**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

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FORM 10-Q
| **(Mark One)**                                                                                                                                                           |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **x**                                                                                                                                                                    | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| **For the Quarterly Period Ended December 31,  2004**                                                                                                               |
| **OR**                                                                                                                                                                   |
| **o**                                                                                                                                                                    | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| **For the transition period from           to           ** |

 

**CommissionFile Number 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.) |

 

**3611VALLEY 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 mark whetherthe 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 o  No x

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

Indicate by check mark whether the Registrant hasfiled all documents and reports required to be filed by Section 12, 13 or15(d) of the Securities Exchange Act of 1934 subsequent to thedistribution of securities under a plan confirmed by a court. Yes o  No x

Thenumber of shares of the Registrant’s common stock outstanding on March 31,2005 was 15,074,216.

 

 

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**PEREGRINESYSTEMS, INC.QUARTERLY REPORT ON FORM 10-QTABLE 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 |   | 21 |
| ITEM 3.                            | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                 |   | 43 |
| ITEM 4.                            | CONTROLS  AND PROCEDURES                                                                    |   | 43 |
| PART II—OTHER INFORMATION     |                                                                                        |   |
| ITEM 1.                            | LEGAL  PROCEEDINGS                                                                          |   | 48 |
| ITEM 2.                            | UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                |   | 50 |
| ITEM 3.                            | DEFAULTS  UPON SENIOR SECURITIES                                                            |   | 50 |
| ITEM 4.                            | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                        |   | 50 |
| ITEM 5.                            | OTHER  INFORMATION                                                                          |   | 50 |
| ITEM 6.                            | EXHIBITS                                                                                    |   | 51 |
| SIGNATURES                              |                                                                                        | 52     |
| CERTIFICATIONS                          |                                                                                        |   |

 

2

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**PART I—FINANCIAL INFORMATION**

**ITEM 1.     UNAUDITEDFINANCIAL STATEMENTS**

**PEREGRINE SYSTEMS, INC.Condensed ConsolidatedBalance Sheets(in thousands, except share data, unaudited)**
| ** **                                                                                                                                                   | ** ** | **Successor Company**      | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                                   | ** ** | **December 31, 2004** | ** ** | **March 31, 2004** | ** ** |
| **ASSETS**                                                                                                                                                   |       |                            |       |   |   |   |   |   |   |
| Current Assets:                                                                                                                                              |       |                            |       |   |   |   |   |   |   |
| Cash and cash  equivalents                                                                                                                                   |       |                            | $          | 75,149 |   |   |   | $ | 105,946 |   |   |
| Cash—restricted                                                                                                                                         |       |                            | 4,782      |   |   |   | 4,654 |   |   |
| Marketable securities                                                                                                                                        |       |                            | 8,000      |   |   |   | — |   |   |
| Accounts receivable, net  of allowance for doubtful accounts                                                                                                 |       |                            | 53,752     |   |   |   | 39,113 |   |   |
| Deferred taxes                                                                                                                                               |       |                            | 4,707      |   |   |   | 4,660 |   |   |
| Other current assets                                                                                                                                         |       |                            | 9,638      |   |   |   | 13,395 |   |   |
| Total current assets                                                                                                                                         |       |                            | 156,028    |   |   |   | 167,768 |   |   |
| Property and equipment,  net                                                                                                                                 |       |                            | 8,531      |   |   |   | 7,507 |   |   |
| Identifiable intangible  assets, net                                                                                                                         |       |                            | 93,126     |   |   |   | 108,889 |   |   |
| Goodwill                                                                                                                                                     |       |                            | 185,701    |   |   |   | 183,650 |   |   |
| Investments and other  assets                                                                                                                                |       |                            | 1,364      |   |   |   | 4,974 |   |   |
| Total assets                                                                                                                                                 |       |                            | $          | 444,750 |   |   |   | $ | 472,788 |   |   |
| **LIABILITIES & STOCKHOLDERS’ EQUITY**                                                                                                         |       |                            |       |   |   |   |   |   |   |
| Current Liabilities:                                                                                                                                         |       |                            |       |   |   |   |   |   |   |
| Accounts payable                                                                                                                                             |       |                            | $          | 2,859 |   |   |   | $ | 6,581 |   |   |
| Accrued expenses                                                                                                                                             |       |                            | 78,936     |   |   |   | 65,454 |   |   |
| Current portion of  deferred revenue                                                                                                                         |       |                            | 66,493     |   |   |   | 69,532 |   |   |
| Current portion of notes  payable                                                                                                                            |       |                            | 18,170     |   |   |   | 22,853 |   |   |
| Total current  liabilities                                                                                                                                   |       |                            | 166,458    |   |   |   | 164,420 |   |   |
| Non-current Liabilities:                                                                                                                                     |       |                            |       |   |   |   |   |   |   |
| Deferred revenue, net of  current portion                                                                                                                    |       |                            | 5,558      |   |   |   | 5,646 |   |   |
| Notes payable, net of  current portion                                                                                                                       |       |                            | 36,232     |   |   |   | 46,467 |   |   |
| Deferred taxes                                                                                                                                               |       |                            | 5,979      |   |   |   | 6,644 |   |   |
| Total non-current  liabilities                                                                                                                               |       |                            | 47,769     |   |   |   | 58,757 |   |   |
| Contingencies—Note 9                                                                                                                               |       |                            |       |   |   |   |   |   |   |
| 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                                                                                                                                  |       |                            | 271,088    |   |   |   | 270,004 |   |   |
| Subscriptions receivable                                                                                                                                     |       |                            | (64        | ) |   |   | (64 | ) |   |
| Accumulated deficit                                                                                                                                          |       |                            | (34,853    | ) |   |   | (17,868 | ) |   |
| Accumulated other  comprehensive loss                                                                                                                        |       |                            | (5,650     | ) |   |   | (2,463 | ) |   |
| Total stockholders’  equity                                                                                                                             |       |                            | 230,523    |   |   |   | 249,611 |   |   |
| Total liabilities and stockholders’ equity                                                                                                              |       |                            | $          | 444,750 |   |   |   | $ | 472,788 |   |   |

 

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

3

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**PEREGRINE SYSTEMS, INC.Condensed ConsolidatedStatements of Operations(in thousands, except per share amounts; unaudited)**
| ** **                                       | ** ** | **Successor Company**                                | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                       | ** ** | **Three Months  Ended  December 31, 2004** | ** ** | **Three MonthsEnded  December 31, 2003** | ** ** |
| **Revenue:**                                     |       |                                                      |       |   |   |   |   |   |   |
| Licenses                                         |       |                                                      | $          | 22,253 |   |   |   | $ | 17,229 |   |   |
| Maintenance                                      |       |                                                      | 28,312     |   |   |   | 24,061 |   |   |
| Consulting and training                          |       |                                                      | 4,666      |   |   |   | 3,423 |   |   |
| **Total revenue**                                |       |                                                      | 55,231     |   |   |   | 44,713 |   |   |
| **Costs and Expenses:**                          |       |                                                      |       |   |   |   |   |   |   |
| Cost of licenses                                 |       |                                                      | 442        |   |   |   | 596 |   |   |
| Cost of maintenance                              |       |                                                      | 4,826      |   |   |   | 4,185 |   |   |
| Cost of consulting and training                  |       |                                                      | 4,885      |   |   |   | 3,718 |   |   |
| Sales and marketing                              |       |                                                      | 17,678     |   |   |   | 13,519 |   |   |
| Research and development                         |       |                                                      | 7,639      |   |   |   | 7,077 |   |   |
| General and administrative                       |       |                                                      | 13,612     |   |   |   | 11,196 |   |   |
| Amortization of intangible assets                |       |                                                      | 5,810      |   |   |   | 5,754 |   |   |
| **Total operating costs and expenses**           |       |                                                      | 54,892     |   |   |   | 46,045 |   |   |
| **Operating  income (loss)**                     |       |                                                      | 339        |   |   |   | (1,332 | ) |   |
| Foreign currency transaction gains (losses), net |       |                                                      | 3,728      |   |   |   | (540 | ) |   |
| Reorganization items, net                        |       |                                                      | (387       | ) |   |   | (1,857 | ) |   |
| Interest income                                  |       |                                                      | 384        |   |   |   | 249 |   |   |
| Interest expense                                 |       |                                                      | (957       | ) |   |   | (1,276 | ) |   |
| Other income                                     |       |                                                      | 250        |   |   |   | — |   |   |
| **Income  (loss) before income taxes**           |       |                                                      | 3,357      |   |   |   | (4,756 | ) |   |
| Income tax expense                               |       |                                                      | (1,452     | ) |   |   | (1,667 | ) |   |
| **Net income (loss)**                            |       |                                                      | $          | 1,905 |   |   |   | $ | (6,423 | ) |   |
| **Net income (loss) per share,  basic:**         |       |                                                      |       |   |   |   |   |   |   |
| Net income (loss) per share                      |       |                                                      | $          | 0.13 |   |   |   | $ | (0.43 | ) |   |
| Basic shares used in computation                 |       |                                                      | 15,069     |   |   |   | 15,000 |   |   |
| **Net income (loss) per share,  diluted:**       |       |                                                      |       |   |   |   |   |   |   |
| Net income (loss) per share                      |       |                                                      | $          | 0.13 |   |   |   | $ | (0.43 | ) |   |
| Diluted shares  used in computation              |       |                                                      | 15,179     |   |   |   | 15,000 |   |   |

 

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

4

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**PEREGRINESYSTEMS, INC.Condensed Consolidated Statements of Operations(in thousands, except per share amounts; unaudited)**
| ** **                                                        | ** ** | ** **                      | ** ** | ** **                      | **Predecessor ** | ** ** |
|-------------------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|-----------------------|------------|
| ** **                                                        | ** ** | **Successor Company**      | ** ** | ** **                      | **Company**           | ** ** |
| ** **                                                        | ** ** | **Nine Months **      | ** ** | **166 Days**               | ** **            | ** ** | **109 Days** | ** ** |
| ** **                                                        | ** ** | **Ended**                       | ** ** | **Ended**                       | ** **            | ** ** | **Ended** | ** ** |
| ** **                                                        | ** ** | **December 31, 2004** | ** ** | **December 31, 2003** | ** **            | ** ** | **July 18, 2003** | ** ** |
| **Revenue:**                                                      |       |                            |       |                            |                  |       |   |   |   |   |   |   |   |   |
| Licenses                                                          |       |                            | $          | 49,021                          |                  |       |   | $ | 31,281 |   |   |   |   | $ | 13,525 |   |   |
| Maintenance                                                       |       |                            | 81,864     |                            |                  |       | 41,853 |   |   |   |   | 29,176 |   |   |
| Consulting and training                                           |       |                            | 12,454     |                            |                  |       | 6,799 |   |   |   |   | 5,954 |   |   |
| **Total revenue**                                                 |       |                            | 143,339    |                            |                  |       | 79,933 |   |   |   |   | 48,655 |   |   |
| **Costs  and Expenses:**                                          |       |                            |       |                            |                  |       |   |   |   |   |   |   |   |   |
| Cost of licenses                                                  |       |                            | 1,164      |                            |                  |       | 906 |   |   |   |   | 706 |   |   |
| Cost of maintenance                                               |       |                            | 13,804     |                            |                  |       | 7,626 |   |   |   |   | 5,152 |   |   |
| Cost of consulting and training                                   |       |                            | 13,180     |                            |                  |       | 7,089 |   |   |   |   | 5,289 |   |   |
| Sales and marketing                                               |       |                            | 49,535     |                            |                  |       | 22,889 |   |   |   |   | 14,588 |   |   |
| Research and development                                          |       |                            | 21,971     |                            |                  |       | 12,994 |   |   |   |   | 8,908 |   |   |
| General and administrative                                        |       |                            | 38,623     |                            |                  |       | 19,411 |   |   |   |   | 13,953 |   |   |
| Amortization of intangible assets                                 |       |                            | 17,424     |                            |                  |       | 10,456 |   |   |   |   | — |   |   |
| Restructuring and other                                           |       |                            | —     |                            |                  |       | — |   |   |   |   | (1,239 | ) |   |
| **Total operating costs and expenses**                            |       |                            | 155,701    |                            |                  |       | 81,371 |   |   |   |   | 47,357 |   |   |
| **Operating  (loss) income from continuing operations**           |       |                            | (12,362    | )                               |                  |       | (1,438 | ) |   |   |   | 1,298 |   |   |
| Foreign currency transaction gains(losses), net                   |       |                            | 2,732      |                            |                  |       | (226 | ) |   |   |   | (998 | ) |   |
| Reorganization items, net                                         |       |                            | (1,533     | )                               |                  |       | (5,663 | ) |   |   |   | 378,821 |   |   |
| Interest income                                                   |       |                            | 966        |                            |                  |       | 623 |   |   |   |   | 618 |   |   |
| Interest expense                                                  |       |                            | (3,214     | )                               |                  |       | (2,787 | ) |   |   |   | (4,706 | ) |   |
| Other income                                                      |       |                            | 250        |                            |                  |       | — |   |   |   |   | — |   |   |
| **(Loss)  income from continuing operations before income taxes** |       |                            | (13,161    | )                               |                  |       | (9,491 | ) |   |   |   | 375,033 |   |   |
| Income tax expense on continuing operations                       |       |                            | (3,824     | )                               |                  |       | (2,327 | ) |   |   |   | (1,096 | ) |   |
| **(Loss)  income from continuing operations**                     |       |                            | (16,985    | )                               |                  |       | (11,818 | ) |   |   |   | 373,937 |   |   |
| Income from discontinued operations, net of income  taxes         |       |                            | —     |                            |                  |       | — |   |   |   |   | 252 |   |   |
| **Net (loss) income**                                             |       |                            | $          | (16,985                         | )                     |       |   | $ | (11,818 | ) |   |   |   | $ | 374,189 |   |   |
| **Net  (loss) income per share, basic:**                          |       |                            |       |                            |                  |       |   |   |   |   |   |   |   |   |
| (Loss) income per share from continuing operations                |       |                            | $          | (1.13                           | )                     |       |   | $ | (0.79 | ) |   |   |   | $ | 1.91 |   |   |
| Income per share from discontinued operations                     |       |                            | —     |                            |                  |       | — |   |   |   |   | — |   |   |
| Net (loss) income per share                                       |       |                            | $          | (1.13                           | )                     |       |   | $ | (0.79 | ) |   |   |   | $ | 1.91 |   |   |
| Basic shares used in computation                                  |       |                            | 15,048     |                            |                  |       | 15,000 |   |   |   |   | 195,654 |   |   |
| **Net  (loss) income per share, diluted:**                        |       |                            |       |                            |                  |       |   |   |   |   |   |   |   |   |
| (Loss) income per share from continuing operations                |       |                            | $          | (1.13                           | )                     |       |   | $ | (0.79 | ) |   |   |   | $ | 1.82 |   |   |
| Income per share from discontinued operations                     |       |                            | —     |                            |                  |       | — |   |   |   |   | — |   |   |
| Net (loss) income per share                                       |       |                            | $          | (1.13                           | )                     |       |   | $ | (0.79 | ) |   |   |   | $ | 1.82 |   |   |
| Diluted shares  used in computation                               |       |                            | 15,048     |                            |                  |       | 15,000 |   |   |   |   | 208,302 |   |   |

 

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

5

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**PEREGRINE SYSTEMS, INC.Condensed Consolidated Statements of Cash Flows(in thousands; unaudited)**
| ** **                                                                                                    | ** ** | **Successor Company**                               | ** ** | ** **                                            | **Predecessor  Company** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|-------------------------------------------------------|--------------------------|------------|
| ** **                                                                                                    | ** ** | **Nine Months  Ended  December 31, 2004** | ** ** | **166 Days  Ended  December 31, 2003** | ** **               | ** ** | **109 Days  Ended  July 18, 2003** | ** ** |
| **Cash flow from operating  activities:**                                                                     |       |                                                     |       |                                                  |                     |       |   |   |   |   |   |   |
| (Loss) income  from continuing operations                                                                     |       |                                                     | $          | (16,985                                               | )                        |       |   | $ | (11,818 | ) |   |   | $ | 373,937 |   |
| Adjustments to reconcile  (loss) income from continuing operations to net cash used in operating  activities: |       |                                                     |       |                                                  |                     |       |   |   |   |   |   |   |
| Depreciation and amortization                                                                                 |       |                                                     | 20,762     |                                                  |                     |       | 13,557 |   |   |   | 2,252 |   |
| Stock compensation expense                                                                                    |       |                                                     | 783        |                                                  |                     |       | — |   |   |   | 551 |   |
| Non-cash reorganization items                                                                                 |       |                                                     | (163       | )                                                     |                     |       | — |   |   |   | (393,901 | ) |
| Foreign currency transaction (gains) losses, net                                                              |       |                                                     | (2,732     | )                                                     |                     |       | 226 |   |   |   | 998 |   |
| Loss on disposal and abandonment of fixed assets                                                              |       |                                                     | 5          |                                                  |                     |       | — |   |   |   | 217 |   |
| Cash used to pay imputed interest portion of long-term  debt and factored receivables                         |       |                                                     | (1,045     | )                                                     |                     |       | — |   |   |   | — |   |
| Gain on sale of investments                                                                                   |       |                                                     | —     |                                                  |                     |       | — |   |   |   | (1,239 | ) |
| Cash used to pay reorganization items                                                                         |       |                                                     | (2,763     | )                                                     |                     |       | (449) |   |   |   | (42,877 | ) |
| Increase (decrease) in  cash resulting from changes in:                                                       |       |                                                     |       |                                                  |                     |       |   |   |   |   |   |   |
| Accounts receivable                                                                                           |       |                                                     | (11,567    | )                                                     |                     |       | (6,868 | ) |   |   | 11,534 |   |
| Other assets                                                                                                  |       |                                                     | 7,311      |                                                  |                     |       | 6,980 |   |   |   | 1,402 |   |
| Accounts payable                                                                                              |       |                                                     | (3,858     | )                                                     |                     |       | 2,098 |   |   |   | 2,630 |   |
| Accrued expenses                                                                                              |       |                                                     | 9,885      |                                                  |                     |       | (6,649 | ) |   |   | 3,970 |   |
| Deferred revenue                                                                                              |       |                                                     | (6,191     | )                                                     |                     |       | 7,098 |   |   |   | (11,131 | ) |
| **Net cash (used in) provided by operating  activities**                                                      |       |                                                     | (6,558     | )                                                     |                     |       | 4,175 |   |   |   | (51,657 | ) |
| **Cash flow from investing  activities:**                                                                     |       |                                                     |       |                                                  |                     |       |   |   |   |   |   |   |
| Purchases of property and equipment                                                                           |       |                                                     | (3,819     | )                                                     |                     |       | (1,336 | ) |   |   | (10 | ) |
| Proceeds from sale of property and equipment                                                                  |       |                                                     | 309        |                                                  |                     |       | — |   |   |   | — |   |
| Change in restricted cash                                                                                     |       |                                                     | (9         | )                                                     |                     |       | (1,006 | ) |   |   | 27,157 |   |
| Purchase of marketable securities                                                                             |       |                                                     | (25,000    | )                                                     |                     |       | — |   |   |   | — |   |
| Proceeds from sale of marketable securities                                                                   |       |                                                     | 17,000     |                                                  |                     |       | — |   |   |   | — |   |
| Collection of Remedy sale indemnification holdback                                                            |       |                                                     | —     |                                                  |                     |       | 10,000 |   |   |   | — |   |
| Sale of investments                                                                                           |       |                                                     | —     |                                                  |                     |       | — |   |   |   | 5,431 |   |
| **Net cash (used in) provided by investing  activities**                                                      |       |                                                     | (11,519    | )                                                     |                     |       | 7,658 |   |   |   | 32,578 |   |
| **Cash flow from financing  activities:**                                                                     |       |                                                     |       |                                                  |                     |       |   |   |   |   |   |   |
| Repayments of factored receivables                                                                            |       |                                                     | (4,342     | )                                                     |                     |       | (6,426 | ) |   |   | (24,282 | ) |
| Repayment of long-term debt                                                                                   |       |                                                     | (10,269    | )                                                     |                     |       | — |   |   |   | (86,516 | ) |
| Collection on subscriptions receivable                                                                        |       |                                                     | —     |                                                  |                     |       | — |   |   |   | 6 |   |
| Issuance of common stock, employee plans                                                                      |       |                                                     | 301        |                                                  |                     |       | 2 |   |   |   | — |   |
| **Net cash used in financing activities**                                                                     |       |                                                     | (14,310    | )                                                     |                     |       | (6,424 | ) |   |   | (110,792 | ) |
| **Effect of exchange rate fluctuations on cash**                                                              |       |                                                     | 1,590      |                                                  |                     |       | 1,957 |   |   |   | 1,057 |   |
| Net cash flow  from discontinued operations                                                                   |       |                                                     | —     |                                                  |                     |       | — |   |   |   | 2,565 |   |
| **Net  (decrease) increase in cash and cash equivalents**                                                     |       |                                                     | (30,797    | )                                                     |                     |       | 7,366 |   |   |   | (126,249 | ) |
| **Cash  and cash equivalents, beginning of period**                                                           |       |                                                     | 105,946    |                                                  |                     |       | 108,065 |   |   |   | 234,314 |   |
| **Cash and cash equivalents, end  of period**                                                                 |       |                                                     | $          | 75,149                                                |                     |       |   | $ | 115,431 |   |   |   | $ | 108,065 |   |

 

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

6

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**PEREGRINESYSTEMS, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**1.**   CompanyOperations

*Business*

Peregrine Systems, Inc. (the Company orPeregrine) is a global provider of enterprise software. Peregrine’s corebusiness is providing information technology asset and service managementsoftware solutions.

From the Company’s initialpublic offering in 1997 through the fiscal year ended March 31, 2002,Peregrine significantly expanded its product lines through a series ofacquisitions, broadening its business beyond its original core market. TheCompany began a major restructuring in 2002 amid concerns about liquidity. Thenon-core Supply Chain Enablement (SCE, comprising Harbinger and Extricity) andRemedy businesses were sold in June 2002 and November 2002,respectively, and are treated as discontinued operations in the consolidatedfinancial statements. During the fiscal year ended March 31, 2003,Peregrine sold other non-core product lines, including products used in fleetmanagement, facility management, telecommunications management, and travelmanagement. Peregrine’s core software product suites, after divestiture ofnon-core products, 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.

*BankruptcyProceedings and Restructuring Activities*

On September 22, 2002, Peregrine and its wholly-ownedsubsidiary, Peregrine Remedy, Inc. (Remedy), 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 for the District of Delaware (the Bankruptcy Court) on July 18, 2003and it became effective on August 7, 2003. From September 22, 2002until August 7, 2003, the Company operated the business as a Debtor-in-Possessionunder the jurisdiction of the Bankruptcy Court.

As a result of its bankruptcy filing underChapter 11, the Company was subject to the provisions of AmericanInstitute of Certified Public Accountants Statement of Position No. 90-7, “FinancialReporting of Entities in Reorganization under the Bankruptcy Code”(SOP 90-7), for the reporting periods subsequent to September 22,2002 through July 18, 2003. Pursuant to SOP 90-7, revenue, expenses(including professional fees), realized gains and losses, and provisions forlosses resulting from the reorganization of the business are reportedseparately as reorganization items.

For detailed informationon the Company’s bankruptcy proceedings and restructuring activities, pleasereview the information contained in Note 2 of the Company’s consolidatedfinancial statements contained in the Company’s Annual Report on Form 10-Kfor the period ended March 31, 2004, filed with the Securities andExchange Commission (SEC) on December 20, 2004.

*Fresh-StartReporting*

In accordance withSOP 90-7, the Company adopted fresh-start reporting as of July 18,2003 as the Company’s emergence from Chapter 11 bankruptcy proceedingsresulted in a new reporting basis. Under 

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fresh-startreporting, the reorganization value of the entity is allocated to the entity’sassets, based on fair values, and liabilities are stated at the present valueof amounts to be paid, determined at current interest rates. The effective dateof the new entity was considered to be the close of business on July 18,2003 for financial reporting purposes. The fiscal periods prior to andincluding July 18, 2003 pertain to what is designated the “PredecessorCompany,” while the fiscal periods subsequent to July 18, 2003 pertain towhat is designated the “Successor Company.” Where a financial statement itemapplies to both the Successor and Predecessor Companies, we refer to theCompany. As a result of the implementation of fresh-start reporting, thefinancial statements of the Successor Company after July 18, 2003 are notcomparable to the Predecessor Company’s financial statements for prior periodsand are separated by a black line to highlight this lack of comparability.

**2.   Summaryof Significant Accounting Policies**

*Basis ofPresentation*

The accompanying interim condensed consolidatedfinancial statements have been prepared, without audit, in accordance with theinstructions to Form 10-Q and, therefore, do not necessarily include allinformation and footnotes necessary for a fair statement of the Company’sconsolidated financial position, results of operations and cash flows inaccordance with accounting 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, discontinuedoperations and fresh-start adjustments that the Company considersnecessary to give a fair statement. These condensed consolidated financialstatements should be read in conjunction with the consolidated financialstatements included in the Company’s Annual Report on Form 10-K for theperiod ended March 31, 2004. Operating results for interim periods are notnecessarily indicative of operating results for an entire fiscal year.

*Use of Estimates*

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the U.S. requires the Company to make estimates and assumptionsthat may affect the reported amounts of assets and liabilities, the disclosureof contingent assets and liabilities, and the reported amounts of revenue andexpenses for the reporting periods. Actual results could differ from theestimates made by management with respect to these items and other items thatrequire management’s estimates. These estimates and assumptions include, butare not limited to, assessing the following: the recoverability of accountsreceivable, goodwill and other intangible assets, software development costsand deferred tax assets; the determination of the worldwide income taxprovision and associated liabilities; and the determination of whether feesinvoiced for license transactions are fixed or determinable and whethercollection of the associated receivable is probable.

*Revenue Recognition*

The Company recognizes revenue in accordance with theprovisions of Statement of Position No. 97-2, “Software RevenueRecognition,” as amended by SOP 98-4 and SOP 98-9 (SOP 97-2),and Staff Accounting Bulletin No. 101, “Revenue Recognition in FinancialStatements,” as amended by SAB 104, issued by the SEC. Peregrine’s revenueis derived principally from software product licensing and related services.The Company’s standard end-user license agreement provides for an initial feefor product use in perpetuity. License fees are generally due upon the grantingof the license. Maintenance revenue consists of fees for technical support andsoftware updates. Consulting and training revenue consists of fees earned forprofessional services provided to customers primarily on a time and material basis.

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Revenue from license agreements with direct customersis recognized when all of the following conditions are met: a non-cancelablelicense agreement has been signed; the product has been delivered; there are nomaterial uncertainties regarding customer acceptance; the fee is fixed ordeterminable; collection of the resulting receivable is deemed probable; riskof concession is deemed remote; and no other significant obligations of theCompany to the customer exist. In certain circumstances, the Company may grantextended payment terms. If a payment is due more than ninety days after thelicense agreement is signed, the license fees are recognized as payments becomedue and payable provided all other conditions for revenue recognition are met.If provided in a license agreement, acceptance provisions generally grantcustomers a right of refund only if the licensed software does not perform inaccordance with its published specifications. The Company believes thelikelihood of non-acceptance in these situations is remote and generallyrecognizes revenue when all other criteria of revenue recognition are met. Ifthe likelihood of non-acceptance cannot be determined to be remote, revenue isrecognized upon the earlier of receipt of written acceptance or when theacceptance period has lapsed.

Revenue from maintenance services is recognizedratably over the term of the support period, generally one year. Consultingrevenue is primarily related to installation and implementation services forthe Company’s software products, which are most often performed on a time andmaterial basis under separate service agreements. Consulting services are notusually essential to the functionality of the software. Revenue from consultingand training services is recognized as the respective services are performed.

For contracts with multiple obligations (e.g., currentand future product delivery obligations, post-contract support or otherservices) the Company recognizes revenue using the residual method. Under theresidual method, the Company allocates revenue to the undelivered elements ofthe contract based on vendor-specific objective evidence of their fairvalue. This objective evidence is the sales price of each element when soldseparately or the annual renewal rate specified in the agreement formaintenance. The Company recognizes revenue allocated to undelivered productswhen all other criteria for revenue recognition have been met.

The Company also derivesrevenue from the sale of its software licenses and maintenance services throughdistributors. Revenue from sales made through distributors is recognized whenthe distributors have sold the software licenses or services to their customersand the criteria for revenue recognition under SOP 97-2 are met. Revenuefrom maintenance services sold through distributors is recognized ratably overthe contractual period with the end user.

*MarketableSecurities*

Marketable securities areaccounted for in accordance with the provisions of Statement of FinancialAccounting Standards No. 115, “Accounting for Certain Investments in Debtand Equity Securities.” Available-for-sale securities are reported at fairvalue, with unrealized gains and losses excluded from earnings and reported ina separate component of stockholders’ equity. Management determines theappropriate classification of marketable debt and equity securities at the timeof purchase, and reevaluates this designation at each balance sheet date. Thecost of investments sold is based on the specific identification method. For individualsecurities classified as available-for-sale the Company determines whether adecline in fair value below the amortized cost basis is other than temporary.If the decline in fair value is judged to be other than temporary, the costbasis of the individual security is written down to fair value as a new costbasis and the amount of the write-down is included in earnings. The new costbasis is not changed for subsequent recoveries in fair value. Subsequentincreases in the fair value of available-for-sale securities are includedin other comprehensive income; subsequent decreases in fair value, if not another-than-temporary impairment, are also included in other comprehensiveincome.

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*Computation of NetIncome (Loss) Per Share*

Computation of net income (loss) per share isperformed in accordance with the provisions of Statement of FinancialAccounting Standards No. 128, “Earnings per Share” (SFAS 128).SFAS 128 requires the Company to compute basic and diluted earnings pershare data for all periods for which an income statement is presented. Basicearnings (loss) per share are computed by dividing net income (loss) by theweighted average number of common shares outstanding during the period.Potentially dilutive securities represent incremental shares issuable uponexercise of the Company’s equity and debt securities under the treasury stockmethod or the if-converted method.

For the three and nine months ended December 31,2004, the Successor Company’s diluted net income and loss per share,respectively, excludes the effect of approximately 0.4 million shares and0.3 million shares, respectively, issuable under employee stock options,because the options are anti-dilutive under the treasury stock method, astheir exercise prices were greater than the average market price of the Company’scommon stock for those periods. In addition, the Successor Company’s dilutednet loss per share for the nine months ended December 31, 2004 excludesthe effects of approximately 0.1 million potentially dilutive shares issuableunder employee stock options, as such options would be anti-dilutive given theCompany’s net loss for the period.

For the three months and the 166 days ended December 31,2003, the Successor Company’s diluted net loss per share excludes the effect ofapproximately 0.1 million shares and 1.0 million shares,respectively, issuable under employee stock options, because the options areanti-dilutive under the treasury stock method, as their exercise prices weregreater than the average market price of the Company’s common stock for theperiod. In addition, the Successor Company’s diluted net loss per share for thethree months ended December 31, 2003 excludes the effects of approximately0.2 million potentially dilutive shares, issuable under employee stockoptions, as such options would be anti-dilutive given the Company’s net lossfor the period.

Areconciliation of the numerators and denominators for the basic and diluted netincome per share from continuing operations calculations for the Successor Companyfor the three months ended December 31, 2004 and the Predecessor Companyfor the 109 days ended July 18, 2003 is presented below (inthousands):
| ** **                                                                                                                                     | ** ** | **Successor  Company**                              | ** ** | ** ** | **Predecessor  Company**                          | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                                                     | ** ** | **Three MonthsEnded  December 31,  2004** | ** ** | ** ** | **109 Days  Ended  July 18, 2003** | ** ** |
| Numerator:                                                                                                                                     |       |                                                |       |       |                                              |       |   |   |   |   |
| Income from continuing  operations for computation of basic income per share from continuing  operations                                       |       |                                                | $          | 1,905      |                                              |       |   |   | $373,937 |   |   |
| Add back interest  expense on convertible subordinated notes                                                                                   |       |                                                | —     |       |                                              |       |   | 4,435 |   |   |
| Income from continuing  operations for computation of diluted income per share from continuing  operations                                |       |                                                | $          | 1,905      |                                              |       |   |   | $378,372 |   |   |
| Denominator:                                                                                                                                   |       |                                                |       |       |                                              |       |   |   |   |   |
| Weighted-average  shares for computation of basic income per share from continuing  operations, excluding unvested restricted shares |       |                                                | 15,069     |       |                                              |       |   | 195,654 |   |   |
| Unvested restricted  shares                                                                                                                    |       |                                                | —     |       |                                              |       |   | 1,284 |   |   |
| Incremental shares on  assumed exercise of stock options, using the treasury stock method                                                 |       |                                                | 110        |       |                                              |       |   | 564 |   |   |
| Incremental shares on  assumed conversion of subordinated notes                                                                                |       |                                                | —     |       |                                              |       |   | 10,800 |   |   |
| Weighted-average shares for computation of  diluted income per share from continuing operations                                                |       |                                                | 15,179     |       |                                              |       |   | 208,302 |   |   |

 

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For the 109 daysended July 18, 2003, the Predecessor Company’s diluted income per sharefrom continuing operations and net income exclude the effect of approximately12.4 million shares, issuable under employee stock options, as inclusionwould be anti-dilutive under the treasury stock method, as their exerciseprices were greater than the average market price of the Company’s common stockfor the period.

*Recapitalization*

Pursuant to theReorganization Plan, the Company was recapitalized effective August 7,2003. In accordance with the Reorganization Plan, 15 million new shareswere issued and 2.65 million shares were reserved for issuance under stockoption plans. Based on a settlement reached in November 2003, holders ofthe Predecessor Company’s common stock received 4,016,250 new shares, or oneshare of the Successor Company’s common stock for every 48.7548 shares of thePredecessor Company’s common stock held. Historical shares and per-shareamounts of the Predecessor Company have not been restated to reflect thisrecapitalization because the Successor Company is considered a new reportingentity.

*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,” to accountfor its fixed stock option plans. Under this method, deferred compensation isrecorded on the date of grant only if the current market price of theunderlying stock exceeds the exercise price. Statement of Financial AccountingStandards No. 123, “Accounting for Stock-Based Compensation”(SFAS 123), established accounting and disclosure requirements using afair-value based method of accounting for stock-based employeecompensation plans. As allowed by SFAS 123, the Company has elected tocontinue to apply the intrinsic value-based method of accountingdescribed above, and has adopted the disclosure requirements of Statement ofAccounting Standards No. 148, “Accounting for Stock-BasedCompensation—Transition and Disclosure, an amendment of FASB Statement No. 123.”

Assumptionsused to value awards granted during the three months ended December 31,2004 and the six months ended September 30, 2004 do not differ materiallyfrom those used during fiscal 2004, except as follows:
| ** **                | ** ** | **Three Months Ended  December 31, 2004** | ** ** | **Six Months Ended  September 30, 2004** | ** ** | **257 Days Ended  March 31, 2004** | ** ** |
|---------------------------|------------|---------------------------------------------------------------|------------|--------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| Expected life (in  years) |       |                                                          | 4.70       |                                                         |       |                                                   | 3.00       |   |   |   | 3.00 |   |   |
| Expected volatility       |       |                                                          | 67         | %                                                            |       |                                                   | 77         | % |   |   | 77 | % |   |

 

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The following tablesillustrate the effect on net income (loss) and net income (loss) per share ifthe Company had applied the fair value recognition provisions of SFAS 123to stock-based employee compensation (in thousands, except per sharedata).

***Three Months***
| ** **                                                                                                                                       | ** ** | **Successor Company**                                | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                                                                                       | ** ** | **Three Months  Ended  December 31, 2004** | ** ** | **Three Months  Ended  December 31, 2003** | ** ** |
| Net income  (loss), as reported                                                                                                                  |       |                                                      | $          | 1,905 |   |   |   | $(6,423 | ) |   |
| Add: Stock-based  employee compensation expense included in reported net income (loss), net of  related  tax effects                             |       |                                                      | —     |   |   |   | — |   |   |
| Deduct: Total  stock-based employee compensation expense determined under a fair-value  based method  for all awards, net of related tax effects |       |                                                      | (1,221     | ) |   |   | (861 | ) |   |
| Pro forma net income  (loss)                                                                                                                     |       |                                                      | $          | 684 |   |   |   | $(7,284 | ) |   |
| Net income (loss)  per share:                                                                                                                    |       |                                                      |       |   |   |   |   |   |   |
| Basic—as reported                                                                                                                           |       |                                                      | $          | 0.13 |   |   |   | $(0.43 | ) |   |
| Basic—pro forma                                                                                                                             |       |                                                      | $          | 0.05 |   |   |   | $(0.49 | ) |   |
| Diluted—as reported                                                                                                                         |       |                                                      | $          | 0.13 |   |   |   | $(0.43 | ) |   |
| Diluted—pro forma                                                                                                                           |       |                                                      | $          | 0.05 |   |   |   | $(0.49 | ) |   |

 

***Nine Months***
| ** **                                                                                                                                           | ** ** | **Successor Company**                               | ** ** | ** **                                              | **Predecessor** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|-----------------|------------|
| ** **                                                                                                                                           | ** ** | **Nine Months  Ended  December 31, 2004** | ** ** | **166 Days  Ended   December 31,  2003** | ** **      | ** ** | **Company   109 Days  Ended  July 18, 2003** | ** ** |
| Net (loss)  income, as reported                                                                                                                      |       |                                                     | $          | (16,985                                                 | )               |       |   | $ | (11,818 | ) |   |   |   | $ | 374,189 |   |   |
| Add: Stock-based  employee compensation expense included in reported net (loss) income, net of  related tax effects                             |       |                                                     | 783        |                                                    |            |       | — |   |   |   |   | 551 |   |   |
| Deduct: Total  stock-based employee compensation expense determined under a fair-value  based method for all awards, net of related tax effects |       |                                                     | (3,843     | )                                                       |            |       | (1,000 | ) |   |   |   | (597 | ) |   |
| Pro forma net  (loss) income                                                                                                                         |       |                                                     | $          | (20,045                                                 | )               |       |   | $ | (12,818 | ) |   |   |   | $ | 374,143 |   |   |
| Net (loss) income  per share:                                                                                                                        |       |                                                     |       |                                                    |            |       |   |   |   |   |   |   |   |   |
| Basic—as reported                                                                                                                               |       |                                                     | $          | (1.13                                                   | )               |       |   | $ | (0.79 | ) |   |   |   | $ | 1.91 |   |   |
| Basic—pro forma                                                                                                                                 |       |                                                     | $          | (1.33                                                   | )               |       |   | $ | (0.85 | ) |   |   |   | $ | 1.91 |   |   |
| Diluted—as reported                                                                                                                             |       |                                                     | $          | (1.13                                                   | )               |       |   | $ | (0.79 | ) |   |   |   | $ | 1.82 |   |   |
| Diluted—pro forma                                                                                                                               |       |                                                     | $          | (1.33                                                   | )               |       |   | $ | (0.85 | ) |   |   |   | $ | 1.82 |   |   |

 

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*ComprehensiveIncome (Loss)*

Other comprehensive income(loss) is defined as the change in equity of a business enterprise during aperiod from transactions and other events and circumstances from non-ownersources. Foreign currency translation adjustments are the only item giving riseto accumulated other comprehensive income (loss) for the periods presented.Comprehensive income (loss) consists of the following (in thousands):

***Three Months***
| ** **                      | ** ** | **Successor Company**                                | ** ** |
|---------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                      | ** ** | **Three Months  Ended  December 31, 2004** | ** ** | **Three Months  Ended  December 31, 2003** | ** ** |
| Net income  (loss), as reported |       |                                                      | $          | 1,905 |   |   |   | $(6,423 | ) |   |
| Foreign currency  translation   |       |                                                      | (3,484     | ) |   |   | 1,839 |   |   |
| Comprehensive loss              |       |                                                      | $          | (1,579 | ) |   |   | $(4,584 | ) |   |

 

***Nine Months***
| ** **                                        | ** ** | **Successor Company**                               | ** ** | ** **                                            | **Predecessor  Company** | ** ** |
|---------------------------------------------------|------------|----------------------------------------------------------|------------|-------------------------------------------------------|--------------------------|------------|
| ** **                                        | ** ** | **Nine Months  Ended  December 31, 2004** | ** ** | **166 Days  Ended  December 31, 2003** | ** **               | ** ** | **109 Days  Ended  July 18, 2003** | ** ** |
| Net (loss)  income, as reported                   |       |                                                     | $          | (16,985                                               | )                        |       |   | $ | (11,818) |   |   |   |   | $ | 374,189 |   |   |
| Foreign currency  translation—current period |       |                                                     | (5,084     | )                                                     |                     |       | 1,269 |   |   |   |   | 956 |   |   |
| Foreign currency  translation—prior periods  |       |                                                     | 1,897      |                                                  |                     |       | — |   |   |   |   | — |   |   |
| Comprehensive (loss)  income                      |       |                                                     | $          | (20,172                                               | )                        |       |   | $ | (10,549) |   |   |   |   | $ | 375,145 |   |   |

 

Foreign currency translation for the quarter ended December 31,2004 of $(3.5) million includes increases in goodwill and identifiableintangibles of $1.3 million and $0.8 million, respectively, relatingto the translation of intangible assets whose functional currency is other thanthe U.S. dollar. Foreign currency translation-current period for the ninemonths ended December 31, 2004 of $(5.1) million includes increasesin goodwill and identifiable intangibles of $1.4 million and$0.9 million, respectively, relating to the translation of intangibleassets whose functional currency is other than the U.S. dollar.

During the preparation ofthe financial statements for the period ended June 30, 2004, the Companynoted that goodwill and identifiable intangibles attributable to foreignentities but recorded at the parent company level were not remeasured in thefunctional currencies of the entities to which they relate for periodssubsequent to the Company’s adoption of fresh-start reporting (July 18,2003). Comprehensive loss for the nine months ended December 31, 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. For that period goodwill and intangible assets increased by$1.1 million and $0.8 million, respectively. The Company believes theeffect of the adjustment to goodwill and identifiable intangible assets,stockholders’ equity and comprehensive income (loss) as of and for theindividual and year-to-date periods from July 18, 2003 through December 31,2004 is not material. As a result of this adjustment, the accompanyingCondensed Consolidated Balance Sheet as of December 31, 2004 appropriatelyreflects the translation effect resulting from the remeasurement in therespective functional currencies to the reporting currency of the U.S. dollar.

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*Recent AccountingPronouncements*

On December 16, 2004the FASB issued Statement of Financial Accounting Standards No. 123R, “Share-BasedPayment,” (SFAS 123R) requiring that the compensation cost relating toshare-based payment transactions be measured and recognized in thefinancial statements using the fair value of the awards. This statementeliminates the alternative to use APB 25’s intrinsic value method ofaccounting that was provided in SFAS 123. Under APB 25, issuing stockoptions to employees generally resulted in no recognition of compensation cost.SFAS 123R requires entities to recognize the cost of employee servicesreceived in exchange for awards of equity instruments based on the grant-datefair value of those awards (with limited exceptions). SFAS 123R covers awide range of share-based compensation arrangements including shareoptions, restricted share plans, performance based awards and employee sharepurchase plans. SFAS 123R replaces SFAS 123 and supersedesAPB 25. In April 2005 the Securities and Exchange Commission amendedRegulation S-X to amend the date for compliance with SFAS 123R to the firstinterim or annual reporting period of a registrant’s first fiscal yearbeginning after June 15, 2005. As a result the Company is required toadopt SFAS 123R on April 1, 2006. The Company is currently assessingthe impact of SFAS 123R on its compensation strategies and financialstatements and determining which transition alternative it will elect. TheCompany believes the adoption of SFAS 123R may have a material effect onits operating results if current compensation strategies are continued.

*Reclassificationsand Revisions*

Certain amounts previouslyreported have been reclassified to conform to the current presentation,including the reporting of foreign currency transaction gains (losses) expenseseparately from general and administrative expense.

**3.   Marketable Securities**

Thefollowing is a summary of marketable securities at December 31, 2004. TheCompany held no such securities at March 31, 2004 (amounts in thousands).
| ** **             | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|---------------------|------------|
| Other debt  securities |       |                | $          | 8,000                        |       |                          |       | $                   | —     |   |   |   | $ | — |   |   |   | $ | 8,000 |   |   |
|                        |            |                     |            |                              |            |                               |            |                     |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Other debt securitiesconsist of auction rate securities which mature in December 2043. Thesesecurities have auction dates which are typically every thirty days resultingin a fair value which approximates carrying value. During the three and ninemonths ended December 31, 2004 proceeds from sales of available-for-salesecurities amounted to $5.0 million and $17.0 million, respectively. Therewere no realized gains or losses as a result of those sales.

**4.   Discontinued Operations**

In September 2002, the Company and Remedy enteredinto an agreement (Sale Agreement) with BMC Software, Inc. (BMC) pursuantto which BMC, subject to bid procedures approved by the Bankruptcy Court,acquired substantially all the assets and assumed substantially all theliabilities of the Remedy business for $355.0 million, subject toadjustments provided for in the Sale Agreement. An indemnification holdback of$10.0 million of the sales proceeds was placed into escrow for BMC andreleased to the Company in November 2003.

Results of discontinuedoperations for the 109 days ended July 18, 2003 consisted of revenuesof $0.3 million and operating income of $0.3 million related to thecollection of a Remedy related trade receivable that had extended payment termsand was not transferred as part of the sale.

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**5.   Restructuring and Other**

For the Predecessor Company’s 109 days ended July 18,2003, restructuring and other represented a gain realized upon the sale ofcertain minority investments in other companies.

During June 2002, theCompany began to implement a restructuring plan to reduce expenses in line withfuture revenue expectations and to focus operations on the core market andestablished an accrual for anticipated future charges for the plan. At March 31,2004, the remaining accrual was $1.1 million, which related primarily toforeign lease settlements. In the nine-month period ended December 31,2004, the Company paid or otherwise settled approximately $0.6 million inlease termination liabilities, leaving a balance of $0.5 million in theaccrual at December 31, 2004.

**6.   Reorganization Items**

Asdescribed in Note 1, on September 22, 2002, the Company and itsRemedy subsidiary filed for voluntary protection from creditors underChapter 11 of the United States Bankruptcy Code. As a result of theCompany’s Chapter 11 filing, its financial accounting has been subject tothe provisions of SOP 90-7 for the reporting periods subsequent to September 22,2002 through July 18, 2003. Pursuant to SOP 90-7, revenue, expenses(including professional fees), realized gains and losses, and provisions forlosses resulting from the reorganization of the business are reportedseparately as reorganization items. Reorganization items, net for the SuccessorCompany for the three months ended December 31, 2004 and the 166 daysended December 31, 2003 consist primarily of professional fees directlyrelated to the bankruptcy filing. Reorganization items, net for the SuccessorCompany for the nine months ended December 31, 2004 consist primarily ofprofessional fees directly related to the bankruptcy filing, net of$0.2 million of gains on settlements with creditors. Reorganization items,net for the Predecessor Company for the 109 days ended July 18, 2003consist of the following (in thousands):
| ** **                                               | ** ** | **Predecessor Company**                      | ** ** |
|----------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                               | ** ** | **109 Days  Ended  July 18, 2003** | ** ** |
| Professional fees                                        |       |                                              | $          | (8,279 | ) |   |
| Employee  retention and benefits                         |       |                                              | (6,302     | ) |   |
| Acceleration of  deferred compensation charges           |       |                                              | (499       | ) |   |
| Gains on  settlements with creditors                     |       |                                              | 35,393     |   |   |
| Increase to fresh-start  basis of assets and liabilities |       |                                              | 358,508    |   |   |
|                                                     |       |                                              | $          | 378,821 |   |   |

 

For the 109 daysended July 18, 2003, the Predecessor Company recorded a net reorganizationgain of $378.8 million. Of this gain, $358.5 million resulted fromthe fair value adjustments to the Company’s assets and liabilities with theadoption of fresh-start reporting. The Company also recognized a$35.4 million gain on its settlement with creditors upon exitingbankruptcy proceedings. These gains were partially offset by costs directlyrelated to the implementation of the Company’s Reorganization Plan.

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**7.   Segment Information**

Beginning in thesecond quarter of fiscal 2005 the Company changed its basis of segmentationfrom a single reportable segment to two reportable segments as a result ofchanges in the manner in which management evaluates the performance of thebusiness. This change was made possible by improvements in internal financialreporting. The two reportable segments align with the internal management ofworldwide business operations:

·       *Americas*.   These include theCompany’s U.S. operations as well as its operations in Canada, Mexico and SouthAmerica.

·       *EMEA/AP.  *These include the Company’soperations in Europe, the Middle East, Africa and the Asia Pacific Region.

The Company’s Chief Executive Officer evaluatessegment financial performance based on segment revenues only. The Company’sChief Executive Officer does not evaluate the financial performance of eachsegment based on its respective operating income, assets or capitalexpenditures.

Thefollowing table summarizes segment revenue for the three months ended December 31,2004 and December 31, 2003 (dollars in thousands):
| ** **          | ** ** | **Successor Company**                                | ** ** |
|---------------------|------------|-----------------------------------------------------------|------------|
| ** **          | ** ** | **Three Months  Ended  December 31, 2004** | ** ** | **Three Months  Ended  December 31, 2003** | ** ** |
| Segment revenue     |       |                                                      |       |   |   |   |   |   |   |
| Americas            |       |                                                      | $          | 27,259 |   |   |   | $ | 24,097 |   |   |
| EMEA/AP             |       |                                                      | 27,972     |   |   |   | 20,616 |   |   |
| Total               |       |                                                      | $          | 55,231 |   |   |   | $ | 44,713 |   |   |
| % of total  revenue |       |                                                      |       |   |   |   |   |   |   |
| Americas            |       |                                                      | 49         | % |   |   | 54 | % |   |
| EMEA/AP             |       |                                                      | 51         | % |   |   | 46 | % |   |
|                |       |                                                      | 100        | % |   |   | 100 | % |   |

 

Thefollowing table summarizes segment revenue for the nine months endedDecember 31, 2004, the 166 days ended December 31, 2003 and the109 days ended July 18, 2003 (dollars in thousands):
| ** **          | ** ** | **Successor Company**                               | ** ** | ** **                                            | **Predecessor  Company** | ** ** |
|---------------------|------------|----------------------------------------------------------|------------|-------------------------------------------------------|--------------------------|------------|
| ** **          | ** ** | **Nine Months  Ended  December 31, 2004** | ** ** | **166 Days  Ended  December 31, 2003** | ** **               | ** ** | **109 Days  Ended  July 18, 2003** | ** ** |
| Segment revenue     |       |                                                     |       |                                                  |                     |       |   |   |   |   |   |   |   |   |
| Americas            |       |                                                     | $          | 78,079                                                |                     |       |   | $ | 43,959 |   |   |   |   | $ | 32,043 |   |   |
| EMEA/AP             |       |                                                     | 65,260     |                                                  |                     |       | 35,974 |   |   |   |   | 16,612 |   |   |
| Total               |       |                                                     | $          | 143,339                                               |                     |       |   | $ | 79,933 |   |   |   |   | $ | 48,655 |   |   |
| % of total  revenue |       |                                                     |       |                                                  |                     |       |   |   |   |   |   |   |   |   |
| Americas            |       |                                                     | 54         | %                                                     |                     |       | 55 | % |   |   |   | 66 | % |   |
| EMEA/AP             |       |                                                     | 46         | %                                                     |                     |       | 45 | % |   |   |   | 34 | % |   |
|                |       |                                                     | 100        | %                                                     |                     |       | 100 | % |   |   |   | 100 | % |   |

 

**8.   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.

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The effective tax rates for the Successor Company’sthree and nine months ended December 31, 2004 were approximately 43.3% and(29.1)%, respectively. The Company’s income tax expense relates primarily toforeign taxes paid for which no offsetting tax benefits are available andinterest accrued on certain tax contingencies. During these periods, theCompany did not recognize any benefit from federal or state income tax losses,because future benefit from losses was not likely to be realized. If taxbenefits accrued by the Successor Company are realized in future periods, thebenefit will be recorded as a reduction 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 deferred taxasset balances as of December 31, 2004, and March 31, 2004 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. Reductions fordeferred tax assets generated prior to the adoption of fresh-startreporting will be recorded as reductions of goodwill.

The Company is currently reviewing the potentialimpact of the one-time favorable foreign dividend provisions enacted on October 22,2004 as part of the American Jobs Creation Act of 2004 (the “Jobs Act”). TheJobs Act creates a temporary incentive for U.S. corporations to repatriateearnings of foreign subsidiaries by providing an elective 85% dividendsreceived deduction for certain dividends paid during a specified period; forthe Company, this would be applicable to either its fiscal year 2005 or itsfiscal year 2006. The deduction is subject to numerous limitations andrequirements, including the adoption of a specific domestic reinvestment planfor the repatriated funds. The Company has not yet determined whether it willrepatriate future earnings of some of its foreign subsidiaries under the JobsAct but will decide within the timeframe the incentive is available. Unremittedearnings on which no deferred taxes have been provided amounted toapproximately $44.5 million at March 31, 2004.

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 offresh-start reporting, any adjustments to the Company’s tax assets orliabilities that existed prior to the adoption of fresh-start reportingare recorded as adjustments to goodwill. For the three months ended December 31,2004 the Company recorded net increases to goodwill totaling approximately $0.1million and for the nine months ended December 31, 2004 the Companyrecorded net reductions to goodwill totaling approximately $0.5 million foradjustments to the Company’s tax assets and liabilities that existed prior tothe adoption of fresh-start reporting. These adjustments related mainly tothe release of certain tax reserves as management has determined the Company nolonger has exposure for the associated matters.

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**9.   Contingent Liabilities**

*Bankruptcy Claims*

Approximately 1,200 claims were filed against theCompany based on events that took place prior to its bankruptcy-law filing.Through March 31, 2005, the Company has paid, settled or otherwisedisposed of general unsecured claims (Class 8) asserted against it with anoriginal aggregate face amount of approximately $380.6 million. To resolvethese claims the Company has paid or agreed to pay over time approximately$45.0 million in cash. As of March 31, 2005, there were generalunsecured claims asserted in the original aggregate face amount ofapproximately $3.5 million remaining to be resolved. There were alsoapproximately $1.7 million in priority and administrative claims remainingto be resolved. These remaining general unsecured and other claims includeclaims that are asserted in a minimum amount or an unliquidated amount and theclaims can be amended to higher amounts. Prior claim determinations are alsosubject to appeal. Because the total liability associated with the claimsdepends upon the final amounts asserted by claimants, the outcome of claimsclassification hearings by the Bankruptcy Court, claims objections, settlementnegotiations, and potential litigation and appeals, the total amount to be paidby the Company is uncertain. The Company believes that it has set asideadequate reserves for payments of the Class 8 claims as well as theremaining priority and administrative claims and that the aggregate Class 8claims payment should be within and possibly below the range of paymentsprojected at between $49.0 million and $65.0 million by the variousconstituencies in the bankruptcy proceedings. Payments exceeding the reservedamounts could have an adverse effect on the Company’s financial position,results of operations or liquidity. Because claims remain in dispute, theCompany is unable to predict the payment amount or the period over whichpayments would be made.

One of the moresignificant unsecured claims was asserted by Microsoft Corporation and itsMSLI, GP affiliate (collectively, Microsoft), for alleged unauthorized andunlicensed use of their software. Microsoft filed (i) a proof of claim in December 2002seeking at least $3.0 million related to the Company’s use of Microsoftproducts in the period prior to the bankruptcy filing, (ii) an adversarycomplaint in January 2003 seeking monetary damages in an unspecified amountas well as injunctive relief, and (iii) an administrative claim in September 2003seeking monetary damages in an unspecified amount related to the period afterthe Company’s bankruptcy filing. The Company agreed with Microsoft that all ofits claims and contentions should be decided in the context of the adversarycomplaint filed in the Bankruptcy Court. In March 2003, Peregrine filed ananswer to Microsoft’s adversary complaint denying the material allegations andraising affirmative defenses. Between October 2003 and June 2004, theCompany engaged in settlement negotiations with Microsoft. In November 2003the Company entered into a new enterprise license agreement with Microsoft. In June 2004Peregrine entered into a settlement agreement with Microsoft that resolved theadversary complaint pursuant to which Microsoft dismissed the adversarycomplaint with prejudice and the Company granted Microsoft an allowedadministrative claim and Class 8 claim under the Reorganization Plan. Allpayments required under the settlement agreement have been accrued and reportedon the consolidated balance sheet.

*Securities andExchange Commission Enforcement Actions and Federal Government Investigations*

In June and July 2003,the Company entered into agreements to settle a civil action brought against itby the SEC. Under the terms of the settlement, the Company agreed to:

·       beenjoined from violating federal securities laws;

·       complyon an accelerated basis with the rules regarding management’s reporting oninternal controls in accordance with the Sarbanes-Oxley Act of 2002;

·       retainan internal auditor to assist with the accurate reporting of the Company’sfinancial results;

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·       establisha corporate compliance program and retain a compliance officer to perform anongoing review of the effectiveness of the Company’s governance systems;

·       commencea training program for the Company’s officers and employees to preventviolations of federal securities laws; and

·       makea public statement that discloses the condition of the Company’s internalcontrol structure and its procedures for financial reporting on the effectivedate of its Reorganization Plan.

Because the Company is not current in its periodicreporting obligations to the SEC, it is not in compliance with the requirementof the settlement relating to violation of federal securities laws. While theCompany remains in discussions with the SEC, it can give no assurance that afurther enforcement action will not be brought against it by the SEC.Responding to any such enforcement action could be expensive and time-consumingfor management and could adversely affect the Company’s reputation and abilityto generate sales.

A number of the Company’s former employees, includingits former chief financial officer, treasurer, assistant treasurer and twoformer sales executives, have pleaded guilty to various felony charges inconnection with Peregrine’s past accounting irregularities and are awaitingsentencing. A number of other former employees, including Peregrine’s formerchief executive officer and chairman, chief operating officer, two executivevice presidents of worldwide sales, the vice president of finance and chiefaccounting officer and other sales and finance executives, have been chargedwith various felonies in connection with the Company’s accountingirregularities and are awaiting trial. An Arthur Andersen partner who formerlywas the Company’s lead auditor also was indicted in connection with theseevents. The criminal charges generally relate to the manipulation of the Company’sapparent financial condition, misleading investors, hindering the government’sinvestigation or conspiracy. In most of these cases, the SEC filed a civilaction against the individuals alleging violations of the Securities Act of1933 and the Securities Exchange Act of 1934 and the rules promulgatedthereunder.

The Department of Justice and the SEC are continuingtheir investigations into a number of individuals formerly associated withPeregrine. While the Company is fully cooperating with the SEC and the DOJ intheir investigations and the Company is not aware that Peregrine or any of itscurrent employees is a subject or target of investigation, it is possible thatthe SEC could bring further civil actions against the Company or that the DOJcould bring criminal charges against the Company. Any such actions or chargescould adversely affect the Company’s reputation among existing and potentialcustomers and adversely affect the Company’s revenue, stock price and employeemorale.

On July 5, 2002, theCompany received a letter from the Committee on Energy and Commerce of the U.S.House of Representatives with a subpoena for documents pursuant to Rules Xand XI of the U.S. House of Representatives concerning the Company’saccounting irregularities. The Company provided the Committee on Energy andCommerce the documents it subpoenaed. The Company is not aware of any otheractivities by the Committee relating to it.

*Luddy v. Peregrine*

In May 2004, FredericLuddy, the Company’s former chief technology officer, filed a complaint againstthe Company in the Court of Chancery for the State of Delaware seekingadvancement of certain legal fees and expenses. Mr. Luddy is a defendantin a class action suit filed on behalf of former Peregrine stockholders underthe federal securities laws, pending in the U.S. District Court for theSouthern District of California (the Federal Securities Action), and in anaction filed by the Peregrine Litigation Trustee as successor to certain rightsand causes of action of Peregrine under the Reorganization Plan, pending in theSuperior Court of the State of California for the County of San Diego (theLitigation Trustee Action). These actions seek to recover monetary damages fromMr. Luddy based on pre-bankruptcy events. 

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Mr. Luddy’scomplaint alleged that Peregrine is required to advance or reimburse him forhis defense expenses in connection with the Federal Securities Action and theLitigation Trustee Action. His complaint also alleged that, pursuant to aparagraph of the Bankruptcy Court’s order confirming the Reorganization Plan,his indemnity claim can be pursued in state court. In June 2004, theCompany removed Mr. Luddy’s complaint from Delaware state court to theBankruptcy Court. The Company also filed a motion in Bankruptcy Court todismiss the complaint on the basis that, among other things, Mr. Luddyfailed to file any proof of claim before the Bankruptcy Court and that hisclaim is barred by the discharge injunction entered in connection with theBankruptcy Court’s approval of the Reorganization Plan. On August 9, 2004,Mr. Luddy filed a unilateral dismissal of his complaint, withoutprejudice, and on the same day filed a new complaint in the Delaware Court ofChancery, seeking the same relief as in his prior complaint. The Companyremoved Mr. Luddy’s new complaint to the Bankruptcy Court and filed a newmotion to dismiss his complaint. Mr. Luddy, in turn, filed a motion toremand the case to state court. On November 10, 2004, the Bankruptcy Courtdenied Mr. Luddy’s motion for remand and found that it had jurisdiction toconsider the complaint. Also on November 10, 2004, the Bankruptcy Courtgranted in part and denied in part the Company’s motion to dismiss, withoutprejudice to the Company’s right to renew the motion later, after discovery andformal fact finding. On February 23, 2005, Mr. Luddy filed an amendedcomplaint, which the Company answered on March 15, 2005. Discovery isscheduled to be completed by May 2005, but no trial date has been set.Peregrine believes Mr. Luddy’s claims are without merit and intends tovigorously defend against them. While the outcome is not currentlydeterminable, in the opinion of management the matter will not materiallyaffect the Company’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.

**10.   Subsequent Events**

*Sale of Investment*

In January 2005 the Company received a$4.2 million initial payment in connection with the sale of one of itscost-method investments. The Company was carrying this investment at$3.1 million as of December 31, 2004 and March 31, 2004. TheCompany will recognize a $1.1 million gain on this sale in the fiscal 2005fourth quarter. In addition to the $4.2 million initial payment received,the Company has rights to receive up to $0.5 million of additionalproceeds from the sale of this investment upon final resolution of purchasecontingencies. Given the uncertainties surrounding the contingencies, amountssubsequently received, if any, will be recorded as an additional gain on thesale in the period received. At December 31, 2004, the carrying amount ofthe investment is included in other current assets.

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

*The followingdiscussion and analysis of our financial condition, results of operations,liquidity and capital resources should be read in conjunction with the condensedconsolidated financial statements and related notes included in this report.Some of the information contained in this discussion and analysis, or set forthelsewhere in this report, includes forward-looking statements thatinvolve risk and uncertainties. Readers should carefully review the informationset forth under the caption “Risk Factors” contained in our Annual Report on Form 10-Kfor the fiscal year ended March 31, 2004, filed December 20, 2004,for a discussion of important factors that could cause actual results to differmaterially from our historical or anticipated results described herein, orimplied by the forward-looking statements in this report. We undertake noobligation to revise or update any forward-looking statements for any reason.*

*The informationcontained in this section is generally limited to the reporting periods coveredby this report. Please note, however, that we have supplemented our discussionof liquidity and capital resources for the three months ended December 31,2004 with a more current discussion of our liquidity and capital resources asof March 31, 2005.*

*Most of the financial results described in thissection are historical. Until our periodic reports are up to date, investorswill not have current financial information. For this reason, and based on theother risk factors contained in our Annual Report on Form 10-K forthe fiscal year ended March 31, 2004, we believe trading in our securitiesat this time is highly speculative and involves a high degree of risk.*

**OVERVIEW**

From our initialpublic offering in 1997 through 2001, we significantly expanded our productlines and business through a series of acquisitions, the most significant ofwhich were:

·       Apsylogin September 1997, in which we acquired our AssetCenter product, forapproximately $38.6 million;

·       TelcoResearch Corporation in March 2000 for approximately $112.7 million;

·       HarbingerCorporation in June 2000 for approximately $1.8 billion;

·       LoranNetwork Holding Corporation in September 2000 for approximately$88.1 million;

·       IBMCorporation’s Tivoli Service Desk suite of products in December 2000 for atotal net price of approximately $50.2 million;

·       Extricity, Inc.in April 2001 for approximately $185.2 million; and

·       RemedyCorporation in August 2001 for approximately $1.4 billion.

As our operations grew through these acquisitions, ouroperating costs increased significantly. At the same time, the softwareindustry began a downturn and we faced a challenging sales environment. Thesefactors created a liquidity crisis for us that was exacerbated by covenantdefaults under our credit facility during the quarter ended December 31,2001. This resulted in our required repayment of approximately$100.0 million of outstanding debt.

In January 2002, the SEC began an informalinvestigation into Peregrine and our then chief executive officer, StephenGardner, pertaining to transactions with Critical Path, Inc. that hadtaken place in the first half of fiscal 2001 and involved $3.3 million inPeregrine revenue. In February 2002, Peregrine’s Audit Committee initiatedan independent investigation into the transactions with Critical Path. In earlyMay 2002, the Audit Committee and, upon its recommendation, the Board ofDirectors initiated a broad internal investigation, obtained the resignationsof Mr. Gardner and our chief financial officer at that time, 

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Matthew Gless, amongothers, and publicly disclosed that we were conducting an internalinvestigation into potential accounting irregularities or frauds, including allegedaccounting abuses by our senior management resulting in a substantiveoverstatement of revenue in prior periods. In mid-May 2002, we announcedthat we would restate our consolidated financial statements for all of fiscalyears 2000 and 2001 and for the first three quarters of fiscal 2002 (that is,the period from April 1999 through December 2001) as a result of thediscovery of accounting irregularities during those periods, and we alsoannounced that our financial statements and related audit reports for therestatement period should not be relied upon.

In June 2002our newly appointed chief executive officer and chief financial officer, andthe rest of the management team, simultaneously focused on four immediategoals:

·       Acceleratingthe process of reducing our operating costs;

·       Obtainingthird-party funding arrangements;

·       Sellingnon-core assets to fund ongoing operations; and

·       Managingthe business to conserve cash.

We streamlined our operations by divesting a number ofbusinesses and non-core product lines and significantly reduced our personneland cost structure. We also implemented a restructuring plan to reduce expensesin line with future revenue expectations.

On September 22, 2002, we filed for voluntaryprotection under Chapter 11 of the United States Bankruptcy Code with theUnited States Bankruptcy Court for the District of Delaware. Our ReorganizationPlan was confirmed by the Bankruptcy Court on July 18, 2003. We emergedfrom bankruptcy law protection on August 7, 2003.

As a result of our bankruptcy law filing underChapter 11, we were subject to the provisions of AICPA Statement ofPosition 90-7, “Financial Reporting of Entities in Reorganizationunder the Bankruptcy Code,” (SOP 90-7) for the reporting periodssubsequent to September 22, 2002 through July 18, 2003. Pursuant toSOP 90-7, we were required, among other things, to classify on theconsolidated balance sheet liabilities arising prior to the September 22,2002 petition date that were subject to compromise separately from those thatwere not, as well as liabilities arising post-petition. The liabilities thatwere potentially affected by the Reorganization Plan were reported at theestimated amounts that would be allowed under the Reorganization Plan, even ifthey were ultimately settled for lesser amounts. Revenue, expenses (includingprofessional fees), realized gains and losses, and provisions for lossesresulting from the reorganization of the business were reported separately asreorganization items.

We applied the fresh-startreporting provisions of SOP 90-7 in the quarter ended September 30,2003. The effect of fresh-start reporting is discussed in Note 1 ofour notes to consolidated financial statements included in our Annual Report onForm 10-K for the period ended March 31, 2004.

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**CRITICALACCOUNTING POLICIES AND ESTIMATES**

Our consolidatedfinancial statements are prepared in accordance with generally acceptedaccounting principles. These accounting principles require us to make certainestimates, judgments and assumptions. We believe that the estimates, judgmentsand assumptions upon which we rely are reasonable based upon informationavailable to us at the time that these estimates, judgments and assumptions aremade. These estimates, judgments and assumptions can affect the reportedamounts of assets and liabilities as of the date of the financial statements,as well as the reported amounts of revenue and expenses during the periodspresented. To the extent there are material differences between theseestimates, judgments or assumptions and actual results, our financialstatements will be affected. The significant accounting policies that webelieve are the most critical to aid in fully understanding and evaluating ourreported financial results include the following:

·       Fresh-StartReporting;

·       RevenueRecognition;

·       Valuationof Long-Lived Assets;

·       LegalContingencies; and

·       Accountingfor Income Taxes.

**Fresh-Start Reporting**

We adopted the fresh-start reporting provisionsof SOP 90-7 on July 18, 2003. This resulted in a new basis ofaccounting. Under fresh-start reporting, the reorganization value of theentity, as described below, is allocated to the entity’s assets based on fairvalues, and liabilities are stated at the present value of amounts to be paiddetermined at current interest rates. The determination of the reorganizationvalue and fair value of assets relies on a number of estimates and assumptions,the ultimate outcome of which are inherently subject to significantuncertainties and contingencies beyond our control.

Reorganization value is the fair value of the entitybefore considering liabilities, and it approximates the amount a willing buyerwould pay for the assets of the entity immediately after reorganization. Withthe assistance of third-party financial advisors, we determined the fairvalue of the new common stock for the reorganized Company to be$270 million, which represents the business enterprise value adjusted fordebt financing and other liabilities net of cash. For purposes of applying SOP 90-7,we used a business enterprise value of $277 million, representing our bestestimate of the Company’s reorganized business enterprise value.

Fresh-start reporting requires that thereorganization value be allocated to the entity’s assets in conformity with proceduresspecified by Statement of Financial Accounting Standards No. 141, “BusinessCombinations” (SFAS 141). We engaged an independent appraiser to assist indetermining the fair market value of our identifiable intangible assets.Identifiable intangible assets consist of developed technology, trademarks andtrade names, customer contracts and customer lists. The fair value of theseidentifiable intangible assets was estimated to be $125.1 million and wasdetermined using the Company’s estimated future cash flow discounted at theCompany’s weighted cost of capital of 12.0%. The identifiable intangible assetshave estimated useful lives ranging from five to six years.

Any amount remaining afterallocation of the reorganization value of the Company to identified tangibleand intangible assets is recorded as goodwill. Goodwill is not amortized, butis subject to periodic evaluation for impairment at least annually.

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**Revenue Recognition**

As described below, significant management judgmentand estimates must be made and used in connection with the revenue recognizedin any accounting period. Material differences could result in the amount andthe timing of our revenue for any period if our management made differentjudgments or utilized different estimates. Our revenue is derived principallyfrom software product licensing and related services. Our standard end-userlicense agreement provides for an initial fee for use of our products inperpetuity. License fees are generally due upon the granting of the license. Maintenancerevenue consists of fees for technical support and software updates. Consultingand training revenue is for fees earned for professional services provided tocustomers primarily on a time and material basis. We recognize revenue inaccordance with the provisions of Statement of Position 97-2, “SoftwareRevenue Recognition,” as amended by SOP 98-4 and SOP 98-9(SOP 97-2), and Staff Accounting Bulletins No. 101, “RevenueRecognition in Financial Statements” and No. 104, “Revenue Recognition,”issued by the SEC.

We recognize revenue from license agreements withdirect customers when all of the following conditions are met: a non-cancelablelicense agreement has been signed; the product has been delivered; there are nomaterial uncertainties regarding customer acceptance; the fee is fixed ordeterminable; collection of the resulting receivable is deemed probable; riskof concession is deemed remote; and we have no other significant obligations.Estimates on collectibility are made by management on a transaction-by-transactionbasis. If provided in a license agreement, acceptance provisions generallygrant customers a right of refund only if the licensed software does notperform in accordance with its published specifications. We believe thelikelihood of non-acceptance in these situations is remote and we generallyrecognize revenue when all other criteria for revenue recognition are met. Ifsuch determination cannot be made, revenue is recognized upon the earlier ofreceipt of written acceptance or when the acceptance period has lapsed.

For contracts with multiple obligations (e.g., currentand future product delivery obligations, post-contract support or otherservices), we recognize revenue using the residual method. Under the residualmethod, we allocate revenue to the undelivered elements of the contract basedon vendor-specific objective evidence of their fair value. This objectiveevidence is the sales price of each element when sold separately or the annualrenewal rate specified in the agreement for maintenance. We recognize revenueallocated to undelivered products when all of the other criteria for revenuerecognition have been met.

Revenue from maintenance services is recognizedratably over the contractual period, generally one year. Consulting revenue isprimarily derived from software product integration services, which wetypically perform on a time and material basis under separate serviceagreements. In our judgment, consulting services are not usually consideredessential to the functionality of the software. Training revenue derives frominstructor-led and online educational services provided relating to ourproducts. As a result, we recognize license revenue upon delivery of thesoftware, which generally is prior to the delivery of the consulting andtraining services. Revenue from consulting and training services are recognizedas the respective services are performed.

The Company also derivesrevenue from the sale of its software licenses and maintenance services throughdistributors. Revenue from sales made through distributors is recognized whenthe distributors have sold the software licenses or services to their customersand the criteria for revenue recognition under SOP 97-2 are met.Revenue from maintenance services sold through distributors is recognizedratably over the contractual period with the end user.

**Impairment of Long-Lived Assets**

We evaluate therecoverability of our long-lived assets, including property and equipment andcertain identifiable intangible assets, exclusive of goodwill, in accordancewith Statement of Financial Accounting Standards No. 144, “Accounting forthe Impairment or Disposal of Long-Lived Assets” (SFAS 144). 

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Goodwillis tested for impairment in accordance with Statement of Financial AccountingStandards No. 142 “Goodwill and Other Intangible Assets.” SFAS 144requires us to review for impairment of long-lived assets whenever events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable. Factors that could trigger an impairment review include:

·       Significantunderperformance relative to historical or projected future operating results;

·       Significantchanges in the manner of use of the assets or the strategy for our overallbusiness;

·       Significantdecrease in the market value of the assets; and

·       Significantnegative industry or economic trends.

When we determine that thecarrying amount of long-lived assets may not be recoverable based upon theexistence of one or more of the above indicators, we assess the assets forimpairment based on the estimated future undiscounted cash flows expected toresult from the use of the asset and its eventual disposition. If the carryingamount of an asset exceeds its estimated future undiscounted cash flows, animpairment loss is recorded for the excess of the asset’s carrying amount overits fair value. Fair value is generally determined based on the estimatedfuture discounted cash flows over the remaining useful life of the asset usinga discount rate determined by our management to be commensurate with the riskinherent in our current business model. The assumptions supporting the cashflows, including the discount rates, are determined using our best estimates asof the date of the impairment review.

**Legal Contingencies**

We are currently involvedin various claims and legal proceedings. Periodically, we review the status ofeach significant matter and assess our potential financial exposure. If thepotential loss from any claim or legal proceeding is considered probable andthe amount can be reasonably estimated, we accrue a liability for the estimatedloss. Significant judgment is required in both the determination of probabilityand the determination of whether an exposure is reasonably estimable. Becauseof uncertainties related to these matters, accruals are based on the bestinformation available at the time in accordance with SFAS No. 5, “Accountingfor Contingencies.” As additional information becomes available, we reassessthe potential liability related to our pending claims and litigation and mayrevise our estimates. Such revisions in the estimates of the potentialliabilities could have a material impact on our results of operations andfinancial position. See “Legal Proceedings,” beginning on page 48 of thisreport and Note 9 of our notes to condensed consolidated financialstatements for a description of our material legal proceedings.

**Accounting for Income Taxes**

Significant judgment is required in determining ourworldwide income tax provision. In a global business, there are manytransactions and calculations in which the ultimate tax outcome is uncertain.Some of these uncertainties arise as a consequence of revenue sharing and costreimbursement arrangements among related entities and segregation of foreignand domestic income and expense to avoid double taxation. We have accruedreserves for tax contingencies based upon our estimates of the tax toultimately be paid. This estimate is updated as new information becomesavailable. While these estimates are based upon the information available whenthese statements are issued, no assurance can be given that the final outcomeof these matters will not differ from that which is reflected in our historicalincome tax provisions and accruals. Such differences could have a materialeffect on our income tax provision and financial position, results ofoperations or liquidity in the period for which such determination is made.

We have recorded avaluation allowance on substantially all of our net deferred tax asset balancesas of December 31, 2004, and March 31, 2004 because of uncertaintiesrelated to utilization of deferred tax assets, primarily related to netoperating loss carryforwards, before they expire. At such time, if any, as itis determined that it is more likely than not that the deferred tax assets arerealizable, the valuation 

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allowancewill be reduced. Reductions for deferred tax assets generated prior to theadoption of fresh-start reporting will be recorded as reductions togoodwill.

**RESULTS OF OPERATIONS**

On July 18, 2003, the Bankruptcy Court confirmedthe Reorganization Plan and it became effective on August 7, 2003. Resultsof operations presented for periods prior to and including July 18, 2003pertain to our company prior to its reorganization (our Predecessor Company).The results of operations presented for periods after July 18, 2003pertain to our company after its reorganization (our Successor Company). Wherediscussion applies to both the Predecessor Company and the Successor Company,we refer to the Company. As a result of the implementation of fresh-startreporting on July 18, 2003, the Successor Company’s results of operationsare not comparable to results reported in prior periods for the PredecessorCompany, because of differences in the basis of reporting and the capitalstructure for the Predecessor Company and the Successor Company. SeeNote 1 of our notes to consolidated financial statements included in ourAnnual Report on Form 10-K for the period ended March 31, 2004for additional information about the consummation of the Reorganization Planand the implementation of fresh-start reporting.

As required by Item 303(b) ofRegulation S-K, the discussion and analysis of results of operationscovers all periods for which financial statements are presented, even thosethat relate to periods shorter than full three- and nine-month periods.However, for clarity of presentation, where the adoption of fresh-startreporting did not have a material effect, we have only compared the results ofoperations of our Successor Company for the nine-month period ended December 31,2004 with the historical results of operations of the Successor and PredecessorCompany on a combined basis for the nine-month period ended December 31,2003.

The discussion and analysis of results of operationsfor the shortened periods are not directly comparable to the full nine-monthperiod in the current fiscal year. For example, our Successor Company’s licenserevenue, maintenance revenue, amortization, income taxes, discontinued operationsand reorganization items, net were all affected by the adoption of fresh-startaccounting. In order to provide an informative comparison of results ofoperations with our Successor Company’s results for the nine-month periodended December 31, 2004, our Predecessor Company’s results of operationsare presented for the 109-day period ended July 18, 2003 beside ourSuccessor Company’s results of operations for the 166-day period ended December 31,2003, as well as on a pro forma combined basis for the combined nine-monthperiod. This information is provided for comparative purposes only, but thevalue of such a comparison may be limited. The pro forma combined financialinformation does not reflect the results of operations that either ourPredecessor Company or our Successor Company would have achieved for the fullfiscal 2004 nine-month period. The pro forma combined financial information forthe nine-month period ended December 31, 2003 is presented on a merelyadditive basis and does not give pro forma effect to our Predecessor Company’sresults as if the consummation of the Reorganization Plan and the related fresh-startand other adjustments had occurred at the beginning of the period presented.

26

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The following tables setforth, for the periods indicated, the selected condensed consolidated statementof operations data as a percentage of total revenue:

***Three Months***
| ** **                                        | ** ** | **Successor Company**                                | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                        | ** ** | **Three Months  Ended  December 31, 2004** | ** ** | **Three Months  Ended  December 31, 2003** | ** ** |
| Revenue:                                          |       |                                                      |       |   |   |   |   |   |   |
| Licenses                                          |       |                                                      | 40.3       | % |   |   | 38.5 | % |   |
| Maintenance                                       |       |                                                      | 51.3       | % |   |   | 53.8 | % |   |
| Consulting and training                           |       |                                                      | 8.4        | % |   |   | 7.7 | % |   |
| Total revenue                                     |       |                                                      | 100.0      | % |   |   | 100.0 | % |   |
| Costs and expenses:                               |       |                                                      |       |   |   |   |   |   |   |
| Cost of licenses                                  |       |                                                      | 0.8        | % |   |   | 1.3 | % |   |
| Cost of maintenance                               |       |                                                      | 8.7        | % |   |   | 9.4 | % |   |
| Cost of consulting and training                   |       |                                                      | 8.9        | % |   |   | 8.3 | % |   |
| Sales and marketing                               |       |                                                      | 32.0       | % |   |   | 30.3 | % |   |
| Research and development                          |       |                                                      | 13.8       | % |   |   | 15.8 | % |   |
| General and administrative                        |       |                                                      | 24.7       | % |   |   | 25.0 | % |   |
| Amortization of intangible assets                 |       |                                                      | 10.5       | % |   |   | 12.9 | % |   |
| Total operating costs and expenses                |       |                                                      | 99.4       | % |   |   | 103.0 | % |   |
| Operating income  (loss)                          |       |                                                      | 0.6        | % |   |   | (3.0 | )% |   |
| Foreign currency  transaction gains (losses), net |       |                                                      | 6.7        | % |   |   | (1.2 | )% |   |
| Reorganization  items, net                        |       |                                                      | (0.7       | )% |   |   | (4.2 | )% |   |
| Interest income                                   |       |                                                      | 0.7        | % |   |   | 0.6 | % |   |
| Interest expense                                  |       |                                                      | (1.7       | )% |   |   | (2.9 | )% |   |
| Other income                                      |       |                                                      | 0.5        | % |   |   | 0.0 | % |   |
| Income (loss)  before income taxes                |       |                                                      | 6.1        | % |   |   | (10.7 | )% |   |
| Income tax  expense                               |       |                                                      | (2.6       | )% |   |   | (3.7 | )% |   |
| Net income (loss)                                 |       |                                                      | 3.5        | % |   |   | (14.4 | )% |   |

 

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***Nine Months***
| ** **                                                    | ** ** | **Successor  Company  Nine Months  Ended  December 31,  2004** | ** ** | **Successor  Company  166 Days  Ended  December 31,  2003** | ** ** | **Predecessor  Company  109 Days  Ended  July 18,  2003** | ** ** | **Pro Forma  Combined  Nine Months  Ended  December 31,  2003** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|
| Revenue:                                                      |       |                                                                     |       |                                                                  |       |                                                                |       |                                                                           |       |   |   |   |   |   |   |   |   |
| Licenses                                                      |       |                                                                     | 34.2       | %                                                                     |       |                                                                | 39.1       | %                                                                              |       |   | 27.8 | % |   |   | 34.9 | % |   |
| Maintenance                                                   |       |                                                                     | 57.1       | %                                                                     |       |                                                                | 52.4       | %                                                                              |       |   | 60.0 | % |   |   | 55.2 | % |   |
| Consulting and training                                       |       |                                                                     | 8.7        | %                                                                     |       |                                                                | 8.5        | %                                                                              |       |   | 12.2 | % |   |   | 9.9 | % |   |
| Total revenue                                                 |       |                                                                     | 100.0      | %                                                                     |       |                                                                | 100.0      | %                                                                              |       |   | 100.0 | % |   |   | 100.0 | % |   |
| Costs and expenses:                                           |       |                                                                     |       |                                                                  |       |                                                                |       |                                                                           |       |   |   |   |   |   |   |   |   |
| Cost of licenses                                              |       |                                                                     | 0.8        | %                                                                     |       |                                                                | 1.1        | %                                                                              |       |   | 1.5 | % |   |   | 1.3 | % |   |
| Cost of maintenance                                           |       |                                                                     | 9.6        | %                                                                     |       |                                                                | 9.5        | %                                                                              |       |   | 10.6 | % |   |   | 9.9 | % |   |
| Cost of consulting and training                               |       |                                                                     | 9.2        | %                                                                     |       |                                                                | 8.9        | %                                                                              |       |   | 10.9 | % |   |   | 9.6 | % |   |
| Sales and marketing                                           |       |                                                                     | 34.6       | %                                                                     |       |                                                                | 28.6       | %                                                                              |       |   | 30.0 | % |   |   | 29.1 | % |   |
| Research and development                                      |       |                                                                     | 15.3       | %                                                                     |       |                                                                | 16.3       | %                                                                              |       |   | 18.3 | % |   |   | 17.0 | % |   |
| General and administrative                                    |       |                                                                     | 26.9       | %                                                                     |       |                                                                | 24.3       | %                                                                              |       |   | 28.7 | % |   |   | 25.9 | % |   |
| Amortization of intangible assets                             |       |                                                                     | 12.2       | %                                                                     |       |                                                                | 13.1       | %                                                                              |       |   | 0.0 | % |   |   | 8.1 | % |   |
| Restructuring and other                                       |       |                                                                     | 0.0        | %                                                                     |       |                                                                | 0.0        | %                                                                              |       |   | (2.5 | )% |   |   | (1.0 | )% |   |
| Total operating costs and expenses                            |       |                                                                     | 108.6      | %                                                                     |       |                                                                | 101.8      | %                                                                              |       |   | 97.5 | % |   |   | 99.9 | % |   |
| (Loss) income  from continuing operations                     |       |                                                                     | (8.6       | )%                                                                    |       |                                                                | (1.8       | )%                                                                             |       |   | 2.5 | % |   |   | 0.1 | % |   |
| Foreign currency  transaction gains (losses), net             |       |                                                                     | 1.9        | %                                                                     |       |                                                                | (0.3       | )%                                                                             |       |   | (2.1 | )% |   |   | (1.0 | )% |   |
| Reorganization  items, net                                    |       |                                                                     | (1.1       | )%                                                                    |       |                                                                | (7.1       | )%                                                                             |       |   | 778.6 | % |   |   | 290.2 | % |   |
| Interest income                                               |       |                                                                     | 0.7        | %                                                                     |       |                                                                | 0.8        | %                                                                              |       |   | 1.3 | % |   |   | 1.0 | % |   |
| Interest expense                                              |       |                                                                     | (2.3       | )%                                                                    |       |                                                                | (3.5       | )%                                                                             |       |   | (9.7 | )% |   |   | (5.8 | )% |   |
| Other income                                                  |       |                                                                     | 0.2        | %                                                                     |       |                                                                | 0.0        | %                                                                              |       |   | 0.0 | % |   |   | 0.0 | % |   |
| (Loss) income  from continuing operations before income taxes |       |                                                                     | (9.2       | )%                                                                    |       |                                                                | (11.9      | )%                                                                             |       |   | 770.6 | % |   |   | 284.5 | % |   |
| Income tax  expense on continuing operations                  |       |                                                                     | (2.7       | )%                                                                    |       |                                                                | (2.9       | )%                                                                             |       |   | (2.3 | )% |   |   | (2.7 | )% |   |
| (Loss) income  from continuing operations                     |       |                                                                     | (11.9      | )%                                                                    |       |                                                                | (14.8      | )%                                                                             |       |   | 768.3 | % |   |   | 281.8 | % |   |
| Income from  discontinued operations, net of income taxes     |       |                                                                     | 0.0        | %                                                                     |       |                                                                | 0.0        | %                                                                              |       |   | 0.5 | % |   |   | 0.2 | % |   |
| Net (loss) income                                             |       |                                                                     | (11.9      | )%                                                                    |       |                                                                | (14.8      | )%                                                                             |       |   | 768.8 | % |   |   | 282.0 | % |   |

 

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**COMPARISON OF RESULTS OF OPERATIONS**

**REVENUE**

Revenue comprises license fees, maintenance servicefees and fees for consulting and training services.

Thefollowing table summarizes Successor Company revenue for the three months endedDecember 31, 2004 and 2003 (dollars in thousands):
| ** ** | ** ** | **Successor  Company  Three Months  Ended  December 31,** | ** ** | **Successor  Company  Three Months  Ended  December 31,** | ** ** | **Change** | ** ** |
|------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|------------|------------|
| ** ** | ** ** | **2004**                                                            | ** ** | **2003**                                                            | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Revenue    |       |                                                                | $          | 55,231                                                              |       |       |       | $ | 44,713 |   |   | $ | 10,518 |   |   | 24 | % |   |
|            |            |                                                                     |            |                                                                     |            |            |            |  |  |  |  |  |  |  |  |  |  |  |

 

Revenue totaled $55.2 million for the threemonths ended December 31, 2004, an increase of $10.5 million, or 24%,from the $44.7 million for the three months ended December 31, 2003.The reasons for the revenue increases or decreases are discussed below.

Thefollowing table summarizes Successor Company revenue for the nine months ended December 31,2004 and pro forma combined revenue for the nine months ended December 31,2003 and (dollars in thousands):
| ** **                   | ** ** | **Successor  Company  Nine Months  Ended  December 31,** | ** ** | **Successor  Company  166 Days  Ended  December 31,** | ** ** | **Predecessor  Company  109 Days  Ended  July 18,** | ** ** | **Pro Forma  Combined  Nine Months  Ended  December 31,** | ** ** | **Change** | ** ** |
|------------------------------|------------|--------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|------------|------------|
| ** **                   | ** ** | **2004**                                                           | ** ** | **2003**                                                        | ** ** | **2003**                                                      | ** ** | **2003**                                                                 | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| ***Total  Revenue***         |       |                                                               |       |                                                            |       |                                                          |       |                                                                     |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| New                          |       |                                                               | $          | 143,339                                                         |       |                                                          |       | $                                                                        | 79,933     |       |       |   | $ | 43,060 |   |   |   | $ | 122,993 |   |   | $ | 20,346 |   |   | 17 | % |   |
| Pre-fiscal 2003 transactions |       |                                                               | —     |                                                            |       |                                                          | —     |                                                                     |       |       | 5,595      |   |   |   | 5,595 |   |   | (5,595 | ) |   | (100 | )% |   |
| Total                        |       |                                                               | $          | 143,339                                                         |       |                                                          |       | $                                                                        | 79,933     |       |       |   | $ | 48,655 |   |   |   | $ | 128,588 |   |   | $ | 14,751 |   |   | 11 | % |   |

 

Revenue totaled$143.3 million for the nine months ended December 31, 2004, anincrease of $14.8 million, or 11%, from the $128.6 million pro formacombined revenue for the nine months ended December 31, 2003. Licenserevenue for the nine months ended December 31, 2003 includes$5.6 million for license transactions entered into prior to fiscal 2003but for which all revenue recognition criteria were not satisfied until the proforma combined nine months ended December 31, 2003. Revenue for the ninemonths ended December 31, 2004 increased by $20.3 million, or 17%,from the pro forma combined revenue for the nine months ended December 31,2003, excluding license transactions initiated prior to fiscal 2003. Thereasons for the revenue increases or decreases are discussed below.

*Licenses*

We generally license our products to end-users underperpetual license agreements for an up-front fee. License revenue for the proforma combined nine months ended December 31, 2003 includes$5.6 million from license transactions originally entered into prior tofiscal 2003 but for which all revenue recognition criteria were not satisfieduntil that period. The delay in recognizing revenue from license transactionsoriginally entered into prior to fiscal 2003 arises from long-term installmentpayments, which are recognized as installments come due, and amounts related toproducts for which the expiration of certain product exchange or upgrade rightsoccurred in the later period. Commencing in fiscal 2003, we changed certainbusiness practices by limiting the number of long-term installment contractsand contracts 

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containing productexchange or upgrade rights. Upon the application of fresh-start reportingas of July 18, 2003, amounts that would have been recognized as revenue infuture fiscal quarters by the Successor Company for such arrangements wereeliminated because we had no significant future performance obligations underthese agreements. Anticipated collections of Predecessor Company extended payreceivables were recorded as other assets in connection with the adoption offresh-start reporting. At December 31, 2004 other assets included$0.4 million of such receivables which were collected during the quarterended March 31, 2005.

Thefollowing table summarizes Successor Company license revenue for the threemonths ended December 31, 2004 and 2003 (dollars in thousands):
| ** ** | ** ** | **Successor  Company  Three Months  Ended  December 31,** | ** ** | **Successor  Company  Three Months  Ended  December 31,** | ** ** | **Change** | ** ** |
|------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|------------|------------|
| ** ** | ** ** | **2004**                                                            | ** ** | **2003**                                                            | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Licenses   |       |                                                                | $          | 22,253                                                              |       |       |       | $ | 17,229 |   |   | $ | 5,024 |   |   | 29 | % |   |
|            |            |                                                                     |            |                                                                     |            |            |            |  |  |  |  |  |  |  |  |  |  |  |

 

License revenue for the three months ended December 31,2004 increased by $5.0 million, or 29%, from the three months ended December 31,2003. The increase primarily reflected higher unit sales as a result of demandfor new and additional licenses, largely from our existing customer base. Thisdemand was precipitated, in part, by our emergence from bankruptcy proceedingsin August 2003 and our subsequent increased sales and marketing efforts. Inaddition, license revenue for the three months ended December 31, 2004includes $1.7 million from license transactions entered into during the sixmonths ended September 30, 2004 but for which all revenue recognitioncriteria were not satisfied until the current quarter. As of December 31,2004 $0.6 million of license revenue from license transactions entered intoduring the nine months ended December 31, 2004 is being deferred to the fourthquarter of fiscal 2005 as all revenue recognition criteria were not satisfieduntil that subsequent period.

Thefollowing table summarizes Successor Company license revenue for the ninemonths ended December 31, 2004 and pro forma combined license revenue forthe nine months ended December 31, 2003 (dollars in thousands):
| ** **                   | ** ** | **Successor  Company  Nine Months  Ended  December 31,** | ** ** | **Successor  Company  166 Days  Ended  December 31,** | ** ** | **Predecessor  Company  109 Days  Ended  July 18,** | ** ** | **Pro Forma  Combined  Nine Months  Ended  December 31,** | ** ** | **Change** | ** ** |
|------------------------------|------------|--------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|------------|------------|
| ** **                   | ** ** | **2004**                                                           | ** ** | **2003**                                                        | ** ** | **2003**                                                      | ** ** | **2003**                                                                 | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| ***Licenses***               |       |                                                               |       |                                                            |       |                                                          |       |                                                                     |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| New                          |       |                                                               | $          | 49,021                                                          |       |                                                          |       | $                                                                        | 31,281     |       |       |   | $ | 7,930 |   |   |   | $ | 39,211 |   |   | $ | 9,810 |   |   | 25 | % |   |
| Pre-fiscal 2003 transactions |       |                                                               | —     |                                                            |       |                                                          | —     |                                                                     |       |       | 5,595      |   |   |   | 5,595 |   |   | (5,595 | ) |   | (100 | )% |   |
| Total                        |       |                                                               | $          | 49,021                                                          |       |                                                          |       | $                                                                        | 31,281     |       |       |   | $ | 13,525 |   |   |   | $ | 44,806 |   |   | $ | 4,215 |   |   | 9 | % |   |

 

License revenue totaled$49.0 million for the nine months ended December 31, 2004, anincrease of $4.2 million, or 9%, from the $44.8 million for the proforma combined nine months ended December 31, 2003. License revenue forthe period ended December 31, 2004 resulted mostly from licensetransactions entered into during the period and, as a result of the adoption offresh-start reporting, did not include any revenue from licensetransactions initiated prior to fiscal 2003. License revenue for the ninemonths ended December 31, 2004 increased by $9.8 million, or 25%,from the pro forma combined nine months ended December 31, 2003, excludingtransactions initiated prior to fiscal 2003. The increase primarily reflectedhigher unit sales as a result of demand for new and additional licenses,largely from our existing customer base, precipitated, in part, by ouremergence from bankruptcy proceedings in August 2003 and our subsequent increasedsales and marketing efforts. License revenue for the pro forma combined nine 

30

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monthsended December 31, 2003 included $39.2 million of license feesattributable mostly to new license transactions entered into during the periodand $5.6 million attributable to license transactions initiated prior tofiscal 2003 but for which revenue was first recognizable in the pro formacombined nine months ended December 31, 2003.

*Maintenance*

Most customers purchase maintenance services whenbuying new or additional licenses. Maintenance services consist primarily ofproviding enhancements and upgrades for our products along with customersupport services for our products. Generally, maintenance contracts are enteredinto for one-year periods, contain economic index fee escalation provisions andare renewable annually at the customer’s option. Maintenance contracts aregenerally prepaid by the customer and revenue is recognized ratably over thecontract period. Maintenance revenue may include fees for services rendered inprior periods in instances in which customers did not renew their maintenancecontracts until the current period.

As described earlier, we adopted the fresh-startreporting provisions of SOP 90-7 as of July 18, 2003. Fresh-startreporting requires that the reorganization value be allocated to the entity’sassets in accordance with SFAS No. 141. In accordance with thesepronouncements, we determined the fair market value of our assets andliabilities at July 18, 2003, including our deferred maintenance revenuebalances. Accordingly, we reduced our deferred maintenance revenue balances by$6.3 million to reflect the fair value of maintenance contracts existingat July 18, 2003. This $6.3 million adjustment has the effect ofreducing maintenance revenue over the maintenance contract period for thosecontracts that existed when we adopted fresh-start reporting. In thethree and nine months ended December 31, 2004 maintenance revenue wasreduced by $0.3 million and $1.2 million, respectively. The balanceof the adjustment of $0.7 million at December 31, 2004 will beamortized through March 31, 2007.

Thefollowing table summarizes Successor Company maintenance revenue for the threemonths ended December 31, 2004 and 2003 (dollars in thousands):
| ** **  | ** ** | **Successor  Company  Three Months  Ended  December 31,** | ** ** | **Successor  Company  Three Months  Ended  December 31,** | ** ** | **Change** | ** ** |
|-------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|------------|------------|
| ** **  | ** ** | **2004**                                                            | ** ** | **2003**                                                            | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Maintenance |       |                                                                | $          | 28,312                                                              |       |       |       | $ | 24,061 |   |   | $ | 4,251 |   |   | 18 | % |   |
|             |            |                                                                     |            |                                                                     |            |            |            |  |  |  |  |  |  |  |  |  |  |  |

 

Maintenance revenue totaled $28.3 million for thethree months ended December 31, 2004, an increase of $4.3 million, or18%, from the $24.1 million for the three months ended December 31,2003. This increase is net of the $0.3 million reduction discussed above anda $1.8 million reduction resulting from the adoption of fresh-startreporting for the three months ended December 31, 2004 and 2003,respectively. Excluding the reductions in maintenance revenue resulting fromthe adoption of fresh-start reporting, maintenance revenue increased$2.8 million, or 11%, from the three months ended December 31, 2003.The increase occurred mainly as a result of increased focus on renewal effortsand because the revenue attributable to additional licenses covered bymaintenance contracts exceeded the revenue lost from cancellations, in whole orin part, of maintenance contracts during the renewal process.

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Thefollowing table summarizes Successor Company maintenance revenue for the ninemonths ended December 31, 2004 and pro forma combined maintenance revenuefor the nine months ended December 31, 2003 (dollars in thousands):
| ** **  | ** ** | **Successor  Company  Nine Months  Ended  December 31,** | ** ** | **Successor  Company  166 Days  Ended  December 31,** | ** ** | **Predecessor  Company  109 Days  Ended  July 18,** | ** ** | **Pro Forma  Combined  Nine Months  Ended  December 31,** | ** ** | **Change** | ** ** |
|-------------|------------|--------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|------------|------------|
| ** **  | ** ** | **2004**                                                           | ** ** | **2003**                                                        | ** ** | **2003**                                                      | ** ** | **2003**                                                                 | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Maintenance |       |                                                               | $          | 81,864                                                          |       |                                                          |       | $                                                                        | 41,853     |       |       |   | $ | 29,176 |   |   |   | $ | 71,029 |   |   | $ | 10,835 |   |   | 15 | % |   |
|             |            |                                                                    |            |                                                                 |            |                                                               |            |                                                                          |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Maintenance revenuetotaled $81.9 million for the nine months ended December 31, 2004, anincrease of $10.8 million, or 15%, from the $71.0 million reportedfor the pro forma combined nine months ended December 31, 2003. Thisincrease is net of the $1.2 million reduction discussed above and a$3.5 million reduction resulting from the adoption of fresh-startreporting for the nine months ended December 31, 2004 and the pro formacombined nine months ended December 31, 2003, respectively. Excluding thereduction in maintenance revenue resulting from the adoption of fresh-startreporting, maintenance revenue increased $8.6 million, or 11%, from thepro forma combined nine months ended December 31, 2003. The increaseoccurred mainly as a result of increased focus on renewal efforts and becausethe revenue attributable to additional licenses covered by maintenancecontracts exceeded the revenue lost from cancellations, in whole or in part, ofmaintenance contracts during the renewal process.

*Consulting andTraining*

Consulting and training services include a range ofprofessional and educational services intended to help our customers use oursoftware products more effectively. Beginning in June 2002, as part ofexpense-cutting initiatives, we reduced our consulting staff and began torefer customers more frequently to third-party service providers forgeneral consulting services. We began to focus on supplementing our customers’and the third-party service providers’ project teams with consultantspossessing specialized knowledge of the more complex aspects of our productsand the best practices for integrating our products into the customers’business operations.

During the latter half of fiscal 2004, the Companybegan to reinvest in expanding its consulting business due to increasingcustomer demand after emergence from bankruptcy. The Company hired additionalbusiness development personnel, new managers and other staff to address thisdemand.

Thefollowing table summarizes Successor Company consulting and training revenuefor the three months ended December 31, 2004 and 2003 (dollars inthousands):
| ** **               | ** ** | **Successor  Company  Three Months  Ended  December 31,** | ** ** | **Successor  Company  Three Months  Ended  December 31,** | ** ** | **Change** | ** ** |
|--------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|------------|------------|
| ** **               | ** ** | **2004**                                                            | ** ** | **2003**                                                            | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Consulting and  training |       |                                                                | $          | 4,666                                                               |       |       |       | $ | 3,423 |   |   | $ | 1,243 |   |   | 36 | % |   |
|                          |            |                                                                     |            |                                                                     |            |            |            |  |  |  |  |  |  |  |  |  |  |  |

 

Revenue for consulting and training services totaled$4.7 million for the three months ended December 31, 2004, anincrease of $1.2 million, or 36%, from the $3.4 million for the threemonths ended December 31, 2003. This increase primarily reflects theresult of the Company’s reinvestment in its consulting business during thelatter half of fiscal 2004.

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The followingtable summarizes Successor Company consulting and training revenue for the ninemonths ended December 31, 2004 and pro forma combined consulting andtraining revenue for the nine months ended December 31, 2003 (dollars inthousands):
| ** **              | ** ** | **Successor  Company  Nine Months  Ended  December 31,** | ** ** | **Successor  Company  166 Days  Ended  December 31,** | ** ** | **Predecessor  Company  109 Days  Ended  July 18,** | ** ** | **Pro Forma  Combined  Nine Months  Ended  December 31,** | ** ** | **Change**             | ** ** |
|-------------------------|------------|--------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|------------------------|------------|
| ** **              | ** ** | **2004**                                                           | ** ** | **2003**                                                        | ** ** | **2003**                                                      | ** ** | **2003**                                                                 | ** ** | ** Amount ** | ** ** | **Percent** | ** ** |
| Consulting and training |       |                                                               | $          | 12,454                                                          |       |                                                          |       | $                                                                        | 6,799      |                   |       |   | $ | 5,954 |   |   |   | $ | 12,753 |   |   |   | $ | (299 | ) |   |   | (2 | )% |   |
|                         |            |                                                                    |            |                                                                 |            |                                                               |            |                                                                          |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Revenue for consulting andtraining services totaled $12.5 million for the nine months ended December 31,2004, a decrease of $0.3 million, or 2%, from the $12.8 million proforma combined consulting and training revenue for the nine months ended December 31,2003. This decrease primarily reflects the fact that the pro forma combinednine months ended December 31, 2003 includes revenue from arrangementsthat were in place prior to June 2002 when we changed our consultingservices strategy. This fiscal 2004 revenue related to pre-June 2002arrangements was greater than the revenue increases related to our reinvestmentefforts which began in the latter half of fiscal 2004.

**Revenue by Segment**

Weorganize our business operations according to two segments:

·       *Americas*.   These include the Company’sU.S. operations as well as its operations in Canada, Mexico and South America.

·       *EMEA/AP.  *These include the Company’soperations in Europe, the Middle East, Africa and the Asia Pacific Region.

Thefollowing table summarizes Successor Company revenue by segment for the threemonths ended December 31, 2004 and 2003 (dollars in thousands):
| ** **         | ** ** | **Successor Company**                      | ** ** | ** **                                      | ** ** | ** ** | ** ** |
|--------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|------------|------------|
| ** **         | ** ** | **Three Months  Ended  December 31,** | ** ** | **Three Months  Ended  December 31,** | ** ** | **Change** | ** ** |
| ** **         | ** ** | **2004**                                        | ** ** | **2003**                                        | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Revenue            |       |                                            |       |                                            |       |       |       |   |   |   |   |   |   |   |   |
| Americas           |       |                                            | $          | 27,259                                          |       |       |       | $ | 24,097 |   |   | $ | 3,162 |   |   | 13 | % |   |
| EMEA/AP            |       |                                            | 27,972     |                                            |       |       | 20,616     |   |   | 7,356 |   |   | 36 | % |   |
| Total              |       |                                            | $          | 55,231                                          |       |       |       | $ | 44,713 |   |   | $ | 10,518 |   |   | 24 | % |   |
| % of total revenue |       |                                            |       |                                            |       |       |       |   |   |   |   |   |   |   |   |
| Americas           |       |                                            | 49         | %                                               |       |       | 54         | % |   |   |   |   |   |   |   |
| EMEA/AP            |       |                                            | 51         | %                                               |       |       | 46         | % |   |   |   |   |   |   |   |
|               |       |                                            | 100        | %                                               |       |       | 100        | % |   |   |   |   |   |   |   |

 

Revenue for the Americasterritory totaled $27.3 million for the three months ended December 31,2004, an increase of $3.2 million, or 13%, from the three months ended December 31,2003. License revenue for the Americas territory totaled $8.4 million forthe three months ended December 31, 2004, and was substantially the sameas the three months ended December 31, 2003. Maintenance revenue for theAmericas territory for the three months ended December 31, 2004 increased$2.4 million from the three months ended December 31, 2003 primarilyas a result of increased focus on renewal efforts and because the revenueattributable to additional licenses covered by maintenance contracts exceededthe revenue lost from cancellations, in whole or in part, of maintenancecontracts during the renewal process. Americas consulting and training revenuefor the three months ended December 31, 2004 increased $0.9 millionfrom the three months ended December 31, 2003 primarily as a result of theCompany’s reinvestment in its consulting business during the latter half offiscal 2004.

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Revenue for the EMEA/APterritory totaled $28.0 million for the three months ended December 31,2004, an increase of $7.4 million, or 36%, from the three months ended December 31,2003. License revenue in EMEA/AP for the three months ended December 31,2004 increased by $5.2 million from the three months ended December 31,2003, primarily as a result of higher unit sales as a result of demand for newand additional licenses, largely from our existing customer base, precipitated,in part, by our emergence from bankruptcy proceedings in August 2003 andour subsequent increased sales and marketing efforts as well as favorablefluctuations in exchange rates with the U.S. dollar. EMEA/AP maintenancerevenue in the three months ended December 31, 2004 increased by$1.8 million from the three months ended December 31, 2003, primarilyas a result of increased focus on renewal efforts and because the revenueattributable to additional licenses covered by maintenance contracts exceededthe revenue lost from cancellations, in whole or in part, of maintenancecontracts during the renewal process. EMEA/AP consulting and training revenuefor the three months ended December 31, 2004 increased $0.4 millionfrom the three months ended December 31, 2003 and primarily reflects thereinvestment efforts which began in the latter half of fiscal 2004.

Thefollowing table summarizes Successor Company revenue by segment for the ninemonths ended December 31, 2004 and pro forma combined revenue by segmentfor the nine months ended December 31, 2003 (dollars in thousands):
| ** **         | ** ** | **Successor  Company  Nine Months  Ended  December 31,** | ** ** | **Successor  Company  166 Days  Ended  December 31,** | ** ** | **Predecessor  Company  109 Days  Ended  July 18,** | ** ** | **Pro Forma  Combined  Nine Months  Ended  December 31,** | ** ** | **Change** | ** ** |
|--------------------|------------|--------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|------------|------------|
| ** **         | ** ** | **2004**                                                           | ** ** | **2003**                                                        | ** ** | **2003**                                                      | ** ** | **2003**                                                                 | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Revenue            |       |                                                               |       |                                                            |       |                                                          |       |                                                                     |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Americas           |       |                                                               | $          | 78,079                                                          |       |                                                          |       | $                                                                        | 43,959     |       |       |   | $ | 32,043 |   |   |   | $ | 76,002 |   |   | $ | 2,077 |   |   | 3 | % |   |
| EMEA/AP            |       |                                                               | 65,260     |                                                            |       |                                                          | 35,974     |                                                                     |       |       | 16,612     |   |   |   | 52,586 |   |   | 12,674 |   |   | 24 | % |   |
| Total              |       |                                                               | $          | 143,339                                                         |       |                                                          |       | $                                                                        | 79,933     |       |       |   | $ | 48,655 |   |   |   | $ | 128,588 |   |   | $ | 14,751 |   |   | 11 | % |   |
| % of total revenue |       |                                                               |       |                                                            |       |                                                          |       |                                                                     |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Americas           |       |                                                               | 54         | %                                                               |       |                                                          | 55         | %                                                                        |       |       | 66         | % |   |   | 59 | % |   |   |   |   |   |   |   |
| EMEA/AP            |       |                                                               | 46         | %                                                               |       |                                                          | 45         | %                                                                        |       |       | 34         | % |   |   | 41 | % |   |   |   |   |   |   |   |
|               |       |                                                               | 100        | %                                                               |       |                                                          | 100        | %                                                                        |       |       | 100        | % |   |   | 100 | % |   |   |   |   |   |   |   |

 

Revenue for the Americasterritory totaled $78.1 million for the nine months ended December 31,2004, an increase of $2.1 million, or 3%, from the pro forma combinedrevenue for the nine months ended December 31, 2003. License revenue forthe Americas territory totaled $23.9 million for the nine months ended December 31,2004, a decrease of $2.2 million, from the pro forma combined licenserevenue for the nine months ended December 31, 2003. License revenue forthe Americas territory for the nine months ended December 31, 2003includes $5.2 million for license transactions entered into prior tofiscal 2003 but for which all revenue recognition criteria were not satisfieduntil the pro forma combined nine months ended December 31, 2003. Licenserevenue for the Americas territory for the nine months ended December 31,2004 increased by $3.0 million, from the pro forma combined licenserevenue for the nine months ended December 31, 2003, excludingtransactions initiated prior to fiscal 2003. The increase primarily reflectedhigher unit sales as a result of demand for new and additional licenses,largely from our existing customer base, precipitated, in part, by ouremergence from bankruptcy proceedings in August 2003 and our subsequentincreased sales and marketing efforts. Maintenance revenue for the Americasterritory for the nine months ended December 31, 2004 increased$3.4 million from the pro forma combined nine months ended December 31,2003 primarily as a result of increased focus on renewal efforts and becausethe revenue attributable to additional licenses covered by maintenancecontracts exceeded the revenue lost from cancellations, in whole or in part, ofmaintenance contracts during the 

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renewalprocess. Americas consulting and training revenue for the nine months ended December 31,2004 increased $0.9 million from the pro forma combined nine months ended December 31,2003 and primarily reflects the reinvestment efforts which began in the latterhalf of fiscal 2004.

Revenue for the EMEA/APterritory totaled $65.3 million for the nine months ended December 31,2004, an increase of $12.7 million, or 24%, from the pro forma combinedrevenue for the nine months ended December 31, 2003. License revenue inEMEA/AP for the nine months ended December 31, 2004 increased$6.4 million from the pro forma combined nine months ended December 31,2003 as a result of higher unit sales of new and additional licenses, largelyto our existing customer base, precipitated, in part, by our emergence frombankruptcy proceedings in August 2003 and our subsequent increased salesand marketing efforts as well as favorable fluctuations in exchange rates withthe U.S. dollar. In addition, revenues increased as the result of hiring newpersonnel and improved execution of the sales model. EMEA/AP maintenancerevenue in the nine months ended December 31, 2004 increased by$7.4 million from the pro forma combined nine months ended December 31,2003 primarily as a result of increased focus on renewal efforts and becausethe revenue attributable to additional licenses covered by maintenancecontracts exceeded the revenue lost from cancellations, in whole or in part, ofmaintenance contracts during the renewal process. EMEA/AP consulting andtraining revenue for the nine months ended December 31, 2004 decreased$1.2 million from the pro forma combined nine months ended December 31,2003 and primarily reflects the June 2002 change in our consultingservices strategy, offset in part by the impact associated with thereinvestment efforts which began in the latter half of fiscal 2004.

**COSTS AND EXPENSES**

*Cost of Licenses*

The cost of licensesprimarily consists of third-party software royalties, product packaging,documentation and production, and distribution costs.

The cost of licensestotaled $0.4 million for the three months ended December 31, 2004, adecrease of $0.2 million, or 26%, from the three months ended December 31,2003. The cost of licenses represented 2% and 3% of license revenue for thethree months ended December 31, 2004 and 2003, respectively. This decreaseresulted primarily from reductions in software royalties.

The cost of licensestotaled $1.2 million for the nine months ended December 31, 2004, adecrease of $0.4 million, or 28%, from the pro forma combined cost oflicenses for the nine months ended December 31, 2003. The cost of licensesrepresented 2% and 4% of license revenue for the nine months ended December 31,2004 and the pro forma combined nine months ended December 31, 2003,respectively. This decrease resulted primarily from reductions in softwareroyalties and from ongoing cost reductions implemented in the latter portion offiscal 2003 through the quarter ended June 30, 2003. We began to outsourcemost of our product distribution beginning in the three months ended June 30,2003, and fully implemented the outsourcing prior to the quarter ended June 30,2004.

*Cost of Maintenance*

The cost of maintenanceservices primarily consists of personnel, facilities and system costs relatedto technical support services to our customers on maintenance contracts.

The cost of maintenancetotaled $4.8 million for the three months ended December 31, 2004, anincrease of $0.6 million, or 15%, from the three months ended December 31,2003. This increase resulted primarily from increases in personnel costs. Thecost of maintenance represented 17% of maintenance revenue for each of thethree months ended December 31, 2004 and 2003.

The cost of maintenancetotaled $13.8 million for the nine months ended December 31, 2004, anincrease of $1.0 million, or 8%, from the pro forma combined nine months ended December 31,2003. This increase resulted primarily from increases in personnel costs. Thecost of maintenance represented 17% 

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and 18%of maintenance revenue for the nine months ended December 31, 2004 and thepro forma combined nine months ended December 31 2003, respectively.

*Cost of Consulting and Training*

The cost of consulting andtraining services primarily consists of personnel, facilities and system costsassociated with providing these services. The cost of consulting and trainingservices also includes fees paid to third-party subcontractors providingservices on our behalf.

The cost of consulting andtraining totaled $4.9 million for the three months ended December 31,2004, an increase of $1.2 million, or 31%, from the three months ended December 31,2003. This increase resulted from increases in direct personnel costs and isconsistent with the increase in associated revenues. The cost of consulting andtraining represented 105% and 109% of consulting and training revenue for thethree months ended December 31, 2004 and 2003, respectively. The decreaseas a percentage of consulting and training revenues reflects the static natureof the associated overhead costs relative to the corresponding increase indirect personnel costs.

The cost of consulting andtraining totaled $13.2 million for the nine months ended December 31,2004, an increase of $0.8 million, or 6%, from the pro forma combined ninemonths ended December 31, 2003. The cost of consulting and trainingrepresented 106% and 97% of consulting and training revenue for the nine monthsended December 31, 2004 and the pro forma combined nine months ended December 31,2003, respectively. The cost increase is the result of the Company reinvestingin expanding its consulting business during the latter half of fiscal 2004. Theincrease as a percentage of consulting and training revenues reflects thestatic nature of the associated overhead costs relative to a correspondingdecrease in direct personnel costs.

*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 $17.7 million for the three months ended December 31,2004, an increase of $4.2 million, or 31%, from the three months ended December 31,2003. The increase reflects an increase in strategic marketing consulting fees,commission expense and personnel costs. The increase in commission expenseresulted primarily from the increase in license revenue, exclusive oftransactions initiated prior to fiscal 2003.

Sales and marketingexpenses totaled $49.5 million for the nine months ended December 31,2004, an increase of $12.1 million, or 32%, from the pro forma combinednine months ended December 31, 2003. The increase reflects an increase instrategic marketing consulting fees, commission expense and personnel costs.The increase in commission expense resulted primarily from the increase inlicense revenue, exclusive of transactions initiated prior to fiscal 2003.

*Research and Development*

Research and development(R&D) expenses primarily consist of personnel, facilities and systems costsassociated with our R&D efforts, which include software development andproduct management efforts. R&D expenses also include the cost of servicesfor consultants or other third parties that we hire from time to time toaugment our own R&D personnel. No software development costs werecapitalized during the periods presented, as costs incurred betweentechnological feasibility and product releases were minimal.

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R&D expenses totaled$7.6 million for the three months ended December 31, 2004, anincrease of $0.6 million, or 8%, from the three months ended December 31,2003. This increase is primarily due to increases in personnel costs.

R&D expenses totaled$22.0 million for the nine months ended December 31, 2004, and weresubstantially the same as the pro forma combined nine months ended December 31,2003.

*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$13.6 million for the three months ended December 31, 2004, anincrease of $2.4 million, or 22%, from the three months ended December 31,2003. The increase primarily reflects an increase in personnel costs.Additionally, we incurred increased professional fees for tax and financial andaccounting related services.

G&A expenses totaled$38.6 million for the nine months ended December 31, 2004, anincrease of $5.3 million, or 16%, from the pro forma combined nine monthsended December 31, 2003. The increase primarily reflects an increase in personnelcosts offset in part by decreases in professional fees.

*Amortization of Intangible Assets*

Fresh-startreporting requires that the reorganization value be allocated to the entity’sassets in conformity with procedures specified by SFAS 141. Identifiableintangible assets identified in connection with fresh-start reportingwhich are subject to amortization consist of developed technology, trademarksand trade names, maintenance contracts and customer lists. With the adoption offresh-start reporting, our Successor Company determined the fair value ofthese identifiable intangibles to be $125.1 million, and to have usefullives ranging from five to six years. For each of the three months ended December 31,2004 and 2003 our Successor Company recorded non-cash charges for amortizationof intangible assets of $5.8 million. For the nine months ended December 31,2004 and the 166 days ended December 31, 2003 our Successor Companyrecorded non-cash charges for amortization of intangible assets of$17.4 million and $10.5 million, respectively.

*Restructuring and Other*

Restructuring and otherfor our Predecessor Company totaled $1.2 million for the 109 daysended July 18, 2003 and represents a gain realized upon the sale ofcertain minority investments in other companies.

*Foreign Currency 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 period-endmarket rates. Foreign currency transactions resulted in gains of$3.7 million and $2.7 million for the three and nine months ended December 31,2004, respectively, with such gains resulting primarily from the impact of the weakeningU.S. dollar on our foreign-denominated short-term intercompany receivable andpayable balances. Foreign currency transactions resulted in losses of $0.5million for the three months ended December 31, 2003 and losses of$1.2 million for the pro forma combined nine months ended December 31,2003.

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*Reorganization Items, Net*

As discussed above, as aresult of our bankruptcy-law filing, as of September 22, 2002, we becamesubject to the provisions of SOP 90-7 for the reporting periods subsequentto September 22, 2002. Pursuant to SOP 90-7, revenue, expenses(including professional fees), realized gains and losses, and provisions forlosses resulting from our Predecessor Company’s reorganization of the businessthrough the bankruptcy proceedings are reported separately as reorganizationitems, except for the sale of the assets of our wholly-owned subsidiary,Remedy, which is recorded in discontinued operations. Our Successor Company hasalso incurred charges recorded in reorganization items, net, primarily relatedto bankruptcy-proceeding professional fees.

Reorganization items, nettotaled $0.4 million and $1.9 million for the three months ended December 31,2004 and 2003, respectively, and consist primarily of professional feesdirectly related to the bankruptcy filing. Reorganization items, net totaled $1.5million for the nine months ended December 31, 2004, and consist primarilyof professional fees directly related to the bankruptcy filing, net of $0.2 millionof gains on settlements with creditors. Reorganization items, net totaled$5.7 million for the 166 days ended September 30, 2003 and alsoconsist primarily of professional fees directly related to the bankruptcyfiling.

Reorganizationitems, net for our Predecessor Company consist of the following (in thousands):
| ** **                                               | ** ** | **109 Days  Ended  July 18,  2003** | ** ** |
|----------------------------------------------------------|------------|-----------------------------------------------|------------|
| Professional fees                                        |       | $                                             | (8,279     | ) |
| Employee  retention and benefits                         |       | (6,302                                        | )          |
| Acceleration of  deferred compensation charges           |       | (499                                          | )          |
| Gains on  settlements with creditors                     |       | 35,393                                        |       |
| Increase to fresh-start  basis of assets and liabilities |       | 358,508                                       |       |
|                                                     |       | $                                             | 378,821    |   |

 

In the 109 days endedJuly 18, 2003, our Predecessor Company recorded a net reorganization gainof $378.8 million. Of this gain, $358.5 million resulted from thefair value adjustment to our assets and liabilities in connection with theadoption of fresh-start reporting. We also recognized a$35.4 million gain on our settlement with creditors upon exitingbankruptcy. These gains were offset somewhat by professional fees directlyrelated to our bankruptcy proceeding and other costs directly related to theimplementation of our Reorganization Plan.

*Interest Income*

Interest income totaled$0.4 million for the three months ended December 31, 2004, anincrease of $0.1 million, or 54%, from the three months ended December 31,2003. This increase is primarily the result of increased investment ofavailable cash balances in interest bearing accounts.

Interest income totaled$1.0 million for the nine months ended December 31, 2004, a decreaseof $0.3 million, or 22%, from the pro forma combined nine months ended December 31,2003. This decrease is primarily the result of lower available cash balances toinvest.

*Interest Expense*

Interest expense primarilyincludes interest expense and amortized costs related to our borrowings.Interest expense totaled $1.0 million for the three months ended December 31,2004, a decrease of $0.3 million, or 25%, from the three months ended December 31,2003. Interest expense totaled $3.2 million for the nine months ended December 31,2004, a decrease of $4.3 million, or 57%, from the 

38

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proforma combined nine months ended December 31, 2003. Interest expense forboth periods decreased primarily as a result of lower debt balances, offset inpart by higher interest rates on currently outstanding debt.

*Other Income*

Other income for the threeand nine months ended December 31, 2004 represents the collection of anemployee receivable that had previously been written off as uncollectible priorto our bankruptcy filing.

*Income Taxes*

Tax expense is derivedprimarily from taxes on foreign operations for which no U.S. federal benefitcan be recorded and interest accrued on the Company’s tax contingencies.

Income tax expense totaled$1.5 million and $1.7 million for the three months ended December 31,2004 and 2003, respectively. This tax expense represented 43.3% of income fromcontinuing operations before income taxes for the three months ended December 31,2004 and 35.1% of the loss from continuing operations before income taxes forthe three months ended December 31, 2003.

Income tax expense totaled$3.8 million for the nine months ended December 31, 2004, and $3.4 millionfor the pro forma combined nine months ended December 31, 2003. This taxexpense represented 29.1% of the loss from continuing operations before incometaxes for the nine months ended December 31, 2004 and 0.9% of income fromcontinuing operations before income taxes for the pro forma combined ninemonths ended December 31, 2003.

*Discontinued Operations*

As part of our efforts toraise cash and reduce expenses, we sold our Remedy business in November 2002.This business is treated as discontinued operations by the Predecessor Companyin the condensed consolidated financial statements included in this report.Income from discontinued operations related to Remedy for the 109 daysended July 18, 2003 of $0.3 million pertained to the collection of atrade receivable that had extended payment terms.

**LIQUIDITY ANDCAPITAL RESOURCES**

*We have supplemented our discussion of liquidity andcapital resources for the three-month period ended December 31, 2004with a more current discussion of our liquidity and capital resources as of March 31,2005.*

We primarily generate cashfrom software licensing, maintenance renewals and the provision of consultingand training services. Our primary uses of cash are for general working capitalpurposes, taxes, debt service and bankruptcy claims. We also use cash topurchase capital assets to support our business. In fiscal 2005 and fiscal2004, our principal liquidity requirements have been for operating expenses,working capital and debt and bankruptcy related payments. We have funded theseliquidity requirements from cash on hand that was primarily generated from thedisposal of our non-core product lines and our SCE and Remedy businesses in2002.

Thefollowing table summarizes the Successor Company cash and cash equivalents,restricted cash, marketable securities and working capital (deficit) as of December 31,2004 and March 31, 2004 (dollars in thousands):
| ** **                 | ** ** | **December 31, 2004** | ** ** | **March 31, 2004** | ** ** |
|----------------------------|------------|---------------------------------|------------|------------------------------|------------|
| Cash and cash  equivalents |       |                            | $          | 75,149                       |       |   |   | $ | 105,946 |   |   |
| Cash—restricted       |       |                            | 4,782      |                         |       |   | 4,654 |   |   |
| Marketable  securities     |       |                            | 8,000      |                         |       |   | — |   |   |
| Working capital  (deficit) |       |                            | (10,430    | )                            |       |   | 3,348 |   |   |

 

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Cash equivalents primarily consist of overnight moneymarket accounts, time deposits, commercial paper and government agency notes.The restricted cash relates primarily to security for certain real propertyleases, equipment lease obligations and a liability to a vendor. Marketablesecurities consist entirely of auction rate securities. Working capital(deficit) consists primarily of cash and cash equivalents, marketablesecurities, accounts receivable, and other current assets net of accountspayable, accrued expenses, and current portions of deferred revenue and notespayable.

Forthe nine months ended December 31, 2004, the 166 days ended December 31,2003 and the 109 days ended July 18, 2003 our cash flows were asfollows (dollars in thousands):
| ** **                                            | ** ** | **Successor Company**                               | ** ** | **Predecessor  Company**                              | ** ** |
|-------------------------------------------------------|------------|----------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                            | ** ** | **Nine Months  Ended  December 31, 2004** | ** ** | **166 Days  Ended  December 31, 2003** | ** ** | **109 Days  Ended  July 18, 2003** | ** ** |
| Cash (used in)  provided by:                          |       |                                                     |       |                                                  |       |   |   |   |   |   |   |
| Operating activities                                  |       |                                                     | $          | (6,558                                                | )          |   |   | $ | 4,175 |   |   | $ | (51,657 | ) |
| Investing activities                                  |       |                                                     | (11,519    | )                                                     |       |   | 7,658 |   |   | 32,578 |   |
| Financing activities                                  |       |                                                     | (14,310    | )                                                     |       |   | (6,424 | ) |   | (110,792 | ) |
| Effect of  exchange rate fluctuations on cash         |       |                                                     | 1,590      |                                                  |       |   | 1,957 |   |   | 1,057 |   |
| Net cash flows  from discontinued operations          |       |                                                     | —     |                                                  |       |   | — |   |   | 2,565 |   |
| Net (decrease) increase  in cash and cash equivalents |       |                                                     | $          | (30,797                                               | )          |   |   | $ | 7,366 |   |   | $ | (126,249 | ) |

 

**Operating Activities**

For the nine months ended December 31, 2004 theSuccessor Company used $6.6 million of cash in operating activities. OurSuccessor Company reported a net loss of $17.0 million and cash outflowsfrom changes in working capital of $4.4 million. These were partiallyoffset by non-cash charges of $20.8 million for amortization anddepreciation. Working capital outflows were primarily impacted by an increasein accounts receivable of $11.6 million and decreases in deferred revenue andaccounts payable of $6.2 million and $3.9 million, respectively. Theseoutflows were offset, in part, by a decrease in other assets of $7.3 millionand an increase in accrued expenses of $9.9 million. The decrease in otherassets included the collection of $4.5 million of extended pay receivablesrecorded as other assets in connection with fresh-start reporting. Of theamortization charge, $17.4 million was related to the new identifiable intangiblesestablished with the adoption of fresh-start reporting treatment as of July 18,2003.

For the 166 days ended December 31, 2003, ourSuccessor Company operations provided $4.2 million in net cash. OurSuccessor Company reported a net loss of $11.8 million, including non-cashcharges of $13.6 million for amortization and depreciation. Of theamortization charge, $10.5 million was related to the new identifiableintangibles established with the adoption of fresh-start accountingtreatment as of July 18, 2003.

Our Predecessor Companyused $51.7 million of net cash in operating activities in the 109 daysended July 18, 2003. Our Predecessor Company reported net income fromcontinuing operations of $373.9 million for this period. However, most ofthe income was non-cash in nature, because it resulted from the adoption offresh-start reporting treatment. During the period, our PredecessorCompany used $42.9 million of cash for reorganization items related toimplementing our Reorganization Plan, which accounts for most of the decreasein the period.

**InvestingActivities**

For the nine months ended December 31,2004 the Successor Company used $11.5 million of net cash for investingactivities, which primarily reflects $8.0 million of net purchases ofmarketable securities and 

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$3.8 millionof cash used for capital expenditures, mostly for computers and data processingequipment and leasehold improvements.

For the 166 daysended December 31, 2003 the Successor Company provided $7.7 million ofnet cash from investing activities, which primarily reflects the collection of$10.0 million released from escrow as part of the Remedy sale, net of $1.3million in capital expenditures and the commitment of an additional $1.0 millionto restricted cash, related mostly to new real estate leases.

For the 109 daysended July 18, 2003 the Predecessor Company provided $32.6 million ofnet cash from investing activities. Cash from investing activities increased$27.2 million because that amount of restricted cash became available forgeneral use in accordance with our Reorganization Plan and also increased$5.4 million from the sale of investments.

**FinancingActivities**

For the nine months ended December 31,2004 the Successor Company used $14.3 million of net cash in financing activities.This reflects repayment of $10.3 million of principal on long-term debt aswell as $4.3 million of principal on factor loans.

For the 166 daysended December 31, 2003 the Successor Company repaid $6.4 million ofits factor loan obligations.

For the 109 daysended July 18, 2003, under the terms of the Reorganization Plan, ourPredecessor Company paid down $24.3 million on factor loans and paid$86.5 million, in addition to other consideration, to the holders of itsconvertible subordinated notes.

**Status at March 31,2005**

As of March 31, 2005,the end of our fiscal 2005 year, our Successor Company had non-tradeobligations, including accrued interest, of approximately $47.2 millionand cash and cash equivalents of approximately $89.9 million, of which$4.8 million was restricted. The non-trade obligations consisted of $37.1 millionin senior notes (including accrued interest) and $10.1 million in deferredpayment obligations related to bankruptcy settlements (net of unearned imputedinterest).

In fiscal 2005 we usedcash for infrastructure improvements, sales and marketing efforts and, to alesser extent, product development. These expenditures and efforts wereintended to support our current operations and position us for future growth.Our fiscal 2005 business plan differed in material respects from the businessplan and financial projections we included in our disclosure statement insupport of our fourth amended Reorganization Plan in connection with ourbankruptcy proceedings. As a result, the projections included in the disclosurestatement do not reflect financial results based on our current business plan.

We believe our cash onhand and anticipated operating cash flows will be sufficient to fund ouroperations and planned capital expenditures and to satisfy our schedulednon-trade obligations for at least twelve months from the date of this report.However, our ability to generate adequate cash depends upon our futureperformance, which in turn is subject to general economic conditions, andfinancial, business and other factors affecting our operations, includingfactors beyond our control. We currently have no lines of credit or similarfacilities with any financial institutions. There can be no assurance thatadditional financing will be available in the future, or that if available, wewill be able to obtain it on terms favorable to us. Please review theinformation set forth under the caption “Risk Factors” in our Annual Report on Form 10-Kfor the fiscal year ended March 31, 2004.

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**Bankruptcy Claims**

Approximately 1,200 claims were filed against us basedon events that took place prior to our bankruptcy filing. Through March 31,2005, the aggregate face amount of the general unsecured (Class 8) claimsasserted against us, plus the amounts we scheduled for payment for Class 8claims without a claim asserted against us, totaled approximately $384.1 million.After eliminating duplicate claims, claims filed in error, or claims that wereinvalid for some other reason, we were left with approximately 500 Class 8claims totaling $251.1 million. Claim amounts are amended from time totime by the creditors and potential creditors asserting them and sometimes arefiled with a face amount that is the minimum amount asserted by the creditor.The amounts sought by such creditors can be increased. There are also ongoingdisputes in the Bankruptcy Court regarding whether certain claims are properlyclassified as general unsecured claims under Class 8 of the ReorganizationPlan, which are payable in cash, or as subordinated claims under Class 9of the Reorganization Plan. Class 9 creditors share in the pool of commonshares already issued and reserved for these claims. For these and otherreasons, the total potential liability associated with Class 8 claims isdifficult to determine. In connection with agreeing to the Reorganization Plan,the various constituencies independently analyzed the claims and determinedthat the total payment on the Class 8 general unsecured claims was likelyto be between $49.0 million and $65.0 million.

Since August 2003, we have been spendingsubstantial time and money on the process of analyzing and, as appropriate,objecting to claims that we believe are without merit or asserted for aninflated amount. We have negotiated settlements to various claims. This processmay continue for several months. Based on the Reorganization Plan, any claimsthat we do not dispute or that are determined to be valid by the BankruptcyCourt after we have made an objection may be paid under one of two options, atthe creditor’s election: We may be required either to pay 70% of the allowedamount of the claim, with 60% being paid in cash on the date of settlement andthe remaining 10% paid out over a four-year period in equal annualinstallments, or we may be required to pay 100% of the allowed amount of theclaim, with 20% being paid in cash on the date of settlement and the remaining80% being paid out over a four-year period in equal annual installments. Wehave also agreed with some creditors to pay 65% of the allowed amount of theclaim in cash on the date of settlement and nothing more.

We began paying claims onthe effective date of the Reorganization Plan and continue to pay as claims aresettled, liquidated, or otherwise resolved. Through March 31, 2005, wehave paid, settled or otherwise disposed of Class 8 claims with anoriginal aggregate face amount of approximately $380.6 million (includingapproximately $133.0 million of duplicate, erroneous and otherwise invalidclaims). To resolve these claims we have paid or agreed to pay over timeapproximately $45.0 million in cash. As of March 31, 2005, there weregeneral unsecured claims asserted in the original aggregate face amount ofapproximately $3.5 million remaining to be resolved. There were alsoapproximately $1.7 million in priority and administrative claims remainingto be resolved. These remaining general unsecured and other claims includeclaims that are asserted in a minimum amount or an unliquidated amount, and theclaims can be amended to higher amounts. Prior claim determinations are alsosubject to appeal. Because the total liability associated with the claimsdepends upon the final amounts asserted by claimants, the outcome of claimsclassification hearings by the Bankruptcy Court, claims objections, settlementnegotiations, and potential litigation and appeals, the total amount to be paidby us is uncertain. We believe that we have set aside adequate reserves forpayments of the Class 8 claims as well as the priority and administrativeclaims and that the aggregate payment should fall within and possibly below therange of previously estimated payments of between $49.0 million and$65.0 million, determined by the various constituencies in the bankruptcyproceedings. However, payments in excess of the reserved amounts could have anadverse effect on our liquidity and financial condition. Because claims remainin dispute, we are unable to predict the final payment amount or the periodover which payments would be made.

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**THE REORGANIZATION PLAN**

For a discussion of theterms of the Reorganization Plan confirmed by the Bankruptcy Court on July 18,2003, please refer to the information under the caption “Management’sDiscussion and Analysis of Financial Condition and Results of Operations—OurPlan of Reorganization” in our Annual Report on Form 10-K for theperiod ended March 31, 2004.

**RECENT ACCOUNTING PRONOUNCEMENTS**

On December 16, 2004the FASB issued Statement of Financial Accounting Standards No. 123R, “Share-BasedPayment,” (SFAS 123R) requiring that the compensation cost relating toshare-based payment transactions be measured and recognized in thefinancial statements using the fair value of the awards. This statementeliminates the alternative to use Accounting Principles Board (APB) Opinion No. 25’s,“Accounting for Stock Issued to Employees” intrinsic value method of accountingthat was provided in Statement of Financial Accounting Standards No. 123, “Accountingfor Stock-Based Compensation.” Under APB Opinion No. 25, issuingstock options to employees generally resulted in recognition of no 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 Statement of Financial AccountingStandards No. 123, “Accounting for Stock-Based Compensation” andsupersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.”In April 2005 the Securities and Exchange Commission amended Regulation S-X toamend the date for compliance with SFAS 123R to the first interim or annualreporting period of a registrant’s first fiscal year beginning after June 15,2005. As a result the Company is required to adopt SFAS 123R on 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 may have a material effect on its operating results if currentcompensation strategies are continued.

**RISK FACTORS**

There are significant riskfactors that currently affect or may affect our business, financial conditionor operating results. As of the date of this report we are not current infiling our periodic reports with the SEC. Readers should carefully considerthese factors before making an investment decision with respect to our commonstock. These risk factors are detailed beginning on page 62 in our AnnualReport on Form 10-K for the year ended March 31, 2004.

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

As of December 31,2004, there were no material changes to the information previously reportedunder Item 7A in our Annual Report on Form 10-K for the fiscalyear ended March 31, 2004.

**ITEM 4.**                CONTROLSAND PROCEDURES

**EVALUATIONOF DISCLOSURE CONTROLS AND PROCEDURES**

As required byparagraph (b) of Rule 13a-15 under the Securities ExchangeAct of 1934, as of the last day of the period covered by this report,management, including our chief executive officer and chief financial officer,evaluated the effectiveness of the design and operation of our disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act). Our chief executive officer and chief financial officerconcluded that our disclosure controls and procedures were not effective as ofthat date primarily as a result of the ineffectiveness of our internal controlover financial reporting.

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**MANAGEMENT’SQUARTERLY REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING**

Our management acknowledges its responsibility forestablishing and maintaining adequate internal control over financial reportingthat includes effective accounting policies and procedures. Our progress inestablishing such adequate internal controls is described below under thecaption “Changes in Internal Controls Over Financial Reporting.”

Under the supervision and with the participation ofour management, including the chief executive officer and chief financialofficer, we evaluated the effectiveness of our internal control over financialreporting based on the framework in *InternalControl—Integrated Framework*, issued by the Committee of SponsoringOrganizations of the Treadway Commission.

Our management,including our chief executive officer and chief financial officer, hasconcluded that our internal control over financial reporting was not effectiveas of the end of the fiscal period covered by this report. Their conclusion wasbased on a number of factors, including:

·       thefact that we cannot yet prepare timely financial information and are not filingperiodic reports on a timely basis;

·       thedifficulty we have in assembling all relevant contemporaneous documentation forsignificant transactions;

·       thesignificant turnover in our management and our finance staff we experiencedthrough the second half of fiscal 2005; and

·       theother factors described below and in our Annual Report on Form 10-Kfor the year ended March 31, 2004 under the caption “Changes in InternalControl Over Financial Reporting” and our Quarterly Reports on Form 10-Qfor the quarters ended June 30, 2004 and September 30, 2004, filed February 15,2005 and April 5, 2005, respectively, regarding the condition of ourinternal controls over financial reporting under the caption “Changes inInternal Control over Financial Reporting.”

Readers should carefully review the information setforth under the caption “Changes in Internal Control Over Financial Reporting”included in our Annual Report on Form 10-K for the fiscal year endedMarch 31, 2004; the information set forth under the caption “Changes inInternal Control Over Financial Reporting” included in our Quarterly Reports onForm 10-Q for the quarters ended June 30, 2004 and September 30,2004, filed February 15, 2005 and April 5, 2005, respectively, andthe information set forth below under “Changes in Internal Control OverFinancial Reporting.”

In view of the fact that the financial informationpresented in this report was prepared in the absence of effective internalcontrols over financial reporting, we devoted a significant amount of time andresources to the analysis of the financial statements contained in this report.In particular, we reviewed all significant account balances and transactionsreflected in the financial statements contained in this report and otherwiseanalyzed the transactions underlying our financial statements to verify theaccuracy of the financial statements contained in this report.

Nevertheless, there can beno assurance that either this review process or our existing disclosurecontrols and procedures will prevent or detect all errors and all fraud, ifany, or result in accurate and reliable disclosure. A control system canprovide only reasonable, not absolute, assurance that the objectives of thecontrol system are met. Because of the inherent limitations in all controlsystems, no evaluation of controls can provide absolute assurance that allcontrol issues and instances of fraud, if any, have been detected.Additionally, judgments in decision-making can be faulty and breakdownsin internal controls can occur because of simple errors or mistakes that arenot detected on a timely basis.

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**CHANGESIN INTERNAL CONTROLS OVER FINANCIAL REPORTING**

**CertainInternal Control Events During the Third Quarter of Fiscal 2005**

During the third quarterof fiscal 2005, our senior management continued efforts to remedy thesignificant deficiencies, including material weaknesses, in our internalcontrol over financial reporting. We continued our employee training program onthe principles of revenue recognition in accordance with generally acceptedaccounting principles.

**InternalControl Assessment as of the Filing Date of This Report**

*We are including information in this report aboutmaterial changes to identified internal control weaknesses over financialreporting for the period subsequent to December 20, 2004, which wediscussed in our Annual Report on Form 10-K for the 2004 fiscal yearended March 31, 2004, filed on December 20, 2004, in order to providereaders with a current understanding of the identified weaknesses in internalcontrol over financial reporting. These internal control weaknesses are beingaddressed as part of our Sarbanes-Oxley compliance project, as more fullydiscussed below. Readers should carefully review the discussion of thedeficiencies and material changes in our internal control over financialreporting for the period prior to December 20, 2004 set forth under thecaption “Changes in Internal Control Over Financial Reporting” in our AnnualReport on Form 10-K for the fiscal year ended March 31, 2004;and set forth under the caption “Changes in Internal Control Over FinancialReporting” in our Quarterly Reports on Form 10-Q for the quartersended June 30, 2004 and September 30, 2004, filed February 15,2005 and April 5, 2005, respectively.*

***Accounting Policies and Procedures***

Previously, our accountingpolicies and procedures had not been adequately documented, nor were ouraccounting procedures comprehensive in scope. We have now substantiallycompleted the documentation of a comprehensive set of policies and proceduresthat we believe remedy the deficiencies in the design of our internal controlsover financial reporting. We are in the process of remediating these policiesand procedures throughout the company.

***Period-End Accounting Closing Procedure***

We have recentlyestablished a number of closing procedures to improve the timeliness ofconducting quarterly closings and performing account reconciliations inconnection with the preparation of our financial statements and have increasedour staff in the accounting organization to support these procedures.Documentation of these closing procedures is substantially complete, and we arein the process of implementing them. We will not be able to prepare financialstatements on a timely basis until these closing procedures are fullyimplemented.

***Account Reconciliation***

Historically, we had notcompleted the documentation and implementation of timely processes to reconcileour general ledger accounts to the detailed subsidiary ledgers and addressreconciling items on a timely basis. We have now established and documentedprocedures for reconciling the general ledger accounts to the detailedsubsidiary ledgers and are currently in the process of remediating theseprocedures throughout the Company.

***Financial Reporting System***

Historically, ourautomated financial reporting systems have been overly complex, poorlyintegrated and inconsistently implemented. As a result, preparation offinancial statements has required and continues to require multiple steps,including manual reconciliation of most accounts, and extensive managementreview. Many of our critical systems necessary to generate revenue informationremain 

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off-lineand are not integrated with our standard accounting system, PeopleSoft. Infiscal 2004, we upgraded our PeopleSoft system, enabling us to operate ourmajor financial operations on a common platform worldwide, and we have updateda number of billing and accounts receivable processes. We intend to implementadditional systems improvements in this area, which will be designed tomitigate the risk of inaccurate or incomplete information resulting from usingmanual processes and complex financial reporting systems.

***Sales Order Processing System***

Historically, our salesorder processing system has not been integrated and has required thattransaction information be recorded by several individuals and entered intoseveral databases. Our financial management has had to devote substantial timeto checking sales information to ensure that revenue information is correct. Wehave evaluated improvements to the systems for recording our sales transactionsand a new, simplified process and a standardized sales order configuration andpricing tool has been implemented worldwide, including a standard product list.We believe the use of this tool will reduce the duplication of information andimprove the flow of information from our sales order processing staff to ourrevenue recognition staff. We continue to work on our processes and systems tocreate a standardized order management process for sales of maintenance andprofessional services.

***Assembly of Information Supporting Revenue Recognition***

We have documented andimplemented a process for supporting our revenue recognition decisions that webelieve adequately addresses the material risks associated with improper orinsufficient information being available to properly record revenue.Historically, we did not have a formal practice of fully documenting thesupport for our revenue recognition decisions at the time revenue contractswere executed. The lack of a formal process for compiling and documenting such informationat the time of sale caused and will continue to cause delays in the preparationof financial results for prior periods because added resources are required toassemble and reevaluate such information prior to publishing our financialstatements.

***Management Reporting and Analysis***

Financial reports have notbeen widely disseminated within the organization, nor have they been preparedon a timely basis. Our corporate subsidiary structure is unnecessarily complex,and the historical consolidation process has not been properly documented, bothof which make management reporting and analysis difficult to prepare on atimely basis. We continue to simplify our corporate structure. We havesubstantially completed the documentation of our consolidation and budgetreporting processes and believe that the simplification of the businessstructure will improve the timeliness and quality of management reporting.

***Staffing and Training of Finance Personnel***

Historically, turnoveramong finance personnel was substantial, and we were understaffed. As a resultof certain changes in financial management and the addition of financial staffduring fiscal 2005, we believe we are adequately staffed in our financeorganization. We are in the process of training our staff on a number of newpolicies and procedures recently developed as part of our Sarbanes-Oxley complianceproject, which is more fully discussed below.

***Segregation of Duties/Responsibilities and ManagementReview***

Historically, ouraccounting personnel have been responsible for posting and reconciling accountsunder their control without timely review by an independent reviewer. Inconnection with the 

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documentationof our policies and procedures, we analyzed segregation of duties, includingmanagement review and the assignment of appropriate levels of user-access tocertain applications. These procedures are intended to ensure that theappropriate management personnel review reconciliations and other financialinformation.

***Contract Management***

There have been deficienciesin our customer contract management processes. We have established somesignature procedures and have centralized certain contract management functionsand have established more formal policies and procedures in this area. We havedocumented a worldwide signature authority and approval policy.

**Sarbanes-Oxley Compliance**

We have undertaken a project specifically focusing onthe Company’s internal controls and procedures, including complying with therequirements of the rules implementing Section 404 of the Sarbanes-OxleyAct of 2002 and adopting processes to facilitate our independent auditors’future testing of our internal controls with regards to their attestation as tothe effectiveness of our internal control over financial reporting. We havecategorized the project into the following phases:

*Risk Assessment.  *Webelieve this has been completed in all material respects.

*Documentation.  *Webelieve this has been completed in all material respects.

*Remediation.  *Althoughwe have developed an initial set of remediations to correct identified designdeficiencies in our internal controls, we anticipate that we will have toreassess them as part of the internal and external testing phases of theproject.

*Internal and External Testing.  *Wehave substantially completed internal testing of our significant policies,processes, procedures and controls to assess their effectiveness and are in theprocess of compiling and evaluating the test results. Once we have evaluatedthis internal testing, management will be in a position to determine whetherour internal controls over financial reporting are operating effectively. Next,we expect that our independent auditors will perform their own tests of ourinternal controls over financial reporting as well as assess management’sassertions regarding these controls.

Given the number of control deficiencies that we haveidentified and the limited amount of time to complete the remediation andtesting processes as well as to assess the internal controls for operatingeffectiveness, we will not be able to conclude that all of our internalcontrols over financial reporting are effective as of March 31, 2005. Also,we may not have sufficiently completed our remediation and internal testingefforts with sufficient time to allow our independent registered publicaccounting firm an adequate period to observe the effectiveness of ourremediation efforts in order to conclude as to the effectiveness of ourinternal controls and our assessment of them. Further, even if our independentregistered public accounting firm has sufficient time to perform its review forpurposes of rendering an opinion as to the effectiveness of our internalcontrols, some of the internal controls we implemented were not operatingeffectively as of March 31, 2005.

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**PART II—OTHER INFORMATION**

**ITEM 1.**                LEGALPROCEEDINGS

**Federal GovernmentInvestigations**

In June and July 2003,we entered into an agreement to settle a civil action brought against us by theSEC. Because we are not current in our reporting obligations to the SEC, we arenot in compliance with the provision of the settlement requiring that we notviolate federal securities laws. A U.S. Department of Justice investigation ofPeregrine remains open and we believe the SEC and the DOJ are continuing theirinvestigations of a number of individuals in connection with our pastaccounting irregularities. We are not aware of any current employee being thesubject of a government investigation. While we remain in discussions with theSEC, and are fully cooperating with the SEC and the DOJ in theirinvestigations, it is possible that the SEC could bring a further civil actionagainst Peregrine or that the DOJ could bring criminal charges againstPeregrine, which could have an adverse effect on our reputation among existingand potential customers as well as an adverse effect on our revenue and coulddamage employee morale.

**General UnsecuredClaims; Microsoft Corporation, MSLI, GP Claims**

Approximately 1,200 claims were filed against us basedon events that took place prior to our bankruptcy filing. The originalaggregate face amount of the general unsecured claims plus the amounts wescheduled for payment without a claim asserted against us totaled approximately$384.1 million. After eliminating duplicate claims, claims filed in error,or claims that were invalid for some other reason, we were left withapproximately 500 general unsecured claims totaling approximately$251.1 million. As of March 31, 2005, there were general unsecuredclaims asserted in the original aggregate face amount of approximately$3.5 million, and priority and administrative claims of approximately$1.7 million remaining to be resolved. For more information regardingthese unsecured claims, see “Management’s Discussion and Analysis of FinancialConditions and Results of Operations—Liquidity and Capital Resources—BankruptcyClaims,” beginning on page 43 of this report.

One of the moresignificant unsecured claims was asserted by Microsoft Corporation and itsMSLI, GP affiliate (collectively, Microsoft), for alleged unauthorized andunlicensed use of their software. Microsoft filed (i) a proof of claim in December 2002seeking at least $3.0 million related to our use of Microsoft products inthe period prior to the bankruptcy filing, (ii) an adversary complaint in January 2003seeking monetary damages in an unspecified amount as well as injunctive reliefand, (iii) an administrative claim in September 2003 seeking monetarydamages in an unspecified amount related to the period after our bankruptcyfiling. We agreed with Microsoft that all of its claims and contentions shouldbe decided in the context of the adversary complaint filed in the BankruptcyCourt. In March 2003, we filed an answer to Microsoft’s adversarycomplaint denying the material allegations and raising affirmative defenses.Between October 2003 and June 2004, we engaged in settlementnegotiations with Microsoft. In November 2003, we entered into asettlement agreement with Microsoft that resolved the adversary complaintpursuant to which Microsoft dismissed the adversary complaint with prejudiceand we granted Microsoft an allowed administrative claim and Class 8 claimunder the Reorganization Plan. All payments required under the settlementagreement had previously been reserved as liabilities subject to compromise inthe consolidated balance sheet.

**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 (theLatham Report). After our bankruptcy filing in September 2002, theOfficial Committee of Unsecured Creditors filed a motion to appoint a trusteeand, as an exhibit to 

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their motion, filed a copyof the Latham Report under seal. Thereafter, a party in interest, Copley Press, Inc.,which owns the *San Diego Union Tribune*,petitioned the Bankruptcy Court to unseal the pleadings and other documentsfiled under seal, including the Latham Report. We filed a motion to havecertain filings unsealed in whole or in part and to have redacted certainportions of some unsealed filings to protect third parties’ privacy rights, toprotect confidential information, and for other valid reasons. However, weopposed the unsealing of the Latham Report. Among other things, we argued thatthe Latham Report was intended as a preliminary report and thus as a startingpoint for the government investigations, and that it contained confidentialcommercial information. At the hearing on Copley’s motion, the Bankruptcy Courtheld that the Latham Report had been improperly filed, and struck it from the record.Copley appealed the Bankruptcy Court’s decision to the United States DistrictCourt for the district of Delaware. On July 12, 2004, the District Courtissued a 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 have appealed the District Court’sdecision to the United States Court of Appeals for the Third Circuit. On April22, 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. At this point we have notdetermined whether or not we will withdraw our appeal to the Third Circuit.Copley contends that the appeal is now moot and must be dismissed. 

The Latham Report also has been filed in court, underprovisional seal, by one of our former directors, John J. Moores, inconnection with two lawsuits pending against him and others (not includingPeregrine) in San Diego. One action was filed as a class action on behalf offormer Peregrine shareholders under the federal securities laws and iscurrently pending in the U.S. District Court for the Southern District ofCalifornia (the Federal Securities Action). The other action was filed by thePeregrine Litigation Trustee as successor to certain rights and causes ofaction of Peregrine under the Reorganization Plan, and is pending in theSuperior Court of the State of California for the County of San Diego (theLitigation Trustee Action). Mr. Moores is a defendant in both actions andhas filed the Latham Report, under temporary seal, in both actions inconnection with motions to dismiss the complaints against him. We have filedmotions in both cases to have the Latham Report stricken from the record or, asan alternative, to have the Latham Report, or portions of it, permanentlysealed. Our motion in the Litigation Trustee Action is scheduled to be heard inJune 3, 2005. In the Federal Securities Action, on February 2, 2005the court ruled that it will not consider the Latham Report in ruling on Mr. Moores’pending motion to dismiss the complaint. The Latham Report will not bestricken, but will remain under seal and, on this basis, our motion tointervene, strike or reconsider was denied as moot.

In the criminal actionsagainst former Peregrine employees and others pending in the U.S. DistrictCourt for the Southern District of California, a protective order was enteredon February 28, 2005 to provide limited protection for the confidentialinformation of non-parties, such as the Latham Report and other Peregrineconfidential information.

**Luddy v. Peregrine**

In May 2004, FredericLuddy, our former chief technology officer, filed a complaint against us in theCourt of Chancery for the State of Delaware seeking advancement of certainlegal fees and expenses. Mr. Luddy is a defendant in the LitigationTrustee Action and the Federal Securities Action, which seek to 

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recovermonetary damages from Mr. Luddy based on events that transpired beforePeregrine filed for bankruptcy law protection. 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 alleges that, pursuant to a paragraph of theBankruptcy Court’s order confirming our Reorganization Plan, his indemnity claimcan be pursued in state court. In June 2004, we removed Mr. Luddy’scomplaint from Delaware state court to the Bankruptcy Court. We also filed amotion in Bankruptcy Court to dismiss the complaint on the basis, among otherthings, that Mr. Luddy failed to file any proof of claim before theBankruptcy Court and that his claim is barred by the discharge injunctionentered in connection with the Bankruptcy Court’s approval of ourReorganization Plan. On August 9, 2004, Mr. Luddy filed a motion inBankruptcy Court seeking to voluntarily dismiss his complaint, withoutprejudice, and on the same day filed a new complaint in the Delaware Court ofChancery, seeking the same relief as in his prior complaint. We removed Mr. Luddy’snew complaint to the Bankruptcy Court and filed a new motion to dismiss hiscomplaint. Mr. Luddy, in turn, filed a motion to remand the case to statecourt. On November 10, 2004, the Bankruptcy Court denied Mr. Luddy’smotion for remand and found that it had jurisdiction to consider the complaint.Also on November 10, 2004, the Bankruptcy Court granted in part and deniedin part our motion to dismiss, without prejudice to the company’s right torenew the motion later after discovery and formal fact finding. On February 23,2005, Mr. Luddy filed an amended complaint, which we answered on March 15,2005. Discovery is scheduled to be completed by May 2005, but no trialdate has been set. We believe Mr. Luddy’s claims are without merit and weintend to vigorously defend against them. While the outcome is not currentlydeterminable, in the opinion of management the matter will not materiallyaffect our financial position, results of operations or liquidity.

**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 October 28, 2004we issued to one former executive officer a total of 16,852 shares of ouroutstanding stock upon exercise of stock options for an aggregate purchaseprice of $167,509. These shares were issued by us 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 bankruptcy proceedings.

**ITEM 3.**                DEFAULTSUPON SENIOR SECURITIES

None.

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

None.

**ITEM 5.**                OTHERINFORMATION

None.

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**ITEM 6.**                EXHIBITS

The followingare filed as exhibits to this Quarterly Report on Form 10-Q:

31.1 Certification of the Chief Executive Officer pursuant to § 302 ofthe Sarbanes-Oxley Act of 2002.

31.2 Certification of the Chief Financial Officerpursuant to § 302 of the Sarbanes-Oxley Act of 2002.

32.1 Certification of the Chief Executive Officerpursuant to § 906 of the Sarbanes-Oxley Act of 2002.

32.2 Certification of the Chief Financial Officerpursuant 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.
|                      | PEREGRINE SYSTEMS, INC. |
|----------------------|-------------------------|
| Date: April 29, 2005 | (Registrant)            |
|                 | By:                     | /s/ Kenneth J. Saunders |
|                 | * *                | *Executive Vice President & Chief  Financial Officer* |
|                 | * *                | *(Principal Financial Officer and Authorized  Signatory)* |

 

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