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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 March 31, 2006

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

Not Applicable

(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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of
accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.

Large accelerated
filer ̈Accelerated filer  x    Non-accelerated filer ̈

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 April 28, 2006, the most recent practicable
date prior to the filing of this report, was 77,792,312.



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##### Table of Contents

BORLAND SOFTWARE CORPORATION FORM 10-Q

TABLE OF CONTENTS



|         |  |                                                                                                                     |  |     
|-------- |  | ------------------------------------------------------------------------------------------------------------------- |  | ----
|         |  |                                                                                                                     |  | PAGE
|         |  | PART I FINANCIAL INFORMATION                                                                                        |  |     
|Item 1.  |  | Financial Statements (unaudited)                                                                                    |  | 1   
|         |  |                                                                                                                    
|         |  | Condensed Consolidated Balance Sheets at March 31, 2006 and December 31, 2005                                       |  | 1   
|         |  |                                                                                                                    
|         |  | Condensed Consolidated Statements of Operations for the three months ended March 31, 2006 and 2005                  |  | 2   
|         |  |                                                                                                                    
|         |  | Condensed Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2006 and 2005 |  | 3   
|         |  |                                                                                                                    
|         |  | Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2006 and 2005                  |  | 4   
|         |  |                                                                                                                    
|         |  | Notes to Condensed Consolidated Financial Statements                                                                |  | 5   
|         |  |                                                                                                                    
|Item 2.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                               |  | 17  
|         |  |                                                                                                                    
|Item 3.  |  | Quantitative and Qualitative Disclosures About Market Risk                                                          |  | 27  
|         |  |                                                                                                                    
|Item 4.  |  | Controls and Procedures                                                                                             |  | 29  
|         |  |                                                                                                                    
|         |  | PART II OTHER INFORMATION                                                                                           |  |     
|         |  |                                                                                                                    
|Item 1.  |  | Legal Proceedings                                                                                                   |  | 32  
|         |  |                                                                                                                    
|Item 1A. |  | Risk Factors                                                                                                        |  | 33  
|         |  |                                                                                                                    
|Item 2.  |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                         |  | 45  
|         |  |                                                                                                                    
|Item 3.  |  | Defaults on Senior Securities                                                                                       |  | 46  
|         |  |                                                                                                                    
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                                 |  | 46  
|         |  |                                                                                                                    
|Item 5.  |  | Other Information                                                                                                   |  | 46  
|         |  |                                                                                                                    
|Item 6.  |  | Exhibits                                                                                                            |  | 46  
|         |  |                                                                                                                    
|         |  | Signature                                                                                                           |  | 48  



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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)



|                                                                                                                     |  |               |          |   |                  |   |          |  
|-------------------------------------------------------------------------------------------------------------------- |  | ------------- | -------- | - | ---------------- | - | -------- | -
|                                                                                                                     |  | March 31,2006 |          |   | December 31,2005 |  
|ASSETS                                                                                                               |  |               |          |   |                  |   |          |  
|Current assets:                                                                                                      |  |               |          |   |                  |   |          |  
|Cash and cash equivalents                                                                                            |  | $             | 133,228  |   |                  | $ | 49,075   |  
|Short-term investments                                                                                               |  |               | 39,846   |   |                  |   | 126,003  |  
|Accounts receivable, net of allowances of $6,339 and $7,235                                                          |  |               | 48,225   |   |                  |   | 54,405   |  
|Prepaid expenses                                                                                                     |  |               | 15,249   |   |                  |   | 13,583   |  
|Other current assets                                                                                                 |  |               | 1,513    |   |                  |   | 2,287    |  
|                                                                                                                     |  |               |          |   |                  |   |          |  
|Total current assets                                                                                                 |  |               | 238,061  |   |                  |   | 245,353  |  
|Property and equipment, net                                                                                          |  |               | 17,815   |   |                  |   | 17,837   |  
|Goodwill                                                                                                             |  |               | 187,691  |   |                  |   | 187,337  |  
|Intangible assets, net                                                                                               |  |               | 3,260    |   |                  |   | 3,900    |  
|Other non-current assets                                                                                             |  |               | 8,602    |   |                  |   | 10,103   |  
|                                                                                                                     |  |               |          |   |                  |   |          |  
|Total assets                                                                                                         |  | $             | 455,429  |   |                  | $ | 464,530  |  
|                                                                                                                     |  |               |          |   |                  |   |          |  
|                                                                                                                     |  |              
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                 |  |               |          |   |                  |   |          |  
|                                                                                                                     |  |              
|Current liabilities:                                                                                                 |  |               |          |   |                  |   |          |  
|Accounts payable                                                                                                     |  | $             | 17,859   |   |                  | $ | 14,002   |  
|Accrued expenses                                                                                                     |  |               | 37,458   |   |                  |   | 40,204   |  
|Short-term restructuring                                                                                             |  |               | 3,797    |   |                  |   | 3,905    |  
|Income taxes payable                                                                                                 |  |               | 17,127   |   |                  |   | 17,285   |  
|Deferred revenues                                                                                                    |  |               | 52,193   |   |                  |   | 55,470   |  
|Other current liabilities                                                                                            |  |               | 6,550    |   |                  |   | 6,210    |  
|                                                                                                                     |  |               |          |   |                  |   |          |  
|Total current liabilities                                                                                            |  |               | 134,984  |   |                  |   | 137,076  |  
|Long-term restructuring                                                                                              |  |               | 8,443    |   |                  |   | 9,275    |  
|Long-term deferred revenues                                                                                          |  |               | 1,665    |   |                  |   | 1,709    |  
|Other long-term liabilities                                                                                          |  |               | 4,575    |   |                  |   | 4,530    |  
|                                                                                                                     |  |               |          |   |                  |   |          |  
|Total liabilities                                                                                                    |  |               | 149,667  |   |                  |   | 152,590  |  
|                                                                                                                     |  |               |          |   |                  |   |          |  
|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; 77,811,387 and 77,806,793 shares issued and outstanding |  |               | 778      |   |                  |   | 778      |  
|Additional paid-in capital                                                                                           |  |               | 646,711  |   |                  |   | 650,947  |  
|Accumulated deficit                                                                                                  |  |               | (237,597 | ) |                  |   | (228,658 | )
|Deferred compensation                                                                                                |  |               |         |   |                  |   | (7,191   | )
|Cumulative other comprehensive income                                                                                |  |               | 6,338    |   |                  |   | 6,532    |  
|                                                                                                                     |  |               |          |   |                  |   |          |  
|                                                                                                                     |  |               | 416,230  |   |                  |   | 422,408  |  
|Less common stock in treasury at cost, 15,275,899 and 15,310,399 shares                                              |  |               | (110,468 | ) |                  |   | (110,468 | )
|                                                                                                                     |  |               |          |   |                  |   |          |  
|Total stockholders equity                                                                                           |  |               | 305,762  |   |                  |   | 311,940  |  
|                                                                                                                     |  |               |          |   |                  |   |          |  
|Total liabilities and stockholders equity                                                                           |  | $             | 455,429  |   |                  | $ | 464,530  |  
|                                                                                                                     |  |               |          |   |                  |   |          |  

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



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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 March 31, |       
|                                                                                  |  | 2006                         |        |   | 2005 |  
|License and other revenues                                                        |  | $                            | 39,395 |   |      | $ | 43,564 |  
|Service revenues                                                                  |  |                              | 30,177 |   |      |   | 27,760 |  
|                                                                                  |  |                              |        |   |      |   |        |  
|Total revenues                                                                    |  |                              | 69,572 |   |      |   | 71,324 |  
|                                                                                  |  |                              |        |   |      |   |        |  
|Cost of license and other revenues                                                |  |                              | 2,231  |   |      |   | 2,878  |  
|Cost of service revenues                                                          |  |                              | 13,041 |   |      |   | 9,381  |  
|Amortization of acquired intangibles                                              |  |                              | 525    |   |      |   | 2,512  |  
|                                                                                  |  |                              |        |   |      |   |        |  
|Cost of revenues                                                                  |  |                              | 15,797 |   |      |   | 14,771 |  
|                                                                                  |  |                              |        |   |      |   |        |  
|Gross profit                                                                      |  |                              | 53,775 |   |      |   | 56,553 |  
|                                                                                  |  |                              |        |   |      |   |        |  
|Selling, general and administrative                                               |  |                              | 46,204 |   |      |   | 42,292 |  
|Research and development                                                          |  |                              | 15,405 |   |      |   | 14,629 |  
|Restructuring, amortization of other intangibles and acquisition-related expenses |  |                              | 1,050  |   |      |   | 1,095  |  
|                                                                                  |  |                              |        |   |      |   |        |  
|Total operating expenses                                                          |  |                              | 62,659 |   |      |   | 58,016 |  
|                                                                                  |  |                              |        |   |      |   |        |  
|Operating loss                                                                    |  |                              | (8,884 | ) |      |   | (1,463 | )
|Gain on sale of investment                                                        |  |                              |       |   |      |   | 4,680  |  
|Interest and other income, net                                                    |  |                              | 1,342  |   |      |   | 1,220  |  
|                                                                                  |  |                              |        |   |      |   |        |  
|Income (loss) before income taxes                                                 |  |                              | (7,615 | ) |      |   | 4,437  |  
|Income tax provision                                                              |  |                              | 1,397  |   |      |   | 943    |  
|                                                                                  |  |                              |        |   |      |   |        |  
|Net income (loss)                                                                 |  | $                            | (8,939 | ) |      | $ | 3,494  |  
|                                                                                  |  |                              |        |   |      |   |        |  
|Net income (loss) per share:                                                      |  |                              |        |   |      |   |        |  
|Net income (loss) per sharebasic                                                 |  | $                            | (0.12  | ) |      | $ | 0.04   |  
|Net income (loss) per sharediluted                                               |  | $                            | (0.12  | ) |      | $ | 0.04   |  
|                                                                                  |  |                             
|Shares used in computing basic net income (loss) per share                        |  |                              | 76,640 |   |      |   | 80,373 |  
|Shares used in computing diluted net income (loss) per share                      |  |                              | 76,640 |   |      |   | 81,590 |  

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



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##### Table of Contents

BORLAND SOFTWARE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands, unaudited)



|                                                                           |  |                              |        |   |      |   |        |  
|-------------------------------------------------------------------------- |  | ---------------------------- | ------ | - | ---- | - | ------ | -
|                                                                           |  | Three Months Ended March 31, |       
|                                                                           |  | 2006                         |        |   | 2005 |  
|Net income (loss)                                                          |  | $                            | (8,939 | ) |      | $ | 3,494  |  
|Other comprehensive income:                                                |  |                              |        |   |      |   |        |  
|Foreign currency translation adjustments                                   |  |                              | (238   | ) |      |   | (2,389 | )
|Fair market value adjustment for available-for-sale securities, net of tax |  |                              | 38     |   |      |   |       |  
|                                                                           |  |                              |        |   |      |   |        |  
|Comprehensive income (loss)                                                |  | $                            | (9,139 | ) |      | $ | 1,105  |  
|                                                                           |  |                              |        |   |      |   |        |  

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



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BORLAND SOFTWARE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands, unaudited)



|                                                                                                   |  |                              |         |   |      |   |          |  
|-------------------------------------------------------------------------------------------------- |  | ---------------------------- | ------- | - | ---- | - | -------- | -
|                                                                                                   |  | Three Months Ended March 31, |        
|                                                                                                   |  | 2006                         |         |   | 2005 |  
|CASH FLOWS FROM OPERATING ACTIVITIES:                                                              |  |                              |         |   |      |   |          |  
|Net income (loss)                                                                                  |  | $                            | (8,939  | ) |      | $ | 3,494    |  
|Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: |  |                              |         |   |      |   |          |  
|Depreciation and amortization                                                                      |  |                              | 1,998   |   |      |   | 3,759    |  
|Stock-based compensation                                                                           |  |                              | 2,850   |   |      |   | (44      | )
|Gain on sale of investment                                                                         |  |                              |        |   |      |   | (4,680   | )
|Changes in assets and liabilities, net of acquisitions:                                            |  |                              |         |   |      |   |          |  
|Accounts receivable, net                                                                           |  |                              | 6,120   |   |      |   | 14,859   |  
|Other assets                                                                                       |  |                              | 679     |   |      |   | (2,622   | )
|Accounts payable and accrued expenses                                                              |  |                              | 1,134   |   |      |   | 1,022    |  
|Income taxes payable                                                                               |  |                              | (1,000  | ) |      |   | (2,249   | )
|Short-term restructuring                                                                           |  |                              | (41     | ) |      |   | 164      |  
|Deferred revenues                                                                                  |  |                              | (3,276  | ) |      |   | 2,410    |  
|Non-current restructure and other                                                                  |  |                              | 339     |   |      |   | 791      |  
|                                                                                                   |  |                              |         |   |      |   |          |  
|Cash provided by (used in) operating activities                                                    |  |                              | (136    | ) |      |   | 16,904   |  
|                                                                                                   |  |                              |         |   |      |   |          |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                              |  |                              |         |   |      |   |          |  
|Purchase of property and equipment                                                                 |  |                              | (1,778  | ) |      |   | (1,016   | )
|Acquisition of TeraQuest, net of cash acquired                                                     |  |                              |        |   |      |   | (4,195   | )
|Proceeds from the sale of an investment                                                            |  |                              |        |   |      |   | 4,680    |  
|Purchases of short-term investments                                                                |  |                              | (76,400 | ) |      |   | (163,212 | )
|Sales and maturities of short-term investments                                                     |  |                              | 162,556 |   |      |   | 155,506  |  
|                                                                                                   |  |                              |         |   |      |   |          |  
|Cash provided by (used in) investing activities                                                    |  |                              | 84,378  |   |      |   | (8,237   | )
|                                                                                                   |  |                              |         |   |      |   |          |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                              |  |                              |         |   |      |   |          |  
|Proceeds from issuance of common stock, net                                                        |  |                              | 105     |   |      |   | 1,532    |  
|Repurchase of common stock                                                                         |  |                              |        |   |      |   | (6,138   | )
|                                                                                                   |  |                              |         |   |      |   |          |  
|Cash provided by (used in) financing activities                                                    |  |                              | 105     |   |      |   | (4,606   | )
|                                                                                                   |  |                              |         |   |      |   |          |  
|Effect of exchange rate changes on cash                                                            |  |                              | (194    | ) |      |   | 2,217    |  
|                                                                                                   |  |                              |         |   |      |   |          |  
|Net change in cash and cash equivalents                                                            |  |                              | 84,153  |   |      |   | 1,844    |  
|Beginning cash and cash equivalents                                                                |  |                              | 49,075  |   |      |   | 76,432   |  
|                                                                                                   |  |                              |         |   |      |   |          |  
|Ending cash and cash equivalents                                                                   |  | $                            | 133,228 |   |      | $ | 78,276   |  
|                                                                                                   |  |                              |         |   |      |   |          |  

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



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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 March 31, 2006 and December 31, 2005 and for the three months ended March 31, 2006 and 2005 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 March 31, 2006 and December 31, 2005, its results of operations for the three months ended March 31, 2006 and 2005, and cash flows for the three months ended March 31,
2006 and 2005. Certain prior period amounts have been reclassified in order to be consistent with current financial statement presentation. These reclassifications had no impact on previously reported net income or cash flows.

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, 2005 as filed with the Securities and Exchange Commission (SEC) on May 2, 2006.

NOTE 2. STOCK-BASED COMPENSATION

General

Our employee stock option plans are long-term retention plans that are intended to attract, retain and
provide incentives for talented employees, including officers and non-employee directors, and to align stockholder and employee interests. We believe our employee stock option plans are critical to our operation and productivity. Our employee stock
option plans allow us to grant, on a discretionary basis, both incentive stock options and non-qualified stock options, as well as restricted stock and stock bonuses.

Employee Stock Option Plans

Currently, we grant stock options to our employees, including
executive officers from our 2003 Supplemental Stock Option Plan, our 2002 Stock Incentive Plan, and our 1997 Stock Option Plan. In addition, we are able to grant stock options from our 1998 Stock Option Plan and may decide to do so. Under our 2002
Stock Incentive Plan, we automatically grant options to non-employee directors on a non-discretionary basis. Generally, options have been granted that vest monthly over a four-year vesting period from the date of grant. For most grantees, options
expire at the earlier of either three months after termination of the grantees employment or ten years after the date of grant.

Employee Stock Purchase Plan

Our 1999 Employee Stock Purchase Plan, or ESPP, allows eligible employees
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. There are two offering periods, a twelve-month Annual Offering Period that
begins on or about December 1 of each year and a six-month Half-Year Offering Period that generally begins on or about June 1 of each year. Our ESPP is deemed to be compensatory, and therefore, ESPP expenses under SFAS 123R
have been included in our Condensed Consolidated Statements of Operations for the quarter ended March 31, 2006.

Restricted
Stock

We have granted restricted shares to key employees, including officers, under our 2003 Supplemental Stock Option Plan and our
2002 Stock Incentive Plan. These plans provide for the granting of restricted stock and/or performance awards to officers and key employees. Restricted shares issued under these plans are considered outstanding at the time of grant, as the
stockholders are entitled to voting rights.



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##### Table of Contents

Stock-Based Compensation

On January 1, 2006, we adopted SFAS 123 (revised 2004), or SFAS 123R, Share-Based Payment, which addresses the accounting for
stock-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprises equity instruments or
that may be settled by the issuance of such equity instruments. In January 2005, the SEC issued SAB 107, which provides supplemental implementation guidance for SFAS 123R. SFAS 123R eliminates the ability to account for stock-based
compensation transactions using the intrinsic value method under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, or APB 25, and instead generally requires that such transactions be
accounted for using a fair-value-based method. We use the Black-Scholes-Merton option-pricing model to determine the fair-value of stock-based awards under SFAS 123R, consistent with that used for pro forma disclosures under SFAS 123,
Accounting for Stock-Based Compensation. We have elected to use the modified prospective transition method as permitted by SFAS 123R and, accordingly, prior periods have not been restated to reflect the impact of SFAS
123R. Beginning in fiscal 2006, the modified prospective transition method requires that stock-based compensation expense be recorded for all new and unvested stock options, restricted stock, restricted stock units, and employee stock purchase
plan shares that are ultimately expected to vest as the requisite service is rendered. Stock-based compensation expense for awards granted prior to January 1, 2006 is based on the grant date fair-value as determined under the pro forma
provisions of SFAS 123. Our deferred compensation balance of $7.2 million as of December 31, 2005, which was accounted for under APB 25, was reclassified into our additional paid-in-capital upon the adoption of SFAS 123R. We have recorded
an incremental $2.1 million of stock-based compensation expense during the quarter ended March 31, 2006 as a result of the adoption of SFAS 123R, which had the effect of reducing our earnings per share by $0.03. The adoption of SFAS 123R did
not impact our consolidated tax provision in the quarter ended March 31, 2006 due to our net loss carryforwards in the regions that recognized SFAS 123R stock-based compensation expenses.

No stock-based compensation costs were capitalized as part of the cost of an asset as of March 31, 2006. As of March 31, 2006, total
unrecognized stock-based compensation costs related to stock options and restricted stock units amounted to $18.2 million. Unvested stock-based compensation costs will be recognized as the underlying stock option or restricted stock unit vests over
a period of up to 5 years. The amount of unrecognized stock-based compensation will be affected by any future stock option or restricted stock grants and by restructuring activities that includes the termination of any employee that has received
stock option or restricted stock grants that are unvested as of their termination date.

Based on our historical experience of pre-vesting
option cancellations, we have assumed an annualized forfeiture rate of 1% for our options granted to executive officers and 14% for our options granted to non-executive officers. Under the true-up provisions of SFAS 123R, we will record additional
expense if the actual forfeiture rate is lower than we estimated, and will record a recovery of prior expense if the actual forfeiture is higher than we estimated.

Prior to the adoption of SFAS 123R, we accounted for stock-based compensation using the intrinsic value method prescribed in APB 25 and related Interpretations. Under APB 25, 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. Upon exercise of stock options, we issue shares of common stock from the same plan the options were originally issued.

The assumptions used to value option grants for the quarters ended March 31, 2006 and March 31, 2005 are as follows:



|                        |  |                             |  |           
|----------------------- |  | --------------------------- |  | ----------
|                        |  | Three Months EndedMarch 31,
|                        |  | 2006                        |  | 2005      
|Expected life           |  | 4.65 years                  |  | 4.15 years
|Risk-free interest rate |  | 4.20%                       |  | 3.88%     
|Volatility              |  | 53.0%                       |  | 58.0%     
|Dividend yield          |  | 0.00%                       |  | 0.00%     



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##### Table of Contents

The assumptions used to value employee stock purchase rights for the quarters ended March 31, 2006
and March 31, 2005 are as follows:



|                        |  |                             |  |         
|----------------------- |  | --------------------------- |  | --------
|                        |  | Three Months EndedMarch 31,
|                        |  | 2006                        |  | 2005    
|Expected life           |  | 6 months                    |  | 6 months
|Risk-free interest rate |  | 4.32%                       |  | 3.69%   
|Volatility              |  | 38.0%                       |  | 39.0%   
|Dividend yield          |  | 0.00%                       |  | 0.00%   

The expected term of employee stock options represents the weighted-average period that the stock
options are expected to remain outstanding. We derived the expected term assumption based on our historical settlement experience, while giving consideration to options that have lives less than the contractual terms and vesting schedules in
accordance with guidance in SFAS 123R and SAB 107. Prior to the adoption of SFAS 123R, we used our historical settlement experience to derive the expected term for the purposes of pro forma information under SFAS 123, as disclosed in our
Notes to Consolidated Financial Statements for the related periods.

The risk-free interest rate assumption is based upon observed interest
rates appropriate for the term of our employee stock options.

Beginning January 1, 2006, we estimated the volatility of our stock
using historical volatility as well as the implied volatility in market-traded options on our common stock in accordance with guidance in SFAS 123R and SAB 107. Management determined that a blend of implied volatility and historical volatility is
more reflective of market conditions and a better indicator of expected volatility than using purely historical volatility. We will continue to monitor these and other relevant factors used to measure expected volatility for future option grants.
Prior to the adoption of SFAS 123R, we had used our historical stock price volatility in accordance with SFAS 123 for purposes of pro forma information disclosed in our Notes to Consolidated Financial Statements for the related periods.

The dividend yield assumption is based on our history and expectation of dividend payouts.

Total stock-based compensation recognized on our Condensed Consolidated Statement of Operations for the quarter ended March 31, 2006 is as follows:



|                                                                                  |  |              |       |                             |   |                 |  |                                                               |     |       |   |       |  |   |      
|--------------------------------------------------------------------------------- |  | ------------ | ----- | --------------------------- | - | --------------- |  | ------------------------------------------------------------- | --- | ----- | - | ----- |  | - | -----
|                                                                                  |  | StockOptions |       | EmployeeStockPurchaseRights |   | RestrictedStock |  | Amortization ofDeferredCompensationresulting fromAcquisitions |     | Total
|Cost of service revenues                                                          |  | $            | 40    |                             | $ | 28              |  | $                                                             | 53  |       | $ |      |  | $ | 121  
|Selling, general and administrative                                               |  |              | 1,336 |                             |   | 208             |  |                                                               | 701 |       |   |      |  |   | 2,245
|Research and development                                                          |  |              | 331   |                             |   | 140             |  |                                                               | 4   |       |   |      |  |   | 475  
|Restructuring, amortization of other intangibles and acquisition-related expenses |  |              |      |                             |   |                |  |                                                               |    |       |   | 1,005 |  |   | 1,005
|                                                                                  |  |              |       |                             |   |                 |  |                                                               |     |       |   |       |  |   |      
|Total                                                                             |  | $            | 1,707 |                             | $ | 376             |  | $                                                             | 758 |       | $ | 1,005 |  | $ | 3,846
|                                                                                  |  |              |       |                             |   |                 |  |                                                               |     |       |   |       |  |   |      



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##### Table of Contents

The following table illustrates the effect on net income after taxes and net income per common share as
if we had applied the fair value recognition provisions of SFAS 123 to stock-based compensation during the three-month period ended March 31, 2005 (in thousands, except per share amounts):



|                                                                                                                          |  |                                 |        |  
|------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | -
|                                                                                                                          |  | ThreeMonths EndedMarch 31, 2005 |       
|Net income - as reported                                                                                                  |  | $                               | 3,494  |  
|Add: Stock-based employee compensation expense included in reported net income, net of tax                                |  |                                 | 91     |  
|Deduct: Stock-based employee compensation expense determined under the fair value based method for all awards, net of tax |  |                                 | (4,054 | )
|                                                                                                                          |  |                                 |        |  
|Net loss - pro forma                                                                                                      |  | $                               | (469   | )
|                                                                                                                          |  |                                 |        |  
|Net income per share - as reported:                                                                                       |  |                                 |        |  
|Basic                                                                                                                     |  | $                               | 0.04   |  
|Diluted                                                                                                                   |  | $                               | 0.04   |  
|Net (loss) per share - pro forma:                                                                                         |  |                                 |        |  
|Basic                                                                                                                     |  | $                               | (0.01  | )
|Diluted                                                                                                                   |  | $                               | (0.01  | )

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 and other performance factors. Restricted stock granted to our Chief Executive Officer may vest early upon achievement of corporate performance targets established by the Compensation Committee of the Board of
Directors, in accordance with his employment contract. 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.

General Stock Option Information

The following table sets forth a summary of option activity
under our stock option program for the three months ended March 31, 2006:



|                     |  |                            |   |  |                             |   |  |                                |      
|-------------------- |  | -------------------------- | - |  | --------------------------- | - |  | ------------------------------ | -----
|                     |  | Options Availablefor Grant |   |  | Number ofOptionsOutstanding |   |  | Weighted AverageExercise Price
|At December 31, 2005 |  | 5,201,356                  |   |  | 16,030,710                  |   |  | $                              | 9.23 
|Granted              |  | (781,300                   | ) |  | 776,300                     |   |  | $                              | 6.15 
|Exercised            |  |                           |   |  | (66,082                     | ) |  | $                              | 6.00 
|Cancelled            |  | 427,734                    |   |  | (567,033                    | ) |  | $                              | 14.75
|                     |  |                            |   |  |                             |   |  |                                |      
|At March 31, 2006    |  | 4,847,790                  |   |  | 16,173,895                  |   |  | $                              | 8.90 
|                     |  |                            |   |  |                             |   |  |                                |      

The weighted-average fair value of options granted during the quarters ended March 31, 2006
and 2005 was $2.91 and $3.40, respectively. The intrinsic value of options exercised during the period was $0.3 million and the fair value of restricted stock vested during the period was $0.8 million.



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##### Table of Contents

Information regarding the stock options outstanding at March 31, 2006 is summarized
below:



|                         |  |                    |  |                                              |  |                                  |       |                    |            |                                  |   |      
|------------------------ |  | ------------------ |  | -------------------------------------------- |  | -------------------------------- | ----- | ------------------ | ---------- | -------------------------------- | - | -----
|Range of Exercise Prices |  | Number Outstanding |  | Weighted- Average Remaining Contractual Life |  | Weighted- Average Exercise Price |       | Number Exercisable |            | Weighted- Average Exercise Price
|                         |  |                    |  | (in years)                                   |  |                                  |       |                    |            |                                 
|$2.44$5.73              |  | 3,959,215          |  | 7.41                                         |  | $                                | 5.47  |                    | 2,494,156  |                                  | $ | 5.37 
|$5.75$6.71              |  | 3,339,323          |  | 8.68                                         |  | $                                | 6.26  |                    | 868,641    |                                  | $ | 6.09 
|$6.75$9.25              |  | 3,394,447          |  | 7.83                                         |  | $                                | 8.30  |                    | 3,284,345  |                                  | $ | 8.33 
|$9.30$10.88             |  | 3,258,529          |  | 7.77                                         |  | $                                | 9.98  |                    | 3,245,633  |                                  | $ | 9.98 
|$10.93$714.22           |  | 2,222,381          |  | 5.49                                         |  | $                                | 18.32 |                    | 2,222,381  |                                  | $ | 18.32
|                         |  |                    |  |                                              |  |                                  |       |                    |            |                                  |   |      
|                         |  | 16,173,895         |  | 7.57                                         |  | $                                | 8.90  |                    | 12,115,156 |                                  | $ | 9.84 
|                         |  |                    |  |                                              |  |                                  |       |                    |            |                                  |   |      

The weighted-average remaining contractual life for all exercisable stock options at
March 31, 2006 was 6.89 years. As of March 31, 2006, the aggregated intrinsic value of our options outstanding was $0.5 million and the aggregated intrinsic value of our options exercisable was $0.5 million.

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 quarter ended March 31, 2006 due to our net loss in that period.

The following table
sets forth the computation of basic and diluted net income (loss) per share (in thousands, except per share amounts):



|                                                                                                    |  |                             |        |   |      |   |       
|--------------------------------------------------------------------------------------------------- |  | --------------------------- | ------ | - | ---- | - | ------
|                                                                                                    |  | Three Months EndedMarch 31,
|                                                                                                    |  | 2006                        |        |   | 2005
|Numerator:                                                                                          |  |                             |        |   |      |   |       
|Net income (loss)                                                                                   |  | $                           | (8,939 | ) |      | $ | 3,494 
|Denominator:                                                                                        |  |                             |        |   |      |   |       
|Denominator for basic net income (loss) per shareweighted-average shares                           |  |                             | 76,640 |   |      |   | 80,373
|Effect of dilutive securities:                                                                      |  |                             |        |   |      |   |       
|Employee stock options                                                                              |  |                             |       |   |      |   | 1,178 
|Restricted common shares                                                                            |  |                             |       |   |      |   | 39    
|                                                                                                    |  |                             |        |   |      |   |       
|Denominator for diluted net income (loss) per shareweighted-average shares and assumed conversions |  |                             | 76,640 |   |      |   | 81,590
|                                                                                                    |  |                             |        |   |      |   |       
|Net income (loss) per sharebasic                                                                   |  | $                           | (0.12  | ) |      | $ | 0.04  
|Net income (loss) per sharediluted                                                                 |  | $                           | (0.12  | ) |      | $ | 0.04  

The diluted net loss per share calculation for the quarter ended March 31, 2006 excludes
options to purchase 16.2 million shares of common stock and 1.2 million weighted unvested restricted common shares due to our net loss in that period.

The diluted net income per share calculation for the quarter ended March 31, 2005 excludes options to purchase 8.2 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. ACQUISITIONS

Legadero

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 and was acquired to complement our existing Application Lifecycle Management (ALM) products and services. The
purchase price consisted of fixed consideration of $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
was placed in escrow and 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. At December 31, 2005, $4.6 million of unearned contingent
consideration remained in escrow. In addition, we incurred $0.1 million of acquisition-related costs. Options to purchase 378,000 shares of common stock pursuant to our 2003 Supplemental Stock Option Plan were issued to Legadero employees who are
now our employees. These options will vest over a four-year period. Cash acquired in the acquisition was $0.3 million. Results of operations for Legadero 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 tendered            |  | $ | 7,509
|Direct transaction costs |  |   | 131  
|                         |  |   |      
|Total purchase price     |  | $ | 7,640
|                         |  |   |      

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



|                                          |  |   |        |  
|----------------------------------------- |  | - | ------ | -
|Current assets and other tangible assets: |  |   |        |  
|Cash                                      |  | $ | 287    |  
|Current assets                            |  |   | 31     |  
|Deferred tax assets                       |  |   | 1,107  |  
|Goodwill                                  |  |   | 4,425  |  
|Amortizable intangible assets:            |  |   |        |  
|Developed technology                      |  |   | 2,400  |  
|Customer list                             |  |   | 100    |  
|Trademarks, trade names and service marks |  |   | 100    |  
|Non-compete covenants                     |  |   | 100    |  
|In-process research and development       |  |   | 300    |  
|                                          |  |   |        |  
|Total assets acquired                     |  |   | 8,850  |  
|                                          | 
|Liabilities assumed:                      |  |   |        |  
|Current liabilities                       |  |   | (103   | )
|Deferred tax liabilities                  |  |   | (1,107 | )
|                                          |  |   |        |  
|Net assets acquired                       |  | $ | 7,640  |  
|                                          |  |   |        |  

The developed technology, customer list and trademarks, trade names and service marks are being
amortized over a three-year life from the date of acquisition and non-compete covenants are being amortized over a two-year life from the date of acquisition. Of the purchase price, $0.3 million represented acquired in-process research and
development, or IPR&D, that had not yet reached technological feasibility and had no alternative future use. Accordingly, this amount was immediately charged to operating expense upon consummation of the acquisition. Independent third-party
sources assisted us in calculating the value of IPR&D using the income approach by estimating the expected cash flows from the projects once commercially viable, discounting the net cash flows back to their present value and then applying a
percentage of completion.

In accordance with SFAS 109, Accounting for Income Taxes, deferred tax liabilities of $1.1
million 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 $1.1 million 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 Legadero will be recorded against goodwill.



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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 $0.5 million 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 was placed in escrow and 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. At
December 31, 2005, $0.6 million of unearned contingent consideration remained in escrow. In addition, $0.9 million 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 tendered            |  | $ | 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   | )
|                                          |  |   |        |  
|Net assets acquired                       |  | $ | 5,914  |  
|                                          |  |   |        |  

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

In accordance with SFAS 109, deferred tax liabilities of $0.9 million 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 $0.9 million 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.

NOTE 5. GOODWILL AND INTANGIBLE
ASSETS

Changes in the carrying amount of goodwill are as follows (in thousands):



|                                           |  |          |        
|------------------------------------------ |  | -------- | -------
|                                           |  | Goodwill
|Balance as of December 31, 2005            |  | $        | 187,337
|Adjustments to initial purchase accounting |  |          | 354    
|                                           |  |          |        
|Balance as of March 31, 2006               |  | $        | 187,691
|                                           |  |          |        

The adjustments to goodwill during the quarter ended March 31, 2006 were primarily related to
the purchase of certain software technology assets, partially offset by an adjustment related to our acquisition of TeraQuest.



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



|                    |  |                      |        |                         |   |         |                    |  |   |      
|------------------- |  | -------------------- | ------ | ----------------------- | - | ------- | ------------------ |  | - | -----
|                    |  | March 31, 2006      
|                    |  | Gross CarryingAmount |        | AccumulatedAmortization |   |         | Net CarryingAmount
|Acquired technology |  | $                    | 33,120 |                         | $ | (31,020 | )                  |  | $ | 2,100
|Trademarks          |  |                      | 8,400  |                         |   | (8,317  | )                  |  |   | 83   
|Other               |  |                      | 6,720  |                         |   | (5,643  | )                  |  |   | 1,077
|                    |  |                      |        |                         |   |         |                    |  |   |      
|                    |  | $                    | 48,240 |                         | $ | (44,980 | )                  |  | $ | 3,260
|                    |  |                      |        |                         |   |         |                    |  |   |      



|                    |  |                      |        |                         |   |         |                    |  |   |      
|------------------- |  | -------------------- | ------ | ----------------------- | - | ------- | ------------------ |  | - | -----
|                    |  | December 31, 2005   
|                    |  | Gross CarryingAmount |        | AccumulatedAmortization |   |         | Net CarryingAmount
|Acquired technology |  | $                    | 33,120 |                         | $ | (30,566 | )                  |  | $ | 2,554
|Trademarks          |  |                      | 8,400  |                         |   | (8,215  | )                  |  |   | 185  
|Other               |  |                      | 6,720  |                         |   | (5,559  | )                  |  |   | 1,161
|                    |  |                      |        |                         |   |         |                    |  |   |      
|                    |  | $                    | 48,240 |                         | $ | (44,340 | )                  |  | $ | 3,900
|                    |  |                      |        |                         |   |         |                    |  |   |      

The intangible assets are all amortizable and have original estimated useful lives as follows:
acquired technology2 to 3 years; trademarks3 years; other1 to 3 years. Based on the current amount of intangibles subject to amortization, the estimated future amortization expense related to our intangible assets at March 31,
2006 is as follows (in thousands):



|                |  |                    |      
|--------------- |  | ------------------ | -----
|                |  | FutureAmortization
|2006 (9 months) |  | $                  | 928  
|2007            |  |                    | 1,194
|2008            |  |                    | 896  
|2009            |  |                    | 242  
|                |  |                    |      
|Total           |  | $                  | 3,260
|                |  |                    |      

NOTE 6. RESTRUCTURING

We account for our restructuring activities in accordance with SFAS 146 Accounting for Costs Associated with Exit or Disposal Activities, SFAS 112, Employers Accounting for
Postemployment Benefitsan amendment of FASB Statement No. 5 and 43, and SEC Staff Accounting Bulletin No. 100, Restructuring and Impairment Charges, as applicable. The following table summarizes our
restructuring activity for the quarter ended March 31, 2006 (amounts in thousands):



|                                   |  |                       |     |   |            |   |        |       |  |       |     |  |   |        |  
|---------------------------------- |  | --------------------- | --- | - | ---------- | - | ------ | ----- |  | ----- | --- |  | - | ------ | -
|                                   |  | Severanceand Benefits |     |   | Facilities |   |        | Other |  | Total |    
|Accrual at December 31, 2005       |  | $                     | 192 |   |            | $ | 12,684 |       |  | $     | 304 |  | $ | 13,180 |  
|Cash paid and write-offs           |  |                       | (14 | ) |            |   | (858   | )     |  |       |    |  |   | (872   | )
|Reversal of previous restructuring |  |                       | (68 | ) |            |   |       |       |  |       |    |  |   | (68    | )
|                                   |  |                       |     |   |            |   |        |       |  |       |     |  |   |        |  
|Accrual at March 31, 2006          |  | $                     | 110 |   |            | $ | 11,826 |       |  | $     | 304 |  | $ | 12,240 |  
|                                   |  |                       |     |   |            |   |        |       |  |       |     |  |   |        |  

Of the $12.2 million in our restructuring accrual at March 31, 2006, $3.8 million was in our
short-term accrual and $8.4 million was in our long-term accrual. Our long-term restructuring accrual is comprised of $8.1 million for the lease obligation for excess capacity at our Scotts Valley, California facility, $0.2 million for the lease
obligation for excess capacity at a facility in Raleigh, North Carolina and $0.1 million for the lease obligation for excess capacity at a facility in Sydney, Australia.



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During the first quarter of 2006 we paid $0.9 million related to restructured facility operating leases
and reversed $0.1 million of accrued severance and benefits expenses due to changes to our severance estimates we originally made during our 2005 restructurings.

The restructuring charges relating to operating leases have been recorded, net of assumed sublease income and present value factors. Substantially all of these restructuring 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.

NOTE
7. GAIN ON SALE OF INVESTMENT

In March 2005, we sold an equity investment in privately held Trolltech A.S. that was previously
determined to be impaired and written-off in fiscal 2002. We recognized a gain of $4.7 million in the quarter ended March 31, 2005 on this transaction.

NOTE 8. INCOME TAXES

For the quarters ended March 31, 2006 and 2005, we recorded an income tax expense of $1.4 million
and $0.9 million, respectively. Our non-U.S. income tax provision is based on our estimated annualized foreign effective tax rate plus foreign income withholding taxes actually incurred and our U.S. tax is based on our actual results for the quarter
ended March 31, 2006. In the year ago quarter, our tax provision was based on our annualized effective tax rate.

The effective tax
rates for the quarters ended March 31, 2006 and 2005 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.
We provide U.S. income taxes on the earnings of our foreign subsidiaries unless those earnings are considered permanently reinvested.

NOTE 9. STOCK
REPURCHASE PROGRAM

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, or the Discretionary 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.

No shares were repurchased through our Discretionary Program during the quarter ended
March 31, 2006. The Discretionary Program is currently in effect and at December 31, 2005, $59.3 million remains authorized for future repurchases.

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 FASB Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, some of which are specifically grandfathered in because the guarantees were in effect prior to December 31, 2002.
Accordingly, we have no liabilities recorded for these agreements as of March 31, 2006, 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.

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



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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.

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 March 31, 2006 we had a balance of $1.2 million accrued.

We sell software licenses and
services to our customers via contractual arrangements. As part of those contractual arrangements, 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.
Additionally, from time to time we enter into agreements with certain customers in certain foreign jurisdictions, which provide for penalties to be incurred if specific non-performance or breach of agreement occurs on our behalf. To date
we have not incurred a significant expense in relation to these penalties and we believe the estimated fair value of these penalties is minimal.

Leases

We lease certain of our office and operating facilities and certain furniture and equipment under various
operating leases. 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.We recorded an obligation
of $0.8 million at the time we entered into the capital lease and at March 31, 2006 we had a total obligation of $0.4 million remaining.

Our operating leases expire at various times through 2016. At March 31, 2006, future minimum lease and sublease payments under non-cancelable leases and subleases and future minimum lease and sublease income under non-cancelable leases
and subleases were as follows (in thousands):



|                              |  |       |        |   |                 |   |        |              |  |   |              |   |                  |   |       |  |   |      
|----------------------------- |  | ----- | ------ | - | --------------- | - | ------ | ------------ |  | - | ------------ | - | ---------------- | - | ----- |  | - | -----
|                              |  | Total |        |   | Less than 1year |   |        | 1 to 3 years |  |   | 3 to 5 years |   | More than 5years
|Operating leases              |  | $     | 36,201 |   |                 | $ | 7,577  |              |  | $ | 17,761       |   |                  | $ | 4,632 |  | $ | 6,231
|Restructured operating leases |  |       | 11,802 |   |                 |   | 2,723  |              |  |   | 8,463        |   |                  |   | 616   |  |   |     
|Capital lease                 |  |       | 387    |   |                 |   | 106    |              |  |   | 281          |   |                  |   |      |  |   |     
|                              |  |       |        |   |                 |   |        |              |  |   |              |   |                  |   |       |  |   |      
|Gross commitments             |  | $     | 48,390 |   |                 | $ | 10,406 |              |  | $ | 26,505       |   |                  | $ | 5,248 |  | $ | 6,231
|Sublease income               |  |       | (342   | ) |                 |   | (333   | )            |  |   | (9           | ) |                  |   |      |  |   |     
|                              |  |       |        |   |                 |   |        |              |  |   |              |   |                  |   |       |  |   |      
|Net commitments               |  | $     | 48,048 |   |                 | $ | 10,073 |              |  | $ | 26,496       |   |                  | $ | 5,248 |  | $ | 6,231
|                              |  |       |        |   |                 |   |        |              |  |   |              |   |                  |   |       |  |   |      

Rent expense, net, for all operating leases was $2.6 million and $3.2 million for the quarters
ended March 31, 2006, and 2005, respectively.



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The restructuring-related operating leases above represent total lease commitments that are not
associated with continuing operations and include exited facilities located in California, North Carolina and Australia.

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 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 commenced in the second half of 2004.

Subsequently, there were discussions with the plaintiff concerning a possible settlement of the litigation. As a result of these discussions, a
settlement was reached. Under the settlement we agreed to pay $475,000 and actual costs to administer the settlement fund up to a maximum of $25,000, in exchange for dismissal of the action and a full and general release of all claims relating to or
concerning the factual and legal allegations in the complaint (with the sole exception of claims by former Starbase shareholders who contend they did not receive the full consideration to which they were entitled from the acquisition by Borland).
The settlement is conditioned on certification of the plaintiff class; approval by the Delaware Chancery Court and satisfaction of all other legal requirements.

The parties executed a Stipulation of Settlement and proposed Scheduling Order that was signed by the Vice Chancellor on March 30, 2006. This triggered the requirement by Borland to fund the $475,000 settlement
as well as the $25,000 for administration fees within five business days. We funded the settlement within the required time limit.

The
Court set a date of June 13, 2006 for a Fairness Hearing at which time the Vice Chancellor will consider any objections to the settlement and determine whether to approve the settlement. There is no assurance that the Vice Chancellor will
approve the settlement. In addition, an objecting shareholder could appeal the approval of the settlement. If the settlement does not become final, the parties could resume litigation or attempt to renegotiate the settlement.

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.

Service Commitments

We have commitments
regarding an outsourcing arrangement for portions of our information technology operations. The committed expenditures average $5.2 million per year from November 2004 through November 2014. We can terminate this contract with or without cause upon
payment of a termination fee, the maximum amount of which is $1.9 million at March 31, 2006, declining to $0.5 million in the final year of the contract. These amounts are not included in the operating lease commitments table above.



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NOTE 11. RECENT ACCOUNTING PRONOUNCEMENTS

In February 2006, the FASB issued SFAS 155, Accounting for Certain Hybrid Financial Instruments which amends SFAS 133,
Accounting for Derivative Instruments and Hedging Activities and SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS 155 simplifies the accounting for
certain derivatives embedded in other financial instruments by allowing them to be accounted for as a whole if the holder elects to account for the whole instrument on a fair value basis. SFAS 155 also clarifies and amends certain other provisions
of SFAS 133 and SFAS 140. SFAS 155 is effective for all financial instruments acquired, issued or subject to a remeasurement event occurring in fiscal years beginning after September 15, 2006. We do not expect the adoption of SFAS 155 to have a
material impact on our consolidated financial position, results of operations or cash flows.

In November 2005, the FASB
issued FASB Staff Position (FSP) FAS 123R-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards, (FSP FAS 123R-3). FSP FAS 123R-3 provides a practical exception when
a company transitions to the accounting requirements in SFAS No. 123R.SFAS 123R requires a company to calculate the pool of excess tax benefits available to absorb tax deficiencies recognized subsequent to adopting SFAS 123R (termed the
APIC Pool), assuming the company had been following the recognition provisions prescribed by SFAS 123.We are currently evaluating the guidance in FSP FAS 123R-3 and we anticipate the adoption of FSP FAS 123R-3 will not have an impact on our
overall results of operations or financial position.

In May 2005 the FASB issued SFAS 154, Accounting Changes and Error
Corrections, which replaces Accounting Principles Board No. 20, Accounting Changes, and SFAS 3, Reporting Accounting Changes in Interim Financial Statements. SFAS 154 applies to all voluntary
changes in accounting principle, and changes the requirements for accounting for and reporting of a change in accounting principle. SFAS 154 requires retrospective application to prior periods financial statements of a voluntary change in
accounting principle unless it is impracticable. APB 20 previously required that most voluntary changes in accounting principle be recognized with a cumulative effect adjustment in net income of the period of the change. SFAS 154 is effective for
accounting changes made in annual periods beginning after December 15, 2005.

NOTE 12. SUBSEQUENT EVENTS

Acquisition of Segue Software

On April 19, 2006, we completed the acquisition of Segue Software, Inc. pursuant to an Agreement and Plan of Merger, dated as of February 7, 2006. Segue is now a wholly-owned subsidiary of Borland. Segue is headquartered in
Lexington, Massachusetts, and is a provider of quality and testing solutions. Segue offers solutions that define, measure, manage and improve software quality throughout the entire application lifecycle. Under the terms of the Agreement and Plan of
Merger, we paid $8.67 per share in cash for all outstanding shares of Segue. The transaction was valued at approximately $105 million and was funded with existing cash on hand. We will incur additional acquisition-related costs and we are currently
in the process of determining the aggregated total of such costs. If we had completed the Segue transaction as of quarter end, our cash, cash equivalents and short-term investments would have decreased to approximately $68 million (the approximate
$173 million balance at quarter end less the approximately $105 million funding of the transaction). Although our cash and cash equivalents balance was significantly reduced following the completion of the acquisition, we believe that our current
available cash and cash equivalents will be sufficient to meet our working capital and operating expense requirements for at least the next twelve months. However, there are many factors relating to our use of cash and 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. Results of operations for Segue will be included in our consolidated financial statements from the date of acquisition. For
the year ended December 31, 2005, Segue reported net revenue of $36.4 million, up 10% from 2004, and software license revenue of $15.9 million, up 9% from 2004. Segue also reported net income in 2005 of $2.9 million, as compared to net income
in 2004 of $1.7 million.

Planned Restructuring Activities

On April 27, 2006, our management determined to commit to restructuring actions with respect to consolidation of facilities and personnel. We intend
to reduce our workforce by approximately 300 employees, or approximately 20 percent of our regular full-time staff. We currently estimate that the total costs to be incurred in connection with these restructuring actions will be approximately $13
million to $16 million, spread over the second, third and fourth quarters of 2006. Of this total, we estimate that approximately $4 million to $5 million will represent facilities-related expenses and $9 million to $11 million will relate to
one-time severance-related expenses. Approximately $1.5 million of the facilities-related expenses are expected to relate to lease reinstatement costs, asset write-offs and moving expenses. Substantially all of these costs will require the outlay of
cash, although the timing of lease payments relating to leased facilities will be unchanged by the restructuring action. We began to implement these restructuring efforts on May 3, 2006 with notifications of personnel action to affected
personnel. The personnel actions are expected to be completed by end of July 2006.



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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 Risk Factors 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), which is the transformation of software development from separate tasks into a managed and efficient business process. To assist organizations with this
transformation, we offer platform-independent Application Lifecycle Management (ALM) software designed to increase efficiency, visibility and control over all phases of the software delivery lifecyclefrom deciding which software to
create, to defining, developing and delivering that software. We also offer software process improvement services and educational services to customers across the world. We believe this combination of ALM technology, process expertise and skills
training combine to help customers manage the growing complexity of software development and provide a foundation for delivering high-quality software, on-time, on-budget, with increased business value.

We are evolving our business to provide more multi-product enterprise class software development solutions that include significant services. As part of
our ongoing business evolution, in February 2006, we announced a plan to aggressively drive our ALM business and SDO strategy forward. As part of that plan, we entered into a merger agreement to acquire Segue Software, Inc., or Segue, a provider of
global quality and testing solutions. The acquisition of Segue was completed on April 19, 2006. For the year ended December 31, 2005, Segue reported net revenue of $36.4 million, up 10% from 2004, and software license revenue of $15.9
million, up 9% from 2004. Segue also reported net income in 2005 of $2.9 million, as compared to net income in 2004 of $1.7 million. Under the terms of the merger agreement, we paid $8.67 per share in cash for all outstanding shares of Segue. The
transaction was valued at approximately $105 million and was funded with existing cash on hand.

In addition, as part of our plan to focus
on ALM and our overall SDO strategy, we announced plans to seek a buyer for our integrated developer environment, or IDE, products, which includes the Borland Developer Studio (Delphi, C++ Builder, and C# Builder), JBuilder and Interbase product
lines. Revenues from our IDE products represent approximately 30% of our total revenues. Historically our business operations for all of our products have been integrated and managed as a collective whole, and thus precise expenses attributable to
individual products are not determinable. The IDE products are generally mature products and require less support and maintenance and therefore carry significant product line margins. The go-to-market model for the IDE products however has generally
required an extensive management, sales and office presence throughout the world, which has been expensive to maintain.



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Depending on the transaction structure and value of the disposition, it is possible that we will generate
a gain from the sale of our IDE products. We will most likely be able to utilize net operating losses to eliminate a large portion of the taxable income resulting from the sale.

We are currently analyzing the impact that the acquisition of Segue and the potential IDE divestiture will have on our business and future financial
performance. We expect in the short term to experience disruption and change and anticipate our financial performance could suffer in the next several quarters. We anticipate we will make organizational and operational changes around the Segue
acquisition and the potential IDE divestiture, which are expected to include closure of certain facilities, layoffs of redundant workforce and overall streamlining of sales, services and research and development operations. We have begun portions of
these changes, and announced our intention to reduce our workforce by approximately 300 employees, or approximately 20 percent of our regular full-time staff. We currently estimate that the total costs to be incurred in connection with these
restructuring actions will be approximately $13 million to $16 million, spread over the second, third and fourth quarters of 2006. Of this total, we estimate that approximately $4 million to $5 million will represent facilities-related expenses and
$9 million to $11 million will relate to one-time severance-related expenses. Approximately $1.5 million of the facilities-related expenses are expected to relate to lease reinstatement costs, asset write-offs and moving expenses. Substantially all
of these costs will require the outlay of cash, although the timing of lease payments relating to leased facilities will be unchanged by the restructuring action. We began to implement these restructuring efforts on May 3, 2006 with
notifications of personnel action to affected personnel. The personnel actions are expected to be completed by end of July 2006. In consideration of these and other expenses associated with the integration of Segue and those associated with our
announced plan to seek a buyer for our IDE products, as well as the resultant changes each will require in our organization, we expect to operate unprofitably through at least the second and third quarters of 2006. Our goal for these changes is to
further our strategic focus on ALM, improve revenue growth, reduce costs, improve profit margins and increase shareholder value.

The
following is a summary of our key financial results for the quarter ended March 31, 2006:



| |  |  | Total revenues decreased 2% to $70 million from $71 million for the quarter ended March 31, 2005.
| | - |  | -------------------------------------------------------------------------------------------------



| |  |  | Licenses and other revenues decreased 9% to $39 million from $44 million for the quarter ended March 31, 2005.
| | - |  | --------------------------------------------------------------------------------------------------------------



| |  |  | Service revenues increased 9% to $30 million from $28 million for the quarter ended March 31, 2005.
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | Gross margins decreased to 77% from 79% for the quarter ended March 31, 2005.
| | - |  | -----------------------------------------------------------------------------



| |  |  | Operating expenses increased 8% to $63 million from $58 million for the quarter ended March 31, 2005.
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | We recognized a gain of $4.7 million on the sale of an investment in the quarter ended March 31, 2005.
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | Net loss was $8.9 million compared to net income of $3.5 million for the quarter ended March 31, 2005.
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | Cash, cash equivalents and short-term investments decreased $2 million to $173 million as of March 31, 2006, from $175 million as of December 31, 2005. We have used a
portion of this balance to fund the acquisition of Segue, which closed in the second quarter and was valued at approximately $105 million.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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, 2005 as filed
with the SEC on May 2, 2006.



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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 (dollars in thousands):



|                                                                                  |  |                              |        |   |      |     |    |  |   |        |   |  |     |  
|--------------------------------------------------------------------------------- |  | ---------------------------- | ------ | - | ---- | --- | -- |  | - | ------ | - |  | --- | -
|                                                                                  |  | Three Months Ended March 31, |       
|                                                                                  |  | 2006                         |        |   | 2005 |    
|License and other revenues                                                        |  | $                            | 39,395 |   |      | 57  | %  |  | $ | 43,564 |   |  | 61  | %
|Service revenues                                                                  |  |                              | 30,177 |   |      | 43  |    |  |   | 27,760 |   |  | 39  |  
|                                                                                  |  |                              |        |   |      |     |    |  |   |        |   |  |     |  
|Total revenues                                                                    |  |                              | 69,572 |   |      | 100 |    |  |   | 71,324 |   |  | 100 |  
|                                                                                  |  |                              |        |   |      |     |    |  |   |        |   |  |     |  
|Cost of license and other revenues                                                |  |                              | 2,231  |   |      | 3   |    |  |   | 2,878  |   |  | 4   |  
|Cost of service revenues                                                          |  |                              | 13,041 |   |      | 19  |    |  |   | 9,381  |   |  | 13  |  
|Amortization of acquired intangibles                                              |  |                              | 525    |   |      | 1   |    |  |   | 2,512  |   |  | 4   |  
|                                                                                  |  |                              |        |   |      |     |    |  |   |        |   |  |     |  
|Cost of revenues                                                                  |  |                              | 15,797 |   |      | 23  |    |  |   | 14,771 |   |  | 21  |  
|                                                                                  |  |                              |        |   |      |     |    |  |   |        |   |  |     |  
|Gross profit                                                                      |  |                              | 53,775 |   |      | 77  |    |  |   | 56,553 |   |  | 79  |  
|                                                                                  |  |                              |        |   |      |     |    |  |   |        |   |  |     |  
|Selling, general and administrative                                               |  |                              | 46,204 |   |      | 66  |    |  |   | 42,292 |   |  | 59  |  
|Research and development                                                          |  |                              | 15,405 |   |      | 22  |    |  |   | 14,629 |   |  | 20  |  
|Restructuring, amortization of other intangibles and acquisition-related expenses |  |                              | 1,050  |   |      | 2   |    |  |   | 1,095  |   |  | 2   |  
|                                                                                  |  |                              |        |   |      |     |    |  |   |        |   |  |     |  
|Total operating expenses                                                          |  |                              | 62,659 |   |      | 90  |    |  |   | 58,016 |   |  | 81  |  
|                                                                                  |  |                              |        |   |      |     |    |  |   |        |   |  |     |  
|Operating loss                                                                    |  |                              | (8,884 | ) |      | (13 | )  |  |   | (1,463 | ) |  | (2  | )
|Gain on sale of investment                                                        |  |                              |       |   |      | 0   |    |  |   | 4,680  |   |  | 6   |  
|Interest and other income, net                                                    |  |                              | 1,342  |   |      | 2   |    |  |   | 1,220  |   |  | 2   |  
|                                                                                  |  |                              |        |   |      |     |    |  |   |        |   |  |     |  
|Income (loss) before income taxes                                                 |  |                              | (7,615 | ) |      | (11 | )  |  |   | 4,437  |   |  | 6   |  
|Income tax provision                                                              |  |                              | 1,397  |   |      | 2   |    |  |   | 943    |   |  | 1   |  
|                                                                                  |  |                              |        |   |      |     |    |  |   |        |   |  |     |  
|Net income (loss)                                                                 |  | $                            | (8,939 | ) |      | (13 | )% |  | $ | 3,494  |   |  | 5   | %
|                                                                                  |  |                              |        |   |      |     |    |  |   |        |   |  |     |  

Total Revenues

The following table presents our total revenues for the quarters ended March 31, 2006 and 2005 and the absolute dollar and percentage change from the
comparable prior year period (dollars in thousands):



|               |  |                             |        |        |   |        |  |   |        |   |  |    |   
|-------------- |  | --------------------------- | ------ | ------ | - | ------ |  | - | ------ | - |  | -- | --
|               |  | Three Months EndedMarch 31, |        | Change |  
|               |  | 2006                        |        | 2005   |   | $      |  |   | %      |  
|Total revenues |  | $                           | 69,572 |        | $ | 71,324 |  | $ | (1,752 | ) |  | (2 | )%

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 quarters ended March 31, 2006 or 2005.

Licenses and Other
Revenues

The following table presents our licenses and other revenues and the absolute dollar and percentage change from the
comparable prior year period (dollars in thousands):



|                                  |  |                             |        |   |        |   |        |   |  |   |        |   |  |     |   
|--------------------------------- |  | --------------------------- | ------ | - | ------ | - | ------ | - |  | - | ------ | - |  | --- | --
|                                  |  | Three Months EndedMarch 31, |        |   | Change |  
|                                  |  | 2006                        |        |   | 2005   |   |        | $ |  |   | %      |  
|License and other revenues        |  | $                           | 39,395 |   |        | $ | 43,564 |   |  | $ | (4,169 | ) |  | (10 | )%
|As a percentage of total revenues |  |                             | 57     | % |        |   | 61     | % |  |   |        |   |  |     |   

License and other revenues represent amounts for license fees and royalties earned for granting
customers the right to use and distribute our software products. License and other revenues declined in the quarter ended March 31, 2006 due primarily to a $7.5 million decrease in revenues from products within our Deployment product category.
Our Deployment products provide application middleware for transaction-intensive applications and assist users that have significant data processing needs, especially the telecommunications market, which has been soft in recent quarters. Partially
offsetting this



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decline was an increase in license revenues of $2.4 million from our ALM enterprise products. Additionally, license
revenues from our IDE products increased $0.9 million due to demand for the latest release of our Delphi product line, especially in Europe. We released Delphi 2006 in the fourth quarter of 2005.

While revenue recognition for our software licenses may be affected by numerous aspects of an arrangement, for the majority of our customer contracts we
recognize software license revenue upon shipment of product. As of March 31, 2006, we had on-hand sales orders that would have been recognized as period revenue, had those orders been shipped, totaling approximately $5 million of product
licenses.

Service Revenues

The following table presents our service revenues and the absolute dollar and percentage change from the comparable prior year period (dollars in thousands):



|                                  |  |                             |        |   |        |   |        |   |  |   |       |  |   |  
|--------------------------------- |  | --------------------------- | ------ | - | ------ | - | ------ | - |  | - | ----- |  | - | -
|                                  |  | Three Months EndedMarch 31, |        |   | Change |  
|                                  |  | 2006                        |        |   | 2005   |   |        | $ |  | % |      
|Service revenues                  |  | $                           | 30,177 |   |        | $ | 27,760 |   |  | $ | 2,417 |  | 9 | %
|As a percentage of total revenues |  |                             | 43     | % |        |   | 39     | % |  |   |       |  |   |  

Service revenues represent amounts earned for consulting and education services for our software
products, and for technical support, which includes call support, maintenance and upgrades. The increase in service revenues in the quarter ended March 2006 was a result of an increase in our consulting and education services revenues. Consulting
and education services revenues increased $2.6 million to $8.7 million in the quarter ended March 31, 2006 from $6.2 million in the quarter ended March 31, 2005, due to the expansion of our consulting services team and the related
formation of our process optimization practice. Consulting and education services revenues totaled 29% and 22% of service revenues in the quarters ended March 31, 2006 and 2005, respectively. Technical support revenues decreased $0.1 million to
$21.4 million in the quarter ended March 31, 2006 from $21.5 million in the quarter ended March 31, 2005.

International
Revenues

International revenues represented 60% of total revenues in both quarters ended March 31, 2006 and 2005. Revenues
from our operations in Europe increased $0.8 million due to increases in both license and service revenues, while revenues from our operations in Asia decreased $1.5 million due to decreases in both license and service revenues, especially in Japan.

The following table presents our total revenues by country and their percentage change (dollars in thousands):



|                    |  |                             |        |        |   |        |  |   |        |   |  |    |   
|------------------- |  | --------------------------- | ------ | ------ | - | ------ |  | - | ------ | - |  | -- | --
|                    |  | Three Months EndedMarch 31, |        | Change |  
|                    |  | 2006                        |        | 2005   |   | $      |  |   | %      |  
|United States       |  | $                           | 28,142 |        | $ | 28,262 |  | $ | (120   | ) |  | (0 | )%
|Germany             |  |                             | 7,677  |        |   | 7,204  |  |   | 473    |   |  | 7  | % 
|All other countries |  |                             | 33,753 |        |   | 35,858 |  |   | (2,105 | ) |  | (6 | )%
|                    |  |                             |        |        |   |        |  |   |        |   |  |    |   
|Total Revenues      |  | $                           | 69,572 |        | $ | 71,324 |  | $ | (1,752 | ) |  | (2 | )%
|                    |  |                             |        |        |   |        |  |   |        |   |  |    |   

No other single country accounted for total revenues greater than 10% of total revenues in the
quarters ended March 31, 2006 or 2005.

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, primarily the Euro and the United Kingdom Pound Sterling.



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##### Table of Contents

Regional Revenues

The following table presents our total revenues by region and their percentage change (dollars in thousands):



|                               |  |                              |        |        |   |        |  |   |        |   |  |     |   
|------------------------------ |  | ---------------------------- | ------ | ------ | - | ------ |  | - | ------ | - |  | --- | --
|                               |  | Three Months Ended March 31, |        | Change |  
|                               |  | 2006                         |        | 2005   |   | $      |  |   | %      |  
|Americas                       |  | $                            | 33,434 |        | $ | 34,563 |  | $ | (1,129 | ) |  | (3  | )%
|Europe, Middle East and Africa |  |                              | 26,214 |        |   | 25,368 |  |   | 846    |   |  | 3   | % 
|Asia Pacific                   |  |                              | 9,924  |        |   | 11,393 |  |   | (1,469 | ) |  | (13 | )%
|                               |  |                              |        |        |   |        |  |   |        |   |  |     |   
|Total Revenues                 |  | $                            | 69,572 |        | $ | 71,324 |  | $ | (1,752 | ) |  | (2  | )%
|                               |  |                              |        |        |   |        |  |   |        |   |  |     |   

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 our Americas region decreased $1.1 million, or 3%, in the quarter ended March 31, 2006 as a result of a decline in
license revenues. This decrease included a decline in license revenues of $4.2 million, partially offset by an increase in service revenues of $3.1 million. License revenues declined due primarily to a decrease in revenues of $4.9 million from our
Deployment products that are often sold into the telecommunications market, and due to continued weakness Java IDE product line, which declined $1.5 million. Additionally, license revenues from our other IDE products decreased $0.6 million.
Partially offsetting the decline in license revenues were increases in ALM license revenues of $1.6 million. Service revenues increased due to an increase in consulting and education services revenues related to the expansion of our consulting
services team and due to an increase in technical support revenues. The strength in technical support revenues was attributable to our expanding base of enterprise-level customers who have purchased multi-product solutions with technical support
contracts attached.

EMEA. Revenues in the EMEA region increased $0.8 million, or 3%, in the quarter ended March 31, 2006 as a
result of an increase in license revenues of $1.9 million, partially offset by a decrease in service revenues of $1.0 million. The increase in license revenues was due to strength in both our IDE products and our ALM enterprise products. Revenues
from IDE products and from our ALM products increased $1.0 million each. Service revenues decreased $1.0 million due to a decline in technical support revenues. The strengthening of the U.S. dollar versus the Euro and British Pound Sterling
since the year-ago quarter had the effect of reducing revenues in the EMEA region by approximately $2.6 million in the quarter ended March 31, 2006.

APAC. Revenues in the APAC region decreased $1.5 million, or 13%, in the quarter ended March 31, 2006 due to a decline in license revenues of $1.9 million, partially offset by an increase in service
revenues of $0.4 million. The decline was due primarily to the continued weakness of our Deployment products, which declined $1.7 million, and a slow rate of adoption of our ALM enterprise products, particularly in Japan. ALM revenues declined $0.2
million in our APAC region. Service revenues increased due primarily to the strength of technical support revenues as we have focused on selling initial and renewal technical support contracts. The strengthening of the U.S. dollar versus the
Japanese Yen and Australian dollar since the year-ago quarter had the effect of reducing revenues in the APAC region by approximately $0.6 million in the quarter ended March 31, 2006.

Cost of Revenues

The
following table presents cost of revenues and the absolute dollar and percentage changes from the comparable prior year period (dollars in thousands):



|                                           |  |                              |        |   |        |   |       |   |  |   |        |   |  |     |   
|------------------------------------------ |  | ---------------------------- | ------ | - | ------ | - | ----- | - |  | - | ------ | - |  | --- | --
|                                           |  | Three Months Ended March 31, |        |   | Change |  
|                                           |  | 2006                         |        |   | 2005   |   |       | $ |  |   | %      |  
|Cost of license and other revenues         |  | $                            | 2,231  |   |        | $ | 2,878 |   |  | $ | (647   | ) |  | (22 | )%
|As a percent of license and other revenues |  |                              | 6      | % |        |   | 7     | % |  |   |        |   |  |     |   
|Cost of service revenues                   |  | $                            | 13,041 |   |        | $ | 9,381 |   |  | $ | (3,660 | ) |  | (39 | )%
|As a percent of service revenues           |  |                              | 43     | % |        |   | 34    | % |  |   |        |   |  |     |   
|Amortization of acquired intangibles       |  | $                            | 525    |   |        | $ | 2,512 |   |  | $ | (1,987 | ) |  | (79 | )%
|As a percent of total revenues             |  |                              | 1      | % |        |   | 4     | % |  |   |        |   |  |     |   



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##### Table of Contents

Cost of Licenses and Other Revenues

Cost of license and other revenues consists primarily of variable costs including production costs, product packaging costs and royalties paid to
third-party vendors. Costs of licensing and other revenues tend to fluctuate with changes in product mix. The reductions in the cost of license and other revenues on an absolute dollar basis when comparing the quarters ended March 31, 2006 and
2005 were principally attributable to a decrease in license revenues in the quarter ended March 31, 2006, partially offset by slightly higher royalty costs. On a percentage basis, cost of license revenues increased in the quarter ended
March 31, 2006 due to royalty costs. Royalty costs were 2% and 3% of license and other revenues in the quarters ended March 31, 2006 and 2005, respectively. The level of royalty costs in future periods will be dependent 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, and consulting and education services. Service gross margins were 58% and 66% in the quarters
ended March 31, 2006 and 2005, respectively. The decrease in gross margins in the quarter ended March 31, 2006 was due to an increase in labor costs, including an increase in the use of outside consultants, as demand for our consulting and
education services continues to grow. Consulting and education services costs increased $3.0 million to $10.2 million in the quarter ended March 31, 2006 from $7.2 million in the year-ago quarter. Consulting and education services gross margins
were (17)% and (18)% in the quarters ended March 31, 2006 and 2005, respectively. We are in the early stages of building our consulting and education practices and expect to continue to invest in this area. While we believe gross margins for
consulting and education services will improve in the coming quarters, we cannot be sure this will be the case. Technical support costs increased $0.7 million to $2.8 million in the quarter ended March 31, 2006 from $2.1 million in the year-ago
quarter due to an increase in maintenance contract renewal costs. Technical support gross margins were 87% and 90% in the quarters ended March 31, 2006 and 2005, respectively. Additionally, cost of service revenues included $0.1 million of
employee stock-based compensation expenses in the quarter ended March 31, 2006, as a result of our adoption of SFAS 123R in that quarter.

Amortization of Acquired Intangibles

Amortization of acquired intangibles consists of the amortization of purchased
technology and maintenance contracts from acquisitions. Amortization of acquired intangibles decreased in the quarter ended March 31, 2006 due to the completion of the amortization of the acquired technology in December 2005 related to the
acquisition of Starbase, and the completion of the acquired technology in January 2006 related to the acquisition of TogetherSoft. Partially offsetting these decreases in amortization expenses were increases relating to the acquisitions of TeraQuest
in January 2005 and Legadero in October 2005. During the quarter ended March 31, 2006, we recorded $0.1 million and $0.2 million of amortization expense, respectively, in relation to these acquisitions.

Operating Expenses

Selling, General and Administrative Expenses

The following table presents our selling, general and administrative
expenses and the absolute dollar and percentage change from the comparable prior year period (dollars in thousands):



|                                             |  |                              |        |   |        |   |        |   |  |   |       |  |   |  
|-------------------------------------------- |  | ---------------------------- | ------ | - | ------ | - | ------ | - |  | - | ----- |  | - | -
|                                             |  | Three Months Ended March 31, |        |   | Change |  
|                                             |  | 2006                         |        |   | 2005   |   |        | $ |  | % |      
|Selling, general and administrative expenses |  | $                            | 46,204 |   |        | $ | 42,292 |   |  | $ | 3,912 |  | 9 | %
|As a percent of total revenues               |  |                              | 66     | % |        |   | 59     | % |  |   |       |  |   |  



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##### Table of Contents

The increase in selling, general and administrative expenses in the quarter ended March 31, 2006 was
attributable to an increase in employee-related expenses, which includes employee stock-based and incentive compensation expenses, and an increase in audit and legal fees. Stock-based compensation expenses increased $2.4 million as a result of our
adoption of SFAS 123R in the quarter ended March 31, 2006 and from the amortization of deferred compensation resulting from restricted stock awards granted to key employees as part of our retention program. Employee incentive compensation
expenses increased $1.0 million as a result of an increase in our incentive compensation accrual, which is payable upon achievement of certain financial and performance targets during the first six-months, and year, of 2006. Audit and legal fees
increased $1.8 million in the quarter ended March 31, 2006. Partially offsetting these increases were decreases of $0.8 million in advertising and marketing programs and $0.3 million in bad debt expense.

Research and Development Expenses

The following table presents our research and development expenses for the quarters ended March 31, 2006 and 2005 and the absolute dollar and percentage change from the comparable prior year period (dollars in thousands):



|                                  |  |                              |        |   |        |   |        |   |  |   |     |  |   |  
|--------------------------------- |  | ---------------------------- | ------ | - | ------ | - | ------ | - |  | - | --- |  | - | -
|                                  |  | Three Months Ended March 31, |        |   | Change |  
|                                  |  | 2006                         |        |   | 2005   |   |        | $ |  | % |    
|Research and development expenses |  | $                            | 15,405 |   |        | $ | 14,629 |   |  | $ | 776 |  | 5 | %
|As a percent of total revenues    |  |                              | 22     | % |        |   | 20     | % |  |   |     |  |   |  

The increase in research and development expenses in the quarter ended March 31, 2006 was, in
part, attributable to an increase in employee incentive compensation expenses of $1.5 million as a result of an increase in our incentive compensation accrual, which is payable upon achievement of certain financial and performance targets during the
first six-months of 2006. Additionally, as a result of our adoption of SFAS 123R in the quarter ended March 31, 2006, we recorded $0.5 million of employee stock-based compensation expenses. Partially offsetting these increases was a decrease in
software translation costs of $0.7 million due to the timing of our software translation projects. Also, salary and benefit expenses decreased $0.6 million as a result of reductions in our research and development headcount due to our 2005
restructurings.

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

The following table summarizes our restructuring, amortization of other intangibles and acquisition-related expenses and the absolute dollar and
percentage change from the comparable prior year period (dollars in thousands):



|                                  |  |                              |       |   |        |   |       |   |  |   |      |   |  |      |   
|--------------------------------- |  | ---------------------------- | ----- | - | ------ | - | ----- | - |  | - | ---- | - |  | ---- | --
|                                  |  | Three Months Ended March 31, |       |   | Change |  
|                                  |  | 2006                         |       |   | 2005   |   |       | $ |  |   | %    |  
|Restructuring                     |  | $                            | (68   | ) |        | $ | 233   |   |  | $ | (301 | ) |  | (129 | )%
|Amortization of other intangibles |  |                              | 113   |   |        |   | 742   |   |  |   | (629 | ) |  | (85  | )%
|Acquisition-related expenses      |  |                              | 1,005 |   |        |   | 120   |   |  |   | 885  |   |  | 738  | % 
|                                  |  |                              |       |   |        |   |       |   |  |   |      |   |  |      |   
|Total                             |  | $                            | 1,050 |   |        | $ | 1,095 |   |  | $ | (45  | ) |  | (4   | )%
|                                  |  |                              |       |   |        |   |       |   |  |   |      |   |  |      |   
|As a percent of total revenues    |  |                              | 2     | % |        |   | 2     | % |  |   |      |   |  |      |   

Restructuring. We reversed $0.1 million of restructuring expenses in the quarter ended
March 31, 2006 relating to changes to our estimate of severance and benefits charges we originally made during our 2005 restructuring activities.

Restructuring expenses recorded in the quarter ended March 31, 2005 totaled $0.2 million and were for severance and benefits charges resulting from the termination of an employee in selling, general and
administrative.

The restructuring charges relating to operating leases have been recorded, net of assumed sublease income and present
value factors. Substantially all of these restructuring 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.
Substantially all amounts related to severance and benefits were paid prior to March 31, 2006.



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##### Table of Contents

The following table summarizes our restructuring activity for the three months ended March 31, 2006
(in thousands):



|                                   |  |                       |     |   |            |   |        |       |  |       |     |  |   |        |  
|---------------------------------- |  | --------------------- | --- | - | ---------- | - | ------ | ----- |  | ----- | --- |  | - | ------ | -
|                                   |  | Severanceand Benefits |     |   | Facilities |   |        | Other |  | Total |    
|Accrual at December 31, 2005       |  | $                     | 192 |   |            | $ | 12,684 |       |  | $     | 304 |  | $ | 13,180 |  
|Cash paid and write-offs           |  |                       | (14 | ) |            |   | (858   | )     |  |       |    |  |   | (872   | )
|Reversal of previous restructuring |  |                       | (68 | ) |            |   |       |       |  |       |    |  |   | (68    | )
|                                   |  |                       |     |   |            |   |        |       |  |       |     |  |   |        |  
|Accrual at March 31, 2006          |  | $                     | 110 |   |            | $ | 11,826 |       |  | $     | 304 |  | $ | 12,240 |  
|                                   |  |                       |     |   |            |   |        |       |  |       |     |  |   |        |  

Of the $12.2 million in our restructuring accrual at March 31, 2006, $3.8 million was in our
short-term accrual and $8.4 million was in our long-term accrual. Our long-term restructuring accrual is comprised of $8.1 million for the lease obligation for excess capacity at our Scotts Valley, California facility, $0.2 million for the lease
obligation for excess capacity at a facility in Raleigh, North Carolina and $0.1 million for the lease obligation for excess capacity at a facility in Sydney, Australia.

Amortization of other intangibles. In the quarter ended March 31, 2006, we incurred $0.1 million of amortization expense related to intangible trade names and non-compete agreements as a result of our
acquisitions, compared to $0.8 million in the year-ago quarter. Amortization of other intangibles decreased due to the completion of the amortization of the non-compete agreements in January 2005 and the completion of the amortization of the trade
names in January 2006 related to the acquisition of TogetherSoft

Acquisition-related expenses. In the quarter ended March 31, 2006 we
recorded $1.0 million in acquisition-related expenses, which was primarily contingent consideration payable under the terms of the TeraQuest and Legadero acquisition agreements. Acquisition-related expenses in the year-ago quarter consisted of $0.1
million of contingent consideration payable under the terms of the TeraQuest acquisition agreement.

Gain on Sale of Investment

In the quarter ended March 31, 2005 we recognized a gain of $4.7 million on the sale of an equity investment in privately held
Trolltech A.S. that was previously determined to be impaired and written-off in fiscal 2002.

Interest and Other Income, Net

The following table presents our interest and other income, net for the quarters ended March 31, 2006 and 2005 and the
absolute dollar and percentage change from the comparable prior year period (dollars in thousands):



|                               |  |                              |       |   |        |   |       |   |  |   |     |  |    |  
|------------------------------ |  | ---------------------------- | ----- | - | ------ | - | ----- | - |  | - | --- |  | -- | -
|                               |  | Three Months Ended March 31, |       |   | Change |  
|                               |  | 2006                         |       |   | 2005   |   |       | $ |  | % |    
|Interest and other income, net |  | $                            | 1,342 |   |        | $ | 1,220 |   |  | $ | 122 |  | 10 | %
|As a percent of total revenues |  |                              | 2     | % |        |   | 2     | % |  |   |     |  |    |  

The increase in interest and other income, net in the quarter ended March 31, 2006 was
primarily attributable to higher yields earned on our invested capital, which resulted in a $0.5 million increase in net interest income as compared to the year-ago quarter, partially offset by a $0.2 million increase in realized foreign currency
losses. 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 and the absolute dollar and percentage change from the comparable prior year period (dollars in thousands):



|                               |  |                              |       |   |        |   |     |   |  |   |     |  |    |  
|------------------------------ |  | ---------------------------- | ----- | - | ------ | - | --- | - |  | - | --- |  | -- | -
|                               |  | Three Months Ended March 31, |       |   | Change |  
|                               |  | 2006                         |       |   | 2005   |   |     | $ |  | % |    
|Income tax provision           |  | $                            | 1,397 |   |        | $ | 943 |   |  | $ | 454 |  | 48 | %
|As a percent of total revenues |  |                              | 2     | % |        |   | 1   | % |  |   |     |  |    |  



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##### Table of Contents

On a consolidated basis, we generated a pre-tax loss of $7.6 million in the quarter ended March 31,
2006 and pre-tax income of $4.4 million in the quarter ended March 31, 2005. Our income tax provision, as a percentage of pre-tax income (loss), was (18)% and 21% for the quarters ended March 31, 2006 and 2005, respectively. The change in
income tax provision in absolute dollars in the quarter ended March 31, 2006 as compared to the year ago period was largely as a result of higher income taxes on our profitable foreign subsidiaries. In the quarters ended March 31,
2006 and 2005, substantially all of our tax provision related to non-US taxes.

Our effective tax rate is primarily dependent on the
location of taxable profits (if any), the utilization of our net operating loss, or NOL, carryforwards in certain jurisdictions, and the imposition of withholding taxes on revenues regardless of our profitability.

Liquidity and Capital Resources

Cash and
cash equivalents and short-term investments. Cash, cash equivalents and short-term investments were $173.1 million at March 31, 2006, a decrease of $2.0 million from a balance of $175.1 million at December 31, 2005. Working
capital decreased $6.9 million to $101.4 million at March 31, 2006 from $108.3 million at December 31, 2005. The components of the change in working capital, net of foreign currency fluctuations, included a decrease in accounts receivable
of $6.1 million and an increase in accounts payable and accrued liabilities of $1.1 million. These decreases to working capital in the first quarter of 2006 were partially offset by a decrease in deferred revenues of $3.3 million and a decrease in
income taxes payable of $1.0 million.

Net cash provided by and used in operating activities. Net cash used in operating
activities in the first quarter of 2006 was $0.1 million, which included a net loss of $8.9 million, partially offset by net working capital sources of cash of $4.0 million and non-cash related expenses of $4.8 million. Working capital sources of
cash included a decrease in accounts receivable and an increase in accounts payable and accrued expenses. The decrease in accounts receivable relates primarily to a decrease in revenues in the first quarter of 2006, as compared to the prior quarter,
and due to the timing of bookings of sales orders. The increase in accounts payable is related to the timing of payments to our vendors. Working capital uses of cash included a decrease in deferred revenues due to a decrease in bookings of
maintenance contracts in the first quarter of 2006 as compared to the prior quarter. Additionally, our income taxes payable decreased due to payments made during the quarter ended March 31, 2006.

Net cash provided by operating activities during the first quarter of 2005 was $16.9 million, comprised of net income of $3.5 million, non-cash
related expenses of $3.7 million and net working capital sources of cash of $14.4 million, partially offset by a $4.7 million gain from the sale of an equity investment. Working capital sources of cash included a decrease in accounts receivable and
increases in accounts payable and deferred revenues. The net increase in accounts payable relates primarily to the timing of payments at the end of the first quarter of 2005. Deferred revenues increased due to the booking of support contracts.
Working capital uses of cash included a decrease in accrued expenses due to a decrease in accrued incentive payroll, commissions and bonuses related to Borland not achieving its financial performance objectives during the first quarter of 2005.

To the extent that non-cash items increase or decrease our future operating results, there will be no corresponding impact on our cash
flows. After excluding the effects of these non-cash charges, the primary changes in cash flows relating to operating activities result from changes in working capital. Our primary source of operating cash flows is the collection of accounts
receivable from our customers. Our operating cash flows are also impacted by fluctuations in our accounts payable due to the timing of payments to our vendors. We generally pay our vendors and service providers in accordance with the invoice terms
and conditions. The timing of cash payments in future periods will be affected by the terms of accounts payable arrangements. We intend to continue to fund our operating expenses through cash flows from operations.

Net cash provided by and used in investing activities. Net cash provided by investing activities during the first quarter of 2006 was $84.4
million. During the first quarter of 2006 we had net sales and maturities of short-term investments of $86.2 million and purchases of property and equipment of $1.8 million. We converted 68% of our short-term investments into cash for use in the
acquisition of Segue Software, Inc., which closed in April 2006.

Net cash used in investing activities during the first quarter of 2005
was $8.2 million. We used $7.7 million, net, for the purchases of short-term investments and $4.2 million, net of cash acquired, for the purchase of TeraQuest. Refer to Note 4 of Notes to Condensed Consolidated Financial Statements for further
discussion of this acquisition. Additionally, we used $1.0 million for the purchases of property and equipment. These uses of cash were partially offset by proceeds of $4.7 million from the sale of an equity investment.



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##### Table of Contents

Net cash provided by and used in financing activities. Net cash provided by financing
activities during the first quarter of 2006 was $0.1 million, consisting primarily of $0.4 million received for the issuance of shares of our common stock from stock option exercises, partially offset by $0.3 million from restricted stock awards
surrendered by Borland employees in order to meet tax withholding obligations in connection with the vesting of an installment of their restricted stock awards.

Net cash used in financing activities during the first quarter of 2005 was $4.6 million, consisting primarily of $6.1 million used for the repurchase of our common stock, partially offset by $1.5 million received for
the issuance of shares of our common stock from the exercise of stock options.

Segue Acquisition. On April 19, 2006, we
completed the acquisition of Segue Software, Inc. pursuant to an Agreement and Plan of Merger, dated as of February 7, 2006. Segue is now a wholly-owned subsidiary of Borland. The transaction was valued at approximately $105 million and was
funded with existing cash on hand. If we had completed the Segue transaction as of quarter end, our cash, cash equivalents and short-term investments would have decreased to approximately $68 million (the approximate $173 million balance at quarter
end less the approximately $105 million funding of the transaction). We will incur additional acquisition-related costs and we are currently in the process of determining the aggregated total of such costs. Additionally, in consideration of expenses
associated with the integration of Segue and those associated with our announced plan to seek a buyer for our integrated development environment products (as discussed in the following paragraph) as well as the resultant changes each will require in
our organization, we expect to operate unprofitably for the next several quarters. Although our cash and cash equivalents balance was significantly reduced following the completion of the acquisition, we believe that our current available cash and
cash equivalents will be sufficient to meet our working capital and operating expense requirements for at least the next twelve months. In the future, we may utilize additional cash resources to fund other acquisitions or investments in other
businesses, technologies or product lines.

IDE Divestiture. Also in February 2006, we announced our plan to seek a buyer for our
integrated development environment, or IDE, products. We are currently analyzing the impact this divestiture will have on our existing business. While the specific products that we divest will not be determined until we enter into an agreement with
a selected buyer, we estimate that the disposition will encompass products that generated revenue of approximately $84 million in the year ended December 31, 2005, or approximately 30% of our total revenues for the year. We also intend to make
operational changes as a result of this divestiture, the impact of which has yet to be precisely quantified.

Operating Capital and
Capital Expenditure Requirements.Although 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. We also may require additional capital for other purposes not presently contemplated. If we are unable to obtain sufficient
capital, we could be required to curtail capital equipment purchases or research and development expenditures, which could harm our business. Factors that could affect our cash used or generated from operations and, as a result, our need to seek
additional borrowings or capital include:



| |  |  | greater that expected expenses associated with the integration of Segue, the divestiture of the IDE products and/or the operational and organizational changes associated with those
activities;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | decreased demand and market acceptance for our products and/or our customers products;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | competitive pressures resulting in lower than expected average selling prices; and
| | - |  | ----------------------------------------------------------------------------------



| |  |  | new product announcements or product introductions by our competitors.
| | - |  | ----------------------------------------------------------------------

For additional factors see the section entitled Risk Factors.

Currency. Although
we utilize foreign currency forward exchange contracts to reduce our foreign currency exchange rate risk, strengthening of the United States 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.



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Contractual Obligations and Off-Balance Sheet Arrangements

Leases. As of March 31, 2006, long-term liabilities amounted to $14.7 million, which included $2.7 million of long-term lease
obligations. We lease certain of our office and operating facilities and certain furniture and equipment under various operating leases. 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.We recorded an obligation of $0.8 million at the time we entered into the capital lease and at March 31, 2006 we had a total obligation of $0.4
million remaining.

Our operating leases expire at various times through 2016. At March 31, 2006, future minimum lease and sublease
payments under non-cancelable leases and subleases, and future minimum lease and sublease income under non-cancelable leases and subleases were as follows (in thousands):



|                              |  |       |        |   |                 |   |        |              |  |   |              |   |                  |   |       |  |   |      
|----------------------------- |  | ----- | ------ | - | --------------- | - | ------ | ------------ |  | - | ------------ | - | ---------------- | - | ----- |  | - | -----
|                              |  | Total |        |   | Less than 1year |   |        | 1 to 3 years |  |   | 3 to 5 years |   | More than 5years
|Operating leases              |  | $     | 36,201 |   |                 | $ | 7,577  |              |  | $ | 17,761       |   |                  | $ | 4,632 |  | $ | 6,231
|Restructured operating leases |  |       | 11,802 |   |                 |   | 2,723  |              |  |   | 8,463        |   |                  |   | 616   |  |   |     
|Capital lease                 |  |       | 387    |   |                 |   | 106    |              |  |   | 281          |   |                  |   |      |  |   |     
|                              |  |       |        |   |                 |   |        |              |  |   |              |   |                  |   |       |  |   |      
|Gross commitments             |  | $     | 48,390 |   |                 | $ | 10,406 |              |  | $ | 26,505       |   |                  | $ | 5,248 |  | $ | 6,231
|Sublease income               |  |       | (342   | ) |                 |   | (333   | )            |  |   | (9           | ) |                  |   |      |  |   |     
|                              |  |       |        |   |                 |   |        |              |  |   |              |   |                  |   |       |  |   |      
|Net commitments               |  | $     | 48,048 |   |                 | $ | 10,073 |              |  | $ | 26,496       |   |                  | $ | 5,248 |  | $ | 6,231
|                              |  |       |        |   |                 |   |        |              |  |   |              |   |                  |   |       |  |   |      

The restructured operating leases above represent total lease commitments that are not associated
with continuing operations and include exited facilities located in California, North Carolina and Australia.

Additionally, we have a
commitment regarding an outsourcing arrangement for portions of our information technology operations. The committed expenditures average of $5.2 million per year from November 2004 through November 2014. We can terminate this contract with or
without cause upon payment of a termination fee, the maximum amount of which is $1.9 million at March 31, 2006, declining to $0.5 million in the final year of the contract. These amounts are not included in the operating lease commitments table
above.

Indemnifications. For information regarding our indemnification obligations, refer to Note 10 of Notes to Condensed
Consolidated Financial Statements in Item 1.

Royalties We have certain royalty commitments associated with the shipment
and licensing of certain products. Royalty expense, which was recorded in cost of license and other revenues on our Condensed Consolidated Statements of Operations, was $0.8 million and $1.2 million for the quarters ended March 31, 2006 and
2005, respectively.

Off-Balance Sheet Arrangements. As part of our ongoing business, we do not participate in material
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 March 31, 2006, we are not involved in any material unconsolidated transactions.

Effect of New Accounting Pronouncements

For
information regarding the effect of new accounting pronouncements, refer to Note 11 of Notes to Condensed Consolidated Financial Statements in Item 1.

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



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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 first quarter of 2006, we recorded net realized foreign exchange losses of $0.3 million, included as part of interest and other income, net,
in our Condensed Consolidated Statements of Operations. The foreign exchange losses were generated due primarily 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 and payables 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
first quarter of 2006 we recorded unrealized foreign currency losses of $0.2 million, in cumulative other comprehensive income on our Condensed Consolidated Balance Sheets, in part, due to foreign currency movements on our long-term inter-company
balances. As of March 31, 2006, we had $16.3 million, $3.0 million, $1.3 million, $0.4 million and $0.3 million in long-term inter-company balances that will be settled in Australian dollars, Singapore dollars, Brazilian Reais, South Korean
Won, and Japanese Yen, 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 March 31, 2006. 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 March 31, 2006. 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):



|                                             |  |                |        |   |                              |          |                               |   |        |  
|-------------------------------------------- |  | -------------- | ------ | - | ---------------------------- | -------- | ----------------------------- | - | ------ | -
|                                             |  | NotionalAmount |        |   | Weighted-AverageContractRate |          | Net FairValue atMarch 31,2006 |  
|Foreign currency forward exchange contracts: |  |                |        |   |                              |          |                               |   |        |  
|Australian dollar                            |  | $              | (195   | ) |                              | 0.7084   |                               | $ | (195   | )
|Brazilian Real                               |  |                | 1,295  |   |                              | 2.2650   |                               |   | 1,271  |  
|Canadian dollar                              |  |                | 4,576  |   |                              | 1.1792   |                               |   | 4,577  |  
|Czech Koruna                                 |  |                | (471   | ) |                              | 23.8010  |                               |   | (472   | )
|Euro                                         |  |                | (2,494 | ) |                              | 1.1982   |                               |   | (2,498 | )
|Hong Kong dollar                             |  |                | 1,036  |   |                              | 7.7573   |                               |   | 1,036  |  
|Indian Rupee                                 |  |                | 5,101  |   |                              | 45.1700  |                               |   | 5,044  |  
|Japanese Yen                                 |  |                | (2,526 | ) |                              | 118.5300 |                               |   | (2,531 | )
|Russian Rouble                               |  |                | (1,520 | ) |                              | 27.6000  |                               |   | (1,532 | )
|Singapore dollar                             |  |                | 6,904  |   |                              | 1.6116   |                               |   | 6,906  |  
|South Korean Won                             |  |                | 423    |   |                              | 981.75   |                               |   | 422    |  
|United Kingdom Pound Sterling                |  |                | 850    |   |                              | 1.7324   |                               |   | 851    |  
|                                             |  |                |        |   |                              |          |                               |   |        |  
|Total                                        |  | $              | 12,979 |   |                              |          |                               | $ | 12,879 |  
|                                             |  |                |        |   |                              |          |                               |   |        |  

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 commercial paper, auction rate securities and certificates of deposit. By corporate policy, we limit the amount of our credit exposure to $5.0 million for any one commercial
issuer.



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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 March 31, 2006 and December 31, 2005, we held no investments classified as long-term. At March 31, 2006, the weighted-average
interest rate we earned on our cash and cash equivalents balance of $132.9 million was 4.10% and the weighted-average interest rate we earned on our short-term investments balance of $39.8 million was 4.56%. At December 31, 2005, the
weighted-average interest rate we earned on our cash and cash equivalents balance of $49.1 million was 4.21% and the weighted-average interest rate we earned on our short-term investments balance of $126.0 million was 4.23%. The difference in the
weighted-average interest rates associated with cash and cash equivalents and short-term investments is due primarily 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 March 31, 2006, 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 March 31, 2006, or December 31, 2005.

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 Rule 13a-14(a) of the Securities Exchange Act of 1934 (the Exchange Act). This section of the Quarterly Report contains the information concerning the controls evaluation
referred to in Rule 13a-14(a) Certifications and this information should be read in conjunction with the Rule 13a-14(a) Certifications for a more complete understanding of the topics presented.

Evaluation of Our Disclosure Controls and Procedures

Disclosure controls and procedures are those controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SECs rules and forms, and that such information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required
disclosure.

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 pursuant to the Exchange Act rules. This evaluation and review was done under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer and other management. Based upon
the evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as a result of material weaknesses in our internal control over financial reporting discussed below as of December 31, 2005 which remain unremediated
as of March 31, 2006, our disclosure controls and procedures were not effective as of the end of the period covered by this report.

Managements Report on Internal Control Over Financial Reporting

Our management is responsible for establishing
and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Internal control over financial reporting is a process designed by, or under the supervision of, our
Chief Executive Officer and Chief Financial Officer, 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



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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.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Because of their inherent limitations, internal control over financial reporting may not prevent or
detect misstatements or 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. 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.

Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, assessed the effectiveness
of our internal control over financial reporting as of December 31, 2005 based on the criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a
material misstatement of the annual or interim financial statements will not be prevented or detected. In connection with managements assessment of internal control over financial reporting, management identified the following material
weaknesses as of December 31, 2005:

We did not maintain an effective control environment based on the criteria established in the COSO
framework with respect to promoting compliance with policies and procedures and the prevention or detection of the override of our controls. As a result of this control deficiency, a senior officer was able to override controls which resulted in:
(1) an amendment to a sales contract creating an obligation to deliver an additional software feature without authorization of the finance and legal organization, and (2) a post-contract offer to refund the customer payment in the same
transaction without authorization of the finance and legal organization. A control environment sets the tone of an organization, influences the control consciousness of its people, and is the foundation of all other components of internal control
over financial reporting. In the instances noted above, the control consciousness of certain individuals was not adequate and resulted in a lack of compliance with our established control policies and procedures. This control deficiency could result
in a material misstatement to our annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, management has determined that this control deficiency constitutes a material weakness.

We did not maintain effective controls over third-party contractor invoices and contracts. Specifically, effective controls were not in place in our
services organization to ensure that invoices from three third-party contractors were completely and accurately recorded. In addition, effective controls were not in place over the authorization of work performed by a third-party contractor. As a
result of the control deficiency, an employee was able to override controls and have contractor invoices sent directly to the services organization and, further, failed to forward those invoices to the accounts payable department in a timely
fashion. As a consequence, these invoices were not reflected in our financial statements for the three and nine month periods ended September 30, 2005, and our cost of service revenue was understated. This control deficiency resulted in the
restatement of our interim consolidated financial statements for the quarter ended September 30, 2005 to increase cost of service revenues and related accruals by $446,000 and audit adjustments to the annual consolidated financial statements
for the year ended December 31, 2005 to increase cost of service revenues and related accruals by $89,000. Additionally, this control deficiency could result in a misstatement of third-party contractor costs, revenue and deferred revenue that
would result in a material misstatement to our annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, management has determined that this control deficiency constitutes a material weakness.



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Based on their assessment and because of the material weaknesses described above, management has
concluded that the Companys internal control over financial reporting was not effective as of December 31, 2005 based on the criteria established in Internal Control  Integrated Framework issued by the COSO.

Material Weakness Remediation

We assign a
high priority to the improvement of our internal control over financial reporting. The material weaknesses described above were unremediated as of March 31, 2006. We currently expect to implement new training courses for senior personnel
throughout the company attended by our Chief Executive Officer. In addition, we intend to institute procedures that will require that third-party contractor hours be tracked in a separate system and reconciled with the time recorded on invoices
received. We also intend to require new certifications of our senior personnel concerning invoicing, billing and customer commitments. We intend to finalize and implement these measures at the earliest practicable date.

Based on the results of the procedures we performed in connection with the preparation of this Quarterly Report on Form 10-Q, management believes that
the financial statements included in this Quarterly Report on Form 10-Q fairly present in all material respects our financial condition, results of operations and cash flows in accordance with GAAP for the periods presented.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the first quarter ended March 31, 2006 which our management concluded
materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



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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 commenced in the second half of 2004.

Subsequently, there were discussions with the plaintiff concerning a possible settlement of the litigation. As a result of these discussions, a
settlement was reached. Under the settlement we agreed to pay $475,000 and actual costs to administer the settlement fund up to a maximum of $25,000, in exchange for dismissal of the action and a full and general release of all claims relating to or
concerning the factual and legal allegations in the complaint (with the sole exception of claims by former Starbase shareholders who contend they did not receive the full consideration to which they were entitled from the acquisition by Borland).
The settlement is conditioned on certification of the plaintiff class; approval by the Delaware Chancery Court and satisfaction of all other legal requirements.

The parties executed a Stipulation of Settlement and proposed Scheduling Order that was signed by the Vice Chancellor on March 30, 2006. This triggered the requirement by Borland to fund the $475,000 settlement
as well as the $25,000 for administration fees within five business days. We funded the settlement within the required time limit.

The
Court set a date of June 13, 2006 for a Fairness Hearing at which time the Vice Chancellor will consider any objections to the settlement and determine whether to approve the settlement. There is no assurance that the Vice Chancellor will
approve the settlement. In addition, an objecting shareholder could appeal the approval of the settlement. If the settlement does not become final, the parties could resume litigation or attempt to renegotiate the settlement.

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.



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ITEM 1A. RISK FACTORS

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 midst of focusing the company on the development and
distribution of enterprise software development solutions and divesting our individual software development tools. If we are unable to successfully complete this change quickly and smoothly, our operating results could be harmed.

We are undergoing a change from a company that develops and delivers various product lines targeted to multiple individual markets to one that focuses
primarily on the development and distribution of enterprise software development solutions. In support of this transformation, we acquired Segue Software, Inc. (Segue) in April 2006 and, in February 2006, we announced our intention to
seek a buyer for our IDE products. This change involves many aspects (each of which involves substantial risks), including:



| |  |  | Changes in go-to-market strategy. To achieve revenue growth, we must enhance our enterprise selling capability, increase sales force productivity and generally complete
more large revenue, multi-product sales of our ALM solution set. We will also need to further define our roadmaps, integrate the Segue software quality optimization products and other acquired products into our ALM solution set, and generally
continue to evolve our ALM offerings 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. In addition, this enterprise go-to-market strategy involves different skills, partners and competencies than the
channel go-to-market strategy historically used for the IDE products. If we fail to coordinate our efforts and deliver broader value to our customers, 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. The transition to our new business model requires that we focus our sales effort on enterprise customers. To
drive these changes, we have made and will continue to make changes throughout our global sales force, particularly in Europe and Japan where productivity has been below expectations. On May 3, 2006, we announced the hiring of a new VP of our
EMEA operations and a combination of our APAC and Japan regions under single leadership. 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 rely more on selling enterprise solutions, 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 increased 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 financial performance that we anticipate, which could harm our business.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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, we 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, our revenues will suffer.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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,
including our new President and CEO who joined Borland in November 2005. As a result, our management team has a relatively short history working together, and there is risk that they will be able to manage the company effectively, especially in the
face of the dramatic change related to a major acquisition and divestiture of products. In addition, we are currently searching for a new head of worldwide research and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  | development. Failure to find a suitable candidate in a timely fashion could delay or hamper our efforts to streamline and enhance our research and development activities. During
this transition in leadership and our business, 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 change to their advantage. If we are unable to effectively manage through this transition quickly and effectively, our revenues could be harmed.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Changes in our corporate structure. The acquisition of Segue and the potential divestiture of the IDE products represent two very different transactions. The Segue
transaction relates to building on our enterprise software development solutions. The IDE products divestiture represents the disposition of individual products delivered to the market largely though a global channel network. Both transactions are
complex, and carry risks related to both our potential failure to complete them, and our failure to realize the benefits we expect from their completion. In addition, executing on both transactions will require a concurrent effort to align our
organization, change our business processes, update our financial and IT systems, and generally evolve our day-to-day operations. Failure to successfully transition our people and processes and systems could harm our business.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Changes in our services organization. On May 3, 2006, we announced a reorganization of our services organization. We have combined our consulting services and sales
organizations to better focus on customer engagements. We have also combined our technical support organization with our research and development organization to more closely align customer feedback on our products with our development efforts. The
implementation of these changes will require careful planning and coordination to ensure we maintain customer satisfaction. In addition, such changes may result in loss of key services personnel. In the event customer satisfaction is harmed or we
lose key personnel, our business could be harmed.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

There are several other types of risks inherent in our transformation,
generally described in the following paragraphs and throughout this document. While we believe that changing 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 process smoothly and quickly. If we are unable to manage this change smoothly and quickly, our business, results of operations, financial condition and prospects will be harmed. Additionally, in
consideration of expenses associated with the integration of Segue and those associated with our announced plan to seek a buyer for our IDE products, as well as the resultant changes each will require in our organization, we expect to operate
unprofitably at least through the second and third quarters of 2006.

We may be unable to integrate our operations successfully and realize all of
the anticipated benefits of the merger with Segue.

The acquisition of Segue is a significant transaction for us. The acquisition
price was approximately $105 million in cash, which represented more than half of our cash balances at December 31, 2005. We have made several assumptions regarding cost and revenue synergies for the combined company, many of which are
dependent upon how successful we are in integrating operations of the two companies. Segue has its headquarters in Lexington, Massachusetts, and has significant development and technical support centers in Linz, Austria and Belfast, Ireland. We do
not have a significant presence in any of these locations. The acquisition involves the integration of two companies that previously have operated independently, which is a complex, costly and time-consuming process. The difficulties of combining
the companies operations include, among other things:



| |  |  | the necessity of coordinating geographically disparate organizations, systems and facilities;
| | - |  | ---------------------------------------------------------------------------------------------



| |  |  | integrating personnel with diverse business backgrounds;
| | - |  | --------------------------------------------------------



| |  |  | consolidating corporate and administrative functions;
| | - |  | -----------------------------------------------------



| |  |  | consolidating research and development operations;
| | - |  | --------------------------------------------------



| |  |  | coordinating sales and marketing functions;
| | - |  | -------------------------------------------



| |  |  | persuading employees that the Borland and Segue business cultures are compatible, maintaining morale and retaining key employees, in particular those in sales and software
engineering positions;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | preserving the research and development, collaboration, distribution, marketing, promotion and other important relationships of Borland and Segue, while coordinating and
rationalizing research and development activities to enhance introduction of new products and technologies with reduced costs;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | demonstrating to customers that the acquisition will not result in adverse changes in customer service standards or business focus;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------



| |  |  | training our respective sales forces with regard to each others technologies and how to effectively sell them;
| | - |  | ---------------------------------------------------------------------------------------------------------------



| |  |  | coordinating and combining international operations, relationships and facilities, which may be subject to additional risks, costs and constraints imposed by local laws and
regulations;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | managing integration issues of our acquired businesses shortly after, simultaneously with, or pending the completion of other acquisitions or divestitures;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | maintaining productivity and support while consolidating the corporate information technology infrastructure; and
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | combining product offerings and preventing customers from deferring purchasing decisions or switching to other suppliers due to uncertainty about the direction of our product
offerings and our willingness to support and service existing products.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The process of integrating operations could cause an
interruption of, or loss of momentum in, the activities of the combined companys business and the loss of key personnel. The diversion of managements attention and any delays or difficulties encountered in connection with the acquisition
and the integration of the two companies operations could harm the business, results of operations, financial condition or prospects of the combined company after the merger.

Among the factors considered by our Board of Directors in connection with its approval of the merger agreement were the opportunities for cost savings
from operating efficiencies that could result from the acquisition. We can not be certain that these savings will be realized within the time periods contemplated or that they will be realized at all. We also can not be certain that the integration
of Borland and Segue will result in the realization of the full benefits anticipated by us to result from the acquisition.

The potential divestiture
of our IDE products is important for the future growth and profitability of our business, and our failure to efficiently divest these products or divest them at all could harm our business.

The potential divestiture of our IDE products is a significant transaction for us. The IDE products are generally mature products and require less support
and maintenance and therefore carry significant product line margins. The go-to-market model for the IDE products however has generally required an extensive management, sales and office presence throughout the world, which has been expensive to
maintain. The market for our IDE products, particularly JBuilder, 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. Revenue from our IDE products has thus declined significantly as a group in recent years. If
we are unable to efficiently divest the IDE products or unable to find a buyer at all, we will continue to be subject to these market trends and organizational dynamics, which would make it difficult to grow our business overall.

The IDE products are an integrated part of our overall worldwide operations. The process for divesting the product lines will involve many complicated
tasks, including identifying and dedicating personnel to the IDE products, shifting work responsibilities among existing personnel, identifying and separating customer and partner relationships, identifying and separating assets, and identifying and
separating intellectual property. In addition, we anticipate the divestiture will require us to provide a series of transition services to the buyer for a period of time, including access to facilities, network connectivity, communications,
development systems, IT systems and financial reporting. Any divestiture will thus be difficult, complex and costly to implement, and a failure to implement such divestiture smoothly and efficiently could materially adversely affect our business,
results of operations and financial condition.

The potential divestiture could have a disruptive effect on our current business. Customers
may decide to delay purchases pending the outcome of the divestiture, and competitors may target our installed base of customers to switch to their products. Either of these factors could cause revenues to decline in the short term. The potential
divestiture may cause us to incur material expenses. We may also incur indemnification obligations for liabilities, losses or expenses arising in connection with the sale of the IDE products. There is no assurance that upon completion of the IDE
divestiture we will be able to achieve greater profitability, strengthen our core operations or compete more effectively in existing or new markets. Entering into such a divestiture transaction may entail risks and uncertainties in addition to those
which may result from the



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divestiture related changes to our business, including but not limited to extraordinary transaction costs, unknown
indemnification liabilities and unforeseen administrative complications, any of which could result in reduced revenues, increased charges or post-transaction administrative costs or could otherwise have a material adverse effect on our business,
results of operations and financial condition.

Furthermore, our failure to complete the divestiture, failure to divest our IDE products on
advantageous terms or our inability to successfully implement and execute such divestiture could jeopardize our future growth and profitability. We would be forced to determine whether to attempt to divest the IDE products again, continue to operate
the IDE products or explore another strategic alternative. If we try to divest the IDE products at a later time, we would need to expend significant time and resources that would otherwise be used to operate our business and we would likely have to
divest the IDE products on terms that could be less favorable to us than the terms we currently anticipate being able to obtain.

Our plans for the
restructuring of our company are complex, and our failure to complete the restructuring effectively could adversely effect our business.

We are attempting to integrate our acquisition of Segue and to complete the divestiture of our IDE products at substantially the same time. Both transactions are complex, and carry risks related both to our potential failure to complete
them, and our potential failure to realize the benefits we expect following completion. In addition, pursuing such transactions at substantially the same time may entail risks and uncertainties in addition to those which may result from either the
acquisition or the divestiture alone, including but not limited to extraordinary transaction costs, unknown indemnification liabilities and unforeseen administrative and operational complications, any of which could result in reduced revenues,
increased charges or post-transaction administrative costs or could otherwise have a material adverse effect on our business, results of operations and financial condition.

Furthermore, the process of purchasing a business and selling assets could cause an interruption of, or loss of momentum in, the activities of the
companys business and the distraction of employees or the loss of key personnel. The activities involved are complicated and detailed, and they will put strain on the organization. The diversion of managements attention and any delays or
difficulties encountered in connection with completing the merger, the integration of operations, and the divestiture of our IDE products at substantially the same time could harm our overall business, results of operations, financial condition or
prospects to an even greater extent than either the acquisition or the divestiture alone. There is no guarantee that these transactions will have the anticipated results, or that these transactions will present the advantages that we anticipate
towards our goal of becoming a company focused on development and distribution of enterprise software development solutions.

We will need to realign
our research and development organization in connection with the acquisition of Segue and the IDE products divestiture.

We will
have a substantial number of new research and development personnel join us through the Segue acquisition, and we will have a substantial number of existing research and development personnel exit the company through the IDE divestiture. In
addition, we may consolidate or close certain research and development locations. These personnel additions and subtractions will occur in different geographical locations around the world and will require a coordinated management and training
effort. The changes will also affect the mix of personnel and skills in various engineering locations, which will require an evolution and rationalization of the research and development approach. There are numerous risks inherent in this process
including the potential loss of technical talent, the possibility of disruption or distractions in developing products, delays in shipping products, and the potential for product quality to suffer. We are currently searching for a new head of
worldwide research and development. Failure to find a suitable candidate in a timely fashion could delay or hamper our efforts to streamline and enhance our research and development approach.

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 IDE 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. Over the past several quarters, we have 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. Selling enterprise solutions to large customers represents a
fundamentally different go-to-market approach than selling through the channel. To that end, we have substantially



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changed our business model, hired and allocated many new sales personnel dedicated exclusively to named enterprise
accounts and built plans around augmenting our selling efforts with and through large technology and market-facing partners. However, 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 information technology professionals and other executives responsible for making enterprise-wide purchasing decisions;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | develop and reinforce messaging focused on executive-level information technology 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 revenues could suffer.

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
cycles 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 solutions, and evolve our ALM solution 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 many of our existing point products and recently acquired products into a cohesive ALM software development solution. 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 solution. We cannot be certain that we will be successful in designing and marketing new products, integrating acquired 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



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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.

If we are unable to maintain revenue levels for our Deployment Products, our financial results may be harmed.

We currently have a significant amount of our revenue attributable to our deployment products. These products are mature products and we primarily rely on
new sales to existing customers, compliance purchases through customer audits and sales through existing ISV and OEM partners to generate revenue. We have from time to time experienced unexpected weakness and fluctuations in revenue from these
products and believe they may be subject to commoditization. Our deployment products are generally based on older standards and technologies, which increasingly are used only in more select industries, networks and applications. We devote little
marketing to these products and primarily rely on the effectiveness of the sales force and compliance teams to work with customers and partners to generate sales. There have been many changes in the sales force over the past several quarters, and we
anticipate changes will continue to take place over the coming quarters, especially in Europe where we have historically generated a significant amount of revenue from our deployment products. These changes and the activities associated with the
acquisition of Segue and the potential divestiture of the IDE products puts pressure on our ability to focus and execute. If we are unable to maintain effective sales programs for our deployment products, or if customers begin to migrate away from
our deployment products, our business and results of operation will suffer.

We are new at delivering large services projects and failure to manage
these engagements could harm our margins and adversely affect our results of operations.

We have recently begun entering into
large, complex professional services agreements. We have little prior experience in services engagements of this scale. Our inability to structure and manage services agreements 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 and sufficiency of our internal controls could be harmed.

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. For example, we have had difficulties in forecasting our ALM pipeline in Europe and Japan. 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.

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 our ability to successfully grow and manage our business and to develop new products depends, 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 alternate 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



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affected 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 competitive products 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.

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:



| |  |  | issues resulting from the Segue acquisition and from divesting our IDE products;
| | - |  | --------------------------------------------------------------------------------



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



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



| |  |  | commoditization in our deployment products, or shifting buying patterns of customers of those products;
| | - |  | -------------------------------------------------------------------------------------------------------



| |  |  | 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. Additionally, the significant demands placed on our organization due to the Segue acquisition and announced divestiture could adversely affect our ability to accurately forecast costs to our
previous tolerances. 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.

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, depends 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



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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, and hire talent with the correct skill sets, 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. In 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, Computer Associates, BMC 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
aggressive competition. Some of our competitors include IBM, Telelogic, Mercury Interactive, Compuware, 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 to enhancing the functionality of, and the demand for, their core products. As a result, these companies often bundle software products that
compete with our offerings, with products such as application servers, work stations, personal computers, operating systems databases and information technology 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.



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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.

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 be certain 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 that enable
our products to 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 we 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. 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 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 information technology 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.



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We depend on technologies licensed to us by third parties, such as 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.

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 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 60% of our revenues during the quarter ended March 31, 2006, with Germany accounting for 11% 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 several domestic and international locations, and we currently 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;
| | - |  | -------------------------------------------------------------------------------------------------



| |  |  | restrictions on the expatriation of currency;
| | - |  | ---------------------------------------------



| |  |  | foreign taxes, 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.
| | - |  | -----------------------------------------------------------------------------------------------------------



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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.

We have begun the process of upgrading our
Oracle financial system in the United States 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.

We anticipate upgrading our Oracle financial system in the United
States this year. System upgrades 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 upgrade to a 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 as required by Section 404 of the Sarbanes-Oxley Act of 2002 (SOX 404).

We, and our independent registered public accounting firm, have determined that we have material weaknesses in our internal control over financial reporting as of December 31, 2005. As a result, current and potential stockholders
could lose confidence in our financial reporting, which would harm our business and the trading price of our stock.

Under
Section 404 of the Sarbanes-Oxley Act of 2002, we are required to evaluate and determine the effectiveness of our internal control over financial reporting. We have dedicated a significant amount of time and resources to ensure compliance with
this legislation for the year ended December 31, 2005 and will continue to do so for future fiscal periods. We may encounter problems or delays in completing the review and evaluation, the implementation of improvements and the receipt of a
positive attestation, or any attestation at all, by our independent registered public accounting firm. Additionally, managements assessment of our internal control over financial reporting may identify deficiencies that need to be addressed in
our internal control over financial reporting or other matters that may raise concerns for investors.

We announced on March 31, 2006
that we were delaying our filing of our Annual Report on Form 10-K for the fiscal year ended December 31, 2005 in order for the Audit Committee of our Board of Directors to conduct a review, with the assistance of outside advisors, of
third-party contractor liabilities and accrued expenses and a potential customer refund obligation (the Review). The Audit Committees Review is now complete. As a result of this Review, management identified material weaknesses
insofar as we did not maintain effective controls over third-party contractor invoices and contracts and we did not maintain an effective control environment based on the criteria established in Internal Control  Integrated Framework
Issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) with respect to senior managements role in promoting compliance with policies and procedures and the prevention or detection of the override of
our controls. A material weakness is a control deficiency, or combination of control deficiencies, that results in a more than remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or
detected.

Because of these material weaknesses, our management concluded that, as of December 31, 2005, we did not maintain effective
internal control over financial reporting. As a result, PricewaterhouseCoopers LLP has issued an adverse opinion with respect to our internal control over financial reporting and their report is included in our Annual Report on Form 10-K filed with
the SEC on May 2, 2006.

We assign a high priority to the improvement of our internal control over financial reporting. We currently
expect to implement new training courses for senior personnel throughout the company attended by our Chief Executive Officer. In addition, we intend to institute procedures that will require that third-party contractor hours be tracked in a separate
system and reconciled with the time recorded on invoices received. We also intend to require new certifications of our senior personnel concerning invoicing, billing and customer commitments. We intend to finalize and implement these measures at the
earliest practicable date. If we fail to remedy our material weaknesses or should we, or our independent registered public



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accounting firm, determine in future fiscal periods that we have additional material weaknesses in our internal control
over financial reporting, the reliability of our financial reports may be impacted, and our results of operations or financial condition may be harmed and the price of our common stock may decline.

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 adopted SFAS 123R on January 1, 2006, which requires us to expense stock options in our statement of operations. 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. Compensation charges under SFAS 123R is affected by our stock price as well as assumptions regarding a number
of complex and subjective variables and the related tax impact. These variables include, but are not limited to, the volatility of our stock price and employee stock option exercise behaviors. As a result of our adoption of SFAS 123R, our earnings
in the quarter ended March 31, 2006 were reduced by $2.1 million, and we estimate it will be substantially more likely that we could experience net losses in future periods as a result of SFAS 123R.

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, 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.



44



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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The shares shown as repurchased in
the table below were surrendered by Borland employees in order to meet tax withholding obligations in connection with the vesting of an installment of their restricted stock awards. Below is a summary of these transactions for the three months ended
March 31, 2006:

ISSUER PURCHASES OF EQUITY SECURITIES



|                                                                                                         |  |                                             |  |                                        |      |                                                                                            |   |                                                                                                                            |   |           
|-------------------------------------------------------------------------------------------------------- |  | ------------------------------------------- |  | -------------------------------------- | ---- | ------------------------------------------------------------------------------------------ | - | -------------------------------------------------------------------------------------------------------------------------- | - | ----------
|Period                                                                                                   |  | (a) TotalNumber ofShares (orUnits)Purchased |  | (b)AveragePrice Paidper Share(or Unit) |      | (c) Total Number ofShares (or Units)Purchased as Partof PubliclyAnnounced Plansor
Programs |   | (d) Maximum Number (orApproximate DollarValue) of Shares (orUnits) that May Yet
BePurchased Under thePlans or Programs (1)
|Beginning dollar value available to be repurchased as of December 31, 2005                               |  |                                             |  |                                        |      |                                                                                            |   |                                                                                                                            | $ | 59,332,237
|                                                                                                         |  |                                             |  |                                       
|January 1, 2006  January 31, 2006 (2)                                                                   |  | 39,928                                      |  | $                                      | 6.55 |                                                                                            |  |                                                                                                                            |   |          
|                                                                                                         |  |                                             |  |                                       
|February 1, 2006  February 28, 2006                                                                     |  |                                            |  | $                                      |     |                                                                                            |  |                                                                                                                            |   |          
|                                                                                                         |  |                                             |  |                                       
|March 1, 2006  March 31, 2006 (3)                                                                       |  | 5,310                                       |  | $                                      | 5.15 |                                                                                            |  |                                                                                                                            |   |          
|                                                                                                         |  |                                             |  |                                        |      |                                                                                            |   |                                                                                                                            |   |           
|Total shares repurchased                                                                                 |  | 45,238                                      |  | $                                      | 6.39 |                                                                                            |  |                                                                                                                            |   |          
|                                                                                                         |  |                                             |  |                                        |      |                                                                                            |   |                                                                                                                            |   |           
|Ending dollar value available to be repurchased under the Discretionary Program as of March 31, 2006 (4) |  |                                             |  |                                        |      |                                                                                            |   |                                                                                                                            | $ | 59,332,237
|                                                                                                         |  |                                             |  |                                        |      |                                                                                            |   |                                                                                                                            |   |           

---

|(1) | In September 2001, our Board of Directors authorized the use of up to $30.0 million to repurchase shares of our outstanding common stock under a discretionary stock repurchase
program (Discretionary Program). In February 2004, our Board of Directors authorized an additional $30.0 million of repurchases under the Discretionary Program, which was announced in our Current Report on Form 8-K filed with the
Securities and Exchange Commission on February 4, 2004. In May 2005, our Board of Directors authorized an additional $75.0 million of repurchases under the Discretionary Program, which was announced in our Current Report on Form 8-K filed with
the Securities and Exchange Commission on May 20, 2005. No shares were repurchased through our Discretionary Program during the quarter ended March 31, 2006.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Includes 39,928 shares of restricted stock surrendered by Borland employees in order to meet tax withholding obligations in connection with the vesting of an installment of their
restricted stock awards.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Includes 5,310 shares of restricted stock surrendered by Borland employees in order to meet tax withholding obligations in connection with the vesting of an installment of their
restricted stock awards.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Includes $59,332,237 available for repurchase under our Discretionary Program. The restricted stock surrendered by Borland employees in order to meet tax withholding obligations in
connection with the vesting of installments of their restricted stock awards were not under the Discretionary Program.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

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

None.

ITEM 5. OTHER INFORMATION

None.

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 |  | Filed Herewith
|Exhibit Number |  | Description of Exhibit                                                                                                                |  | Form                      |  | Date           |  | Number | 
|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.                                   |  | 10-Q                      |  | 11/08/05       |  | 10.74  |  | 
|               |  |                                                                                                                                       |  |                           | 
|10.75          |  | Form of Acceleration Addendum to Stock Issuance Agreement under the Stock Issuance Program of the 2002 Stock Incentive Plan.          |  | 10-Q                      |  | 11/08/05       |  | 10.75  |  | 
|               |  |                                                                                                                                       |  |                           | 
|10.76          |  | Form of Stock Agreement under the Discretionary Option Grant Program of the 2002 Stock Incentive Plan.                                |  | 10-Q                      |  | 11/08/05       |  | 10.76  |  | 
|               |  |                                                                                                                                       |  |                           | 
|10.77          |  | Form of Acceleration Addendum to Stock Option Agreement under the Discretionary Grant Program of the 2002 Stock Incentive Plan +      |  | 10-Q                      |  | 11/08/05       |  | 10.77  |  | 
|               |  |                                                                                                                                       |  |                           | 
|10.78          |  | Form of Addendum to Employment Offer Letters for Severance Benefits for Named Executive Officers. +                                   |  | 10-Q                      |  | 11/08/05       |  | 10.78  |  | 



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|               |  |                                                                                                                                                   |  |                           |  |                |  |        |  |  
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- |  | -------------- |  | ------ |  | -
|               |  |                                                                                                                                                   |  | Incorporated by Reference |  | Filed Herewith
|Exhibit Number |  | Description of Exhibit                                                                                                                            |  | Form                      |  | Date           |  | Number | 
|10.86          |  | 2006 Incentive Compensation Plan for Executive Officers.                                                                                          |  | 8-K                       |  | 03/20/06       |  | 10.86  |  |  
|               |  |                                                                                                                                                   |  |                           | 
|10.87          |  | Borland Software Corporation 2003 Supplemental Stock Option Plan.                                                                                 |  | 8-K                       |  | 03/20/06       |  | 10.87  |  |  
|               |  |                                                                                                                                                   |  |                           | 
|31.1           |  | Certification of Tod Nielsen, 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 Tod Nielsen, 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

---

|+ | The certifications attached as Exhibit 32.1 and Exhibit 32.2 that accompany this Quarterly Report on Form 10-Q, are not deemed filed with the Securities and Exchange Commission and
are not to be incorporated by reference into any filing of Borland Software Corporation under the Securities Act of 1933 or the Securities Exchange Act of 1934 whether made before or after the date of this Form 10-Q, irrespective of any general
incorporation language contained in such filing.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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.



47



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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 15thday of May
2006.



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




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EXHIBIT INDEX



|               |  |                                                                                                                                                   |  |                           |  |                |  |        |  |  
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- |  | -------------- |  | ------ |  | -
|               |  |                                                                                                                                                   |  | Incorporated by Reference |  | Filed Herewith
|Exhibit Number |  | Description of Exhibit                                                                                                                            |  | Form                      |  | Date           |  | Number | 
|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.                                               |  | 10-Q                      |  | 11/08/05       |  | 10.74  |  |  
|               |  |                                                                                                                                                   |  |                           | 
|10.75          |  | Form of Acceleration Addendum to Stock Issuance Agreement under the Stock Issuance Program of the 2002 Stock Incentive Plan.                      |  | 10-Q                      |  | 11/08/05       |  | 10.75  |  |  
|               |  |                                                                                                                                                   |  |                           | 
|10.76          |  | Form of Stock Agreement under the Discretionary Option Grant Program of the 2002 Stock Incentive Plan.                                            |  | 10-Q                      |  | 11/08/05       |  | 10.76  |  |  
|               |  |                                                                                                                                                   |  |                           | 
|10.77          |  | Form of Acceleration Addendum to Stock Option Agreement under the Discretionary Grant Program of the 2002 Stock Incentive Plan.                   |  | 10-Q                      |  | 11/08/05       |  | 10.77  |  |  
|               |  |                                                                                                                                                   |  |                           | 
|10.78          |  | Form of Addendum to Employment Offer Letters for Severance Benefits for Named Executive Officers. +                                               |  | 10-Q                      |  | 11/08/05       |  | 10.78  |  |  
|               |  |                                                                                                                                                   |  |                           | 
|10.86          |  | 2006 Incentive Compensation Plan for Executive Officers.                                                                                          |  | 8-K                       |  | 03/20/06       |  | 10.86  |  |  
|               |  |                                                                                                                                                   |  |                           | 
|10.87          |  | Borland Software Corporation 2003 Supplemental Stock Option Plan.                                                                                 |  | 8-K                       |  | 03/20/06       |  | 10.87  |  |  
|               |  |                                                                                                                                                   |  |                           | 
|31.1           |  | Certification of Tod Nielsen, 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 Tod Nielsen, 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

---

|+ | The certifications attached as Exhibit 32.1 and Exhibit 32.2 that accompany this Quarterly Report on Form 10-Q, are not deemed filed with the Securities and Exchange Commission and
are not to be incorporated by reference into any filing of Borland Software Corporation under the Securities Act of 1933 or the Securities Exchange Act of 1934 whether made before or after the date of this Form 10-Q, irrespective of any general
incorporation language contained in such filing.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



49