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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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



For the Quarterly Period Ended June 30, 2003



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



For the Transition Period From __________ to __________



Commission File Number 0-21484



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TARANTELLA, INC.

(Exact name of registrant as specified in this charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|CALIFORNIA                                                     |  | 94-2549086                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



|                                           |  |           
|------------------------------------------ |  | ----------
|425 Encinal Street, Santa Cruz, California |  | 95060     
|(Address of principal executive office)    |  | (Zip Code)



Registrants
telephone number, including area code (831) 427-7222



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



As of December 31, 2003, registrant had 15,279,271 shares of Common Stock outstanding.



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##### Table of Contents

TARANTELLA, INC.



FORM 10-Q



For the Quarterly Period Ended June 30, 2003



Table of Contents



|                              |  |                                                                                                               |  |     
|----------------------------- |  | ------------------------------------------------------------------------------------------------------------- |  | ----
|                              |  |                                                                                                               |  | Page
|Part I. Financial Information |  |                                                                                                              
|Item 1.                       |  | Financial Statements                                                                                          |  |     
|                              |  | a) Condensed Consolidated Statements of Operations for the three and nine months ended June 30, 2003 and 2002 |  | 3   
|                              |  | b) Condensed Consolidated Balance Sheets, as of June 30, 2003 and September 30, 2002 (restated)               |  | 4   
|                              |  | c) Condensed Consolidated Statements of Cash Flows for the nine months ended June 30, 2003 and 2002           |  | 5   
|                              |  | d) Notes to Condensed Consolidated Financial Statements                                                       |  | 6   
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                         |  | 21  
|Item 3.                       |  | Quantitative and Qualitative Disclosures about Market Risk                                                    |  | 31  
|Item 4.                       |  | Controls and Procedures                                                                                       |  | 32  
|Part II. Other Information    |  |                                                                                                              
|Item 1.                       |  | Legal Proceedings                                                                                             |  | 33  
|Item 2.                       |  | Changes in Securities and Use of Proceeds                                                                     |  | 33  
|Item 3.                       |  | Defaults Upon Senior Securities                                                                               |  | 33  
|Item 4.                       |  | Submission of Matters to a Vote of Security Holders                                                           |  | 33  
|Item 5.                       |  | Other Information                                                                                             |  | 33  
|Item 6.                       |  | Exhibits and Reports on Form 8-K                                                                              |  | 33  
|Signatures                    |  | 35                                                                                                           





2



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##### Table of Contents

Part I. Financial Information

Item I. Financial Statements



TARANTELLA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)



|                                                      |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|----------------------------------------------------- |  | -------------------------- | ------ | - | ------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                                      |  | Three MonthsEnded June 30, |        |   | Nine Months EndedJune 30, |  
|                                                      |  | 2003                       |        |   | 2002                      |   |        | 2003 |  |   | 2002   |  
|                                                      |  | (Unaudited)                |       
|Net revenues:                                         |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Licenses                                              |  | $                          | 3,059  |   |                           | $ | 2,940  |      |  | $ | 8,996  |   |  | $ | 9,224   |  
|Services                                              |  |                            | 693    |   |                           |   | 710    |      |  |   | 1,931  |   |  |   | 1,590   |  
|                                                      |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Total net revenues                                    |  |                            | 3,752  |   |                           |   | 3,650  |      |  |   | 10,927 |   |  |   | 10,814  |  
|                                                      |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Cost of revenues:                                     |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Licenses                                              |  |                            | (14    | ) |                           |   | 127    |      |  |   | 124    |   |  |   | 356     |  
|Services                                              |  |                            | 305    |   |                           |   | 360    |      |  |   | 854    |   |  |   | 867     |  
|                                                      |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Total cost of revenues                                |  |                            | 291    |   |                           |   | 487    |      |  |   | 978    |   |  |   | 1,223   |  
|                                                      |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Gross margin                                          |  |                            | 3,461  |   |                           |   | 3,163  |      |  |   | 9,949  |   |  |   | 9,591   |  
|                                                      |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Operating expenses:                                   |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Research and development                              |  |                            | 1,062  |   |                           |   | 1,322  |      |  |   | 2,955  |   |  |   | 4,375   |  
|Selling, general and administrative                   |  |                            | 3,308  |   |                           |   | 4,642  |      |  |   | 10,709 |   |  |   | 15,733  |  
|Restructuring charge                                  |  |                            | 101    |   |                           |   |       |      |  |   | 1,248  |   |  |   | 1,718   |  
|                                                      |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Total operating expenses                              |  |                            | 4,471  |   |                           |   | 5,964  |      |  |   | 14,912 |   |  |   | 21,826  |  
|                                                      |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Operating loss                                        |  |                            | (1,010 | ) |                           |   | (2,801 | )    |  |   | (4,963 | ) |  |   | (12,235 | )
|                                                      |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Other income (expense):                               |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Interest income, net                                  |  |                            | 4      |   |                           |   | 36     |      |  |   | 50     |   |  |   | 477     |  
|Other income (expense), net                           |  |                            | (118   | ) |                           |   | 444    |      |  |   | (69    | ) |  |   | (894    | )
|Gain (loss) on sale of divisions to Caldera           |  |                            |       |   |                           |   | 445    |      |  |   |       |   |  |   | (2,593  | )
|Gain on sale of Caldera common stock                  |  |                            |       |   |                           |   | 3,141  |      |  |   |       |   |  |   | 4,491   |  
|Loss on equity investment in Caldera                  |  |                            |       |   |                           |   |       |      |  |   |       |   |  |   | (4,010  | )
|                                                      |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Total other income (expense)                          |  |                            | (114   | ) |                           |   | 4,066  |      |  |   | (19    | ) |  |   | (2,529  | )
|                                                      |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Income (loss) before income taxes                     |  |                            | (1,124 | ) |                           |   | 1,265  |      |  |   | (4,982 | ) |  |   | (14,764 | )
|                                                      |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Income tax expense (benefit)                          |  |                            | 122    |   |                           |   |       |      |  |   | 280    |   |  |   | (760    | )
|                                                      |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Net income (loss)                                     |  | $                          | (1,246 | ) |                           | $ | 1,265  |      |  | $ | (5,262 | ) |  | $ | (14,004 | )
|                                                      |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Other comprehensive income:                           |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Unrealized gain on available for sale securities      |  | $                          | 71     |   |                           | $ | 5      |      |  | $ | 177    |   |  | $ | 70      |  
|Foreign currency translation adjustment               |  |                            | 28     |   |                           |   | 8      |      |  |   | 6      |   |  |   | 24      |  
|                                                      |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Total other comprehensive income                      |  |                            | 99     |   |                           |   | 13     |      |  |   | 183    |   |  |   | 94      |  
|                                                      |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Comprehensive income (loss)                           |  | $                          | (1,147 | ) |                           | $ | 1,278  |      |  | $ | (5,079 | ) |  | $ | (13,910 | )
|                                                      |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Earnings (loss) per share:                            |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Basic                                                 |  | $                          | (0.14  | ) |                           | $ | 0.16   |      |  | $ | (0.63  | ) |  | $ | (1.74   | )
|Diluted                                               |  | $                          | (0.14  | ) |                           | $ | 0.15   |      |  | $ | (0.63  | ) |  | $ | (1.74   | )
|Shares used in earnings (loss) per share calculation: |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Basic                                                 |  |                            | 8,764  |   |                           |   | 8,114  |      |  |   | 8,403  |   |  |   | 8,069   |  
|Diluted                                               |  |                            | 8,764  |   |                           |   | 8,548  |      |  |   | 8,403  |   |  |   | 8,069   |  



See accompanying notes
to condensed consolidated financial statements.



3



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##### Table of Contents

TARANTELLA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS



|                                                                                                                                                   |  |              |          |   |                          |   |          |  
|-------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | -------- | - | ------------------------ | - | -------- | -
|                                                                                                                                                   |  | June 30,2003 |          |   | September 30,2002        |  
|                                                                                                                                                   |  |              |          |   | (As restated,see note 2) |  
|(In thousands)                                                                                                                                     |  | (Unaudited)  |         
|                                                                                                                                                   |  |              |          |   |                          |  
|Assets                                                                                                                                             |  |              |          |   |                          |   |          |  
|Current assets:                                                                                                                                    |  |              |          |   |                          |   |          |  
|Cash and cash equivalents                                                                                                                          |  | $            | 4,594    |   |                          | $ | 7,055    |  
|Available-for-sale equity securities                                                                                                               |  |              | 400      |   |                          |   | 223      |  
|Trade receivables, net of allowance for doubtful accounts of $759 at June 30, 2003 and $340 at September 30, 2002                                  |  |              | 3,106    |   |                          |   | 2,686    |  
|Caldera and other receivables                                                                                                                      |  |              | 321      |   |                          |   | 229      |  
|Prepaids and other current assets                                                                                                                  |  |              | 811      |   |                          |   | 780      |  
|                                                                                                                                                   |  |              |          |   |                          |   |          |  
|Total current assets                                                                                                                               |  |              | 9,232    |   |                          |   | 10,973   |  
|                                                                                                                                                   |  |              |          |   |                          |   |          |  
|Property and equipment, net                                                                                                                        |  |              | 897      |   |                          |   | 1,214    |  
|Restricted cash                                                                                                                                    |  |              |         |   |                          |   | 500      |  
|Acquired intangible assets, net                                                                                                                    |  |              | 1,381    |   |                          |   |         |  
|Goodwill                                                                                                                                           |  |              | 2,364    |   |                          |   |         |  
|Other assets                                                                                                                                       |  |              | 387      |   |                          |   | 567      |  
|                                                                                                                                                   |  |              |          |   |                          |   |          |  
|Total assets                                                                                                                                       |  | $            | 14,261   |   |                          | $ | 13,254   |  
|                                                                                                                                                   |  |              |          |   |                          |   |          |  
|Liabilities and shareholders equity                                                                                                               |  |              |          |   |                          |   |          |  
|Current liabilities:                                                                                                                               |  |              |          |   |                          |   |          |  
|Trade payables                                                                                                                                     |  | $            | 656      |   |                          | $ | 448      |  
|Royalties payable                                                                                                                                  |  |              | 21       |   |                          |   | 202      |  
|Royalties payable former New Moon shareholders                                                                                                    |  |              | 1,784    |   |                          |   |         |  
|Income taxes payable                                                                                                                               |  |              | 591      |   |                          |   | 581      |  
|Accrued restructuring charges                                                                                                                      |  |              | 542      |   |                          |   | 871      |  
|Other payablesCaldera                                                                                                                             |  |              |         |   |                          |   | 400      |  
|Accrued expenses and other current liabilities                                                                                                     |  |              | 4,454    |   |                          |   | 3,963    |  
|Deferred revenues                                                                                                                                  |  |              | 1,679    |   |                          |   | 945      |  
|                                                                                                                                                   |  |              |          |   |                          |   |          |  
|Total current liabilities                                                                                                                          |  |              | 9,727    |   |                          |   | 7,410    |  
|                                                                                                                                                   |  |              |          |   |                          |   |          |  
|Long-term deferred revenues                                                                                                                        |  |              | 49       |   |                          |   | 33       |  
|                                                                                                                                                   |  |              |          |   |                          |   |          |  
|Total long-term liabilities                                                                                                                        |  |              | 49       |   |                          |   | 33       |  
|                                                                                                                                                   |  |              |          |   |                          |   |          |  
|Shareholders equity:                                                                                                                              |  |              |          |   |                          |   |          |  
|Preferred stock, authorized 20,000 shares; no shares issued and outstanding                                                                        |  |              |         |   |                          |   |         |  
|Common stock, no par value, authorized 100,000 shares; issued and outstanding 9,948 shares at June 30, 2003 and 8,206 shares at September 30,
2002 |  |              | 124,597  |   |                          |   | 120,844  |  
|Accumulated other comprehensive income                                                                                                             |  |              | 300      |   |                          |   | 117      |  
|Accumulated deficit                                                                                                                                |  |              | (120,412 | ) |                          |   | (115,150 | )
|                                                                                                                                                   |  |              |          |   |                          |   |          |  
|Total shareholders equity                                                                                                                         |  |              | 4,485    |   |                          |   | 5,811    |  
|                                                                                                                                                   |  |              |          |   |                          |   |          |  
|Total liabilities and shareholders equity                                                                                                         |  | $            | 14,261   |   |                          | $ | 13,254   |  
|                                                                                                                                                   |  |              |          |   |                          |   |          |  



See accompanying notes
to condensed consolidated financial statements.



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TARANTELLA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                                                               |  |                           |        |   |      |   |         |  
|---------------------------------------------------------------------------------------------- |  | ------------------------- | ------ | - | ---- | - | ------- | -
|                                                                                               |  | Nine Months EndedJune 30, |       
|                                                                                               |  | 2003                      |        |   | 2002 |  
|(In thousands)                                                                                 |  | (Unaudited)               |       
|Cash flows from operating activities:                                                          |  |                           |        |   |      |   |         |  
|Net loss                                                                                       |  | $                         | (5,262 | ) |      | $ | (14,004 | )
|Adjustments to reconcile net loss to net cash used for operating activities:                   |  |                           |        |   |      |   |         |  
|Depreciation and amortization                                                                  |  |                           | 595    |   |      |   | 714     |  
|Foreign currency exchange loss (gain)                                                          |  |                           | (18    | ) |      |   | 36      |  
|Gain on sale of marketable security                                                            |  |                           |       |   |      |   | (4,491  | )
|Loss on disposal of property and equipment                                                     |  |                           | 82     |   |      |   | 284     |  
|Loss on sale of divisions to Caldera                                                           |  |                           |       |   |      |   | 2,593   |  
|Equity losses in Caldera                                                                       |  |                           |       |   |      |   | 4,010   |  
|Impairment of equity investments                                                               |  |                           |       |   |      |   | 796     |  
|Stock compensation expense                                                                     |  |                           |       |   |      |   | 733     |  
|Changes in operating assets and liabilities, net of acquisition of New Moon Systems (Note 10): |  |                           |        |   |      |   |         |  
|Trade receivables                                                                              |  |                           | (298   | ) |      |   | 1,077   |  
|Other receivables                                                                              |  |                           | (92    | ) |      |   |        |  
|Prepaids and other current assets                                                              |  |                           | 60     |   |      |   |        |  
|Other assets                                                                                   |  |                           | 680    |   |      |   | 153     |  
|Trade payables                                                                                 |  |                           | (227   | ) |      |   | (238    | )
|Royalties payable                                                                              |  |                           | (181   | ) |      |   | (279    | )
|Income taxes payable                                                                           |  |                           | 10     |   |      |   | (159    | )
|Accrued restructuring expenses                                                                 |  |                           | (329   | ) |      |   | 128     |  
|Accrued expenses and other current liabilities                                                 |  |                           | (754   | ) |      |   | (3,621  | )
|Other payablesCaldera                                                                         |  |                           | (400   | ) |      |   |        |  
|Deferred revenues                                                                              |  |                           | 638    |   |      |   | (102    | )
|Other long-term liabilities                                                                    |  |                           |       |   |      |   | (760    | )
|                                                                                               |  |                           |        |   |      |   |         |  
|Net cash used in operating activities                                                          |  |                           | (5,496 | ) |      |   | (13,130 | )
|                                                                                               |  |                           |        |   |      |   |         |  
|Cash flows from investing activities:                                                          |  |                           |        |   |      |   |         |  
|Net cash received from the New Moon acquisition                                                |  |                           | 3,323  |   |      |   |        |  
|Royalty paymentNew Moon shareholders                                                          |  |                           | (43    | ) |      |   |        |  
|Sales of short-term investments and marketable securities                                      |  |                           |       |   |      |   | 2,000   |  
|Purchases of property and equipment                                                            |  |                           | (152   | ) |      |   | (153    | )
|Purchases of software and technology licenses                                                  |  |                           |       |   |      |   | (4      | )
|Proceeds from sale of marketable securities                                                    |  |                           |       |   |      |   | 1,531   |  
|Proceeds from sale of divisions to Caldera                                                     |  |                           |       |   |      |   | 4,451   |  
|                                                                                               |  |                           |        |   |      |   |         |  
|Net cash provided by investing activities                                                      |  |                           | 3,128  |   |      |   | 7,825   |  
|                                                                                               |  |                           |        |   |      |   |         |  
|Cash flows from financing activities:                                                          |  |                           |        |   |      |   |         |  
|Payments on capital lease obligations                                                          |  |                           | (220   | ) |      |   | (2      | )
|Net proceeds from issuance of common stock                                                     |  |                           | 139    |   |      |   | 94      |  
|                                                                                               |  |                           |        |   |      |   |         |  
|Net cash provided by (used in) financing activities                                            |  |                           | (81    | ) |      |   | 92      |  
|                                                                                               |  |                           |        |   |      |   |         |  
|Effects of exchange rate changes on cash and cash equivalents                                  |  |                           | (12    | ) |      |   | 2       |  
|                                                                                               |  |                           |        |   |      |   |         |  
|Decrease in cash and cash equivalents                                                          |  |                           | (2,461 | ) |      |   | (5,211  | )
|Cash and cash equivalents at beginning of period                                               |  |                           | 7,055  |   |      |   | 12,100  |  
|                                                                                               |  |                           |        |   |      |   |         |  
|Cash and cash equivalents at end of period                                                     |  | $                         | 4,594  |   |      | $ | 6,889   |  
|                                                                                               |  |                           |        |   |      |   |         |  
|Supplemental disclosure of cash flow information:                                              |  |                           |        |   |      |   |         |  
|Cash paid:                                                                                     |  |                           |        |   |      |   |         |  
|Income taxes                                                                                   |  | $                         | 305    |   |      | $ | 424     |  
|Interest                                                                                       |  |                           | 2      |   |      |   | 20      |  
|Non-cash financing and investing activities:                                                   |  |                           |        |   |      |   |         |  
|Unrealized gain on available-for-sale equity securities                                        |  |                           | 177    |   |      |   | 70      |  
|Product sale exchanged for equity investment                                                   |  |                           |       |   |      |   | 375     |  
|Shares issued for acquisition of New Moon Systems (Note 10)                                    |  |                           | 3,614  |   |      |   |        |  
|Royalties payableNew Moon Systems shareholders                                                |  |                           | 1,784  |   |      |   |         |  



See accompanying notes
to condensed consolidated financial statements.



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##### Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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Note 1Basis of Presentation



Tarantella, Inc. (the Company) is a leading provider of Internet infrastructure software that enables web-based access to enterprise applications from
virtually any client device. Headquartered in Santa Cruz, California, Tarantella operates development centers in the United States, the United Kingdom and India with sales representatives in the U.S., U.K., Germany, Mexico, Canada, France, Spain and
Italy. Tarantella products are sold through an integrated worldwide channel of Tarantella account executives, distributors, value-added resellers, systems integrators and computer and software manufacturers. Tarantella maintains exclusive
distribution relationships in Japan as well as distribution and agent relationships in China, Northern and Southeast Asia. In total, Tarantella products are available through resellers in more than 30 countries.



The Company was incorporated in 1979 as a California Corporation under the name The Santa
Cruz Operation (SCO), Inc. On May 4, 2001, SCO completed the sale of its Server Software and Professional Services Divisions to Caldera Systems, Inc., retaining the Tarantella Division. A new company, Caldera International, was formed
which combined the assets acquired from SCO with the assets of Caldera Systems. Upon the completion of the sale, SCO changed its corporate name to Tarantella, Inc.



The companys flagship product, Tarantella Enterprise 3, a UNIX/Linux-based application access suite, is installed in corporations and
governmental agencies around the world. Tarantella Enterprise 3 was introduced to the marketplace in 2001. Earlier client integration products, which are part of the Vision2K Suite, were introduced in the late 1990s and are currently still
available. In June 2003, Tarantella acquired New Moon Systems Inc, and added New Moon Canaveral iQ from Tarantella ® (Canaveral iQ) to its product offering. Canaveral iQ is a Windows-based application access suite, intended for small to mid-sized business customers and departmental deployments with Windows-only
infrastructure. In aggregate, Tarantella boasts over 12,000 customer sites including several of the most respected brands in the Fortune magazine Global 2000.



In the opinion of management, the accompanying unaudited condensed consolidated statements of operations, balance sheets and statements of cash flows include all
material adjustments (consisting of normal recurring adjustments) which the Company considers necessary for a fair presentation of its financial condition and results of operations as of and for the interim periods presented. The financial
statements include the accounts of the Company and its wholly owned subsidiaries after all material intercompany balances and transactions have been eliminated. These condensed consolidated financial statements should be read in conjunction with the
Companys audited consolidated financial statements and notes thereto included in the Companys 2002 Annual Report on Form 10-K. The consolidated interim results presented are not necessarily indicative of results to be expected for a full
year. The September 30, 2002 balance sheet was derived from restated audited financial statements, and is included for comparative purposes. The accompanying condensed consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X.



Reclassification



Certain prior period amounts have been reclassified to conform to current period presentation. These reclassifications had no significant impact on the financial
statements for the periods presented.



Going concern and managements
plans



The condensed consolidated financial statements have been prepared
on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. Losses from operations were $1.0 million for the third quarter of fiscal 2003, and $2.8 million for the
third quarter of fiscal 2002. The Company has incurred net losses of approximately $5.3 million during the first nine months of fiscal 2003 and $14.0 million during the first nine months of fiscal 2002. Net cash used for operating activities was
$5.5 million in the first nine months of fiscal 2003 and $13.1 million in the first nine months of fiscal 2002. The Company has negative working capital of $0.5 million at June 30, 2003 and an accumulated deficit of $120.4 million as of June 30,
2003 compared to $115.2 million as of September 30, 2002. These conditions, among others, raise substantial doubt about the Companys ability to continue as a going concern. The condensed consolidated financial statements do not reflect any
adjustments that might be required as a result of this uncertainty.



While
growing Tarantella products licenses and services revenues year over year, the Companys management has reduced its operating expenses by 32% in the first nine months of fiscal 2003 over the first nine months of fiscal 2002. The Company has
driven down expenses through its restructuring plans as described in Note 5. The Companys management believes that, based on its current plans, its existing cash and cash equivalents, short-term investments, cash received from private
placement transactions, and funds



6



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generated from operations will be sufficient to meet the Companys operating requirements for the next twelve
months. Although the Companys current business plan does not foresee the need for further financing activities to fund the Companys operations for the foreseeable future, due to risks and uncertainties in the market place, the Company
may need to raise additional capital. Management cannot be assured that additional financing will be available when it is needed.



Revenue Recognition



The Companys revenue is derived primarily from two sources, across many industries: (i) product license revenue, derived primarily from product sales to resellers and end users, including large scale enterprises
and royalty revenue, derived primarily from initial license fees, ongoing royalties from product sales by source code OEMs, and software updates; and (ii) services and support revenue, derived primarily from support and education and consulting
services to end users.



The Company accounts for revenue under the provisions
of AICPA Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended. Product revenue is recognized upon shipment if evidence of an arrangement exists, the fee is fixed and determinable and collection of resulting
receivables is probable. Sales to distributors are recognized upon sale by the distributor to resellers or end users. In certain instances when distributors waive their right to return product, revenue is recognized upon shipment if evidence of an
arrangement exists, the fee is fixed and determinable and collection of resulting receivables is probable. Estimated product returns are recorded upon recognition of revenue from customers having rights of return, including exchange rights for
unsold products and product upgrades.



Software revenue is recognized using the
residual method. Under the residual method revenue is recognized if vendor specific objective evidence of fair value exists for all the undelivered elements in an arrangement. Vendor specific objective evidence of fair value is based on the price
when the element is sold separately or, if not sold separately, is established by management. The fair value of services and post contract support is determined based upon separate sales and renewal rates set forth in the contract, respectively.



The Company recognizes revenue from maintenance fees for ongoing customer
support and product updates ratably over the period of the maintenance contract. Payments for maintenance fees are generally made in advance and are non-refundable. For revenue allocated to education and consulting services or derived from the
separate sale of such services, the Company recognizes revenue as the related services are performed.



The Company recognizes product revenue from royalty payments upon receipt of quarterly royalty reports from OEMs (original equipment manufacturer) related to their product sales.



Note 2Restatement



Subsequent to the issuance of the Companys consolidated financial statements for the fiscal year ended September 30, 2002, the
three months ended December 31, 2002 and the three and six months ended March 31, 2003, the Companys management determined that the accounting treatment initially afforded to certain transactions was not correct. As a result, the
accompanying condensed consolidated financial statements have been restated as described below.



During the third quarter of fiscal 2003 the Company announced that it had become aware of business practices in the Companys Northern European territory that required immediate changes in sales personnel within
the region and certain internal controls. After conducting an internal review of certain transactions in the Northern European territory, as well as other domestic and international transactions, the Companys management determined it was
necessary to restate revenues recorded in previous interim periods of fiscal 2003 and the fourth quarter of fiscal 2002. There were seven revenue transactions in Europe that did not sell out of the Companys distributor, as the Company had
previously believed. There were three revenue transactions totaling $0.2 million in the fourth quarter of fiscal 2002, two transactions totaling $0.2 in the first quarter of fiscal 2003, and two transactions totaling $0.2 million in the
second quarter of fiscal 2003. Since sales to distributors are recognized upon sell out by the distributor to resellers or end users, revenue for these transactions was reversed. Two of these transactions sold out of inventory in subsequent quarters
and revenue was recognized and products related to five of these transactions have been returned to the Company.



There were also two additional transactions in the first quarter of fiscal 2003 in the United States totaling $0.2 million where the terms of the original transaction
were amended. The amendment requires that the Company recognize such revenue no earlier than receipt of payment, which occurred in the third quarter of fiscal 2003 for both transactions.



In addition, as part of the internal revenue investigation, the Company determined that there was one revenue transaction in the fourth
quarter of fiscal 2002 totaling $0.3 million, and two revenue transactions, one in the first quarter and one in the second quarter of fiscal 2003, totaling $0.2 million, for one customer, that should have been recorded when cash was received, as the
customers ability to pay was not certain. One transaction was later paid through a barter transaction, however revenue was not recognized as the barter arrangement was determined to be a reciprocal arrangement. Two of these transactions remain
unpaid and revenue will be recognized upon receipt of cash.



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As a result of the reversal of these revenues in the fourth quarter of fiscal 2002, the first quarter of fiscal 2003 and
the second quarter of fiscal 2003, there was also a reversal of the cost of goods sold, commission expense and cooperative (COOP) advertising expense associated with these revenues.



The Company also corrected for amounts it determined were incorrectly recorded in the fourth
quarter of 2002. These adjustments included (i) an over accrual for commission and bonus expenses, (ii) an under accrual for miscellaneous expenses, and (iii) incorrectly recorded accelerated depreciation for an asset acquired. The depreciation
error also impacted the first two quarters in fiscal 2003.



In addition, the
Company has made certain reclassifications to correct the prior year financial statements. These reclassifications relate to the classification of customer credits issued and long-term deposits.



The Company is in contact with the Securities & Exchange Commission in connection with an
informal inquiry related to the events leading up to the Companys restatement.



A summary of the significant effects of the restatements on previously reported condensed consolidated financial statements is as follows:



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##### Table of Contents

|                                               |  |                         |          |   |             |   |          |  
|---------------------------------------------- |  | ----------------------- | -------- | - | ----------- | - | -------- | -
|                                              
|(In thousands)                                 |  | September 30 2002       |         
|                                              
|                                               |  | AsPreviously Reported * |          |   | As Restated |  
|Trade receivables, net                         |  | $                       | 3,045    |   |             | $ | 2,686    |  
|Caldera and other receivables                  |  |                         | 236      |   |             |   | 229      |  
|Prepaids and other current assets              |  |                         | 823      |   |             |   | 780      |  
|Total current assets                           |  |                         | 11,382   |   |             |   | 10,973   |  
|Property and equipment, net                    |  |                         | 1,192    |   |             |   | 1,214    |  
|Other assets                                   |  |                         | 524      |   |             |   | 567      |  
|Total assets                                   |  |                         | 13,598   |   |             |   | 13,254   |  
|Royalties payable                              |  |                         | 212      |   |             |   | 202      |  
|Accrued expenses and other current liabilities |  |                         | 3,892    |   |             |   | 3,963    |  
|Total current liabilities                      |  |                         | 7,349    |   |             |   | 7,410    |  
|Accumulated deficit                            |  |                         | (114,745 | ) |             |   | (115,150 | )
|Total shareholders equity                     |  |                         | 6,216    |   |             |   | 5,811    |  
|Total liabilities and shareholders equity     |  |                         | 13,598   |   |             |   | 13,254   |  



|* |  | Amounts as previously reported reflect reclassifications made to conform to current year presentation.
|- |  | ------------------------------------------------------------------------------------------------------



Note 3Recent Accounting Pronouncements



In June 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards
(SFAS) No. 146, Accounting for Costs Associated with Exit or Disposal Activities (SFAS 146), which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring) (EITF
94-3). SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost, as defined in EITF 94-3, was recognized at the date
of an entitys commitment to an exit plan. SFAS 146 also establishes that the liability should initially be measured and recorded at fair value. The Company adopted the provisions of SFAS 146 for exit or disposal activities that are initiated
after December 31, 2002. The adoption of SFAS 146 may affect the timing of recognizing future restructuring costs as well as the amounts recognized.



In November 2002, FASB issued FASB Interpretation 45 (FIN 45), Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. The Interpretation elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also clarifies that at the time a
company issues a guarantee, the company must recognize an initial liability for the fair value, or market value, of the obligations it assumes under the guarantee and must disclose that information in its interim and annual financial statements. The
provisions related to recognizing a liability at inception of the guarantee for the fair value of the guarantors obligations do not apply to product warranties or to guarantees accounted for as derivatives. The initial recognition and initial
measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002. The adoption of this statement did not have a material impact on the Companys financial position or results of operations. The
Company provides disclosures required by FIN 45 in Note 12 to the condensed consolidated financial statements.



In May 2003, the EITF reached a consensus on EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. This Issue addresses certain aspects of the accounting by a vendor for arrangements under
which it will perform multiple revenue-generating activities. This Issue addresses when and how an arrangement involving multiple deliverables should be divided into separate units of accounting. The guidance in this Issue is effective for revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of these provisions did not have a material effect on the Companys financial position or results of operations.



In January 2003 the FASB issued FIN No. 46, Consolidation of Variable Interest
Entities and a revised interpretation of FIN No. 46 (FIN No. 46-R) in December 2003. FIN No. 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity
do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. Should the Company form a
variable interest entity, FIN No. 46-R will be effective at that time, but not later than the quarter ending March 31, 2004.





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##### Table of Contents

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of
both Liabilities and Equity. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise became effective for the Company July 1, 2003. The adoption of SFAS No. 150 did not have a material effect on the Companys financial position or results of operations.



|
|

Stock Based Compensation



The Company accounts for stock-based compensation arrangements under the provisions of Accounting Principles Board (APB) Opinion
No. 25, Accounting for Stock Issued to Employees for its fixed stock option plan and employee stock purchase plan and accordingly, has not recognized compensation cost in the accompanying condensed consolidated statement of operations
for options issued at fair value. SFAS No. 123 permits the use of either a fair value based method or the intrinsic value method to measure the expense associated with stock-based compensation arrangements. The Company has recognized stock
compensation costs for stock options granted at less than fair value on the date of grant.



In accordance with the interim disclosure provisions of SFAS No. 148, the pro forma effect on the Companys net income (loss) had compensation expense been recorded for the three and nine months ended June 30,
2003 and 2002, respectively, as determined under the fair value method, is shown below (in thousands, except per share amounts):



|                                                                                                                                          |  |                                       |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------- | ------ | - | ------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                                                                                                                          |  | Three MonthsEnded June 30,            |        |   | Nine Months EndedJune 30, |  
|                                                                                                                                          |  | 2003                                  |        |   | 2002                      |   |        | 2003 |  |   | 2002   |  
|                                                                                                                                          |  | (In thousands, except per share data) |       
|Net income (loss), as reported                                                                                                            |  | $                                     | (1,246 | ) |                           | $ | 1,265  |      |  | $ | (5,262 | ) |  | $ | (14,004 | )
|Add: Stock-based employee compensation expense included in reported net loss, net of related tax effects                                  |  |                                       | 10     |   |                           |   | 0      |      |  |   | 10     |   |  |   | 595     |  
|Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax
effects |  |                                       | (1,314 | ) |                           |   | (1,670 | )    |  |   | (4,069 | ) |  |   | (5,320  | )
|                                                                                                                                          |  |                                       |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Pro forma net loss                                                                                                                        |  | $                                     | (2,550 | ) |                           | $ | (405   | )    |  | $ | (9,321 | ) |  | $ | (18,729 | )
|                                                                                                                                          |  |                                       |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Net income (loss) per share as reported                                                                                                   |  |                                       |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|                                                                                                                                          |  |                                       |        |  
|Basic                                                                                                                                     |  | $                                     | (0.14  | ) |                           | $ | 0.16   |      |  | $ | (0.63  | ) |  | $ | (1.74   | )
|                                                                                                                                          |  |                                       |        |  
|Diluted                                                                                                                                   |  |                                       | (0.14  | ) |                           | $ | 0.15   |      |  |   | (0.63  | ) |  | $ | (1.74   | )
|                                                                                                                                          |  |                                       |        |  
|Pro forma net loss per share                                                                                                              |  |                                       |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|                                                                                                                                          |  |                                       |        |  
|Basic                                                                                                                                     |  |                                       | (0.29  | ) |                           | $ | (0.05  | )    |  |   | (1.11  | ) |  | $ | (2.32   | )
|                                                                                                                                          |  |                                       |        |  
|Diluted                                                                                                                                   |  |                                       | (0.29  | ) |                           | $ | (0.05  | )    |  |   | (1.11  | ) |  | $ | (2.32   | )



The fair value of each option grant
was estimated on the date of grant using the Black-Scholes option-pricing model. The principal determinants of option pricing are fair market value of the Companys common stock at the date of grant, expected volatility, risk-free interest
rate, expected option lives and dividend yields. Weighted average assumptions employed by the Company were: expected volatility of 100% for the three and nine months ended June 30, 2003, 94% for the three and nine months ended June 2002, and a
risk-free interest rate of 2.27% and 3.73% for the three and nine months ended June 30, 2003 and 2002, respectively. In addition, the Company assumed an expected option life of four years for non-executive employees and five years for executive
employees and assumed no dividend yield for both periods.



10



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Note 4Earnings Per Share Disclosures



Basic and diluted earnings per share (EPS) were calculated as follows for the three months and nine months ended June 30, 2003
and 2002 (in thousands, except per share data):



|                                                                                                                                                              |  |                            |        |                           |      |   |       |  |   |        |   |  |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------- | ------ | ------------------------- | ---- | - | ----- |  | - | ------ | - |  | - | ------- | -
|                                                                                                                                                              |  | Three MonthsEnded June 30, |        | Nine Months EndedJune 30, |     
|                                                                                                                                                              |  | 2003                       |        |                           | 2002 |   | 2003  |  |   | 2002   |  
|Basic:                                                                                                                                                        |  |                            |        |                           |      |   |       |  |   |        |   |  |   |         |  
|Net income (loss)                                                                                                                                             |  | $                          | (1,246 | )                         |      | $ | 1,265 |  | $ | (5,262 | ) |  | $ | (14,004 | )
|                                                                                                                                                              |  |                            |        |                           |      |   |       |  |   |        |   |  |   |         |  
|Weighted average shares                                                                                                                                       |  |                            | 8,764  |                           |      |   | 8,114 |  |   | 8,403  |   |  |   | 8,069   |  
|Earnings (loss) per share                                                                                                                                     |  | $                          | (0.14  | )                         |      | $ | 0.16  |  | $ | (0.63  | ) |  | $ | (1.74   | )
|                                                                                                                                                              |  |                            |        |                           |      |   |       |  |   |        |   |  |   |         |  
|Diluted:                                                                                                                                                      |  |                            |        |                           |      |   |       |  |   |        |   |  |   |         |  
|Net income (loss)                                                                                                                                             |  | $                          | (1,246 | )                         |      | $ | 1,265 |  | $ | (5,262 | ) |  | $ | (14,004 | )
|                                                                                                                                                              |  |                            |        |                           |      |   |       |  |   |        |   |  |   |         |  
|Weighted average shares                                                                                                                                       |  |                            | 8,764  |                           |      |   | 8,114 |  |   | 8,403  |   |  |   | 8,069   |  
|Common equivalent shares from stock options and warrants                                                                                                      |  |                            |       |                           |      |   | 434   |  |   |       |   |  |   |        |  
|                                                                                                                                                              |  |                            |        |                           |      |   |       |  |   |        |   |  |   |         |  
|Shares used in per share calculation                                                                                                                          |  |                            | 8,764  |                           |      |   | 8,548 |  |   | 8,403  |   |  |   | 8,069   |  
|                                                                                                                                                              |  |                            |        |                           |      |   |       |  |   |        |   |  |   |         |  
|Earnings (loss) per share                                                                                                                                     |  | $                          | (0.14  | )                         |      | $ | 0.15  |  | $ | (0.63  | ) |  | $ | (1.74   | )
|                                                                                                                                                              |  |                            |        |                           |      |   |       |  |   |        |   |  |   |         |  
|Options and warrants outstanding, not included in computation of diluted EPS because the exercise price was greater than the average market
price             |  |                            | 1,400  |                           |      |   | 1,962 |  |   | 2,113  |   |  |   | 1,994   |  
|                                                                                                                                                              |  |                            |        |                          
|Options outstanding, not included in computation of diluted EPS because their inclusion would have an anti-dilutive effect due to net loss
during the period. |  |                            | 1,528  |                           |      |   |      |  |   | 845    |   |  |   | 857     |  



Note 5Accrued Restructuring
Charges



Fiscal 2003



On June 5, 2003, the Company announced a restructuring plan, which resulted in a charge of
$0.2 million. On June 5, 2003 the Company acquired New Moon Systems Inc. (New Moon). In order to keep spending levels flat with pre-acquisition levels, the Company assessed the overall resource requirements for the combined business and
reduced infrastructure accordingly.



The entire restructuring charge of $0.2
million was for severance, related to the elimination of 12 positions. The positions eliminated were 9 in the US, 2 in the UK and 1 in Germany. The reductions in work force affected the product development, sales, marketing and general and
administrative functions of the Company. As of June 30, 2003, 5 of the 12 employees had terminated. The remaining 7 employees terminated during the fourth quarter of fiscal 2003.



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Fiscal 2003 Third Quarter Restructuring Accrual



|                                    |  |                   |     |   |            |   |                        |  |       |   |  |   |     |  
|----------------------------------- |  | ----------------- | --- | - | ---------- | - | ---------------------- |  | ----- | - |  | - | --- | -
|(In Thousands)                      |  | Reductionin Force |     |   | Facilities |   | Disposalof FixedAssets |  | Total |  
|Restructuring charge accrued        |  | $                 | 153 |   |            | $ |                       |  | $     |  |  | $ | 153 |  
|Payments/utilization of the accrual |  |                   | (57 | ) |            |   |                       |  |       |  |  |   | (57 | )
|                                    |  |                   |     |   |            |   |                        |  |       |   |  |   |     |  
|Accrual at June 30, 2003            |  | $                 | 96  |   |            | $ |                       |  | $     |  |  | $ | 96  |  
|                                    |  |                   |     |   |            |   |                        |  |       |   |  |   |     |  



During the first quarter of fiscal
2003, the Company announced a restructuring plan, which resulted in a charge of $1.1 million. The Company reduced its spending levels to align its operating expenses with the Companys continued lower than expected revenues.



A severance charge of $0.8 million included the elimination of 10 positions in the United
States, 13 positions in the United Kingdom, and 2 positions in Italy. The reductions in work force affected the product development, sales, marketing and general and administrative functions of the Company. As of December 31, 2002, all 25 positions
had been eliminated, however all severance was not paid until June 30, 2003.



A
facilities charge of $0.3 million was related to space the Company vacated at two locations in the U.K. This included a non-cash charge of $89,000 related to the write-off of leasehold improvements at the two vacated facilities.



The Company completed all of the cost reduction actions initiated in the first quarter of
fiscal year 2003 during the quarter. Liabilities remain for lease obligation on the two facilities in the U.K.



Fiscal 2003 First Quarter Restructuring Accrual



|                                    |  |                   |      |   |            |   |     |                        |  |   |       |   |  |   |       |  
|----------------------------------- |  | ----------------- | ---- | - | ---------- | - | --- | ---------------------- |  | - | ----- | - |  | - | ----- | -
|(In Thousands)                      |  | Reductionin Force |      |   | Facilities |   |     | Disposalof FixedAssets |  |   | Total |  
|Restructuring charge accrued        |  | $                 | 820  |   |            | $ | 238 |                        |  | $ | 89    |   |  | $ | 1,147 |  
|Payments/utilization of the accrual |  |                   | (408 | ) |            |   | (24 | )                      |  |   | (89   | ) |  |   | (521  | )
|                                    |  |                   |      |   |            |   |     |                        |  |   |       |   |  |   |       |  
|Accrual at December 31, 2002        |  |                   | 412  |   |            |   | 214 |                        |  |   |      |   |  |   | 626   |  
|Payments/utilization of the accrual |  |                   | (240 | ) |            |   | (74 | )                      |  |   |      |   |  |   | (314  | )
|                                    |  |                   |      |   |            |   |     |                        |  |   |       |   |  |   |       |  
|Accrual at March 31, 2003           |  |                   | 172  |   |            |   | 140 |                        |  |   |      |   |  |   | 312   |  
|Payments/utilization of the accrual |  |                   | (113 | ) |            |   | (33 | )                      |  |   |      |   |  |   | (146  | )
|Provision Adjustment                |  |                   | (59  | ) |            |   |    |                        |  |   |      |   |  |   | (59   | )
|                                    |  |                   |      |   |            |   |     |                        |  |   |       |   |  |   |       |  
|Accrual at June 30, 2003            |  | $                 |     |   |            | $ | 107 |                        |  | $ |      |   |  | $ | 107   |  
|                                    |  |                   |      |   |            |   |     |                        |  |   |       |   |  |   |       |  



Fiscal 2002



During the first quarter of fiscal 2002, the Company announced a restructuring plan, which
resulted in a charge of $1.6 million. The Company reduced its spending levels to align its operating expenses with the Companys lower than expected revenues. The restructuring included a reduction in staffing of 52 employees, a reserve for
unused facilities at the Companys corporate headquarters, and costs associated with closing several foreign offices.



This included a severance charge of $0.9 million for the elimination of 19 positions in the United States, 23 positions in the United Kingdom, and 10 positions in Japan.
The reductions in force affected the product development, support, sales, marketing and general and administrative functions of the Company. As of March 31, 2002, all 52 positions had been eliminated.



Also included was facilities charge of $0.7 million related to space the Company vacated. The
Company had anticipated that it would sub-lease the space by December 31, 2002. As of September 30, 2002, the Company had not secured a sub-lease tenant, so a provision adjustment of $0.6 million was made to reserve for the cost of this space
through December 31, 2003. In the fourth quarter of fiscal 2003, the Company made a provision adjustment to reserve the space through September 30, 2004. The lease for this building expires on June 30, 2005. In addition, a charge was taken for
expenses associated with office closures in Japan and Brazil. There was a non-cash charge of $39,000 related to fixed asset disposals at the Japan subsidiary.



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The Company completed the cost reduction actions initiated in fiscal 2002, with the exception of sub-leasing excess space
at the Companys corporate headquarters in Santa Cruz, California.



Fiscal 2002 First Quarter Restructuring Accrual



|                                    |  |                   |   |            |   |      |                        |  |       |   |  |   |      |  
|----------------------------------- |  | ----------------- | - | ---------- | - | ---- | ---------------------- |  | ----- | - |  | - | ---- | -
|(In Thousands)                      |  | Reductionin Force |   | Facilities |   |      | Disposalof FixedAssets |  | Total |  
|Accrual at September 30, 2002       |  |                   |  |            |   | 750  |                        |  |       |  |  |   | 750  |  
|Payments/utilization of the accrual |  |                   |  |            |   | (157 | )                      |  |       |  |  |   | (157 | )
|                                    |  |                   |   |            |   |      |                        |  |       |   |  |   |      |  
|Accrual at December 31, 2002        |  |                   |  |            |   | 593  |                        |  |       |  |  |   | 593  |  
|Payments/utilization of the accrual |  |                   |  |            |   | (140 | )                      |  |       |  |  |   | (140 | )
|                                    |  |                   |   |            |   |      |                        |  |       |   |  |   |      |  
|Accrual at March 31, 2003           |  |                   |  |            |   | 453  |                        |  |       |  |  |   | 453  |  
|Payments/utilization of the accrual |  |                   |  |            |   | (158 | )                      |  |       |  |  |   | (158 | )
|                                    |  |                   |   |            |   |      |                        |  |       |   |  |   |      |  
|Accrual at June 30, 2003            |  | $                 |  |            | $ | 295  |                        |  | $     |  |  | $ | 295  |  
|                                    |  |                   |   |            |   |      |                        |  |       |   |  |   |      |  



Fiscal 2001



During the second quarter of fiscal 2001, the Company announced a restructuring plan which
resulted in a charge of $1.6 million, which when taken with a provision adjustment to a previously established restructuring reserve for severance related to the sale of divisions to Caldera, resulted in net charge for the period of $1.1 million.
The restructuring charge included a reduction in personnel of 28 employees and a reserve for unused facilities. Total cash expenditures were $1.6 million (see table below).



The $1.6 million restructuring charge included a severance charge of $1.5 million for the elimination of 16 positions in the United States,
4 positions in the United Kingdom, and 8 positions in various other geographies. The reduction in work force affected the sales, marketing and general and administrative functions of the Company. As of September 30, 2001, all 28 positions had been
eliminated. The Company vacated additional space within its Santa Cruz, California office in the first quarter of fiscal 2002, and an additional charge of $81,000 was recorded for estimated payments on the lease for an additional 12 months. In the
fourth quarter of fiscal 2002, an additional charge of $85,000 was recorded because the facility was not yet sub-leased. The facility was not sub-leased as of June 30, 2003 and the restructuring reserve at the end of the third quarter of fiscal 2003
covered rents through December 31, 2003. In the fourth quarter of fiscal 2003, the Company made a provision adjustment to reserve the space through September 30, 2004. The lease for this building expires on June 30, 2005.



Fiscal 2001 Second Quarter Restructuring Accrual



|                                    |  |                   |   |            |   |     |       |  |   |     |  
|----------------------------------- |  | ----------------- | - | ---------- | - | --- | ----- |  | - | --- | -
|(In Thousands)                      |  | Reductionin Force |   | Facilities |   |     | Total | 
|Accrual at September 30, 2002       |  |                   |  |            |   | 106 |       |  |   | 106 |  
|Payments/utilization of the accrual |  |                   |  |            |   | (22 | )     |  |   | (22 | )
|                                    |  |                   |   |            |   |     |       |  |   |     |  
|Accrual at December 31, 2002        |  |                   |  |            |   | 84  |       |  |   | 84  |  
|Payments/utilization of the accrual |  |                   |  |            |   | (20 | )     |  |   | (20 | )
|                                    |  |                   |   |            |   |     |       |  |   |     |  
|Accrual at March 31, 2003           |  |                   |  |            |   | 64  |       |  |   | 64  |  
|Payments/utilization of the accrual |  |                   |  |            |   | (22 | )     |  |   | (22 | )
|                                    |  |                   |   |            |   |     |       |  |   |     |  
|Accrual at June 30, 2003            |  | $                 |  |            | $ | 42  |       |  | $ | 42  |  
|                                    |  |                   |   |            |   |     |       |  |   |     |  



During the fourth quarter of fiscal
2001, the Company announced a restructuring plan, which resulted in a charge of $0.5 million. The restructuring charge included a reduction in personnel of 10 employees and a planned elimination of offices in Singapore and Australia. Total cash
expenditures were $0.4 million.



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The severance charge of $0.4 million included the elimination of 4 positions in the United States and 6 positions in the
United Kingdom. The reductions in work force affected the sales, marketing and general and administrative functions of the Company. At September 30, 2001, all 10 positions had been eliminated. A provision adjustment of $64,000 was made to release
excess restructuring reserve, which resulted from the fact that the Company had not anticipated that the Australian office would be sub-leased. The remaining reserve of $2,000 at June 30, 2003 relates to the facility in Australia, which the Company
is in the final stages of closing.



Fiscal 2001 Fourth
Quarter Restructuring Accrual



|                                    |  |                   |   |            |   |    |       |  |   |    |  
|----------------------------------- |  | ----------------- | - | ---------- | - | -- | ----- |  | - | -- | -
|(In Thousands)                      |  | Reductionin Force |   | Facilities |   |    | Total | 
|Accrual at September 30, 2002       |  |                   |  |            |   | 15 |       |  |   | 15 |  
|Payments/utilization of the accrual |  |                   |  |            |   | (1 | )     |  |   | (1 | )
|                                    |  |                   |   |            |   |    |       |  |   |    |  
|Accrual at December 31, 2002        |  |                   |  |            |   | 14 |       |  |   | 14 |  
|Payments/utilization of the accrual |  |                   |  |            |   | (9 | )     |  |   | (9 | )
|                                    |  |                   |   |            |   |    |       |  |   |    |  
|Accrual at March 31, 2003           |  |                   |  |            |   | 5  |       |  |   | 5  |  
|Payments/utilization of the accrual |  |                   |  |            |   | (3 | )     |  |   | (3 | )
|                                    |  |                   |   |            |   |    |       |  |   |    |  
|Accrual at June 30, 2003            |  | $                 |  |            | $ | 2  |       |  | $ | 2  |  
|                                    |  |                   |   |            |   |    |       |  |   |    |  



Note 6Industry and Geographic
Segment Information



The following table presents information on revenue
and long-lived assets by geography. Revenue is allocated based on the location from which the sale is satisfied and long-lived asset information is based on the physical location of the asset.



|                         |  |                            |       |                           |   |       |  |      |        |  |   |       
|------------------------ |  | -------------------------- | ----- | ------------------------- | - | ----- |  | ---- | ------ |  | - | ------
|                         |  | Three MonthsEnded June 30, |       | Nine Months EndedJune 30,
|                         |  | 2003                       |       | 2002                      |   | 2003  |  | 2002
|                         |  | (In thousands)             |       | (In thousands)           
|Net revenues:            |  |                            |       |                           |   |       |  |      |        |  |   |       
|United States            |  | $                          | 1,606 |                           | $ | 2,359 |  | $    | 5,017  |  | $ | 6,363 
|Canada and Latin America |  |                            | 160   |                           |   | 84    |  |      | 557    |  |   | 522   
|EMEIA(1)                 |  |                            | 1,488 |                           |   | 786   |  |      | 3,904  |  |   | 2,857 
|Asia Pacific             |  |                            | 489   |                           |   | 380   |  |      | 1,424  |  |   | 995   
|Corporate adjustments    |  |                            | 9     |                           |   | 41    |  |      | 25     |  |   | 77    
|                         |  |                            |       |                           |   |       |  |      |        |  |   |       
|Total net revenues       |  | $                          | 3,752 |                           | $ | 3,650 |  | $    | 10,927 |  | $ | 10,814
|                         |  |                            |       |                           |   |       |  |      |        |  |   |       



|                        |  |                |       |                   |   |      
|----------------------- |  | -------------- | ----- | ----------------- | - | -----
|                        |  | June 30,2003   |       | September 30,2002
|                        |  | (In thousands)
|Long-lived assets:      |  |                |       |                   |   |      
|United States           |  | $              | 4,589 |                   | $ | 1,310
|EMEIA(1)                |  |                | 440   |                   |   | 471  
|                        |  |                |       |                   |   |      
|Total long-lived assets |  | $              | 5,029 |                   | $ | 1,781
|                        |  |                |       |                   |   |      



|(1) |  | Europe, Middle East, India and Africa
|--- |  | -------------------------------------



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##### Table of Contents

Note 7Investments



Available-for-sale equity securities:



At June 30, 2003, the Company held 505,767 shares of Rainmaker stock. The Company accounts for this investment as available-for-sale, and accordingly, records it at fair
market value based on quoted market prices. Any unrealized gains or losses are included as part of accumulated other comprehensive income. The fair market value of the investment at June 30, 2003 was $399,556 and the cost was $170,830 resulting in
an unrealized gain of $228,726. Rainmakers common stock is traded on the Nasdaq under the symbol RMKR.



Note 8Transactions with Caldera



On May 4, 2001, the Company consummated the sale of its Server Software and Professional Services divisions to Caldera Systems, Inc. Under the terms of the transaction,
Caldera Systems, Inc. acquired the assets of the Server and Professional Services groups. A new company, Caldera International, Inc. (Caldera International), was formed which combined the assets acquired from the Company with the assets
of Caldera Systems, Inc. Upon the completion of the sale, the Company is continuing to operate its Tarantella business, and accordingly, changed its corporate name to Tarantella, Inc. and Nasdaq trading symbol to TTLA to reflect the new corporate
name.



As consideration for the transaction, the Company received 16 million
common stock shares of Caldera International (representing approximately 28.2% of Caldera International), $23 million in cash (of which $7 million was received on January 26, 2001) and a non-interest bearing promissory note in the amount of $8
million that was originally to be received in quarterly installments of $2 million beginning in August 2002.



As part of the original transaction, if the OpenServer line of business of the Server and Professional Services groups generated revenues in excess of specified thresholds during the three-year period following the
completion of the combination, the Company had earn-out rights entitling it to receive 45% of these excess revenues. The transaction was treated as a disposal of Server and Professional Services groups and a gain of $53,267,000 was recorded upon
completion of the transaction.



For the fourth fiscal quarter of 2001, the
Companys operating results included 28.2% of the operating results of Caldera International, adjusted for amortization of 5 months of negative goodwill of approximately $0.7 million. The net amount of the losses included was $4.6 million. In
the fourth fiscal quarter of 2001, the Company also recorded an impairment of the investment, net of the remaining negative goodwill of $7.8 million, in the amount of $22.5 million. The impairment was recorded as the share price of Caldera
International was significantly below the fair market value of Tarantellas and was deemed to be other than temporarily impaired.



During the first fiscal quarter of 2002, the Companys net loss included equity losses of $4.0 million for its share of Caldera International losses. After recording
this loss, the carrying value of the shares of Caldera International stock was reduced to zero, in accordance with APB opinion No. 18., The Equity Method of Accounting for Investments in Common Stock.



During the second quarter of fiscal 2002, the Company signed an agreement with Caldera
International to redeem the $8 million note receivable held by the Company for $5 million. The note was originally payable in four quarterly installments of $2 million each, beginning in August 2002. A loss of $3,038,000 was recorded against the
gain on the sale of divisions to Caldera for the redemption of the note receivable.



Additionally, Caldera International agreed to the buyout of certain licenses for products bundled in older releases of The Santa Cruz Operation, Inc.s software, and the buyback of 500,000 post split shares of Caldera International
stock held by the Company for $555,000. On March 7, 2002, Caldera International executed a 1 for 4 reverse stock split. Accordingly, the shares held by the Company were adjusted to reflect the stock split.



During the third quarter of fiscal 2002, Tarantella announced an agreement with Caldera
International for Caldera International to repurchase the remaining 3,289,401 shares of Caldera International common stock held by Tarantella. Tarantella recorded other income of $3,059,250 from this transaction in the third fiscal quarter and
subsequently received the cash in July 2002. For the fiscal year ended September 30, 2002, the Company sold 4,010,417 post split shares of Caldera International stock for total proceeds of $4,360,938. As of September 30, 2002, the Company no longer
owns any securities in Caldera International. During the third quarter of fiscal 2002, Caldera International also bought out the remaining term of the OpenServer revenue sharing plan that was part of the



15



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##### Table of Contents

original transaction, for $100,000, which was recorded as a gain on the sale of divisions to Caldera. In addition,
royalty reserves of $345,000 related to the original transaction were written off and recorded as a gain on the sale of divisions to Caldera.



As part of the agreement between the Company and Caldera International, various building leases were assigned to Caldera International, however, the Company was a
guarantor under such leases which expire in 2005. In the fourth quarter of fiscal 2002 the Company was released from its obligation as guarantor. There were also building leases, related to the agreement between the Company and Caldera
International, that were assigned to the Company, for which Caldera International was a guarantor, and for which the Company had $0.5 million of restricted cash in escrow. During the third quarter of fiscal 2003 Caldera International was released
from its obligation as guarantor and the $0.5 million restricted cash that was in escrow was returned to the Company.



Note 9Reverse Stock Split



On November 14, 2002 the Board of Directors unanimously adopted resolutions approving and recommending to the shareholders for their approval a series of amendments to
the Companys Amended and Restated Articles of Incorporation to effect a reverse stock split of the Companys Common Stock at a ratio to be determined by the Companys Board of Directors. On February 27, 2003 the stockholders approved
amendments to the Companys Amended and Restated Articles of Incorporation to effect a reverse stock split. On May 19, 2003, the Board of Directors unanimously approved the implementation of a reverse split with a ratio of one for five. On June
6, 2003, the Company implemented a one-for-five reverse split and the Companys outstanding common shares were reduced from 49.7 million shares to approximately 9.9 million shares. The reverse stock split has been retroactively reflected in the
accompanying condensed consolidated financial statements and notes thereto for all periods presented.



Note 10Business Combinations



Acquisition of New Moon Systems Inc.:



On June 5, 2003,
Tarantella completed the acquisition of New Moon Systems, Inc., a privately-held California corporation (New Moon ) pursuant to an Agreement and Plan of Reorganization (the Agreement), dated May 29, 2003. New Moon,
headquartered in San Jose, CA, develops software to simply and cost-effectively manage and deploy Windows-based applications to end-user desktops in small and medium-sized businesses, as well as enterprise departmental customers. Canaveral iQ
extends the capabilities of Microsofts Windows Terminal Services and answers the demand for a simple and intelligent means of centrally managing remote applications.



Pursuant to the Agreement, Tarantella issued a total of 1,592,000 shares of Tarantella common stock valued at $3.6 million in exchange for
all of the outstanding shares of New Moon and to satisfy its obligations to the former employees of New Moon. The fair value of the Companys common stock was determined based on the average closing price per share of the Companys common
stock over the five day period including the two days before and after the terms of the acquisition were agreed to and announced. The New Moon shareholders shall also receive a minimum cash earnout of approximately $1.8 million over a period from
January 1, 2004 to December 31, 2006 based on a royalty of 30% of New Moon product revenues, net of direct costs. The minimum earnout is subject to change since it is reduced if the Company incurs further liabilities on behalf of New Moon. After the
shareholders have been paid the minimum earnout, they would be entitled to an additional royalty of 15% of New Moon product revenues, net of direct costs, during this period. In the event the minimum earnout is not achieved by the conclusion of the
quarter ending December 31, 2006, Tarantella shall pay along with the final earnout payment an amount equal to the minimum earnout less all aggregate earnouts paid to date, less any off-sets and any escrow claim deficiencies. The Company also
incurred approximately $0.3 million of direct merger costs, for a total purchase price of approximately $5.7 million.



The results of operations of New Moon subsequent to June 5, 2003, have been included in the Companys condensed consolidated financial statements for the quarter
ended June 30, 2003.



The pro forma financial information reflects a total
purchase price for New Moon of $5.7 million as follows (in thousands):



Purchase price:



|                                             |  |   |      
|-------------------------------------------- |  | - | -----
|Fair Value of Tarantella common stock issued |  | $ | 3,614
|Minimum cash earnout                         |  |   | 1,784
|Acquisition costs                            |  |   | 300  
|                                             |  |   |      
|Total consideration                          |  | $ | 5,698
|                                             |  |   |      



Under the purchase method of
accounting, the estimated total price is allocated to New Moons net tangible and intangible assets based upon their estimated fair market value as of the date of acquisition, June 5, 2003. The allocation of the purchase price to goodwill and
intangibles is based upon an independent, third-party appraisal and managements estimates as follows (in thousands):



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##### Table of Contents

|                                               |  |   |      
|---------------------------------------------- |  | - | -----
|Net tangible assets acquired                   |  |   |      
|Assets                                         |  |   |      
|Cash and cash equivalents                      |  | $ | 3,323
|Trade receivables, net                         |  |   | 110  
|Prepaids and other current assets              |  |   | 91   
|Property and equipment, net                    |  |   | 145  
|                                               |  |   |      
|Total assets                                   |  |   | 3,669
|                                               |  |   |      
|Liabilities                                    |  |   |      
|Trade payables                                 |  |   | 435  
|Accrued expenses and other current liabilities |  |   | 949  
|Deferred revenues                              |  |   | 112  
|Capital lease obligation, current portion      |  |   | 259  
|                                               |  |   |      
|Total liabilities                              |  |   | 1,755
|                                               |  |   |      
|Net tangible assets acquired                   |  |   | 1,914
|                                               |  |   |      
|Intangible assets acquired                     |  |   |      
|Developed technology                           |  |   | 500  
|Patents/core technology                        |  |   | 700  
|Customer base                                  |  |   | 20   
|Trade name/Trademark                           |  |   | 200  
|                                               |  |   |      
|Total intangible assets acquired               |  |   | 1,420
|                                               |  |   |      
|Goodwill                                       |  |   | 2,364
|                                               |  |   |      
|Total purchase price                           |  | $ | 5,698
|                                               |  |   |      



Net tangible assets acquired as of
June 5, 2003 of approximately $1.9 million represent the net tangible assets of New Moon. A portion of the purchase price has been allocated to identifiable intangible assets. The income approach, which includes an analysis of cash flows and risks
associated with achieving such cash flows, was used to estimate the fair value of the Companys existing technology and subscription/maintenance agreements. The royalty savings approach, which estimates the value of an asset by capitalizing the
royalties saved because the Company owns the asset, was used to estimate the fair value of the Companys patents/core technology and trade name/trademarks. The cost approach, which uses the concept of replacement cost as an indicator of fair
value, was used to estimate the fair value of the Companys value-added reseller (VAR) relationships. The Company is amortizing all identifiable intangible assets on a straight-line basis over an estimated useful life of three
years.



The residual purchase price of $2.4 million was recorded as goodwill.
Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, goodwill relating to the New Moon
acquisition is not being amortized and will be carried at cost and tested for impairment annually and whenever events indicate that an impairment may have occurred. As of June 30, 2003, the Company has accrued acquisition costs of $300,000. The
allocation of the purchase price to goodwill is subject to change as more information becomes available related to acquisition costs.



New Moon had approximately 27 employees at the date of the acquisition. Prior to June 6, 2003, and in connection with the merger, the Company gave redundancy notices to
15 former New Moon employees, and accrued $0.3 million related to their severance benefits. The estimated cost of terminating the employees was accounted for as part of the purchase price. Of the total number of employees to be terminated, 7 were in
research and development, 3 were in sales and marketing and 5 in general and administration. During the quarter ended June 30, 2003, 8 of the redundant employees left the Company and the remainder left at various dates through September 30, 2003.
During the quarter ended June 30, 2003, $0.1 million was paid out as termination benefits and the remaining $0.2 million was paid out during the quarter ended September 30, 2003.



The following unaudited pro forma information shows the results of operations for the three and nine months ended June 30, 2003 and 2002, as
if the New Moon acquisition had occurred at the beginning of the periods presented and at the purchase price established at the time of the acquisition:



UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS

(In
thousands, except per share data)



|               |  |                            |        |   |                           |   |        |      |  |   |         |   |  |   |         |  
|-------------- |  | -------------------------- | ------ | - | ------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|               |  | Three MonthsEnded June 30, |        |   | Nine Months EndedJune 30, |  
|               |  | 2003                       |        |   | 2002                      |   |        | 2003 |  |   | 2002    |  
|               |  | (Unaudited)                |        |   | (Unaudited)               |  
|Net revenues   |  | $                          | 3,844  |   |                           | $ | 3,837  |      |  | $ | 11,208  |   |  | $ | 11,031  |  
|Net loss       |  | $                          | (3,626 | ) |                           | $ | (1,231 | )    |  | $ | (11,828 | ) |  | $ | (21,744 | )
|Loss per share |  | $                          | (0.35  | ) |                           | $ | (0.13  | )    |  | $ | (1.18   | ) |  | $ | (2.25   | )



The pro forma information is
presented for illustrative purposes only and is not necessarily indicative of the operating results that would have occurred if the acquisition had been consummated at the beginning of the earliest period presented, nor is it necessarily indicative
of future operating results.



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##### Table of Contents

Note 11Acquired Intangible Assets, Net



|                                    |  |                     |       |                      |   |                         |   |                      |  |   |      
|----------------------------------- |  | ------------------- | ----- | -------------------- | - | ----------------------- | - | -------------------- |  | - | -----
|                                    |  | As of June 30, 2003
|                                    |  | GrossCarryingAmount |       | EstimatedUsefulLives |   | AccumulatedAmortization |   | IntangibleAssets,Net
|                                    |  | (In thousands)      |       | (In years)           |   |                         |   |                     
|Amortized intangible assets         |  |                     |       |                      |   |                         |   |                      |  |   |      
|Technology                          |  | $                   | 500   |                      | 3 |                         | $ | 14                   |  | $ | 486  
|Patents                             |  |                     | 700   |                      | 3 |                         |   | 19                   |  |   | 681  
|Trademarks                          |  |                     | 200   |                      | 3 |                         |   | 5                    |  |   | 195  
|Other                               |  |                     | 20    |                      | 3 |                         |   | 1                    |  |   | 19   
|                                    |  |                     |      
|Total                               |  | $                   | 1,420 |                      |   |                         | $ | 39                   |  | $ | 1,381
|                                    |  |                     |      
|Aggregate amortization expense:     |  |                     |       |                      |   |                         |   |                      |  |   |      
|For nine months ended June 30, 2003 |  | $                   | 39    |                      |   |                         |   |                      |  |   |      
|Estimated amortization expense:     |  |                     |       |                      |   |                         |   |                      |  |   |      
|For year ending September 30, 2003  |  |                     | 158   |                      |   |                         |   |                      |  |   |      
|For year ending September 30, 2004  |  |                     | 473   |                      |   |                         |   |                      |  |   |      
|For year ending September 30, 2005  |  |                     | 473   |                      |   |                         |   |                      |  |   |      
|For year ending September 30, 2006  |  |                     | 316   |                      |   |                         |   |                      |  |   |      
|                                    |  |                     |       |                      |   |                         |   |                      |  |   |      
|                                    |  | $                   | 1,420 |                      |   |                         |   |                      |  |   |      
|                                    |  |                     |       |                      |   |                         |   |                      |  |   |      



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Note 12Indemnification and Warranties



Indemnification



The Company licenses its software and services pursuant to a software license agreement, in which the Company agrees to indemnify, hold harmless and defend the customer
against damages arising out of claims filed by third parties that the Companys products infringe any copyright or other intellectual property right. The term of the indemnification is generally perpetual, limited by applicable statutes of
limitations. The license agreement generally limits the scope of the remedies for such indemnification obligation, including but not limited to certain product usage limitations and the right to replace an infringing product or modify it to make it
non-infringing. If the Company cannot address the infringement by replacing or repairing the product, the Company is allowed to cancel the license and return the fees paid by the customer. The Company has never incurred expense under such
indemnification provisions. The Company believes the estimated fair value of these indemnification agreements is minimal.



As permitted under California law, the Company has agreements whereby it indemnifies its officers and directors for certain events while the officer or director is, or
was, serving at the Companys request in such capacity. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited, however, the Company has a Directors and
Officers insurance policy that limits the Companys exposure and enables it to recover at least a portion of any future amounts paid. As a result of its insurance policy coverage, the Company believes the estimated fair value of these
indemnification agreements is minimal.



Warranties



The Company generally warrants for a period of 90 days that its software products will
perform substantially in accordance with its published specifications, that the reproduction of the software on the media material provided by the Company is correct and that the documentation is correctly printed. In the event of any
non-conformance, the Company agrees to repair, replace or accept return of the non-conforming product and refund any fees paid by the customer for said non-conforming product. The Company has never incurred significant expense under its product
warranties. The Company believes the estimated fair value of these warranty agreements is immaterial.



As discussed in Note 7, as part of the agreement between the Company and Caldera International, various building leases were assigned to Caldera International. However, the Company was a guarantor under such leases
that expire in 2005. In the fourth quarter of fiscal 2002 the Company was released from its obligation as guarantor. There were also building leases, related to the agreement between the Company and Caldera International, that were assigned to the
Company, for which Caldera International was a guarantor, and for which the Company had $0.5 million of restricted cash in escrow. During the third quarter of fiscal 2003 Caldera International was released from its obligation as guarantor and the
$0.5 million restricted cash that was in escrow was returned to the Company.



Note 13Subsequent Events



Restructuring



On July 24, 2003 the Company announced a reduction of approximately 30%
in the Companys worldwide workforce and additional actions to reduce overall operating expense by more than 20%, which includes a reduction of approximately 50% in executive compensation costs. As a result of this restructuring the Company
recorded a non-recurring charge of $0.4 million.



In the first quarter of
fiscal 2004, the Company implemented a restructuring which reduced the existing workforce by two employees. The Company recorded a charge of $0.3 million for this restructuring in the first quarter of fiscal 2004.



De-Listing Status



On October 20, 2003, the Company announced that it had received notification from the Nasdaq Listing Qualifications Panel that the
Companys stock would discontinue trading on the Nasdaq SmallCap Market effective with open of business on Tuesday, October 21, 2003.



This action followed Tarantellas appeal to Nasdaq for a listing extension after not meeting the stated time requirements to file SEC Form 10-Q for the
Companys third fiscal quarter. The Nasdaq Panel determination to delist the Companys stock was based on the Companys filing delinquency, public interest concerns, and the ongoing nature of the internal revenue investigation. On
December 8, 2003, the Company filed an appeal to reverse that portion of the Nasdaq Panels decision relating to its public interest concerns. On February 27, 2004, the Nasdaq advised the Company that its appeal had been denied.



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##### Table of Contents

Tarantellas common stock is not currently eligible to trade on the OTC Bulletin Board but is eligible for quotation
on the OTC Pink Sheets. The Companys trading symbol has changed to TTLA.PK.



Regaining SEC compliance may allow the Companys shares to be eligible for trading on the OTC Bulletin Board. If the Company resumes compliance with the periodic reporting requirements of the 1934 Exchange Act, it will attempt to meet
the listing requirements for the Nasdaq SmallCap Market, however some requirements such as minimum bid price and market capitalization are outside of the Companys control.



Management Changes



On December 11, 2003, the Company announced that its Board of Directors has appointed Frank Wilde as Chief Executive Officer, President and Director of the Company. Mr.
Wilde succeeds Doug Michels, who has become a strategic advisor to the Company, focusing initially on merger and acquisition opportunities. Mr. Michels will also continue as a Director of Tarantella.



The board has also approved the request by several senior executives including Frank Wilde,
Doug Michels and Alok Mohan, the Companys Chairman, to receive a substantial portion of their calendar year 2004 compensation in the form of restricted stock in lieu of cash.



On January 6, 2004, the Company announced the appointment of John Greeley as Chief Financial Officer (CFO), reporting directly to Frank
Wilde, Chief Executive Officer (CEO). Mr. Greeley assumes the CFO responsibilities from Alok Mohan, Tarantellas Chairman, who had been acting CFO since September 8, 2003.



Private Placements



On September 30, 2003, the Company completed a private placement of common stock and warrants to Special Situations Technology Funds and Vertical Ventures resulting in
gross proceeds to the Company of approximately $2,254,200 for which the Company paid fees of $155,345. The Company issued 1,950,000 shares of common stock at a price of $1.156 and warrants to purchase 1,950,000 shares of common stock at $1.395 per
share. The warrants have a value of $895,592, based on the relative fair value using a Black-Scholes calculation, using a volatility of 100%, an annual dividend of zero and a discount rate of 2.63%. The Company can require the warrant holders to
exercise one-third of the warrants provided the shares issuable thereunder are registered with the SEC and the share price equals or exceeds $1.674 for a period of twenty consecutive trading days. In addition, the Company can redeem up to two-thirds
of the warrants or all of the warrants for $0.01 per share should the closing bid price of the shares reach the target prices of $2.232 and $2.790, respectively. The warrant holders may exercise the warrants prior to redemption. The warrants expire
on September 30, 2008.



On December 26, 2003, the Company completed a private
placement of common stock and warrants to investors, including Special Situations Technology Funds, who are expanding on their previous investment, Starlight Digital Technologies, LLC, an investment group in which Mr. Wilde acts as Managing
Director, and an additional private investor, resulting in gross proceeds to the Company of approximately $2,750,000. In connection with the financing, the Company will pay placement fees in the amount of $232,303.



In the private placement, the investors purchased 2,750,000 shares of Tarantella common stock
at a price of $1.00 per share. The investors also acquired warrants to purchase up to an additional 550,000 shares at an exercise price of $1.39 per share. The warrants are exercisable for five years. The Company also has agreed to register the
shares of common stock issued to the investors as well as the shares issuable upon exercise of the warrants for resale once the Company has complied with its reporting obligations under the Securities Exchange Act of 1934, as amended.



In connection with the investment, the Company also amended its existing shareholder rights
plan such that Special Situations shall be permitted to acquire up to 30% beneficial ownership of the outstanding stock of the Company without triggering the Companys shareholder rights plan, provided that for purposes of determining Special
Situations beneficial ownership, neither the warrants nor any future exercises of warrants will be considered.



On February 23, 2004, the Company announced the completion of a private placement of common stock and warrants to various investors. In the private placement, the
investors purchased 11,678,580 shares of Tarantella common stock at a price of $1.40 per share. The investors also acquired warrants to purchase up to an additional 2,335,714 shares at an exercise price of $1.70 per share for gross proceeds of
$16,350,000. The warrants are exercisable for five years. If the warrants are fully exercised, the Company would receive additional gross proceeds of approximately $3,970,714. The Company also has agreed to register the shares of common stock issued
to the investors as well as the shares issuable upon exercise of the warrants for resale once the Company has complied with its reporting obligations under the Securities Exchange Act of 1934, as amended. In connection with the financing, the
Company will pay fees in the amount of $1,074,000.



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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations



This Managements Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Companys condensed
consolidated financial statements and notes thereto included elsewhere in the Quarterly Report on Form 10-Q, as well as the Managements Discussion and Analysis of Financial Condition and Result of Operations included in the Companys
Annual Report on Form 10-K for the fiscal year ended September 30, 2002. In addition to historical information contained herein, this Discussion and Analysis contains forward-looking statements. These statements involve risks and uncertainties and
can be identified by the use of forward-looking terminology such as estimates, projects, anticipates, plans, future, may, will, should,
predicts, potential, continue, expects, intends, believes, and similar expressions. Examples of forward-looking statements include those relating to financial risk management
activities and the adequacy of financial resources for operations. These and other forward-looking statements are only estimates and predictions. While the Company (also referred to as Tarantella) believes that the expectations reflected
in the forward-looking statements are reasonable, the Companys actual results could differ materially. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect managements expectations only as
of the date hereof.



Restatement



Subsequent to the issuance of the Companys consolidated financial statements for the
year ended September 30, 2002, the Companys management determined that the accounting treatment initially afforded to certain transactions was not correct. As a result, the accompanying condensed consolidated financial statements have been
restated.



The effects of the restatement are presented in note 2 of the Notes
to the Condensed Consolidated Financial Statements and have been reflected in managements discussion and analysis of financial condition and results of operations.



De-Listing Status



On October 20, 2003, the Company announced that it had received notification from the Nasdaq Listing Qualifications Panel that the Companys stock would discontinue
trading on the Nasdaq SmallCap Market effective with open of business on Tuesday, October 21, 2003.



This action followed Tarantellas appeal to Nasdaq for a listing extension after not meeting the stated time requirements to file SEC Form 10-Q for the Companys third fiscal quarter. The Nasdaq Panel
determination to delist the Companys stock was based on the Companys filing delinquency, public interest concerns, and the ongoing nature of the internal revenue investigation. On December 8, 2003, the Company filed an appeal to reverse
that portion of the Nasdaq Panels decision relating to its public interest concerns. On February 27, 2004, the Nasdaq advised the Company that its appeal had been denied.



Tarantellas common stock is not currently eligible to trade on the OTC Bulletin Board but is eligible for quotation on the OTC Pink
Sheets. The Companys trading symbol has changed to TTLA.PK.



Regaining
SEC compliance may allow the Companys shares to be eligible for trading on the OTC Bulletin Board. If the Company resumes compliance with the periodic reporting requirements of the 1934 Exchange Act, it will attempt to meet the listing
requirements for the Nasdaq SmallCap Market, however some requirements such as minimum bid price and market capitalization are outside of the Companys control.



Management Changes



On December 11, 2003, the Company announced that its Board of Directors has appointed Frank Wilde as Chief Executive Officer, President and Director of the Company. Mr.
Wilde succeeds Doug Michels, who has become a strategic advisor to the Company, focusing initially on merger and acquisition opportunities. Mr. Michels will also continue as a Director of Tarantella.



The board has also approved the request by several senior executives including Frank Wilde,
Doug Michels and Alok Mohan, the Companys Chairman, to receive a substantial portion of their calendar year 2004 compensation in the form of restricted stock in lieu of cash.



On January 6, 2004, the Company announced the appointment of John Greeley as Chief Financial Officer (CFO), reporting directly to Frank
Wilde, Chief Executive Officer (CEO). Mr. Greeley assumes the CFO responsibilities from Alok Mohan, Tarantellas Chairman, who had been acting CFO since September 8, 2003.



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Critical Accounting Policies



The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United
States requires management to make judgments, assumptions and estimates that affect the amounts reported in the Companys consolidated financial statements and the accompanying notes. Note 3 to the consolidated financial statements in our
Annual Report on Form 10-K for the fiscal year ended September 30, 2002 describes the significant accounting policies and methods used in the preparation of the consolidated financial statements for the three fiscal years in the period ended
September 30, 2002. The amounts of assets and liabilities reported on the Companys balance sheets and the amounts of revenues and expenses reported for each of our fiscal periods are affected by estimates and assumptions which are used for,
but not limited to, the accounting for revenue, bad debts, product returns, certain accrued expenses, restructuring and liabilities and a valuation allowance for deferred tax assets. Actual results could differ from these estimates. The following
critical accounting policies are significantly affected by judgments, assumptions and estimates used in the preparation of the condensed consolidated financial statements.



Revenue Recognition



The Companys revenue is derived primarily from two sources, across many industries: (i) products license revenue, derived primarily from product sales to resellers
and end users, including large scale enterprises and royalty revenue, derived primarily from initial license fees, ongoing royalties from product sales by source code OEMs, and software updates; and (ii) services and support revenue, derived
primarily from support and education and consulting services to end users.



The
Company accounts for revenue under the provisions of AICPA Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended. Product revenue is recognized upon shipment if evidence of an arrangement exists, the fee is
fixed and determinable and collection of resulting receivables is probable. Sales to distributors, are recognized upon sale by the distributor to resellers or end users. In certain instances when distributors waive their right to return product,
revenue is recognized upon shipment if evidence of an arrangement exists, the fee is fixed and determinable and collection of resulting receivables is probable. Estimated product returns are recorded upon recognition of revenue from customers having
rights of return, including exchange rights for unsold products and product upgrades.



Software revenue is recognized using the residual method. Under the residual method revenue is recognized if vendor specific objective evidence of fair value exists for all the undelivered elements in an arrangement. Vendor specific
objective evidence of fair value is based on the price when the element is sold separately or, if not sold separately, is established by management. The fair value of services and post contract support is determined based upon separate sales and
renewal rates set forth in the contract, respectively.



The Company recognizes
revenue from maintenance fees for ongoing customer support and product updates ratably over the period of the maintenance contract. Payments for maintenance fees are generally made in advance and are non-refundable. For revenue allocated to
education and consulting services or derived from the separate sale of such services, the Company recognizes revenue as the related services are performed.



The Company recognizes product revenue from royalty payments upon receipt of quarterly royalty reports from OEMs (original equipment manufacturer) related to their
product sales.



The Company performs ongoing credit evaluations of its
customers financial condition and does not require collateral. The Company maintains allowances for potential credit losses and such losses have been within managements expectations.



Returns and Reserves



The Company records a provision for product returns for related sales in the same period as the related revenues are recorded. These
estimates are based on historical sales returns, analysis of credit memo data and other known factors. If the historical data the Company uses to calculate these estimates do not properly reflect future returns, revenue could be affected.



Allowance for doubtful accounts



Payments from customers are continuously monitored and allowances are maintained for doubtful
accounts for estimated losses resulting from the inability of customers to make required payments. When evaluating the adequacy of allowances for doubtful accounts, various factors are taken into account, including accounts receivable aging,
customer credit-worthiness, historical bad debts, and geographic and political risk. If the financial condition of customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. As
of September 30, 2003, the Companys net accounts receivable balance was $3.0 million.



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Income Taxes



Tarantella has operations in many countries other than the United States. Transfer prices for services provided between the United States and these countries have been
documented as reasonable, however, tax authorities could challenge these transfer prices and assess additional taxes on prior period transactions. Any such assessment could require the Company to record an additional tax provision in its statement
of operations.



Income tax assets and liabilities are determined by taxable
jurisdiction. The Company evaluates net deferred tax assets in each tax jurisdiction by estimating the likelihood of the Company generating future profits to realize these assets. The Company has assumed that it will not generate sufficient future
taxable income to realize these assets and has created valuation reserves to reduce the net deferred tax asset values to zero.



Restructuring



During fiscal 2003 and fiscal 2002, the Company recorded several reserves in connection with restructuring programs. These reserves include estimates for employee severance, facility redundancies and disposal of fixed
assets. Actual costs have not differed materially from these estimates.



Goodwill and Other Intangible Assets



Intangible assets have been
recorded in connection with the acquisition on New Moon Systems Inc. The cost of the acquisition was allocated to the assets and liabilities acquired, including identifiable intangible assets, with the remaining amount being classified as goodwill.
Certain identifiable intangible assets such as purchased technology and customer lists are amortized to operating expenses over time. Under current accounting guidelines adopted on July 1, 2002, goodwill will not be amortized to expense but rather
periodically assessed for impairment. Accordingly, the allocation of the acquisition cost to identifiable intangible assets and goodwill has a significant impact on our future operating results. The allocation process requires extensive use of
estimates and assumptions, including estimates of future cash flows expected to be generated by the acquired assets. Further, when impairment indicators are identified with respect to previously recorded intangible assets, the values of the assets
are determined using valuation techniques that require significant management judgment. Should conditions be different than managements current assessment, material write-downs of intangible assets may be required. The Company will perform the
annual goodwill impairment test as of July 1, 2004 to determine if there is any goodwill impairment. Under SFAS 142, goodwill and intangible assets of a reporting unit shall be tested for impairment between annual tests if an event occurs or
circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Company believes that there has been no event as of September 30, 2003, that reduced the fair value of our reporting unit
below the goodwill and intangible assets carrying amounts. The Company will perform evaluations more frequently if business conditions indicate an assessment in an interim period is warranted. The Company will periodically review the estimated
remaining useful lives of other intangible assets. A reduction in estimate of remaining useful lives could result in increased amortization expense in future periods.



Reclassification



Certain prior period amounts have been reclassified to conform to current period presentation. These reclassifications had no significant impact on the financial
statements for the periods presented.



Results of Operations



Net Revenues



The Companys net revenues are derived from software licenses and fees for services.



Net revenues for the three months ended June 30, 2003 were $3.8 million, an increase of 3%
over the $3.7 million in the same period in fiscal 2002. Net revenues for the nine months ended June 30, 2003 increased 1% to $10.9 million compared to $10.8 million for the nine months ended June 2002. Although revenues were virtually flat from the
third quarter of fiscal 2002 to the third quarter of fiscal 2003, there were regions with increases which were offset by decreases in the United States. The overall revenue performance for the third quarter of fiscal 2003, broken out geographically,
was a $0.6 million increase in Europe, $0.1 million in the Canada and Latin America region and $0.1 million increase in Asia, while revenues in the United States decreased by $0.8 million. Revenue performance year to date, broken out geographically,
was a $0.9 million increase in Europe and $0.4 million increase in Asia. Revenues in the United States decreased $1.6 million. The increase in net revenues in all regions, except the United States, was mainly due to larger average transaction size
due to sales to large enterprise customers. The reason for the decrease in revenues in the United States in the third quarter of fiscal 2003 was a drop off in sales to government customers. The decrease in revenues in the United States for the nine
months ended June 30, 2003 was due to reduced revenue to Independent Software Vendor (ISV) customers.



License revenues for the three months ended June 30, 2003 were $3.1 million, an increase of 4% from $2.9 million in the same quarter of fiscal 2002. License revenues for
the nine months ended June 30, 2003 were $9.0 million compared to $9.2 million for the same period of fiscal 2002, a decrease of 2% from the prior year.



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Service revenues were flat at $0.7 million for the three months ended June 30, 2003, compared to $0.7 million for the
three months ended June 30, 2002. Service revenue was 18% of the total revenue for the third fiscal quarters of 2003 and 19% for the third quarter of fiscal 2002. Service revenues increased to $1.9 million for the nine months ended June 30, 2003,
from $1.6 million in the same period in fiscal 2002, an increase of 21%. Service revenue was 18% of the total revenue for the first nine months of 2003, compared to 15% for the same period in the prior year.



International revenues were 57% of total revenues for the third quarter of fiscal 2003 and
34% for the same period in the prior year. For the nine months ended June 30, 2003, international revenues were 54%, of total revenues compared to 40% for the same period in the prior year.



Costs and Expenses



Cost of license revenues for the three months ended June 30, 2003 decreased by 111% to a credit of $14,000 from $127,000 of expense in the
same period of fiscal 2002. There was a credit in cost of license revenues in the third quarter of fiscal 2003 due to the release of reserves related to the sale of divisions to Caldera, which were no longer deemed necessary. For the nine months
ended June 30, 2003, cost of license revenues decreased by 65% to $0.1 million from $0.4 million in the same period of fiscal 2002. Cost of license revenues decreased because of lower overhead, which is attributable to lower headcount, due to
planned reductions in force and due to the release of excess royalty reserves. There were also lower royalty costs due to favorable product mixes.



Cost of service revenues for the three months ended June 30, 2003 remained relatively flat at $0.3 million compared to $0.4 million for the same period in fiscal 2002.
Cost of service revenues for the nine months ended June 30, 2003 also remained relatively flat at $0.9 million compared to the same period in fiscal 2002. Service gross margin also increased to 56% for the nine months ended June 30, 2003, from 45%
for the same period of fiscal 2002. The improvement in the services gross margin is a result of lower costs due to headcount reductions and employee pay reductions of 15%.



Total cost of revenues as a percentage of net revenues decreased to 8% in the third quarter of fiscal 2003 from 13% for the same period in
fiscal 2002. For the nine months ended June 30, 2003, cost of revenues as a percentage of net revenues decreased to 9% from 11% for the same period in fiscal 2002. Cost of revenues as a percentage of net revenue was lower mainly due to lower costs
due to headcount reductions and employee pay reductions of 15%.



Research and
development expenses decreased by 20% to $1.1 million in the third quarter of fiscal 2003 from $1.3 million in the comparable quarter of fiscal 2002, and as a percentage of net revenues were 28% and 36%, respectively. For the nine months ended June
30, 2003 research and development expenses decreased by 32% to $3.0 million from $4.4 million in the comparable period of fiscal 2002, and as a percentage of net revenues were 27% and 40%, respectively. The decrease in research and development
expenses can be attributed to lower labor costs driven by lower headcount as a result of planned reductions in work force. In addition, labor costs were lower because of employee pay reductions of 15%.



Selling, general and administrative expenses decreased by 29% to $3.3 million in the third
quarter of fiscal 2003 from $4.6 million in the comparable quarter of the prior year. For the nine months ended June 30, 2003, selling, general and administrative expenses decreased by 32% to $10.7 million from $15.7 million in the comparable period
of fiscal 2002. The significant decrease in expenses is due mainly to lower labor costs that were driven by lower headcount as a result of a planned reduction in work force. In addition, labor costs were lower because of a pay reduction of 15% for
employees in Marketing and General and Administrative departments and 7.5% for employees in Sales. Selling, general and administrative expenses as a percentage of net revenues were 88% in the third quarter of fiscal 2003 and 127% in the same period
in fiscal 2002. For the nine months ended June 30, 2003, selling, general and administrative expenses were 98% of net revenues compared to 145% in the same period of fiscal 2002.



Restructuring charges for the third quarter of fiscal 2003 were $0.1 million. There were no restructuring charges in the third quarter of
fiscal 2002. For the nine months ended June 30, 2003, restructuring charges were $1.3 million for restructuring plans that were initiated in the first quarter and third quarter of fiscal 2003. For the nine months ended June 30, 2002, restructuring
charges were $1.7 million for a restructuring plan that was initiated in the first quarter of fiscal 2002. The Company plans to substantially complete these plans by September 30, 2003. The Company cannot assure that its current estimates of costs
associated with these restructuring actions will not change during the implementation period.



Interest income, net was $4,000 for the third quarter of fiscal 2003 and $36,000 for the same period in fiscal 2002. For the nine months ended June 30, 2003, interest income, net was $50,000 compared to $477,000 for
the same period in fiscal 2002. The decrease in interest income, net reflects the lower cash balances held for the quarter and the nine month period ended June 30, 2003, as well as the collection of the Caldera note receivable. Interest income was
also lower due to a lower average interest rate for the period. In the third quarter of fiscal 2003, the interest rate was approximately 0.85%. In the third quarter of fiscal 2002, the interest rate was approximately 1.65%. For the nine months ended
June 30, 2003 the interest rate was 1.21%.



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For the third quarter of fiscal 2003, other expense, net was $118,000, compared to other income, net of $444,000 for the
same period of fiscal 2002. The other expense in the third quarter of fiscal 2003 included an investment impairment of $151,000, partially offset by foreign exchange gain of $54,000. The other income in the third quarter of fiscal 2002 included a
write-off of a customer rebate of $427,000. For the nine months ended June 30, 2003, other expense, net was $69,000 compared to $894,000 for the same period in fiscal 2002. The other expense for the nine months ended June 30, 2003 included net
losses on investments of $140,000, partially offset by foreign exchange gain of $90,000. The other expense for the nine months ended June 30, 2002 included investment impairments of $846,000, warrant expense of $242,000 and foreign exchange loss of
$170,000. These losses were partially offset by a write-off of a customer rebate of $427,000.



In the third quarter of fiscal 2002 there was a gain on the sale of divisions to Caldera of $0.4 million. For the nine months ended June 30, 2002 the loss on the sale of divisions to Caldera was $2.6 million. The
gain on the sale of divisions to Caldera for the third quarter of fiscal 2002 was for a buyout of the OpenServer revenue earnout by Caldera of $0.1 million and the release of a royalty reserve of $0.3 million, related to the sale of divisions to
Caldera, for reserves no longer deemed necessary. The loss for the nine months ended June 30, 2002 was related to the early redemption of a note payable from Caldera International.



Gain on sale of Caldera stock for the three months ended June 30, 2002 was $3.1 million. For the nine months ended June 30, 2002, gain on
sale of Caldera stock was $4.5 million.



Loss on equity investment in Caldera
was $4.0 million for the nine months ended June 30, 2002. This loss reflected the Companys portion of Caldera Internationals losses.



Income tax provision was $0.1 million for the third quarter of fiscal 2003 compared to zero for the same period in fiscal year 2002. For the nine months ended June 30,
2003 there was an income tax provision of $0.3 million compared to an income tax benefit of $0.8 million for the same period in fiscal 2002. The tax provision for the three and nine months ended June 30, 2003, reflects foreign taxes payable.
The tax benefit for the nine months ended June 30, 2002 reflects a benefit due to a change in U.S. tax law enacted in March 2002 as well as a benefit related to the reduction of foreign audit issues.



Net loss for the third quarter of fiscal 2003 was $1.2 million compared to net income of $1.3
million for the same quarter of fiscal 2002. For the nine months ended June 30, 2003, net loss was $5.3 million compared to $14.0 million for the same period of fiscal 2002. The net income in the third quarter of fiscal 2002 was due to the $3.1
million gain from the sale of shares of Caldera stock. The sale of stock was partially offset by operating losses of $2.8 million. The decrease in net loss for the nine months ended June 30, 2003, compared to the same period of fiscal 2002, is
primarily due to lower operating expenses, and the absence of losses related to the investment in Caldera. The losses related to the investment in Caldera were $6.6 million for the nine months ended June 30, 2002.



Liquidity and Capital Resources



Cash, cash equivalents and short-term investments were $4.6 million at June 30, 2003,
representing 32% of total assets. The decrease in cash and cash equivalents of $2.5 million from September 30, 2002 is mainly due to operating losses of $5.0 million, a prepayment of royalties of $0.3 million, and a decrease in other payables
Caldera of $0.4 million. These decreases in cash were partially offset by increases due to receipt of cash from the New Moon transaction of $3.3 million and release of restricted cash from escrow of $0.5 million. The Companys operating
activities used cash of $5.5 million in the first nine months of fiscal 2003, compared to $13.1 million used for operating activities in the first nine months of fiscal 2002. The decrease in the cash used for operating activities is due to the
significant reduction in operating loss in the first nine months of fiscal 2003, as compared to the first nine months of fiscal 2002. The operating loss was $5.0 million in the first nine months of fiscal 2003 compared to a loss of $12.2 million in
the first nine months of fiscal 2002. Cash provided by investing activities was $3.1 million in the first nine months of fiscal 2003 compared to cash provided by investing activities of $7.8 million for the first nine months of fiscal 2002. The cash
provided by investing activities for the nine months ended June 30, 2003 was due primarily to the cash acquired from New Moon Systems of $3.3 million. The cash provided by investing activities for the nine months ended June 30, 2002 was primarily
due to proceeds received from the sale of Caldera common stock of $2.9 million, and the early redemption of a note payable by Caldera for $5.0 million. Negligible cash was provided by and used in financing activities in the first nine months of
fiscal 2003 and fiscal 2002.



The Companys days sales outstanding
(DSO) at June 30, 2003 was 75, an increase of 9 days from June 30, 2002. DSO is calculated using revenues for the quarter, and net accounts receivable at the end of the quarter. The increase in DSO was due to an increase in past due
receivables. The unreserved past due accounts receivable increased from $0.1 million at June 30, 2002 to $0.6 million at June 30, 2003, causing an increase in DSO.



The Company has operating lease commitments of $1.9 million in fiscal 2003. See Note 10 of the Companys Form 10-K for the fiscal year
ended September 30, 2002 for operating lease commitments beyond fiscal 2003.



Losses from operations were $5.0 million for the first nine months of fiscal 2003, and $12.2 million for the first nine months of 2002. The Company has incurred net losses of approximately $5.3 million during the first nine months of fiscal
2003 and $14.0 million during the first nine months of fiscal 2002. Net cash used in operating activities was $5.5 million in the first nine months of fiscal 2003 and $13.1 million in the first nine months of fiscal 2002. The Company has an
accumulated deficit of $120.4 million as of June 30, 2003. These conditions, among others, raise substantial doubt about the Companys ability to continue as a going concern.



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The Companys management believes that, based on the Companys current plans, its existing cash and cash
equivalents, short-term investments, cash received from private placement transactions, and funds generated from operations will be sufficient to meet its operating requirements for the next twelve months. The Companys financial plan assumes
revenue growth and decreased spending. If the Company does not achieve the revenue growth it anticipates or if expenses do not decline as planned, the Company will need additional financing. Management cannot be assured that additional financing
will be available when it is needed.



Subsequent to June 30, 2003, the Company
completed the following financing activities:



In the fourth quarter of fiscal
2003, the Company secured a $1.5 million line of credit from a bank, which is secured by the Companys assets.



On September 30, 2003, the Company completed a private placement of common stock and warrants to Special Situations Technology Funds and Vertical Ventures resulting in
gross proceeds to the Company of approximately $2,254,200 for which the Company paid fees of $155,345. The Company issued 1,950,000 shares of common stock at a price of $1.156 and warrants to purchase 1,950,000 shares of common stock at $1.395 per
share. The warrants have a value of $895,592, based on the relative fair value using a Black-Scholes calculation, using a volatility of 100%, an annual dividend of zero and a discount rate of 2.63%. The Company can require the warrant holders to
exercise one-third of the warrants provided the shares issuable thereunder are registered with the SEC and the share price equals or exceeds $1.674 for a period of twenty consecutive trading days. In addition, the Company can redeem up to two-thirds
of the warrants or all of the warrants for $0.01 per share should the closing bid price of the shares reach the target prices of $2.232 and $2.790, respectively. The warrant holders may exercise the warrants prior to redemption. The warrants expire
on September 30, 2008.



On December 26, 2003, the Company completed a private
placement of common stock and warrants to the following investors: Special Situations Technology Funds (who are expanding on their previous investment), Starlight Digital Technologies, LLC, an investment group in which Mr. Wilde acts as Managing
Director, and an additional private investor, resulting in gross proceeds to the Company of approximately $2,750,000. In connection with the financing, the Company paid placement fees in the amount of $232,303.



On February 23, 2004, the Company announced the completion of a private placement of common
stock and warrants to various investors. In the private placement, the investors purchased 11,678,580 shares of Tarantella common stock at a price of $1.40 per share. The investors also acquired warrants to purchase up to an additional 2,335,714
shares at an exercise price of $1.70 per share for gross proceeds of $16,350,000. The warrants are exercisable for five years. If the warrants are fully exercised, the Company would receive additional gross proceeds of approximately $3,970,714. The
Company also has agreed to register the shares of common stock issued to the investors as well as the shares issuable upon exercise of the warrants for resale once the Company has complied with its reporting obligations under the Securities Exchange
Act of 1934, as amended. In connection with the financing, the Company will pay fees in the amount of $1,074,000.



Factors That May Affect Future Results



Set forth below and elsewhere in this filing and in other documents the Company files with the SEC are risks and uncertainties that could cause actual results to differ
materially from the results contemplated by the forward-looking statements in this filing.



The Companys operating results may fluctuate in future periods.



The results of operations for any quarter or fiscal year are not necessarily indicative of the results to be expected in future periods. The Companys operating results have in the past been, and will continue to
be, subject to quarterly and annual fluctuations as a result of a number of factors, including but not limited to:



|- |  | Overall technology spending
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|- |  | Changes in general economic conditions and specific market conditions in the Internet infrastructure industry
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|- |  | Rapid technological changes that can adversely affect the demand for the Companys products
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|- |  | Fluctuations in demand for the Companys products and services
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|- |  | The publics perception of the Company and its products
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|- |  | The long sales and implementation cycle for the Companys products
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|- |  | General industry trends and the potential effects of price and product competition in the Internet infrastructure industry
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|- |  | The introduction and acceptance of new technologies and products
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|- |  | Reductions in sales to, or loss of, significant customers
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|- |  | The timing of orders, timing of shipments, and the ability to satisfy all contractual obligations in customer contracts
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|- |  | The impact of acquired technologies and businesses
|- |  | --------------------------------------------------



|- |  | The Companys ability to control spending and achieve targeted cost reductions
|- |  | ------------------------------------------------------------------------------



|- |  | The ability of the Company to generate cash adequate to continue operations
|- |  | ---------------------------------------------------------------------------



|- |  | The potential loss of key employees
|- |  | -----------------------------------



|- |  | The Companys ability to attract and retain qualified personnel
|- |  | ---------------------------------------------------------------



|- |  | Adverse changes in the value of equity investments in third parties held by the Company
|- |  | ---------------------------------------------------------------------------------------



|- |  | The ability of the Companys customers and suppliers to obtain financing or to fund capital expenditures
|- |  | --------------------------------------------------------------------------------------------------------



As a consequence, operating results for a particular future period are difficult to predict.



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The Company is exposed to general economic and market conditions.



Any significant downturn in the Companys customers markets, or domestic and
global conditions, which result in a decline in demand for their software and services could harm the Companys business. The state of the economy has had a negative impact on the software industry. This could result in customers continuing to
delay or cancel orders for software. Any of these occurrences could have a significant impact on the Companys operating results, revenues and costs and may cause the market price of the Companys common stock to decline or become more
volatile.



The Companys future operating results may be affected by
various uncertain trends and factors that are beyond the Companys control. These include adverse changes in general economic conditions and rapid or unexpected changes in the technologies affecting the Companys products. The process of
developing new high technology products is complex and uncertain and requires accurate anticipation of customer needs and technological trends.



The Company depends on the development and acceptance of new products in a rapidly changing market.



The market for the Companys products is characterized by rapidly changing technology, evolution of new industry standards, and
frequent introductions of new products and product enhancements. The Companys success will depend upon its continued ability to enhance its existing products, to introduce new products on a timely and cost-effective basis to meet evolving
customer requirements, to achieve market acceptance for new product offerings, and to respond to emerging industry standards and other technological changes. There can be no assurance that the Company will be successful in developing new products or
enhancing its existing products or that such new or enhanced products will receive market acceptance. The Companys success also depends upon its ability to license from third parties and to incorporate into its products new technologies that
become industry standards. There can be no assurance that the Company will continue to obtain such licenses on favorable terms or that it will successfully incorporate such third-party technologies into its own products.



The Company anticipates new releases of products in the fiscal year ending September 30,
2004. There can be no assurance that such new releases will not be affected by technical problems or bugs, as is common in the software industry. Furthermore, there can be no assurance that these or other future product introductions
will not be delayed. Delays in the availability, or a lack of market acceptance, of new or enhanced products could have an adverse effect on the Companys business. There can be no assurance that product introductions in the future will not
disrupt product revenues and adversely affect operating results.



The
Company competes in the highly competitive Internet infrastructure market.



The industry has become increasingly competitive and, accordingly, the Companys results may also be adversely affected by the actions of existing or future competitors, including the development of new technologies, the introduction
of new products, and the reduction of prices by such competitors to gain or retain market share. The Companys results of operations could be adversely affected if it were required to lower its prices significantly.



Operating results for a particular quarter are difficult to predict.



The Company participates in a highly dynamic industry and future results could be subject to
significant volatility, particularly on a quarterly basis. The Companys revenues and operating results may be unpredictable due to the Companys shipment patterns. The Company operates with little backlog of orders because its products
are generally shipped as orders are received. In general, a substantial portion of the Companys revenues have been booked and shipped in the third month of the quarter, with a concentration of these revenues in the latter half of that third
month. In addition, the timing of closing of large license contracts and the release of new products and product upgrades increase the risk of quarter to quarter fluctuations and the uncertainty of quarterly operating results. The Companys
staffing and operating expense levels are based on an operating plan and are relatively fixed throughout the quarter. As a result, if revenues are not realized in the quarter as expected, the Companys expected operating results and cash
balances could be adversely affected, and such effect could be substantial and could result in an operating loss and depletion of the Companys cash balances.



It may be difficult to raise needed capital in the future.



The Company may require substantial additional capital to finance future growth and fund ongoing operations through the remainder of fiscal
2004 and beyond. Although the Companys current business plan does not foresee the need for further financing activities to fund the Companys operations for the foreseeable future, due to risks and uncertainties in the market place, the
Company may need to raise additional capital. The Company may raise additional funds through public or private financing, strategic relationships or other arrangements. The Company cannot be certain that the funding, if needed, will be available on
attractive terms, or at all. Furthermore, any additional equity financing may be dilutive to shareholders, and debt financing, if available, may involve restrictive



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covenants. Strategic arrangements, if necessary to raise additional funds, may require the Company to relinquish its
rights to certain of its technologies or products. If the Company fails to raise capital when needed, the business will be negatively affected, which could cause the stock price to decline.



The Companys revenues may be affected by the seasonality of revenues in the European
and government markets.



The Company experiences seasonality of revenues
for both the European and the U.S. federal government markets. European revenues during the quarter ending June 30 are historically lower or relatively flat compared to the prior quarter. This reflects a reduction of customer purchases in
anticipation of reduced selling activity during the summer months. Sales to the U.S. federal government generally increase during the quarter ending September 30. This seasonal increase is primarily attributable to increased purchasing activity by
the U.S. federal government prior to the close of its fiscal year. Additionally, net revenues for the first quarter of the fiscal year are typically lower or relatively flat compared to net revenues of the prior quarter.



Cost of revenues may be affected by changes in the mix of products and
services.



The overall cost of revenues may be affected by
changes in the mix of net revenue contribution between licenses and services, geographical regions and channels of distribution, as the costs associated with these revenues may have substantially different characteristics. The Company may also
experience a change in margin as net revenues increase or decrease since technology costs and services costs are fixed within certain volume ranges.



The Companys operational results could be affected by price variations.



The Companys results of operations could be adversely affected if it were to lower its prices significantly. In the event the Company
reduced its prices, the Companys standard terms for selected distributors would be to provide credit for inventory ordered in the previous 180 days, such credits to be applied against future purchases. The Company, as a matter of policy, does
not allow product returns for a refund, unless the product is covered under the 90 day warranty period, the product is non-conformant and the Company cannot repair or replace the product. Product returns are generally allowances for stock balancing
and are accompanied by compensating and offsetting orders. Revenues are net of a provision for estimated future stock balancing and excess quantities above levels the Company believes are appropriate in its distribution channels. The Company
monitors the quantity and mix of its product sales.



The Company is
dependent upon information received from third parties in order to determine reserves for product returns.



The Company depends on information received from external sources in evaluating the inventory levels at distribution partners in the determination of reserves for the
return of materials not sold, stock rotation and price protection. Significant effort has gone into developing systems and procedures for determining the appropriate reserve level. In the event information is not received timely or accurately, the
Companys ability to monitor the inventory levels will be affected and may negatively impact the Companys business.



The Companys business depends upon its proprietary rights and there is a risk that such rights will be infringed.



The Company attempts to protect its software with a combination of patent, copyright,
trademark, and trade secret laws, employee and third party nondisclosure agreements, license agreements, and other methods of protection. Despite these precautions, it may be possible for unauthorized third parties to copy certain portions of the
Companys products or reverse engineer or obtain and use information the Company regards as proprietary. While the Companys competitive position may be affected by its ability to protect its intellectual property rights, the Company
believes that trademark and copyright protections are less significant to the Companys success than other factors, such as the knowledge, ability, and experience of the Companys personnel, name recognition, and ongoing product
development and support. Further, certain provisions of the Companys licenses, including provisions protecting against unauthorized use, copying, transfer, and disclosure of the licensed product, may be unenforceable under the laws of certain
jurisdictions. In addition, the laws of some foreign countries do not protect the Companys intellectual property rights to the same extent as do the laws of the U.S.



Risks of claims from third parties for intellectual property infringement could adversely affect the business.



As the number of software products in the industry increases and the
functionality of these products further overlaps, the Company believes that software products will increasingly become subject to infringement claims. There can be no assurance that third parties will not assert infringement claims against the
Company and/or against the Companys suppliers of technology. In general, the Companys suppliers have agreed to indemnify the Company in the event any such claim involves supplier-provided software or technology, but any such claim,
whether or not involving a supplier, could require the Company to enter into royalty arrangements or result in costly litigation.



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The Companys business may be adversely affected by events outside the Companys control.



While the Company has not been the target of software viruses specifically designed to
impede the performance of the Companys products, such viruses could be created and deployed against the Companys products in the future. Similarly, experienced computer programmers or hackers could attempt to penetrate the Companys
network security or the security of the Companys web sites. A hacker who penetrates the Companys network or web sites could misappropriate proprietary information or cause interruptions of services. The Company might be required to
expend significant capital and resources to protect against, or to alleviate, problems caused by virus creators and/or hackers. In addition, war, power shortage, natural disasters, acts of terror, and regional and global health risks could impact
the Companys ability to conduct business in certain regions. Any of these events could have an adverse effect on the Companys business, results of operations, and financial condition.



The Companys results of operations may be affected by fluctuations in foreign
currency exchange rates.



Although the Companys revenues are
predominantly in U.S. dollars, substantial portions of the Companys revenues are derived from sales to customers outside the United States. Trade sales to international customers represented 53%, 44% and 52% of total revenues for fiscal 2003,
2002 and 2001 respectively. The Companys revenues can be affected by general economic conditions in the United States, Europe and other international markets. Also, portions of the Companys operating expenses are transacted in foreign
currencies. The Companys operating strategy and pricing take into account changes in exchange rates over time. However, the Companys results of operations may be significantly affected in the short term by fluctuations in foreign
currency exchange rates.



The Companys results of operations may be
affected by the assessment of additional taxes.



Tarantella has operations
in many countries other than the United States. Transfer prices for services provided between the United States and these countries have been documented as reasonable, however, tax authorities could challenge these transfer prices and assess
additional taxes on prior period transactions. Any such assessment could require the Company to record an additional tax provision in its statement of operations.



The Companys success largely depends upon its ability to retain and recruit key personnel.



The Companys continued success depends to a significant extent on senior management
and other key employees. None of these individuals is subject to a long-term employment contract or a non-competition agreement. The loss of one or more key employees or the Companys inability to attract and retain other key employees could
have a material adverse effect on the Company.



The Company may never
achieve profitability in the future.



Following the Companys
divestiture of its server software and professional services divisions in May 2001, the Company has not achieved profitability, and may never generate sufficient revenues to achieve profitability.



The outcome of SEC inquiry is uncertain.



The Company is in contact with the Securities and Exchange Commission in connection with an
informal inquiry related to the events leading up to the Companys restatement. The Company cannot predict to the outcome of this inquiry.



If the Company is unable to effectively integrate and develop the operations of New Moon Systems, Inc. (New Moon), the business may suffer.



The Company acquired New Moon in June 2003. The Company intends to integrate the
operations, certain employees, products and technology of New Moon into its own, and faces various risks as a result of this acquisition including, but not limited to:



| |  |  | The ability to retain and motivate certain of New Moons employees;
| | - |  | -------------------------------------------------------------------



| |  |  | The ability to retain and develop New Moons customers;
| | - |  | -------------------------------------------------------



| |  |  | The failure to integrate the technology, operations and certain members of the workforce of New Moon with the Tarantella business;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------



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| |  |  | The failure to realize the potential financial or strategic benefits of the acquisition;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | The incurrence of substantial unanticipated integration costs;
| | - |  | --------------------------------------------------------------



| |  |  | The diversion of significant management attention and financial resources in assimilating New Moons business;
| | - |  | --------------------------------------------------------------------------------------------------------------



| |  |  | The disruption of the Companys ongoing business.
| | - |  | -------------------------------------------------



If the Company is not able to successfully integrate and develop New Moons business, the Companys business may be negatively affected in future periods, which
may cause the stock price to decline. In addition, if the value of intangible assets and goodwill acquired becomes impaired, the Company will be required to write down the value of the assets, which would negatively affect financial results. The
Company may incur liabilities from New Moon including liabilities for IP infringement or indemnification of New Moons customers for similar claims, which could materially and adversely affect the business.



The Company may make future acquisitions that may result in additional risks.



The Company may continue to make investments in complementary companies,
products or technologies. If the Company buys a company or a division of a company, they may experience difficulty integrating that company or divisions personnel and operations, which could negatively affect operating results. In addition:



| |  |  | Key personnel of the acquired company may decide not to accept employment with the Company;
| | - |  | -------------------------------------------------------------------------------------------



| |  |  | The ongoing business may be disrupted or receive insufficient management attention;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | The Company may not be able to recognize the anticipated cost savings or other financial benefits;
| | - |  | --------------------------------------------------------------------------------------------------



In connection with future acquisitions, the Company may be required to assume the liabilities of the acquired companies. By assuming the
liabilities, the Company may incur liabilities, including liabilities for IP infringement or indemnification of customers of acquired businesses for similar claims, which could materially and adversely affect the business. The Company may have to
incur debt or issue equity securities to pay for any future acquisition, the issuance of which may involve restrictive covenants or be dilutive to existing shareholders.



The Companys stock is subject to substantial price and volume fluctuations due to a number of factors, many of which are beyond its
control, and those fluctuations may prevent shareholders from reselling their common stock at a profit.



The stock market in general, and the market for shares of technology companies in particular, has experienced extreme price and volume fluctuations, which have often been unrelated to the operating performance of the
affected companies. Strategic factors such as new product introductions, acquisitions or restructurings by the Company or its competitors may have a significant impact on the market price of the Companys common stock. Furthermore,
quarter-to-quarter fluctuations in operating results may have a significant impact on the market price of the stock. These conditions, as well as factors that generally affect the market for stocks of high technology companies, could cause the price
of the Companys stock to fluctuate substantially over short periods.



The Companys common stock may be difficult to trade.



The Companys stock was de-listed by the Nasdaq on October 21, 2003, and is now quoted on the Over-the-Counter (OTC) Pink Sheets. Trading the Companys stock may be more difficult due to the limited trading activity on
the OTC market. This could cause a further decline in the Companys stock price. Declines in the market price of the Companys stock could greatly impair the Companys ability to raise capital through equity or debt financing.



Former New Moon shareholders will have the ability to sell a large number
of shares of Tarantella common stock, which may cause the trading price of the Companys common stock to decline.



In connection with the acquisition of New Moon, the Company issued approximately 1,592,000 shares (calculated after the 1-for-5 reverse stock split which was implemented
on June 6, 2003) of the Companys common stock to former New Moon shareholders. During the one year period following the closing of the acquisition, the aggregate number of shares of common stock sold in any calendar quarter by each of the
former New Moon shareholders shall not exceed 25% of the aggregate number of shares of common stock issued to such former New Moon shareholders pursuant to the acquisition; provided, however, that the percentage tradable in any calendar quarter
shall be increased by an amount proportionate to the amount by which the trading volume of common stock



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exceeds 15,000,000 shares in the prior quarter. Furthermore, if the Company grants registration rights or issues shares
of capital stock as part of a subsequent acquisition of the stock or assets of another company, and the sale of such stock is not subject to volume restrictions, then the 25% limitation described in the previous sentence will no longer be in effect.
With the exception of the limitations set forth in this paragraph, the Company does not have any control over the timing of any sales by the former New Moon shareholders. As a result, the market price of the Companys common stock may fall if a
large portion of those shares is sold in the public market.



Recent
Accounting Pronouncements



In June 2002, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 146, Accounting for Costs Associated with Exit or Disposal Activities (SFAS 146), which addresses financial
accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit
an Activity (including Certain Costs Incurred in a Restructuring)(EITF 94-3). SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3,
a liability for an exit cost, as defined in EITF 94-3, was recognized at the date of an entitys commitment to an exit plan. SFAS 146 also establishes that the liability should initially be measured and recorded at fair value. The Company
adopted the provisions of SFAS 146 for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS 146 may affect the timing of recognizing future restructuring costs as well as the amounts recognized.



In November 2002, FASB issued FASB Interpretation 45 (FIN 45),
Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. The Interpretation elaborates on the existing disclosure requirements for most guarantees, including
loan guarantees such as standby letters of credit. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value, or market value, of the obligations it assumes under the
guarantee and must disclose that information in its interim and annual financial statements. The provisions related to recognizing a liability at inception of the guarantee for the fair value of the guarantors obligations do not apply to
product warranties or to guarantees accounted for as derivatives. The initial recognition and initial measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002. The adoption of this statement did
not have a material impact on the Companys financial position or results of operations. The Company provides disclosures required by FIN 45 in Note 12 to the condensed consolidated financial statements.



In May 2003, the EITF reached a consensus on EITF Issue No. 00-21, Revenue Arrangements
with Multiple Deliverables. This Issue addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. This Issue addresses when and how an arrangement involving
multiple deliverables should be divided into separate units of accounting. The guidance in this Issue is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of these provisions did not have a
material effect on the Companys financial position or results of operations.



In January 2003 the FASB issued FIN No. 46, Consolidation of Variable Interest Entities and a revised interpretation of FIN No. 46 (FIN No. 46-R) in December 2003. FIN No. 46 requires certain variable interest entities to
be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. Should the Company form a variable interest entity, FIN No. 46-R will be effective at that time, but not later than the quarter ending March 31, 2004.



In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise became effective for the Company July 1, 2003. The adoption of SFAS No. 150 did not have a material effect on the Companys financial position or results of
operations.



Item 3. Quantitative and Qualitative Disclosures About Market Risk



Reference is made to part II, Item 7A, Quantitative and Qualitative Disclosures about Market Risk, in the Companys Annual Report on Form 10-K for the year ended September 30, 2002.



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Item 4. Controls and Procedures



(a) Evaluation
of disclosure controls and procedures.



The events cited in this report
that are the subject of the restatement were the result of material weaknesses in the Companys system of internal controls and operations. The Company has taken and intends to continue to take measures to cure these weaknesses, which include
changes in senior management, strengthening the independence of the Board of Directors and tightening internal policies and procedures.



The Company has carried out an evaluation, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief
Financial Officer, of the effectiveness of the design and operation of disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. It should be noted
that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future
conditions, regardless of how remote. Based upon their evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that disclosure controls and procedures are effective to ensure that material information required to be
disclosed in the Company reports that are filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, except as noted below
with respect to the restatement.



(b) Changes in internal controls.



Due to the matters that caused the restatement of the audited
consolidated financial statements and related notes for the three and twelve months ended September 30, 2002 and the unaudited condensed consolidated financial statements and related notes for the three months ended December 31, 2002 and three and
six months ended March 31, 2003, the Company has taken a number of steps to improve the effectiveness of internal controls, including the following:



The Company now requires extensive sales certifications from all sales representatives and systems engineers to be provided to the Companys finance department.



The Company requires proof of an end user purchase order when fulfilling
transactions over $25,000.



The Company now requires all distributors to submit
sales out reports and inventory reports prior to the closing of a financial period.



The Company drafted a revenue recognition handbook and distributed it to all sales personnel. Each person in sales has certified they have read and understand the handbook.



We believe that these efforts have addressed the material weaknesses and significant deficiencies that affected our internal controls in
2002 and 2003. The Company continues to improve and refine its internal controls. This process is ongoing, and the Company seeks to foster an exemplary internal control environment.



Other than as summarized above, there has been no change in the Companys internal control over financial reporting that occurred
during the most recent fiscal quarter that has materially affected or is reasonably likely to materially affect the Companys internal controls over financial reporting. The Company will continue to assess disclosure controls and procedures and
will take any further actions that are deemed necessary.



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Part II. Other Information



Item 1. Legal Proceedings



On August 28, 2003, a
former Tarantella sales representative, filed an action against Tarantella, Inc. and Tarantella International, Inc., a wholly owned subsidiary of Tarantella, (collectively, Tarantella) in the California Superior Court in Santa Clara
County, California. The complaint purports to state claims for breach of contract, negligent and intentional misrepresentation, fraud, and deceit. The complaint alleges that the plaintiff is owed certain commissions on sales of Tarantella products
made to the U.S. government. Tarantella has filed a response denying the claims. The case is presently in the discovery stage.



Tarantella believes it has defenses to the employees plaintiffs claims and intends to vigorously defend itself. Should the employees plaintiffs
claims succeed, however, Tarantella could be required to pay monetary damages. Accordingly, a judgment in favor of the employees plaintiff could have a material adverse effect on Tarantellas business, financial position and results. No
specific relief has been sought.



No other material legal proceedings are
pending to which the Company is a party.



Item 2. Changes in Securities and Use of Proceeds



In June, 2003, the Company issued an aggregate of 1,592,000 newly issued shares of Tarantella common stock (calculated after giving effect to the 1-for-5 reverse stock split effected on June 6, 2003) in exchange for all of the outstanding
shares of New Moon Systems. The fair value of the Tarantella common stock issued in connection with the New Moon acquisition was $3,614,000. The shares of Tarantella common stock issued to the New Moon Systems shareholders were issued as restricted
securities as defined under Rule 144 of the Securities Act of 1933, as amended, in a transaction exempt from registration under the Securities Act, by reason of Section 4(2) thereof and/or Regulation D promulgated thereunder.



Item 3. Defaults Upon Senior Securities



Not
applicable



Item 4. Submission of Matters to a Vote of Security Holders



Not applicable



Item 5. Other Information



Not applicable



Item 6. Exhibits and Reports on Form 8-K



(a)
Exhibits



|     |  |                                                                                                                                                                   
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
|31.1 |  | Certification of Chief Executive Officer Pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as Adopted Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
|     | 
|31.2 |  | Certification of Chief Financial Officer Pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as Adopted Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
|     | 
|32.1 |  | Certification of Chief Executive Officer Pursuant To 18 U.S.C. Section 1350, as Adopted Pursuant To Section 906 Of the Sarbanes-Oxley Act of 2002                 
|     | 
|32.2 |  | Certification of Chief Financial Officer Pursuant To 18 U.S.C. Section 1350, as Adopted Pursuant To Section 906 Of the Sarbanes-Oxley Act of 2002                 



(b) Reports on Form 8-K



The Company filed the following Report on Form 8-K during the quarter
ended June 30, 2003.



On June 9th the Company filed a Report on Form 8-K for
the completion of the acquisition of New Moon Systems Inc., a privately-held California corporation (New Moon), in a merger of a wholly owned subsidiary of Tarantella (Merger Sub) with and into New Moon, pursuant to an
Agreement and Plan of Reorganization (the Agreement), dated May 29, 2003, by and among Tarantella, Merger Sub and New Moon. The acquisition was completed on June 5, 2003.



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On June 9th the Company filed a Report on Form 8-K to provide an unaudited pro forma balance sheet as of April 30, 2003,
reflecting the impact of the acquisition of New Moon Systems Inc., completed on June 5, 2003, as if such transaction were completed on April 30, 2003 on the Companys balance sheet as of such date, as required by Nasdaq pursuant to the decision
of the Listing Qualifications Panel on May 16, 2003.



On May 29, 2003 the
Company filed a Report on Form 8-K to disclose the issuance of a press release announcing the signing of a definitive agreement regarding its proposed acquisition of New Moon Systems Inc. The press release also announced that Tarantella planed to
execute a reverse stock split at a ratio of one share for every five shares.



On April 22, 2003 the Company filed a Report on Form 8-K to disclose that on April 22, 2003, Tarantella, Inc. issued a press release regarding its financial results for its second fiscal quarter ended March 31, 2003.



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Signatures



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



TARANTELLA, INC.By:

/s/    JOHN M.
GREELEYJohn M. Greeley Vice President, Chief Financial Officer March 5, 2004By:

/s/    JENNY
TWADDLEJenny Twaddle Vice President, Corporate Controller March 5, 2004




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