six months ended June 30, 2004 (unaudited) and 2003 (unaudited)                                                                           |  | 5
|        |  |                                                                                       |  | Notes to the Consolidated Condensed Financial Statements (unaudited)                                                                                                                              |  | 6
|Item 2. |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 11                                                                                                                                                                                               
|Item 3. |  | Quantitative and Qualitative Disclosures about Market Risk                            |  | 31                                                                                                                                                                                               
|Item 4. |  | Controls and Procedures                                                               |  | 31                                                                                                                                                                                               
|        |  |                                                                                      
|        |  | PART II  OTHER INFORMATION                                                           |  |                                                                                                                                                                                                  
|        |  |                                                                                      
|Item 1. |  | Legal Proceedings                                                                     |  | 32                                                                                                                                                                                               
|Item 2. |  | Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities      |  | 32                                                                                                                                                                                               
|Item 3. |  | Defaults upon Senior Securities                                                       |  | 33                                                                                                                                                                                               
|Item 4. |  | Submission of Matters to a Vote of Security Holders                                   |  | 33                                                                                                                                                                                               
|Item 5. |  | Other Information                                                                     |  | 33                                                                                                                                                                                               
|Item 6. |  | Exhibits and Reports on Form 8-K                                                      |  | 33                                                                                                                                                                                               



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MOTIVE, INC.



CONSOLIDATED
CONDENSED BALANCE SHEETS

(in thousands, except share amounts)



|                                                                                                                                                                                                                                 |  |               |         |   |                  |   |         |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                                                                                                                                                 |  | June 30, 2004 |         |   | December 31,2003 |  
|                                                                                                                                                                                                                                 |  | (unaudited)   |         |   |                  |  
|ASSETS                                                                                                                                                                                                                           |  |               |         |   |                  |   |         |  
|Current assets:                                                                                                                                                                                                                  |  |               |         |   |                  |   |         |  
|Cash and cash equivalents                                                                                                                                                                                                        |  | $             | 80,362  |   |                  | $ | 28,433  |  
|Accounts receivable, net                                                                                                                                                                                                         |  |               | 12,635  |   |                  |   | 21,276  |  
|Prepaid expenses and other current assets                                                                                                                                                                                        |  |               | 2,943   |   |                  |   | 2,437   |  
|                                                                                                                                                                                                                                 |  |               |         |   |                  |   |         |  
|Total current assets                                                                                                                                                                                                             |  |               | 95,940  |   |                  |   | 52,146  |  
|                                                                                                                                                                                                                                 |  |               |         |   |                  |   |         |  
|Restricted cash                                                                                                                                                                                                                  |  |               |        |   |                  |   | 15,000  |  
|Property and equipment, net                                                                                                                                                                                                      |  |               | 6,630   |   |                  |   | 7,008   |  
|Goodwill                                                                                                                                                                                                                         |  |               | 59,143  |   |                  |   | 59,143  |  
|Acquired technology, net                                                                                                                                                                                                         |  |               | 8,455   |   |                  |   | 8,903   |  
|Other intangibles, net                                                                                                                                                                                                           |  |               | 10,018  |   |                  |   | 11,593  |  
|Other assets                                                                                                                                                                                                                     |  |               | 3,888   |   |                  |   | 4,650   |  
|                                                                                                                                                                                                                                 |  |               |         |   |                  |   |         |  
|Total assets                                                                                                                                                                                                                     |  | $             | 184,074 |   |                  | $ | 158,443 |  
|                                                                                                                                                                                                                                 |  |               |         |   |                  |   |         |  
|LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS EQUITY (DEFICIT)                                                                                                                                           |  |               |         |   |                  |   |         |  
|Current liabilities:                                                                                                                                                                                                             |  |               |         |   |                  |   |         |  
|Accounts payable                                                                                                                                                                                                                 |  | $             | 5,767   |   |                  | $ | 5,651   |  
|Accrued liabilities                                                                                                                                                                                                              |  |               | 13,980  |   |                  |   | 17,684  |  
|Deferred revenue                                                                                                                                                                                                                 |  |               | 11,911  |   |                  |   | 13,886  |  
|Current portion of long-term debt                                                                                                                                                                                                |  |               | 1,105   |   |                  |   | 278     |  
|                                                                                                                                                                                                                                 |  |               |         |   |                  |   |         |  
|Total current liabilities                                                                                                                                                                                                        |  |               | 32,763  |   |                  |   | 37,499  |  
|Deferred revenue                                                                                                                                                                                                                 |  |               | 7,281   |   |                  |   | 7,347   |  
|Long-term debt, net of current portion                                                                                                                                                                                           |  |               | 5,000   |   |                  |   | 6,026   |  
|Related party subordinated debt, net                                                                                                                                                                                             |  |               |        |   |                  |   | 10,757  |  
|                                                                                                                                                                                                                                 |  |               |         |   |                  |   |         |  
|Total liabilities                                                                                                                                                                                                                |  |               | 45,044  |   |                  |   | 61,629  |  
|                                                                                                                                                                                                                                 |  |               |         |   |                  |   |         |  
|Redeemable convertible preferred stock:                                                                                                                                                                                          |  |               |         |   |                  |   |         |  
|Preferred Stock: $0.001 par value; 47,000,000 shares authorized, 10,322,056 shares issued and outstanding at December 31, 2003                                                                                                   |  |               |        |   |                  |   | 119,785 |  
|                                                                                                                                                                                                                                 |  |               |         |   |                  |   |         |  
|Stockholders equity (deficit):                                                                                                                                                                                                  |  |               |         |   |                  |   |         |  
|Common stock: $0.001 par value; 150,000,000 shares authorized, 25,597,912 shares issued and outstanding at June 30, 2004 (unaudited);
25,000,000 shares authorized, 9,723,131 shares issued and outstanding at December 31, 2003 |  |               | 26      |   |                  |   | 10      |  
|Additional paid-in capital                                                                                                                                                                                                       |  |               | 234,277 |   |                  |   | 69,734  |  
|Deferred stock compensation                                                                                                                                                                                                      |  |               | (2,779  | ) |                  |   | (4,168  | )
|Accumulated comprehensive loss                                                                                                                                                                                                   |  |               | (415    | ) |                  |   | (181    | )
|Accumulated deficit                                                                                                                                                                                                              |  |               | (92,079 | ) |                  |   | (88,366 | )
|                                                                                                                                                                                                                                 |  |               |         |   |                  |   |         |  
|Total stockholders equity (deficit)                                                                                                                                                                                             |  |               | 139,030 |   |                  |   | (22,971 | )
|                                                                                                                                                                                                                                 |  |               |         |   |                  |   |         |  
|Total liabilities, redeemable convertible preferred stock and stockholders equity (deficit)                                                                                                                                     |  | $             | 184,074 |   |                  | $ | 158,443 |  
|                                                                                                                                                                                                                                 |  |               |         |   |                  |   |         |  



See accompanying notes



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##### Table of Contents

MOTIVE, INC.



CONSOLIDATED
CONDENSED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)



|                                                                                                                                                       |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------------------------------------------------------------------------------------------------ |  | --------------------------- | ------ | - | ------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                                                                                                       |  | Three Months Ended June 30, |        |   | Six Months Ended June 30, |  
|                                                                                                                                                       |  | 2004                        |        |   | 2003                      |   |        | 2004 |  |   | 2003   |  
|                                                                                                                                                       |  | (unaudited)                 |        |   | (unaudited)               |  
|Revenue:                                                                                                                                               |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|License fees                                                                                                                                           |  | $                           | 13,586 |   |                           | $ | 11,228 |      |  | $ | 25,081 |   |  | $ | 17,618 |  
|Services:                                                                                                                                              |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Services                                                                                                                                               |  |                             | 8,374  |   |                           |   | 5,615  |      |  |   | 16,129 |   |  |   | 11,914 |  
|Acquired in business combination                                                                                                                       |  |                             | 2,062  |   |                           |   | 7,827  |      |  |   | 5,488  |   |  |   | 15,830 |  
|                                                                                                                                                       |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Total services revenue                                                                                                                                 |  |                             | 10,436 |   |                           |   | 13,442 |      |  |   | 21,617 |   |  |   | 27,744 |  
|                                                                                                                                                       |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Total revenue                                                                                                                                          |  |                             | 24,022 |   |                           |   | 24,670 |      |  |   | 46,698 |   |  |   | 45,362 |  
|                                                                                                                                                       |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Cost of revenue:                                                                                                                                       |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|License fees                                                                                                                                           |  |                             | 157    |   |                           |   | 1,026  |      |  |   | 351    |   |  |   | 1,069  |  
|Amortization of acquired technology                                                                                                                    |  |                             | 234    |   |                           |   | 117    |      |  |   | 448    |   |  |   | 214    |  
|Services                                                                                                                                               |  |                             | 7,084  |   |                           |   | 8,146  |      |  |   | 14,621 |   |  |   | 15,578 |  
|                                                                                                                                                       |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Total cost of revenue                                                                                                                                  |  |                             | 7,475  |   |                           |   | 9,289  |      |  |   | 15,420 |   |  |   | 16,861 |  
|                                                                                                                                                       |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Gross margin                                                                                                                                           |  |                             | 16,547 |   |                           |   | 15,381 |      |  |   | 31,278 |   |  |   | 28,501 |  
|                                                                                                                                                       |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Operating expenses:                                                                                                                                    |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Sales and marketing                                                                                                                                    |  |                             | 8,262  |   |                           |   | 8,735  |      |  |   | 15,817 |   |  |   | 15,884 |  
|Research and development                                                                                                                               |  |                             | 4,683  |   |                           |   | 3,913  |      |  |   | 8,917  |   |  |   | 7,523  |  
|General and administrative                                                                                                                             |  |                             | 2,046  |   |                           |   | 2,081  |      |  |   | 4,215  |   |  |   | 3,971  |  
|Amortization of intangibles                                                                                                                            |  |                             | 802    |   |                           |   | 571    |      |  |   | 1,575  |   |  |   | 1,047  |  
|Amortization of deferred stock compensation (1)                                                                                                        |  |                             | 637    |   |                           |   | 115    |      |  |   | 1,488  |   |  |   | 281    |  
|Business restructuring charge                                                                                                                          |  |                             |       |   |                           |   |       |      |  |   |       |   |  |   | 1,422  |  
|                                                                                                                                                       |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Total operating expenses                                                                                                                               |  |                             | 16,430 |   |                           |   | 15,415 |      |  |   | 32,012 |   |  |   | 30,128 |  
|                                                                                                                                                       |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Income (loss) from operations                                                                                                                          |  |                             | 117    |   |                           |   | (34    | )    |  |   | (734   | ) |  |   | (1,627 | )
|Interest income (expense), net                                                                                                                         |  |                             | (2,018 | ) |                           |   | (458   | )    |  |   | (2,528 | ) |  |   | (948   | )
|Other income (expense), net                                                                                                                            |  |                             | (55    | ) |                           |   | 85     |      |  |   | 417    |   |  |   | 142    |  
|                                                                                                                                                       |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Loss before income taxes                                                                                                                               |  |                             | (1,956 | ) |                           |   | (407   | )    |  |   | (2,845 | ) |  |   | (2,433 | )
|Provision for income taxes                                                                                                                             |  |                             | 187    |   |                           |   | 1,130  |      |  |   | 868    |   |  |   | 1,387  |  
|                                                                                                                                                       |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Net loss                                                                                                                                               |  | $                           | (2,143 | ) |                           | $ | (1,537 | )    |  | $ | (3,713 | ) |  | $ | (3,820 | )
|                                                                                                                                                       |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Basic and diluted loss per share                                                                                                                       |  | $                           | (0.20  | ) |                           | $ | (0.15  | )    |  | $ | (0.36  | ) |  | $ | (0.38  | )
|                                                                                                                                                       |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Shares used in computing basic and diluted loss per share                                                                                              |  |                             | 10,820 |   |                           |   | 9,982  |      |  |   | 10,288 |   |  |   | 9,973  |  
|                                                                                                                                                       |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|(1)    If the amortization of deferred stock compensation were allocated to specific operating statement line
items, it would be allocated as follows: | 
|                                                                                                                                                       |  |                             |        |  
|Cost of services revenue                                                                                                                               |  | $                           | 32     |   |                           | $ | 11     |      |  | $ | 85     |   |  | $ | (17    | )
|Sales and marketing                                                                                                                                    |  |                             | 248    |   |                           |   | 19     |      |  |   | 568    |   |  |   | 121    |  
|Research and development                                                                                                                               |  |                             | 210    |   |                           |   | 14     |      |  |   | 498    |   |  |   | 31     |  
|General and administrative                                                                                                                             |  |                             | 147    |   |                           |   | 71     |      |  |   | 337    |   |  |   | 146    |  
|                                                                                                                                                       |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|                                                                                                                                                       |  | $                           | 637    |   |                           | $ | 115    |      |  | $ | 1,488  |   |  | $ | 281    |  
|                                                                                                                                                       |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  



See accompanying notes



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MOTIVE, INC.



CONSOLIDATED
CONDENSED STATEMENTS OF CASH FLOWS

(in thousands)



|                                                                                          |  |                           |         |   |      |   |         |  
|----------------------------------------------------------------------------------------- |  | ------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                          |  | Six Months Ended June 30, |        
|                                                                                          |  | 2004                      |         |   | 2003 |  
|                                                                                          |  | (unaudited)               |        
|Cash flows from operating activities                                                      |  |                           |         |   |      |   |         |  
|Net loss                                                                                  |  | $                         | (3,713  | ) |      | $ | (3,820  | )
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |  |                           |         |   |      |   |         |  
|Depreciation                                                                              |  |                           | 1,751   |   |      |   | 2,009   |  
|Amortization of deferred stock compensation                                               |  |                           | 1,488   |   |      |   | 281     |  
|Amortization and write-off of debt discount                                               |  |                           | 1,743   |   |      |   | 244     |  
|Amortization of intangibles                                                               |  |                           | 2,023   |   |      |   | 1,261   |  
|Other noncash items                                                                       |  |                           | (232    | ) |      |   | 443     |  
|Changes in operating assets and liabilities net of acquisitions                           |  |                           | 3,266   |   |      |   | (19,541 | )
|                                                                                          |  |                           |         |   |      |   |         |  
|Net cash provided by (used in) operating activities                                       |  |                           | 6,326   |   |      |   | (19,123 | )
|                                                                                          |  |                           |         |   |      |   |         |  
|Cash flows from investing activities                                                      |  |                           |         |   |      |   |         |  
|Proceeds from maturities of short-term investments                                        |  |                           |        |   |      |   | 1,410   |  
|Restricted cash                                                                           |  |                           | 15,000  |   |      |   |        |  
|Cash acquired in BroadJump acquisition                                                    |  |                           |        |   |      |   | 51,655  |  
|Cash used in BroadJump acquisition                                                        |  |                           |        |   |      |   | (5,654  | )
|Purchase of property and equipment                                                        |  |                           | (1,373  | ) |      |   | (2,578  | )
|                                                                                          |  |                           |         |   |      |   |         |  
|Net cash provided by investing activities                                                 |  |                           | 13,627  |   |      |   | 44,833  |  
|                                                                                          |  |                           |         |   |      |   |         |  
|Cash flows from financing activities                                                      |  |                           |         |   |      |   |         |  
|Payments made on long-term debt                                                           |  |                           | (199    | ) |      |   | (8,281  | )
|Payments made on subordinated debt                                                        |  |                           | (12,500 | ) |      |   |        |  
|Proceeds from IPO                                                                         |  |                           | 44,134  |   |      |   |        |  
|Proceeds from issuance of common stock                                                    |  |                           | 747     |   |      |   | 126     |  
|Repurchase of common stock                                                                |  |                           | (206    | ) |      |   | (154    | )
|                                                                                          |  |                           |         |   |      |   |         |  
|Net cash provided by (used in) financing activities                                       |  |                           | 31,976  |   |      |   | (8,309  | )
|                                                                                          |  |                           |         |   |      |   |         |  
|Net increase in cash and cash equivalents                                                 |  |                           | 51,929  |   |      |   | 17,401  |  
|Cash and cash equivalents at beginning of period                                          |  |                           | 28,433  |   |      |   | 32,728  |  
|                                                                                          |  |                           |         |   |      |   |         |  
|Cash and cash equivalents at end of period                                                |  | $                         | 80,362  |   |      | $ | 50,129  |  
|                                                                                          |  |                           |         |   |      |   |         |  



See accompanying notes



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MOTIVE, INC.

NOTES TO THE CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)



|1. | Basis of Presentation
|-- | ---------------------



The accompanying unaudited consolidated condensed financial statements of Motive, Inc. (we, us, our, or the
Company) have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the SEC). These consolidated condensed financial statements do not include all of the information and
footnotes required by generally accepted accounting principles for annual financial statements. In our opinion, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The
preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect reported assets, liabilities, revenues and expenses, as well as disclosure
of contingent assets and liabilities. Actual results could differ from those estimates. In addition, operating results for the three-month and six-month periods ended June 30, 2004 are not necessarily indicative of the results that may be expected
for the year ending December 31, 2004, or for any other period.



These consolidated condensed financial statements and notes should be read with the consolidated financial statements and notes for the period ended December 31, 2003 included in our final prospectus for our initial public offering filed
with the SEC on June 24, 2004.



|2. | Initial Public Offering
|-- | -----------------------



The SEC declared our registration statement effective on June 24, 2004, which we filed on Form S-1 (Registration No. 333-111030) under the Securities Act
of 1933 in connection with the initial public offering of our common stock. An aggregate of 5,750,000 shares were registered under this registration statement, including 750,000 shares subject to the underwriters over-allotment option.



On June 30, 2004, we completed our initial public offering in
which we sold 5,000,000 shares of our common stock for $10 per share, for an aggregate public offering price of $50 million. Of this total, we applied approximately $3.5 million to underwriting discounts and commissions; $2.4 million to related
costs; and $12.5 million to pay in full our senior subordinated promissory notes. As a result, we retained approximately $31.6 million of the offering proceeds, which we intend to use for working capital and general corporate purposes.



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|3. | Stock-Based Compensation
|-- | ------------------------



The following table illustrates the effect on income available to common stockholders and earnings per share if we had applied the fair value recognition
provision of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, to stock-based compensation (in thousands, except per share data):



|                                                                                                                                                                                        |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------- | ------ | - | ------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                                                                                                                                        |  | Three Months Ended June 30, |        |   | Six Months Ended June 30, |  
|                                                                                                                                                                                        |  | 2004                        |        |   | 2003                      |   |        | 2004 |  |   | 2003   |  
|                                                                                                                                                                                        |  | (unaudited)                 |        |   | (unaudited)               |  
|Net loss as reported                                                                                                                                                                    |  | $                           | (2,143 | ) |                           | $ | (1,537 | )    |  | $ | (3,713 | ) |  | $ | (3,820 | )
|                                                                                                                                                                                        |  |                             |        |  
|Total stock-based compensation cost, net of related tax effects, included in the determination of net loss as reported                                                                  |  |                             | 637    |   |                           |   | 115    |      |  |   | 1,488  |   |  |   | 281    |  
|                                                                                                                                                                                        |  |                             |        |  
|Total stock-based compensation cost, net of related tax effects, that would have been included in the determination of net loss if the fair
value method had been applied to all awards |  |                             | (1,157 | ) |                           |   | (467   | )    |  |   | (2,035 | ) |  |   | (1,029 | )
|                                                                                                                                                                                        |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Pro forma net loss                                                                                                                                                                      |  | $                           | (2,663 | ) |                           | $ | (1,889 | )    |  | $ | (4,260 | ) |  | $ | (4,568 | )
|                                                                                                                                                                                        |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Pro forma net loss per share, basic and diluted                                                                                                                                         |  | $                           | (0.25  | ) |                           | $ | (0.19  | )    |  | $ | (0.41  | ) |  | $ | (0.46  | )
|                                                                                                                                                                                        |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  



|4. | Goodwill and Other Intangible Assets
|-- | ------------------------------------



Goodwill and other intangible assets consist of the following (in thousands):



|                                   |  |               |        |   |                  |   |        |  
|---------------------------------- |  | ------------- | ------ | - | ---------------- | - | ------ | -
|                                   |  | June 30, 2004 |        |   | December 31,2003 |  
|                                   |  | (unaudited)   |        |   |                  |  
|Goodwill                           |  | $             | 59,143 |   |                  | $ | 59,143 |  
|                                   |  |               |        |   |                  |   |        |  
|Acquired Technology:               |  |               |        |   |                  |   |        |  
|Acquired technology                |  | $             | 9,351  |   |                  | $ | 9,351  |  
|Accumulated amortization           |  |               | (896   | ) |                  |   | (448   | )
|                                   |  |               |        |   |                  |   |        |  
|                                   |  | $             | 8,455  |   |                  | $ | 8,903  |  
|                                   |  |               |        |   |                  |   |        |  
|Other Intangibles:                 |  |               |        |   |                  |   |        |  
|Customer contractual relationships |  |               | 7,255  |   |                  | $ | 7,255  |  
|Order backlog                      |  |               | 920    |   |                  |   | 920    |  
|Patented technologies              |  |               | 500    |   |                  |   | 500    |  
|Trade secrets and other technology |  |               | 500    |   |                  |   | 500    |  
|Non-competition agreements         |  |               | 4,800  |   |                  |   | 4,800  |  
|Accumulated amortization           |  |               | (3,957 | ) |                  |   | (2,382 | )
|                                   |  |               |        |   |                  |   |        |  
|                                   |  | $             | 10,018 |   |                  | $ | 11,593 |  
|                                   |  |               |        |   |                  |   |        |  



Estimated annual
amortization expense of intangible assets for calendar years 2004, 2005, 2006, 2007 and 2008 is $4,096,000, $4,809,000, $5,255,0000, $6,082,000 and $256,000, respectively.



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|5. | Earnings Per Share
|-- | ------------------



In accordance with SFAS No. 128, Earnings Per Share, basic earnings (loss) per share is computed by dividing the earnings (loss) for the period by
the weighted average number of common shares outstanding during the period less common shares subject to repurchase. Diluted earnings (loss) per share is computed by dividing the earnings (loss) for the period by the weighted average number of
common and common equivalent shares outstanding during the period. We have excluded all convertible preferred stock, outstanding stock options, outstanding warrants to purchase common stock and common stock subject to repurchase from the calculation
of diluted loss per common share because all such securities are antidilutive for all applicable periods presented. The total number of shares excluded from the calculations of diluted loss per share, prior to application of the treasury stock
method for options, was 13,878,860 and 12,857,285 for the three months ended June 30, 2004 and 2003, respectively, and 14,229,977 and 12,877,611 for the six months ended June 30, 2004 and 2003, respectively.



The following is a reconciliation of the numerator and denominator of basic
and diluted net loss per share (in thousands, except per share amounts):



|                                                              |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------- |  | --------------------------- | ------ | - | ------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                              |  | Three Months Ended June 30, |        |   | Six Months Ended June 30, |  
|                                                              |  | 2004                        |        |   | 2003                      |   |        | 2004 |  |   | 2003   |  
|                                                              |  | (unaudited)                 |        |   | (unaudited)               |  
|Basic and diluted:                                            |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Net loss                                                      |  | $                           | (2,143 | ) |                           | $ | (1,537 | )    |  | $ | (3,713 | ) |  | $ | (3,820 | )
|                                                              |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Weighted-average shares of common stock outstanding           |  |                             | 10,871 |   |                           |   | 10,048 |      |  |   | 10,340 |   |  |   | 10,050 |  
|                                                              |  |                             |        |  
|Weighted-average shares of common stock subject to repurchase |  |                             | (51    | ) |                           |   | (66    | )    |  |   | (52    | ) |  |   | (77    | )
|                                                              |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Shares used in computing basic and diluted loss per share     |  |                             | 10,820 |   |                           |   | 9,982  |      |  |   | 10,288 |   |  |   | 9,973  |  
|                                                              |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Basic and diluted loss per share                              |  | $                           | (0.20  | ) |                           | $ | (0.15  | )    |  | $ | (0.36  | ) |  | $ | (0.38  | )
|                                                              |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  



|6. | Debt
|-- | ----



Our bank line of credit expired in June 2004. No amounts were due under this line of credit at December 31, 2003, March 31, 2004 or at the date of expiration.



In June 2004, we repaid in full our related party senior subordinated
promissory notes in the aggregate principal amount of $12.5 million using proceeds from our initial public offering. We allocated the remaining debt discount of approximately $1.5 million to interest expense.



Total interest expense incurred during the three months ended June 30, 2004
and 2003 was approximately $2,141,000 and $629,000, respectively. Total interest expense incurred during the six months ended June 30, 2004 and 2003 was approximately $2,737,000 and $1,297,000, respectively.



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|7. | Comprehensive Loss
|-- | ------------------



Comprehensive loss is the total of net loss and all other non-owner changes in stockholders equity. Our other comprehensive loss consists of
unrealized gains or losses on available-for-sale investments and foreign currency translation adjustments. The components of comprehensive loss are as follows (in thousands):



|                                         |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|---------------------------------------- |  | --------------------------- | ------ | - | ------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                         |  | Three Months Ended June 30, |        |   | Six Months Ended June 30, |  
|                                         |  | 2004                        |        |   | 2003                      |   |        | 2004 |  |   | 2003   |  
|                                         |  | (unaudited)                 |        |   | (unaudited)               |  
|Net loss                                 |  | $                           | (2,143 | ) |                           | $ | (1,537 | )    |  | $ | (3,713 | ) |  | $ | (3,820 | )
|Other comprehensive loss                 |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Change in unrealized loss on investments |  |                             | (115   | ) |                           |   |       |      |  |   | (115   | ) |  |   |       |  
|Foreign currency translation adjustment  |  |                             | (48    | ) |                           |   | (21    | )    |  |   | (119   | ) |  |   | (49    | )
|                                         |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Total comprehensive loss                 |  | $                           | (2,306 | ) |                           | $ | (1,558 | )    |  | $ | (3,947 | ) |  | $ | (3,869 | )
|                                         |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  



|8. | Income Taxes
|-- | ------------



We have incurred operating losses for all fiscal years from inception through December 31, 2003. Our provision for income taxes consists primarily of
foreign income tax withholdings related to international sales. We have recorded a valuation allowance for the full amount of our net deferred tax assets, which include net operating loss and research and development credit carryforwards, because of
the uncertainty regarding their realization.



|9. | Stockholders Equity
|-- | --------------------



Redeemable Convertible Preferred Stock



In connection with our initial public offering in June 2004, all series of redeemable convertible preferred stock, a total of 10,322,056 shares, were
automatically converted to common stock using a one-for-one conversion ratio.



Common Stock



In
March 2004, our Board of Directors authorized a 4-for-1 reverse stock split for all common and preferred shares. All shares and per share amounts, including warrants and options for such shares, included in the accompanying consolidated condensed
financial statements have been adjusted to give retroactive effect to the reverse stock split.



Of the 25,597,912 shares and 9,723,131 shares of common stock issued and outstanding as of June 30, 2004 and December 31, 2003, respectively, 47,230 shares and 43,317 shares were unvested and subject to our right of
repurchase, at a price per share equal to the original exercise price. These repurchase rights lapse according to a time-based vesting schedule.



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|10. | Acquisition of BroadJump, Inc.
|--- | ------------------------------



In connection with our January 2003 acquisition of BroadJump, Inc, we accrued total exit costs of $13,894,000. The following table summarizes activity for
the remaining exit costs included in accrued liabilities at December 31, 2003, March 31, 2004 and June 30, 2004 (in thousands):



|                                      |  |                           |       |  
|------------------------------------- |  | ------------------------- | ----- | -
|                                      |  | Facility LeaseCommitments |      
|Balance at December 31, 2003          |  | $                         | 7,085 |  
|Cash activity (unaudited)             |  |                           | (497  | )
|                                      |  |                           |       |  
|Balance at March 31, 2004 (unaudited) |  |                           | 6,588 |  
|Cash activity (unaudited)             |  |                           | (546  | )
|                                      |  |                           |       |  
|Balance at June 30, 2004 (unaudited)  |  | $                         | 6,042 |  
|                                      |  |                           |       |  



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



Cautionary Statement



The following discussion should be read along with the unaudited consolidated condensed financial statements and notes included in Item 1 of this
Quarterly Report, as well as the audited consolidated financial statements and notes and Managements Discussion and Analysis of Financial Condition and Results of Operations for the fiscal year ended December 31, 2003, included in our final
prospectus dated June 24, 2004 for our initial public offering filed with the Securities and Exchange Commission. This Managements Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements regarding future
events and our future results are based on current expectations, estimates, forecasts, and projections and the beliefs and assumptions of our management. Words such as we expect, anticipate, target,
project, believe, goals, estimate, potential, predict, may, might, could, intend, variations of these types of words and similar
expressions are intended to identify these forward-looking statements. Readers are cautioned that these forward-looking statements are predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict. Therefore,
actual results may differ materially and adversely from those expressed in any forward-looking statements.



Among the important factors that could cause actual results to differ materially from those indicated by our forward-looking statements are those
discussed below under the subheading Risk Factors that May Affect Future Results and elsewhere in this report. We undertake no obligation to revise or update publicly any forward-looking statement for any reason. Readers should carefully
review the risk factors described in Risk Factors that May Affect Future Results below, as well as in the documents filed by us with the Securities and Exchange Commission, specifically our final prospectus dated June 24, 2004, as well
as our most recent reports on Form 8-K, as they may be amended from time to time.



Overview



We are a leading provider of service
management software that enables companies to build management and service directly into their customer-facing products and services, optimizing time and reducing waste from labor-intensive management processes. From our incorporation in April 1997,
we have developed and successfully deployed our service management software solutions to industry-leading technology vendors, service providers and large enterprises. We estimate that these customers have used our software in connection with more
than 30 million technology products and devices. We have continued to enhance the functionality of our products, and our current service management product suite includes products in the service operations management, self management and policy
management categories.



Our future success will depend on many
factors, including but not limited to:



| |  | the measurable benefits that our products provide to our customers, such as allowing them to execute rapid and profitable change, optimizing management processes across company
boundaries, increasing productivity, optimizing asset utilization, and creating new sources of revenue;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | our service management software being built directly into the technology products and services of our customers; and
| | - | --------------------------------------------------------------------------------------------------------------------



| |  | our flexible term or usage-based licensing model.
| | - | -------------------------------------------------



In evaluating our financial condition and operating performance, our management team and our board of directors focus on a wide variety of information and
performance metrics, including, among others, the following:



| |  | the level of revenue generated from sales of our software products to existing and new customers;
| | - | -------------------------------------------------------------------------------------------------



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| |  | the mix of revenue generated from license fees and services fees;
| | - | -----------------------------------------------------------------



| |  | the mix of revenue generated within the U.S. and outside the U.S.;
| | - | ------------------------------------------------------------------



| |  | the extent to which customers license our products under term as opposed to perpetual licenses;
| | - | -----------------------------------------------------------------------------------------------



| |  | our ability to manage our cost structure such that it supports our revenue generation efforts while optimizing profitability; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------



| |  | our employee headcount numbers, both in terms of function within the company and in terms of geographic dispersal, which numbers are directly reflective of our cost structure.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The principal operational challenge that we face
is the fact that our quarterly revenue and results of operations are difficult to predict. Unlike more established software vendors, we have experienced, and expect to continue to experience, fluctuations in revenue and operating results from
quarter to quarter. Weak capital spending and competitive pressures may challenge our future financial performance. Additionally, we typically derive a significant portion of our revenue each quarter from a number of license agreements closed in the
last month of a quarter. If we fail to close certain agreements that are expected to be completed toward the end of a quarter, our quarterly results would suffer.



To address these challenges, we intend to continue to invest to enhance our current products and services and to develop new
products and services. We also intend to increase our services, sales and development resources, and to invest in the expansion of our international operations, which represented 32% of our revenue in 2003. We may seek to accomplish these expansions
by acquiring businesses that possess products, technology, or operations that are complementary to ours.



Another operational challenge that we face is the fact that our operating expenses are, to a large extent, fixed in the short term. If our revenue falls
below our expectation in a quarter and we are not able to greatly reduce our operating expenses in response, our operating results for that quarter could be adversely affected. To address this challenge, we attempt to closely monitor our cost
structure and operating expense trends, as well as to closely monitor our sales pipeline and related sales activities.



In addition, our ability to compete effectively will depend on the timely introduction and success of future software products and releases and the
ability of our products to interoperate and perform well with existing and future leading databases, applications, operating systems and other platforms. To address this challenge, we have made and will continue to make significant investments in
research and development to keep pace with technological change in our industry.



On June 30, 2004, we completed our initial public offering in which we sold 5 million shares of our common stock at $10 per share, for an aggregate public offering price of $50.0 million. Our sale of shares of common
stock resulted in aggregate net proceeds of approximately $44.1 million. See Note 2 to the consolidated condensed financial statements for additional information.



We intend that the discussion of our financial condition and results of operations that follows to provide information that
will assist in understanding our financial statements, the changes in certain key items in those financial statements from period to period, and the primary factors that accounted for those changes, as well as how certain accounting principles,
policies and estimates affect our financial statements.



Sources of Revenue



Through June 30,
2004, substantially all of our revenue was derived from licensing our product suite and providing related services. Customers pay us license fees for the right to use our products for a fixed or perpetual term. Over the last two years, more than 70%
of the license agreements we entered into were fixed-term as opposed to perpetual. We anticipate that the percentage for 2004 will also be above 70%. The term of our licenses is typically three years. We price our license fees based on an expected
volume of usage during the license term.



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Our licensing arrangements may also include the provision of certain services. Services revenue is
comprised of revenue from professional services, such as consulting services, maintenance and support services and hosting and managed services. Consulting services include a range of services such as installation, implementation and non-complex
interface development for the customers specific applications. Maintenance and support services represent technical support of our software products and include the right to unspecified product upgrades on an if-and-when available basis.
Hosting and managed services involve remote management of our solutions.



We experience seasonality in our revenue, with the fourth quarter of the year typically having the highest revenue for the year. We believe that this seasonality results primarily from customer budgeting cycles and
our sales compensation model. We expect that this seasonality will continue.



In January 2003, we acquired BroadJump, a provider of Internet-based service solutions for broadband companies, to solidify our position as a leader in providing service management software for broadband technology
ecosystems. We accounted for the BroadJump acquisition using the purchase method of accounting and BroadJump has been included in our results of operations from the date of acquisition. As a result, we assumed liabilities related to existing
software arrangements with a fair value of approximately $40.1 million. The fair value of these assumed liabilities, which was recorded as deferred revenue, relates to the remaining contractual obligations under the BroadJump software arrangements
and is being recognized ratably as services revenue acquired in business combination over the remaining life of the individual software arrangements. This revenue will continue to decline on a quarterly basis through 2006 when the remaining
individual contractual obligations under the BroadJump software arrangements expire. The following table summarizes how this revenue will be recognized in each calendar quarter of 2004 through 2006 (in millions):



|     |  |               |     |         |   |          |  |         |     |  |   |    
|---- |  | ------------- | --- | ------- | - | -------- |  | ------- | --- |  | - | ---
|     |  | Quarter Ended
|     |  | Mar. 31       |     | June 30 |   | Sept. 30 |  | Dec. 31
|2004 |  | $             | 3.4 |         | $ | 2.1      |  | $       | 1.5 |  | $ | 1.4
|2005 |  |               | 1.3 |         |   | 1.0      |  |         | 0.9 |  |   | 0.9
|2006 |  |               | 0.9 |         |   | 0.9      |  |         | 0.6 |  |   | 0.3



We expect this
declining services revenue stream to be partially offset by new contracts with these former BroadJump customers for use of a broader range of our products. We expect these new contracts to contain a ratio of license fees revenue to services revenue
commensurate with our historical experience.



Excluding
services revenue acquired in business combination, license fees revenue has typically represented 64% to 77% of total revenue in recent years and services revenue has typically represented 23% to 36% of total revenue in recent years. In the future,
we anticipate that this mix will be approximately 65% license fees revenue and 35% services revenue on an annual basis.



Results of Operations



In view of our limited operating history and changes in the general economic climate, we believe that period-to-period comparisons of revenue and
operating results are not necessarily meaningful and should not be relied upon as indications of future performance. Our prospects must be considered in light of the risks, expenses and difficulties encountered by companies in new and rapidly
evolving markets. Additionally, despite our revenue growth during prior periods, we do not believe that historical growth rates are necessarily sustainable or indicative of future growth.



The following discussion and analysis of our financial condition and results of operations are based upon our consolidated
condensed financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these consolidated condensed financial statements requires us to make estimates and judgments that affect
the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under
the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Estimates and assumptions are reviewed periodically, and actual results
may differ from these estimates under different assumptions or conditions.



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The following table sets forth, for the periods indicated, our consolidated condensed statements of
operations as a percentage of total revenue.



|                                            |  |                            |    |  |                          |    |  |      |    |  |      |   
|------------------------------------------- |  | -------------------------- | -- |  | ------------------------ | -- |  | ---- | -- |  | ---- | --
|                                            |  | Three MonthsEnded June 30, |    |  | Six MonthsEnded June 30, |   
|                                            |  | 2004                       |    |  | 2003                     |    |  | 2004 |    |  | 2003 |   
|Revenue:                                    |  |                            |    |  |                          |    |  |      |    |  |      |   
|License fees                                |  | 57                         | %  |  | 46                       | %  |  | 54   | %  |  | 39   | % 
|Services:                                   |  |                            |    |  |                          |    |  |      |    |  |      |   
|Services                                    |  | 35                         |    |  | 23                       |    |  | 34   |    |  | 26   |   
|Acquired in business combination            |  | 8                          |    |  | 31                       |    |  | 12   |    |  | 35   |   
|                                            |  |                            |    |  |                          |    |  |      |    |  |      |   
|Total services revenue                      |  | 43                         |    |  | 54                       |    |  | 46   |    |  | 61   |   
|                                            |  |                            |    |  |                          |    |  |      |    |  |      |   
|Total revenue                               |  | 100                        |    |  | 100                      |    |  | 100  |    |  | 100  |   
|                                            |  |                            |    |  |                          |    |  |      |    |  |      |   
|Cost of revenue:                            |  |                            |    |  |                          |    |  |      |    |  |      |   
|License fees                                |  | 1                          |    |  | 4                        |    |  | 1    |    |  | 2    |   
|Amortization of acquired technology         |  | 1                          |    |  | 1                        |    |  | 1    |    |  | 1    |   
|Services                                    |  | 29                         |    |  | 33                       |    |  | 31   |    |  | 34   |   
|                                            |  |                            |    |  |                          |    |  |      |    |  |      |   
|Total cost of revenue                       |  | 31                         |    |  | 38                       |    |  | 33   |    |  | 37   |   
|                                            |  |                            |    |  |                          |    |  |      |    |  |      |   
|Gross margin                                |  | 69                         |    |  | 62                       |    |  | 67   |    |  | 63   |   
|                                            |  |                            |    |  |                          |    |  |      |    |  |      |   
|Operating expenses:                         |  |                            |    |  |                          |    |  |      |    |  |      |   
|Sales and marketing                         |  | 34                         |    |  | 35                       |    |  | 34   |    |  | 35   |   
|Research and development                    |  | 19                         |    |  | 16                       |    |  | 19   |    |  | 16   |   
|General and administrative                  |  | 9                          |    |  | 8                        |    |  | 9    |    |  | 9    |   
|Amortization of intangibles                 |  | 3                          |    |  | 2                        |    |  | 4    |    |  | 2    |   
|Amortization of deferred stock compensation |  | 3                          |    |  | 1                        |    |  | 3    |    |  | 1    |   
|Business restructuring charge               |  |                           |    |  |                         |    |  |     |    |  | 3    |   
|                                            |  |                            |    |  |                          |    |  |      |    |  |      |   
|Total operating expenses                    |  | 68                         |    |  | 62                       |    |  | 69   |    |  | 66   |   
|                                            |  |                            |    |  |                          |    |  |      |    |  |      |   
|Income (loss) from operations               |  | 1                          |    |  |                         |    |  | (2   | )  |  | (3   | ) 
|Interest income (expense), net              |  | (9                         | )  |  | (2                       | )  |  | (5   | )  |  | (2   | ) 
|Other income (expense), net                 |  |                           |    |  |                         |    |  | 1    |    |  |     |   
|                                            |  |                            |    |  |                          |    |  |      |    |  |      |   
|Loss before income taxes                    |  | (8                         | )  |  | (2                       | )  |  | (6   | )  |  | (5   | ) 
|Provision for income taxes                  |  | 1                          |    |  | 4                        |    |  | 2    |    |  | 3    |   
|                                            |  |                            |    |  |                          |    |  |      |    |  |      |   
|Net loss                                    |  | (9                         | )% |  | (6                       | )% |  | (8   | )% |  | (8   | )%
|                                            |  |                            |    |  |                          |    |  |      |    |  |      |   



Comparison of
the Three Months Ended June 30, 2004 and 2003



Revenue



Total revenue decreased by $0.7
million from $24.7 million for the three months ended June 30, 2003 to $24.0 million for the three months ended June 30, 2004. The decrease was primarily due to a $5.8 million decrease in services revenue acquired as a result of the BroadJump
acquisition, partially offset by a $2.4 million increase in license fees revenue and an increase in services revenue of $2.7 million.



Revenue from North America decreased by $7.1 million from $22.5 million for the three months ended June 30, 2003 to $15.4 million for the three months
ended June 30, 2004. Revenue from Europe and Asia Pacific increased by $6.4 million from $2.2 million for the three months ended June 30, 2003 to $8.6 million for the three months ended June 30, 2004. Revenue from outside North America represented
9% and 36% of our total revenue for the three months ended June 30, 2003 and 2004, respectively. For more information about our international revenue and expansion plans, please see Quantitative and Qualitative Disclosures About Market
Risk.



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##### Table of Contents

Our revenue recognition policy requires that we only recognize revenue when persuasive evidence of an
agreement exists, delivery of the product has occurred, no unfulfilled vendor obligations remain, the fee is fixed and determinable and collectibility is probable. If the fee for a license has payment terms that exceed our normal payment terms, the
fee is not considered to be fixed or determinable and we only recognize license revenue when amounts actually become due. Therefore, the revenue contribution by a customer in any given period is dictated by the payment terms associated with such
customers agreement. As a result, the revenueboth in absolute dollars and as a percentage of total revenue attributable to any particular customer in any given period can vary significantly. See Critical Accounting
PoliciesRevenue Recognition below. Mercury Interactive accounted for 28% of our total revenue for the three months ended June 30, 2003, and British Telecommunications and Telus accounted for 17% and 16%, respectively, of our total
revenue for the three months ended June 30, 2004.



License Fees. Revenue from license fees increased by $2.4 million from $11.2 million for the three months ended June 30, 2003 to $13.6 million for the three months ended June 30, 2004, representing 46% and 57%, respectively,
of our total revenue. License fees increased as a percentage of total revenue for the three months ended June 30, 2004 because license fees increased by 21% from the second quarter in 2003 to the second quarter in 2004, while services revenue for
this period decreased as a result of the declining revenue from the contracts acquired in the BroadJump acquisition in January 2003.



The increase in license fees in absolute dollars was primarily due to an $8.4 million increase in license fees revenue from existing customers from $2.7
million to $11.0 million, partially offset by a $6.0 million decrease in license fees revenue from new license customers. The increase in revenue from existing customers was primarily due to new product sales to existing customers, as well as
renewals of existing term contracts, and revenue recognized on contracts entered into in previous periods based on their negotiated payment terms and the application of our revenue recognition policy described below.



Services. Our revenue from services decreased by $3.0 million
from $13.4 million for the three months ended June 30, 2003 to $10.4 million for the three months ended June 30, 2004, representing 54% and 43%, respectively, of our total revenue. Approximately $5.7 million of the decrease was due to declining
services revenue from contracts acquired in the BroadJump acquisition and approximately $0.7 million of the decrease was due to a decrease in hosting revenue. These decreases were partially offset by a $2.9 million increase in consulting and
training services revenue and an approximately $0.6 million increase in maintenance revenue due to growth in the number and size of maintenance contracts. Revenue from acquired contracts was $7.8 million and $2.1 million, or 31% and 8% of our total
revenue, for the three months ended June 30, 2003 and 2004, respectively. This revenue will decline on a quarterly basis through 2006 when the remaining individual contractual obligations under the BroadJump software arrangements expire (see
Critical Accounting PoliciesRevenue Recognition). We expect this declining services revenue stream to be partially offset by new contracts with these former BroadJump customers for use of a broader range of our products.



Cost of Revenue



Cost of License Fees Revenue. Cost of license fees revenue
includes third-party software royalties, product packaging, documentation production and shipping costs related to software used by our customers. Cost of license fees revenue decreased by $0.8 million from $1.0 million for the three months ended
June 30, 2003 to $0.2 million for the three months ended June 30, 2004, representing 9% and 1%, respectively, of our license fees revenue. The decrease in cost of license fees revenue in absolute dollars was due to nonrecurring royalties paid in
2003 pursuant to an agreement granting us the right to integrate and distribute certain third-party software to several of our customers through March 31, 2004. We have expensed all costs incurred in the research and development of our software
products as incurred, and, as a result, cost of license fees revenue includes no amortization of capitalized software development costs.



Amortization of Acquired Technology. As a result of our January 2003 purchase of BroadJump, we acquired certain intangible technology assets
having an estimated fair value of $9.4 million and an estimated useful life of five years. Amortization of these intangible assets in the amounts of $117,000 and $234,000 was recorded as a cost of revenue for the three months ended June 30, 2003 and
2004, respectively. These amounts represented 1% of total revenue in both of these periods.



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Cost of Services Revenue. Cost of services revenue includes salaries and related expenses
for our customer support, consulting, training and hosting and managed services organizations, third-party contractor expenses and an allocation of our facilities, communications and depreciation expenses. Cost of services revenue also includes the
costs incurred in connection with servicing the remaining contractual obligations under the acquired BroadJump software arrangements. Costs associated with these remaining obligations decreased by $2.2 million from $4.0 million for the three months
ended June 30, 2003 to $1.8 million for the three months ended June 30, 2004.



Excluding the costs incurred in connection with servicing the BroadJump software arrangements, total services costs increased by $1.2 million from $4.1 million for the three months ended June 30, 2003 to $5.3 million
for the three months ended June 30, 2004. This increase was primarily due to $470,000 in increased costs associated with servicing our growing international customer base, $440,000 in increased salary related costs and $360,000 in increased
third-party consulting costs.



Total services costs represented
61% and 68% of total services revenue for the three months ended June 30, 2003 and 2004, respectively. Excluding the costs and revenue associated with the acquired BroadJump software arrangements, cost of services revenue represented 74% and 63% of
total services revenue for the three months ended June 30, 2003 and 2004, respectively.



Operating Expenses



Sales and Marketing. Sales and marketing expenses consist of salaries and related costs of our sales and marketing organizations, sales commissions, travel and entertainment expenses, costs of our marketing programs, including
public relations, and collateral materials, and rent and facilities costs associated with our regional sales offices. Sales and marketing expenses decreased by $0.4 million from $8.7 million for the three months ended June 30, 2003 to $8.3 million
for the three months ended June 30, 2004, representing 35% and 34%, respectively, of our total revenue. The decrease in absolute dollars was primarily due to a decrease of $175,000 in sales commissions that resulted from a change in our incentive
plan structure, a decrease of $190,000 in travel costs and a decrease of $100,000 in salary costs that resulted from an average decrease in sales and marketing staff from June 30, 2003 to June 30, 2004.



Research and Development. Research and development expenses
consist of employee salaries, benefits, consulting costs and the cost of software development tools and expenses associated with the development of new products, enhancements of existing products and quality assurance activities. Research and
development expenses increased by $0.8 million from $3.9 million for the three months ended June 30, 2003 to $4.7 million for the three months ended June 30, 2004, representing 16% and 19%, respectively, of our total revenue. The increase in
absolute dollars was primarily due to an increase of $270,000 in third-party consulting costs, approximately $400,000 in increased salary costs and $80,000 in increased recruiting costs.



General and Administrative. General and administrative expenses consist of salaries and related costs of our
administrative, finance, business operations and information technology personnel as well as legal and accounting services and costs associated with our recruiting programs. General and administrative expenses decreased by $0.1 million from $2.1
million for the three months ended June 30, 2003 to $2.0 million for the three months ended June 30, 2004, representing 8% and 9%, respectively, of our total revenue. The decrease in absolute dollars was primarily due to a decrease of approximately
$200,000 in salary expenses resulting from a reduction in personnel in the general and administrative organizations, partially offset by an increase of $100,000 in legal and professional costs.



Amortization of Intangibles. Total amortization expense was
$571,000 and $802,000 for the three months ended June 30, 2003 and 2004, respectively, representing 2% and 3%, respectively, of our total revenue. In January 2003, we recorded $13.0 million of definite-lived intangibles in connection with the
BroadJump acquisition, which are being amortized over their estimated lives through 2008.



Amortization of Deferred Stock Compensation. Deferred stock compensation represents the difference between the exercise price of certain stock option grants and the deemed fair value of our common stock
at the time of such grants. We are amortizing these amounts over the vesting periods of the applicable options, resulting in amortization expense of $115,000 and $637,000 for the three months ended June 30, 2003 and 2004, respectively. The increase
in amortization was related to the grant of in-the-money options in the fourth quarter of 2003 and first quarter of 2004, which is being amortized over the vesting period of the applicable options.



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Interest Income (Expense), Net



Interest income (expense), net decreased from $(458,000) for the three
months ended June 30, 2003 to $(2.0) million for the three months ended June 30, 2004. The decrease in interest income (expense), net during these periods was primarily due to the $1.5 million write-off of the remaining debt discount on the
subordinated debt, which was repaid in full in June 2004.



Other Income (Expense), Net



Other
income (expense), net decreased from $85,000 for the three months ended June 30, 2003 to $(55,000) for the three months ended June 30, 2004 due to losses on collections of accounts receivable denominated in foreign currency as a result of
fluctuations in exchange rates.



Provision for Income
Taxes and Net Operating Losses



We have incurred
operating losses for all fiscal years from inception through December 31, 2003. Our provision for income taxes consists primarily of foreign income tax withholdings related to international sales. We have recorded a valuation allowance for the full
amount of our net deferred tax assets, which include net operating loss and research and development credit carryforwards, because of the uncertainty regarding their realization.



Comparison of the Six Months Ended June 30, 2004 and 2003



Revenue



Total revenue increased by $1.3 million from $45.4 million for the six
months ended June 30, 2003 to $46.7 million for the six months ended June 30, 2004. The increase was primarily due to a $7.5 million increase in license fees revenue and an increase in services revenue of $4.2 million, partially offset by a $10.3
million decrease in services revenue acquired as a result of the BroadJump acquisition.



Revenue from North America decreased by $9.1 million from $40.1 million for the six months ended June 30, 2003 to $31.0 million for the six months ended June 30, 2004. Revenue from Europe and Asia Pacific increased by
$10.4 million from $5.3 million for the six months ended June 30, 2003 to $15.7 million for the six months ended June 30, 2004. Revenue from outside North America represented 12% and 34% of our total revenue for the six months ended June 30, 2003
and 2004, respectively. Our targeted geographic revenue mix is approximately 55% from the Americas and 45% from Europe and Asia Pacific. For more information about our international revenue and expansion plans, please see Quantitative and
Qualitative Disclosures About Market Risk.



Mercury
Interactive accounted for 15% of our total revenue for the six months ended June 30, 2003, and no customers accounted for 10% or more of our total revenue for the six months ended June 30, 2004.



License Fees. Revenue from license fees increased by $7.5
million from $17.6 million for the six months ended June 30, 2003 to $25.1 million for the six months ended June 30, 2004, representing 39% and 54%, respectively, of our total revenue. License fees increased as a percentage of total revenue for the
six months ended June 30, 2004 because license fees increased by 42% from 2003 to 2004 while services revenue for this period decreased as a result of the declining revenue from the contracts acquired in the BroadJump acquisition in January 2003.



The increase in license fees in absolute dollars was primarily
due to a $12.3 million increase in license fees revenue from existing customers from $4.3 million to $16.6 million, partially offset by a $4.8 million decrease in license fees revenue from new license customers. The increase in revenue from existing
customers was primarily due to new product sales into existing customers, as well as renewals of existing term contracts, and revenue recognized on contracts entered into in previous periods based on their negotiated payment terms and the
application of our revenue recognition policy described below.



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Services. Our revenue from services decreased by $6.1 million from $27.7 million for the
six months ended June 30, 2003 to $21.6 million for the six months ended June 30, 2004, representing 61% and 46%, respectively, of our total revenue. Approximately $10.3 million of the decrease was due to declining services revenue from contracts
acquired in the BroadJump acquisition and approximately $0.9 million was due to a decrease in hosting revenue. This decrease was partially offset by a $3.8 million increase in consulting and training services revenue and an approximately $1.3
million increase in maintenance revenue due to growth in the number and size of maintenance contracts. Revenue from acquired contracts was $15.8 million and $5.5 million or 35% and 12% of our total revenue for the six months ended June 30, 2003 and
2004, respectively. This revenue will decline on a quarterly basis through 2006 when the remaining individual contractual obligations under the BroadJump software arrangements expire (see Critical Accounting PoliciesRevenue
Recognition).



Cost of Revenue



Cost of License Fees Revenue. Cost of license fees revenue
includes third-party software royalties, product packaging, documentation production and shipping costs related to software used by our customers. Cost of license fees revenue decreased by $0.7 million from $1.1 million for the six months ended June
30, 2003 to $0.4 million for the six months ended June 30, 2004, representing 2% and 1%, respectively, of our license fees revenue. The decrease in cost of license fees revenue in absolute dollars was due to nonrecurring royalties paid in 2003
pursuant to an agreement granting us the right to integrate and distribute certain third-party software to several of our customers through March 31, 2004. We have expensed all costs incurred in the research and development of our software products
as incurred, and, as a result, cost of license fees revenue includes no amortization of capitalized software development costs.



Amortization of Acquired Technology. As a result of our January 2003 purchase of BroadJump, we acquired certain intangible technology assets
having an estimated fair value of $9.4 million and an estimated useful life of five years. Amortization of these intangible assets in the amounts of $214,000 and $448,000 was recorded as a cost of revenue for the six months ended June 30, 2003 and
2004, respectively. These amounts represented 1% of revenue in both of these periods.



Cost of Services Revenue. Cost of services revenue includes salaries and related expenses for our customer support, consulting, training and hosting and managed services organizations, third-party
contractor expenses and an allocation of our facilities, communications and depreciation expenses. Cost of services revenue also includes the costs incurred in connection with servicing the remaining contractual obligations under the acquired
BroadJump software arrangements. Costs associated with these remaining obligations decreased by $3.2 million from $7.7 million for the six months ended June 30, 2003 to $4.5 million for the six months ended June 30, 2004.



Excluding the costs incurred in connection with servicing the BroadJump
software arrangements, total services costs increased by $2.2 million from $7.9 million for the six months ended June 30, 2003 to $10.1 million for the six months ended June 30, 2004. This increase was primarily due to $960,000 in increased costs
associated with servicing our growing international customer base, $830,000 in increased salary related costs and $480,000 in increased third-party consulting costs.



Total services costs represented 56% and 68% of total services revenue for the six months ended June 30, 2003 and 2004,
respectively. Excluding the costs and revenue associated with the acquired BroadJump software arrangements, cost of services revenue represented 66% and 63% of total services revenue for the six months ended June 30, 2003 and 2004, respectively.



Operating Expenses



Sales and Marketing. Sales and marketing expenses consist of
salaries and related costs of our sales and marketing organizations, sales commissions, travel and entertainment expenses, costs of our marketing programs, including public relations, and collateral materials, and rent and facilities costs
associated with our regional sales offices. Sales and marketing expenses decreased by $0.1 million from $15.9 million for the six months ended June 30, 2003 to $15.8 million for the six months ended June 30, 2004, representing 35% and 34%,
respectively, of our total revenue. The decrease in absolute dollars was primarily due to a decrease of $170,000 in sales commissions



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due to a change in our incentive plan structure, a decrease of $100,000 in third-party consulting costs, and a decrease
of $90,000 in marketing program costs. These decreases were partially offset by an increase in office costs of $200,000 related to expansions of our international office space.



Research and Development. Research and development expenses consist of employee salaries, benefits, consulting
costs and the cost of software development tools and expenses associated with the development of new products, enhancements of existing products and quality assurance activities. Research and development expenses increased by $1.4 million from $7.5
million for the six months ended June 30, 2003 to $8.9 million for the six months ended June 30, 2004, representing 16% and 19%, respectively, of our total revenue. The increase in absolute dollars was primarily due to an increase of $530,000 in
third-party consulting costs and approximately $700,000 in increased salary costs, $80,000 in increased recruiting costs and $80,000 in increased travel costs as a result of an average increase in development personnel from June 30, 2003, to June
30, 2004.



General and Administrative. General
and administrative expenses consist of salaries and related costs of our administrative, finance, business operations and information technology personnel as well as legal and accounting services and costs associated with our recruiting programs.
General and administrative expenses increased by $0.2 million from $4.0 million for the six months ended June 30, 2003 to $4.2 million for the six months ended June 30, 2004, representing 9% of our total revenue in both of the respective periods.
The increase in absolute dollars was due to an increase of $520,000 in legal and professional costs and an increase of $90,000 in recruiting costs related to an outside director search, partially offset by a decrease in salary expenses of $400,000
resulting from a reduction in personnel in the general and administrative organizations.



Amortization of Intangibles. Total amortization expense was $1.0 million and $1.6 million for the six months ended June 30, 2003 and 2004, respectively, representing 2% and 4%, respectively, of our total
revenue. In January 2003, we recorded $13.0 million of definite-lived intangibles in connection with the BroadJump acquisition, which are being amortized over their estimated lives through 2008.



Amortization of Deferred Stock Compensation. Deferred stock
compensation represents the difference between the exercise price of certain stock option grants and the deemed fair value of our common stock at the time of such grants. We are amortizing these amounts over the vesting periods of the applicable
options, resulting in amortization expense of $281,000 and $1.5 million for the six months ended June 30, 2003 and 2004, respectively. The increase in amortization was related to the grant of in-the-money options in the fourth quarter of 2003 and
first quarter of 2004, which is being amortized over the vesting periods of the applicable options.



Business Restructuring Charge. During the first quarter of 2003, we initiated a restructuring program as a result of our integration of
BroadJump. We incurred a non-recurring charge of approximately $1.4 million related to severance and other employee termination benefits related to a reduction in workforce of approximately 25 employees in January 2003, as well as costs associated
with the closing of duplicative facilities and the elimination of other overlapping efforts. As of June 30, 2004, all termination benefits related to the restructuring had been paid.



Interest Income (Expense), Net



Interest income (expense), net decreased from $(1.0) million for the six months ended June 30, 2003 to $(2.5) million for
the six months ended June 30, 2004. The decrease in interest income (expense), net during these periods was primarily due to the $1.5 million write-off of the remaining debt discount on the subordinated debt, which was repaid in full in June 2004.



Other Income (Expense), Net



Other income (expense), net increased from $142,000 for the six months ended
June 30, 2003 to $417,000 for the six months ended June 30, 2004 due to gains on collections of accounts receivable denominated in foreign currency as a result of fluctuations in exchange rates.



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Provision for Income Taxes and Net Operating Losses



We have incurred operating losses for all fiscal years from inception
through December 31, 2003. Our provision for income taxes consists primarily of foreign income tax withholdings related to international sales. We have recorded a valuation allowance for the full amount of our net deferred tax assets, which include
net operating loss and research and development credit carryforwards, because of the uncertainty regarding their realization.



Liquidity and Capital Resources



Since inception, we have funded our operations and met our capital expenditure requirements through the private sale of equity securities and
acquisitions, in addition to the completion of our initial public offering in June 2004. The net proceeds from our private securities issuances plus cash received from acquisitions was approximately $107 million through June 30, 2004. The net
proceeds from our initial public offering were $44.1 million. Cash provided by operating activities was $6.3 million for the six months ended June 30, 2004.



To date, cash used in investing activities has consisted primarily of capital expenditures totaling $1.4 million and $2.6 million for the six months ended
June 30, 2004 and 2003, respectively, to acquire property and equipment, mainly computer hardware and software for our employee base and our hosting and managed services operations. Cash provided by other investing activities includes $51.7 million
in cash acquired in connection with the acquisition of BroadJump in January 2003. Additionally, $5.7 million of cash was used in connection with the acquisition of BroadJump, of which $4.8 million was related to payments for non-competition
agreements with certain executive officers of BroadJump. There were no short-term investing activities for the six months ended June 30, 2004 and proceeds from short-term investing activities were $1.4 million for the six months ended June 30, 2003.
We also had an increase in restricted cash in 2003 in the amount of $15.0 million due to covenants existing on our term loans and line of credit. This amount was no longer restricted as of June 30, 2004 because this covenant was removed in the first
quarter of 2004.



At June 30, 2004, we had cash and cash
equivalents on hand of $80.4 million and working capital of $63.2 million. Our accounts receivable decreased $8.6 million during the six months ended June 30, 2004. This decrease was primarily due to the fluctuations in revenue, timing of shipments
and the timing of payments received from our customers. Our payment terms generally require payment within 30 to 90 days of shipment.



In October 2002, we issued senior subordinated promissory notes totaling $12.5 million, bearing interest at 11% annually, to certain of our stockholders.
These notes were repaid in full in June 2004. We have incurred $2.7 million in interest expense for the six months ended June 30, 2004, of which $1.5 million was due to the write off of the remaining debt discount on the subordinated notes.
Additionally, we have term loans with Comerica Bank, which bear interest at rates ranging from the banks prime rate (4.5% at June 30, 2004) plus 2.0% to prime plus 2.5%. At June 30, 2004, $6.1 million was outstanding under the term loans.
These loans are secured by substantially all of our assets, including intellectual property. The loans include financial covenants requiring us to maintain (a) a ratio of (i) cash, cash equivalents and eligible accounts receivable to (ii) current
liabilities plus all indebtedness owed to the bank less deferred revenue, of at least 1.30 to 1.00 and (b) tangible net worth of not less than one dollar at the end of each fiscal quarter. In addition, the loans restrict our ability to pay
dividends, effect mergers or acquisitions, or have an account of greater than $2.0 million at another institution without the banks prior approval. At June 30, 2004, we were in compliance with such covenants and restrictions. On June 30, 2004,
an additional $15.0 million line of credit that we previously had with Comerica Bank expired with no amounts outstanding.



We believe that cash on hand, cash equivalents, short-term investments and commercial credit facilities will be sufficient to meet our working capital
requirements for at least the next 12 months. Thereafter, we may require additional funds to support our working capital requirements or for other purposes and may seek to raise such additional funds through public or private equity financings or
from other sources. There can be no assurance that additional financing will be available at all or that, if available, such financing will be obtainable on terms favorable to us or our stockholders. The sale of additional equity or convertible debt
securities could dilute the per share value of our common stock. Additionally, we could be forced to engage in debt financing on terms that could restrict our ability to make capital expenditures or incur additional indebtedness, which could impede
our ability to achieve our business objectives.



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Off-Balance Sheet Arrangements



We had no off-balance sheet arrangements as of December 31, 2002 and 2003 or as of June 30, 2004.



Critical Accounting Policies



Revenue Recognition



License fees revenue is comprised of fees for term and, to a lesser extent,
perpetual licenses of our software. To date, we have not entered into any software arrangement solely for the license of products and, therefore, we have not demonstrated vendor specific objective evidence (VSOE) of fair value for the
license element. We (1) recognize revenue for the fees associated with a perpetual license or a term license with VSOE for maintenance using the residual method in accordance with Statement of Position (SOP) 98-9, Modification of SOP
97-2, Software Revenue Recognition, With Respect to Certain Transactions, regardless of any separate prices stated within the contract for each element, or (2) recognize revenue for the fees associated with a term license without VSOE for
maintenance ratably over the term of the agreement, generally one to three years. Prior to the fourth quarter of 2001, we did not have VSOE to determine the fair value of maintenance for term licenses. As a result, license fees revenue also includes
maintenance for term licenses entered into prior to the establishment of VSOE of maintenance for term licenses. License fees revenue is recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, no unfulfilled
vendor obligations remain, the fee is fixed or determinable and collectibility is probable.



If the fee for the license has any payment terms that are in excess of our normal payment terms, the fee is considered not to be fixed or determinable. In this scenario, the amount of revenue recognized for perpetual
license arrangements and term license arrangements with VSOE for maintenance is limited to the amount currently due from the customer. In such arrangements, license fees are recognized as license fees revenue as the related amounts become
due. Because each such arrangement is individually negotiated, the payment schedule and resulting revenue recognition associated with each agreement can vary. The amount of revenue recognized for term license arrangements without VSOE for
maintenance is limited to the lesser of the amount due from the customer during each reporting period and a ratable portion of the total unallocated arrangement fee. In most cases, this means that both license fees and maintenance associated with
the underlying arrangement are recognized as license fees revenue ratably over the term of the contract, which generally tends to defer revenue recognition over longer periods of time. To the extent that sufficient amounts are not due from the
customer to cover the ratable revenue recognition for an applicable period, the amount of revenue recognized is limited to the amount currently due.



If an arrangement includes a right of acceptance or a right to cancel, revenue is recognized when acceptance is received or the right to cancel has
expired.



License fees revenue from arrangements with resellers
involving nonrefundable fixed minimum license fees are recognized when payment becomes due from the customer and delivery of the product has occurred, assuming no significant unfulfilled vendor obligations remain. Royalties related to such reseller
arrangements in excess of the fixed minimum amounts are recognized as revenue when such amounts are reported to us.



Services revenue is comprised of revenue from professional services, such as consulting services, maintenance and support services and hosting and managed
services. Consulting services include a range of services such as installation, implementation and non-complex interface development for the customers specific applications. Maintenance and support services represent technical support of our
software products and include the right to unspecified product upgrades on an if-and-when available basis. Hosting and managed services involve remote management of our solutions for which we receive fees. We have determined that the service
elements of our software arrangements are not essential to the functionality of the software. We have also determined that our professional services: (1) are available from other vendors; (2) do not involve a significant degree of risk or unique
acceptance criteria; and (3) qualify for separate accounting as we have sufficient experience in providing such services.



VSOE of fair value of services in multiple element arrangements is based upon rates for consulting and training services and fees for pre-packaged
technical support and hosting and managed services which we have



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charged in stand-alone contracts for these services. For perpetual licensing arrangements and term licensing arrangements
with VSOE for maintenance and hosting and managed services, in accordance with paragraph 57 of SOP 97-2, VSOE of fair value for maintenance and hosting and managed services is determined by reference to the price the customer has paid or will be
required to pay when it is sold separately. VSOE of fair value for maintenance and hosting and managed services contracts under perpetual license arrangements and term license arrangements with VSOE for maintenance and hosting and managed services
is based upon our pricing practice that maintenance and hosting and managed services renewal rates are based upon a percentage of the quoted license fees in the related contract. Each contract typically offers additional renewal periods at a stated
price or rate. Maintenance revenue is deferred and recognized on a straight-line basis as services revenue over the life of the related agreement, which is typically one year. Hosting and managed services revenue is deferred and recognized on a
straight-line basis as services revenue over the life of the related agreement, which typically ranges from one month to one year.



In January 2003, we assumed liabilities related to existing software arrangements with a fair value of approximately $40.1 million as a result of the
BroadJump acquisition. The fair value of these assumed liabilities, which was recorded as deferred revenue, relates to the remaining contractual obligations under the BroadJump software arrangements and is being recognized ratably as services
revenue acquired in business combination over the remaining life of each software arrangement. This revenue will continue to decline on a quarterly basis through 2006 when the remaining individual contractual obligations under the BroadJump software
arrangements expire.



Accounts receivable include amounts due
from customers for which revenue has been recognized. Deferred revenue includes amounts received from customers for which revenue has not been recognized.



Allowance for Doubtful Accounts



We continuously assess the collectibility of outstanding customer invoices and in doing so, we maintain an allowance for estimated losses resulting from
the non-collection of customer receivables. In estimating this allowance, we consider factors such as: historical collection experience; a customers current credit worthiness; customer concentration; age of the receivable balance, both
individually and in the aggregate; and general economic conditions that may affect a customers ability to pay. Actual customer collections could differ from our estimates and accordingly could exceed our related loss allowance.



Goodwill and Other Intangible Assets



The Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 141, Business Combinations,and SFAS No. 142, Goodwill and Other Intangible Assets, in June 2001. Pursuant to SFAS No. 141, assembled workforce no longer meets the criteria to be
recognized and reported apart from goodwill. As a result, we have reclassified assembled workforces of $212,093, net of amortization and impairment charges, to goodwill. Effective January 1, 2002, we adopted SFAS No. 142 and no longer amortize
goodwill. In accordance with SFAS No. 142, we periodically assess our intangible assets, including goodwill, for indicators of impairment.



Prior to January 1, 2002, intangible assets related to the Ventix acquisition were being amortized using the straight-line method over a two-year period
for acquired technology and a three-year period for workforce and goodwill. The acquired technology from the Ventix acquisition was fully amortized as of March 31, 2002. In January 2003, we acquired BroadJump and recorded certain intangibles,
including acquired technology, customer contractual relationships, order backlog and non-competition agreements. Amounts allocated to acquired technology, customer contractual relationships and order backlog are being amortized over the respective
assets estimated useful lives of four to five years using a method of amortization that reflects the pattern in which their economic benefits are consumed based upon estimated contributions to discounted cash flows during the applicable
period. Amounts allocated to non-compete agreements are being amortized over their estimated useful lives of three years using the straight line method. We periodically review the estimated useful lives of our identifiable intangible assets, taking
into consideration any events or circumstances which might result in a diminished fair value or revised useful life.



We assess whether goodwill and indefinite-lived intangibles are impaired on an annual basis. Upon determining the existence of goodwill and/or
indefinite-lived intangibles impairment, we measure that impairment



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based on the amount by which the book value of goodwill and/or indefinite-lived intangibles exceeds its fair value. The
implied fair value of goodwill is determined by deducting the fair value of a reporting units identifiable assets and liabilities from the fair value of the reporting unit as a whole, as if that reporting unit had just been acquired and the
purchase price were being initially allocated. Additional impairment assessments may be performed on an interim basis if we encounter events or changes in circumstances that would indicate that, more likely than not, the book value of goodwill
and/or indefinite-lived intangibles has been impaired.



Stock-Based Compensation



We account
for our employee stock-based compensation using the intrinsic value method in accordance with Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees.We make disclosures regarding employee
stock-based compensation using the fair value method in accordance with SFAS No. 123, Accounting for Stock Based Compensation. We have calculated the fair value of options granted and have determined the pro forma impact on net income (loss).
We account for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force (EITF) No. 96-18, Accounting for Instruments That Are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling Goods or Services.



Risk
Factors that May Affect Future Results



In addition to the
other information included in this Quarterly Report, you should carefully consider the risks described below. The risks and uncertainties described below are not the only ones that we face. Additional risks and uncertainties not presently known to
us or that we currently deem not significant may also affect our business operations. If any of these risks actually occur, our business, financial condition, or results of operations could be seriously harmed. In that event, the market price of our
common stock could decline.



Our total revenue was $20.0 million in the
third quarter and $27.0 million in the fourth quarter of 2003, and $22.7 million in the first quarter and $24.0 million in the second quarter of 2004, and we expect that our quarterly financial results will continue to fluctuate and may be difficult
to predict. If our future results are below the expectations of public market analysts and investors, the price of our common stock may decline.



Our quarterly revenue and results of operations are difficult to predict. Unlike more established enterprise software vendors, we have experienced, and
expect to continue to experience, fluctuations in revenue and operating results from quarter to quarter. As a result, we believe that quarter-to-quarter comparisons of our revenue and operating results are not necessarily meaningful, and that such
comparisons may not be accurate indicators of future performance. The reasons for these fluctuations include, but are not limited to:



| |  | the timing of sales of our software, including the relatively long sales cycles of up to nine months or more associated with most of our larger software sales to large enterprises;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | our dependence on larger software sales to a relatively small number of large enterprises;
| | - | ------------------------------------------------------------------------------------------



| |  | our dependence on license revenue from new software sales (as opposed to recurring maintenance revenue) to achieve our revenue objectives;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------



| |  | budget and spending decisions by our customers, who are concentrated in the communications and high technology markets;
| | - | -----------------------------------------------------------------------------------------------------------------------



| |  | our ability to renew existing licenses, most of which are for a term of three years, or to secure new licenses on beneficial terms;
| | - | -----------------------------------------------------------------------------------------------------------------------------------



| |  | demand for our service management software;
| | - | -------------------------------------------



| |  | market acceptance of newly released products or delays in new product introductions;
| | - | ------------------------------------------------------------------------------------



| |  | our utilization and billing rates for our professional services personnel;
| | - | --------------------------------------------------------------------------



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| |  | our history of growth through acquisitions which have typically affected our operating results;
| | - | -----------------------------------------------------------------------------------------------



| |  | the amount and timing of operating costs related to the expansion of our business, operations and infrastructure; and
| | - | ---------------------------------------------------------------------------------------------------------------------



| |  | changes in our pricing policies or our competitors pricing policies.
| | - | ---------------------------------------------------------------------



In addition, we experience seasonality in our revenue, with the fourth quarter of the year typically having the highest revenue for the year. We believe
that this seasonality results primarily from customer budgeting cycles and our sales compensation model. We expect that this seasonality will continue.



Our operating expenses, which include sales and marketing, research and development and general and administrative expenses, are based on our expectations
of future revenue and are, to a large extent, fixed in the short term. If revenue falls below our expectations in a quarter and we are not able to quickly reduce our operating expenses in response, our operating results for that quarter could be
adversely affected. It is possible that in some future quarter our operating results may be below the expectations of public market analysts and investors and, as a result, the price of our common stock may fall.



Our customer base is concentrated. Accordingly, the loss of a major customer could
cause our revenue to decline.



Our quarterly revenue
is especially subject to fluctuation because it depends on the completion of large orders for our products and related services primarily from a small number of large customers. For example, sales to Hewlett-Packard represented 19% of our total
revenue in 2002, Mercury Interactive Corporation accounted for 11% of our total revenue in 2003, and for the three-months ended June 30, 2004 British Telecommunications plc and Telus Corporation represented 17% and 16% of our total revenue,
respectively. Although our customer make-up varies from quarter to quarter, a small number of customers are likely to continue to account for a significant portion of our revenue, and our revenue could decline due to the loss or delay of a single
customer order or the failure of an existing customer to renew its license. Our ability to mitigate this risk is based almost entirely on our ability to obtain additional customers and to expand our sales to existing customers. Our failure to obtain
additional customers, the loss or delay of customer orders or the failure of existing customers to renew their licenses will harm our business and operating results.



We have never been profitable on an annual basis and we have incurred net losses in almost every fiscal period since we began
operations. We may incur losses in the future.



To
date, we have not been profitable on an annual basis and we have incurred net losses in almost every fiscal period since we began operations. For the year ended December 31, 2003, we had a net loss of $1.2 million, for the six months ended June 30,
2004 we had a net loss of $3.7 million, and as of June 30, 2004, we had an accumulated deficit of approximately $92.1 million. We will need to generate significant additional revenue and manage expenses appropriately to achieve and maintain
profitability. Therefore, we may not be able to achieve or increase profitability on a quarterly or annual basis.



We have a limited history of sales of some of our products, which makes it difficult to evaluate our prospects.



Some of the products in our current product suite have been released within
the past year, including our Business Class Manager, which was released in August 2003, our Usage Policy Manager, which was released in September 2003, and our Motive Profile, which was released in May 2004. These products target solving
customers problems that we have not previously addressed. There can be no assurance that our customers will perceive these products as adequately addressing those problems or that there will be substantial demand for them. It is difficult to
evaluate our future prospects because of our limited experience with these products, the rapidly evolving and competitive nature of the markets in which we sell these products and other factors that are beyond our control.



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The typical sales cycle for our products and services is long and it may be difficult for us to predict when
certain customers will complete the sales cycle. As a result, our quarterly operating results may fluctuate and the price of our common stock could decline.



We believe that a customers decision to purchase our software and services is highly discretionary, involves a
significant commitment of resources and is influenced by customer budgetary cycles. To successfully sell our software and services, we must educate potential customers regarding their use and benefits, which can require significant time and
resources from us and our customers. The period between our initial contact with a potential customer and the purchase of our software and services is often long and subject to delays associated with the budgeting, approval and competitive
evaluation processes that frequently accompany significant capital expenditures. Our sales cycle varies substantially and may require up to nine months or more depending on the customer and the size of the transaction. A lengthy sales cycle may have
an impact on the timing of our revenue, which in turn could cause our quarterly operating results to fluctuate and our stock price to trade at lower levels than would otherwise be the case.



Our failure to adapt to technological change in our industry and to develop and achieve
broad adoption and acceptance of our new products could cause the loss of existing and potential customers and therefore adversely affect our revenue and earnings. We are dependent on new product introductions for future revenue growth and such
introductions involve significant risks.



If we fail
to keep pace with technological change in our industry, such failure would have an adverse effect on our revenue and earnings. During the past several years, many new technological advancements and competing products have entered the marketplace to
address the same problems that our products and services are intended to address. Our ability to compete effectively and our growth prospects depend upon many factors, including the success of our existing software products, the timely introduction
and success of future software products and releases and the ability of our products to interoperate and perform well with existing and future leading databases, applications, operating systems and other platforms. We have made significant
investments in research and development and our business model requires us to generate substantial revenue from new product introductions. We released two new products in 2003, one new product in the second quarter of 2004 and anticipate releasing
one new product in the third quarter of 2004. New product introductions involve significant risks. For example, delays in new product introductions or less-than-anticipated market acceptance of our new products are possible and would have an adverse
effect on our revenue and earnings. We cannot be certain that our new products or future enhancements to existing products will meet customer performance needs or expectations when shipped or that they will be free of significant software defects or
bugs. If they do not meet customer needs or expectations, for whatever reason, upgrading or enhancing these products could be costly and time consuming. In addition, the selling price of software products tends to decline significantly over the life
of the product. If we are unable to offset any reductions in the selling prices of our products by introducing new products at higher prices or by reducing our costs, our revenue, gross margin and operating results would be adversely affected.



If we do not successfully address the risks inherent in the expansion of
our international operations, our business could suffer.



We currently have operations in Canada, the United Kingdom, Germany, Switzerland, France, Spain and Japan, and we intend to expand further into international markets. Unlike more established enterprise software vendors, we have limited
experience in international operations and may not be able to compete effectively in international markets or to operate profitably in these markets. At the same time, our dependence on international revenue has steadily increased over time. Our
international revenue was $29.5 million for the year ended December 31, 2003, an increase of $14.0 million over international revenue of $15.5 million for 2002. Our international revenue was $14.9 million for the three months ended June 30, 2004, an
increase of $10.4 million over international revenue of $4.5 million for the three months ended June 30, 2003. Our international revenue was $24.3 million for the six months ended June 30, 2004, an increase of $15.8 million over international
revenue of $8.5 million for the six months ended June 30, 2003. Continued expansion of our international operations will require a significant amount of attention from our management and substantial financial resources and may require us to add
qualified management in these markets. Our direct sales model requires us to attract, retain and manage qualified sales personnel capable of selling into markets outside the U.S. In our opinion, this is significantly more difficult in markets
outside the U.S. Additionally, in some cases, our costs of sales may increase if our customers require us to sell through local distributors.



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For the six months ended June 30, 2004, 52% of our revenue was derived from international operations. If
we are unable to continue to grow our international operations in a cost effective and timely manner, our business and operating results could be harmed. Doing business internationally involves additional risks that could harm our operating results,
particularly:



| |  | differing technology standards;
| | - | -------------------------------



| |  | difficulties in collecting accounts receivable and longer collection periods;
| | - | -----------------------------------------------------------------------------



| |  | political and economic instability;
| | - | -----------------------------------



| |  | fluctuations in currency exchange rates;
| | - | ----------------------------------------



| |  | imposition of currency exchange controls;
| | - | -----------------------------------------



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



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



| |  | dependence on local vendors;
| | - | ----------------------------



| |  | compliance with multiple conflicting and changing governmental laws and regulations;
| | - | ------------------------------------------------------------------------------------



| |  | seasonal reductions in business activity specific to certain markets;
| | - | ---------------------------------------------------------------------



| |  | longer sales cycles;
| | - | --------------------



| |  | restrictions on repatriation of earnings;
| | - | -----------------------------------------



| |  | differing labor regulations;
| | - | ----------------------------



| |  | restrictive privacy regulations in different countries, particularly in the European Union;
| | - | -------------------------------------------------------------------------------------------



| |  | restrictions on the export of sensitive U.S. technologies such as data security and encryption; and
| | - | ---------------------------------------------------------------------------------------------------



| |  | import and export restrictions and tariffs.
| | - | -------------------------------------------



Our business is dependent on the renewal of licenses by our existing customers. If our customers do not renew their licenses for our products or if they do not
renew their licenses on terms that are favorable to us, our operating results could be adversely affected and the price of our common stock could decline.



Most of our licenses are for a fixed term of three years. For example, for the year ended December 31, 2003, approximately
78% of the license agreements we entered into were fixed term licenses, as opposed to perpetual licenses. In addition, the revenue from our contracts acquired in the BroadJump acquisition will decline on a quarterly basis through 2006 when the
remaining obligations expire. As the end of the term of a fixed term license approaches, we attempt to negotiate the renewal of the license with the customer for the same product and/or for new products and services. If our customers choose not to
renew their fixed term licenses with us or if we are unable to license additional products to our existing customers on beneficial terms, our business, operating results and financial condition could be harmed.



If we do not expand our sales and distribution capabilities, we may not be able to
expand the sales of our software and services and achieve revenue growth.



We need to substantially expand our direct and indirect sales and distribution efforts, both domestically and internationally, in order to increase sales of our software and related services. Competition for qualified
sales and marketing personnel is intense, and we might not be able to hire and retain adequate numbers of such personnel to



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maintain our growth. New hires require training and take time to achieve full productivity. Our competitors have
attempted to hire our employees and we expect that they will continue to do so. We also plan to expand our relationships with system integrators, enterprise software vendors and other third-party resellers to develop our indirect sales channel. As
we develop our indirect sales channel, we will need to manage potential conflicts between our direct sales force and third-party reselling efforts.



If we do not expand our professional services organization, our customers may become dissatisfied and our operating results could suffer. Also, our professional
services organization may not operate in a profitable manner.



Our software sales, particularly those to large enterprises, are often dependent on our ability to provide a significant level of professional services to our customers. Clients that license our software typically engage our professional
services organization to assist with installation, training, consulting and implementation of our software. We believe that growth in our software sales depends to a significant degree on our ability to provide our clients with these services. We
cannot be certain that our professional services business will operate in a profitable manner. We plan to further increase the number of services personnel to meet customer needs. New services personnel will require training and education and take
time to reach full productivity. We may not be able to recruit the services personnel we need or retain our current services personnel because competition for qualified services personnel is intense. We are in a relatively new market and only a
limited number of individuals have the skills needed to provide the services that our clients require. To meet our needs for services personnel, we may also need to use third-party consultants to supplement our own professional services
organization.



If we fail to attract, train, and retain highly qualified
employees, our business may be harmed



Our future
success will depend on our continued ability to attract, train and retain highly qualified employees. As of June 30, 2004, we had 111 employees in our professional services organization, 86 employees in our sales and marketing organizations, 113
employees in our development organization, and 43 employees in our general and administrative organization. Our employees are not represented by a collective bargaining agreement and we have never experienced a strike or similar stoppage. We
consider our relations with our employees to be good.



If we lose the
services of any of our senior management or other key personnel, our business may be harmed.



Our success will depend on the skills, experience and performance of our senior management, engineering, sales, marketing and other key personnel, many of
whom have worked together for a relatively short period of time. Currently, we do not have long-term employment agreements with any of our executive officers, with the exception of Kenny Van Zant who joined us as a result of our acquisition of
BroadJump in early 2003 and received an employment agreement as part of the terms and conditions of that acquisition. The loss of the services of any of our senior management or other key personnel, including our Chief Executive Officer, Scott
Harmon, could harm our business. Mr. Harmon, in particular, is one of our co-founders and possesses unique knowledge of our markets, our products and our customers. We possess key man life insurance for Scott Harmon, but not for any of our other
officers.



Our failure to expand our strategic alliances would impede our
revenue growth.



Unlike more established enterprise
software vendors, we must successfully establish and extend relationships that enable us to expand market acceptance of our software solutions. Specifically, we must establish new and extend existing distribution alliances with specialized
technology and services firms, such as support outsourcers. We must also establish new and extend existing solutions alliances with leading providers of complementary technologies. Although our business does not depend on any one strategic alliance,
our strategic alliances as a whole are a valuable component of our business. Without adequate strategic alliances, we may have to devote substantially more resources than we would otherwise to the sales, marketing and implementation of our products
and the development of complementary products in order to deliver comprehensive service management solutions, and our efforts may not be as effective as those who have such alliances. In many cases, the firms with which we wish to form alliances
have extensive relationships with our existing and potential customers and may influence the decisions of these customers by recommending products. If we fail to establish, successfully implement or maintain these alliances, our ability to achieve
market acceptance of our service management software will suffer and our business and operating results will be harmed.



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We have experienced significant growth in our business in the past and we may not be able to manage our future
growth efficiently or profitably.



We have expanded
the scope of our operations at a rapid rate in the past. For example, in January 2003, we acquired BroadJump, Inc., a provider of broadband Internet activation and support solutions. Primarily as a result of the BroadJump acquisition, the number of
people we employ grew from 240 employees as of December 31, 2002 to 353 employees as of June 30, 2004. Future expansion efforts could be expensive and may strain our managerial and other resources. To manage future growth effectively, we must
maintain and enhance our financial and accounting systems and controls, integrate new personnel and manage expanded operations. If we do not manage growth properly, it could harm our business, operating results and financial condition.



We may find it difficult to integrate potential future business combinations, which
could disrupt our business, dilute stockholder value and adversely affect our operating results.



From inception to date, we have completed three acquisitions of other companies and businesses. We may acquire other companies and businesses in the
future, which could add substantial complexity and additional burdens to the substantial tasks already performed by our management team. We may need to integrate operations that have different and unfamiliar corporate cultures. Likewise, we may need
to integrate disparate technologies and product offerings, as well as multiple direct and indirect sales channels. These integration efforts may not succeed or may distract our managements attention from existing business operations. Our
failure to successfully manage and integrate future acquisitions could seriously harm our business.



In addition, our existing stockholders ownership would be diluted if we financed our acquisitions by issuing equity securities. Under the purchase
method of accounting, now required under generally accepted accounting principles for all acquisitions, we could be required to incur in-process research and development or other charges in connection with future acquisitions, which would adversely
affect our operating results.



The service management software and
services industry is highly competitive, the market for our products is subject to rapid change and we may not be able to compete effectively.



The market for our products is intensely competitive, subject to rapid change and significantly affected by new product introductions and other market
activities of industry participants. Although we do not currently compete against any one entity with respect to all aspects of our software solutions, our solutions compete against various vendors software products designed to accomplish
specific elements of functionality. Moreover, these vendors may broaden their product portfolios to more directly compete against our products.



Our current and potential competitors may have longer operating histories, significantly greater financial, technical and other resources or greater name
recognition than we do. Our competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements. Competitive pressures could reduce our market share or require us to reduce the price of our products,
either of which could harm our business and operating results.



If our
products fail to perform properly due to undetected errors or similar problems, our business could suffer because, among other things, we might have to limit or suspend product shipments, we might have to expand resources providing enhancements to
correct such errors and we may experience other adverse consequences described below.



Our software products are complex and have been more recently developed than those of more established enterprise software vendors. Software such as ours often contains undetected errors or bugs. Such
errors are frequently found during the period immediately following introduction of new software or enhancements to existing software. We continually introduce new products. If we detect any errors before we ship a product, we might have to limit or
suspend product shipments for an extended period of time while we address the problem. We may not discover software errors that affect our new or current products or enhancements until after they are deployed and we may need to provide enhancements
to correct such errors. Therefore, it is possible that, despite testing by us, errors may occur in our software. These errors could result in:



| |  | damage to our reputation;
| | - | -------------------------



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| |  | lost sales;
| | - | -----------



| |  | delays in commercial release;
| | - | -----------------------------



| |  | product liability claims;
| | - | -------------------------



| |  | delays in or loss of market acceptance of our products;
| | - | -------------------------------------------------------



| |  | license terminations or renegotiations; and
| | - | -------------------------------------------



| |  | unexpected expenses and diversion of resources to remedy errors.
| | - | ----------------------------------------------------------------



Furthermore, our customers may use our software together with products from other companies. As a result, when problems occur, it may be difficult to
identify the source of the problem. Even when these problems are not caused by our software, they may cause us to incur significant costs, divert the attention of our engineering personnel from our product development efforts, impact our reputation
and cause significant customer relations problems.



Our failure to
integrate third-party technologies could harm our business because we may incur increased costs and experience delays procuring or building replacement technologies.



We do not own all of the technology that is used in our business and that is incorporated into our products. Accordingly, we
intend to continue licensing technologies from third parties, including applications used in our research and development activities and technologies that are integrated into our products. These technologies may not continue to be available to us on
commercially reasonable terms or at all. Our inability to obtain any of these licenses could delay product development until equivalent technology can be identified, licensed and integrated. This inability in turn would harm our business and
operating results. For example, we license security and encryption technology from RSA Security. The RSA agreement continues indefinitely unless terminated in the event of a material default by either party or insolvency, or unless we terminate for
convenience on 90-days written notice. Our use of third-party technologies exposes us to increased risks, including, but not limited to, risks associated with the integration of new technology into our products, the diversion of our resources
from development of our own proprietary technology and our inability to generate revenue from licensed technology sufficient to offset associated acquisition and maintenance costs.



If the system security of our software is breached, our business and reputation could suffer.



A fundamental and unique requirement for effective use of many of our
products is the secure transmission, collection and storage of confidential end user information. Third parties may attempt to breach our security or that of our customers. We may be liable to our customers for any breach in such security and any
breach could harm our customers, our business and our reputation. In addition, our software contains features which may allow us or our customers to control, monitor or collect data from computers running the software. Therefore, we may be subject
to claims associated with invasion of privacy or inappropriate disclosure, use or loss of this information. Any imposition of liability, particularly liability that is not covered by insurance or is in excess of insurance coverage, could harm our
reputation and our business and operating results. Also, computers, including those that utilize our software, are vulnerable to computer viruses, physical or electronic break-ins and similar disruptions, which could lead to interruptions, delays or
loss of data. We may be required to expend significant capital and other resources to further protect against security breaches or to rectify problems caused by any security breach.



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We rely upon patents, trademarks, copyrights and trade secrets to protect our proprietary rights, which may provide
us with inadequate protection.



Our success and
ability to compete depend to a significant degree upon the protection of our software and other proprietary technology rights. We may not be successful in protecting our proprietary technology, and our proprietary rights may not provide us with a
meaningful competitive advantage. To protect our proprietary technology, we rely on a combination of patents, trademarks, copyrights, trade secrets and disclosure agreements, each of which affords only limited protection. Any inability to protect
our intellectual property rights could seriously harm our business, operating results and financial condition. It is possible that:



| |  | our pending patent applications may not result in the issuance of patents;
| | - | --------------------------------------------------------------------------



| |  | any patents issued to us may not be broad enough to protect our proprietary rights;
| | - | -----------------------------------------------------------------------------------



| |  | any issued patent could be successfully challenged by one or more third parties, which could result in our loss of the right to prevent others from exploiting the inventions claimed
in those patents; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | current and future competitors may independently develop similar technologies, duplicate our products or design around any of our patents.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------



In addition, the laws of some foreign countries do not protect our
proprietary rights in our products to the same extent as do the laws of the U.S. Despite the measures taken by us, it may be possible for a third party to copy or otherwise obtain and use our proprietary technology and information without
authorization. Policing unauthorized use of our products is difficult, and litigation may be necessary in the future to enforce our intellectual property rights. Any litigation could be time consuming and expensive to prosecute or resolve, result in
substantial diversion of management attention and resources, and materially harm our business, financial condition and results of operations.



Claims that we infringe upon third parties intellectual property rights could be costly to defend or settle, thus adversely affecting our operating results.



Litigation regarding intellectual property rights is
common in the software industry. We expect that software products and services may be increasingly subject to third-party infringement claims as the number of competitors in our industry segment grows and the functionality of products in different
industry segments overlaps. We may from time to time encounter disputes over rights and obligations concerning intellectual property. Although we believe that our intellectual property rights are sufficient to allow us to market our software without
incurring liability to third parties, third parties may bring claims of infringement against us. Such claims may be with or without merit. Any litigation to defend against claims of infringement or invalidity could result in substantial costs and
diversion of resources. Furthermore, a party making such a claim could secure a judgment that requires us to pay substantial damages. A judgment could also include an injunction or other court order that could prevent us from selling our software.
Our business, operating results and financial condition could be harmed if any of these events occurred.



In addition, we have agreed, and will likely agree in the future, to indemnify certain of our customers against certain claims that our software infringes
upon the intellectual property rights of others. We could incur substantial costs in defending ourselves and our customers against infringement claims. In the event of a claim of infringement, we and our customers may be required to obtain one or
more licenses from third parties. We, or our customers, may be unable to obtain necessary licenses from third parties at a reasonable cost, if at all. Defense of any lawsuit or failure to obtain any such required licenses could harm our business,
operating results and financial condition.



If we become subject to
product liability claims, they could be time consuming and costly to defend, thus adversely affecting our operating results.



Errors, defects or other performance problems in our software could result in financial or other damages to our customers. They could seek damages from us
for losses associated with these errors, defects or other performance problems. If successful, these claims could have a material adverse effect on our business, operating results or financial condition. Although we possess product liability
insurance and errors and omissions insurance, there is no guarantee that our insurance would be enough to cover the full amount of any loss we might suffer. Our license agreements typically contain provisions designed to limit our exposure to
product liability claims, but existing or future laws or unfavorable judicial decisions could negate these limitation of liability provisions. We have not experienced any product liability claims to date. However, a product liability claim brought
against us, even if unsuccessful, could be time consuming and costly to defend and could harm our reputation.



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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



We develop our products in the United States and market them in North America, South America, Europe and the Asia/Pacific markets. As a result, our future
financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. As the majority of our sales are currently made in U.S. dollars, a strengthening of the dollar could
make our products less competitive in foreign markets.



From
our inception through June 30, 2004, we have derived approximately $71.1 million of revenue from customers outside the United States, and our international revenue was $29.5 million for the year ended December 31, 2003, an increase of $14.0 million
over international revenue of $15.5 million for 2002. Our international revenue was $14.9 million for the three months ended June 30, 2004, an increase of $10.4 million over international revenue of $4.5 million for the three months ended June 30,
2003. We intend to continue to further expand our European and Asia/Pacific operations in the near term. To the extent our foreign operations expenses increase or to the extent we begin to denominate more foreign sales in local currencies, we will
become subject to foreign currency fluctuations. We do not currently anticipate using hedging activities to offset these fluctuations.



Our interest income is sensitive to changes in the general level of U.S. interest rates, particularly since the majority of our investments are in
short-term instruments. Due to the short-term nature of our investments, we believe that there is no material interest rate risk exposure.



As of June 30, 2004, our outstanding debt was $6.1 million, of which $5.0 million was long-term. Our interest expense related to long-term debt is
sensitive to changes in the prime interest rate. However, we do not believe that a 10% change in the prime rate would have a significant impact on our interest expense.



ITEM 4. CONTROLS AND PROCEDURES



In accordance with Rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934 (the Exchange Act), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures were effective as of June 30, 2004 to provide reasonable assurance that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and forms.



There has been no change in our internal controls over financial reporting that occurred during the three months ended June 30, 2004 that has materially
affected, or is reasonably likely to materially affect, our internal controls over financial reporting.



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PART II:



ITEM 1. LEGAL PROCEEDINGS



From time to time, we
may be involved in litigation relating to claims arising out of our ordinary course of business. We are not currently a party to any material legal proceedings.



ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES



(a) Not applicable

(b) Not applicable

(c) Not applicable

(d) The
Securities and Exchange Commission declared our first registration statement effective on June 24, 2004, which we filed on Form S-1 (Registration No. 333-111030) under the Securities Act of 1933 in connection with the initial public offering of our
common stock. An aggregate of 5,750,000 shares were registered under this registration statement, including 750,000 shares subject to the underwriters over-allotment option. The managing underwriters of the offering were J.P. Morgan
Securities, Inc., acting as sole book-runner and co-lead manager, Thomas Weisel Partners LLC, acting as co-lead manager, and Friedman, Billings, Ramsey & Co., Inc., Needham & Company, Inc. and Americas Growth Capital, LLC acting as
co-managers.



On June 30, 2004, we completed our initial public
offering in which we sold 5,000,000 shares of our common stock at $10 per share, for an aggregate public offering price of $50 million. We applied the gross proceeds as follows:



|                                            |  |   |      |  |        
|------------------------------------------- |  | - | ---- |  | -------
|Gross Proceeds                              |  | $ | 50.0 |  | million
|Use of Proceeds:                            |  |   |      |  |        
|Underwriting discount and commissions       |  |   | 3.5  |  | million
|Related costs and expenses                  |  |   | 2.4  |  | million
|Payment of subordinated debt:               |  |   |      |  |        
|Austin Ventures VII, L.P.                   |  |   | 11.8 |  | million
|Piper Jaffrey Technology Capital SBIC, L.P. |  |   | 0.2  |  | million
|Eric L. Jones and Joye A. Jones             |  |   | 0.3  |  | million
|Joye A. Jones                               |  |   | 0.2  |  | million
|                                            |  |   |      |  |        
|Total Use of Proceeds                       |  |   | 18.4 |  | million
|                                            |  |   |      |  |        
|Net Proceeds                                |  | $ | 31.6 |  | million
|                                            |  |   |      |  |        



We retained
approximately $31.6 million of the offering proceeds for working capital and general corporate purposes.



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(e) The following table provides information with respect to any purchase made by or on behalf of the
Company or any affiliated purchase of shares of the Companys common stock during the quarter ended June 30, 2004:



ISSUER PURCHASES OF EQUITY SECURITIES



|           |  |                                |     |  |                             |        |                                                                               |     |                                                                                                          |    
|---------- |  | ------------------------------ | --- |  | --------------------------- | ------ | ----------------------------------------------------------------------------- | --- | -------------------------------------------------------------------------------------------------------- | ---
|Period     |  | Total Numberof SharesPurchased |     |  | Average PricePaid per Share |        | Total Number ofShares Purchased asPart of PubliclyAnnounced Plans
or Programs |     | Maximum Number (orApproximate Dollar Value)of Shares that May Yet BePurchased under the Plansor Programs
|April 2004 |  | 1,320                          | (1) |  | $                           | 4.8823 |                                                                               | N/A |                                                                                                          | N/A
|May 2004   |  | 340                            | (1) |  | $                           | 6.5092 |                                                                               | N/A |                                                                                                          | N/A
|June 2004  |  | 15                             | (1) |  | $                           | 6.5092 |                                                                               | N/A |                                                                                                          | N/A

---

|(1) | Options issued to employees are subject to a time-based vesting schedule. Options could be exercised prior to vesting but were subject to repurchase by the Company upon termination
of employment at a price per share equal to the original exercise price.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



ITEM 3. DEFAULTS UPON SENIOR SECURITIES



Not
applicable.



ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS



In April 2004, holders of over two-third of our then-outstanding preferred stock executed a written consent pursuant to which each share of our then-outstanding preferred stock would automatically convert into the
number of shares of common stock into which such shares were convertible at the then-effective conversion ratio upon the closing of a public offering of our common stock occurring no later than June 30, 2004, and involving an offering price of at
least $9.00 per share (appropriately adjusted for any stock split, dividend, combination or other recapitalization) and $25,000,000 in the aggregate. Upon the consummation of our initial public offering, all such shares of outstanding preferred
stock converted into shares of common stock on a one-for-one basis.



ITEM 5. OTHER INFORMATION



Not applicable.



ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



|(a) | Exhibits.
|--- | ---------



|      |  |                                                                                                                                                                                                 
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1.1 |  | Amended and Restated Certificate of Incorporation.                                                                                                                                              
|      | 
|3.2.2 |  | Amended and Restated Bylaws                                                                                                                                                                     
|      | 
|4.1*  |  | Specimen certificate for shares of common stock, filed with Amendment No. 3 to Registration Statement on Form S-1 (File No. 333-111030) dated May 14, 2004 and incorporated herein by
reference.
|      | 
|31.1  |  | Certificate of the Chief Executive Officer pursuant to Rules 13a-14 and 15d-14 promulgated under the Securities Exchange Act of 1934, as amended.                                               
|      | 
|31.2  |  | Certificate of the Chief Financial Officer pursuant to Rules 13a-14 and 15d-14 promulgated under the Securities Exchange Act of 1934, as amended.                                               
|      | 
|32.1  |  | Certificate of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. § 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).                                            

---

|* | Incorporated by reference, as indicated.
|- | ----------------------------------------



|(b) | Reports on Form 8-K:
|--- | --------------------



None.



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SIGNATURE



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.



MOTIVE, INC./s/ Scott L. HarmonScott L. Harmon President and Chief Executive OfficerDate: August 2, 2004/s/ Paul M. BakerPaul M. BakerChief Financial OfficerDate: August 2, 2004




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