##### Table of Contents

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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



For the quarterly period ended September 30, 2005



OR



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



For the transition period from  to



001-10824

(Commission File Number)



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Borland Software Corporation

(Exact Name of Registrant as Specified in its
Charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 94-2895440                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



20450 STEVENS CREEK
BOULEVARD, SUITE 800

CUPERTINO, CALIFORNIA 95014

(Address of Principal Executive Offices) (Zip Code)



Registrants Telephone Number, Including Area Code: (408) 863-2800





(Former Address, if Changed Since Last Report)



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



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



Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).YES ̈NO  x



The number of shares of the registrants common stock, par value $0.01 per share, outstanding as of October 31,
2005, the most recent practicable date prior to the filing of this report, was 76,220,969.



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##### Table of Contents

INDEX



|        |  |                                                                                                                                 |  |     
|------- |  | ------------------------------------------------------------------------------------------------------------------------------- |  | ----
|        |  |                                                                                                                                 |  | PAGE
|PART I  |  | FINANCIAL INFORMATION                                                                                                           |  |     
|        |  |                                                                                                                                
|Item 1. |  | Financial Statements (unaudited)                                                                                                |  | 1   
|        |  |                                                                                                                                
|        |  | Condensed Consolidated Balance Sheetsat September 30, 2005 and December 31, 2004                                                |  | 1   
|        |  |                                                                                                                                
|        |  | Condensed Consolidated Statements of Operationsfor the three and nine months ended September 30, 2005 and 2004                  |  | 2   
|        |  |                                                                                                                                
|        |  | Condensed Consolidated Statements of Comprehensive Income (Loss)for the three and nine months ended September 30, 2005 and 2004 |  | 3   
|        |  |                                                                                                                                
|        |  | Condensed Consolidated Statements of Cash Flowsfor the nine months ended September 30, 2005 and 2004                            |  | 4   
|        |  |                                                                                                                                
|        |  | Notes to Condensed Consolidated Financial Statements                                                                            |  | 5   
|        |  |                                                                                                                                
|Item 2. |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                           |  | 15  
|        |  |                                                                                                                                
|Item 3. |  | Quantitative and Qualitative Disclosures About Market Risk                                                                      |  | 36  
|        |  |                                                                                                                                
|Item 4. |  | Controls and Procedures                                                                                                         |  | 37  
|        |  |                                                                                                                                
|PART II |  | OTHER INFORMATION                                                                                                               |  |     
|        |  |                                                                                                                                
|Item 1. |  | Legal Proceedings                                                                                                               |  | 39  
|        |  |                                                                                                                                
|Item 2. |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                                     |  | 39  
|        |  |                                                                                                                                
|Item 5. |  | Other Information                                                                                                               |  | 40  
|        |  |                                                                                                                                
|Item 6. |  | Exhibits                                                                                                                        |  | 41  
|        |  |                                                                                                                                
|        |  | Signature                                                                                                                       |  | 42  



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##### Table of Contents

PART I

FINANCIAL INFORMATION



Item 1. Financial Statements



BORLAND SOFTWARE CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value and share amounts, unaudited)



|                                                                                                                     |  |                    |          |   |                  |   |          |  
|-------------------------------------------------------------------------------------------------------------------- |  | ------------------ | -------- | - | ---------------- | - | -------- | -
|                                                                                                                     |  | September 30, 2005 |          |   | December 31,2004 |  
|ASSETS                                                                                                               |  |                    |          |   |                  |   |          |  
|Current assets:                                                                                                      |  |                    |          |   |                  |   |          |  
|Cash and cash equivalents                                                                                            |  | $                  | 62,236   |   |                  | $ | 76,432   |  
|Short-term investments                                                                                               |  |                    | 126,884  |   |                  |   | 144,766  |  
|Accounts receivable, net of allowances of $6,655 and $9,830                                                          |  |                    | 49,197   |   |                  |   | 62,924   |  
|Other current assets                                                                                                 |  |                    | 11,316   |   |                  |   | 12,642   |  
|                                                                                                                     |  |                    |          |   |                  |   |          |  
|Total current assets                                                                                                 |  |                    | 249,633  |   |                  |   | 296,764  |  
|Property and equipment, net                                                                                          |  |                    | 17,943   |   |                  |   | 16,117   |  
|Goodwill                                                                                                             |  |                    | 183,159  |   |                  |   | 182,390  |  
|Intangible assets, net                                                                                               |  |                    | 4,419    |   |                  |   | 12,630   |  
|Other non-current assets                                                                                             |  |                    | 8,306    |   |                  |   | 7,382    |  
|                                                                                                                     |  |                    |          |   |                  |   |          |  
|Total assets                                                                                                         |  | $                  | 463,460  |   |                  | $ | 515,283  |  
|                                                                                                                     |  |                    |          |   |                  |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                 |  |                    |          |   |                  |   |          |  
|Current liabilities:                                                                                                 |  |                    |          |   |                  |   |          |  
|Accounts payable                                                                                                     |  | $                  | 13,360   |   |                  | $ | 10,384   |  
|Accrued expenses                                                                                                     |  |                    | 38,954   |   |                  |   | 45,358   |  
|Income taxes payable                                                                                                 |  |                    | 15,382   |   |                  |   | 16,443   |  
|Deferred revenues                                                                                                    |  |                    | 50,347   |   |                  |   | 51,647   |  
|Short-term restructuring                                                                                             |  |                    | 4,615    |   |                  |   | 1,864    |  
|Other current liabilities                                                                                            |  |                    | 5,161    |   |                  |   | 6,874    |  
|                                                                                                                     |  |                    |          |   |                  |   |          |  
|Total current liabilities                                                                                            |  |                    | 127,819  |   |                  |   | 132,570  |  
|Long-term restructuring                                                                                              |  |                    | 10,502   |   |                  |   | 2,052    |  
|Long-term liabilities                                                                                                |  |                    | 4,415    |   |                  |   | 4,281    |  
|                                                                                                                     |  |                    |          |   |                  |   |          |  
|                                                                                                                     |  |                    | 142,736  |   |                  |   | 138,903  |  
|                                                                                                                     |  |                    |          |   |                  |   |          |  
|Commitments and contingencies (Note 10)                                                                              |  |                    |          |   |                  |   |          |  
|                                                                                                                     |  |                   
|Stockholders equity:                                                                                                |  |                    |          |   |                  |   |          |  
|Preferred stock; $.01 par value; 1,000,000 shares authorized; 0 shares issued and outstanding                        |  |                    |         |   |                  |   |         |  
|Common stock; $.01 par value; 200,000,000 shares authorized; 76,223,011 and 80,936,862 shares issued and outstanding |  |                    | 762      |   |                  |   | 809      |  
|Additional paid-in capital                                                                                           |  |                    | 641,993  |   |                  |   | 638,077  |  
|Accumulated deficit                                                                                                  |  |                    | (217,700 | ) |                  |   | (198,826 | )
|Deferred compensation                                                                                                |  |                    | (1,536   | ) |                  |   | (1,002   | )
|Cumulative other comprehensive income                                                                                |  |                    | 7,673    |   |                  |   | 12,671   |  
|                                                                                                                     |  |                    |          |   |                  |   |          |  
|                                                                                                                     |  |                    | 431,192  |   |                  |   | 451,729  |  
|Less common stock in treasury at cost, 15,400,717 and 9,999,084 shares                                               |  |                    | (110,468 | ) |                  |   | (75,349  | )
|                                                                                                                     |  |                    |          |   |                  |   |          |  
|                                                                                                                     |  |                    | 320,724  |   |                  |   | 376,380  |  
|                                                                                                                     |  |                    |          |   |                  |   |          |  
|Total liabilities and stockholders equity                                                                           |  | $                  | 463,460  |   |                  | $ | 515,283  |  
|                                                                                                                     |  |                    |          |   |                  |   |          |  



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



1



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##### Table of Contents

BORLAND SOFTWARE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts, unaudited)



|                                                                                  |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |        
|--------------------------------------------------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | -------
|                                                                                  |  | Three Months Ended September 30, |        |   | Nine Months Ended September 30,
|                                                                                  |  | 2005                             |        |   | 2004                            |   |        | 2005 |  |   | 2004   
|License and other revenues                                                        |  | $                                | 39,236 |   |                                 | $ | 53,063 |      |  | $ | 120,959 |   |  | $ | 158,017
|Service revenues                                                                  |  |                                  | 28,614 |   |                                 |   | 24,585 |      |  |   | 84,779  |   |  |   | 69,016 
|                                                                                  |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |        
|Total revenues                                                                    |  |                                  | 67,850 |   |                                 |   | 77,648 |      |  |   | 205,738 |   |  |   | 227,033
|                                                                                  |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |        
|Cost of license and other revenues                                                |  |                                  | 1,515  |   |                                 |   | 2,172  |      |  |   | 6,390   |   |  |   | 6,646  
|Cost of service revenues                                                          |  |                                  | 9,679  |   |                                 |   | 6,255  |      |  |   | 28,638  |   |  |   | 18,058 
|Amortization of acquired intangibles                                              |  |                                  | 2,517  |   |                                 |   | 2,388  |      |  |   | 7,550   |   |  |   | 7,324  
|                                                                                  |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |        
|Cost of revenues                                                                  |  |                                  | 13,711 |   |                                 |   | 10,815 |      |  |   | 42,578  |   |  |   | 32,028 
|                                                                                  |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |        
|Gross profit                                                                      |  |                                  | 54,139 |   |                                 |   | 66,833 |      |  |   | 163,160 |   |  |   | 195,005
|                                                                                  |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |        
|Selling, general and administrative expenses                                      |  |                                  | 43,170 |   |                                 |   | 42,502 |      |  |   | 126,432 |   |  |   | 125,296
|Research and development expenses                                                 |  |                                  | 14,277 |   |                                 |   | 17,304 |      |  |   | 42,975  |   |  |   | 51,290 
|Restructuring, amortization of other intangibles and acquisition-related expenses |  |                                  | 1,646  |   |                                 |   | 5,283  |      |  |   | 19,371  |   |  |   | 8,236  
|                                                                                  |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |        
|Total operating expenses                                                          |  |                                  | 59,093 |   |                                 |   | 65,089 |      |  |   | 188,778 |   |  |   | 184,822
|                                                                                  |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |        
|Operating income (loss)                                                           |  |                                  | (4,954 | ) |                                 |   | 1,744  |      |  |   | (25,618 | ) |  |   | 10,183 
|Gain on sale of investment                                                        |  |                                  |       |   |                                 |   |       |      |  |   | 4,680   |   |  |   |       
|Interest and other income, net                                                    |  |                                  | 1,317  |   |                                 |   | 764    |      |  |   | 3,824   |   |  |   | 787    
|                                                                                  |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |        
|Income (loss) before income taxes                                                 |  |                                  | (3,637 | ) |                                 |   | 2,508  |      |  |   | (17,114 | ) |  |   | 10,970 
|Income tax provision                                                              |  |                                  | 1,185  |   |                                 |   | 2,668  |      |  |   | 1,760   |   |  |   | 7,571  
|                                                                                  |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |        
|Net income (loss)                                                                 |  | $                                | (4,822 | ) |                                 | $ | (160   | )    |  | $ | (18,874 | ) |  | $ | 3,399  
|                                                                                  |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |        
|Net income (loss) per share:                                                      |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |        
|                                                                                  |  |                                  |        |  
|Net income (loss) per share  basic                                               |  | $                                | (0.06  | ) |                                 | $ | (0.00  | )    |  | $ | (0.24   | ) |  | $ | 0.04   
|                                                                                  |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |        
|Net income (loss) per share  diluted                                             |  | $                                | (0.06  | ) |                                 | $ | (0.00  | )    |  | $ | (0.24   | ) |  | $ | 0.04   
|                                                                                  |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |        
|Shares used in computing basic net income (loss) per share                        |  |                                  | 76,017 |   |                                 |   | 80,114 |      |  |   | 77,937  |   |  |   | 80,434 
|                                                                                  |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |        
|Shares used in computing diluted net income (loss) per share                      |  |                                  | 76,017 |   |                                 |   | 80,114 |      |  |   | 77,937  |   |  |   | 81,867 
|                                                                                  |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |        



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



2



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##### Table of Contents

BORLAND SOFTWARE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands, unaudited)



|                                                               |  |                                  |        |   |                                 |   |      |      |  |   |         |   |  |   |       |  
|-------------------------------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------- | - | ---- | ---- |  | - | ------- | - |  | - | ----- | -
|                                                               |  | Three Months Ended September 30, |        |   | Nine Months Ended September 30, |  
|                                                               |  | 2005                             |        |   | 2004                            |   |      | 2005 |  |   | 2004    |  
|Net income (loss)                                              |  | $                                | (4,822 | ) |                                 | $ | (160 | )    |  | $ | (18,874 | ) |  | $ | 3,399 |  
|                                                               |  |                                  |        |  
|Other comprehensive loss:                                      |  |                                  |        |   |                                 |   |      |      |  |   |         |   |  |   |       |  
|Foreign currency translation adjustments                       |  |                                  | (430   | ) |                                 |   | 178  |      |  |   | (4,916  | ) |  |   | (218  | )
|Fair market value adjustment for available-for-sale securities |  |                                  | (82    | ) |                                 |   |     |      |  |   | (82     | ) |  |   |      |  
|                                                               |  |                                  |        |   |                                 |   |      |      |  |   |         |   |  |   |       |  
|Comprehensive income (loss)                                    |  | $                                | (5,334 | ) |                                 | $ | 18   |      |  | $ | (23,872 | ) |  | $ | 3,181 |  
|                                                               |  |                                  |        |   |                                 |   |      |      |  |   |         |   |  |   |       |  



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



3



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##### Table of Contents

BORLAND SOFTWARE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands, unaudited)



|                                                                                         |  |                                |          |   |      |   |         |  
|---------------------------------------------------------------------------------------- |  | ------------------------------ | -------- | - | ---- | - | ------- | -
|                                                                                         |  | Nine Months EndedSeptember 30, |         
|                                                                                         |  | 2005                           |          |   | 2004 |  
|OPERATING ACTIVITIES:                                                                    |  |                                |          |   |      |   |         |  
|Net income (loss)                                                                        |  | $                              | (18,874  | ) |      | $ | 3,399   |  
|Adjustments to reconcile net income (loss) to net cash provided by operating activities: |  |                                |          |   |      |   |         |  
|Depreciation and amortization                                                            |  |                                | 13,182   |   |      |   | 16,508  |  
|Loss on disposal of fixed assets                                                         |  |                                | (6       | ) |      |   | 13      |  
|Gain on sale of an equity investment                                                     |  |                                | (4,680   | ) |      |   |        |  
|Changes in assets and liabilities, net of effect of business acquisitions:               |  |                                |          |   |      |   |         |  
|Accounts receivable, net                                                                 |  |                                | 12,805   |   |      |   | (432    | )
|Other assets                                                                             |  |                                | 1,232    |   |      |   | 3,311   |  
|Accounts payable and accrued expenses                                                    |  |                                | (3,321   | ) |      |   | (6,237  | )
|Income taxes payable                                                                     |  |                                | (3,229   | ) |      |   | 4,412   |  
|Short-term restructuring                                                                 |  |                                | 2,751    |   |      |   | (2,598  | )
|Deferred revenues                                                                        |  |                                | 749      |   |      |   | 2,502   |  
|Long-term restructuring                                                                  |  |                                | 8,450    |   |      |   | (1,758  | )
|Other                                                                                    |  |                                | 113      |   |      |   | 1,071   |  
|                                                                                         |  |                                |          |   |      |   |         |  
|Net cash provided by operating activities                                                |  |                                | 9,172    |   |      |   | 20,191  |  
|                                                                                         |  |                                |          |   |      |   |         |  
|INVESTING ACTIVITIES:                                                                    |  |                                |          |   |      |   |         |  
|Purchases of property and equipment                                                      |  |                                | (5,790   | ) |      |   | (2,022  | )
|Acquisition of TeraQuest Metrics, Inc., net of cash acquired                             |  |                                | (4,436   | ) |      |   |        |  
|Acquisition of intangible developed technology assets                                    |  |                                |         |   |      |   | (225    | )
|Purchases of short-term investments                                                      |  |                                | (264,378 | ) |      |   | (40,252 | )
|Sales and maturities of short-term investments                                           |  |                                | 282,206  |   |      |   | 34,275  |  
|Proceeds from the sale of an equity investment                                           |  |                                | 4,680    |   |      |   |        |  
|                                                                                         |  |                                |          |   |      |   |         |  
|Net cash provided by (used in) investing activities                                      |  |                                | 12,282   |   |      |   | (8,224  | )
|                                                                                         |  |                                |          |   |      |   |         |  
|FINANCING ACTIVITIES:                                                                    |  |                                |          |   |      |   |         |  
|Proceeds from issuance of common stock, net                                              |  |                                | 3,922    |   |      |   | 7,372   |  
|Repurchase of common stock                                                               |  |                                | (35,172  | ) |      |   | (18,306 | )
|                                                                                         |  |                                |          |   |      |   |         |  
|Net cash used in financing activities                                                    |  |                                | (31,250  | ) |      |   | (10,934 | )
|                                                                                         |  |                                |          |   |      |   |         |  
|Effect of exchange rate changes on cash                                                  |  |                                | (4,400   | ) |      |   | 600     |  
|                                                                                         |  |                                |          |   |      |   |         |  
|Net change in cash and cash equivalents                                                  |  |                                | (14,196  | ) |      |   | 1,633   |  
|Cash and cash equivalents at beginning of period                                         |  |                                | 76,432   |   |      |   | 100,498 |  
|                                                                                         |  |                                |          |   |      |   |         |  
|Cash and cash equivalents at end of period                                               |  | $                              | 62,236   |   |      | $ | 102,131 |  
|                                                                                         |  |                                |          |   |      |   |         |  



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



4



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##### Table of Contents

BORLAND SOFTWARE CORPORATION



Notes to Condensed Consolidated Financial Statements (unaudited)



NOTE 1BASIS OF PRESENTATION



The
accompanying Borland Software Corporation (Borland) condensed consolidated financial statements at September 30, 2005 and December 31, 2004 and for the three and nine months ended September 30, 2005 and 2004 are unaudited
and have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and Rule 10-01 of Regulation S-X. Accordingly, they do not include all financial information
and disclosures required by GAAP for complete financial statements and certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted. The unaudited interim
condensed consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary
for a fair statement of Borlands financial position at September 30, 2005 and December 31, 2004, its results of operations for the three and nine months ended September 30, 2005 and 2004, and cash flows for the nine months ended
September 30, 2005 and 2004. Certain prior period amounts have been reclassified in order to be consistent with current financial statement presentation, including the reclassification of auction rate securities to short-term investments from
cash and cash equivalents as of September 30, 2004. This reclassification impacted net cash used in investing activities presented in our Condensed Consolidated Statement of Cash Flows for the nine months ended September 30, 2004.



Reclassifications are as follows (in thousands):



|                                                      |  |                                              |         |   |                 |   |         |                  |  |   |          |  
|----------------------------------------------------- |  | -------------------------------------------- | ------- | - | --------------- | - | ------- | ---------------- |  | - | -------- | -
|                                                      |  | September 30, 2004                           |        
|                                                      |  | As OriginallyReported                        |         |   | As Reclassified |   |         | Reclassification | 
|Cash and cash equivalents                             |  | $                                            | 207,826 |   |                 | $ | 102,131 |                  |  | $ | (105,695 | )
|Short-term investments                                |  |                                              | 2,430   |   |                 |   | 108,125 |                  |  |   | 105,695  |  
|                                                      |  |                                              |         |   |                 |   |         |                  |  |   |          |  
|Total                                                 |  | $                                            | 210,256 |   |                 | $ | 210,256 |                  |  | $ |         |  
|                                                      |  |                                              |         |   |                 |   |         |                  |  |   |          |  
|                                                      | 
|                                                      |  | For the Nine Months Ended September 30, 2004 |        
|                                                      |  | As OriginallyReported                        |         |   | As Reclassified |   |         | Reclassification | 
|Purchases of short-term investments                   |  | $                                            | (7,379  | ) |                 | $ | (40,252 | )                |  | $ | (32,873  | )
|Sales and maturities of short-term investments        |  |                                              | 10,572  |   |                 |   | 34,275  |                  |  |   | 23,703   |  
|Purchases of property and equipment                   |  |                                              | (2,022  | ) |                 |   | (2,022  | )                |  |   |         |  
|Acquisition of intangible developed technology assets |  |                                              | (225    | ) |                 |   | (225    | )                |  |   |         |  
|                                                      |  |                                              |         |   |                 |   |         |                  |  |   |          |  
|Cash provided by (used in) investing activities       |  | $                                            | 946     |   |                 | $ | (8,224  | )                |  | $ | (9,170   | )
|                                                      |  |                                              |         |   |                 |   |         |                  |  |   |          |  



The preparation of
condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The results of operations for interim periods are not necessarily indicative of the results to be
expected for any subsequent quarter or for the full year. The condensed consolidated financial statements and related notes should be read in conjunction with our audited financial statements included in our Annual Report on Form 10-K for the fiscal
year ended December 31, 2004 as filed with the Securities and Exchange Commission (SEC) on March 25, 2005.



NOTE 2STOCK-BASED COMPENSATION



Stock-Based Compensation Plans



We account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion 25, Accounting for
Stock Issued to Employees (APB 25) and related Interpretations. Under APB 25,



5



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##### Table of Contents

compensation cost is measured as the excess, if any, of the closing market price of our stock at the date of grant over
the exercise price of the option granted. We recognize compensation cost for stock options, if any, ratably over the vesting period. Generally, we grant options with an exercise price equal to the closing market price of our stock on the grant date.



Our Employee Stock Purchase Plan (ESPP) allows
participants to purchase shares at 85% of the lower of the fair value of the common stock at the beginning of the offering period or the fair value on the purchase date.



We have also granted restricted stock to certain employees with a cash purchase price less than the closing market price of
the underlying stock on the date of grant. Our restricted common stock awards generally vest over two to five years from the date of grant based on continued service. We record as deferred compensation, the aggregate amount by which the closing
price of our common stock on the date of grant exceeds the cash purchase price of the restricted common stock, within stockholders equity. Deferred compensation associated with these grants is amortized to operating expenses over the
respective vesting term. We provide additional pro forma disclosures as required under Statement of Financial Accounting Standards (SFAS) 123, Accounting for Stock-Based Compensation (SFAS 123), as amended
by SFAS 148, Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of FASB Statement No. 123.



Pro Forma Net Income (Loss) and Net Income (Loss) Per Share



Compensation expense included in pro forma net income (loss) and net income (loss) per share for the awards granted under our stock option and ESPP
programs is determined using the fair value recognition provisions of SFAS 123 employing the Black-Scholes pricing model. The fair value of each stock option is estimated on the date of grant using the Black-Scholes pricing model with the following
weighted average assumptions:



|                        |  |                                  |   |  |                                 |   |  |            |   |  |            |  
|----------------------- |  | -------------------------------- | - |  | ------------------------------- | - |  | ---------- | - |  | ---------- | -
|                        |  | Three Months Ended September 30, |   |  | Nine Months Ended September 30, |  
|                        |  | 2005                             |   |  | 2004                            |   |  | 2005       |   |  | 2004       |  
|Expected life           |  | 4.02 years                       |   |  | 4.03 years                      |   |  | 4.02 years |   |  | 4.03 years |  
|Risk-free interest rate |  | 4.04                             | % |  | 3.51                            | % |  | 3.93       | % |  | 3.41       | %
|Volatility              |  | 54.0                             | % |  | 43.0                            | % |  | 54.0       | % |  | 43.0       | %
|Dividend yield          |  | 0.00                             | % |  | 0.00                            | % |  | 0.00       | % |  | 0.00       | %



The fair value of each
ESPP award is estimated using the Black-Scholes pricing model with the following weighted average assumptions:



|                        |  |                                  |   |  |                                 |   |  |          |   |  |          |  
|----------------------- |  | -------------------------------- | - |  | ------------------------------- | - |  | -------- | - |  | -------- | -
|                        |  | Three Months Ended September 30, |   |  | Nine Months Ended September 30, |  
|                        |  | 2005                             |   |  | 2004                            |   |  | 2005     |   |  | 2004     |  
|Expected life           |  | 6 months                         |   |  | 6 months                        |   |  | 6 months |   |  | 6 months |  
|Risk-free interest rate |  | 3.44                             | % |  | 1.24                            | % |  | 3.30     | % |  | 1.24     | %
|Volatility              |  | 46.0                             | % |  | 52.0                            | % |  | 46.0     | % |  | 52.0     | %
|Dividend yield          |  | 0.00                             | % |  | 0.00                            | % |  | 0.00     | % |  | 0.00     | %



The weighted average
fair value of the stock options granted under our employee stock option plans and the stock awarded under our ESPP during the three months ended September 30, 2005 and 2004, as defined by SFAS 123, was $3.62 and $3.52 per share, respectively,
and was $4.10 and $4.12 per share for the nine months ended September 30, 2005 and 2004, respectively.



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Had we recorded compensation expenses based on the estimated fair value on the grant dates of our stock
options and ESPP awards as defined by SFAS 123, our pro forma net income (loss) and net income (loss) per share for the three and nine ended September 30, 2005 and 2004, would have been as follows (in thousands, except per share amounts):



|                                                           |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |        |  
|---------------------------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------ | -
|                                                           |  | Three Months Ended September 30, |        |   | Nine Months Ended September 30, |  
|                                                           |  | 2005                             |        |   | 2004                            |   |        | 2005 |  |   | 2004    |  
|Net income (loss):                                         |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |        |  
|As reported                                                |  | $                                | (4,822 | ) |                                 | $ | (160   | )    |  | $ | (18,874 | ) |  | $ | 3,399  |  
|Stock compensation adjustment  intrinsic value            |  |                                  | 140    |   |                                 |   | 9      |      |  |   | 428     |   |  |   | 18     |  
|Stock compensation expense  fair value, net of tax effect |  |                                  | (3,295 | ) |                                 |   | (3,646 | )    |  |   | (12,033 | ) |  |   | (7,144 | )
|                                                           |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |        |  
|Pro forma net loss                                         |  | $                                | (7,977 | ) |                                 | $ | (3,797 | )    |  | $ | (30,479 | ) |  | $ | (3,727 | )
|                                                           |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |        |  
|Net income (loss) per share:                               |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |        |  
|As reported  basic                                        |  | $                                | (0.06  | ) |                                 | $ | (0.00  | )    |  | $ | (0.24   | ) |  | $ | 0.04   |  
|As reported  diluted                                      |  | $                                | (0.06  | ) |                                 | $ | (0.00  | )    |  | $ | (0.24   | ) |  | $ | 0.04   |  
|                                                           |  |                                  |        |  
|Pro forma  basic                                          |  | $                                | (0.10  | ) |                                 | $ | (0.05  | )    |  | $ | (0.39   | ) |  | $ | (0.05  | )
|Pro forma  diluted                                        |  | $                                | (0.10  | ) |                                 | $ | (0.05  | )    |  | $ | (0.39   | ) |  | $ | (0.05  | )



The pro forma amounts
include compensation expense related to stock option grants and ESPP awards for the three and nine months ended September 30, 2005 and 2004.



NOTE 3NET INCOME (LOSS) PER SHARE



We compute net income (loss) per share in accordance with SFAS 128, Earnings per Share. Under the provisions of SFAS 128, basic net
income (loss) per share is computed by dividing the net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is computed by dividing the net income (loss) for the period by
the weighted average number of common and potentially dilutive shares outstanding during the period. Potentially dilutive shares, which consist of incremental shares issuable upon exercise of stock options and unvested restricted stock, are included
in diluted net income per share to the extent such shares are dilutive. Diluted net loss per share is the same as basic net loss per share for the three months ended September 30, 2005 and 2004, and the nine months ended September 30,
2005, due to our net loss in each of those periods.



The
following table sets forth the computation of basic and diluted net income (loss) per share for the three and nine months ended September 30, 2005 and 2004 (in thousands, except per share amounts):



|                                                                                    |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |       
|----------------------------------------------------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------
|                                                                                    |  | Three Months Ended September 30, |        |   | Nine Months Ended September 30,
|                                                                                    |  | 2005                             |        |   | 2004                            |   |        | 2005 |  |   | 2004   
|Numerator:                                                                          |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |       
|Net income (loss)                                                                   |  | $                                | (4,822 | ) |                                 | $ | (160   | )    |  | $ | (18,874 | ) |  | $ | 3,399 
|                                                                                    |  |                                  |        |  
|Denominator:                                                                        |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |       
|Denominator for basic income (loss) per share  weighted average shares outstanding |  |                                  | 76,017 |   |                                 |   | 80,114 |      |  |   | 77,937  |   |  |   | 80,434
|Effect of dilutive securities                                                       |  |                                  |       |   |                                 |   |       |      |  |   |        |   |  |   | 1,433 
|                                                                                    |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |       
|Denominator for diluted income (loss) per share                                     |  |                                  | 76,017 |   |                                 |   | 80,114 |      |  |   | 77,937  |   |  |   | 81,867
|                                                                                    |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |       
|Net income (loss) per share  basic                                                 |  | $                                | (0.06  | ) |                                 | $ | (0.00  | )    |  | $ | (0.24   | ) |  | $ | 0.04  
|                                                                                    |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |       
|Net income (loss) per share  diluted                                               |  | $                                | (0.06  | ) |                                 | $ | (0.00  | )    |  | $ | (0.24   | ) |  | $ | 0.04  
|                                                                                    |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |       



The diluted net loss
per share calculation for the three months ended September 30, 2005 and 2004, excludes options to purchase 14.2 million and 12.5 million shares of common stock, respectively, and 248,000 and 271,000 unvested restricted common shares,
respectively, due to our net loss in these periods.



The
diluted net loss per share calculation for the nine months ended September 30, 2005 excludes options to purchase 13.9 million shares of common stock and 253,000 unvested restricted common shares due to our net loss in that period. The
diluted net income per share calculation for the nine months ended September 30, 2004 excludes 268,000 unvested restricted common shares and options to purchase 7.8 million shares of common stock because the exercise price of these options
was greater than the average market price of a share of common stock during the respective period and the inclusion of such options would have been antidilutive.



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NOTE 4ACQUISITION



TeraQuest Metrics, Inc.



On January 7, 2005, we completed the acquisition of privately held TeraQuest Metrics, Inc. (TeraQuest). TeraQuest was a Texas-based
consulting firm focusing on software improvement, quality assurance and risk management for corporate and government software organizations and is now part of our newly created Process Optimization Practice.



The purchase price consisted of fixed consideration of $5.4 million in
cash and $523,000 of acquisition-related costs. Contingent consideration includes cash retention payments of $1.3 million to be earned through the continued employment of certain key employees. This contingent consideration will vest and be
paid over a two-year period or earlier under certain circumstances and will be recognized as compensation expense in the period earned. In addition, $850,000 of restricted stock, which vests over a four-year period, was issued to certain TeraQuest
employees upon the closing. Results of operations for TeraQuest have been included in our consolidated financial statements from the date of acquisition. The acquisition was accounted for as a purchase and the total purchase price was recorded as
follows (in thousands):



|                         |  |   |      
|------------------------ |  | - | -----
|Cash paid                |  | $ | 5,391
|Direct transaction costs |  |   | 523  
|                         |  |   |      
|Total purchase price     |  | $ | 5,914
|                         |  |   |      



Based upon the
purchase price of the acquisition, the purchase price allocation was as follows (in thousands):



|                                          |  |   |        |  
|----------------------------------------- |  | - | ------ | -
|Current assets and other tangible assets: |  |   |        |  
|Cash                                      |  | $ | 1,478  |  
|Current assets                            |  |   | 2,049  |  
|Deferred tax assets                       |  |   | 870    |  
|Goodwill                                  |  |   | 2,692  |  
|Customer list                             |  |   | 1,475  |  
|                                          |  |   |        |  
|Total assets acquired                     |  |   | 8,564  |  
|                                          | 
|Liabilities assumed:                      |  |   |        |  
|Current liabilities                       |  |   | (1,780 | )
|Deferred tax liabilities                  |  |   | (870   | )
|                                          |  |   |        |  
|Total purchase price                      |  | $ | 5,914  |  
|                                          |  |   |        |  



The customer list is
being amortized over a three-year life from the date of acquisition.



In accordance with SFAS 109, Accounting for Income Taxes, deferred tax liabilities of $870,000 have been recorded for the tax effect of the amortizable intangible assets as well as other taxable temporary differences. We
have recorded an offsetting deferred tax asset of $870,000 to reflect future deductible differences that could be allocable to offset future taxable income. We are releasing a portion of the valuation allowance to the extent the realization of
deferred tax assets becomes assured as a result of the additional taxable income generated by the non-deductible amortizable intangible assets and other taxable temporary differences. Any future release of valuation allowance against deferred tax
assets of TeraQuest will be recorded against goodwill.



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NOTE 5GOODWILL AND INTANGIBLE ASSETS



The changes in the carrying amount of goodwill for the nine months ended September 30, 2005 is as follows (in
thousands):



|                                           |  |       |         |  
|------------------------------------------ |  | ----- | ------- | -
|                                           |  | Total |        
|Balance as of December 31, 2004            |  | $     | 182,390 |  
|Adjustments to initial purchase accounting |  |       | (1,923  | )
|Acquisition of TeraQuest                   |  |       | 2,692   |  
|                                           |  |       |         |  
|Balance as of September 30, 2005           |  | $     | 183,159 |  
|                                           |  |       |         |  



The adjustments to
goodwill during the nine months ended September 30, 2005 are primarily related to reversals of accrued expenses and other liabilities originally recorded as part of the purchase accounting for our acquisitions and due to fluctuations in foreign
currency exchange rates, especially the United Kingdom Pound Sterling and the Euro.



The following tables summarize our intangible assets, net (in thousands):



|                                          |  |                      |        |                         |   |         |                   |  |   |      
|----------------------------------------- |  | -------------------- | ------ | ----------------------- | - | ------- | ----------------- |  | - | -----
|                                          |  | September 30, 2005  
|                                          |  | Gross carrying value |        | Accumulatedamortization |   |         | Net carryingvalue
|Acquired technology                       |  | $                    | 30,720 |                         | $ | (28,203 | )                 |  | $ | 2,517
|Maintenance contracts                     |  |                      | 8,700  |                         |   | (8,700  | )                 |  |   |     
|Trademarks, trade names and service marks |  |                      | 8,300  |                         |   | (7,504  | )                 |  |   | 796  
|Other                                     |  |                      | 6,522  |                         |   | (5,416  | )                 |  |   | 1,106
|                                          |  |                      |        |                         |   |         |                   |  |   |      
|Total                                     |  | $                    | 54,242 |                         | $ | (49,823 | )                 |  | $ | 4,419
|                                          |  |                      |        |                         |   |         |                   |  |   |      



|                                          |  |                      |        |                         |   |         |                   |  |   |       
|----------------------------------------- |  | -------------------- | ------ | ----------------------- | - | ------- | ----------------- |  | - | ------
|                                          |  | December 31, 2004   
|                                          |  | Gross carrying value |        | Accumulatedamortization |   |         | Net carryingvalue
|Acquired technology                       |  | $                    | 30,720 |                         | $ | (21,022 | )                 |  | $ | 9,698 
|Maintenance contracts                     |  |                      | 8,700  |                         |   | (8,700  | )                 |  |   |      
|Trademarks, trade names and service marks |  |                      | 8,300  |                         |   | (5,430  | )                 |  |   | 2,870 
|Other                                     |  |                      | 5,047  |                         |   | (4,985  | )                 |  |   | 62    
|                                          |  |                      |        |                         |   |         |                   |  |   |       
|Total                                     |  | $                    | 52,767 |                         | $ | (40,137 | )                 |  | $ | 12,630
|                                          |  |                      |        |                         |   |         |                   |  |   |       



Estimated future
amortization expense related to our intangible assets at September 30, 2005 is as follows (in thousands):



|                              |  |                   |      
|----------------------------- |  | ----------------- | -----
|                              |  | September 30,2005
|2005 (remaining three months) |  | $                 | 2,977
|2006                          |  |                   | 907  
|2007                          |  |                   | 535  
|                              |  |                   |      
|Total                         |  | $                 | 4,419
|                              |  |                   |      



NOTE 6RESTRUCTURING



The following table summarizes our restructuring
activities for the nine months ended September 30, 2005, which have been accounted for in accordance with EITF 94-3 and SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities, SFAS 112, Employers
Accounting for Postemployment Benefits-an amendment of FASB Statements 5 and 43, SEC Staff Accounting Bulletin 100, Restructuring and Impairment Charges and EITF 95-3, Recognition of Liabilities in Connection
with a Purchase Business Combination,as applicable (in thousands):



|                              |  |                        |        |   |            |   |        |       |  |   |       |   |  |   |        |  
|----------------------------- |  | ---------------------- | ------ | - | ---------- | - | ------ | ----- |  | - | ----- | - |  | - | ------ | -
|                              |  | Severance and Benefits |        |   | Facilities |   |        | Other |  |   | Total |  
|Accrual at December 31, 2004  |  | $                      | 418    |   |            | $ | 3,190  |       |  | $ | 308   |   |  | $ | 3,916  |  
|March 2005 restructuring      |  |                        | 306    |   |            |   |       |       |  |   |      |   |  |   | 306    |  
|June 2005 restructuring       |  |                        | 2,831  |   |            |   | 12,818 |       |  |   | 38    |   |  |   | 15,687 |  
|September 2005 restructuring  |  |                        | 839    |   |            |   | (114   | )     |  |   |      |   |  |   | 725    |  
|Cash payments and write-offs  |  |                        | (3,598 | ) |            |   | (1,881 | )     |  |   | (38   | ) |  |   | (5,517 | )
|                              |  |                        |        |   |            |   |        |       |  |   |       |   |  |   |        |  
|Accrual at September 30, 2005 |  | $                      | 796    |   |            | $ | 14,013 |       |  | $ | 308   |   |  | $ | 15,117 |  
|                              |  |                        |        |   |            |   |        |       |  |   |       |   |  |   |        |  



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Restructuring expenses recorded in the three months ended September 30, 2005 totaled $725,000 and
included $839,000 for severance and benefits partially offset by a facility restructuring expense reversal of $114,000. Severance and benefits expenses related to headcount reductions of 27 employees, of which 21 were in research and development and
6 were in selling, general and administrative. The facility restructuring reversal was an adjustment to the facility restructuring expense previously recorded for vacating a portion of a building located in Scotts Valley, California.



During the second quarter of 2005, we undertook restructuring activities to
consolidate underutilized facilities in Scotts Valley, California. We also eliminated 51 positions of which 44 were in selling, general and administrative and 7 were in research and development. Additionally, we reversed a previous restructuring
charge taken for our Twyford, UK facility in the amount of $303,000. We expect to utilize unused space in this facility as part of a reorganization of our European operations. Net restructuring costs recorded in the second quarter of 2005 in
connection with our June 2005 restructuring activities were $15.7 million, including $13.4 million in the United States and $2.3 million in Europe and Asia. Of the total, $12.8 million represented facilities-related expenses and $2.9 million was
related to severance expenses.



In March 2005, we recorded a
cash restructuring charge for $306,000 for severance and benefits expenses resulting from the termination of an employee in selling, general and administrative.



Substantially all of these costs have or will require the outlay of cash, although the timing of lease payments relating to leased facilities over the
next five years will be unchanged by the restructuring action.



At September 30, 2005, we had $10.5 million in our long-term restructuring accrual, of which $9.5 million was related to the lease obligation for excess capacity at the Scotts Valley, California facility, $898,000 was related to a
lease obligation for excess capacity at a facility in Raleigh, North Carolina and $131,000 was related to a lease obligation for excess capacity at a facility in Sydney, Australia.



NOTE 7GAIN ON SALE OF INVESTMENT



In March 2005, we sold an equity investment in a privately held company that was previously determined to be impaired and written-off in December 2002. We
recognized a gain of $4.7 million in the nine months ending September 30, 2005 on this transaction.



NOTE 8INCOME TAXES



For the three months ended September 30, 2005 and 2004, we recorded an income tax expense of $1.2 million and $2.7 million, respectively. For the nine months ended September 30, 2005 and 2004, we recorded income tax expense of
$1.8 million and $7.6 million, respectively. Our income tax provision is based on our operating results for the nine months ended September 30, 2005 and on foreign income withholding taxes actually incurred.



The effective tax rates for the three and nine months ended
September 30, 2005 and 2004 differ from statutory tax rates principally because we did not fully benefit from the operating losses we incurred in the U.S. and we incurred income tax in a number of foreign jurisdictions. In the three and nine
months ended September 30, 2005, we also recorded a $300,000 tax expense relating to the non-permanently reinvested earnings of a foreign subsidiary. We provide U.S. income taxes on the earnings of our foreign subsidiaries unless those earnings
are considered permanently reinvested. At September 30, 2005, $8.7 million of earnings from our subsidiary in Japan were not considered permanently reinvested, and were subsequently distributed to the U.S. parent in the form of a dividend.
Additionally, we took a $730,000 benefit for the closure of a foreign tax audit and a $540,000 benefit for the refund of a foreign tax payment during the nine months ended September 30, 2005.



Deferred income taxes are recorded in accordance with SFAS 109,
Accounting for Income Taxes, and are determined based on the differences between financial reporting and the tax basis of assets and liabilities using deferred tax rates and laws in effect when the differences are expected to
reverse. SFAS 109 provides for recognition of deferred tax assets if the realization of such assets is more likely than not to occur. With the exception of certain foreign subsidiaries, we have determined that it is more likely than not that our
deferred tax assets in all jurisdictions will not be realized, due to



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uncertainties related to our ability to utilize deferred tax assets, primarily net operating losses carried forward
before they expire. Accordingly, we have recorded deferred tax assets of $1.1 million for those foreign operations, related to temporary book-tax differences and net operating loss carryforwards, and a full valuation allowance against the remainder
of our deferred tax assets at September 30, 2005.



NOTE
9REPURCHASE OF COMMON STOCK



Discretionary Repurchase Program



In September 2001, our Board of Directors authorized
the use of up to $30 million to repurchase shares of our outstanding common stock under a discretionary stock repurchase program. In February 2004 and May 2005, our Board of Directors authorized an additional $30 million and $75 million,
respectively, under this program bringing the total discretionary stock repurchase authorizations to $135 million.



We elected not to repurchase any shares of common stock under our discretionary program during the three months ended September 30, 2005. During the
nine months ended September 30, 2005, we repurchased 4,971,800 shares of common stock at an average price of $6.62 per share for an aggregate cost of $32.9 million.



During the three months ended September 30, 2004, we repurchased 610,500 shares of common stock at an average price of
$8.18 per share for an aggregate cost of $5.0 million. During the nine months ended September 30, 2004, we repurchased 1,723,200 shares of common stock at an average price of $8.70 per share for an aggregate cost of $15.0 million.



The discretionary program is currently in effect and at September 30,
2005, $59.3 million remains authorized for future repurchases.



10b5-1
Repurchase Program



In August 2003, our Board of
Directors authorized a 10b5-1 stock repurchase program whereby up to 1,000,000 shares or $15 million worth of our outstanding common stock, whichever comes first, may be repurchased with a per day trading limit of 2,000 shares.



During the three months ended September 30, 2005, we repurchased 48,000
common shares at an average price of $6.41 a share for total consideration of $308,000. During the nine months ended September 30, 2005, we repurchased 298,000 shares at an average price of $7.42 per share for total consideration of $2.2
million.



During the three months ended September 30,
2004, we repurchased 128,000 common shares at an average price of $8.03 a share for total consideration of $1.0 million. During the nine months ended September 30, 2004, we repurchased 374,000 shares at an average price of $8.85 per share for
total consideration of $3.3 million.



The 10b5-1 Program
expired during the three months ended September 30, 2005 when the accumulated total number of shares repurchased under the program reached its authorized maximum of 1,000,000 shares.



NOTE 10COMMITMENTS AND CONTINGENCIES



Indemnifications and Guarantees



The following is a summary of our agreements that we have determined are within the scope of Financial Accounting Standards Board (FASB)
Interpretation 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, some of which are specifically grandfathered because the guarantees were in effect
prior to December 31, 2002. Accordingly, we have no liabilities recorded for these agreements as of September 30, 2005, except as noted below.



We have agreements whereby we indemnify our officers and directors for certain events or occurrences while the officer or director is, or was serving, in
such capacity. The term of the indemnification period is for the officers or directors lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however,
we have a director and officer insurance policy that in certain circumstances enables us to recover a portion of any future amounts paid. As a result of our insurance policy coverage, we believe the estimated fair value of these indemnification
agreements is minimal.



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As part of our TeraQuest acquisition in January 2005 and our Legadero acquisition in October 2005, we
entered into retention agreements totaling $1.3 million and $5.4 million, respectively, to be paid over two-year periods from the respective dates of acquisition based upon continued employment of certain key employees. Refer to Notes 4 and 12 of
Notes to Condensed Consolidated Financial Statements for additional information.



As part of the Starbase and TogetherSoft acquisitions, we entered into agreements whereby we indemnify the officers and directors of the acquired company for certain events or occurrences while such officers or
directors served in such capacity. The term of the indemnification period is for the officers or directors lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is
unlimited; however, we have purchased director and officer insurance policies for Starbase and TogetherSoft, if applicable, through 2009, that in certain circumstances enable us to recover a portion of any future amounts paid. As a result of our
insurance policy coverage, we believe the estimated fair value of these indemnification agreements is minimal.



We entered into an agreement for the outsourcing of inventory fulfillment. We guarantee that in the event we terminate the fulfillment agreement, we will
purchase all inventory held by the vendor at the time of termination. We estimate and accrue reserves for excess inventory at the vendor. As of September 30, 2005, we had inventory in excess of the reserves of $400,000, which represents the
potential charge relating to this guarantee for this period.



During the year ended December 31, 2003, we entered into a five-year operating lease for our corporate offices in Cupertino, California. In the event that we do not exercise our option to extend the term of the lease, we guarantee
certain costs to restore the property to certain conditions in place at the time the lease commenced. We are accruing the estimated fair value of the lease restoration costs over the lease term and at September 30, 2005, we had a balance of
$1.1 million accrued.



We sell software licenses and services
to our customers via a contractual arrangement. As part of that contractual arrangement, we generally provide a warranty for our software products and services to our customers. Our products are generally warranted to perform substantially as
described in the associated product documentation. Our services are generally warranted to be performed in a professional and workmanlike manner. We have not incurred significant expense under our product or services warranties. As a result, we
believe the estimated fair value of these agreements is minimal.



We also enter into standard indemnification agreements in our ordinary course of business with our customers, suppliers and other third-party providers. With respect to our customer license agreements, each contract generally includes
certain provisions for indemnifying the customer against losses, damages, expenses and liabilities incurred by the customer in the event our software is found to infringe upon certain intellectual property rights of a third party. In our services
agreements, we generally agree to indemnify our customers against any acts by our employees or agents that cause property damage or personal injury. In our technology license agreements, we also generally agree to indemnify our technology suppliers
against any losses, damages, expenses and liabilities incurred by the suppliers in connection with certain intellectual property right infringement claims by any third party with respect to our products. Finally, from time to time we enter into
other industry-standard indemnification agreements with third party providers. The maximum potential amount of future payments we could be required to make under any of these indemnification agreements is presently unknown. To date, we have not
incurred significant expense to defend lawsuits or settle claims related to these indemnification agreements. As a result, we believe the estimated fair value of these agreements is minimal.



We also have arrangements with certain vendors whereby we guarantee the
expenses incurred by the vendor. The term is from execution of the arrangement until cancellation and payment of any outstanding amounts. We would be required to pay any unsettled expenses upon notification from the vendor. The maximum potential
amount of future payments we could be required to make under these indemnification agreements is insignificant. As a result, we believe the estimated fair value of these agreements is minimal.



Leases



We lease certain of our office and operating facilities and certain furniture and equipment under various operating leases.
Our remaining operating lease terms extend through 2016 and as of September 30, 2005, future minimum lease payments under noncancelable operating leases were as follows, (in thousands):



|                              |  |                 |       |      |   |        |  |      |       |      |   |            |  |       |       |  |   |       |  |   |       
|----------------------------- |  | --------------- | ----- | ---- | - | ------ |  | ---- | ----- | ---- | - | ---------- |  | ----- | ----- |  | - | ----- |  | - | ------
|                              |  | 2005 (3 months) |       | 2006 |   | 2007   |  | 2008 |       | 2009 |   | Thereafter |  | Total
|Operating leases              |  | $               | 2,702 |      | $ | 7,336  |  | $    | 5,876 |      | $ | 3,087      |  | $     | 2,895 |  | $ | 4,929 |  | $ | 26,825
|Restructured operating leases |  |                 | 935   |      |   | 3,753  |  |      | 3,294 |      |   | 2,946      |  |       | 2,585 |  |   | 646   |  |   | 14,159
|                              |  |                 |       |      |   |        |  |      |       |      |   |            |  |       |       |  |   |       |  |   |       
|Total commitments             |  | $               | 3,637 |      | $ | 11,089 |  | $    | 9,170 |      | $ | 6,033      |  | $     | 5,480 |  | $ | 5,575 |  | $ | 40,984



Rent expense, net, for
all operating leases was $2.4 million and $8.5 million for the three and nine months ended September 30, 2005, respectively, and was $3.0 million and $9.1 million for the three and nine months ended September 30, 2004, respectively. In
addition, in December 2003, we entered into a five year lease for a facility in Tokyo, Japan, which is classified as a capital lease in accordance with SFAS No. 13 Accounting for Leases.This capital lease is not included in
the operating lease table presented above.



Litigation



On November 27, 2002, a stockholder class action
and derivative lawsuit, Dieterich v. Harrer, et al., Case No. 02CC00350, was filed against Starbase Corporation, or Starbase, and five former directors of Starbase in the Superior Court of the State of California for Orange County, claiming
that the former directors had breached fiduciary duties owed to Starbase and stockholders of Starbase. We are paying the costs of defending this litigation pursuant to indemnification obligations under the merger agreement relating to our
acquisition of Starbase. Following a series of motions, the case was dismissed without prejudice on August 20, 2003. On October 28, 2003, a stockholder class action relating to the same matter, Dieterich v. Harrer, et al, Case
No. 024-N, was filed against the former directors of Starbase in Chancery Court of



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the State of Delaware, alleging breach of fiduciary duties by the former directors of Starbase. The lawsuit also named as
defendants Borland, and the following four former executive officers of Borland: Dale Fuller, Keith Gottfried, Frederick Ball, and Doug Barre. Defendants moved to dismiss and in August 2004, the Chancery Court granted in part and denied in part the
motion to dismiss. Discovery has commenced and there is no date set for trial. We intend to defend ourselves vigorously. There is no indication at present whether the lawsuit will have a material effect on our financial condition, results of
operations or liquidity.



From time to time, we may be involved
in other lawsuits, claims, investigations and proceedings, consisting of intellectual property, commercial, employment and other matters, which arise in the ordinary course of business. In accordance with SFAS 5, Accounting for
Contingencies we record a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These accruals are reviewed at least quarterly and adjusted to reflect the impacts of
negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case. Litigation is inherently unpredictable; however, we believe that we have valid defenses with respect to the legal matters
pending against us, as well as adequate accruals for any probable and estimable losses. If an unfavorable ruling or other development were to occur in any specific period, there exists the possibility of a material adverse impact on the results of
operations for that period. We believe that, except as described above, given our current liquidity and cash and investment balances, even were we to receive an adverse judgment with respect to litigation that we are currently a party to, it is
likely that such a judgment would not have a material impact on our financial condition, results of operations or liquidity.



From time to time we receive notices from third parties claiming infringement by our products of third party patent, trademark and other intellectual
property rights, disputing royalties, or disputing other commercial arrangements. Regardless of the merit of any such claim, responding to these claims could be time consuming and expensive, and may require us to enter into licensing or royalty
agreements which may not be offered or available on terms acceptable to us. If a successful claim is made against us, our business could be materially and adversely affected. We expect that our software products will increasingly be subject to such
claims as the number of products and competitors in our industry segment increases, the functionality of products overlap and industry participants become more aggressive in using patents offensively.



Service Commitments



We have commitments regarding an outsourcing arrangement for
portions of our information technology operations. The committed expenditures are an average of $5.2 million per year through November 2014. We can terminate this contract with or without cause upon payment of a termination fee, the maximum amount
of which is $2.1 million in 2005 declining to $500,000 in the final year of the contract.



NOTE 11RECENT ACCOUNTING PRONOUNCEMENTS



In May 2005 the FASB issued SFAS 154, Accounting Changes and Error Corrections. This statement replaces APB 20 and SFAS 3 and changes the requirements for the accounting for and reporting of a
change in accounting principle. APB 20 previously required that most voluntary changes in accounting principle be recognized by including in net income (loss) of the period of the change the cumulative effect of changing to the new accounting
principle. SFAS 154 requires retrospective application to prior periods financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change.
SFAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005.



In December 2004, the FASB issued SFAS 123R, Share-Based Payment,which requires companies to expense the estimated fair value of
employee stock options and similar awards. In March 2005, the SEC issued Staff Accounting Bulletin (SAB) 107, providing supplemental implementation guidance for SFAS 123R. On April 14, 2005, the SEC adopted a new rule amending the
compliance dates for SFAS 123R. In accordance with the new rule, the accounting provisions of SFAS 123R will be effective for us beginning in fiscal 2006. The pro forma disclosures previously permitted under SFAS 123 will no longer be an alternative
to financial statement recognition. On October 27, 2005 we accelerated the vesting of all unvested options held by employees to enable us to avoid recognizing future compensation expense associated with these options upon adoption of SFAS 123R.
Refer to Note 12Subsequent Events for additional information. We expect the adoption of SFAS 123R and SAB 107 will have a material adverse impact on our net income (loss) and net income (loss) per share. Refer to Note
2Stock-Based Compensation for the pro forma net income (loss) and net income (loss) per share amounts for the three and nine months ended September 30, 2005 and 2004, as if we had used a fair-value-based method similar to the
methods required under SFAS 123R to measure compensation expense for employee stock awards.



In December 2004, the FASB issued Staff Position FAS 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004. The
American Jobs Creation Act of 2004 introduces a limited time 85% dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer (repatriation provision), provided certain criteria are met. FAS 109-2 provides
accounting and disclosure guidance for the repatriation provision. We presently do not plan to repatriate foreign earnings under the provisions of the American Jobs Creation Act of 2004, although we may revisit this decision.



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In December 2004, the FASB issued SFAS 153, Exchanges of Nonmonetary Assets, which
eliminates the exception for non-monetary exchanges of similar productive assets and replaces it with a general exception for exchanges of non-monetary assets that do not have commercial substance. SFAS 153 will be effective for non-monetary asset
exchanges occurring in fiscal periods beginning after June 15, 2005. We do not believe the adoption of SFAS 153 will have a material impact on our consolidated financial position, results of operations or cash flows.



NOTE 12SUBSEQUENT EVENTS



On October 3, 2005, we completed the acquisition of privately held
Legadero Software, Inc., or Legadero. Legadero is a Texas-based provider of IT management and governance solutions for software development and delivery. The purchase price consisted of fixed consideration of approximately $7.5 million in cash
plus contingent consideration of $5.4 million for retention payments to be earned through the continued employment of certain key employees. This contingent consideration will vest and be paid over a two-year period or earlier under certain
circumstances and will be recognized as compensation expense in the period earned. In addition, we expect to incur approximately $150,000 of acquisition-related costs. Options to purchase 378,000 shares of common stock pursuant to our 2003
Supplemental Stock Option Plan were issued to certain Legadero key employees who are now our employees. These options will vest over a four-year period. Cash acquired in the acquisition was approximately $100,000. Results of operations for Legadero
will be included in our consolidated financial statements from the date of acquisition.



On October 27, 2005, the Compensation Committee of the Borland Board of Directors approved accelerating the vesting of all unvested stock options granted under our stock option plans granted on or prior to
September 30, 2005 having an exercise price higher than the closing price of our common stock on November 4, 2005, which was $5.67 per share. Unvested stock options held by members of the Board of Directors were excluded from the vesting
acceleration. The primary purpose of the accelerated vesting was to avoid recognizing future compensation expense associated with these options upon adoption of SFAS 123R. SFAS 123R will require that compensation expense associated with stock
options be recognized in the statement of operations, rather than as a footnote disclosure to our consolidated financial statements. We estimate the aggregate future expense that will be eliminated as a result of the acceleration of the vesting of
these options is approximately $13 million, with approximately $8 million eliminated for 2006. We will report approximately $13 million of additional pro forma stock compensation expense under SFAS 123 in the fourth quarter of 2005 due to the
acceleration of all unvested stock options in that quarter.



On
October 27, 2005, the Compensation Committee approved severance benefits for certain Named Executive Officers listed in Borlands 2005 proxy statement, specifically Kenneth R. Hahn, Timothy J. Stevens and Matthew A. Thompson, which supersedes
severance provisions contained in their respective employment agreements (the Severance Agreement). With respect to a termination in connection with a change in control, the Severance Agreement provides for severance benefits under these
circumstances consisting of (i) a severance payment equal to 100% of the executives annual base salary; (ii) continuation of health coverage by having Borland pay the executives COBRA premiums for up to 12 months and (iii) accelerated
vesting of all future equity awards, if any.



On November 8,
2005, we announced the appointment of Tod Nielsen to the position of President and Chief Executive Officer. Mr. Nielsen will also join Borlands Board of Directors effective November 9, 2005.



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



Forward-Looking Statements



The statements made throughout this Quarterly Report on Form 10-Q that are not historical facts are forward-looking statements and, accordingly, involve
estimates, projections, goals, forecasts, assumptions and uncertainties that could cause actual results or outcomes to differ materially from those expressed or implied in the forward-looking statements. These forward-looking statements may relate
to, but are not limited to, revenues, composition of revenues, cash flows, earnings, margins, costs, expenses, strategy, research and development, customer service and relationships, demand for our products, market and technological trends in the
software industry, licenses, developments in technology, product quality, competition, sales, cash resources, utilization of cash resources, personnel, acquisitions, interest rates, foreign currency exchange rates and various economic and business
trends. Generally, you can identify forward-looking statements by the use of words such as expect, estimate, project, budget, forecast, anticipate, goal,
intend, plan, may, will, could, should, believes, predicts, potential, continue and similar expressions or the negative or other
variations thereof. These forward-looking statements involve substantial risks and uncertainties. Examples of such risks and uncertainties are described under Factors That May Affect Our Future Operating Results And Adversely Affect The Market
Price Of Our Stock and elsewhere in this report, as well as in our other filings with the SEC or in materials incorporated by reference herein or therein. You should be aware that the occurrence of any of these risks and uncertainties may
cause our actual results to differ materially from those anticipated in our forward-looking statements and have a material adverse effect on our business, results of operations and financial condition. New factors may emerge from time to time, and
it may not be possible for us to predict new factors, nor can we assess the potential effect of any new factors on us.



These forward-looking statements are found at various places throughout this Form 10-Q, including the financial statement footnotes. We caution you not to
place undue reliance on these forward-looking statements, which, unless otherwise indicated, speak only as of the date they were made. We do not undertake any obligation to update or release publicly any revisions to these forward-looking statements
to reflect events or circumstances after the date of this Form 10-Q, except as required by law.



Overview



Borland is a global leader in Software Delivery Optimization (SDO), the transformation of software development from a series of individual activities into a managed business process. We provide software and services that are
designed to align the people, processes and technology required to maximize the business value of software. By enabling a managed business process for the entire software development and delivery lifecycle, we help customers address the constraints
of software development that limit the effectiveness and efficiency of their efforts.



Increasingly, enterprises are demanding more speed, more reliability and a higher return on investment from the software that facilitates their business productivity. To this end, existing point products
that only address a single aspect of the application development lifecycle, or broader solutions that are based on only one technology platform, are proving inadequate to meet the software development needs of todays corporate information
technology (IT) organizations. We believe enterprises are increasingly demanding a more disciplined approach to aligning the people, processes and technology that are required to deliver high quality software on time and within budget.



We have been transforming our go-to-market focus over the past
several quarters from selling individual point products to selling multi-product enterprise solutions and services that span the software application development lifecycle. As part of this transformation, we continue to focus on revamping and
training our worldwide sales force, increasing sales force productivity, growing our pipeline of sales leads and opportunities, developing stronger alliances with systems integrators and technology partners that have established relationships with
enterprise-level customers, and selling our individual products through our network of channel partners. We have also experienced longer and less predicable sales cycles, which is typical for larger solution sales, and we expect to compete directly
and more often with larger companies. We therefore expect to continue to experience variability in our financial results as we pursue this transformation.



Although the first half of 2005 was challenging for us, we believe our Application Lifecycle Management (ALM) and SDO strategies are beginning
to gain traction. In the third quarter of 2005, we achieved better performance in the Americas region offsetting continued weakness abroad, particularly in Europe and Japan. We will continue our emphasis on accelerating growth of our ALM enterprise
solutions while at the same time managing maturing product lines, which continue to decline. For example, revenues from our Java IDE product line continue to decline in part due to pricing pressures from open source products and represented only 7%
of our total revenues in the third quarter of 2005, down from 15% in the year-ago quarter. Our service revenues, which include technical support and consulting services for software products, continue to grow sequentially and now represent 42% of
total revenues. Technical support



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revenues have grown as our base of enterprise-level customers has expanded and our consulting services revenues, which
are driven by our Process Optimization Practice, have experienced healthy growth since our acquisition of TeraQuest in January 2005. Our Process Optimization Practice continues to drive interest in higher-level discussions with enterprise customers
regarding our ALM solutions.



The following is a summary of our
key financial results for the three and nine months ended September 30, 2005:



| |  |  | Total revenues decreased 13% to $68 million from $78 million for the three months ended September 30, 2005 and decreased 9% to $206 million from $227 million for the nine
months ended September 30, 2005.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Licenses and other revenues decreased 26% to $39 million from $53 million for the three months ended September 30, 2005 and decreased 23% to $121 million from $158 million for
the nine months ended September 30, 2005.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Service revenues increased 16% to $29 million from $25 million for the three months ended September 30, 2005 and increased 23% to $85 million from $69 million for the nine
months ended September 30, 2005.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Gross margins decreased to 80% from 86% for the three months ended September 30, 2005 and decreased to 79% from 86% for the nine months ended September 30, 2005.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Operating expenses decreased 9% to $59 million from $65 million for the three months ended September 30, 2005 and increased 2% to $189 million from $185 million for the nine
months ended September 30, 2005.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We recognized a gain of $4.7 million on the sale of an investment in the nine months ended September 30, 2005.
| | - |  | --------------------------------------------------------------------------------------------------------------



| |  |  | Net loss was $4.8 million for the three months ended September 30, 2005 compared to $160,000 for the three months ended September 30, 2004 and net loss was $18.9 million
for the nine months ended September 30, 2005 compared to net income of $3.4 million for the nine months ended September 30, 2004.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Cash, cash equivalents and short-term investments decreased $32 million to $189 million as of September 30, 2005, from $221 million as of December 31, 2004.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We repurchased 48,000 shares and 5,269,800 shares of our common stock for $308,000 and $35 million during the three and nine months ended September 30, 2005, respectively.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



For a more in-depth discussion of our business,
including a discussion of our critical accounting policies and estimates, please read our Annual Report on Form 10-K for the year ended December 31, 2004 as filed with the SEC on March 25, 2005, as amended pursuant to Form 10-K/A filed
with the SEC on March 30, 2005.



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Results of Operations



The following table presents our Condensed Consolidated Statements of Operations data and the related percentage of total
revenues for the three and nine months ended September 30, 2005 and 2004 (dollars in thousands):



|                                                                                  |  |                                  |        |   |                                  |     |    |      |   |        |      |  |     |    |  |   |         |   |  |     |    |  |   |         |  |     |  
|--------------------------------------------------------------------------------- |  | -------------------------------- | ------ | - | -------------------------------- | --- | -- | ---- | - | ------ | ---- |  | --- | -- |  | - | ------- | - |  | --- | -- |  | - | ------- |  | --- | -
|                                                                                  |  | Three Months EndingSeptember 30, |        |   | Nine Months Ending September 30, |    
|                                                                                  |  | 2005                             |        |   | 2004                             |     |    | 2005 |   |        | 2004 | 
|License and other revenues                                                        |  | $                                | 39,236 |   |                                  | 58  | %  |      | $ | 53,063 |      |  | 68  | %  |  | $ | 120,959 |   |  | 59  | %  |  | $ | 158,017 |  | 70  | %
|Service revenues                                                                  |  |                                  | 28,614 |   |                                  | 42  | %  |      |   | 24,585 |      |  | 32  | %  |  |   | 84,779  |   |  | 41  | %  |  |   | 69,016  |  | 30  | %
|                                                                                  |  |                                  |        |   |                                  |     |    |      |   |        |      |  |     |    |  |   |         |   |  |     |    |  |   |         |  |     |  
|Total revenues                                                                    |  |                                  | 67,850 |   |                                  | 100 | %  |      |   | 77,648 |      |  | 100 | %  |  |   | 205,738 |   |  | 100 | %  |  |   | 227,033 |  | 100 | %
|                                                                                  |  |                                  |        |   |                                  |     |    |      |   |        |      |  |     |    |  |   |         |   |  |     |    |  |   |         |  |     |  
|Cost of license and other revenues                                                |  |                                  | 1,515  |   |                                  | 2   | %  |      |   | 2,172  |      |  | 3   | %  |  |   | 6,390   |   |  | 3   | %  |  |   | 6,646   |  | 3   | %
|Cost of service revenues                                                          |  |                                  | 9,679  |   |                                  | 14  | %  |      |   | 6,255  |      |  | 8   | %  |  |   | 28,638  |   |  | 14  | %  |  |   | 18,058  |  | 8   | %
|Amortization of acquired intangibles                                              |  |                                  | 2,517  |   |                                  | 4   | %  |      |   | 2,388  |      |  | 3   | %  |  |   | 7,550   |   |  | 4   | %  |  |   | 7,324   |  | 3   | %
|                                                                                  |  |                                  |        |   |                                  |     |    |      |   |        |      |  |     |    |  |   |         |   |  |     |    |  |   |         |  |     |  
|Cost of revenues                                                                  |  |                                  | 13,711 |   |                                  | 20  | %  |      |   | 10,815 |      |  | 14  | %  |  |   | 42,578  |   |  | 21  | %  |  |   | 32,028  |  | 14  | %
|                                                                                  |  |                                  |        |   |                                  |     |    |      |   |        |      |  |     |    |  |   |         |   |  |     |    |  |   |         |  |     |  
|Gross profit                                                                      |  |                                  | 54,139 |   |                                  | 80  | %  |      |   | 66,833 |      |  | 86  | %  |  |   | 163,160 |   |  | 79  | %  |  |   | 195,005 |  | 86  | %
|                                                                                  |  |                                  |        |   |                                  |     |    |      |   |        |      |  |     |    |  |   |         |   |  |     |    |  |   |         |  |     |  
|Selling, general and administrative expenses                                      |  |                                  | 43,170 |   |                                  | 64  | %  |      |   | 42,502 |      |  | 55  | %  |  |   | 126,432 |   |  | 62  | %  |  |   | 125,296 |  | 55  | %
|Research and development expenses                                                 |  |                                  | 14,277 |   |                                  | 21  | %  |      |   | 17,304 |      |  | 22  | %  |  |   | 42,975  |   |  | 21  | %  |  |   | 51,290  |  | 22  | %
|Restructuring, amortization of other intangibles and acquisition-related expenses |  |                                  | 1,646  |   |                                  | 2   | %  |      |   | 5,283  |      |  | 7   | %  |  |   | 19,371  |   |  | 9   | %  |  |   | 8,236   |  | 4   | %
|                                                                                  |  |                                  |        |   |                                  |     |    |      |   |        |      |  |     |    |  |   |         |   |  |     |    |  |   |         |  |     |  
|Total operating expenses                                                          |  |                                  | 59,093 |   |                                  | 87  | %  |      |   | 65,089 |      |  | 84  | %  |  |   | 188,778 |   |  | 92  | %  |  |   | 184,822 |  | 81  | %
|                                                                                  |  |                                  |        |   |                                  |     |    |      |   |        |      |  |     |    |  |   |         |   |  |     |    |  |   |         |  |     |  
|Operating income (loss)                                                           |  |                                  | (4,954 | ) |                                  | (7  | )% |      |   | 1,744  |      |  | 2   | %  |  |   | (25,618 | ) |  | (13 | )% |  |   | 10,183  |  | 5   | %
|Gain on sale of investment                                                        |  |                                  |       |   |                                  | 0   | %  |      |   |       |      |  | 0   | %  |  |   | 4,680   |   |  | 3   | %  |  |   |        |  | 0   | %
|Interest and other income, net                                                    |  |                                  | 1,317  |   |                                  | 2   | %  |      |   | 764    |      |  | 1   | %  |  |   | 3,824   |   |  | 2   | %  |  |   | 787     |  | 0   | %
|                                                                                  |  |                                  |        |   |                                  |     |    |      |   |        |      |  |     |    |  |   |         |   |  |     |    |  |   |         |  |     |  
|Income (loss) before income taxes                                                 |  |                                  | (3,637 | ) |                                  | (5  | )% |      |   | 2,508  |      |  | 3   | %  |  |   | (17,114 | ) |  | (8  | )% |  |   | 10,970  |  | 5   | %
|Income tax provision                                                              |  |                                  | 1,185  |   |                                  | 2   | %  |      |   | 2,668  |      |  | 3   | %  |  |   | 1,760   |   |  | 1   | %  |  |   | 7,571   |  | 3   | %
|                                                                                  |  |                                  |        |   |                                  |     |    |      |   |        |      |  |     |    |  |   |         |   |  |     |    |  |   |         |  |     |  
|Net income (loss)                                                                 |  | $                                | (4,822 | ) |                                  | (7  | )% |      | $ | (160   | )    |  | (0  | )% |  | $ | (18,874 | ) |  | (9  | )% |  | $ | 3,399   |  | 2   | %
|                                                                                  |  |                                  |        |   |                                  |     |    |      |   |        |      |  |     |    |  |   |         |   |  |     |    |  |   |         |  |     |  



Total Revenues



The following table presents our total revenues for
the three and nine months ended September 30, 2005 and 2004 and the absolute dollar and percentage change from the comparable prior year period (dollars in thousands):



|               |  |                                  |        |      |                                 |        |  |   |        |   |  |      |        |      |   |         |  |   |         |  |   |         |   |  |    |   
|-------------- |  | -------------------------------- | ------ | ---- | ------------------------------- | ------ |  | - | ------ | - |  | ---- | ------ | ---- | - | ------- |  | - | ------- |  | - | ------- | - |  | -- | --
|               |  | Three Months Ended September 30, |        |      | Nine Months Ended September 30, |       
|               |  |                                  |        |      |                                 | Change |  |   |        |   |  |      | Change |     
|               |  | 2005                             |        | 2004 |                                 | $      |  |   | %      |   |  | 2005 |        | 2004 |   | $       |  |   | %       | 
|Total revenues |  | $                                | 67,850 |      | $                               | 77,648 |  | $ | (9,798 | ) |  | (13  | )%     |      | $ | 205,738 |  | $ | 227,033 |  | $ | (21,295 | ) |  | (9 | )%



We derive revenues
from licenses of our software and the sale of related services. No single group or customer represented more than 10% of our total revenues in the three or nine months ended September 30, 2005 or 2004.



Licenses and Other Revenues



The following table presents our licenses and other revenues for the three
and nine months ended September 30, 2005 and 2004 and the absolute dollar and percentage change from the comparable prior year period (dollars in thousands):



|                                  |  |                                  |        |   |                                 |   |        |        |  |   |         |   |  |      |    |  |        |         |   |   |   |         |   |  |   |         |   |  |     |   
|--------------------------------- |  | -------------------------------- | ------ | - | ------------------------------- | - | ------ | ------ |  | - | ------- | - |  | ---- | -- |  | ------ | ------- | - | - | - | ------- | - |  | - | ------- | - |  | --- | --
|                                  |  | Three Months Ended September 30, |        |   | Nine Months Ended September 30, |  
|                                  |  |                                  |        |   |                                 |   |        | Change |  |   |         |   |  |      |    |  | Change |        
|                                  |  | 2005                             |        |   | 2004                            |   |        | $      |  |   | %       |   |  | 2005 |    |  | 2004   |         |   | $ |   |         | % | 
|License and other revenues        |  | $                                | 39,236 |   |                                 | $ | 53,063 |        |  | $ | (13,827 | ) |  | (26  | )% |  | $      | 120,959 |   |   | $ | 158,017 |   |  | $ | (37,058 | ) |  | (23 | )%
|As a percentage of total revenues |  |                                  | 58     | % |                                 |   | 68     | %      |  |   |         |   |  |      |    |  |        | 59      | % |   |   | 70      | % |  |   |         |   |  |     |   



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##### Table of Contents

Licenses and other revenues represent amounts for license fees and royalties earned for granting
customers the right to use and distribute our software products. Licenses and other revenues have declined in the three and nine-month periods ended September 30, 2005 primarily due to a decrease in revenues from our Java IDE products, which
declined $6.8 million and $21.0 million in the three and nine months ended September 30, 2005, respectively, due to the continuing commoditization of Java development tools and associated pricing pressure from open source products. In addition,
while we expected a seasonally slower quarter in Europe, the adoption of our ALM enterprise products has been slower than anticipated in that region. Throughout 2005, we have also experienced longer sales cycles for transactions that involve larger,
multi-product purchases. These larger solution sales often require extensive selling efforts throughout many levels within the customers organization and are often accompanied by a lengthy approval process. Given the complexity of these
enterprise-level deals it has been, and will continue to be, difficult to forecast our success in closing these types of transactions.



Service Revenues



The following table presents our service revenues for the three and nine months ended September 30, 2005 and 2004 and the absolute dollar and
percentage change from the comparable prior year period (dollars in thousands):



|                                  |  |                                  |        |   |                                 |   |        |        |  |   |       |  |    |      |  |   |        |   |  |   |        |   |  |   |        |  |    |  
|--------------------------------- |  | -------------------------------- | ------ | - | ------------------------------- | - | ------ | ------ |  | - | ----- |  | -- | ---- |  | - | ------ | - |  | - | ------ | - |  | - | ------ |  | -- | -
|                                  |  | Three Months Ended September 30, |        |   | Nine Months Ended September 30, |  
|                                  |  | 2005                             |        |   | 2004                            |   |        | Change |  |   | 2005  |  |    | 2004 |  |   | Change |  
|                                  |  |                                  |        | $ |                                 | % |        |        |  |   | $     |  | %  |     
|Service revenues                  |  | $                                | 28,614 |   |                                 | $ | 24,585 |        |  | $ | 4,029 |  | 16 | %    |  | $ | 84,779 |   |  | $ | 69,016 |   |  | $ | 15,763 |  | 23 | %
|As a percentage of total revenues |  |                                  | 42     | % |                                 |   | 32     | %      |  |   |       |  |    |      |  |   | 41     | % |  |   | 30     | % |  |   |        |  |    |  



Service revenues
represent amounts earned for technical support (which includes call support, maintenance and upgrades) and consulting and education services for software products. The increases in service revenues in both the three and nine months ended
September 30, 2005 were primarily due to increases in consulting services revenues and technical support revenues. Consulting services revenues increased $3.0 million and $6.6 million in the three and nine months ended September 30, 2005,
respectively, due to the expansion of our consulting services team with the acquisition of TeraQuest in January 2005 and the formation of our Process Optimization Practice. Technical support revenues increased $1.1 million and $8.8 million in the
three and nine months ended September 30, 2005, respectively, due to our expanding base of enterprise-level customers who have purchased multi-product solutions from us. Our technical support revenues have benefited as we have focused our
selling efforts on larger enterprise-level customers, who generally purchase support contracts with their software licenses and tend to renew their support contracts with a higher frequency.



International Revenues



International revenues represented 55% and 61% of total revenues for the
three months ended September 30, 2005 and 2004, respectively, and were 58% and 60% of total revenues for the nine months ended September 30, 2005 and 2004, respectively. The decrease in the percentage of international revenues was
principally due to a decrease in revenues in Europe, especially in the United Kingdom, where IT spending appears to have softened and the sales of our ALM enterprise products has been slower than expected. Additionally, the nine months ended
September 30, 2004 benefited from a particularly large enterprise deal in the United Kingdom. This decrease in international revenues for the three and nine months ended September 30, 2005 was partially mitigated by the weakening of the
U.S. dollar versus the Euro, United Kingdom Pound Sterling, Japanese Yen and other foreign currencies. The weakening of the U.S. dollar had the effect of increasing international revenues by $421,000 and $3.3 million in the three and nine
months ended September 30, 2005, respectively, over the comparable year-ago periods.



The following table presents our total revenues by country and their percentage change for the three and nine months ended September 30, 2005 and 2004 (dollars in thousands):



|                    |  |                                 |        |      |                                 |          |  |     |      |  |      |         |          |   |         |  |     |   
|------------------- |  | ------------------------------- | ------ | ---- | ------------------------------- | -------- |  | --- | ---- |  | ---- | ------- | -------- | - | ------- |  | --- | --
|                    |  | Three Months EndedSeptember 30, |        |      | Nine Months Ended September 30, |         
|                    |  | 2005                            |        | 2004 |                                 | % Change |  |     | 2005 |  | 2004 |         | % Change |  
|United States       |  | $                               | 30,619 |      | $                               | 30,607   |  | 0   | %    |  | $    | 87,171  |          | $ | 89,729  |  | (3  | )%
|Germany             |  |                                 | 7,001  |      |                                 | 8,863    |  | (21 | )%   |  |      | 21,325  |          |   | 24,139  |  | (12 | )%
|United Kingdom      |  |                                 | 5,599  |      |                                 | 8,728    |  | (36 | )%   |  |      | 17,358  |          |   | 27,630  |  | (37 | )%
|All other countries |  |                                 | 24,631 |      |                                 | 29,450   |  | (16 | )%   |  |      | 79,884  |          |   | 85,535  |  | (7  | )%
|                    |  |                                 |        |      |                                 |          |  |     |      |  |      |         |          |   |         |  |     |   
|Total revenues      |  | $                               | 67,850 |      | $                               | 77,648   |  | (13 | )%   |  | $    | 205,738 |          | $ | 227,033 |  | (9  | )%
|                    |  |                                 |        |      |                                 |          |  |     |      |  |      |         |          |   |         |  |     |   



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##### Table of Contents

No other single country accounted for total revenues greater than 10% of total revenues in the three or
nine months ended September 30, 2005 or 2004.



Our
international revenues are influenced by fluctuations in foreign currencies and would be harmed if the U.S. dollar were to strengthen against major foreign currencies, including the Euro, the United Kingdom Pound Sterling and the Japanese Yen.



Regional Revenues



The following table presents our total revenues by region and their
percentage change for the three and nine months ended September 30, 2005 and 2004 (dollars in thousands):



|                               |  |                                 |        |      |                                 |          |  |     |      |  |      |         |          |   |         |  |     |   
|------------------------------ |  | ------------------------------- | ------ | ---- | ------------------------------- | -------- |  | --- | ---- |  | ---- | ------- | -------- | - | ------- |  | --- | --
|                               |  | Three Months EndedSeptember 30, |        |      | Nine Months Ended September 30, |         
|                               |  | 2005                            |        | 2004 |                                 | % Change |  |     | 2005 |  | 2004 |         | % Change |  
|Americas                       |  | $                               | 34,961 |      | $                               | 36,104   |  | (3  | )%   |  | $    | 101,357 |          | $ | 103,700 |  | (2  | )%
|Europe, Middle East and Africa |  |                                 | 21,924 |      |                                 | 28,916   |  | (24 | )%   |  |      | 71,930  |          |   | 87,559  |  | (18 | )%
|Asia Pacific                   |  |                                 | 10,965 |      |                                 | 12,628   |  | (13 | )%   |  |      | 32,451  |          |   | 35,774  |  | (9  | )%
|                               |  |                                 |        |      |                                 |          |  |     |      |  |      |         |          |   |         |  |     |   
|Total revenues                 |  | $                               | 67,850 |      | $                               | 77,648   |  | (13 | )%   |  | $    | 205,738 |          | $ | 227,033 |  | (9  | )%
|                               |  |                                 |        |      |                                 |          |  |     |      |  |      |         |          |   |         |  |     |   



Our Americas
operations include activities of our parent company located in the United States as well as subsidiaries and branch offices in Brazil and Canada. Our Europe, Middle East and Africa (EMEA) operations include activities of our subsidiaries
and branch offices in Finland, France, Germany, Italy, Netherlands, Russia, Spain, Sweden and the United Kingdom. Our Asia Pacific (APAC) operations include activities of our subsidiaries and branch offices in Australia, China, Hong
Kong, India, Japan, Korea, New Zealand, Singapore and Taiwan.



Americas. Revenues in the Americas region decreased in the three and nine months ended September 30, 2005 due to a decline in license revenues. License revenues declined $3.9 million and $11.3 million in the three and nine
months ended September 30, 2005, respectively, due to the continued weakness of our Java IDE product line. Despite a year-over-year decline, we were pleased with the stronger than expected performance in the Americas region and believe that our
ALM enterprise products are beginning to gain traction. Partially offsetting the decline in license revenues was an increase in service revenues of $2.7 million and $8.9 million in the three and nine months ended September 30, 2005,
respectively. Service revenues increased due to an increase in technical support revenues and an increase in consulting revenues related to the acquisition of TeraQuest. The strength in technical support revenues was attributable to a shift to
larger enterprise customers and our operational focus in selling technical support contracts to new customers and renewing existing customers with lapsing contracts.



EMEA.Revenues in the EMEA region decreased in the three and nine months ended September 30, 2005 due to a
decline in license revenues. License revenues declined $7.8 million and $20.9 million in the three and nine months ended September 30, 2005, respectively. The declines were due to a decrease in revenues in the United Kingdom, the continued
weakness of our Java IDE products, the slower than expected adoption of our ALM enterprise products, and what we believe is a softening in IT spending throughout Europe. Revenues in the United Kingdom benefited in the year-ago quarter from a large
enterprise deal for $8.6 million. Partially offsetting the decline in EMEA license revenues was an increase in service revenues of $818,000 and $5.3 million in the three and nine months ended September 30, 2005, respectively, primarily due to
an increase in technical support revenues. Additionally, the weakening of the U.S. dollar versus the Euro and Pound Sterling in 2005 benefited EMEA revenues by $147,000 and $2.2 million in the three and nine months ended September 30,
2005, respectively.



APAC. Revenues in the APAC region
decreased in the three and nine months ended September 30, 2005 due to a decline in license revenues. License revenues declined $2.1 million and $4.9 million in the three and nine months ended September 30, 2005, respectively. The decline
was primarily due to the continued weakness of our Java IDE product line and a slow rate of adoption of our ALM solutions, particularly in Japan. We recently made efforts to reorganize and provide additional resources to our sales force in Japan
including the hiring of a new president to oversee our operations in Japan in May 2005. We have yet to realize the anticipated benefits from these efforts. Partially offsetting the decline in license revenues was an increase in service revenues of
$486,000 and $1.6 million in the three and nine months ended September 30, 2005, respectively. Service revenues increased primarily due to the strength of technical support revenues as we have focused on selling technical support contracts.
Additionally, the weakening of the U.S. dollar versus the Japanese Yen, South Korean Won and other APAC currencies over the past year benefited APAC revenues by $274,000 and $1.1 million in the three and nine months ended September 30, 2005,
respectively.



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##### Table of Contents

Cost of Revenues



The following table presents cost of revenues for the three and nine months ended September 30, 2005 and 2004 and the absolute dollar and
percentage changes from the comparable prior year period (dollars in thousands):



|                                           |  |                                  |       |   |                                 |   |       |        |  |   |       |   |  |      |    |  |        |        |   |  |   |        |   |  |   |        |   |  |    |   
|------------------------------------------ |  | -------------------------------- | ----- | - | ------------------------------- | - | ----- | ------ |  | - | ----- | - |  | ---- | -- |  | ------ | ------ | - |  | - | ------ | - |  | - | ------ | - |  | -- | --
|                                           |  | Three Months Ended September 30, |       |   | Nine Months Ended September 30, |  
|                                           |  | 2005                             |       |   | 2004                            |   |       | Change |  |   | 2005  |   |  | 2004 |    |  | Change |       
|                                           |  |                                  |       | $ |                                 |   | %     |        |  |   |       | $ |  |      | %  | 
|Cost of license and other revenues         |  | $                                | 1,515 |   |                                 | $ | 2,172 |        |  | $ | (657  | ) |  | (30  | )% |  | $      | 6,390  |   |  | $ | 6,646  |   |  | $ | (256   | ) |  | (4 | )%
|As a percent of license and other revenues |  |                                  | 4     | % |                                 |   | 4     | %      |  |   |       |   |  |      |    |  |        | 5      | % |  |   | 4      | % |  |   |        |   |  |    |   
|Cost of service revenues                   |  | $                                | 9,679 |   |                                 | $ | 6,255 |        |  | $ | 3,424 |   |  | 55   | %  |  | $      | 28,638 |   |  | $ | 18,058 |   |  | $ | 10,580 |   |  | 59 | % 
|As a percent of service revenues           |  |                                  | 34    | % |                                 |   | 25    | %      |  |   |       |   |  |      |    |  |        | 34     | % |  |   | 26     | % |  |   |        |   |  |    |   
|Amortization of acquired intangibles       |  | $                                | 2,517 |   |                                 | $ | 2,388 |        |  | $ | 129   |   |  | 5    | %  |  | $      | 7,550  |   |  | $ | 7,324  |   |  | $ | 226    |   |  | 3  | % 
|As a percent of total revenues             |  |                                  | 4     | % |                                 |   | 3     | %      |  |   |       |   |  |      |    |  |        | 4      | % |  |   | 3      | % |  |   |        |   |  |    |   



Cost of Licenses and Other
Revenues



Cost of licenses and other revenues consists
primarily of production costs, product packaging costs and royalties paid to third party vendors. License and other gross margins were 96% in both the three months ended September 30, 2005 and 2004, and were 95% and 96% in the nine months ended
September 30, 2005 and 2004, respectively. Cost of licenses and other revenues tend to fluctuate with changes in product mix. The level of royalty costs in future periods will depend upon our ability to obtain favorable licensing terms for our
products that include third party technology and the extent to which we include such third party technology in our product offerings.



Cost of Service Revenues



Cost of service revenues consists primarily of salaries and benefits, third party contractor costs and related expenses incurred in providing technical
support, maintenance, upgrades, and consulting and education services. Service gross margins were 66% and 75% in the three months ended September 30, 2005 and 2004, respectively, and were 66% and 74% in the nine months ended September 30,
2005 and 2004, respectively. The decrease in gross margins was primarily attributable to an increase in consulting costs as a result of increased consulting headcount. On an absolute dollar basis, cost of service revenues increased in the three and
nine months ended September 30, 2005 due to the expansion of our consulting services team.



Amortization of Acquired Intangibles



Amortization of acquired intangibles consists of the amortization of purchased technology and maintenance contracts from acquisitions. Amortization of acquired intangibles increased in the three and nine months ended
September 30, 2005 due to amortization expense associated with the acquired intangible customer list related to the acquisition of TeraQuest, which added $123,000 and $369,000 of amortization expense, respectively.



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##### Table of Contents

Operating Expenses



Selling, General and Administrative Expenses



The following table presents our selling, general and administrative expenses for the three and nine months ended
September 30, 2005 and 2004 and the absolute dollar and percentage change from the comparable prior year period (dollars in thousands):



|                                             |  |                                 |        |   |                                 |   |        |        |  |   |      |  |   |      |  |   |         |   |  |   |         |   |  |   |       |  |   |  
|-------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------- | - | ------ | ------ |  | - | ---- |  | - | ---- |  | - | ------- | - |  | - | ------- | - |  | - | ----- |  | - | -
|                                             |  | Three Months EndedSeptember 30, |        |   | Nine Months Ended September 30, |  
|                                             |  | 2005                            |        |   | 2004                            |   |        | Change |  |   | 2005 |  |   | 2004 |  |   | Change  |  
|                                             |  |                                 |        | $ |                                 | % |        |        |  |   | $    |  | % |     
|Selling, general and administrative expenses |  | $                               | 43,170 |   |                                 | $ | 42,502 |        |  | $ | 668  |  | 2 | %    |  | $ | 126,432 |   |  | $ | 125,296 |   |  | $ | 1,136 |  | 1 | %
|As a percent of total revenues               |  |                                 | 64     | % |                                 |   | 55     | %      |  |   |      |  |   |      |  |   | 62      | % |  |   | 55      | % |  |   |       |  |   |  



The increase in
selling, general and administrative expenses in absolute dollars and as a percentage of revenues for the three months ended September 30, 2005 was primarily attributable to an increase in salary, commission and related fringe benefit expenses
of $1.3 million and bad debt expenses of $855,000. Salary, commission and fringe benefit expenses increased primarily due to an increase in higher level employees compared to the year-ago quarter and due to severance compensation paid to our former
chief executive officer in the third quarter of 2005. The reversal of certain allowances for bad debt expense in the year-ago quarter had the effect of reducing bad debt expenses in that quarter as compared to the current quarter. Partially
offsetting these increases was a decrease in incentive compensation expense of $820,000, as we did not accrue a portion of our incentive compensation because it is not expected to be paid. Additionally, marketing expenses decreased $775,000 as we
scaled back certain marketing programs, and facilities related expenses decreased $316,000 primarily due to vacating a portion of an underutilized building located in Scotts Valley, California prior to the three months ended September 30, 2005.



The increase in selling, general and administrative expenses
in absolute dollars and as a percentage of revenues for the nine months ended September 30, 2005 was primarily attributable to an increase in salary, commission and fringe benefit expenses of $3.7 million and due to the severance compensation
paid to our former chief executive officer. In addition, the reversal of certain allowances for bad debt in the year-ago period had the effect of reducing bad debt expenses in that period by approximately $1.3 million as compared to the current
period. Partially offsetting these increases was a decrease in incentive compensation expense of $2.9 million, as we did not pay incentive compensation in the first two quarters of 2005 because we did not meet our financial objectives in those
periods. Additionally, marketing expenses decreased $1.0 million as we reduced our discretionary program spending due to lower than anticipated revenues, and facility related expenses decreased $327,000 primarily due to vacating a portion of the
facility located in Scotts Valley, California.



Research and Development
Expenses



The following table presents our research
and development expenses for the three and nine months ended September 30, 2005 and 2004 and the absolute dollar and percentage change from the comparable prior year period (dollars in thousands):



|                                  |  |                                  |        |   |                                 |   |        |        |  |   |        |   |  |      |    |  |        |        |   |  |   |        |   |  |   |        |   |  |     |   
|--------------------------------- |  | -------------------------------- | ------ | - | ------------------------------- | - | ------ | ------ |  | - | ------ | - |  | ---- | -- |  | ------ | ------ | - |  | - | ------ | - |  | - | ------ | - |  | --- | --
|                                  |  | Three Months Ended September 30, |        |   | Nine Months Ended September 30, |  
|                                  |  | 2005                             |        |   | 2004                            |   |        | Change |  |   | 2005   |   |  | 2004 |    |  | Change |       
|                                  |  |                                  |        | $ |                                 |   | %      |        |  |   |        | $ |  |      | %  | 
|Research and development expenses |  | $                                | 14,277 |   |                                 | $ | 17,304 |        |  | $ | (3,027 | ) |  | (17  | )% |  | $      | 42,975 |   |  | $ | 51,290 |   |  | $ | (8,315 | ) |  | (16 | )%
|As a percent of total revenues    |  |                                  | 21     | % |                                 |   | 22     | %      |  |   |        |   |  |      |    |  |        | 21     | % |  |   | 23     | % |  |   |        |   |  |     |   



The decrease in
research and development expenses in absolute dollars and as a percentage of revenues in the three and nine months ended September 30, 2005 was primarily attributable to a decrease in salary and related fringe benefits expenses as we have
reduced spending on certain maturing product lines. Salary and fringe benefits expenses decreased $1.5 million and $4.1 million in the three and nine months ended September 30, 2005, respectively, due to a decrease in our average research and
development headcount. We had approximately 43 fewer research and development employees during



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##### Table of Contents

2005 compared to 2004. Additionally, incentive compensation expense decreased $564,000 in the three months ended
September 30, 2005, as we did not accrue a portion of our incentive compensation because it is not expected to be paid. Incentive compensation expense decreased $3.3 million in the nine months ended September 30, 2005, primarily due to not
meeting our financial objectives in the first half of 2005.



Restructuring, Amortization of Other Intangibles, and Acquisition-Related Expenses



The following table summarizes our restructuring, amortization of other intangibles and acquisition-related expenses for the three and nine months ended
September 30, 2005 and 2004 and the absolute dollar and percentage change from the comparable prior year period (dollars in thousands):



|                                  |  |                                  |       |   |                                 |   |       |        |  |   |        |   |  |      |    |  |        |        |   |  |   |       |   |  |   |        |   |  |     |   
|--------------------------------- |  | -------------------------------- | ----- | - | ------------------------------- | - | ----- | ------ |  | - | ------ | - |  | ---- | -- |  | ------ | ------ | - |  | - | ----- | - |  | - | ------ | - |  | --- | --
|                                  |  | Three Months Ended September 30, |       |   | Nine Months Ended September 30, |  
|                                  |  | 2005                             |       |   | 2004                            |   |       | Change |  |   | 2005   |   |  | 2004 |    |  | Change |       
|                                  |  |                                  |       | $ |                                 |   | %     |        |  |   |        | $ |  |      | %  | 
|Restructuring                     |  | $                                | 725   |   |                                 | $ | 3,542 |        |  | $ | (2,817 | ) |  | (80  | )% |  | $      | 16,645 |   |  | $ | 2,865 |   |  | $ | 13,780 |   |  | 481 | % 
|Amortization of other intangibles |  |                                  | 692   |   |                                 |   | 1,163 |        |  |   | (471   | ) |  | (40  | )% |  |        | 2,126  |   |  |   | 3,517 |   |  |   | (1,391 | ) |  | (40 | )%
|Acquisition-related expenses      |  |                                  | 229   |   |                                 |   | 578   |        |  |   | (349   | ) |  | (60  | )% |  |        | 600    |   |  |   | 1,854 |   |  |   | (1,254 | ) |  | (68 | )%
|                                  |  |                                  |       |   |                                 |   |       |        |  |   |        |   |  |      |    |  |        |        |   |  |   |       |   |  |   |        |   |  |     |   
|Total                             |  | $                                | 1,646 |   |                                 | $ | 5,283 |        |  | $ | (3,637 | ) |  | (69  | )% |  | $      | 19,371 |   |  | $ | 8,236 |   |  | $ | 11,135 |   |  | 135 | % 
|                                  |  |                                  |       |   |                                 |   |       |        |  |   |        |   |  |      |    |  |        |        |   |  |   |       |   |  |   |        |   |  |     |   
|As a percent of total revenues    |  |                                  | 2     | % |                                 |   | 7     | %      |  |   |        |   |  |      |    |  |        | 9      | % |  |   | 4     | % |  |   |        |   |  |     |   



Restructuring.
Restructuring expenses recorded in the three months ended September 30, 2005 totaled $725,000 and included $839,000 for severance and benefits partially offset by a facility restructuring expense reversal of $114,000. Severance and benefits
expenses related to headcount reductions of 27 employees, of which 21 were in research and development and 6 were in selling, general and administrative. The facility restructuring reversal was an adjustment to the facility restructuring expense
previously recorded for vacating a portion of a building located in Scotts Valley, California.



Restructuring expenses recorded in the nine months ended September 30, 2005 totaled $16.6 million and included $654,000 for our September 2005 restructuring, $15.7 million for our June 2005 restructuring and
$306,000 for our March 2005 restructuring. Our June 2005 restructuring included facility costs of $12.8 million related to vacating a portion of an underutilized building located in Scotts Valley, California and $2.9 million for non-recurring
severance and benefits expenses resulting from the elimination of 51 positions, including 44 in selling, general and administrative and 7 in research and development. Our March 2005 restructuring included $306,000 for severance and benefits
resulting from the termination of an employee in selling, general and administrative.



Substantially all of our 2005 restructuring expenses will require the outlay of cash. The timing of lease payments relating to our Scotts Valley, California facility will remain unchanged by our restructuring actions
and are expected to run through March 2010. Substantially all amounts related to severance and benefits are expected to be paid prior to December 31, 2005.



The following table summarizes our restructuring activity for the nine months ended September 30, 2005 (in thousands):



|                              |  |                        |        |   |            |   |        |       |  |   |       |   |  |   |        |  
|----------------------------- |  | ---------------------- | ------ | - | ---------- | - | ------ | ----- |  | - | ----- | - |  | - | ------ | -
|                              |  | Severance and Benefits |        |   | Facilities |   |        | Other |  |   | Total |  
|Accrual at December 31, 2004  |  | $                      | 418    |   |            | $ | 3,190  |       |  | $ | 308   |   |  | $ | 3,916  |  
|March 2005 restructuring      |  |                        | 306    |   |            |   |       |       |  |   |      |   |  |   | 306    |  
|June 2005 restructuring       |  |                        | 2,831  |   |            |   | 12,818 |       |  |   | 38    |   |  |   | 15,687 |  
|September 2005 restructuring  |  |                        | 839    |   |            |   | (114   | )     |  |   |      |   |  |   | 725    |  
|Cash payments and write-offs  |  |                        | (3,598 | ) |            |   | (1,881 | )     |  |   | (38   | ) |  |   | (5,517 | )
|                              |  |                        |        |   |            |   |        |       |  |   |       |   |  |   |        |  
|Accrual at September 30, 2005 |  | $                      | 796    |   |            | $ | 14,013 |       |  | $ | 308   |   |  | $ | 15,117 |  
|                              |  |                        |        |   |            |   |        |       |  |   |       |   |  |   |        |  



At September 30,
2005, we had $10.5 million in our long-term restructuring accrual of which $9.5 million was related to the lease obligation for excess capacity at the Scotts Valley, California facility, $898,000 was related to the lease obligation for excess
capacity at a facility in Raleigh, North Carolina and $131,000 was related to the lease obligation for excess capacity at a facility in Sydney, Australia.



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Amortization of other intangibles. In the three months ended September 30, 2005, we incurred
$692,000 of amortization expense related to intangible trade names and non-compete agreements as a result of our acquisitions compared to $1.2 million in the year-ago quarter. We incurred $2.1 million of amortization expense in the nine months ended
September 30, 2005 compared to $3.5 million in the year-ago period due to the completion of the amortization of the TogetherSoft non-compete intangible asset.



Acquisition-related expenses. In the three and nine months ended September 30, 2005, we recorded $229,000 and
$600,000, respectively, in acquisition-related expenses, which was primarily contingent consideration payable under the terms of the TeraQuest acquisition agreement. Acquisition-related expenses in the year-ago three and nine month periods primarily
consisted of contingent consideration payable under the terms of the VMGear acquisition agreement of $442,000 and $1.4 million, respectively.



Gain on Sale of Investment



In the nine months ended September 30, 2005 we recognized a gain of $4.7 million on the sale of an equity investment in a privately held company.



Interest and Other Income, Net



The following table presents our interest and other income, net for the
three and nine months ended September 30, 2005 and 2004 and the absolute dollar and percentage change from the comparable prior year period (dollars in thousands):



|                               |  |                                 |       |   |                                 |   |     |        |  |   |      |  |    |      |  |   |        |   |  |   |     |   |  |   |       |  |     |  
|------------------------------ |  | ------------------------------- | ----- | - | ------------------------------- | - | --- | ------ |  | - | ---- |  | -- | ---- |  | - | ------ | - |  | - | --- | - |  | - | ----- |  | --- | -
|                               |  | Three Months EndedSeptember 30, |       |   | Nine Months Ended September 30, |  
|                               |  | 2005                            |       |   | 2004                            |   |     | Change |  |   | 2005 |  |    | 2004 |  |   | Change |  
|                               |  |                                 |       | $ |                                 | % |     |        |  |   | $    |  | %  |     
|Interest and other income, net |  | $                               | 1,317 |   |                                 | $ | 764 |        |  | $ | 553  |  | 72 | %    |  | $ | 3,824  |   |  | $ | 787 |   |  | $ | 3,037 |  | 386 | %
|As a percent of net revenues   |  |                                 | 2     | % |                                 |   | 1   | %      |  |   |      |  |    |      |  |   | 2      | % |  |   | 0   | % |  |   |       |  |     |  



The increase in
interest and other income, net during the three and nine months ended September 30, 2005 was primarily attributable to higher yields earned on our invested capital, which resulted in an increase in interest income during 2005, and a reduction
in realized foreign currency losses due to the effectiveness of our foreign currency risk management program. Fluctuations in the Euro versus the U.S. dollar has accounted for the majority of the losses in foreign currency in the recent past. The
amount of foreign currency gains or losses we realize is influenced by fluctuations in the U.S. dollar versus the foreign currencies we conduct business in with respect to our short-term inter-company balances with our international subsidiaries,
along with other transactional activities conducted in foreign currencies.



Income Taxes



The following table
presents our income taxes for the three and nine months ended September 30, 2005 and 2004 and the absolute dollar and percentage change from the comparable prior year period (dollars in thousands):



|                             |  |                                  |       |   |                                 |   |       |        |  |   |        |   |  |      |    |  |        |       |   |  |   |       |   |  |   |        |   |  |     |   
|---------------------------- |  | -------------------------------- | ----- | - | ------------------------------- | - | ----- | ------ |  | - | ------ | - |  | ---- | -- |  | ------ | ----- | - |  | - | ----- | - |  | - | ------ | - |  | --- | --
|                             |  | Three Months Ended September 30, |       |   | Nine Months Ended September 30, |  
|                             |  | 2005                             |       |   | 2004                            |   |       | Change |  |   | 2005   |   |  | 2004 |    |  | Change |      
|                             |  |                                  |       | $ |                                 |   | %     |        |  |   |        | $ |  |      | %  | 
|Income tax provision         |  | $                                | 1,185 |   |                                 | $ | 2,668 |        |  | $ | (1,483 | ) |  | (56  | )% |  | $      | 1,760 |   |  | $ | 7,571 |   |  | $ | (5,811 | ) |  | (77 | )%
|As a percent of net revenues |  |                                  | 2     | % |                                 |   | 3     | %      |  |   |        |   |  |      |    |  |        | 1     | % |  |   | 3     | % |  |   |        |   |  |     |   



The decrease in taxes
for the three months ended September 30, 2005 as compared to the year-ago quarter was primarily attributable to a decrease in the profitability of our foreign operations. The decrease in taxes for the nine months ended September 30, 2005
as compared to the year-ago period was primarily due to a decrease in the profitability of our foreign operations and the reversal of certain tax liabilities. Our income tax provision is based on our operating results for the three and nine months
ended September 30, 2005 and on foreign income withholding taxes actually incurred.



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The effective tax rates for the three and nine months ended September 30, 2005 and 2004 differ from
statutory tax rates principally because we did not fully benefit from the operating losses we incurred in the United States and we incurred income tax in a number of foreign jurisdictions. In the three and nine months ended September 30, 2005,
we also recorded a $300,000 tax expense relating to the non-permanently reinvested earnings of a foreign subsidiary. We provide U.S. income taxes on the earnings of our foreign subsidiaries unless those earnings are considered permanently
reinvested. At September 30, 2005, $8.7 million of earnings from our subsidiary in Japan were not considered permanently reinvested, and were subsequently distributed to the U.S. parent in the form of a dividend. Additionally, we took a
$730,000 benefit for the closure of a foreign tax audit and a $540,000 benefit for the refund of a foreign tax payment during the nine months ended September 30, 2005.



Liquidity and Capital Resources



Cash and cash equivalents and short-term investments. Cash, cash equivalents and short-term investments were $189.1 million at
September 30, 2005, a decrease of $32.1 million from a balance of $221.2 million at December 31, 2004. The decrease in cash and cash equivalents and short-term investments was principally due to the purchase of $35.1 million of treasury
stock under our stock repurchase programs during the nine months ended September 30, 2005.



Liabilities and leases. As of September 30, 2005, we had long-term liabilities of $14.9 million, which consisted of $10.5 million of
long-term restructuring accruals and $4.4 million of long-term leases. We lease certain office space and facilities and certain furniture and equipment under various operating leases.



Our remaining operating lease terms extend through April 30, 2016 and as of September 30, 2005 future minimum
lease payments under noncancelable operating leases were as follows, (in thousands):



|                              |  |                 |       |      |   |        |  |      |       |      |   |            |  |       |       |  |   |       |  |   |       
|----------------------------- |  | --------------- | ----- | ---- | - | ------ |  | ---- | ----- | ---- | - | ---------- |  | ----- | ----- |  | - | ----- |  | - | ------
|                              |  | 2005 (3 months) |       | 2006 |   | 2007   |  | 2008 |       | 2009 |   | Thereafter |  | Total
|Operating leases              |  | $               | 2,702 |      | $ | 7,336  |  | $    | 5,876 |      | $ | 3,087      |  | $     | 2,895 |  | $ | 4,929 |  | $ | 26,825
|Restructured operating leases |  |                 | 935   |      |   | 3,753  |  |      | 3,294 |      |   | 2,946      |  |       | 2,585 |  |   | 646   |  |   | 14,159
|                              |  |                 |       |      |   |        |  |      |       |      |   |            |  |       |       |  |   |       |  |   |       
|Total commitments             |  | $               | 3,637 |      | $ | 11,089 |  | $    | 9,170 |      | $ | 6,033      |  | $     | 5,480 |  | $ | 5,575 |  | $ | 40,984



The restructured
operating leases above represent total lease commitments that are not associated with continuing operations. In addition, in December 2003, we entered into a five-year lease for a facility in Tokyo, Japan, which is classified as a capital lease in
accordance with SFAS 13 Accounting for Leases. This capital lease is not included in the operating lease table presented above.



Net cash provided by operating activities. Net cash provided by operating activities during the nine months ended September 30, 2005 was
$9.2 million, comprised of net working capital sources of $19.6 million plus adjustments for depreciation and amortization expenses of $13.2 million, partially offset by a net loss of $18.9 million and an adjustment of $4.7 million for the gain
from the sale of an equity investment in a privately held company. Working capital sources of cash included a decrease in accounts receivable and increases in short and long-term restructuring accruals and deferred revenues. The decrease in accounts
receivable is due to strong collections in Europe and a decline in overall license revenues. Short and long-term restructuring accruals increased primarily due to our June and September 2005 restructuring activities. Deferred revenues increased due
to an increase in support contracts bookings, whose revenues are generally recognized over a twelve month period. Working capital uses of cash included a decrease in accounts payable and accrued expenses due to the timing and magnitude of payments
made to our vendors.



Net cash provided by operating activities
for the nine months ended September 30, 2004 was $20.2 million, consisting of $3.4 million of net income plus adjustments of $16.5 million for depreciation and amortization expenses and net working capital sources of cash of $300,000. Working
capital sources of cash included increases in income taxes payable and deferred revenues. Income taxes payable increased primarily due to an increase in income before taxes in 2004 and deferred revenues increased due to an increase in support
contract bookings. Working capital uses of cash included decreases in accounts payable and accrued expenses and short and long-term restructuring accruals. The decrease in accounts payable and accrued liabilities was due to the timing and magnitude
of payments made to our vendors. Short and long-term restructuring accruals decreased due to payments made on vacated facilities.



We anticipate our operating expenses to remain relatively stable for the foreseeable future and as a result we intend to fund our operating expenses
through cash flows from operations.



Net cash provided by
investing activities. Net cash provided by investing activities during the nine months ended September 30, 2005 was $12.3 million, including $17.8 million provided by the sales of short-term investments, net of purchases, and $4.7 million
in proceeds from the sale of an equity investment in a privately held company. Partially offsetting these sources was $4.4 million used in our acquisition of TeraQuest, net of cash acquired. Refer to Note 4 of Notes to Condensed Consolidated
Financial Statements for further discussion of this acquisition. Additionally, we used $5.8 million for purchases of property and equipment.



Net cash used in investing activities for the nine months ended September 30, 2004 was $8.2 million, including $6.0 million used in the net purchases
of short-term investments and $2.2 million used for purchases of property, equipment and intangible developed technology assets.



In October 2005, we used approximately $7.5 million of cash to purchase Legadero Software, Inc. Refer to Note 12 of Notes to Condensed Consolidated
Financial Statements for further discussion of this acquisition. We may utilize cash resources to fund additional acquisitions or investments in other businesses, technologies or product lines.



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Net cash used in financing activities. Net cash used in financing activities during the nine
months ended September 30, 2005 was $31.3 million and consisted primarily of $35.2 million used to purchase our common shares under our stock repurchase programs, partially offset by $3.9 million received for the issuance of shares of our
common stock from the exercise of stock options and from the purchase of shares by employees under our employee stock purchase plan.



Net cash used in financing activities was $10.9 million during the nine months ended September 30, 2004 and consisted of $18.3 million used to
purchase our common shares under our stock repurchase programs, partially offset by $7.4 million received for the issuance of shares of our common stock from the exercise of stock options and from the purchase of shares by employees under our
employee stock purchase plan.



Currency. Although
we utilize foreign currency forward exchange contracts to reduce our foreign currency exchange rate risk, the strengthening of the U.S. dollar against the Euro, the United Kingdom Pound Sterling, the Australian and Singapore dollars and the
Japanese Yen could harm our business. We cannot predict currency exchange rate fluctuations and there can be no assurance that foreign currency exchange rates will not have a material adverse impact on our future cash flows and operating results.
Refer to Item 3. Quantitative and Qualitative Disclosures About Market Risk for additional discussion of foreign currency risk.



Off-Balance Sheet Arrangements. We do not participate in transactions that generate relationships with unconsolidated entities or financial
partnerships, such as entities often referred to as structured finance, variable interest or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or
limited purposes. As of September 30, 2005, we were not involved in any unconsolidated transactions.



We believe that our available cash and cash equivalents will be sufficient to meet our working capital and operating expense requirements for at least the
next twelve months. At some point in the future we may require additional funds for either operating or strategic purposes and may seek to raise the additional funds through public or private debt or equity financings. If we ever need to seek
additional financing, there is no assurance that this additional financing will be available, or if available, will be on reasonable terms and not dilutive to our stockholders.



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FACTORS THAT MAY AFFECT OUR FUTURE OPERATING RESULTS AND ADVERSELY AFFECT THE MARKET PRICE OF OUR STOCK



We operate in a rapidly changing environment that
involves many risks, some of which are beyond our control. The following discussion highlights some of these risks. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business
operations or results. If any of these risks actually occur, our business operations or results could be harmed.



We are in the process of transforming the company from one that focuses on the development and distribution of individual software development tools to one that
focuses on the development and distribution of enterprise software development solutions. If we are unable to successfully complete this transformation quickly and smoothly, our operating results could be harmed.



We are undergoing a transformation from a company that focuses on the
development and distribution of individual software development tools to one that focuses on the development and distribution of enterprise software development solutions. This transformation has taken many forms (each of which involves substantial
risks), including:



| |  |  | Changes in go-to-market strategy. To achieve revenue growth, we must increase sales force productivity and generally complete more large revenue, multi-product sales of
our ALM suite. We will also need to further define our roadmaps as we transform our ALM offering to our SDO vision. To do so, we must coordinate the efforts of our marketing, sales, services and research and development organizations to focus on the
needs of large enterprises. These tasks are complicated, involve many people and processes, and require consistency and persistence in the market place to be effective. If we fail to coordinate these efforts, we will not satisfy the demands of the
large enterprise customers that we are targeting and our revenues will suffer.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Changes in our sales organization and sales leadership. We have recently focused our sales effort on enterprise customers. As a part of this effort to transform our
sales organization, we have and will continue to make significant changes throughout our global sales force, particularly in Europe and Japan where productivity has been below our expectations. These efforts may prove unsuccessful in increasing our
sales to enterprise customers.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Changes in our sales cycles. Sales to large enterprises often involve long and unpredictable sales cycles. As we move into enterprise solution selling, we will also
become more dependent on large revenue, multi-product transactions to meet our revenue expectations. Given our relative inexperience in serving enterprise customers and our greater dependency on larger revenue deals with longer sales cycles, we may
be unable to accurately forecast revenues derived from these customers. If we fail to accurately forecast revenues, we may not achieve the revenue or net income that we anticipate, which could harm our business and our stock price.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Changes in our marketing strategy. As part of our transition, we have been and are continuing to redefine our marketing strategy. Our focus is on increasing lead
generation and developing appropriate enterprise-level messaging, all in an effort to provide the necessary tools to our sales organization to sell to the enterprise customer. As an organization, are relatively new at this. If we are unable to
develop effective marketing programs and increase our pipeline of sales opportunities, or if our sales organization in turn is unable to effectively convert leads into customers, then our revenues will be harmed.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Changes in the make-up of our management team. Several members of our management team and senior personnel in a wide range of managerial roles recently joined Borland.
As a result, our management team has a relatively short history working together, and it is unclear whether they will be able to manage the company effectively. Specifically, on November 8, 2005, we announced the appointment of Tod Nielsen as our
new President and Chief Executive Officer. During this transition in leadership, our customers may decide to defer purchasing or decide not to purchase at all, we may experience employee distraction, or we may see increased competitive pressure as
our competitors attempt to use this period of leadership change to their competitive advantage. If we are unable to effectively manage through this transition quickly and effectively, our revenues could be harmed.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



These are just a few of the types of risks associated with transforming the
company to a provider of enterprise software development solutions. There are several other types of risks inherent in such a process, generally described in the following



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paragraphs and throughout this document. While we believe that transforming the organization to focus on the development
and delivery of comprehensive solutions to enterprise customers is critical to growing our business, we may be unable to complete this transformation smoothly and quickly. If we are unable to manage the process smoothly and quickly, our business
will be harmed.



We are relatively new to marketing and selling
comprehensive solutions for the application development lifecycle, and we may not be able to successfully compete in this broader market.



The application development lifecycle market is evolving, and customers are increasingly demanding software that integrates and addresses each stage of
the application development lifecycle. Historically, we have focused on selling point products for particular segments of the application development lifecycle, most notably development tools. We have done this utilizing a combination of an indirect
sales channel that sells individual point products and a direct sales force that manages larger accounts on the basis of geography. We have recently focused our sales efforts on selling enterprise solutions to large customers, as our future growth
will depend in large measure on our ability to sell comprehensive ALM solutions to these larger enterprises. To that end, we have also introduced sales personnel who will be dedicated exclusively to named enterprise accounts. However, we have little
history of selling comprehensive ALM solutions, and we may be unable to transition effectively to selling these solutions to large enterprises. To compete successfully in the enterprise account market, we believe we will need to:



| |  |  | develop stronger relationships with systems integrators and other strategic partners with access to enterprise accounts;
| | - |  | ------------------------------------------------------------------------------------------------------------------------



| |  |  | develop stronger relationships with executive-level IT professionals and other executives responsible for making enterprise-wide purchasing decisions;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | develop and reinforce messaging focused on executive-level IT professionals;
| | - |  | ----------------------------------------------------------------------------



| |  |  | leverage our professional services organization to expand product opportunities within an enterprise customer; and
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | compete with several very large and well-established companies with more experience in these markets.
| | - |  | -----------------------------------------------------------------------------------------------------



We do not have extensive experience in these areas. If we are unable to do any of the foregoing, our operating results could
suffer.



If we are unable to maintain revenue levels in our maturing
product lines, our financial results will be harmed.



A significant portion of our current revenues is based on sales of integrated development environments, or IDEs. The market for IDEs, particularly Java IDEs, has become increasingly commoditized. This is due in part to the overall increase
in the utilization of open source software technologies, including the growing popularity of Eclipse  an open source initiative that provides, among other things, development tools, frameworks, and foundational IDE technology at little or no
charge. We have seen substantial declines in the revenue attributable to JBuilder, our Java IDE offering, and we attribute this decline, at least in part, to pricing pressure created by open source IDEs. Customers may also choose to use open source
technologies simply to avoid potentially lengthy and difficult procurement processes within their organizations. We have recently embraced Eclipse as a major foundational framework for our ALM tools, and will be placing more emphasis on
Eclipse-based offerings in the future, including in the area of Java IDEs. While we believe there is still demand for JBuilder based on reputation, superior quality, and productivity enhancements, we believe our IDE revenues will continue to decline
as the IDE market continues to mature and as we transition to include Eclipse in our IDE offerings. Given the increasing commoditization of the IDE market, and the risks associated with supporting the Eclipse foundation, we may be unable to
accurately forecast the revenues we will generate from the sale of IDEs in future periods. If we fail to accurately forecast revenues from the sale of IDEs and if declines in our revenues for IDEs accelerates, our financial results may suffer and
our stock price may decline.



We also currently have a
significant amount of our revenue attributable to our deployment products. We recently experienced unexpected weakness in revenue from these products and believe they may be subject to commoditization pressure as well. Our deployment products are
generally based on older standards and technologies, which increasingly are used only in more select industries, networks and applications.



We may as a result see fluctuations in revenue from licenses of these products, and may experience difficulty in maintaining historical revenue levels.



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Our increasing focus on enterprise customers may lengthen our sales cycles, which may delay sales beyond forecasted
quarters and increase fluctuations in our financial results.



As we seek to license our software directly to large enterprises, we have experienced sales cycles that are substantially more lengthy and uncertain than those associated with our traditional business of licensing software through indirect
and retail channels and more modest direct sales. As we focus on large transactions that involve multiple elements, enterprise customers generally require us to expend substantial time, effort and money in establishing a relationship and in
educating them about our solutions. Also, sales to enterprise customers generally require an extensive sales effort throughout many levels within the customers organization and often require final approval by several layers of executives,
including the customers chief information officer, chief financial officer and/or other senior executive employee. These factors substantially extend the sales cycle and increase the uncertainty of whether a sale will be made in any particular
quarter, or at all. We have experienced and expect to continue to experience delays and uncertainties in our sales cycle as well as increased up-front expenses in connection with our enterprise sales efforts. The timing of the execution of
enterprise volume licenses could cause our results of operations to vary significantly from quarter to quarter, especially when we anticipate that certain transactions will close in a particular quarter. Further, industry buying patterns suggest
that larger transactions are frequently deferred until later in the quarter, creating increased difficulty in quarterly forecasting. Finally, if a sale is never completed despite months or even years of selling efforts, we will have expended
substantial time, money and resources during the pre-sales effort without generating any revenue to offset these expenses.



Our success is dependent upon our ability to enhance the quality and scalability of our various products, improve the integration and overall functionality of these
products as part of our ALM software development platform, and evolve our ALM platform toward our vision of SDO.



We produce and sell a broad portfolio of products to manage the software development process. The market for these products is characterized by continuous
technological advancement, evolving industry standards and changing customer requirements. A significant portion of our research and development focus is on integrating certain of our point products into our ALM software development platform.
Managing our development activities through our enterprise transformation is complex and involves a number of risks, especially with respect to maintaining competitiveness across our individual products while at the same time bolstering the
integration and functionality of our products as part of our ALM platform. We cannot be certain that we will be successful in designing and marketing new products, providing the necessary product enhancements or features to address increasingly
sophisticated and varied needs of our customers or in enhancing the integration and functionality of our ALM platform.



In addition, our customers use a wide variety of constantly changing hardware, software and operating platforms, adding to our development challenges. We
invest and will continue to invest significant resources to develop products for new or emerging software and hardware platforms in the server, desktop, mobile and other environments that may develop from time to time. However, there is a risk that
a new hardware or software platform for which we do not provide products could rapidly grow in popularity. In particular, we believe that this risk is substantial for particular proprietary platforms and languages for which we may not be given
economically feasible access or access at all. As a result, we may not be in a position to develop products for such platforms or may be late in doing so. If we fail to introduce new products that address the needs of emerging market segments or if
our new products do not achieve market acceptance as a result of delays in development or other factors, our future growth and revenue opportunity could suffer.



Our inability to forecast our revenue pipeline or convert revenue pipeline into contracts could adversely affect our revenues.



We use a pipeline system, a common industry practice, to
forecast sales and trends in our business. Our sales personnel monitor the status of all potential transactions, including the estimated closing date and potential dollar amount of each transaction. We aggregate these estimates periodically to
generate a sales pipeline and then evaluate the pipeline to identify trends in our business. This pipeline analysis and related estimates of revenue may differ significantly from actual revenues in a particular reporting period. When customers delay
purchasing decisions, reduce in amount the purchase or cancel the purchase altogether, it will reduce the rate of conversion of the pipeline into contracts and our revenues will be harmed. In addition, because a substantial portion of our software
license contracts close in the latter part of a quarter, we may not be able to adjust our cost structure to respond to a variation in the conversion of the pipeline into contracts in a timely manner. Our inability to respond to a variation in the
pipeline or in the conversion of the pipeline into contracts in a timely manner, or at all, could cause us to plan or budget inaccurately and thereby could adversely affect our results of operations.



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Because competition for qualified technical and management personnel is intense, we may not be able to recruit or
retain qualified personnel, which could harm our business.



We believe that our ability to successfully grow and manage our business and to develop new products will depend, in large part, on our ability to recruit and retain qualified employees, particularly highly skilled software engineers, sales
personnel and management personnel. Competition for qualified technical and management personnel is intense and in particular, the job market in the Silicon Valley is beginning to recover offering greater opportunities to employees. In addition, in
the past some of our competitors have also utilized their greater resources to provide substantial signing bonuses and other inducements to lure key personnel away from us. We employ a variety of measures to retain our key people, including the
grant of stock options, restricted stock and use of promotions and bonuses. However, due to our financial performance in 2005, no bonus payments were made under our incentive compensation plan in the first half of 2005, which has adversely effected
employee morale and which may lead to employee turnover. We have made efforts to utilize equity based compensation as part of an overall retention program to retain certain key employees; however, we are not certain that our efforts will succeed,
and our failure to attract and retain key personnel could significantly harm our business. If we are unable to recruit and retain quality personnel, our ability to provide solutions that effectively solve customers problems could be harmed. As
a result, we may lose customers or may not achieve anticipated sales during a particular period. In addition, the loss of technical talent may result in our being unable to ship new products or product upgrades at the times that we originally
planned. If we experience delays in the shipment of new products or product upgrades, we may be unable to achieve anticipated sales during a particular period.



We have historically used stock options and other forms of equity compensation as key components of our employee compensation program in order to align
employees interest with the interests of our stockholders, encourage employee retention and provide competitive compensation packages. The decline of our stock price over the last year has made stock options a less attractive portion of our
employee compensation program. Hence, we may find it increasingly difficult to attract, retain and motivate employees, each of which could materially and adversely affect our business, financial condition or results of operations.



A number of factors affecting our revenues make our future results for a particular
period difficult to predict, and therefore we may not meet expectations for a particular period.



We believe that our revenues have the potential to vary significantly from time to time. These variations could cause our stock price to fluctuate
significantly. We believe that these variations may result from many factors, including, but not limited to:



| |  |  | our limited experience in selling large revenue, multiple-product enterprise solutions;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | the size and timing of significant orders and their fulfillment;
| | - |  | ----------------------------------------------------------------



| |  |  | product defects that may be discovered from time to time and other product quality problems;
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | our limited sophistication in consistently forecasting revenues across our geographic regions in light of our transition to an enterprise software company;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the relative mix of demand for our various products and services, especially in light of our increased focus on our services organization;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | timing, and any delay in the introduction, of upgrades or localizations to existing products or releases of new products; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | changes in pricing policies by us or our competitors.
| | - |  | -----------------------------------------------------



Our revenues may also be affected in the short term as a result of not meeting analyst expectations in recent quarters as customers may defer or delay
purchasing decisions. As a result of the foregoing, revenues may be difficult to predict, and any shortfall in revenues for a quarterly period may not be known until late in the quarter. Additionally, our costs, while based on projected revenues,
are relatively fixed in the short term. Therefore, if our revenue levels fall below projections, anticipated profitability will suffer. As a result, we believe that quarterly revenues and operating results will continue to be difficult to forecast,
and period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indications of trends or our future performance.



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Failure to successfully deliver on large transactions may impair our ability to maintain existing and establish new
relationships with enterprise-level customers.



Our
reputation, growth and ability to expand our base of enterprise-level customers depend on the execution of large-scale transactions. Because we are new to providing products and services to enterprise-level customers, our success will depend on our
ability to deploy our products across an enterprise and to deliver products that perform as promised. To be successful in the enterprise market, we must be able to provide high quality products that can scale across the enterprise. In addition, our
success will depend on our ability to properly scale our services organization in order to provide the necessary consulting, education and technical support services needed to successfully deploy our products. If we are unable to provide acceptable
products, or our products are unable to scale effectively with enterprise-level customers, or if we fail to provide adequate professional services to the enterprise customer, we will not be able to execute on our large-scale implementations. Should
this happen, we may lose existing customers and our reputation would be harmed, each of which would cause our revenues to decline.



If we fail to establish strategic relationships with systems integrators or if we are unable to offer adequate services to support existing relationships with
systems integrators, our ability to sell comprehensive solutions to enterprise customers will be harmed.



We believe that growth in our license revenues will depend on our ability to provide our customers with professional services that support the utilization
of our products. This will require establishing stronger relationships with the large systems integrators that have experience implementing enterprise solutions across large organizations. We believe these systems integrators are important to our
sales, marketing and support activities with enterprise customers given their access to large enterprises. If successful, we believe that these relationships will expand the distribution of our products. In addition, to succeed in establishing
successful relationships with systems integrators, we need to provide services that complement their core service offerings. These professional services include maintenance, architectural consulting, training, education, technical support and
project management. We are presently expanding the breadth and depth of our worldwide services organization. If we fail to properly hire and scale our worldwide services organization, we may not be able to provide the services that complement the
core offerings of these systems integrators. If we are unsuccessful in establishing good relations with large systems integrators, our ability to sell our solutions to large enterprises will be greatly diminished, and as a consequence, our revenues
will be harmed.



We may not be able to successfully compete against
current and potential competitors.



Our markets are
intensely competitive. As we enter the market for comprehensive software development solutions, we face competition from some of the largest software providers in the world. For example, IBM, Microsoft, Sun Microsystems, BEA Systems, Mercury
Interactive and others today provide or have stated they intend to provide more comprehensive enterprise software development and integration solutions. Presently, some of these competitors partner with us to enhance the depth of comprehensive
solutions and enhance their reach to our established developer customer base; however, if strategies change and a larger market overlap results, some of these current partners could become more competitive. Many of these competitors have
substantially greater financial, management, marketing and technical resources than we have. In addition, many of our competitors have well established relationships with our current and potential customers, extensive knowledge of the market,
substantial experience in selling enterprise solutions, strong professional services and technical support offerings and extensive product development, sales and marketing resources. As a result of their greater resources and established
relationships, these competitors may be more successful than we are at developing and marketing products and solutions in our markets.



In addition, the markets for our individual products are characterized by rapid change, new and emerging technologies, and fierce competition. Some of our
competitors include IBM, Telelogic, Computer Associates, Quest, Serena, BEA Systems, Microsoft and Sun Microsystems. We attempt to differentiate our products from those of our competitors based on interoperability, total cost of ownership, product
quality, performance, level of integration and reliability. In the future, we may be unable to successfully differentiate our products from those of our competitors, or we may be unable to compete with the substantially greater resources that many
of our competitors have. If so, our business will suffer.



Bundling
arrangements or product give-aways by our competitors, including available, cost-free development technologies, may diminish demand for our products or pressure us to reduce our prices.



Some of our competitors, particularly those that are primarily hardware
vendors or platform providers, generate a substantially greater proportion of their sales in markets in which we do not directly compete. We believe a number of these competitors view sales of software application lifecycle technologies as important
for enhancing the functionality of, and the



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demand for, their core products. As a result, these companies often bundle software products that compete with our
offerings with their other offerings, such as application servers, work stations, personal computers, operating systems databases and IT services. When competitors do so, the effective price for their software products that compete with our software
development platform/solutions are often heavily discounted or offered at no charge. This has required us to reduce the price of our products and related services in certain circumstances, sometimes to no avail. Similarly, industry alliances and
arrangements exist or may be formed in the future under which our competitors ally with companies in markets in which we do not compete to bundle products. These arrangements may also result in lower effective prices for our competitors
products than for our products, putting pressure on our business and diminishing our competitive position.



The complexity of accounting regulations and related interpretations and policies, particularly those related to revenue recognition, could cause us to defer recognition of revenue, or recognize lower revenue
and profits.



We have recently begun entering into
large, complex professional services agreements. We have no prior experience in services engagements of this scale. Our inability to structure and manage services agreement may result in unanticipated changes to the timing of our services revenue.
In addition, if we bundle services together with our license agreements, this may also affect the timing of recognizing our license revenue. We will need to implement new systems or upgrade current systems to manage these large, complex services
agreements. If our systems fail or if our services agreements lead to unanticipated changes to the timing of revenue recognition, then our results of operations could be harmed.



Although we use standard agreements designed to meet current revenue recognition criteria under generally accepted
accounting principles, we must often negotiate and revise terms and conditions of these standard agreements, particularly in multi-product license and services transactions. As our transactions increase in complexity with the sale of larger,
multi-product licenses, negotiation of mutually acceptable terms and conditions may require us to defer recognition of revenue on such licenses. We believe that we are in compliance with Statement of Position 97-2, Software Revenue
Recognition, as amended, however, these future, more complex, multi-product license transactions may require additional accounting analysis to account for them accurately, could lead to unanticipated changes in our current revenue accounting
practices and may contain terms affecting the timing of revenue recognition, which could affect the financial results for a given period.



Our products may contain unknown defects that could result in a loss of revenues, decreased market acceptance, injury to our reputation and product liability
claims.



Software products occasionally contain errors
or defects, especially when they are first introduced or when new versions are released. We cannot assure you that our products are or in the future will be completely free of defects and errors. We could lose revenue as a result of product defects
or errors, including defects contained in third party products by which our products work. In addition, the discovery of a defect or error in a new version or product may result in the following consequences, among others:



| |  |  | delayed shipping of the product;
| | - |  | --------------------------------



| |  |  | delay in market acceptance;
| | - |  | ---------------------------



| |  |  | diversion of development resources;
| | - |  | -----------------------------------



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



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



| |  |  | increased service and warranty costs.
| | - |  | -------------------------------------



As we move away from selling individual point products towards selling enterprise-wide solutions, we also expect our products to become more critical to
our customer. Thus, a defect or error in our products could result in a significant disruption to our customers business. In addition, as we transition to selling larger, more complex solutions, there is also the risk that our current products
will not prove scalable without substantial effort or that there is a market perception that our products are too complex. If are unable to develop products that are free of defects or errors or if our products are not able to scale across an
enterprise or are perceived to be too complex to scale across an enterprise, our business could be harmed.



Consolidation in our industry or fluctuation in our stock price may impede our ability to compete effectively.



Consolidation continues to occur among companies that compete in our markets as companies seek to offer more extensive suites of software products and to
take advantage of efficiencies and economies of scale. Additionally, some of the largest software and hardware providers in the world have sought to expand their software and services offerings through acquisitions in the software development,
deployment and integration space. For instance, in early 2003, IBM acquired



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Rational Software, a provider of application lifecycle development products, and in 2004 purchased SystemCorp, a provider
of software development project and portfolio management products. If these large providers, who have significantly greater financial, management, marketing and technical resources than we have, are successful in increasing their offerings in the
software development market, then this will put significant pressure on our business and harm our ability to compete effectively. Additionally, changes resulting from these and other consolidations may harm our competitive position, particularly as
certain products, when offered as part of a bundled suite, are offered for free or are given away to sell more hardware, infrastructure components or IT services.



As the trend toward consolidation continues, we may encounter increased competition for attractive acquisition targets and
may have to pay higher prices for those businesses or technologies we seek to acquire. In addition, we have seen a recent decline in our stock price which will in turn make it more difficult for us to use stock as a currency for the acquisition of
strategic businesses or technologies. This will put pressure on our ability to seek out potential acquisition targets which may impede our growth and our ability to compete effectively.



We depend on technologies licensed to us by third parties, particularly Sun Microsystems and Microsoft, and the loss of or inability
to maintain these licenses could prevent or delay sales or shipments of certain of our products.



Today, we depend on licenses from third party suppliers for some elements of our products such as various file libraries. In particular, we depend on
technology licenses from Sun Microsystems for certain of our Java products, and we depend on licenses from Microsoft for our Delphi, C++Builder, C#Builder and Borland Developer Studio products. If any of these licenses or other third party licenses
were terminated or were not renewed, or if these third parties failed to notify us in a timely manner of any new or updated technology, we might not be able to ship such products as planned or provide support for such products, including upgrades.
We would then have to seek an alternative to the third partys technology and, in some cases, an alternative may not exist. This could result in delays in releasing and/or shipping our products, increased costs by having to secure unfavorable
royalty arrangements or reduced functionality of our products, which in turn could substantially reduce our revenues.



Our future success depends upon enhancing existing relationships and establishing new technology alliances.



The market landscape for enterprise software application development and
deployment solutions is broad, and our products and solutions must integrate with a wide variety of technologies. To be successful, we must establish and enhance strategic alliances with a wide variety of companies in the software development
ecosystem. Many of these companies have competitive products or have stated a desire to move broadly into the software development lifecycle space. In addition, many of these companies are competitive with one another and approach partnering with us
cautiously. This has made it difficult in some cases to establish or enhance desired relationships or achieve intended objectives. We currently have a number of important strategic alliances and technology relationships with industry leaders. Where
we have established working relationships, our allies may choose to terminate their arrangements with us where no binding contractual arrangements exist. The failure to develop or maintain our strategic alliances and technology relationships or our
allies decision to opt out of their arrangements with us may impede our ability to introduce new products or enter new markets, and consequently harm our revenue prospects.



Failure to manage our international operations could harm our financial results.



A substantial portion of our revenues is from international sales.
International sales accounted for 55% of our revenues during the quarter ended September 30, 2005, with each of Germany and the United Kingdom accounting for significant portions of our total revenue. In addition, a significant portion of our
operations consists of activities outside the United States. We now have research and development facilities in Russia, Singapore, Sweden and the Czech Republic, and we have a direct sales force in place in more than twenty countries around the
world. We have a complicated corporate structure, and historically have had geographically dispersed operational controls. In particular, we rely on personnel in our international locations to properly account for and manage our international
operations, which introduces inherent difficulties in management and control. Given this, we may experience difficulty in efficiently and effectively managing our dispersed and complicated organization. As a result, our results of operations may
suffer. In addition, we are subject to other risks inherent in doing business internationally, including:



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



| |  |  | the difficulty of staffing and managing an organization spread over various countries and continents;
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | potentially reduced or less certain protection for intellectual property rights than is available under the laws of the United States;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------



| |  |  | longer payment cycles in some countries and greater difficulty in collecting accounts receivable;
| | - |  | -------------------------------------------------------------------------------------------------



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| |  |  | restrictions on the expatriation of currency from a particular country;
| | - |  | -----------------------------------------------------------------------



| |  |  | export restrictions, tariffs, duties and other trade barriers;
| | - |  | --------------------------------------------------------------



| |  |  | changes in regulatory requirements and resulting costs;
| | - |  | -------------------------------------------------------



| |  |  | differing cultures and business practices not consistent with our regulatory obligations in the United States;
| | - |  | --------------------------------------------------------------------------------------------------------------



| |  |  | compliance with various conflicting laws and regulations, including employment laws, and resulting costs; and
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | war, threats of war, terrorist activity or political or economic instability in certain parts of the world.
| | - |  | -----------------------------------------------------------------------------------------------------------



One or more of these risks could harm our future research operations and
international sales. If we are unable to manage these risks of doing business internationally, our results of operations could suffer.



If we fail to effectively manage the size of our organization, our operating results could suffer.



As part of our transformation from a provider of individual point product
solutions to an enterprise solution provider, we have engaged in a series of restructurings to realign the organization with our strategy. These changes in our business have placed a significant strain on our management systems and resources. If we
fail to manage the size of our operations effectively, our business could be harmed. In addition, if we are successful in expanding and diversifying our product and customer base, we may be required to increase staffing and other expenditures in
order to meet the anticipated demands of our customers. Given that our customers do not commit to license our software for more than a short time in advance, any increase in expenses in anticipation of future orders that do not materialize could
reduce our profitability.



We have begun the process of implementing and
extending our Oracle financial system worldwide and if we are unsuccessful in deploying the system or, if it takes longer than anticipated to deploy the system, we may incur significant additional costs which would negatively impact our financial
results as well as potentially weaken our internal controls.



In 2005, we made the decision to extend our Oracle financial system worldwide. We are going live with our implementation of the Oracle financial system in our European operations during the fourth quarter of 2005. System conversions are
expensive and time consuming undertakings that impact all areas of the company. While a successful implementation will provide us with many benefits, an unsuccessful or delayed implementation will cost us significant time and resources, as well as
expense. Implementing a new financial system raises costs and risks inherent in any conversion to a new computer system, including, but not limited to, disruption to our normal accounting procedures such as order entry, fulfillment and billing, as
well as problems achieving accuracy in data conversion. Failure to properly or adequately address these issues could result in increased costs, the diversion of managements attention and resources and the inability to forecast revenues and
record and report financial and management information on a timely and accurate basis. This may result in increased costs and could negatively impact our financial results.



In addition, due to the systemic internal control features within financial systems, any changes in our financial system
will have an impact on the testing of our internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002 (SOX 404). Because we are implementing the new financial system during the last quarter of our
fiscal year end, there will be limited, if any, time to remediate any errors. As a result, we are at greater risk for failing to meet SOX 404 testing requirements. If our SOX 404 testing uncovers a material weakness or significant deficiency in our
overall internal controls over financial reporting as of the end of the fiscal year, or our independent registered public accounting firm is not be able to render the required attestation concerning our assessment and the effectiveness of our
internal control over financial reporting, this could adversely effect our investor confidence as well as the market price of our common stock.



We rely on value-added resellers, and other channel partners to complement our direct sales. If we cease doing business with one or more of these parties, our
revenues could suffer.



We rely on value-added
resellers (VARs) and other channel partners to complement our direct sales primarily in relation to our maturing products. The pricing, terms and conditions of our agreements with these parties are individually negotiated and vary by
agreement. A majority of these agreements are non-exclusive. Many of our agreements do not require these channel partners to make a minimum number of purchases, and we have virtually no control over the shipping dates or volumes of software shipped
by our channel partners. Although we believe our relationships with these parties have been productive to date, we cannot guarantee that these relationships will continue to be productive or grow or that the channel partners will continue to
purchase our products at anticipated levels in the future. If we do not maintain good relations with our channel and other partners or if we are unable to secure arrangements with these parties on favorable terms, our business may suffer.



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In particular, we depend on a small number of distributors for a portion of our revenue. While we have
decreased our dependence on these distributors, we expect that a small number of distributors will continue to account for a portion of our revenues for the foreseeable future. Presently, some software distributors are experiencing financial
weakness. If we lose a major distributor, such as Ingram Micro, our revenues could suffer.



We may incur future impairment losses related to intangible assets from prior acquisitions that could harm our future operating results.



In the past few years, we have acquired significant assets and businesses. If the assets and businesses do not perform as
expected, we may be required to take impairment charges related to the intangible assets from these acquisitions. Such charges could harm our operating results.



Recent changes in accounting for equity compensation could adversely affect our earnings and could require a modification to our equity compensation strategy,
which could impact our ability to attract and retain employees.



We currently account for stock options under APB 25 and, accordingly, we record compensation expense related to stock options if the current market price of the underlying stock exceeds the exercise price of the stock
option on the date of grant. On December 15, 2004, the FASB issued SFAS 123R, which will require us to expense stock options in our statement of operations. On April 14, 2005, the SEC adopted a new rule amending the compliance dates for
SFAS 123R which will delay the effective date of compliance for us to fiscal 2006. SFAS 123R applies to all outstanding stock options that are not vested at the effective date and grants of new stock options made subsequent to the effective date.
Upon adoption of SFAS 123R, we estimate that our earnings in 2006 could be reduced significantly, which will make it substantially more likely that we could experience net losses.



We have historically used stock options and other forms of equity compensation as key components of our employee
compensation program in order to align employees interests with the interests of our stockholders, encourage employee retention, and provide competitive compensation packages. The changing regulatory landscape could make it more difficult and
expensive for us to grant stock options to employees in the future. If employees believe that the incentives that they would receive under a modified strategy are less attractive, we may find it difficult to attract, retain and motivate employees.
In addition, the use of alternative equity incentives may increase our compensation expense and may negatively impact our earnings. To the extent that new regulations make it more difficult or expensive to grant equity instruments to employees, we
may incur increased compensation costs, further change our equity compensation strategy or find it increasingly difficult to attract, retain and motivate employees, each of which could materially and adversely affect our business, financial
condition or results of operations.



If we are unable to protect our
intellectual property, we may lose valuable assets.



As a software company, our intellectual property rights are among our most valuable assets. We rely on a combination of patent, copyright, trademark, trade secret laws, confidentiality agreements and other contractual arrangements and other
methods to protect our intellectual property rights, but these measures may provide only limited protection. The protective steps we have taken may be inadequate to deter misappropriations of our intellectual property rights. In addition, it may be
possible for an unauthorized third party to reverse-engineer or decompile our software products. We may be unable to detect the unauthorized use of, or take appropriate steps to enforce, our intellectual property rights, particularly in certain
international markets, making misappropriation of our intellectual property more likely. Litigation may be necessary to protect our intellectual property rights, and such litigation can be time consuming and expensive.



Third party claims of intellectual property infringement may subject us to costly
litigation or settlement terms or limit the sales of our products.



From time to time, we have received notices claiming that we have infringed a third partys patent or other intellectual property right. We expect that software products in general will increasingly be subject to
these claims as the number of products and competitors increase, the functionality of products overlap and as the patenting of software functionality becomes more widespread. Further, the receipt of a notice alleging infringement may require in some
situations that a costly opinion of counsel be obtained to prevent an allegation of intentional infringement. Regardless of its merits, responding to any claim can be time consuming and costly and divert the efforts of our technical and management
personnel from productive tasks. In the event of a successful claim against us, we may be required to pay significant monetary damages,



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including treble damages if we are held to have willfully infringed, discontinue the use and sale of the infringing
products, expend significant resources to develop non-infringing technology and/or enter into royalty and licensing agreements that might not be offered or be available on acceptable terms. If a successful claim were made against us and we failed to
commercially develop or license a substitute technology, our business could be harmed. In addition, we may not have insurance coverage for these types of claims or our insurance coverage for these types of claims may not be adequate.



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Item 3. Quantitative and Qualitative Disclosures About Market Risk



Market risks relating to our operations result primarily from changes in interest rates and foreign currency exchange rates, as well as credit risk
concentrations. To address the foreign currency exchange rate risk we enter into various foreign currency forward exchange contracts as described below. We do not use financial instruments for trading purposes.



Foreign Currency Risk



A significant portion of our business is conducted in currencies other than
the U.S. dollar. The functional currency for all of our foreign operations is the local currency of the country in which we have established business operations. Both revenues and operating expenses in each of these countries are in local
currencies, which mitigates a portion of the exposure related to fluctuations in local currencies against the U.S. dollar. However, our financial results could still be adversely affected by factors such as changes in foreign currency exchange rates
or weak economic conditions in foreign markets. In addition, we have established a program to minimize our foreign currency exposure utilizing forward exchange contracts to manage foreign currency exposures related to short-term inter-company
balances denominated in foreign currencies. The goal of this program is to offset the translation effect of foreign currency-denominated short-term inter-company balances by entering into contracts to buy or sell foreign currency at the time a
foreign currency receivable or payable is generated. At month-end, foreign currency-denominated balances and the forward exchange contracts are marked-to-market and unrealized gains and losses are included in interest and other income, net.



During the three and nine months ended September 30,
2005, we recorded net foreign exchange losses of $135,000 and $381,000, respectively, included as part of interest and other income, net, in our Condensed Consolidated Statements of Operations. The foreign exchange losses were generated primarily
due to fluctuation in the Euro, the United Kingdom Pound Sterling, and the Australian and Singapore dollars versus the U.S. dollar. It is uncertain whether these currency trends will continue. In the future we may experience foreign exchange
losses on our inter-company receivables to the extent that we have not mitigated our exposure utilizing foreign currency forward exchange contracts. Foreign exchange losses could have a materially adverse effect on our operating results and cash
flows.



During the three and nine months ended
September 30, 2005 we recorded unrealized foreign currency losses of $430,000 and $4.8 million, respectively, in cumulative other comprehensive income on the Condensed Consolidated Balance Sheets, in part, due to foreign currency movements on
our long-term inter-company balances. As of September 30, 2005, we had $17.4 million, $2.8 million, $1.5 million, $1.3 million and $399,000 in long-term inter-company balances that will be settled in Australian dollars, Singapore dollars,
Japanese Yen, Brazilian Reais and South Korean Won, respectively.



We have performed a sensitivity analysis to assess the potential financial effect of possible near-term changes in foreign currency exchange rates. Based upon our analysis, the effect of such rate changes is not expected to be material to
our financial condition, results of operations or cash flows because the effect of movements in currency exchange rates on our forward exchange contracts generally offset the related effect on the underlying inter-company balances.



The table below provides information about our derivative financial
instruments, comprised of foreign currency forward exchange contracts as of September 30, 2005. The information is provided in U.S. dollar equivalent amounts, as presented in our financial statements. For foreign currency forward exchange
contracts, the table below presents the notional amounts (at the contract exchange rates), the weighted-average contractual foreign currency exchange rates and the net fair value for our forward contracts as of September 30, 2005. All forward
contracts in the table below represent contracts to buy or sell the currencies listed. All instruments mature within one month (dollar amounts in thousands).



|                                             |  |                 |        |   |                               |            |                                     |   |        |  
|-------------------------------------------- |  | --------------- | ------ | - | ----------------------------- | ---------- | ----------------------------------- | - | ------ | -
|                                             |  | Notional Amount |        |   | Weighted-AverageContract Rate |            | Net Fair Value atSeptember 30, 2005 |  
|Foreign currency forward exchange contracts: |  |                 |        |   |                               |            |                                     |   |        |  
|Australian dollar                            |  | $               | 2,486  |   |                               | 0.7510     |                                     | $ | 2,481  |  
|Canadian dollar                              |  |                 | 259    |   |                               | 1.1806     |                                     |   | 259    |  
|Czech Koruna                                 |  |                 | (437   | ) |                               | 24.3050    |                                     |   | (438   | )
|Euro                                         |  |                 | 2,899  |   |                               | 1.2105     |                                     |   | 2,902  |  
|Hong Kong dollar                             |  |                 | 878    |   |                               | 7.7588     |                                     |   | 879    |  
|Indian Rupee                                 |  |                 | 634    |   |                               | 44.5000    |                                     |   | 628    |  
|Japanese Yen                                 |  |                 | 8,785  |   |                               | 113.5800   |                                     |   | 8,809  |  
|New Zealand dollar                           |  |                 | (707   | ) |                               | 0.6862     |                                     |   | (705   | )
|Russian Rouble                               |  |                 | (1,147 | ) |                               | 28.3350    |                                     |   | (1,155 | )
|Singapore dollar                             |  |                 | 9,670  |   |                               | 1.6986     |                                     |   | 9,672  |  
|South Korean Won                             |  |                 | 9      |   |                               | 1,037.5000 |                                     |   | 9      |  
|United Kingdom Pound Sterling                |  |                 | 1,083  |   |                               | 1.7683     |                                     |   | 1,082  |  
|                                             |  |                 |        |   |                               |            |                                     |   |        |  
|Total                                        |  | $               | 24,412 |   |                               |            |                                     | $ | 24,423 |  
|                                             |  |                 |        |   |                               |            |                                     |   |        |  



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Interest Rate Risk



Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. We do not use
derivative financial instruments in our investment portfolio. We place our cash equivalents and short-term investments in a variety of financial instruments such as certificates of deposit, commercial paper and auction rate securities. By corporate
policy, we limit the amount of our credit exposure to $5.0 million to any one commercial issuer.



We mitigate default risk by investing in securities rated at least A2/P2 as published by Standard and Poors and Moodys, and by positioning our
portfolio to respond appropriately to a significant reduction in the credit rating of any investment issuer. To ensure portfolio liquidity, our portfolio includes only marketable securities with active secondary and resale markets.



Cash and cash equivalents include investments, which have an original
maturity of 90 days or less and short-term investments include investments which have an original maturity of 91 days up to one year. As of September 30, 2005 and December 31, 2004, we held no investments classified as long-term. Our
investment portfolio includes auction rate securities that are issued and rated as long-term bonds but are classified as short-term investments because we intend to hold them for less than one year. At September 30, 2005, the weighted-average
interest rate we earned on our cash and cash equivalents balance of $62.2 million was 3.51% and the weighted-average interest rate we earned on our short-term investments balance of $126.9 million was 3.56%. At December 31, 2004, the
weighted-average interest rate we earned on our cash and cash equivalents balance of $76.4 million was 2.11% and the weighted-average interest rate we earned on our short-term investments balance of $144.8 million was 2.48%. The difference in the
weighted-average interest rates associated with cash and cash equivalents and short-term investments is primarily due to interest rates on auction rate securities which are included in our short-term investments. If market interest rates were to
increase or decrease immediately and uniformly by 10% from levels as of September 30, 2005, it would not materially change the fair market value of our investment portfolio.



Credit Risks



Our financial instruments that are exposed to concentrations of credit risk consist primarily of cash, cash equivalents, short-term investments and trade
receivables. Our cash, cash equivalents and short-term investments are in high-quality securities placed with major banks and financial institutions and commercial paper. Concentrations of credit risk with respect to receivables are limited due to
the large number of customers and their dispersion across geographic areas. We perform periodic credit evaluations of our customers financial condition and generally do not require collateral. No single group or customer represented greater
than 10% of total accounts receivable, net of allowances, as of September 30, 2005, or December 31, 2004.



Item 4. Controls and Procedures



CEO and CFO Certifications



Included as exhibits to this Quarterly Report on Form 10-Q are Certifications of the Chief Executive Officer and the Chief Financial Officer. The first form of certification is required in accordance with
Section 302 of the Sarbanes-Oxley Act of 2002. This section of the Quarterly Report contains the information concerning the controls evaluation referred to in the Section 302 Certifications and this information should be read in
conjunction with the Section 302 Certifications for a more complete understanding of the topics presented.



Disclosure Controls and Procedures and Internal Control over Financial Reporting



Disclosure controls and procedures are those controls and procedures designed with the objective of ensuring that
information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 (Exchange Act) is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms.
Disclosure controls and procedures are designed with the objective of ensuring that such information is accumulated and communicated to our management, including the CEO and CFO, to allow timely decisions regarding required disclosure.



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Internal control over financial reporting is a set of processes designed by, or under the supervision of,
our CEO and CFO, or persons performing similar functions, and implemented by our Board of Directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with accounting principles generally accepted in the United States (GAAP). Internal control over financial reporting includes those policies and procedures that:



| |  |  | pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and dispositions of our assets;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures
are being made only in accordance with authorizations of our management and directors; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the
financial statements.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Limitations on the Effectiveness of
Controls



Our management, including our CEO and CFO,
does not expect that our disclosure controls or our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance
that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent
limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. Because of their inherent limitations, control systems may
not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.



Evaluation of our Disclosure
Controls and Procedures



As of the end of the period
covered by this report, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures. This evaluation and review was done under the supervision and with the participation of our CEO and CFO and other
management. The evaluation of our disclosure controls and procedures by our CEO and CFO included a review of the controls objectives and design, the controls implementation by us and the effect of the controls on the information
generated for use in this Quarterly Report on Form 10-Q.



Based
upon the controls evaluation, our CEO and CFO have concluded that, as of the period covered by this report, our disclosure controls and procedures were effective in that they provide reasonable assurance that information required to be disclosed by
us in the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms.



Changes in Internal Control Over Financial Reporting



There have been no changes in our internal control over financial reporting during the third quarter ended September 30, 2005 which our
management concluded materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. We anticipate we will complete the implementation of a new Oracle financial system in our European operations and
go live with the system in the quarter ending December 31, 2005. We have been working on changing out the old system and implementing the new system for the past several months. The implementation will result in changes to our internal controls over
financial reporting in the quarter. Although we believe effects from the implementation of the new system will be minimal, since the new system will be implemented during the last quarter of our fiscal year end, there will be limited time, if any,
to remediate any errors that arise. This may result in one or more material weaknesses in internal controls arising, that would impact our annual attestation concerning our assessment of the effectiveness of our internal controls over financial
reporting.



38



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##### Table of Contents

PART II

OTHER INFORMATION



Item 1. Legal Proceedings



On November 27, 2002, a stockholder class action and derivative lawsuit, Dieterich v. Harrer, et al., Case No. 02CC00350, was filed against Starbase Corporation, or Starbase, and five former directors of Starbase in the Superior
Court of the State of California for Orange County, claiming that the former directors had breached fiduciary duties owed to Starbase and stockholders of Starbase. We are paying the costs of defending this litigation pursuant to indemnification
obligations under the merger agreement relating to our acquisition of Starbase. Following a series of motions, the case was dismissed without prejudice on August 20, 2003. On October 28, 2003, a stockholder class action relating to the
same matter, Dieterich v. Harrer, et al, Case No. 024-N, was filed against the former directors of Starbase in Chancery Court of the State of Delaware, alleging breach of fiduciary duties by the former directors of Starbase. The lawsuit also
named as defendants Borland, and the following four former executive officers of Borland: Dale Fuller, Keith Gottfried, Frederick Ball, and Doug Barre. Defendants moved to dismiss and in August 2004, the Chancery Court granted in part and denied in
part the motion to dismiss. Discovery has commenced and there is no date set for trial. We intend to defend ourselves vigorously. There is no indication at present whether the lawsuit will have a material effect on our financial condition, results
of operations or liquidity.



From time to time, we may be
involved in other lawsuits, claims, investigations and proceedings, consisting of intellectual property, commercial, employment and other matters, which arise in the ordinary course of business. In accordance with SFAS 5, Accounting for
Contingencies we record a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These accruals are reviewed at least quarterly and adjusted to reflect the impacts of
negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case. Litigation is inherently unpredictable, however, we believe that we have valid defenses with respect to the legal matters
pending against us, as well as adequate accruals for any probable and estimable losses. If an unfavorable ruling were to occur in any specific period, there exists the possibility of a material adverse impact on the results of operations for that
period. We believe that, except as described above, given our current liquidity and cash and investment balances, even were we to receive an adverse judgment with respect to litigation that we are currently a party to, it is likely that such a
judgment would not have a material impact on our financial condition, results of operations or liquidity.



From time to time we receive notices from third parties claiming infringement by our products of third party patent, trademark and other intellectual
property rights, disputing royalties, or disputing other commercial arrangements. Regardless of the merit of any such claim, responding to these claims could be time consuming and expensive, and may require us to enter into licensing or royalty
agreements which may not be offered or available on terms acceptable to us. If a successful claim is made against us, our business could be materially and adversely affected. We expect that our software products will increasingly be subject to such
claims as the number of products and competitors in our industry segment increases, the functionality of products overlap and industry participants become more aggressive in using patents offensively.



Item 2. Unregistered Sales of Equity Securities and Use of Proceeds



|(c) | Below is a summary of stock repurchases for the quarter ended September 30, 2005. See Note 9 of Notes to Condensed Consolidated Financial Statements for information regarding
our stock repurchase programs.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

PURCHASES OF EQUITY SECURITIES (1)



|                                                                                                             |  |                                               |  |                                          |      |                                                                                             |        |                                                                                                                        |   |            |  
|------------------------------------------------------------------------------------------------------------ |  | --------------------------------------------- |  | ---------------------------------------- | ---- | ------------------------------------------------------------------------------------------- | ------ | ---------------------------------------------------------------------------------------------------------------------- | - | ---------- | -
|                                                                                                             |  | (a) Total Numberof Shares (orUnits) Purchased |  | (b) AveragePrice Paid perShare (or Unit) |      | (c) Total Number ofShares (or Units)Purchased as Part ofPublicly AnnouncedPlans or Programs |        | (d) Maximum Number(or Approximate DollarValue) of Shares (orUnits) that May Yet BePurchased Under thePlans or
Programs |  
|Beginning dollar value available to be repurchased as of June 30, 2005 (2)                                   |  |                                               |  |                                          |      |                                                                                             |        |                                                                                                                        | $ | 65,884,532 |  
|July 1, 2005  July 31, 2005                                                                                 |  |                                               |  |                                          |      |                                                                                             |        |                                                                                                                        |   |            |  
|Open market purchases (3)                                                                                    |  | 40,000                                        |  | $                                        | 6.39 |                                                                                             | 40,000 |                                                                                                                        |   | (255,522   | )
|August 1, 2005  August 31, 2005                                                                             |  |                                               |  |                                          |      |                                                                                             |        |                                                                                                                        |   |            |  
|Open market purchases (3)                                                                                    |  | 8,000                                         |  | $                                        | 6.54 |                                                                                             | 8,000  |                                                                                                                        |   | (52,340    | )
|Expiration of the 10b5-1 Program (4)                                                                         |  |                                               |  |                                          |      |                                                                                             |        |                                                                                                                        |   | (6,244,433 | )
|September 1, 2005  September 31, 2005                                                                       |  |                                               |  |                                          |      |                                                                                             |        |                                                                                                                        |   |            |  
|Open market purchases (3)                                                                                    |  |                                              |  |                                          |     |                                                                                             |       |                                                                                                                        |   |           |  
|                                                                                                             |  |                                               |  |                                          |      |                                                                                             |        |                                                                                                                        |   |            |  
|Total shares repurchased                                                                                     |  | 48,000                                        |  |                                          |      |                                                                                             | 48,000 |                                                                                                                        |   |            |  
|                                                                                                             |  |                                               |  |                                          |      |                                                                                             |        |                                                                                                                        |   |            |  
|Ending dollar value available to be repurchased under the Discretionary Program as of September 30, 2005 (5) |  |                                               |  |                                          |      |                                                                                             |        |                                                                                                                        | $ | 59,332,237 |  
|                                                                                                             |  |                                               |  |                                          |      |                                                                                             |        |                                                                                                                        |   |            |  

---

|(1) | In September 2001, our Board of Directors authorized the use of up to $30 million to repurchase shares of our outstanding common stock under a discretionary stock repurchase program
(the Discretionary Program). The Discretionary Program was announced in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) on April 15, 2002. In February 2004, our Board of Directors
authorized an additional $30 million of repurchases under the Discretionary Program, which was announced in our Current Report on Form 8-K filed with the SEC on February 12, 2004. In August 2003, our Board of Directors authorized a 10b5-1 stock
repurchase program (10b5-1 Program) whereby up to 1,000,000 shares or $15 million worth of our outstanding common stock, whichever comes first, may be repurchased with a per day trading limit of 2,000 shares. The 10b5-1 Program was
announced in our Current Report on Form 8-K filed with the SEC on August 7, 2003. On May 20, 2005, the Board of Directors authorized an increase to the Discretionary Program of $75 million, which was announced in our Current Report on Form
8-K filed with the SEC on May 20, 2005.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Includes $59,332,237 under our Discretionary Program and $6,552,295 or 48,000 shares under our 10b5-1 Program.
|--- | --------------------------------------------------------------------------------------------------------------

|(3) | No shares were repurchased other than through our 10b5-1 Program during the three months ended September 30, 2005.
|--- | ------------------------------------------------------------------------------------------------------------------

|(4) | The Board of Directors authorized a 10b5-1 stock repurchase program (10b5-1 Program) whereby up to 1,000,000 shares or $15 million worth of our outstanding common stock,
whichever comes first, may be repurchased. The 10b5-1 Program expired during the three months ended September 30, 2005 when the accumulated total number of shares repurchased under the program since its inception reached 1,000,000.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Includes $59,332,237 under our Discretionary Program.
|--- | -----------------------------------------------------



Item 5. Other Information.



On November 1, 2005, we filed a Current Report on Form 8-K with the SEC to report the amendment of severance arrangements with our named executive officers (the Form 8-K). The following information is a correction from what was
disclosed in such Form 8-K and corrects the information with respect to the types of terminations that will trigger severance benefits for such named executives officers most in connection with a change of control. In addition to the terms of the
severance disclosed in the Form 8-K, if a named executive officer voluntarily terminates employment with Borland as a result of a constructive termination, then the Severance Agreement provides for (i) a severance payment equal to 50% of the
executives annual base salary and (ii) continuation of health coverage by having Borland pay the executives COBRA premiums for up to 12 months.



40



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##### Table of Contents

Item 6. Exhibits



(a) Exhibits



Except as so indicated in Exhibits 32.1 and 32.2, the following exhibits are
filed as part of, or incorporated by reference into, this Quarterly Report.



|               |  |                                                                                                                                                   |  |                           |  |          |  |        |  |               
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- |  | -------- |  | ------ |  | --------------
|               |  |                                                                                                                                                   |  | Incorporated by Reference |  |         
|Exhibit Number |  | Description of Exhibit                                                                                                                            |  | Form                      |  | Date     |  | Number |  | Filed Herewith
|3.1            |  | Restated Certificate of Incorporation of Borland Software Corporation.                                                                            |  | 10-Q                      |  | 08/09/05 |  | 3.1    |  |               
|               |  |                                                                                                                                                   |  |                           | 
|3.2            |  | Amended and Restated Bylaws of Borland Software Corporation.                                                                                      |  | 10-Q                      |  | 08/09/05 |  | 3.2    |  |               
|               |  |                                                                                                                                                   |  |                           | 
|4.1            |  | Stockholder Rights Agreement, dated as of October 26, 2001, between Borland Software Corporation and Mellon Investor Services, L.L.C.             |  | 8-A                       |  | 10/31/01 |  | 1      |  |               
|               |  |                                                                                                                                                   |  |                           | 
|4.2            |  | Specimen Stock Certificate of Borland Software Corporation.                                                                                       |  | 10-Q                      |  | 05/13/02 |  | 4.1    |  |               
|               |  |                                                                                                                                                   |  |                           | 
|4.3            |  | Investor Rights Agreement between Borland Software Corporation and Microsoft Corporation, dated as of June 7, 1999.                               |  | 8-K                       |  | 07/06/99 |  | 4.2(a) |  |               
|               |  |                                                                                                                                                   |  |                           | 
|10.74          |  | Form of Stock Issuance Agreement under the Stock Issuance Program of the 2002 Stock Incentive Plan +                                              |  |                           |  |          |  |        |  | X             
|               |  |                                                                                                                                                   |  |                           | 
|10.75          |  | Form of Acceleration Addendum to Stock Issuance Agreement under the Stock Issuance Program of the 2002 Stock Incentive Plan +                     |  |                           |  |          |  |        |  | X             
|               |  |                                                                                                                                                   |  |                           | 
|10.76          |  | Form of Stock Option Agreement under the Discretionary Option Grant Program of the 2002 Stock Incentive Plan +                                    |  |                           |  |          |  |        |  | X             
|               |  |                                                                                                                                                   |  |                           | 
|10.77          |  | Form of Acceleration Addendum to Stock Option Agreement under the Discretionary Grant Program of the 2002 Stock Incentive Plan +                  |  |                           |  |          |  |        |  | X             
|               |  |                                                                                                                                                   |  |                           | 
|10.78          |  | Form of Addendum to Employment Offer Letters for Severance Benefits for Named Executive Officers +                                                |  |                           |  |          |  |        |  | X             
|               |  |                                                                                                                                                   |  |                           | 
|31.1           |  | Certification of Scott J. Arnold, Chief Executive Officer of Borland Software Corporation, pursuant to Rule 13a-14(a).                            |  |                           |  |          |  |        |  | X             
|               |  |                                                                                                                                                   |  |                           | 
|31.2           |  | Certification of Kenneth R. Hahn, Chief Financial Officer of Borland Software Corporation, pursuant to Rule 13a-14(a).                            |  |                           |  |          |  |        |  | X             
|               |  |                                                                                                                                                   |  |                           | 
|32.1           |  | Certification of Scott J. Arnold, Chief Executive Officer of Borland Software Corporation, pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350. |  |                           |  |          |  |        |  | X             
|               |  |                                                                                                                                                   |  |                           | 
|32.2           |  | Certification of Kenneth R. Hahn, Chief Financial Officer of Borland Software Corporation, pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350. |  |                           |  |          |  |        |  | X             

---

|+ | Management contract or compensatory plan or arrangement
|- | -------------------------------------------------------



A copy of any exhibit will be furnished (at a reasonable cost) to any stockholder of Borland upon receipt of a written request. Such request should be
sent to Borland Software Corporation, 20450 Stevens Creek Boulevard, Suite 800, Cupertino, California 95014, Attention: Investor Relations.



41



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##### Table of Contents

SIGNATURE



Pursuant to the
requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized on the 8thday of November 2005.



BORLAND SOFTWARE CORPORATION(Registrant)/s/ KENNETH R. HAHNKenneth R. HahnSenior Vice President and Chief Financial Officer(Principal Financial Officer and Duly Authorized Officer)




42



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##### Table of Contents

EXHIBIT INDEX



|               |  |                                                                                                                                                   |  |                           |  |          |  |        |  |               
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- |  | -------- |  | ------ |  | --------------
|               |  |                                                                                                                                                   |  | Incorporated by Reference |  |         
|Exhibit Number |  | Description of Exhibit                                                                                                                            |  | Form                      |  | Date     |  | Number |  | Filed Herewith
|3.1            |  | Restated Certificate of Incorporation of Borland Software Corporation.                                                                            |  | 10-Q                      |  | 08/09/05 |  | 3.1    |  |               
|               |  |                                                                                                                                                   |  |                           | 
|3.2            |  | Amended and Restated Bylaws of Borland Software Corporation.                                                                                      |  | 10-Q                      |  | 08/09/05 |  | 3.2    |  |               
|               |  |                                                                                                                                                   |  |                           | 
|4.1            |  | Stockholder Rights Agreement, dated as of October 26, 2001, between Borland Software Corporation and Mellon Investor Services, L.L.C.             |  | 8-A                       |  | 10/31/01 |  | 1      |  |               
|               |  |                                                                                                                                                   |  |                           | 
|4.2            |  | Specimen Stock Certificate of Borland Software Corporation.                                                                                       |  | 10-Q                      |  | 05/13/02 |  | 4.1    |  |               
|               |  |                                                                                                                                                   |  |                           | 
|4.3            |  | Investor Rights Agreement between Borland Software Corporation and Microsoft Corporation, dated as of June 7, 1999.                               |  | 8-K                       |  | 07/06/99 |  | 4.2(a) |  |               
|               |  |                                                                                                                                                   |  |                           | 
|10.74          |  | Form of Stock Issuance Agreement under the Stock Issuance Program of the 2002 Stock Incentive Plan +                                              |  |                           |  |          |  |        |  | X             
|               |  |                                                                                                                                                   |  |                           | 
|10.75          |  | Form of Acceleration Addendum to Stock Issuance Agreement under the Stock Issuance Program of the 2002 Stock Incentive Plan +                     |  |                           |  |          |  |        |  | X             
|               |  |                                                                                                                                                   |  |                           | 
|10.76          |  | Form of Stock Option Agreement under the Discretionary Option Grant Program of the 2002 Stock Incentive Plan +                                    |  |                           |  |          |  |        |  | X             
|               |  |                                                                                                                                                   |  |                           | 
|10.77          |  | Form of Acceleration Addendum to Stock Option Agreement under the Discretionary Grant Program of the 2002 Stock Incentive Plan +                  |  |                           |  |          |  |        |  | X             
|               |  |                                                                                                                                                   |  |                           | 
|10.78          |  | Form of Addendum to Employment Offer Letters for Severance Benefits for Named Executive Officers +                                                |  |                           |  |          |  |        |  | X             
|               |  |                                                                                                                                                   |  |                           | 
|31.1           |  | Certification of Scott J. Arnold, Chief Executive Officer of Borland Software Corporation, pursuant to Rule 13a-14(a).                            |  |                           |  |          |  |        |  | X             
|               |  |                                                                                                                                                   |  |                           | 
|31.2           |  | Certification of Kenneth R. Hahn, Chief Financial Officer of Borland Software Corporation, pursuant to Rule 13a-14(a).                            |  |                           |  |          |  |        |  | X             
|               |  |                                                                                                                                                   |  |                           | 
|32.1           |  | Certification of Scott J. Arnold, Chief Executive Officer of Borland Software Corporation, pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350. |  |                           |  |          |  |        |  | X             
|               |  |                                                                                                                                                   |  |                           | 
|32.2           |  | Certification of Kenneth R. Hahn, Chief Financial Officer of Borland Software Corporation, pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350. |  |                           |  |          |  |        |  | X             

---

|+ | Management contract or compensatory plan or arrangement
|- | -------------------------------------------------------



43