**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

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**FORM 10-Q**

**(Mark One)**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe Quarterly Period Ended September 30, 2005**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transition period from                 to                 **

**CommissionFile Number 000-22209**

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**PEREGRINE SYSTEMS, INC.**

(Exact name of Registrantas specified in its charter)

| **DELAWARE**                                                     | **95-3773312**                     |
|------------------------------------------------------------------|------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) | (IRS Employer  Identification No.) |

 

**3611 VALLEY CENTRE DRIVE,SAN DIEGO, CALIFORNIA 92130**

(Address of principalexecutive offices including zip code)

**(858) 481-5000**

(Registrant’s telephonenumber, including area code)

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Indicate by check markwhether the Registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes x  No o

Indicate by check markwhether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes x  No o

Indicate by check markwhether the Registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes o  No x

Indicate by check markwhether the Registrant has filed all documents and reports required to be filedby Section 12, 13 or 15(d) of the Securities Exchange Act of 1934subsequent to the distribution of securities under a plan confirmed by acourt. Yes x  No o

The number of shares ofthe Registrant’s common stock outstanding on September 30, 2005 was ***15,570,503.***

 

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**PEREGRINE SYSTEMS, INC.**

**QUARTERLY REPORT ON FORM 10-Q**

**TABLE OF CONTENTS**
| PART I—FINANCIAL  INFORMATION |                                                                                        |
|-----------------------------------------|---------------------------------------------------------------------------------------------|
| ITEM  1.                                | UNAUDITED  FINANCIAL STATEMENTS                                                             | 3 |
| ITEM  2.                                | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 15 |
| ITEM  3.                                | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                 | 27 |
| ITEM  4.                                | CONTROLS  AND PROCEDURES                                                                    | 27 |
| PART II—OTHER INFORMATION     |                                                                                        |
| ITEM 1.                                 | LEGAL  PROCEEDINGS                                                                          | 28 |
| ITEM  2.                                | UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                           | 32 |
| ITEM  3.                                | DEFAULTS  UPON SENIOR SECURITIES                                                            | 32 |
| ITEM  4.                                | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                        | 32 |
| ITEM 5.                                 | OTHER  INFORMATION                                                                          | 32 |
| ITEM 6.                                 | EXHIBITS                                                                                    | 32 |
| SIGNATURES                              | 33                                                                                          |

 

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**PART I—FINANCIAL INFORMATION**

**ITEM 1.**                UNAUDITEDFINANCIAL STATEMENTS

**PEREGRINE SYSTEMS, INC.**

**CondensedConsolidated Balance Sheets**

**(Inthousands, except share and par value amounts)**

| ** **                                                                                                                                                   | ** ** | **September 30, 2005** | ** ** | **March 31, 2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                                   | ** ** | **(Unaudited)**                  | ** ** | ** **                   | ** ** |
| **ASSETS**                                                                                                                                                   |       |                             |       |                         |       |   |   |   |   |
| Current Assets:                                                                                                                                              |       |                             |       |                         |       |   |   |   |   |
| Cash and cash  equivalents                                                                                                                                   |       |                             | $          | 54,914                       |       |   |   | $ | 84,765 |   |   |
| Cash—restricted                                                                                                                                         |       |                             | 4,912      |                         |       |   | 4,325 |   |   |
| Accounts receivable, net  of allowance for doubtful accounts                                                                                                 |       |                             | 27,716     |                         |       |   | 35,407 |   |   |
| Deferred taxes                                                                                                                                               |       |                             | 4,151      |                         |       |   | 4,620 |   |   |
| Other current assets                                                                                                                                         |       |                             | 7,652      |                         |       |   | 8,887 |   |   |
| Total current assets                                                                                                                                         |       |                             | 99,345     |                         |       |   | 138,004 |   |   |
| Property and equipment,  net                                                                                                                                 |       |                             | 9,768      |                         |       |   | 8,422 |   |   |
| Identifiable intangible  assets, net                                                                                                                         |       |                             | 74,853     |                         |       |   | 86,942 |   |   |
| Goodwill                                                                                                                                                     |       |                             | 182,694    |                         |       |   | 184,835 |   |   |
| Other assets                                                                                                                                                 |       |                             | 2,021      |                         |       |   | 2,113 |   |   |
| Total assets                                                                                                                                                 |       |                             | $          | 368,681                      |       |   |   | $ | 420,316 |   |   |
| **LIABILITIES & STOCKHOLDERS’ EQUITY**                                                                                                         |       |                             |       |                         |       |   |   |   |   |
| Current Liabilities:                                                                                                                                         |       |                             |       |                         |       |   |   |   |   |
| Accounts payable                                                                                                                                             |       |                             | $          | 4,285                        |       |   |   | $ | 4,106 |   |   |
| Accrued expenses                                                                                                                                             |       |                             | 64,010     |                         |       |   | 69,642 |   |   |
| Current portion of  deferred revenue                                                                                                                         |       |                             | 48,268     |                         |       |   | 66,086 |   |   |
| Current portion of notes  payable                                                                                                                            |       |                             | 17,909     |                         |       |   | 17,811 |   |   |
| Total current  liabilities                                                                                                                                   |       |                             | 134,472    |                         |       |   | 157,645 |   |   |
| Non-current Liabilities:                                                                                                                                     |       |                             |       |                         |       |   |   |   |   |
| Deferred revenue, net of  current portion                                                                                                                    |       |                             | 3,425      |                         |       |   | 5,906 |   |   |
| Notes payable, net of  current portion                                                                                                                       |       |                             | 18,177     |                         |       |   | 29,007 |   |   |
| Deferred taxes                                                                                                                                               |       |                             | 5,161      |                         |       |   | 4,923 |   |   |
| Total non-current  liabilities                                                                                                                               |       |                             | 26,763     |                         |       |   | 39,836 |   |   |
| Commitments and Contingencies—Note 6                                                                                                               |       |                             |       |                         |       |   |   |   |   |
| Stockholders’ Equity                                                                                                                                    |       |                             |       |                         |       |   |   |   |   |
| Preferred stock, $0.0001  par value, 5.0 million shares authorized, no shares issued or  outstanding                                                    |       |                             | —     |                         |       |   | — |   |   |
| Common stock, $0.0001  par value, 100.0 million shares authorized, 15.1 million and  15.0 million shares issued and outstanding, respectively |       |                             | 2          |                         |       |   | 2 |   |   |
| Additional paid-in  capital                                                                                                                                  |       |                             | 280,548    |                         |       |   | 271,114 |   |   |
| Accumulated deficit                                                                                                                                          |       |                             | (61,366    | )                            |       |   | (43,268 | ) |   |
| Unearned compensation                                                                                                                                        |       |                             | (8,591     | )                            |       |   | — |   |   |
| Accumulated other  comprehensive loss                                                                                                                        |       |                             | (3,147     | )                            |       |   | (5,013 | ) |   |
| Total stockholders’  equity                                                                                                                             |       |                             | 207,446    |                         |       |   | 222,835 |   |   |
| Total liabilities and stockholders’ equity                                                                                                              |       |                             | $          | 368,681                      |       |   |   | $ | 420,316 |   |   |

 

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

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**PEREGRINE SYSTEMS, INC.Condensed ConsolidatedStatements of Operations(In thousands, except per share amounts; Unaudited)**

| ** **                                                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Six Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                           | ** ** | **2005**                                             | ** ** | **2004**                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Revenue:**                                                         |       |                                                 |       |                                               |       |   |   |   |   |
| Licenses                                                             |       | $                                                    | 12,593     |                                               | $          | 15,623 |   | $ | 26,090 |   | $ | 26,768 |   |
| Maintenance                                                          |       | 26,145                                               |       | 28,315                                             |       | 52,415 |   | 53,552 |   |
| Consulting and training                                              |       | 5,626                                                |       | 3,996                                              |       | 10,445 |   | 7,788 |   |
| **Total revenue**                                                    |       | 44,364                                               |       | 47,934                                             |       | 88,950 |   | 88,108 |   |
| **Operating  costs and expenses(1):**                                |       |                                                 |       |                                               |       |   |   |   |   |
| Cost of licenses(2)                                                  |       | 2,870                                                |       | 2,774                                              |       | 5,626 |   | 5,628 |   |
| Cost of maintenance                                                  |       | 4,413                                                |       | 4,434                                              |       | 9,088 |   | 8,978 |   |
| Cost of consulting and training                                      |       | 5,618                                                |       | 4,410                                              |       | 10,776 |   | 8,295 |   |
| Sales and marketing                                                  |       | 16,045                                               |       | 15,583                                             |       | 34,521 |   | 31,857 |   |
| Research and development                                             |       | 8,045                                                |       | 6,824                                              |       | 16,514 |   | 14,332 |   |
| General and administrative                                           |       | 10,593                                               |       | 12,192                                             |       | 22,135 |   | 25,011 |   |
| Amortization of intangible assets                                    |       | 3,335                                                |       | 3,332                                              |       | 6,683 |   | 6,708 |   |
| Restructuring, impairments and other                                 |       | —                                               |       | —                                             |       | (198 | ) | — |   |
| **Total operating costs and expenses**                               |       | 50,919                                               |       | 49,549                                             |       | 105,145 |   | 100,809 |   |
| **Operating loss**                                                   |       | (6,555                                               | )          | (1,615                                             | )          | (16,195 | ) | (12,701 | ) |
| Foreign currency transaction gains (losses), net                     |       | (480                                                 | )          | 73                                                 |       | (1,545 | ) | (996 | ) |
| Reorganization items, net                                            |       | (148                                                 | )          | (335                                               | )          | (381 | ) | (1,146 | ) |
| Interest income                                                      |       | 450                                                  |       | 333                                                |       | 1,145 |   | 582 |   |
| Interest expense                                                     |       | (721                                                 | )          | (1,041                                             | )          | (1,541 | ) | (2,257 | ) |
| Other income                                                         |       | 81                                                   |       | —                                             |       | 1,736 |   | — |   |
| **Loss before income taxes**                                         |       | (7,373                                               | )          | (2,585                                             | )          | (16,781 | ) | (16,518 | ) |
| Income tax expense                                                   |       | (966                                                 | )          | (1,093                                             | )          | (1,317 | ) | (2,372 | ) |
| **Net loss**                                                         |       | $                                                    | (8,339     | )                                                  | $          | (3,678 | ) | $ | (18,098 | ) | $ | (18,890 | ) |
| **Net  loss per share, basic and diluted:**                          |       |                                                 |       |                                               |       |   |   |   |   |
| Net loss per share                                                   |       | $                                                    | (0.55      | )                                                  | $          | (0.24 | ) | $ | (1.20 | ) | $ | (1.26 | ) |
| Weighted-average  shares used in computation, basic and diluted |       | 15,077                                               |       | 15,052                                             |       | 15,076 |   | 15,037 |   |

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(1)          See Note 9 for detailsabout stock compensation expense included in operating costs and expenses.

(2)          Includes amortizationexpense related to developed technology of $2,452 and $2,451 for the threemonths ended September 30, 2005 and 2004, respectively, and $4,904 and$4,906 for the six months ended September 30, 2005 and 2004, respectively.

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

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**PEREGRINE SYSTEMS, INC.Condensed ConsolidatedStatements of Cash Flows(In thousands; Unaudited)**

| ** **                                                                    | ** ** | **Six Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                    | ** ** | **2005**                                           | ** ** | **2004** | ** ** |
| **Cash flow from operating  activities:**                                     |       |                                               |       |   |   |
| Net loss                                                                      |       | $                                                  | (18,098    | ) | $ | (18,890 | ) |
| Adjustments to reconcile  net loss to net cash used in operating activities:  |       |                                               |       |   |   |
| Amortization and depreciation                                                 |       | 13,317                                             |       | 14,024 |   |
| Stock compensation expense                                                    |       | 552                                                |       | 783 |   |
| Non-cash reorganization items                                                 |       | —                                             |       | (149 | ) |
| Foreign currency transaction losses, net                                      |       | 1,545                                              |       | 996 |   |
| Gain on recovery of previously paid financing fees                            |       | (490                                               | )          | — |   |
| Gain on sale of investment                                                    |       | (198                                               | )          | — |   |
| Cash used to pay imputed interest on long-term debt  and factored receivables |       | (701                                               | )          | (977 | ) |
| Increase (decrease) in  cash resulting from changes in:                       |       |                                               |       |   |   |
| Accounts receivable                                                           |       | 6,547                                              |       | 5,874 |   |
| Other assets                                                                  |       | 1,211                                              |       | 3,336 |   |
| Accounts payable                                                              |       | 282                                                |       | (3,154 | ) |
| Accrued expenses                                                              |       | (1,590                                             | )          | 2,595 |   |
| Deferred revenue                                                              |       | (18,284                                            | )          | (14,096 | ) |
| **Net cash used in operating activities**                                     |       | (15,907                                            | )          | (9,658 | ) |
| **Cash  flow from investing activities:**                                     |       |                                               |       |   |   |
| Purchases of property and equipment                                           |       | (2,833                                             | )          | (1,838 | ) |
| Proceeds from sale of property and equipment                                  |       | —                                             |       | 309 |   |
| Change in restricted cash                                                     |       | (635                                               | )          | (23 | ) |
| Purchase of marketable securities                                             |       | —                                             |       | (20,000 | ) |
| Proceeds from sale of investment                                              |       | 198                                                |       | — |   |
| Proceeds from sale of marketable securities                                   |       | —                                             |       | 12,000 |   |
| **Net cash used in investing activities**                                     |       | (3,270                                             | )          | (9,552 | ) |
| **Cash  flow from financing activities:**                                     |       |                                               |       |   |   |
| Gain on recovery of previously paid financing fees                            |       | 490                                                |       | — |   |
| Repayments of factored receivables                                            |       | —                                             |       | (3,076 | ) |
| Repayment of long-term debt                                                   |       | (10,336                                            | )          | (10,182 | ) |
| Issuance of common stock, employee plans                                      |       | 291                                                |       | 134 |   |
| **Net cash used in financing activities**                                     |       | (9,555                                             | )          | (13,124 | ) |
| **Effect of exchange rate fluctuations on cash**                              |       | (1,119                                             | )          | (92 | ) |
| **Net  decrease in cash and cash equivalents**                                |       | (29,851                                            | )          | (32,426 | ) |
| **Cash  and cash equivalents, beginning of period**                           |       | 84,765                                             |       | 105,946 |   |
| **Cash and cash equivalents, end  of period**                                 |       | $                                                  | 54,914     |   | $ | 73,520 |   |

 

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

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**PEREGRINE SYSTEMS, INC.NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

**1.   Company**

*Business*

Peregrine Systems, Inc. (the “Company” or “Peregrine”)is a global provider of enterprise software. Peregrine’s core business isproviding information technology asset and service management softwaresolutions.

Peregrine’s core softwareproduct suites are AssetCenter® and ServiceCenter®. AssetCenter andServiceCenter support two main business processes: asset management and servicemanagement. Typically, the assets managed with Peregrine’s products consist ofinformation technology assets, such as computer and computer-networkinghardware and software items, and other assets used to provide infrastructure toa business. The services managed with Peregrine’s products usually consist ofthe service delivery and support processes necessary to troubleshoot, supportand maintain those same information technology and infrastructure assets. Inaddition, the Company offers products in its Configuration Services suite whichprovides a consolidated accurate view of all IT assets and allows customers toautomatically discover, inventory, and better utilize all hardware, software,and network devices.

**2.   Merger Agreement**

On September 19,2005, the Company entered into an Agreement and Plan of Merger (the “MergerAgreement”) with Hewlett-Packard Company (“HP”). Pursuant to the terms of theMerger Agreement, at the effective time of the merger, each share of theCompany’s common stock issued and outstanding immediately prior to theeffective time of the merger will be converted into the right to receive cashin the amount of $26.08. The aggregate purchase price approximates$425 million. Consummation of the merger is subject to customary closingconditions, including (i) approval of the Merger Agreement by thestockholders of the Company, (ii) absence of any law or order prohibitingthe consummation of the merger, (iii) expiration or termination of theapplicable Hart-Scott-Rodino Antitrust Improvements Act of 1976 waiting periodand receipt of certain foreign antitrust approvals, and (iv) the accuracyof the representations and warranties of the parties to the Merger Agreement.The Merger Agreement may be terminated by either the Company or HP undercertain circumstances, and it further provides that, upon termination of theMerger Agreement under certain circumstances, the Company will be required topay HP a customary termination fee in the amount of $11.7 million.

**3.   Summaryof Significant Accounting Policies**

*Basis ofPresentation*

The accompanying unaudited condensed consolidatedfinancial statements as of September 30, 2005 and for the three and sixmonths ended September 30, 2005 and 2004 have been prepared in accordancewith the instructions to Form 10-Q and Article 10 ofRegulation S-X, and therefore do not necessarily include all informationand footnotes necessary for a fair statement of the Company’s consolidatedfinancial position, results of operations and cash flows in accordance withaccounting principles generally accepted in the United States.

In the opinion of theCompany’s management, the unaudited financial information for the interimperiods presented reflects all normal recurring adjustments that the Companyconsiders necessary to give a fair statement. These condensed consolidatedfinancial statements should be read in conjunction with the consolidatedfinancial statements included in the Company’s Annual Report on Form 10-Kfor the fiscal 

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yearended March 31, 2005 filed with the Securities and Exchange Commission (“SEC”)on July 1, 2005 (together with the Company’s Amendment No. 1 to theAnnual Report on Form 10-K/A for the fiscal year ended March 31,2005 filed with the SEC on October 18, 2005, the “Amended Form 10-K”).Operating results for interim periods are not necessarily indicative ofoperating results for an entire fiscal year.

*Computation of NetLoss Per Share*

Computation of net lossper share is performed in accordance with the provisions of Statement ofFinancial Accounting Standards No. 128, “Earnings per Share” (“SFAS 128”).SFAS 128 requires the Company to compute basic and diluted net income(loss) per share data for all periods for which an income statement ispresented. Basic net income (loss) per share is computed by dividing net income(loss) by the weighted average number of common shares outstanding during theperiod. Potentially dilutive securities represent incremental shares issuableupon exercise of options to purchase the Company’s common stock determinedunder the treasury stock method. During the three months ended September 30,2005 and 2004, options to purchase 0.8 million and 0.5 million sharesof common stock, respectively, were outstanding but were excluded from thecomputation of net loss per share because their inclusion would have beenanti-dilutive. During the six months ended September 30, 2005 and 2004,options to purchase 0.5 million and 0.4 million shares of commonstock, respectively, were outstanding but were excluded from the computation ofnet loss per share because their inclusion would have been anti-dilutive.

*Stock-BasedCompensation*

The Company applies the intrinsic value-basedmethod of accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25,“Accounting for Stock Issued to Employees,” (“APB 25”), and relatedinterpretations, including Financial Accounting Standards Board (“FASB”)Interpretation No. 44, “Accounting for Certain Transactions InvolvingStock Compensation: An Interpretation of APB Opinion No. 25” (“FIN 44”) toaccount for its fixed stock option plans. Under this method, deferredcompensation is recorded on the date of grant only if the current market priceof the underlying stock exceeds the exercise price. Statement of FinancialAccounting Standards No. 123, “Accounting for Stock-BasedCompensation” (“SFAS 123”), established accounting and disclosurerequirements using a fair-value based method of accounting for stock-basedemployee compensation plans. As allowed by SFAS 123, the Company haselected to continue to apply the intrinsic value-based method ofaccounting described above, and has adopted the disclosure requirements ofStatement of Accounting Standards No. 148, “Accounting for Stock-BasedCompensation—Transition and Disclosure, an amendment of FASB Statement No. 123”(“SFAS 148”).

On December 16, 2004, the FASB issued Statementof Financial Accounting Standards No. 123R, “Share-Based Payment,” (“SFAS 123R”)requiring that the compensation cost relating to share-based paymenttransactions be measured and recognized in financial statements using the fairvalue of the awards. This statement eliminates the use of APB 25’s intrinsicvalue method of accounting as provided in SFAS 123. Under APB 25, issuingstock options to employees generally resulted in no recognition of compensationcost. SFAS 123R requires entities to recognize the cost of employeeservices received in exchange for awards of equity instruments based on thegrant date fair value of those awards (with limited exceptions). SFAS 123Rcovers a wide range of share-based compensation arrangements includingshare options, restricted share plans, performance based awards and employeeshare purchase plans. SFAS 123R replaces SFAS 123 and supersedes APB25. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”)regarding the SEC’s interpretation of SFAS 123R and the valuation of share-basedpayments for public companies. In April 2005, the SEC amendedRegulation S-X to delay the date for compliance with SFAS 123R to thefirst interim or annual reporting period of a registrant’s first fiscal yearbeginning after September 15, 2005. As a result, the Company is requiredto adopt SFAS 123R on 

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April 1, 2006.The Company is currently assessing the impact of SFAS 123R on itscompensation strategies and financial statements and determining whichtransition alternative it will elect. The Company believes the adoption ofSFAS 123R will have a material effect on its operating results if currentcompensation strategies continue.

TheCompany used the following assumptions to value stock option awards grantedduring the three and six months ended September 30, 2005 and 2004,respectively:

| ** **                | ** ** | **Three Months Ended  September 30,** | ** ** | **Six Months Ended  September 30,** | ** ** |
|---------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                | ** ** | **  2005  **                     | ** ** | **  2004  **                   | ** ** | **  2005  ** | ** ** | **  2004  ** | ** ** |
| Risk-free  interest rate  |       |                                                 | 3.81       | %                                                  |       |   | 3.26 | % |   |   | 3.81 | % |   |   | 3.18 | % |   |
| Expected life (in  years) |       |                                                 | 4.7        |                                               |       |   | 3.0 |   |   |   | 4.7 |   |   |   | 3.0 |   |   |
| Expected  volatility      |       |                                                 | 67         | %                                                  |       |   | 77 | % |   |   | 67 | % |   |   | 77 | % |   |
| Expected dividend yield   |       |                                                 | None       |                                               |       |   | None |   |   |   | None |   |   |   | None |   |   |

 

Thefollowing tables illustrate the effect on net loss and net loss per share hadthe Company applied the fair value recognition provisions of SFAS 123 tostock-based employee compensation (in thousands, except per share data):

| ** **                                                                                                                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Six Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                                                                | ** ** | **2005**                                             | ** ** | **2004**                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss, as  reported                                                                                                                    |       | $                                                    | (8,339     | )                                                  | $          | (3,678 | ) | $ | (18,098 | ) | $ | (18,890 | ) |
| Add: Stock-based  employee compensation expense included in reported net loss, net of  related tax effects                           |       | 552                                                  |       | 92                                                 |       | 552 |   | 783 |   |
| Deduct: Stock-based  employee compensation expense determined under a fair-value based  method for all awards, net of related tax effects |       | (1,889                                               | )          | (831                                               | )          | (3,081 | ) | (2,490 | ) |
| Pro forma net  loss                                                                                                                       |       | $                                                    | (9,676     | )                                                  | $          | (4,417 | ) | $ | (20,627 | ) | $ | (20,597 | ) |
| Net loss per share:                                                                                                                       |       |                                                 |       |                                               |       |   |   |   |   |
| Basic and diluted—as reported                                                                                                        |       | $                                                    | (0.55      | )                                                  | $          | (0.24 | ) | $ | (1.20 | ) | $ | (1.26 | ) |
| Basic and  diluted—pro forma                                                                                                         |       | $                                                    | (0.64      | )                                                  | $          | (0.29 | ) | $ | (1.37 | ) | $ | (1.37 | ) |

 

*Comprehensive Loss*

Othercomprehensive loss is defined as the change in equity of a business enterpriseduring a period from transactions and other events and circumstances fromnon-owner sources. The foreign currency translation adjustment is the only itemgiving rise to accumulated other comprehensive loss for the periods presented.Comprehensive loss consists of the following (in thousands):

| ** **                                        | ** ** | **Three Months Ended  September 30,** | ** ** | **Six Months Ended  September 30,** | ** ** |
|---------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                        | ** ** | **2005**                                             | ** ** | **2004**                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss, as  reported                            |       | $                                                    | (8,339     | )                                                  | $          | (3,678 | ) | $ | (18,098 | ) | $ | (18,890 | ) |
| Foreign currency  translation—current period |       | 617                                                  |       | (665                                               | )          | 3,212 |   | (1,600 | ) |
| Foreign currency  translation—prior periods  |       | —                                               |       | —                                             |       | — |   | 1,897 |   |
| Comprehensive loss                                |       | $                                                    | (7,722     | )                                                  | $          | (4,343 | ) | $ | (14,886 | ) | $ | (18,593 | ) |

 

For the three months ended September 30, 2005,the foreign currency translation gain of $0.6 million includes an increaseof $0.6 million in goodwill and an insignificant impact on identifiableintangible assets relating to the translation of such assets whose functionalcurrency is not the U.S. dollar. For the three 

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months ended September 30,2004, the foreign currency translation loss of $0.7 million includes increasesof $0.3 million and $0.2 million in goodwill and identifiable intangibleassets, respectively, relating to the translation of such assets whosefunctional currency is not the U.S. dollar.

For the six months ended September 30, 2005, theforeign currency translation gain of $3.2 million includes decreases of$0.3 million and $0.5 million in goodwill and identifiable intangibleassets, respectively, relating to the translation of such assets whosefunctional currency is not the U.S. dollar. For the six months ended September 30,2004, the foreign currency translation loss of $1.6 million includes increasesof $0.1 million each in goodwill and identifiable intangible assets relating tothe translation of such assets whose functional currency is not the U.S.dollar.

During the preparation ofthe financial statements for the three months ended June 30, 2004, theCompany noted that goodwill and identifiable intangibles attributable toforeign entities but recorded at the parent company level were not remeasuredin the functional currencies of the entities to which they relate for periodssubsequent to the Company’s adoption of fresh-start reporting on July 18,2003 in connection with its emergence from bankruptcy proceedings.Comprehensive loss for the six months ended September 30, 2004 includes$1.9 million which represents the cumulative effect of changes in foreigncurrency exchange rates on remeasuring goodwill and identifiable intangibleassets from the functional currencies of the entities to which they relate tothe reporting currency of the U.S. dollar from July 18, 2003 through March 31,2004. The $1.9 million increase includes goodwill and intangible assetsincreases of $1.1 million and $0.8 million, respectively. The Companybelieves the effect of the adjustments to comprehensive loss for the six monthsended September 30, 2004 is not material.

*Reclassifications*

Certain amounts that werepreviously reported have been reclassified to conform to the currentpresentation. Amounts reclassified include amortization expense related todeveloped technology resulting in an increase in cost of licenses and adecrease in amortization expense of $2.5 million and $4.9 million for the threeand six months ended September 30, 2004, respectively.

**4.   Income Taxes**

The liability method is used in accounting for incometaxes. Deferred tax assets and liabilities are determined based on differencesbetween the financial reporting and tax basis of assets and liabilities.

The effective tax rates for the three and six monthsended September 30, 2005 were approximately 13.1% and 7.8%, respectively.The Company’s income tax expense for the three and six months ended September 30,2005 relates primarily to interest accrued on certain tax contingencies andtaxes on foreign operations for which no U.S. federal benefit can be recorded.During the three and six months ended September 30, 2005 the Company didnot recognize any benefit from federal or state income tax losses, becausefuture benefit from such losses was not more likely than not expected to berealized. If tax benefits for losses incurred subsequent to the adoption of fresh-startreporting are realized in future periods, the benefit will be recorded as areduction of tax expense.

The Company is required, as part of the process ofpreparing its unaudited condensed consolidated financial statements, toestimate income taxes in each of the jurisdictions in which it operates. Thisprocess involves estimating the current tax liability together with assessingtiming differences resulting from differing treatments of items for tax andfinancial reporting purposes. These differences result in deferred tax assetsand liabilities. The Company must then assess the likelihood that its deferredtax assets will be recovered from future taxable income. To the extent that theCompany believes that recovery is not likely, it must establish a valuationallowance. Significant management judgment is required in determining theprovision for income taxes, deferred tax assets and liabilities and anyvaluation allowance recorded against net deferred tax assets. The Company hasrecorded a valuation allowance on substantially all of its net 

9

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deferred tax assetbalances as of September 30, 2005 and March 31, 2005 because ofuncertainties related to utilization of deferred tax assets, primarily relatedto net operating loss carryforwards, before they expire. At such time, if any,as it is determined that it is more likely than not that the deferred taxassets are realizable, the valuation allowance will be reduced.

The Company is reviewing the potential impact of theone-time favorable foreign dividend provisions enacted on October 22, 2004as part of the American Jobs Creation Act of 2004 (the “Jobs Act”). The JobsAct creates a temporary incentive for U.S. corporations to repatriate earningsof foreign subsidiaries by providing an elective 85% dividends receiveddeduction for certain dividends paid during a specified period; for theCompany, this would be applicable to fiscal year 2006. The deduction is subjectto numerous limitations and requirements, including the adoption of a specificdomestic reinvestment plan for the repatriated funds. The Company has not yetdetermined whether it will repatriate future earnings of some of its foreignsubsidiaries under the Jobs Act but will decide during fiscal year 2006.Unremitted earnings on which no deferred taxes have been provided amounted toapproximately $37.3 million at March 31, 2005.

Because of its size and the nature of its business,the Company is subject to routine tax compliance reviews by the InternalRevenue Service and other taxing authorities, including challenges to variouspositions the Company asserts. The Company has accrued for tax contingenciesbased upon its best estimate of the taxes ultimately expected to be paid andupdates these accruals over time as more information becomes available. Asignificant portion of the Company’s taxes payable balance comprisesliabilities for tax contingencies that have been recorded to address taxexposures. The Company is currently undergoing several examinations by taxingauthorities in various jurisdictions. While the Company believes it hasestablished appropriate reserves for tax contingencies, the taxing authoritiesmay assert that the Company owes taxes in excess of the reserves it hasestablished.

Due to the adoption of fresh-start reporting,any adjustments to the Company’s tax assets or liabilities that existed priorto the adoption of fresh-start reporting are recorded as adjustments togoodwill. For the six months ended September 30, 2005, the Companyrecorded a net decrease to goodwill totaling approximately $1.3 millionfor adjustments to the Company’s tax assets and liabilities that existed priorto the adoption of fresh-start reporting.

The reorganization of theCompany upon emergence from bankruptcy proceedings caused an ownership changeunder Section 382 of the Internal Revenue Code. Such ownership changeresulted in significant limitations being placed on the utilization of thePredecessor Company’s pre-change tax attributes, including net operating losscarry forwards, capital loss carry forwards, tax credits and certain built-inlosses and effectively eliminated a substantial portion of the PredecessorCompany’s total pre-change tax attributes. For the year ended March 31,2005 and forward, the Company is limited to utilizing approximately$4.7 million (tax effected) of such pre-change tax attributes annually tooffset any post-change income. References to the “Predecessor Company” hereinpertain to the fiscal periods prior to and including July 18, 2003. If theCompany were to undergo an ownership change in the future, it is possible thepost-change losses could be significantly limited.

**5.   Segmentand Geographic Information**

Operating segments are defined as components of anenterprise about which separate financial information is available andevaluated regularly by our chief operating decision maker in allocatingresources and assessing performance. The Company’s operating segments aremanaged separately because each segment represents a strategic business unit thatoffers different products or services.

Beginning in the second quarter of fiscal year 2006,the Company reorganized its management structure and changed its internalfinancial reporting. As a result, the Company changed its basis of 

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segmentation from tworeportable segments based on geography to three reportable segments based onproducts and services.

The Company’s three reportable operating segments areLicenses, Maintenance, and Consulting and Training. The Licenses segmentdevelops and markets licenses to use software products. The Maintenance segmentprovides after-sale support for software products. The Consulting and Trainingsegment provides fee-based consulting and training services related to softwareproducts.

The Company does not separately allocate operatingexpenses to these segments, nor does it allocate specific assets to thesesegments. Therefore, segment information reported includes only revenue, costof revenue, and gross profit.

Thefollowing table summarizes reportable segment data for the three and six monthsended September 30, 2005 and 2004, respectively (in thousands):

| ** **                       | ** ** | **Three Months Ended  September 30,** | ** ** | **Six Months Ended  September 30,** | ** ** |
|----------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                       | ** ** | **2005**                                             | ** ** | **2004**                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| License revenue                  |       | $                                                    | 12,593     |                                               | $          | 15,623 |   | $ | 26,090 |   | $ | 26,768 |   |
| Cost of licenses                 |       | 2,870                                                |       | 2,774                                              |       | 5,626 |   | 5,628 |   |
| Gross profit                     |       | $                                                    | 9,723      |                                               | $          | 12,849 |   | $ | 20,464 |   | $ | 21,140 |   |
| Maintenance revenue              |       | $                                                    | 26,145     |                                               | $          | 28,315 |   | $ | 52,415 |   | $ | 53,552 |   |
| Cost of  maintenance             |       | 4,413                                                |       | 4,434                                              |       | 9,088 |   | 8,978 |   |
| Gross profit                     |       | $                                                    | 21,732     |                                               | $          | 23,881 |   | $ | 43,327 |   | $ | 44,574 |   |
| Consulting and training revenue  |       | $                                                    | 5,626      |                                               | $          | 3,996 |   | $ | 10,445 |   | $ | 7,788 |   |
| Cost of  consulting and training |       | 5,618                                                |       | 4,410                                              |       | 10,776 |   | 8,295 |   |
| Gross profit                     |       | $                                                    | 8          |                                               | $          | (414 | ) | $ | (331 | ) | $ | (507 | ) |
| Total revenue                    |       | $                                                    | 44,364     |                                               | $          | 47,934 |   | $ | 88,950 |   | $ | 88,108 |   |
| Total cost of  revenue           |       | 12,901                                               |       | 11,618                                             |       | 25,490 |   | 22,901 |   |
| Gross profit                     |       | $                                                    | 31,463     |                                               | $          | 36,316 |   | $ | 63,460 |   | $ | 65,207 |   |

 

Thefollowing table summarizes revenue from the principal geographic areas in whichthe Company operates based on the location of the entity to which the productsor services were delivered (in thousands):

| ** **    | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------|------------|-----------------------------|------------|---------------------------|------------|
| ** **    | ** ** | **September 30,**      | ** ** | **September 30,**    | ** ** |
| ** **    | ** ** | **2005**                    | ** ** | **2004**                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue:      |       |                        |       |                      |       |   |   |   |   |
| United States |       | $                           | 20,244     |                      | $          | 26,475 |   | $ | 42,636 |   | $ | 47,790 |   |
| EMEA(3)       |       | 19,496                      |       | 18,194                    |       | 36,290 |   | 33,783 |   |
| Rest of world |       | 4,624                       |       | 3,265                     |       | 10,024 |   | 6,535 |   |
| Total revenue |       | $                           | 44,364     |                      | 47,934     |   | $ | 88,950 |   | $ | 88,108 |   |
|               |            |                             |            |                           |            |  |  |  |  |  |  |  |  |

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(3)          EMEAis comprised of Europe, the Middle East and Africa.

**6.   Commitments and Contingencies**

*Federal GovernmentInvestigations and Proceedings Relating to Historical Accounting Irregularities*

In early 2002, theDepartment of Justice (the “DOJ”) and the SEC opened investigations intoPeregrine relating to the accounting improprieties that took place prior to2002. In June 2003, the SEC 

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filed apartially-settled civil action against Peregrine in the United States DistrictCourt for the Southern District of California alleging violations of theSecurities Act of 1933, as amended (the “Securities Act”) and the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”) and the rules promulgatedthereunder. In the same month, the Company’s settlement with the SEC wasapproved by the District Court, resolving the civil complaint. The SECseparately withdrew a request for monetary damages and disgorgement in July 2003.Under the terms of the settlement, the Company agreed, among other things, tobe enjoined from violating the federal securities laws. Because the Company hasnot filed its SEC periodic reports on a timely basis, it has not been incompliance with the requirement of the settlement pertaining to refraining fromviolating federal securities laws. To the Company’s knowledge, the SEC is notconsidering a further enforcement action against it, and the Company is not atarget of any ongoing investigation, but it can not be sure that a furtherenforcement action or criminal proceeding will not be brought against it.Responding to any such actions could be expensive and time-consuming formanagement and could have an adverse effect on the Company’s reputation andability to generate sales.

*BankruptcyReorganization; Claims Litigation*

On September 22, 2002, the Company and its wholly-ownedsubsidiary, Peregrine Remedy, Inc., filed voluntary petitions underChapter 11 of the U.S. Bankruptcy Code. The plan of reorganization of theCompany (the “Reorganization Plan”) was confirmed by the U.S. Bankruptcy Courtin the District of Delaware (the “Bankruptcy Court”) on July 18, 2003, andit became effective on August 7, 2003. Unless otherwise indicated, allreferences to “old common stock” pertain to the Company’s common stock, parvalue $0.001 per share, that was cancelled on August 7, 2003 in connectionwith the Company’s emergence from Chapter 11 bankruptcy proceedings, andall references to “new common stock” pertain to the Company’s common stock, parvalue $0.0001 per share, from and after the effective date of theReorganization Plan. References to the “Predecessor Company” herein pertain tothe fiscal periods prior to and including July 18, 2003.

*Class 8General Unsecured Claims.**  *Approximately 1,200 general unsecured claims werefiled against the Company based on events that took place prior to thebankruptcy filing. The Company began paying claims on the effective date of theReorganization Plan and continues to pay based on settlement terms or as claimsare settled. Through September 30, 2005, in order to resolve these claims,the Company has paid or agreed to pay over time approximately$45.0 million in cash. As of September 30, 2005, there were generalunsecured claims asserted in the original aggregate face amount ofapproximately $0.3 million remaining to be resolved. Bankruptcy relatedclaims to be paid in cash over time at September 30, 2005 total $36.1 million. TheCompany believes amounts accrued at September 30, 2005 are sufficient toresolve the claims.

*Class 7/9Reserve Shares.**  *Underthe Company’s Reorganization Plan, 600,000 shares of new common stock (the “Class 7/9Reserve Shares”), representing 4% of the 15,000,000 shares of new common stockissued on the effective date of the Reorganization Plan, were held in reserveby Peregrine, in its capacity as stock disbursing agent under theReorganization Plan, to be allocated between Class 7 and Class 9under the Reorganization Plan. The allocation was to be based on whether theamount finally paid to resolve Class 8 general unsecured claims fallsbelow, within, or above a range of $49.0 million and $65.0 million,which were the estimates of Class 8 payments determined by the variousconstituencies in the bankruptcy proceedings. As the Company has determinedthat the final amount needed to resolve Class 8 claims will be below$49.0 million, all of the 600,000 shares were allocated to Class 9.As a result of the settlement agreement among representatives of the classeswithin Class 9, the Equity Class within Class 9 (i.e. holders,as of the effective date of the Reorganization Plan, of the Predecessor Company’scommon stock) was entitled to receive 85%, or 510,000, of such shares, and theSecurities Class within Class 9 (i.e. purchasers of old common stockinvolved in a class action brought against the Predecessor Company that wasresolved 

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under the ReorganizationPlan) was entitled to receive 15%, or 90,000, of such shares. The Class 7/9Reserve Shares were distributed in a process that began on August 30,2005.

*Administrative Claims andLuddy v. Peregrine.**  *Administrativeclaims are claims related to obligations the Company purportedly incurred afterit filed for bankruptcy law protection during the administrative period of thebankruptcy case. In order to be paid, administrative claims must meet certainrequirements under the Reorganization Plan and bankruptcy laws. The onlymaterial remaining administrative liability results from a complaint filed in May 2004against the Company by the Company’s former chief technology officer, FredericLuddy, in the Court of Chancery for the State of Delaware. Mr. Luddy’scomplaint alleged that Peregrine is required to advance or reimburse him forhis defense expenses in connection with ongoing civil litigation related to theCompany’s accounting improprieties, but to which the Company is not a party. InJune 2004, the Company removed Mr. Luddy’s complaint from Delawarestate court to the Bankruptcy Court. On November 10, 2004, the BankruptcyCourt found that it had jurisdiction to consider the complaint, and the courtgranted in part and denied in part the Company’s motion to dismiss Mr. Luddy’scomplaint, without prejudice, to the Company’s right to renew the motion laterafter discovery and formal fact finding. Discovery has not yet commenced and notrial date has been set. On October 25, 2005, Mr. Luddy and theCompany signed a settlement agreement to resolve the issues raised in Mr. Luddy’scomplaint. The settlement agreement will become effective 10 days after it isapproved by the Bankruptcy Court. If approved in its current form by theBankruptcy Court, the settlement agreement will not materially affect theCompany’s financial position, results of operations or liquidity.

*Other Litigation*

The Company is alsoinvolved in legal proceedings, claims, and litigation arising from the ordinarycourse of business. Although the ultimate results of these legal proceedings,claims and litigation are not currently determinable, in the opinion ofmanagement these matters will not materially affect the Company’s financialposition, results of operations or liquidity.

*Lease Commitment*

During July 2005, the Company entered into a leasecommitment for additional office space to support operations at itsheadquarters in San Diego. The lease period commences October 1, 2005 andends April 30, 2012. The total lease commitment is $4.1 millionthrough April 2012.

**7.   Restructuring,Impairments and Other**

For the six months ended September 30,2005, restructuring, impairments and other totaled $0.2 million,attributable to a $0.2 million escrow payment received from a sale of oneof the Company’s investments that had been previously impaired.

**8.   Other Income**

During the six months ended September 30, 2005,the Company received cash in the amount of $2.1 million related to thesettlement of a dispute with a customer arising from a software licenseagreement entered into in March 2002. In connection with the settlement,the Company also agreed to issue new software licenses to the customer whichthe customer will evaluate and may decide to install at a later date. Of thecash received, $1.2 million has been accounted for as the resolution of again contingency that arose prior to the Company’s application of fresh-startreporting, effective July 18, 2003, upon the emergence from bankruptcyproceedings and is recorded as other income in the accompanying consolidatedstatements of operations. The settlement included the payment of interestaccrued and the recovery of legal expenses incurred by the Company to litigateand ultimately settle this dispute. The Company has recorded the remaining cashreceived under the settlement of $0.2 million and $0.7 million asinterest income and a reduction of general and administrative expensesreflecting the recovery of legal 

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costs, respectively, inthe accompanying consolidated statements of operations, as such amounts wereearned or incurred subsequent to the Company’s adoption of fresh-startreporting.

Also included in otherincome for the six months ended September 30, 2005 is $0.5 millionfrom the recovery of financing fees paid prior to the Company’s emergence frombankruptcy proceedings to financial institutions with which the Company hadaccounts receivable financing facilities.

**9.   Stockholders’ Equity**

In May 2004, the Company issued to its ChiefExecutive Officer, 40,000 shares of common stock, $0.0001 par value, pursuantto the Company’s 2003 Equity Incentive Plan, representing an aggregate value ofapproximately $0.7 million, which was recognized as compensation expense in theperiod granted.

During August 2005, the Company issued to certainkey employees a total of 468,500 restricted shares of common stock, $0.0001 parvalue, pursuant to the Company’s 2003 Equity Incentive Plan, representing anaggregate value of approximately $9 million, and is being recognized ascompensation expense ratably over a three-year vesting period. The shares ofrestricted stock vest in three equal installments on August 8, 2006, 2007and 2008; subject to full vesting immediately prior to the consummation of achange in control of the Company. Additionally, during the three months ended September 30,2005, the Company issued options to purchase 330,000 shares of its common stockwith exercise prices at the fair market value of the underlying common stock onthe grant date.

Thefollowing table summarizes stock compensation expense included in operatingcosts and expenses for the three and six months ended September 30, 2005and 2004, respectively:

| ** **                        | ** ** | **Three Months  Ended  September 30,** | ** ** | **Six Months  Ended  September 30,** | ** ** |
|-----------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                        | ** ** | **2005**                                         | ** ** | **2004**                                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Cost of  consulting               |       | $                                                | 19         |                                           |       | $ | — |   |   | $ | 19 |   | $ | — |   |
| Cost of  maintenance              |       | 19                                               |       |                                           | —     |   |   | 19 |   | — |   |
| Sales and  marketing              |       | 200                                              |       |                                           | —     |   |   | 200 |   | — |   |
| Research and  development         |       | 51                                               |       |                                           | —     |   |   | 51 |   | — |   |
| General and  administrative       |       |   263                                       |       |                                           |   92  |   |   |   263 |   |   783 |   |
| Total stock compensation  expense |       | $                                                | 552        |                                           |       | $ | 92 |   |   | $ | 552 |   | $ | 783 |   |

 

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**ITEM 2.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

*The following discussion and analysis of our financialcondition, results of operations, liquidity and capital resources should beread in conjunction with the condensed consolidated financial statements andrelated notes included in this report. Some of the information contained inthis discussion and analysis, or set forth elsewhere in this report, includesforward-looking statements within the meaning of Section 27a of theSecurities Act and Section 21e of the Exchange Act. These statementsinclude, among other things, statements concerning our future operations,financial condition and prospects, and business strategies. The words “believe,”“expect,” “anticipate,” “intend,” “seek,” “will,” and other similar expressionsgenerally identify forward-looking statements. These forward-lookingstatements are subject to substantial risks and uncertainties that could causeour future business, financial condition or results of operations to differmaterially from our historical results or currently anticipated results.Readers should carefully review the information set forth under the caption “RiskFactors” contained in our Amended Form 10-K for a discussion ofimportant factors that could cause actual results to differ materially from ourhistorical or anticipated results described herein, or implied by the forward-lookingstatements in this report. We undertake no obligation to revise or update anyforward-looking statements for any reason.*

*Historically, we have not filed our SEC periodicreports on a timely basis. For this reason, and based on the other risk factorscontained in our Amended Form 10-K, we believe trading in oursecurities at this time is highly speculative and involves a high degree ofrisk.*

**OVERVIEW**

Peregrine Systems, Inc. (the “Company” or “Peregrine”and references to “we,” “us,” or “our”) is a global provider of enterprisesoftware. Peregrine’s core business is providing information technology asset andservice management software solutions.

Peregrine’s core software product suites areAssetCenter® and ServiceCenter®. AssetCenter and ServiceCenter support two mainbusiness processes: asset management and service management. Typically, theassets managed with Peregrine’s products consist of information technologyassets, such as computer and computer-networking hardware and softwareitems, and other assets used to provide infrastructure to a business. Theservices managed with Peregrine’s products usually consist of the servicedelivery and support processes necessary to troubleshoot, support and maintainthose same information technology and infrastructure assets. In addition, weoffer products in our Configuration Services suite which provides a consolidatedaccurate view of all IT assets and allows customers to automatically discover,inventory, and better utilize all hardware, software, and network devices.

We have also embraced anew vision called Optimal ITTM and announced our intent to develop a newDecisionCenterTM product to deliver on this vision. DecisionCenter and thesolutions we develop around it will be designed to provide analytics anddecision modeling capabilities that will enable our customers to optimize theperformance of the technology infrastructure using information generated byexisting applications, including ServiceCenter and AssetCenter. The Optimal ITsolutions are expected to provide the capability of collecting, understanding,analyzing and modeling the complex information that describes the technologyenvironment, to enable organizations to make optimal tradeoffs given theconstraints of time, resources, costs and assets.

On September 19,2005, the Company entered into an Agreement and Plan of Merger (the “MergerAgreement”) with Hewlett-Packard Company (“HP”). Pursuant to the terms of theMerger Agreement, at the effective time of the merger, each share of theCompany’s common stock issued and outstanding immediately prior to the effectivetime of the merger will be converted into the right to receive cash in theamount of $26.08. The aggregate purchase price approximates $425 million.Consummation of the merger is subject to customary closing conditions,including (i) approval of the Merger Agreement by the stockholders of theCompany, (ii) absence of any law or order prohibiting the consummation ofthe 

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merger, (iii) expirationor termination of the applicable Hart-Scott-Rodino Antitrust Improvements Actof 1976 waiting period and receipt of certain foreign antitrust approvals, and (iv) theaccuracy of the representations and warranties of the parties to the MergerAgreement. The Merger Agreement may be terminated by either the Company and HPunder certain circumstances, and further provides that, upon certainterminations of the Merger Agreement, the Company will be required to pay HP atermination fee in the amount of $11.7 million.

**RESULTS OF OPERATIONS**

Thefollowing tables set forth for the periods indicated the selected condensedconsolidated statement of operations data as a percentage of total revenue:

| ** **                                       | ** ** | **Three Months  Ended  September 30,** | ** ** | **Six Months  Ended  September 30,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                       | ** ** | **2005**                                         | ** ** | **2004**                                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Revenue:**                                     |       |                                             |       |                                           |       |   |   |   |   |
| Licenses                                         |       | 28.4                                             | %          | 32.6                                           | %          | 29.3 | % | 30.4 | % |
| Maintenance                                      |       | 58.9                                             | %          | 59.1                                           | %          | 58.9 | % | 60.8 | % |
| Consulting and training                          |       | 12.7                                             | %          | 8.3                                            | %          | 11.8 | % | 8.8 | % |
| **Total revenue**                                |       | 100.0                                            | %          | 100.0                                          | %          | 100.0 | % | 100.0 | % |
| **Operating  costs and expenses:**               |       |                                             |       |                                           |       |   |   |   |   |
| Cost of licenses                                 |       | 6.5                                              | %          | 5.8                                            | %          | 6.3 | % | 6.4 | % |
| Cost of maintenance                              |       | 9.9                                              | %          | 9.3                                            | %          | 10.2 | % | 10.2 | % |
| Cost of consulting and training                  |       | 12.7                                             | %          | 9.2                                            | %          | 12.1 | % | 9.4 | % |
| Sales and marketing                              |       | 36.2                                             | %          | 32.5                                           | %          | 38.9 | % | 36.2 | % |
| Research and development                         |       | 18.1                                             | %          | 14.2                                           | %          | 18.6 | % | 16.3 | % |
| General and administrative                       |       | 23.9                                             | %          | 25.4                                           | %          | 24.8 | % | 28.4 | % |
| Amortization of intangible assets                |       | 7.5                                              | %          | 7.0                                            | %          | 7.5 | % | 7.6 | % |
| Restructuring, impairments and other             |       | —                                           | %          | —                                         | %          | (0.2 | )% | — | % |
| **Total operating costs and expenses**           |       | 114.8                                            | %          | 103.4                                          | %          | 118.2 | % | 114.5 | % |
| **Operating  loss**                              |       | (14.8                                            | )%         | (3.4                                           | )%         | (18.2 | )% | (14.5 | )% |
| Foreign currency transaction gains (losses), net |       | (1.1                                             | )%         | 0.2                                            | %          | (1.8 | )% | (1.1 | )% |
| Reorganization items, net                        |       | (0.3                                             | )%         | (0.7                                           | )%         | (0.4 | )% | (1.3 | )% |
| Interest income                                  |       | 1.0                                              | %          | 0.7                                            | %          | 1.3 | % | 0.7 | % |
| Interest expense                                 |       | (1.6                                             | )%         | (2.2                                           | )%         | (1.7 | )% | (2.6 | )% |
| Other income                                     |       | 0.2                                              | %          | —                                         | %          | 1.9 | % | — | % |
| **Loss before  income taxes**                    |       | (16.6                                            | )%         | (5.4                                           | )%         | (18.9 | )% | (18.8 | )% |
| Income tax expense                               |       | (2.2                                             | )%         | (2.3                                           | )%         | (1.4 | )% | (2.7 | )% |
| **Net  loss**                                    |       | (18.8                                            | )%         | (7.7                                           | )%         | (20.3 | )% | (21.5 | )% |

 

**COMPARISON OF RESULTS OF OPERATIONS**

**REVENUE**

Operating segments aredefined as components of an enterprise about which separate financialinformation is available and evaluated regularly by our chief operatingdecision maker, or decision-making group, in allocating resources and assessingperformance. Our operating segments are managed separately because each segmentrepresents a strategic business unit that offers different products orservices.

Beginning in the secondquarter of fiscal year 2006, we reorganized our management structure. As aresult, we changed our basis of segmentation from two reportable segments basedon geography to three reportable segments based on the products and services weoffer.

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Our three reportable operating segments are Licenses,Maintenance, and Consulting and Training. The Licenses segment develops andmarkets licenses to use our software products. The Maintenance segment providesafter-sale support for software products. The Consulting and Training segmentprovides fee-based consulting and training services related to our softwareproducts.

We do not separately allocate operating expenses tothese segments, nor do we allocate specific assets to these segments.Therefore, segment information reported includes only revenues, cost ofrevenues, and gross profit.

Thefollowing table summarizes revenue by segment and geographic distribution forthe three and six months ended September 30, 2005 and 2004, respectively(dollars in thousands):

| ** **                             | ** ** | **Three Months  Ended** | ** ** | ** ** | ** ** | ** **             | ** ** | **Six Months  Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------------|------------|------------------------------|------------|------------|------------|------------------------|------------|----------------------------|------------|------------|------------|------------|------------|
| ** **                             | ** ** | **September 30,**       | ** ** | **Change** | ** ** | **September 30,** | ** ** | **Change**                 | ** ** |
| ** **                             | ** ** | **2005**                     | ** ** | **2004**   | ** ** | **Amount**             | ** ** | **Percent**                | ** ** | **2005**   | ** ** | **2004**   | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Revenue:                               |       |                         |       |       |       |                   |       |                       |       |       |       |       |       |   |   |   |   |   |   |   |   |
| Licenses                               |       |                         |       |       |       |                   |       |                       |       |       |       |       |       |   |   |   |   |   |   |   |   |
| Americas(4)                            |       | $                            | 4,871      |       | $          | 9,406                  |       | $                          | (4,535     | )          |       | (48        | )%         |   | $ | 12,641 |   | $ | 15,500 |   | $ | (2,859 | ) |   | (18 | )% |   |
| EMEA/AP(5)                             |       | 7,722                        |       | 6,217      |       | 1,505                  |       |                       | 24         | %          |       | 13,449     |       | 11,268 |   | 2,181 |   |   | 19 | % |   |
| Total license revenue                  |       | 12,593                       |       | 15,623     |       | (3,030                 | )          |                       | (19        | )%         |       | 26,090     |       | 26,768 |   | (678 | ) |   | (3 | )% |   |
| Maintenance                            |       |                         |       |       |       |                   |       |                       |       |       |       |       |       |   |   |   |   |   |   |   |   |
| Americas(4)                            |       | 14,351                       |       | 16,437     |       | (2,086                 | )          |                       | (13        | )%         |       | 28,838     |       | 30,720 |   | (1,882 | ) |   | (6 | )% |   |
| EMEA/AP(5)                             |       | 11,794                       |       | 11,878     |       | (84                    | )          |                       | (1         | )%         |       | 23,577     |       | 22,832 |   | 745 |   |   | 3 | % |   |
| Total maintenance  revenue             |       | 26,145                       |       | 28,315     |       | (2,170                 | )          |                       | (8         | )%         |       | 52,415     |       | 53,552 |   | (1,137 | ) |   | (2 | )% |   |
| Consulting and Training                |       |                         |       |       |       |                   |       |                       |       |       |       |       |       |   |   |   |   |   |   |   |   |
| Americas(4)                            |       | 3,750                        |       | 2,391      |       | 1,359                  |       |                       | 57         | %          |       | 6,373      |       | 4,599 |   | 1,774 |   |   | 39 | % |   |
| EMEA/AP(5)                             |       | 1,876                        |       | 1,605      |       | 271                    |       |                       | 17         | %          |       | 4,072      |       | 3,189 |   | 883 |   |   | 28 | % |   |
| Total consulting and  training revenue |       | 5,626                        |       | 3,996      |       | 1,630                  |       |                       | 41         | %          |       | 10,445     |       | 7,788 |   | 2,657 |   |   | 34 | % |   |
| Total Revenue                          |       | $                            | 44,364     |       | $          | 47,934                 |       | $                          | (3,570     | )          |       | (7         | )%         |   | $ | 88,950 |   | $ | 88,108 |   | $ | 842 |   |   | 1 | % |   |

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(4)   Americas is comprised of United States, Canada and Latin America.

(5)          EMEA/APis comprised of Europe, the Middle East, Africa, and Asia-Pacific.

*Licenses*

We generally license ourproducts to end-users under perpetual license agreements for an up-front fee.

License revenue for thethree months ended September 30, 2005 decreased by $3.0 million, or19%, from the three months ended September 30, 2004. License revenue forthe Americas territory totaled $4.9 million for the three months ended September 30,2005, a decrease of $4.5 million, or 48%, from the three months ended September 30,2004. License revenue in EMEA/AP totaled $7.7 million for the three monthsended September 30, 2005, an increase of $1.5 million, or 24%, fromthe three months ended September 30, 2004. The decrease in license revenuefor the Americas territory is primarily attributable to a greater number ofrelatively larger transactions recorded in the three months ended September 30,2004. This decrease was partially offset by an increase in license revenue inthe EMEA/AP territory which is primarily attributable to a greater number ofrelatively larger transactions in the three months ended September 30, 2005.

License revenue for the six months ended September 30,2005 decreased by $0.7 million, or 3%, from the six months ended September 30,2004. License revenue for the Americas territory totaled $12.6 million 

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for the six months ended September 30,2005, a decrease of $2.9 million, or 18%, from the six months ended September 30,2004. License revenue in EMEA/AP totaled $13.4 million for the six monthsended September 30, 2005, an increase of $2.2 million, or 19%, fromthe six months ended September 30, 2004. The decrease in license revenuefor the Americas territory is primarily attributable to a greater number ofrelatively larger transactions recorded in the six months ended September 30,2004. This decrease was partially offset by an increase in license revenue inthe EMEA/AP territory primarily attributable to a greater number of relativelylarger transactions in the six months ended September 30, 2005 as well asnew and additional licenses sold to our existing customer base.

*Maintenance*

Most customers purchasemaintenance services when buying new or additional licenses. Maintenanceservices consist primarily of providing enhancements and upgrades for ourproducts along with customer support services for our products. Generally,maintenance contracts are entered into for one-year periods, contain economicindex fee escalation provisions and are renewable annually at the customer’soption. Maintenance contracts are generally prepaid by customers, and revenueis recognized ratably over the support period. Maintenance revenue may includefees for services rendered in prior periods in instances in which customers didnot renew their maintenance contracts until the current period.

We adopted the fresh-start reporting provisionsof SOP 90-7 as of July 18, 2003 in connection with our emergencefrom bankruptcy protection under Chapter 11. Fresh-start reportingrequires that the reorganization value be allocated to the entity’s assets inaccordance with Statement of Financial Accounting Standards No. 141, “BusinessCombinations” (“SFAS 141”). In accordance with these pronouncements, wedetermined the fair market value of our assets and liabilities at July 18,2003, including our deferred maintenance revenue balances. Accordingly, wereduced our deferred maintenance revenue balances by $6.3 million toreflect the fair value of maintenance contracts existing at July 18, 2003.This $6.3 million adjustment has the effect of reducing maintenancerevenue over the maintenance contract periods for those contracts that existedwhen we adopted fresh-start reporting. In the three and six months ended September 30,2005, maintenance revenue was reduced by $0.1 million and$0.2 million, respectively. In the three and six months ended September 30,2004, maintenance revenue was reduced by $0.4 million and$1.0 million, respectively. The balance of the adjustment of$0.2 million at September 30, 2005, will be amortized through March 31,2007.

Maintenance revenue, net of fresh-start adjustments,totaled $26.1 million for the three months ended September 30, 2005,a decrease of $2.2 million, or 8%, from the $28.3 million for thethree months ended September 30, 2004. Excluding the reductions inmaintenance revenue resulting from the adoption of fresh-start reporting,maintenance revenue for the three months ended September 30, 2005decreased by $2.4 million, or 9% from the three months ended September 30,2004. Maintenance revenue for the Americas territory for the three months endedSeptember 30, 2005 decreased $2.1 million, or 13%, from the threemonths ended September 30, 2004. EMEA/AP maintenance revenue in the threemonths ended September 30, 2005 decreased by $0.1 million, or 1%,from the three months ended September 30, 2004. The decrease inmaintenance revenue for the three months ended September 30, 2005 occurredmainly as a result of a decrease of $1.4 million in carryforward revenueattributable to pre-fiscal 2003 contracts.

Maintenance revenuetotaled $52.4 million for the six months ended September 30, 2005, adecrease of $1.1 million, or 2%, from the $53.6 million for the sixmonths ended September 30, 2004. Excluding the reductions in maintenancerevenue resulting from the adoption of fresh-start reporting, maintenancerevenue for the six months ended September 30, 2005 decreased by $1.9million, or 3%, respectively, from the six months ended September 30,2004. This decrease is impacted by the reductions resulting from the adoptionof fresh-start reporting for the six months ended September 30, 2005and 2004, respectively, as discussed above. Maintenance revenue for theAmericas territory for the six months ended September 30, 2005 decreased$1.9 million, or 6%, from the six months ended September 30, 2004. EMEA/AP

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maintenancerevenue for the six months ended September 30, 2005 increased by$0.8 million, or 3%, from the six months ended September 30, 2004. Thedecrease in maintenance revenue for the Americas territory for the six monthsended September 30, 2005 occurred mainly as a result of a decrease of $2.7million in carryforward revenue attributable to pre-fiscal 2003 contracts. Thisdecrease was partially offset by an increase in maintenance revenue in theEMEA/AP territory mainly as a result of revenue attributable to additionallicenses covered by maintenance contracts exceeded the revenue lost fromcancellations, in whole or in part, of maintenance contracts during the renewalprocess.

*Consulting andTraining*

Consulting and training services include a range ofprofessional and educational services intended to help our customers use oursoftware products more effectively.

Revenue for consulting andtraining services totaled $5.6 million for the three months ended September 30,2005, an increase of $1.6 million, or 41%, from the $4.0 million forthe three months ended September 30, 2004. Americas consulting andtraining revenue for the three months ended September 30, 2005, increased$1.3 million, or 57%, from the three months ended September 30, 2004.EMEA/AP consulting and training revenue for the three months ended September 30,2005, increased $0.3 million, or 17%, from the three months ended September 30,2004.

Revenue for consulting andtraining services totaled $10.4 million for the six months ended September 30,2005, an increase of $2.7 million, or 34%, from the $7.8 million forthe six months ended September 30, 2004. Americas consulting and trainingrevenue for the six months ended September 30, 2005, increased$1.8 million, or 39%, from the six months ended September 30, 2004. EMEA/APconsulting and training revenue for the six months ended September 30,2005, increased $0.9 million, or 28%, from the six months ended September 30,2004.

These increases primarilyreflect the Company’s investment in its consulting operations that commenced inthe latter half of fiscal 2004 through the hiring of additional businessdevelopment personnel, new managers and other staff to meet increased demandgenerated during the period.

**COST AND EXPENSES**

**Cost of Revenue**

Thefollowing tables summarize the cost of revenue for the three and six monthsended September 30, 2005 and 2004, respectively (in thousands, except forthe percentages):

| ** **              | ** ** | ** **                                       | ** ** | ** **                                       | ** ** | ** ** | ** ** | ** **                                       | ** ** | **Percent of Revenue by Line Item** | ** ** |
|-------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **              | ** ** | **Three Months  Ended  September 30,** | ** ** | **Three Months  Ended  September 30,** | ** ** | **Change** | ** ** | **Three Months  Ended  September 30,** | ** ** | **Three Months  Ended  September 30,**             | ** ** | ** ** | ** ** |
| ** **              | ** ** | **2005**                                         | ** ** | **2004**                                         | ** ** | **Amount** | ** ** | **Percent**                                      | ** ** | **2005**                                                     | ** ** | **2004** | ** ** | **Change** | ** ** |
| Cost of Revenue:        |       |                                             |       |                                             |       |       |       |                                             |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| License                 |       |                                             | $          | 2,870                                            |       |       |       | $                                                | 2,774      |                                                         |       |   | $ | 96 |   |   |   | 3 | % |   |   | 23 | % |   |   | 18 | % |   |   | 5 | % |   |
| Maintenance             |       |                                             | 4,413      |                                             |       |       | 4,434      |                                             |       |                                                         | (21        | ) |   |   | — | % |   |   | 17 | % |   |   | 16 | % |   |   | 1 | % |   |
| Consulting and training |       |                                             | 5,618      |                                             |       |       | 4,410      |                                             |       |                                                         | 1,208      |   |   |   | 27 | % |   |   | 100 | % |   |   | 110 | % |   |   | (10 | )% |   |
| Total cost of revenue   |       |                                             | $          | 12,901                                           |       |       |       | $                                                | 11,618     |                                                         |       |   | $ | 1,283 |   |   |   | 11 | % |   |   | 29 | % |   |   | 24 | % |   |   | 5 | % |   |

 

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| ** **              | ** ** | ** **                                     | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** **                                     | ** ** | **Percent of Revenue by Line Item** | ** ** |
|-------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|------------|------------|------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **              | ** ** | **Six Months  Ended  September 30,** | ** ** | **Six Months  Ended  September 30,** | ** ** | **Change** | ** ** | **Six Months  Ended  September 30,** | ** ** | **Six Months  Ended  September 30,**               | ** ** | ** ** | ** ** |
| ** **              | ** ** | **2005**                                       | ** ** | **2004**                                       | ** ** | **Amount** | ** ** | **Percent**                                    | ** ** | **2005**                                                     | ** ** | **2004** | ** ** | **Change** | ** ** |
| Cost of Revenue:        |       |                                           |       |                                           |       |       |       |                                           |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| License                 |       |                                           | $          | 5,626                                          |       |       |       | $                                              | 5,628      |                                                         |       |   | $ | (2 | ) |   |   | — | % |   |   | 22 | % |   |   | 21 | % |   |   | 1 | % |   |
| Maintenance             |       |                                           | 9,088      |                                           |       |       | 8,978      |                                           |       |                                                         | 110        |   |   |   | 1 | % |   |   | 17 | % |   |   | 17 | % |   |   | — | % |   |
| Consulting and training |       |                                           | 10,776     |                                           |       |       | 8,295      |                                           |       |                                                         | 2,481      |   |   |   | 30 | % |   |   | 103 | % |   |   | 107 | % |   |   | (4 | )% |   |
| Total cost of  revenue  |       |                                           | $          | 25,490                                         |       |       |       | $                                              | 22,901     |                                                         |       |   | $ | 2,589 |   |   |   | 11 | % |   |   | 29 | % |   |   | 26 | % |   |   | 3 | % |   |

 

*Cost of Licenses*

Cost of licenses primarily consists of amortizationexpense related to developed technology, third-party software royalties,product packaging, documentation and production, and distribution costs.

Cost of licenses totaled $2.9 million for thethree months ended September 30, 2005, an increase of $0.1 million,or 3%, from the three months ended September 30, 2004. Cost of licensesrepresented 23% and 18% of license revenue for the three months ended September 30,2005 and 2004, respectively.

Cost of licenses totaled$5.6 million for each of the six months ended September 30, 2005 and2004. Cost of licenses represented 22% and 21% of license revenue for the sixmonths ended September 30, 2005 and 2004, respectively.

*Cost of Maintenance*

Cost of maintenance services primarily consists ofpersonnel, facilities and system costs related to technical support services toour customers on maintenance contracts.

Cost of maintenance totaled $4.4 million for eachof the three months ended September 30, 2005 and 2004. Cost of maintenancerepresented 17% and 16% of maintenance revenue for the three months ended September 30,2005 and 2004, respectively.

Cost of maintenancetotaled $9.1 million for the six months ended September 30, 2005, anincrease of $0.1 million, or 1%, from the six months ended September 30,2004. Cost of maintenance represented 17% of maintenance revenue for each ofthe six months ended September 30, 2005 and 2004.

*Cost of Consultingand Training*

Cost of consulting and training services primarilyconsists of personnel, facilities and system costs associated with providingthese services. Cost of consulting and training services also includes feespaid to third-party subcontractors providing services on our behalf.

Cost of consulting andtraining totaled $5.6 million for the three months ended September 30,2005, an increase of $1.2 million, or 27%, from the three months ended September 30,2004. The cost increase is the result of expanding the consulting businessprimarily through the addition of personnel. Specifically, there was a$0.8 million increase in costs associated with the use of outsideconsultants. In addition, personnel related costs increased $0.4 million,mostly as a result of increased headcount in our consulting operation. The costof consulting and training represented 100% and 110% of consulting and trainingrevenue for the three months ended September 30, 2005 and 2004,respectively.

Cost of consulting andtraining totaled $10.8 million for the six months ended September 30,2005, an increase of $2.5 million, or 30%, from the six months ended September 30,2004. The cost increase is the 

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resultof expanding the consulting business primarily through the addition ofpersonnel. Specifically, there was a $1.5 million increase in costsassociated with the use of outside consultants. In addition, personnel relatedcosts increased $0.9 million, mostly as a result of an increased headcountin our consulting operation. The cost of consulting and training represented103% and 107% of consulting and training revenue for the six months ended September 30,2005 and 2004, respectively.

**Other Operating Costs and Expenses**

Thefollowing table summarizes operating expenses for the three and six monthsended September 30, 2005 and 2004, respectively (in thousands, except forthe percentages):

| ** **                                | ** ** | **Three Months  Ended  September 30,** | ** ** | **Three Months  Ended  September 30,** | ** ** | **Change** | ** ** | **Six Months  Ended  September 30,** | ** ** | **Six Months  Ended  September 30,** | ** ** | **Change** | ** ** |
|-------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|------------|------------|
| ** **                                | ** ** | **2005**                                         | ** ** | **2004**                                         | ** ** | **Amount** | ** ** | **Percent**                                    | ** ** | **2005**                                       | ** ** | **2004**   | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Other operating costs  and expenses:      |       |                                             |       |                                             |       |       |       |                                           |       |                                           |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Sales and marketing                       |       |                                             | $          | 16,045                                           |       |       |       | $                                              | 15,583     |                                           |       | $          | 462        |   |   | 3 | % |   |   | $ | 34,521 |   |   |   | $ | 31,857 |   |   | $ | 2,664 |   |   | 8 | % |   |
| Research and development                  |       |                                             | 8,045      |                                             |       |       | 6,824      |                                           |       | 1,221                                          |       |       | 18         | % |   |   | 16,514 |   |   |   | 14,332 |   |   | 2,182 |   |   | 15 | % |   |
| General and administrative                |       |                                             | 10,593     |                                             |       |       | 12,192     |                                           |       | (1,599                                         | )          |       | (13        | )% |   |   | 22,135 |   |   |   | 25,011 |   |   | (2,876 | ) |   | (11 | )% |   |
| Amortization of intangible assets         |       |                                             | 3,335      |                                             |       |       | 3,332      |                                           |       | 3                                              |       |       | —     | % |   |   | 6,683 |   |   |   | 6,708 |   |   | (25 | ) |   | — | % |   |
| Restructuring, impairments and other      |       |                                             | —     |                                             |       |       | —     |                                           |       | —                                         |       |       | —     | % |   |   | (198 | ) |   |   | — |   |   | (198 | ) |   | — | % |   |
| Total other  operating costs and expenses |       |                                             | $          | 38,018                                           |       |       |       | $                                              | 37,931     |                                           |       | $          | 87         |   |   | — | % |   |   | $ | 79,655 |   |   |   | $ | 77,908 |   |   | $ | 1,747 |   |   | 2 | % |   |

 

*Sales and Marketing*

Sales and marketingexpenses primarily consist of personnel costs, including sales commissions andtravel costs, facilities and system costs related to our sales, includingtechnical pre-sales, and marketing functions. The costs of advertising andmarketing promotions are also included in sales and marketing expenses.

Sales and marketingexpenses totaled $16.0 million for the three months ended September 30,2005, an increase of $0.5 million, or 3%, from the three months ended September 30,2004. The increase was primarily driven by an increase in personnel relatedcosts of $0.4 million resulting primarily from an increased headcount inour sales and marketing group.

Sales and marketingexpenses totaled $34.5 million for the six months ended September 30,2005, an increase of $2.7 million, or 8%, from the six months ended September 30,2004. The increase was primarily driven by an increase in personnel relatedcosts of $1.7 million resulting primarily from an increased headcount inour sales and marketing group. Also contributing to the change over theprior-year period was an increase in travel expenses of $0.7 million.

*Research andDevelopment*

Research and development (“R&D”) expensesprimarily consist of personnel, facilities and systems costs associated withour R&D efforts, which include software development and product managementefforts. R&D expenses also include the cost of services for consultants orother third parties that we hire from time to time to augment our own R&Dpersonnel.

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R&D expenses totaled$8.0 million for the three months ended September 30, 2005, anincrease of $1.2 million, or 18%, from the three months ended September 30,2004. This increase was primarily due to an increase of $0.7 million inpersonnel costs related to an increased headcount in our research anddevelopment group as well as $0.3 million in costs associated with outsideconsultants who supplement our full-time personnel working on current projects.

R&D expenses totaled$16.5 million for the six months ended September 30, 2005, anincrease of $2.2 million, or 15%, from the six months ended September 30,2004. This increase was primarily due to an increase of $1.2 million inpersonnel costs related to an increased headcount in our research anddevelopment group as well as $0.9 million in costs associated with outsideconsultants who supplement our full-time personnel working on current projects.

*General and Administrative*

General and administrative(“G&A”) expenses consist of personnel, facilities and systems costs relatedto our operations. G&A also includes the cost of business insurance andprofessional fees, including legal, accounting, investment banking and otheradvisory fees, except for fees directly related to our bankruptcyreorganization, which are accounted for under Reorganization Items, Net.

G&A expenses totaled$10.6 million for the three months ended September 30, 2005, adecrease of $1.6 million, or 13%, from the three months ended September 30,2004. The decrease was primarily attributable to costs associated with thereduced use of outside consultants of $1.1 million and an insurance recovery of$0.2 million, which were offset in part by an increase in personnel costs of$0.4 million.

G&A expenses totaled $22.1 million for thesix months ended September 30, 2005, a decrease of $2.9 million, or 11%,from the six months ended September 30, 2004. The decrease was primarilyattributable to the reduced use of outside consultants of $1.1 million, therecovery of legal costs of $0.7 million related to the settlement of adispute with a customer arising from a software license agreement entered intoin March 2002, reduced personnel related costs of $0.5 million, and aninsurance recovery of $0.2 million.

*Amortization ofIntangible Assets*

Identifiable intangible assets subject to amortizationconsist of developed technology, trademarks and trade names, maintenancecontracts and customer lists.

For each of the three months ended September 30,2005 and 2004, the Company recorded non-cash charges for amortization ofintangible assets of $3.3 million. Amortization expense of $2.5 millionrelated to developed technology is included in cost of licenses for each of thethree months ended September 30, 2005 and 2004.

For each of the six months ended September 30,2005 and 2004, the Company recorded non-cash charges for amortization ofintangible assets of $6.7 million. Amortization expense of $4.9 millionrelated to developed technology is included in cost of licenses for each of thesix months ended September 30, 2005 and 2004.

*Restructuring,Impairments and Other*

For the six months ended September 30,2005, restructuring, impairments and other was a gain of $0.2 million,attributable to a $0.2 million escrow payment received from a sale of oneof the Company’s investments that had been previously impaired.

**ForeignCurrency Transaction Gains (Losses), Net**

Foreign currencytransaction gains (losses), net consist primarily of exchange rate gains orlosses resulting from remeasurement of foreign-denominated short-termintercompany and third-party receivable and payable balances and cashbalances of our operating entities into their functional currencies at   

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period-endmarket rates. Foreign currency transactions resulted in a loss of$0.5 million and a gain of $0.1 million for the three months ended September 30,2005 and 2004, respectively. Foreign currency transactions resulted in lossesof $1.5 million and $1.0 million for the six months ended September 30,2005 and 2004, respectively. Losses resulted primarily from the impact of thestrengthening U.S. dollar on our foreign-denominated short-termintercompany receivable and payable balances.

**Reorganization Items, Net**

As a result of ourbankruptcy law filing, we became subject to the provisions of SOP 90-7for the reporting periods subsequent to September 22, 2002. Pursuant toSOP 90-7, revenue, expenses (including professional fees), realized gainsand losses, and provisions for losses resulting from our Predecessor Company’sreorganization of the business through the bankruptcy proceedings are reportedseparately as reorganization items. The Company has also incurred chargesrecorded in reorganization items, net, primarily related to bankruptcy-proceedingprofessional fees.

Reorganization items, net,totaled $0.1 million and $0.3 million for the three months ended September 30,2005 and 2004, respectively, and $0.4 million and $1.1 million forthe six months ended September 30, 2005 and 2004, respectively, andconsist primarily of professional fees incurred in connection with thesettlement of claims directly related to the bankruptcy filing.

**Interest Income**

Interest income totaled$0.4 million for the three months ended September 30, 2005, anincrease of $0.1 million, or 35%, from the three months ended September 30,2004. Interest income totaled $1.1 million for the six months ended September 30,2005, an increase of $0.6 million, or 97%, from the six months ended September 30,2004. This increase resulted partially from investment of increased availablecash balances in interest bearing accounts at higher interest rates. Alsocontributing to the increase during the six months ended September 30,2005 was $0.2 million of interest income related to the settlement of alegal matter as discussed below under “Other Income.”

**Interest Expense**

Interest expense includesinterest charges and amortized costs related to our borrowings. Interestexpense totaled $0.7 million for the three months ended September 30,2005, a decrease of $0.3 million, or 31%, from the three months ended September 30,2004. Interest expense totaled $1.5 million for the six months ended September 30,2005, a decrease of $0.7 million, or 32%, from the six months ended September 30,2004. Interest expense decreased primarily as a result of lower debt balances.

**Income Taxes**

Income tax expense is derived primarily from interestaccrued on the Company’s tax contingencies and also from taxes on foreignoperations for which no U.S. federal benefit can be recorded.

Income tax expense totaled$1.0 million and $1.1 million for the three months endedSeptember 30, 2005 and 2004, respectively. Income tax expense represented13% and 42% of the loss before income taxes for the three months endedSeptember 30, 2005 and 2004, respectively. Income tax expense totaled$1.3 million and $2.4 million for the six months ended September 30,2005 and 2004, respectively. Income tax expense represented 8% and 14% of theloss before income taxes for the six months ended September 30, 2005 and2004, respectively. In order to calculate the interperiod tax provision for eachquarter, the estimated annual effective tax rate is applied to the quarterlypre-tax income (loss) of our legal entities for which pre-tax income isanticipated for the year. For the quarter ended September 30, 2005, themajority of our foreign entities reported pre-tax income, resulting in foreigntax expense which, when added to the tax expense from interest accrued on theCompany’s tax contingencies, increased the tax provision for the quarter.

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**Other Income**

During the six monthsended September 30, 2005, the Company received cash in the amount of$2.1 million related to the settlement of a dispute with a customerarising from a software license agreement entered into in March 2002. Inconnection with the settlement, the Company also agreed to issue new softwarelicenses to the customer which the customer will evaluate and may decide toinstall at a later date. Of the cash received, $1.2 million has beenaccounted for as the resolution of a gain contingency that arose prior to theCompany’s application of fresh-start reporting, effective July 18,2003, upon the emergence from bankruptcy proceedings and is recorded as otherincome in the accompanying consolidated statements of operations. The settlementincluded the payment of interest accrued and the recovery of legal expensesincurred by the Company to litigate and ultimately settle this dispute. TheCompany has recorded the remaining cash received under the settlement of$0.2 million and $0.7 million as interest income and a reduction ofgeneral and administrative expenses reflecting the recovery of legal costs,respectively, in the accompanying consolidated statements of operations, assuch amounts were earned or incurred subsequent to the Company’s adoption offresh-start reporting.

Also included in otherincome for the six months ended September 30, 2005 is $0.5 millionfrom the recovery of financing fees paid prior to the Company’s emergence frombankruptcy proceedings to financial institutions with which the Company hadaccounts receivable financing facilities.

**Effect of Foreign Currency Exchange Rate Fluctuationson Results of Operations**

To provide a framework forassessing how our underlying operations performed, excluding the effect offoreign currency exchange rate fluctuations, we have disclosed below the changein “total revenue” (comprising licenses, maintenance, and consulting andtraining), “cost of revenue” (comprising cost of licenses, maintenance, andconsulting and training), and “operating costs and expenses” (comprising salesand marketing, research and development, general and administrative,amortization of intangible assets, and restructuring, impairments and other)attributable to foreign currency exchange rate fluctuations. To do so, we havecalculated the impact of foreign currency exchange rate fluctuations in U.S.dollars by multiplying the three and six month periods ended September 30,2005 activity in local currencies by the difference between the averageexchange rates in effect during the three and six month periods ended September 30,2005 and the average exchange rates in effect during the three and six monthperiods ended September 30, 2004.

*Revenue*

Total revenue for thethree months ended September 30, 2005 was not impacted significantly fromforeign currency exchange fluctuations. Total revenue for the six months ended September 30,2005 increased $0.8 million from the six months ended September 30,2004, all of which was due to foreign currency exchange rate fluctuations.

*Cost of Revenue*

Cost of revenue for thethree months ended September 30, 2005 was not impacted significantly fromforeign currency exchange fluctuations. Cost of revenue for the six monthsended September 30, 2005 increased $2.6 million from the six monthsended September 30, 2004. Approximately $0.1 million of the increase forthe six month comparison was due to foreign currency exchange ratefluctuations.

*Other Operating Costs and Expenses*

Other operating costs andexpenses for the three months ended September 30, 2005 was not affectedsignificantly by foreign currency exchange fluctuations. Other operating costsand expenses for the six months ended September 30, 2005 increased $1.7 millionfrom the six months ended September 30, 2004. Approximately $0.3 millionof the increase for the six month comparison was due to foreign currencyexchange rate fluctuations.

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**LIQUIDITY ANDCAPITAL RESOURCES**

We primarily generate cash from software licensing,maintenance renewals and the provision of consulting and training services. Ourprimary uses of cash are for general working capital purposes, taxes, debtservice and bankruptcy claims. We also use cash to purchase capital assets tosupport our business. In fiscal 2006 and fiscal 2005, our principal liquidity requirementshave been for operating expenses, working capital and debt and bankruptcyrelated payments. We have funded these liquidity requirements from cash on handthat was primarily generated from the disposal of our non-core product linesand our SCE and Remedy businesses in 2002.

Thefollowing table summarizes cash and cash equivalents, restricted cash, andworking capital (deficit) as of September 30, 2005 and March 31,2005, respectively (dollars in thousands):

| ** **                 | ** ** | **September 30, 2005** | ** ** | **March 31, 2005** | ** ** |
|----------------------------|------------|----------------------------------|------------|------------------------------|------------|
| Cash and cash  equivalents |       |                             | $          | 54,914                       |       |   |   | $ | 84,765 |   |   |
| Cash—restricted       |       |                             | $          | 4,912                        |       |   |   | $ | 4,325 |   |   |
| Working capital  (deficit) |       |                             | $          | (35,127                      | )          |   |   | $ | (19,641 | ) |   |

 

Cash equivalents primarily consist of overnight moneymarket accounts, time deposits, commercial paper and government agency notes.The restricted cash relates to security for certain real property leases andcertain other obligations. Working capital (deficit) consists primarily of cashand cash equivalents, marketable securities, accounts receivable, and othercurrent assets net of accounts payable, accrued expenses, and current portionsof deferred revenue and notes payable.

Thefollowing table summarizes cash flows for the six months ended September 30,2005 and 2004, respectively (dollars in thousands):

| ** **                                    | ** ** | **Six Months  Ended  September 30, 2005** | ** ** | **Six months  Ended  September 30, 2004** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| Cash used in:                                 |       |                                                     |       |                                                     |       |   |   |   |   |
| Operating activities                          |       |                                                     | $          | (15,907                                                  | )          |   |   | $ | (9,658 | ) |   |
| Investing activities                          |       |                                                     | (3,270     | )                                                        |       |   | (9,552 | ) |   |
| Financing activities                          |       |                                                     | (9,555     | )                                                        |       |   | (13,124 | ) |   |
| Effect of  exchange rate fluctuations on cash |       |                                                     | (1,119     | )                                                        |       |   | (92 | ) |   |
| Net decrease in cash and  cash equivalents    |       |                                                     | $          | (29,851                                                  | )          |   |   | $ | (32,426 | ) |   |

 

We believe our cash onhand and operating cash flows will be sufficient to fund our operations andplanned capital expenditures and to satisfy our scheduled non-trade paymentobligations for at least 12 months from the date of this report. However,our ability to generate adequate cash depends upon our future performance,which in turn is subject to general economic conditions and financial, businessand other factors affecting our operations, including factors beyond ourcontrol. Please review the information set forth under the caption “RiskFactors,” contained in our Amended Form 10-K. We currently have nolines of credit or similar facilities with any financial institutions. Therecan be no assurance that additional financing will be available in the futureor that, if available, we will be able to obtain it on terms favorable to us.

**OperatingActivities**

Our primary source of operating cash flows is revenuefrom the sale of software licenses and the provision of, maintenance andsupport services, and post-sale consulting and training. Our primary use ofcash from operating activities is for compensation and personnel relatedexpenditures. For the six months ended September 30, 2005 the Company used$15.9 million of cash in operating activities. We reported a 

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net loss of $18.1 millionand cash outflows from changes in working capital and other of $11.8 million.These were partially offset by non-cash charges of $13.3 million foramortization and depreciation. Of the amortization charge, $11.6 millionwas related to the amortization of identifiable intangibles. Working capitaloutflows were primarily impacted by decreases in deferred revenue and accruedexpenses of $18.3 million and $1.6 million, respectively. Theseoutflows were offset, in part, by decreases in accounts receivable and otherassets of $6.5 million and $1.2 million, respectively, and anincrease in accounts payable of $0.3 million.

For the six months ended September 30,2004, our operations used $9.7 million in net cash. We reported a net lossof $18.9 million, including non-cash charges of $14.0 million foramortization and depreciation. Of the amortization charge, $11.6 millionwas related to the amortization of identifiable intangibles.

**InvestingActivities**

Our primary use of cash in investing activities is thepurchase of property and equipment. For the six months ended September 30,2005, the Company used $3.3 million of net cash for investing activitiesprimarily related to $2.8 million in capital expenditures (e.g. computers anddata processing equipment, leasehold improvements).

For the six months endedSeptember 30, 2004, the Company used $9.6 million of net cash for investingactivities primarily related to the purchase of $8.0 million of marketablesecurities, net of sales proceeds, and $1.8 million in capital expenditures(e.g. computers and data processing equipment, leasehold improvements).

**FinancingActivities**

Our primary source of cash from financing activitieshas been from the issuance of common stock under our employee stock optionplan. Our primary use of cash in financing has been for repayment ofoutstanding debt. For the six months ended September 30, 2005, the Companyrepaid $10.3 million in long-term debt, which was offset in part by a$0.5 million refund of fees paid to factor banks in connection withfactored receivables arrangements that are no longer outstanding and $0.3million received in connection with the issuance of shares of common stock uponexercise of employee stock options.

For the six months ended September 30,2004, the Company used $13.1 million in financing activities. Thesepayments primarily reflect repayment of the principal and interest on factorloans.

**Bankruptcy Claims**

We began paying claims on the effective date of theReorganization Plan and continue to pay as claims are settled, liquidated, orotherwise resolved. Through September 30, 2005, we have paid, settled orotherwise disposed of Class 8 claims with an original aggregate faceamount of approximately $383.6 million. To resolve these claims we havepaid or agreed to pay over time approximately $45.0 million in cash. As ofSeptember 30, 2005, there were general unsecured claims asserted in theoriginal aggregate face amount of approximately $0.3 million remaining tobe resolved. Bankruptcy claims to be paid in cash over time at September 30,2005 total $36.1 million. For more information on the status of claimslitigation, see “Legal Proceedings—Bankruptcy Reorganization; ClaimsLitigation; Class 7/9 Reserve Shares,” beginning on page 30 of thisreport.

**RISK FACTORS**

There are significant riskfactors that currently affect or may affect our business, financial conditionor operating results. Prior to the filing of this Quarterly Report on Form 10-Q,we have not filed our periodic reports with the SEC on a timely basis. Readersshould carefully consider these factors before making an 

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investmentdecision with respect to our common stock. These risk factors are detailedbeginning on page 34 in our Amendment No. 1 to the Annual Report on Form 10-K/Afor the fiscal year ended March 31, 2005, filed with the SEC on October 18,2005.

**ITEM 3.**                QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As of September 30,2005, there were no material changes to the information previously reportedunder Item 7A in our Amended Form 10-K.

**ITEM 4.**                CONTROLSAND PROCEDURES

**EVALUATION OFDISCLOSURE CONTROLS AND PROCEDURES**

We maintain disclosure controls and procedures as suchterm is defined in Rules 13a-15(e) and 15d-15(e) ofthe Exchange Act. These controls and procedures are designed to ensure thatinformation required to be disclosed by us in reports that we file or submitunder the Exchange Act is recorded, processed, summarized, and reported withinthe time periods specified in SEC rules and forms, and that suchinformation is accumulated and communicated to our management, including ourchief executive officer and chief financial officer, as appropriate, to allowtimely decisions regarding required public disclosure.

As of September 30, 2005, management carried outan assessment, under the supervision of and with the participation of our chiefexecutive officer and the chief financial officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures pursuant toExchange Act Rules 13a-15(b) and 15d-15(b). As of thedate of this assessment, the chief executive officer and the chief financialofficer concluded that our disclosure controls and procedures were noteffective because of the material weaknesses described in our Amended Form 10-K.

In view of the fact that the financial informationpresented in this report was prepared in the absence of effective internalcontrol over financial reporting, we have devoted a significant amount of timeand resources to the analysis of the financial statements contained in thisreport. In particular, we have reviewed all significant account balances andtransactions reflected in the financial statements contained in this report andotherwise analyzed the transactions underlying our financial statements toverify the accuracy of the financial statements contained in this report.Accordingly, management believes that the financial statements included in thisreport fairly present, in all material respects, our financial condition,results of operations, and cash flows.

Our Amended Form 10-Kincludes (i) Management’s Report on Internal Control over Financial Reporting,which concludes that the Company’s internal control over financial reporting isnot effective, (ii) an unqualified report of the Company’s independentregistered public accounting firm on management’s assessment and (iii) anadverse opinion of the Company’s independent registered public accounting firmon the effectiveness of the Company’s internal control over financialreporting, each as of March 31, 2005.

**CHANGES IN INTERNALCONTROL OVER FINANCIAL REPORTING**

There were not any material changes to our internalcontrol over financial reporting during the quarter ended September 30,2005 that management believes have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting thatwere not described in our Amended Form 10-K. During the three andsix months ended September 30, 2005, we continued efforts to remedy thedeficiencies in our internal control over financial reporting.

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**PART II—OTHER INFORMATION**

**ITEM 1.**                LEGALPROCEEDINGS

**FederalGovernment Investigations and Proceedings Pertaining to Historical AccountingIrregularities**

*GovernmentInvestigations.**  *Inearly 2002, the DOJ and SEC opened investigations into Peregrine and certainformer Peregrine employees pertaining to the accounting improprieties that tookplace prior to 2002. As a result of the DOJ’s investigation, a number of ourformer employees, including our former chief financial officer, treasurer,assistant treasurer and two sales executives have pleaded guilty to variousfelony charges and are awaiting sentencing. A former managing director of KPMGConsulting has also pleaded guilty to felony counts in connection with theseevents. A number of other former employees, including our former chiefexecutive officer and chairman, chief operating officer, two executive vicepresidents of worldwide sales, vice president of finance and chief accountingofficer, and other sales and finance personnel have been charged with variousfelonies in connection with these accounting irregularities and are awaitingtrial. An Arthur Andersen partner who formerly was our lead auditor also wasindicted in connection with these events. The criminal charges generally relateto the manipulation of our apparent financial condition, misleading investors,hindering the government’s investigation or conspiracy. In most of these cases,the SEC filed a civil action against the individuals alleging violations of theSecurities Act, the Exchange Act and the rules promulgated thereunder.

*Our Settlement with theSecurities and Exchange Commission.**  *In June 2003, the SEC filed apartially-settled civil action against Peregrine in the United StatesDistrict Court for the Southern District of California alleging violations ofthe Securities Act, the Exchange Act and the rules promulgated thereunder.In the same month, our settlement with the SEC was approved by the UnitedStates District Court for the Southern District of California, resolving allthe matters raised in the civil action, except the request for a civil penaltyand disgorgement. The SEC separately withdrew the request for monetary damagesand disgorgement in July 2003. Under the terms of the settlement, weagreed, among other things, to:

·       Beenjoined from violating federal securities laws;

·       Complyon an accelerated basis with the rules regarding management’s reporting oninternal control over financial reporting in accordance with the Sarbanes-OxleyAct of 2002;

·       Retainan internal auditor to assist with the accurate reporting of our financialresults;

·       Establisha corporate compliance program and retain a compliance officer to perform acontinuous review of the effectiveness of our governance systems;

·       Commencea training program for our officers and employees to prevent violations offederal securities laws; and

·       Makea public statement that fully and accurately disclosed the condition of ourinternal control structure and our procedures for financial reporting on theeffective date of our Reorganization Plan.

*Continuing Investigations.**  *The SEC and the DOJ are continuingtheir investigations and we are fully cooperating with them in theseinvestigations and as they prepare for the trials involving former employeesand others. Since we have not filed our SEC periodic reports on a timely basis,we have not been in compliance with the requirement of our settlement with theSEC pertaining to refraining from violating federal securities laws. To ourknowledge, the SEC is not considering a further enforcement action against usand neither Peregrine nor any current employee is a target of an ongoinginvestigation, but we can not be sure that a further enforcement action orcriminal proceeding will not be brought against us. Responding to any suchactions could be expensive and time-consuming for management and could have 

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an adverse effecton our reputation and ability to generate sales. Readers should carefullyreview the information set forth under the caption “Risk Factors,” beginning onpage 34 of our Amendment No. 1 to our fiscal 2005 Annual Report on Form 10-K/Afiled with the SEC on October 18, 2005.

**StockholderLitigation Pertaining to Historical Accounting Irregularities as to WhichPeregrine is No Longer a Party**

During May and June 2002,a number of purported class action complaints were filed against Peregrine onbehalf of purchasers of its securities during various periods from 1999 to2002. The complaints alleged false and misleading statements in SEC filings,financial statements and other public statements and asserted claims forviolations of federal securities laws. The complaints were ultimatelyconsolidated into an action before the United States District Court for theSouthern District of California (the “Federal Securities Action”). In January 2003,the District Court entered an order designating a group of individualsidentified as the Loran Group as lead plaintiff with respect to claims arisingfrom violations of Sections 10(b) and 20(a) of the Securities Act andHeywood Waga as lead plaintiff with respect to claims arising from violationsof Section 11 of the Exchange Act. In November 2003, the BankruptcyCourt certified a class consisting of persons who acquired Peregrine securitiesfrom July 22, 1999 through May 3, 2002, led by the Loran Group andHeywood Waga (the “Securities Class”), and a class, consisting of personsholding the Predecessor Company’s common stock as of the effective date of theReorganization Plan (the “Equity Class”). The Securities Class and theEquity Class were certified by the Bankruptcy Court solely for purposes ofallowing them to enter into a settlement agreement with Peregrine to resolvethe allocation of new common stock among the various interests in Class 9under our Reorganization Plan, consisting of the Securities Class, the Equity Class andcertain of our former directors and officers asserting indemnity claimsrelating to lawsuits filed against them (the “Indemnification Class”). TheBankruptcy Court’s order approving the settlement agreement resolved thestockholder claims against us and we are not a party to the Federal SecuritiesAction.

**PeregrineLitigation Trustee Action to Which Peregrine is Not a Party**

Under our ReorganizationPlan, an independent litigation trust was established and initially funded with$3.2 million in cash and 708,750 shares of new common stock. With limitedexceptions, potential claims and causes of action we had against our formerofficers and directors for negligence, breach of fiduciary duty, insidertrading or any other breaches of duty imposed by law, all potential claims wehad against our former auditor Arthur Andersen relating to accounting servicesprovided to us, claims brought by third parties against some of our formerdirectors and officers purportedly on our behalf as derivative claims, andcertain other claims, were transferred to the litigation trust. The assignedtrustee (the “Litigation Trustee”) has the authority to prosecute, abandon,release, settle or otherwise dispose of these claims at the trustee’s solediscretion, without the consent, authority or approval of any third parties,including the Bankruptcy Court, except that the lead plaintiffs in the FederalSecurities Action must consent in advance to any release, settlement,compromise or liquidation of claims. We are required under a Bankruptcy Courtstipulation and the litigation trust agreement to provide the LitigationTrustee with access to our books and records, to make our employees availableas witnesses and to be available for depositions, interviews and otherproceedings. In February 2004, the Litigation Trustee filed suit inCalifornia Superior Court in San Diego County against a number of our formerdirectors and officers under theories of insider trading, breach of fiduciaryduty, waste of corporate assets, conspiracy and unjust enrichment (the “LitigationTrustee Action”). The trustee also is pursuing claims against Arthur Andersenfor violations of the federal securities laws in connection with accountingservices Arthur Andersen provided to us. The Litigation Trustee Action isongoing, but we are not a party to it. All of the proceeds resulting from theLitigation Trustee Action, if any, are for the benefit of the Securities Class andwe are not entitled to receive any such proceeds.

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**BankruptcyReorganization; Claims Litigation; Class 7/9 Reserve Shares**

On September 22, 2002, the Company and itswholly-owned subsidiary, Peregrine Remedy, Inc., filed voluntary petitionsunder Chapter 11 of the U.S. Bankruptcy Code. The plan of reorganizationof the Company (the “Reorganization Plan”) was confirmed by the U.S. BankruptcyCourt in the District of Delaware (the “Bankruptcy Court”) on July 18,2003, and it became effective on August 7, 2003. Unless otherwiseindicated, all references to “old common stock” pertain to the Company’s commonstock, par value $0.001 per share, that was cancelled on August 7, 2003 inconnection with the Company’s emergence from Chapter 11 bankruptcyproceedings, and all references to “new common stock” pertain to the Company’scommon stock, par value $0.0001 per share, from and after the effective date ofthe Reorganization Plan. References to the “Predecessor Company” herein pertainto the fiscal periods prior to and including July 18, 2003. 

*Class 8General Unsecured Claims.**  *Approximately 1,200 general unsecured claims werefiled against the Predecessor Company based on events that took place prior tothe bankruptcy filing. The Company began paying claims on the effective date ofthe Reorganization Plan and continues to pay based on settlement terms or asclaims are settled. Through September 30, 2005, in order to resolve theseclaims, the Company has paid or agreed to pay over time approximately$45.0 million in cash. As of September 30, 2005, there were generalunsecured claims asserted in the original aggregate face amount ofapproximately $0.3 million remaining to be resolved. Bankruptcy relatedclaims to be paid in cash over time at September 30, 2005 total $36.1million. The Company believes amounts accrued at September 30, 2005 aresufficient to resolve the claims.

*Class 7/9Reserve Shares.**  *Underour Reorganization Plan, 600,000 shares of new common stock (the “Class 7/9Reserve Shares”), representing 4% of the 15,000,000 shares of new common stockissued on the effective date of the Reorganization Plan, were held in reserveby Peregrine, in its capacity as stock disbursing agent under theReorganization Plan, to be allocated between Class 7 and Class 9. Theallocation is based on whether the amount finally paid to resolve Class 8claims falls below, within, or above the range of $49.0 million and$65.0 million, which were the estimates of Class 8 paymentsdetermined by the various constituencies in the bankruptcy proceedings. As theCompany has determined that the final amount needed to resolve Class 8claims will be below $49.0 million, all of these 600,000 shares wereallocated to Class 9. As a result of the Class 9 settlement, theEquity Class within Class 9 (i.e. holders, as of the effectivedate of the Reorganization Plan, of the Predecessor Company’s common stock)were entitled to receive 85%, or 510,000, of such shares and the Securities Class withinClass 9 (i.e. purchasers of old common stock involved in a classaction brought against the Predecessor Company that was resolved in theReorganization Plan) were entitled to receive 15%, or 90,000, of such shares.The Class 7/9 Reserve Shares were distributed in a process that began on August 30,2005. 

*Administrative Claims andLuddy v. Peregrine.**  *Administrativeclaims are claims related to obligations we purportedly incurred after we filedfor bankruptcy law protection during the administrative period of thebankruptcy case. In order to be paid, administrative claims must meet certainrequirements under the Reorganization Plan and bankruptcy laws. The onlymaterial remaining administrative claim is a claim asserted by our former chieftechnology officer, Frederic Luddy. In May 2004, Mr. Luddy filed acomplaint against us in the Court of Chancery for the State of Delaware seekingadvancement of certain legal fees and expenses. Mr. Luddy’s complaintalleged that Peregrine is required to advance or reimburse him for his defenseexpenses in connection with the Federal Securities Action and the LitigationTrustee Action. His complaint also alleged that, pursuant to a paragraph of theBankruptcy Court’s order confirming our Reorganization Plan, his indemnityclaim can be pursued in state court. In June 2004, we removed Mr. Luddy’scomplaint from Delaware state court to the Bankruptcy Court. In November 2004,the Bankruptcy Court found that it had jurisdiction to consider the complaint.At the same time, the Bankruptcy Court granted in part and denied in part ourmotion to dismiss, without prejudice to our right to renew the motion laterafter discovery and formal fact finding. On February 23, 2005, Mr. Luddyfiled 

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an amendedcomplaint, which we answered on March 15, 2005. Discovery has not yetcommenced and no trial date has been set. OnOctober 25, 2005, Mr. Luddy and the Company signed a settlementagreement to resolve the issues raised in Mr. Luddy’s complaint. Thesettlement agreement will become effective 10 days after it is approved by theBankruptcy Court. If approved in its current form by the Bankruptcy Court, the settlementagreement will not materially affect the Company’s financial position, resultsof operations or liquidity.

**LitigationRegarding the Latham Report**

To assist the SEC in its investigation, in August 2002we provided to the SEC, pursuant to a confidentiality agreement, an extensivereport and supporting materials containing the preliminary findings andconclusions of our outside counsel, Latham & Watkins, regarding itsinvestigation into, among other things, our accounting irregularities (the “LathamReport”). After our bankruptcy law filing in September 2002, the OfficialCommittee of Unsecured Creditors of the Company and Peregrine Remedy, Inc.(“Remedy”) appointed in the cases commenced under Chapter 11 of the U.S.Bankruptcy Code by the Company and Remedy filed a motion to appoint a trusteeand, as an exhibit to their motion, filed a copy of the Latham Report underseal. Thereafter, Copley Press, Inc. (“Copley”), which owns the *San Diego Union Tribune*, petitioned theBankruptcy Court to unseal the pleadings and other documents filed under seal,including the Latham Report. We opposed the unsealing of the Latham Report. Atthe hearing on Copley’s motion, the Bankruptcy Court held that the LathamReport had been improperly filed, and struck it from the record. Copleyappealed the Bankruptcy Court’s decision to the United States District Courtfor the District of Delaware. On July 12, 2004, the District Court issueda decision reversing the Bankruptcy Court’s decision and ordering theBankruptcy Court to have the Latham Report returned to the record, under seal,and to engage in an access analysis to determine what portions of the LathamReport, if any, should be unsealed. We appealed the District Court’s decisionto the United States Court of Appeals for the Third Circuit. On April 22,2005, as required by the District Court’s order, and by agreement betweenCopley and Peregrine, we filed a partially redacted version of the LathamReport and a proposed court order with the Bankruptcy Court. The filing madethe unredacted portions of the report a part of the public record. Under theproposed order, the redacted portions of the report would be deemed sealed andwould not be a part of the public record. The sealing of the redacted text wasbased on a compromise between Copley and Peregrine, without prejudice to ourrespective positions, and is not based on any judicial predetermination ofcause or justification, or lack thereof, for such sealing. Copley or otherparties could move to unseal additional portions of the report, subject to aprocess that is defined in the proposed order. On September 13, 2005, wedismissed our appeal to the Third Circuit. 

The Latham Report also hasbeen filed in court, under provisional seal, by John J. Moores, a formerdirector, in connection with the Federal Securities Action and the Litigation TrusteeAction. Mr. Moores filed the Latham Report, under temporary seal, in bothactions in connection with motions to dismiss the complaints against him. Wehave filed motions in both cases to have the Latham Report stricken from therecord or, as an alternative, to have the Latham Report, or portions of it,permanently sealed. On February 2, 2005, the District Court in the FederalSecurities Action ruled, among other things, that the Latham Report would notbe stricken from the record, but that it would remain under seal pending anyfurther applications to unseal it. Similarly, in the Litigation Trustee Action,we have entered into an agreed stipulation and order with Mr. Mooresproviding that the unredacted Latham Report filed by him in that action under temporaryseal would remain under seal pending any further motions to unseal to bebrought by Mr. Moores and other parties in interest. No such motion hasbeen brought to date. In the criminal actions against former Peregrineemployees and others pending in the U.S. District Court for the SouthernDistrict of California, a protective order was entered on February 28,2005 to provide limited protection for the confidential information ofnonparties, such as the Latham Report and other Peregrine confidential information.

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**Other Litigation**

We are also involved inlegal proceedings, claims, and litigation arising from the ordinary course ofbusiness. Although the ultimate results of these legal proceedings, claims andlitigation are not currently determinable, in the opinion of management thesematters will not materially affect our financial position, results of operationor liquidity.

**ITEM 2.**                UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS

On July 20, September 14,September 15, September 22, and September 29, 2005 we issued toformer employees 154 shares, 105 shares, 47 shares, 25,352 shares and 1,584shares, respectively, of our new common stock for exercise prices of $15.62 forall the transactions but the September 22, 2005 sales, for which theexercise price was $9.94, and for aggregate purchase prices of $3,080, $1,995,$900, $641,279 and $40,075, respectively, upon the exercise of vested optionsby these former employees. These shares were issued without registration inreliance on the exemption provided by Section 3(A)(7) of theSecurities Act, and comparable provisions of state securities laws, forsecurities issued in connection with the approval and an order of the U.S.Bankruptcy Court pursuant to our prior bankruptcy proceedings.

**ITEM 3.**                DEFAULTSUPON SENIOR SECURITIES

None.

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

**ITEM 5.**                OTHERINFORMATION

None.

**ITEM 6.**                EXHIBITS

Thefollowing are filed as exhibits to this Quarterly Report on Form 10-Q:
| 31.1 | Certification of the Chief Executive Officer  pursuant to § 302 of the Sarbanes-Oxley Act of 2002.  |
|------|---------------------------------------------------------------------------------------------------------------|
| 31.2 | Certification of the  Chief Financial Officer pursuant to § 302 of the Sarbanes-Oxley  Act of 2002. |
| 32.1 | Certification of the  Chief Executive Officer pursuant to § 906 of the Sarbanes-Oxley  Act of 2002. |
| 32.2 | Certification of the  Chief Financial Officer pursuant to § 906 of the Sarbanes-Oxley  Act of 2002. |

 

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
| Date: November 9, 2005 | PEREGRINE SYSTEMS, INC. |
|-----------------------------|-------------------------|
|                        | (Registrant)            |
|                        | By:                     | /s/ KENNETH J. SAUNDERS |
|                        |                    | *Executive Vice President & Chief  Financial  Officer (Principal Financial Officer and  Authorized Signatory)* |

 

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