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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549



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FORM 10-Q



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



For the quarterly period ended September 30, 2004



OR



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



For the transition period from  to



Commission file number 0-22158



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NetManage, Inc.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                  
|-------------------------------------------------------------- |  | ---------------------------------
|Delaware                                                       |  | 77-0252226                       
|(State or other jurisdiction of Incorporation or organization) |  | (IRS employer identification no.)



20883 Stevens Creek
Boulevard

Cupertino, California 95014

(Address of principal executive offices, including zip code)



(408) 973-7171

(Registrants telephone number, including area code)



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



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



Number of shares of registrants common stock outstanding as of November
8, 2004: 9,192,042



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##### Table of Contents

NetManage, Inc.



Table of Contents



|         |  |                                                                                                                                                |  |         
|-------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------- |  | --------
|         |  |                                                                                                                                                |  | Page No.
|PART I.  |  | FINANCIAL INFORMATION                                                                                                                          |  |         
|         |  |                                                                                                                                               
|Item 1.  |  | Financial Statements                                                                                                                           |  |         
|         |  |                                                                                                                                               
|         |  | Condensed Consolidated Balance Sheets at September 30, 2004 and December 31, 2003                                                              |  | 3       
|         |  |                                                                                                                                               
|         |  | Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2004 and September 30, 2003                  |  | 4       
|         |  |                                                                                                                                               
|         |  | Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months ended September 30, 2004 and September 30, 2003 |  | 5       
|         |  |                                                                                                                                               
|         |  | Condensed Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2004 and September 30, 2003                            |  | 6       
|         |  |                                                                                                                                               
|         |  | Notes to Condensed Consolidated Financial Statements                                                                                           |  | 7       
|         |  |                                                                                                                                               
|Item 2.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                                          |  | 15      
|         |  |                                                                                                                                               
|Item 3.  |  | Quantitative and Qualitative Disclosures About Market Risk                                                                                     |  | 30      
|         |  |                                                                                                                                               
|Item 4.  |  | Controls and Procedures                                                                                                                        |  | 31      
|         |  |                                                                                                                                               
|PART II. |  | OTHER INFORMATION                                                                                                                              |  |         
|         |  |                                                                                                                                               
|Item 1.  |  | Legal Proceedings                                                                                                                              |  | 31      
|         |  |                                                                                                                                               
|Item 2.  |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                                                    |  | 31      
|         |  |                                                                                                                                               
|Item 3.  |  | Defaults upon Senior Securities                                                                                                                |  | 31      
|         |  |                                                                                                                                               
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                                                            |  | 31      
|         |  |                                                                                                                                               
|Item 5.  |  | Other Information                                                                                                                              |  | 31      
|         |  |                                                                                                                                               
|Item 6.  |  | Exhibits and Reports on Form 8-K                                                                                                               |  | 32      
|         |  |                                                                                                                                               
|         |  | Signatures                                                                                                                                     |  | 33      



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NETMANAGE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

(Unaudited)



|                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ----------------- | -------- | - | ---------------- | - | -------- | -
|                                                                                                                                                                                                             |  | September 30,2004 |          |   | December 31,2003 |  
|ASSETS                                                                                                                                                                                                       |  |                   |          |   |                  |   |          |  
|Current assets:                                                                                                                                                                                              |  |                   |          |   |                  |   |          |  
|Cash and cash equivalents                                                                                                                                                                                    |  | $                 | 25,877   |   |                  | $ | 20,160   |  
|Short-term investments                                                                                                                                                                                       |  |                   | 196      |   |                  |   | 139      |  
|Accounts receivable, net of allowances of $889 and $922, respectively                                                                                                                                        |  |                   | 4,905    |   |                  |   | 12,781   |  
|Prepaid expenses and other current assets                                                                                                                                                                    |  |                   | 2,800    |   |                  |   | 3,204    |  
|                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Total current assets                                                                                                                                                                                         |  |                   | 33,778   |   |                  |   | 36,284   |  
|                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Property and equipment, at cost:                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Computer software and equipment                                                                                                                                                                              |  |                   | 1,326    |   |                  |   | 1,686    |  
|Furniture and fixtures                                                                                                                                                                                       |  |                   | 5,161    |   |                  |   | 5,501    |  
|Leasehold improvements                                                                                                                                                                                       |  |                   | 2,224    |   |                  |   | 1,356    |  
|                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|                                                                                                                                                                                                             |  |                   | 8,711    |   |                  |   | 8,543    |  
|Less-accumulated depreciation                                                                                                                                                                                |  |                   | (5,842   | ) |                  |   | (6,364   | )
|                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Net property and equipment                                                                                                                                                                                   |  |                   | 2,869    |   |                  |   | 2,179    |  
|                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Goodwill                                                                                                                                                                                                     |  |                   | 1,762    |   |                  |   | 1,762    |  
|Other intangibles, net                                                                                                                                                                                       |  |                   | 163      |   |                  |   | 1,591    |  
|Other assets                                                                                                                                                                                                 |  |                   | 74       |   |                  |   | 35       |  
|                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Total assets                                                                                                                                                                                                 |  | $                 | 38,646   |   |                  | $ | 41,851   |  
|                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                         |  |                   |          |   |                  |   |          |  
|Current liabilities:                                                                                                                                                                                         |  |                   |          |   |                  |   |          |  
|Accounts payable                                                                                                                                                                                             |  | $                 | 2,104    |   |                  | $ | 2,328    |  
|Accrued liabilities                                                                                                                                                                                          |  |                   | 3,072    |   |                  |   | 5,853    |  
|Accrued payroll and related expenses                                                                                                                                                                         |  |                   | 2,903    |   |                  |   | 3,079    |  
|Deferred revenue                                                                                                                                                                                             |  |                   | 12,384   |   |                  |   | 15,939   |  
|Income taxes payable                                                                                                                                                                                         |  |                   | 1,385    |   |                  |   | 1,238    |  
|                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Total current liabilities                                                                                                                                                                                    |  |                   | 21,848   |   |                  |   | 28,437   |  
|Long-term liabilities                                                                                                                                                                                        |  |                   | 2,256    |   |                  |   | 584      |  
|                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Total liabilities                                                                                                                                                                                            |  |                   | 24,104   |   |                  |   | 29,021   |  
|                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Commitments and contingencies (Note 5)                                                                                                                                                                       |  |                   |          |   |                  |   |          |  
|Stockholders equity:                                                                                                                                                                                        |  |                   |          |   |                  |   |          |  
|Preferred stock, $0.01 par value -Authorized - 1,000,000 and 5,000,000 shares, respectivelyNo shares issued and
outstanding                                                                                  |  |                   |         |   |                  |   |         |  
|Common stock, $0.01 par value -Authorized - 36,000,000 and 125,000,000 shares, respectivelyIssued  10,972,424 and 10,787,553
shares, respectivelyOutstanding - 8,895,576 and 8,710,705 shares, respectively |  |                   | 110      |   |                  |   | 108      |  
|Treasury stock, at cost - 2,076,848 shares                                                                                                                                                                   |  |                   | (20,804  | ) |                  |   | (20,804  | )
|Additional paid in capital                                                                                                                                                                                   |  |                   | 179,349  |   |                  |   | 178,080  |  
|Accumulated deficit                                                                                                                                                                                          |  |                   | (140,153 | ) |                  |   | (140,842 | )
|Accumulated other comprehensive loss                                                                                                                                                                         |  |                   | (3,960   | ) |                  |   | (3,712   | )
|                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Total stockholders equity                                                                                                                                                                                   |  |                   | 14,542   |   |                  |   | 12,830   |  
|                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Total liabilities and stockholders equity                                                                                                                                                                   |  | $                 | 38,646   |   |                  | $ | 41,851   |  
|                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  



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



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##### Table of Contents

NETMANAGE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)



|                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                            |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                            |  | 2004                            |        |   | 2003                           |   |        | 2004 |  |   | 2003   |  
|Net revenues:                               |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|License fees                                |  | $                               | 4,813  |   |                                | $ | 4,022  |      |  | $ | 13,570 |   |  | $ | 14,258 |  
|Services                                    |  |                                 | 6,820  |   |                                |   | 7,355  |      |  |   | 20,939 |   |  |   | 23,109 |  
|                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Total net revenues                          |  |                                 | 11,633 |   |                                |   | 11,377 |      |  |   | 34,509 |   |  |   | 37,367 |  
|                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Cost of revenues:                           |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|License fees                                |  |                                 | 369    |   |                                |   | 277    |      |  |   | 1,115  |   |  |   | 1,353  |  
|Services                                    |  |                                 | 920    |   |                                |   | 1,066  |      |  |   | 2,717  |   |  |   | 3,593  |  
|Amortization of developed technology        |  |                                 | 336    |   |                                |   | 294    |      |  |   | 923    |   |  |   | 953    |  
|                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Total cost of revenues                      |  |                                 | 1,625  |   |                                |   | 1,637  |      |  |   | 4,755  |   |  |   | 5,899  |  
|                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Gross margin                                |  |                                 | 10,008 |   |                                |   | 9,740  |      |  |   | 29,754 |   |  |   | 31,468 |  
|                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Operating expenses:                         |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Research and development                    |  |                                 | 1,722  |   |                                |   | 1,831  |      |  |   | 5,247  |   |  |   | 6,547  |  
|Sales and marketing                         |  |                                 | 5,663  |   |                                |   | 5,805  |      |  |   | 16,404 |   |  |   | 19,440 |  
|General and administrative                  |  |                                 | 1,951  |   |                                |   | 2,958  |      |  |   | 7,011  |   |  |   | 8,727  |  
|Restructuring charges, net                  |  |                                 | 32     |   |                                |   | 339    |      |  |   | (106   | ) |  |   | 1,829  |  
|Amortization of intangible assets           |  |                                 | 150    |   |                                |   | 150    |      |  |   | 449    |   |  |   | 449    |  
|                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Total operating expenses                    |  |                                 | 9,518  |   |                                |   | 11,083 |      |  |   | 29,005 |   |  |   | 36,992 |  
|                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Income (loss) from operations               |  |                                 | 490    |   |                                |   | (1,343 | )    |  |   | 749    |   |  |   | (5,524 | )
|Loss on investments, net                    |  |                                 |       |   |                                |   |       |      |  |   |       |   |  |   | (32    | )
|Interest income (expense) and other, net    |  |                                 | 40     |   |                                |   | (109   | )    |  |   | 72     |   |  |   | 11     |  
|Foreign currency transaction gains (losses) |  |                                 | 293    |   |                                |   | (401   | )    |  |   | (66    | ) |  |   | 489    |  
|                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Income (loss) before income taxes           |  |                                 | 823    |   |                                |   | (1,853 | )    |  |   | 755    |   |  |   | (5,056 | )
|Provision (benefit) for income taxes        |  |                                 | (40    | ) |                                |   | 4      |      |  |   | 66     |   |  |   | (297   | )
|                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Net income (loss)                           |  | $                               | 863    |   |                                | $ | (1,857 | )    |  | $ | 689    |   |  | $ | (4,759 | )
|                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Net income (loss) per share:                |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Basic                                       |  | $                               | 0.10   |   |                                | $ | (0.21  | )    |  | $ | 0.08   |   |  | $ | (0.55  | )
|Diluted                                     |  | $                               | 0.09   |   |                                | $ | (0.21  | )    |  | $ | 0.07   |   |  | $ | (0.55  | )
|Weighted average common shares:             |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Basic                                       |  |                                 | 8,895  |   |                                |   | 8,665  |      |  |   | 8,843  |   |  |   | 8,646  |  
|Diluted                                     |  |                                 | 9,189  |   |                                |   | 8,665  |      |  |   | 9,395  |   |  |   | 8,646  |  



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



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NETMANAGE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

(Unaudited)



|                                              |  |                                 |      |   |                                |   |        |      |  |   |      |   |  |   |        |  
|--------------------------------------------- |  | ------------------------------- | ---- | - | ------------------------------ | - | ------ | ---- |  | - | ---- | - |  | - | ------ | -
|                                              |  | Three Months EndedSeptember 30, |      |   | Nine Months EndedSeptember 30, |  
|                                              |  | 2004                            |      |   | 2003                           |   |        | 2004 |  |   | 2003 |  
|Net income (loss)                             |  | $                               | 863  |   |                                | $ | (1,857 | )    |  | $ | 689  |   |  | $ | (4,759 | )
|Other comprehensive income (loss):            |  |                                 |      |   |                                |   |        |      |  |   |      |   |  |   |        |  
|Unrealized gain (loss) on investments, net    |  |                                 | (28  | ) |                                |   | 36     |      |  |   | (69  | ) |  |   | 83     |  
|Foreign currency translation adjustments, net |  |                                 | (394 | ) |                                |   | 407    |      |  |   | (179 | ) |  |   | (643   | )
|                                              |  |                                 |      |   |                                |   |        |      |  |   |      |   |  |   |        |  
|Total comprehensive income (loss)             |  | $                               | 441  |   |                                | $ | (1,414 | )    |  | $ | 441  |   |  | $ | (5,319 | )
|                                              |  |                                 |      |   |                                |   |        |      |  |   |      |   |  |   |        |  



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



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NETMANAGE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



|                                                                                                   |  |                                |        |   |      |   |        |  
|-------------------------------------------------------------------------------------------------- |  | ------------------------------ | ------ | - | ---- | - | ------ | -
|                                                                                                   |  | Nine months endedSeptember 30, |       
|                                                                                                   |  | 2004                           |        |   | 2003 |  
|Cash flows from operating activities:                                                              |  |                                |        |   |      |   |        |  
|Net income (loss)                                                                                  |  | $                              | 689    |   |      | $ | (4,759 | )
|Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: |  |                                |        |   |      |   |        |  
|Depreciation and amortization                                                                      |  |                                | 2,118  |   |      |   | 2,289  |  
|Loss on disposal of property, plant and equipment                                                  |  |                                | 13     |   |      |   | 22     |  
|Provision for doubtful accounts and returns                                                        |  |                                | 93     |   |      |   | 95     |  
|Stock compensation expense                                                                         |  |                                | 458    |   |      |   | 67     |  
|Liquidation of dormant entities                                                                    |  |                                | (426   | ) |      |   |       |  
|Loss on investments, net                                                                           |  |                                |       |   |      |   | 32     |  
|Changes in operating assets and liabilities:                                                       |  |                                |        |   |      |   |        |  
|Accounts receivable                                                                                |  |                                | 7,783  |   |      |   | 12,845 |  
|Prepaid expenses and other current assets                                                          |  |                                | 404    |   |      |   | 203    |  
|Other assets                                                                                       |  |                                | (74    | ) |      |   | 88     |  
|Accounts payable                                                                                   |  |                                | (168   | ) |      |   | (699   | )
|Accrued liabilities, payroll and payroll-related expenses                                          |  |                                | (2,844 | ) |      |   | (4,554 | )
|Deferred revenue                                                                                   |  |                                | (3,438 | ) |      |   | (7,130 | )
|Income taxes payable                                                                               |  |                                | 147    |   |      |   | 210    |  
|Long-term liabilities                                                                              |  |                                | 1,673  |   |      |   | (303   | )
|                                                                                                   |  |                                |        |   |      |   |        |  
|Net cash provided by (used in) operating activities                                                |  |                                | 6,428  |   |      |   | (1,594 | )
|                                                                                                   |  |                                |        |   |      |   |        |  
|Cash flows from investing activities:                                                              |  |                                |        |   |      |   |        |  
|Purchases of short-term investments                                                                |  |                                | (136   | ) |      |   | (193   | )
|Proceeds from sales and maturities of short-term investments                                       |  |                                | 37     |   |      |   | 133    |  
|Purchases of property and equipment                                                                |  |                                | (1,483 | ) |      |   | (454   | )
|                                                                                                   |  |                                |        |   |      |   |        |  
|Net cash used in investing activities                                                              |  |                                | (1,582 | ) |      |   | (514   | )
|                                                                                                   |  |                                |        |   |      |   |        |  
|Cash flows from financing activities:                                                              |  |                                |        |   |      |   |        |  
|Proceeds from sale of common stock                                                                 |  |                                | 813    |   |      |   | 32     |  
|Purchases of common stock                                                                          |  |                                |       |   |      |   | (175   | )
|                                                                                                   |  |                                |        |   |      |   |        |  
|Net cash provided by (used in) financing activities                                                |  |                                | 813    |   |      |   | (143   | )
|                                                                                                   |  |                                |        |   |      |   |        |  
|Effect of exchange rate changes on cash                                                            |  |                                | 58     |   |      |   | (234   | )
|                                                                                                   |  |                                |        |   |      |   |        |  
|Net increase (decrease) in cash and cash equivalents                                               |  |                                | 5,717  |   |      |   | (2,485 | )
|Cash and cash equivalents, beginning of period                                                     |  |                                | 20,160 |   |      |   | 24,014 |  
|                                                                                                   |  |                                |        |   |      |   |        |  
|Cash and cash equivalents, end of period                                                           |  | $                              | 25,877 |   |      | $ | 21,529 |  
|                                                                                                   |  |                                |        |   |      |   |        |  



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



6



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##### Table of Contents

NETMANAGE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



1. Interim financial data



The accompanying interim unaudited condensed consolidated financial statements of NetManage, Inc. (the Company) have been prepared in
accordance with accounting principles generally accepted in the United States of America (generally accepted accounting principles) for interim financial information and in accordance with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not contain all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the accompanying unaudited condensed
consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation. Actual results for fiscal year 2004 could differ materially from those reported in this
quarterly report on Form 10-Q. The Company believes the results of operations for interim periods are subject to fluctuation and may not be an indicator of future financial performance. The financial statements should be read in conjunction with the
audited financial statements and notes thereto, included in the Companys annual report on Form 10-K for the year ended December 31, 2003, as filed with the Securities and Exchange Commission.



2. Consolidation



The interim unaudited condensed consolidated financial statements include the Companys accounts and those of its
wholly owned subsidiaries. All inter-company accounts and transactions have been eliminated.



3. Summary of significant accounting policies



Use of estimates



The preparation of the
condensed consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent
assets and liabilities at the date of the condensed consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.



Foreign currency translation, foreign exchange contracts and comprehensive income (loss)



The functional currency of the Companys foreign
subsidiaries is the local currency. Gains and losses resulting from the translation of the foreign subsidiaries financial statements are reported as a separate component of stockholders equity. Gains and losses resulting from foreign
currency transactions are included in net income (loss).



The
Company currently does not enter into financial instruments for either trading or speculative purposes.



Total comprehensive income (loss) is comprised of net income (loss) and other comprehensive items such as foreign currency translation gain (loss) and
unrealized gains or losses on marketable securities classified as available for sale.



Short-term investments



The Company
accounts for its investments under the provisions of Statement of Financial Accounting Standards, or SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities.Under SFAS No. 115, the Companys investments classified
as available-for-sale securities are reported at fair value, with unrealized gains and losses, net of tax, reported in the condensed consolidated balance sheet as Accumulated other comprehensive loss. Held-to-maturity securities are
valued using the amortized cost method. At September 30, 2004 and December 31, 2003, the fair value of the time deposit investments, which have original maturities in excess of 90 days, approximated amortized cost and, as such, gross unrealized
holding gains and losses were not material. The fair value of the available-for-sale securities was determined based on quoted market prices at the reporting dates for those instruments. The carrying value of the Companys short-term
investments by major security type consisted of the following as of September 30, 2004 and December 31, 2003 (in thousands):



|                    |  |                   |     |                  |   |    
|------------------- |  | ----------------- | --- | ---------------- | - | ---
|Description         |  | September 30,2004 |     | December 31,2003
|Time deposits       |  | $                 | 127 |                  | $ | 2  
|KANA Software, Inc* |  |                   | 69  |                  |   | 137
|                    |  |                   |     |                  |   |    
|                    |  | $                 | 196 |                  | $ | 139
|                    |  |                   |     |                  |   |    

---

|* | KANA Software, Inc. is a publicly traded company in which the Company owns a minority interest of less than 1%.
|- | ---------------------------------------------------------------------------------------------------------------



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##### Table of Contents

Goodwill and other intangible assets, net



Effective January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangibles Assets.Under SFAS No.
142, goodwill is no longer subject to amortization over its estimated useful life. Rather, SFAS No. 142 requires that goodwill and other intangible assets deemed to have an indefinite useful life be reviewed for impairment upon adoption of SFAS No.
142 and at least annually thereafter.



Intangible assets with
determinable useful lives are amortized on a straight-line basis over their estimated useful lives ranging from two to seven years. The following table provides a summary of the carrying amounts of other intangible assets (in thousands):



|                                           |  |                   |         |   |                  |   |         |  
|------------------------------------------ |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                           |  | September 30,2004 |         |   | December 31,2003 |  
|Carrying amount of:                        |  |                   |         |   |                  |   |         |  
|Developed technology                       |  | $                 | 11,506  |   |                  | $ | 11,185  |  
|Customer base                              |  |                   | 3,177   |   |                  |   | 3,177   |  
|RUMBA® trade name                          |  |                   | 1,492   |   |                  |   | 1,492   |  
|Patents & copyrights                       |  |                   | 399     |   |                  |   | 399     |  
|                                           |  |                   |         |   |                  |   |         |  
|Gross carrying amount of other intangibles |  |                   | 16,574  |   |                  |   | 16,253  |  
|Less accumulated amortization:             |  |                   |         |   |                  |   |         |  
|Developed technology                       |  |                   | (11,439 | ) |                  |   | (10,139 | )
|Customer base                              |  |                   | (3,115  | ) |                  |   | (2,835  | )
|RUMBA trade name                           |  |                   | (1,463  | ) |                  |   | (1,331  | )
|Patents & copyrights                       |  |                   | (394    | ) |                  |   | (357    | )
|                                           |  |                   |         |   |                  |   |         |  
|Net carrying amount of other intangibles   |  | $                 | 163     |   |                  | $ | 1,591   |  
|                                           |  |                   |         |   |                  |   |         |  



The aggregate
amortization expense for the three and nine months ended September 30, 2004 was $0.5 million and $1.4 million respectively. The aggregate amortization expense for the three and nine months ended September 30, 2003 was $0.4 million and $1.4 million
respectively.



Estimated future amortization for the remainder
of 2004 is $163,000 at which point the identifiable intangible assets as of September 30, 2004 will be fully amortized.



Accrued liabilities and restructuring



Accrued liabilities at September 30, 2004 and December 31, 2003 consisted of the following (in thousands):



|                                   |  |                   |       |                  |   |      
|---------------------------------- |  | ----------------- | ----- | ---------------- | - | -----
|Description                        |  | September 30,2004 |       | December 31,2003
|Current restructuring (see Note 4) |  | $                 | 436   |                  | $ | 1,457
|Other accruals                     |  |                   | 2,636 |                  |   | 4,396
|                                   |  |                   |       |                  |   |      
|Total accrued liabilities          |  | $                 | 3,072 |                  | $ | 5,853
|                                   |  |                   |       |                  |   |      



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



Long-term
liabilities



Long-term liabilities at September 30,
2004 and December 31, 2003 consisted of the following (in thousands):



|                                       |  |                   |       |                  |   |    
|-------------------------------------- |  | ----------------- | ----- | ---------------- | - | ---
|Description                            |  | September 30,2004 |       | December 31,2003
|Non-current restructuring (see Note 4) |  | $                 | 345   |                  | $ | 336
|Non-current deferred revenue           |  |                   | 1,911 |                  |   | 248
|                                       |  |                   |       |                  |   |    
|Total long-term liabilities            |  | $                 | 2,256 |                  | $ | 584
|                                       |  |                   |       |                  |   |    



8



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##### Table of Contents

Concentrations of credit risk



Financial instruments, which subject the Company to concentrations of credit risk, consist principally of cash investments
and trade receivables. The Company has a cash investment policy that limits the amount of credit exposure to any one issuer and restricts placement of these investments to issuers evaluated as creditworthy. Concentrations of credit risk with respect
to trade receivables are limited due to the large number of customers comprising the Companys customer base and their dispersion across many different industries and geographies. One customer accounted for approximately 23% of consolidated
revenues in the three month period ended September 30, 2004 and no customer accounted for 10% or more of consolidated revenues in the three month period ended September 30, 2003. There were no customers that accounted for 10% or more of consolidated
revenues in the nine month periods ended September 30, 2004 and 2003.



Accounting for stock based compensation



In December 2002, the FASB issued SFAS No. 148, Accounting for Stock Based Compensation-Transition and Disclosure-an Amendment of FASB Statement No. 123, which provides alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has adopted the amended annual and interim disclosure requirements of SFAS No. 123.



SFAS No. 123, Accounting for Stock-Based Compensation,encourages all
entities to adopt a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the fair value of the award which is recognized over the service period, which is
usually the vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees,whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. Stock options issued
under the Companys stock option plans have no intrinsic value at the grant date. Accordingly, under APB Opinion No. 25, no compensation cost is recognized. The Company has elected to continue with the method of accounting prescribed in APB
Opinion No. 25 and, as a result, must provide pro forma disclosures of net income (loss) and income (loss) per share and other disclosures as if the fair value based method of accounting had been applied. Had compensation cost for the Companys
outstanding stock options been determined based on the fair value at the grant dates for awards under those plans consistent with the method prescribed by SFAS No. 123, the Companys net income (loss) and income (loss) per share would have been
adjusted to the pro forma amounts indicated below (in thousands except per share data):



|                                                                                                             |  |                                  |       |   |                                 |   |        |      |  |   |       |   |  |   |        |  
|------------------------------------------------------------------------------------------------------------ |  | -------------------------------- | ----- | - | ------------------------------- | - | ------ | ---- |  | - | ----- | - |  | - | ------ | -
|                                                                                                             |  | Three Months Ended September 30, |       |   | Nine Months Ended September 30, |  
|                                                                                                             |  | 2004                             |       |   | 2003                            |   |        | 2004 |  |   | 2003  |  
|Net income (loss) as reported                                                                                |  | $                                | 863   |   |                                 | $ | (1,857 | )    |  | $ | 689   |   |  | $ | (4,759 | )
|Add: Total stock-based employee compensation expense determined under fair value based method for all awards |  |                                  | (199  | ) |                                 |   | (385   | )    |  |   | (630  | ) |  |   | (1,087 | )
|                                                                                                             |  |                                  |       |   |                                 |   |        |      |  |   |       |   |  |   |        |  
|Pro forma net income (loss)                                                                                  |  | $                                | 664   |   |                                 | $ | (2,242 | )    |  | $ | 59    |   |  | $ | (5,846 | )
|                                                                                                             |  |                                  |       |   |                                 |   |        |      |  |   |       |   |  |   |        |  
|Weighted average common shares:                                                                              |  |                                  |       |   |                                 |   |        |      |  |   |       |   |  |   |        |  
|Basic                                                                                                        |  |                                  | 8,895 |   |                                 |   | 8,665  |      |  |   | 8,843 |   |  |   | 8,646  |  
|Diluted                                                                                                      |  |                                  | 9,189 |   |                                 |   | 8,665  |      |  |   | 9,395 |   |  |   | 8,646  |  
|Basic income (loss) per share, as reported                                                                   |  | $                                | 0.10  |   |                                 | $ | (0.21  | )    |  | $ | 0.08  |   |  | $ | (0.55  | )
|Diluted income (loss) per share, as reported                                                                 |  | $                                | 0.09  |   |                                 | $ | (0.21  | )    |  | $ | 0.07  |   |  | $ | (0.55  | )
|Basic income (loss) per share, pro forma                                                                     |  | $                                | 0.07  |   |                                 | $ | (0.26  | )    |  | $ | 0.01  |   |  | $ | (0.68  | )
|Diluted income (loss) per share, pro forma                                                                   |  | $                                | 0.07  |   |                                 | $ | (0.26  | )    |  | $ | 0.01  |   |  | $ | (0.68  | )



The fair value of each
option granted is estimated on the date of grant using the Black-Scholes model with the following assumptions used for grants during the applicable periods:



|                        |  |                                      |  |                                     |  |                                      |  |                                    
|----------------------- |  | ------------------------------------ |  | ----------------------------------- |  | ------------------------------------ |  | -----------------------------------
|                        |  | Three Months EndedSeptember 30, 2004 |  | Nine Months EndedSeptember 30, 2004 |  | Three Months EndedSeptember 30, 2003 |  | Nine Months EndedSeptember 30, 2003
|Volatility              |  | 71.03%                               |  | 83.63%                              |  | 63.82%                               |  | 82.35%                             
|Risk-free interest rate |  | 3.23-3.27%                           |  | 2.63-3.27%                          |  | 1.24-3.03%                           |  | 1.00-3.03%                         
|Dividend yield          |  | 0.00%                                |  | 0.00%                               |  | 0.00%                                |  | 0.00%                              
|Expected term           |  | 3 - 4 monthsbeyond vest date         |  | 3 - 4 monthsbeyond vest date        |  | 3 - 4 monthsbeyond vest date         |  | 3 - 4 monthsbeyond vest date       



9



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##### Table of Contents

Stock option exchange offer



On May 16, 2003 the Company announced a voluntary stock option exchange program for certain of its employees. The offer to
exchange options, or Offer, was open to eligible option holders, excluding non-employee members of the board of directors and non-exempt employees, holding options to purchase shares of the Companys common stock with an exercise price per
share of $1.50 or greater. In accordance with the terms of the Offer, participating employees tendered eligible options in exchange for replacement options. These replacement options were granted to employees at least six months and one day
following the date their original options were tendered and cancelled. Under the terms of the Offer, replacement options vest and become exercisable for the balance of the option shares in accordance with the same type of installment vesting
schedule that was in effect for the cancelled options, but measured from the grant date of the replacement options. In addition, no vesting credit was provided for the period between the date the original options were tendered and the date the
replacement options were granted.



On June 13, 2003, employees
tendered options to purchase an aggregate of 542,150 shares in connection with the Offer. These options were cancelled under the Companys 1992 Stock Option Plan as amended and restated, and the 1999 Non-statutory Stock Option Plan as amended,
or Company Plans, following their exchange. Subject to the continued employment of the employees who exchanged options, replacement options were granted on or around December 16, 2003. As of December 16, 2003, the number of tendered options eligible
for replacement were reduced to 531,047 due to the termination of certain employees after June 13, 2003.



The exercise price of the replacement options of $4.78 per share was based on the fair market value of the Companys common stock on the date the
replacement options were granted. The fair market value of the Companys common stock was equal to the last reported sale price of its common stock on the Nasdaq National Market on December 16, 2003.



The exchange program was accounted for in accordance with FASB Interpretation
No. 44, Accounting for Certain Transactions Involving Stock Compensationan Interpretation of APB Opinion No. 25and resulted in no compensation expense.



Net income (loss) per share



Basic net income (loss) per share data has been computed using the weighted-average number of shares of common stock outstanding during the indicated
periods. Diluted net income (loss) per share data has been computed using the weighted-average number of shares of common stock and potential dilutive common shares. Potential dilutive common shares include dilutive shares issuable upon the exercise
of outstanding common stock options computed using the treasury stock method.



For the three and nine month periods ended September 30, 2004 and 2003, potentially dilutive securities, consisting of stock options, are as shown in the following table. In those periods in which a net loss was
recorded, the potentially dilutive securities were not included in the computation of diluted net loss per share because to do so would have been anti-dilutive.



|                                                                                                                                                                                                          |  |                                  |         |      |                                 |        |      |  |      |         |  |   |        |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------- | ------- | ---- | ------------------------------- | ------ | ---- |  | ---- | ------- |  | - | ------ | -
|                                                                                                                                                                                                          |  | Three Months Ended September 30, |         |      | Nine Months EndedSeptember 30,  |       
|                                                                                                                                                                                                          |  | 2004                             |         | 2003 |                                 |        | 2004 |  | 2003 |        
|Potentially dilutive shares                                                                                                                                                                               |  |                                  | 294,474 |      |                                 | 96,844 |      |  |      | 552,154 |  |   | 29,918 |  
|                                                                                                                                                                                                         
|The following table sets forth the computation of basic and diluted net income (loss) per share for the three and nine months ended September 30, 2004
and 2003 (in thousands, except per share amounts): | 
|                                                                                                                                                                                                          |  |                                 
|                                                                                                                                                                                                          |  | Three Months Ended September 30, |         |      | Nine Months Ended September 30, |       
|                                                                                                                                                                                                          |  | 2004                             |         | 2003 |                                 |        | 2004 |  | 2003 |        
|Net income (loss)                                                                                                                                                                                         |  | $                                | 863     |      | $                               | (1,857 | )    |  | $    | 689     |  | $ | (4,759 | )
|Shares used to compute basic net income (loss) per share                                                                                                                                                  |  |                                  | 8,895   |      |                                 | 8,665  |      |  |      | 8,843   |  |   | 8,646  |  
|Potentially dilutive shares used to compute net income per share on a diluted basis                                                                                                                       |  |                                  | 294     |      |                                 | 97     |      |  |      | 552     |  |   | 30     |  
|Shares used to compute diluted net income (loss) per share                                                                                                                                                |  |                                  | 9,189   |      |                                 | 8,762  |      |  |      | 9,385   |  |   | 8,676  |  
|Net income (loss) per share:                                                                                                                                                                              |  |                                  |         |      |                                 |        |      |  |      |         |  |   |        |  
|Basic                                                                                                                                                                                                     |  | $                                | 0.10    |      | $                               | (0.21  | )    |  | $    | 0.08    |  | $ | (0.55  | )
|Diluted                                                                                                                                                                                                   |  | $                                | 0.09    |      | $                               | (0.21  | )    |  | $    | 0.07    |  | $ | (0.55  | )



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##### Table of Contents

Income taxes



As part of the process of preparing its condensed consolidated financial statements, the Company is required to estimate its income taxes in each of the
jurisdictions in which the Company operates. This process involves estimating the Companys actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax
and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Companys condensed consolidated balance sheet. The Company must then assess the likelihood that its deferred tax assets will be
recovered from future taxable income and to the extent the Company believes that recovery is not likely, it must establish a valuation allowance. To the extent the Company establishes a valuation allowance or the allowance in a period changes, the
amount recognized as a provision for income taxes in the statement of operations could change. The income tax benefit of $40,000 for the quarter ended September 30, 2004 includes an international tax benefit of $24,000 and a U.S. state tax benefit
of $16,000. The income tax provision of $4,000 for the quarter ended September 30, 2003 is comprised of an international tax benefit of $134,000 and U.S. state tax expense of $138,000. The income tax provision of $66,000 for the nine months ended
September 30, 2004 consists of an international tax expense of $54,000 and a U.S. state tax expense of $12,000. The income tax benefit of $297,000 for the nine months ended September 30, 2003 resulted primarily from tax refunds of $481,000 in
Germany, net of international tax expense of $38,000 and U.S. state tax expense of $146,000.



Recent accounting pronouncements



In March 2004, the EITF reached a consensus on Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, which provides guidance for determining when
an investment is other-than-temporally impaired. In addition, Issue 03-1 contains disclosure requirements regarding impairments that have not been recognized in the statement of operations which are effective with the Companys annual report
for the year ending December 31, 2004. Issue 03-1 requires that companys have the ability and intent to hold an investment that has a fair value less than its adjusted cost basis for a reasonable period of time to permit recovery of the
investment.



The FASB issued Interpretation No. 46,
Consolidation of Variable Interest Entities (FIN 46) in January 2003, and a revised interpretation of FIN 46 (FIN 46-R) in December 2003. FIN 46 requires certain variable interest entities (VIEs) to
be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. The adoption of FIN 46-R did not have an impact on the financial position, results of operations or cash flows of the Company.



In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. This
Statement was effective for financial instruments entered into or modified after May 31, 2003, and otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The Company currently has no financial instruments
which meet these requirements.



In April 2003 the FASB issued
SFAS No. 149, Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities.This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments
embedded in other contracts. The Statement clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, clarifies when a derivative contains a financing component, amends the definition of an
underlying derivative to conform it to language used in FASB Interpretation FIN No. 45, and amends certain other existing pronouncements. SFAS No. 149 was effective for contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. All provisions of the Statement, except those related to forward purchases or sales of when-issued securities, should be applied prospectively. The Company currently has no instruments that
meet the definition of a derivative, and therefore, the adoption of this Statement had no impact on the Companys financial position or results of operations.



In November 2002, the FASB issued FIN 45, Guarantors Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others,which addresses the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees. FIN 45 also requires the recognition of a
liability by a guarantor at the inception of certain guarantees that are entered into or modified after December 31, 2002. The adoption of FIN 45 did not have a material affect on the financial statements.



Reclassifications



Certain reclassifications have been made to the 2003 condensed consolidated
financial statements to conform to the current period presentation.



4.
Restructuring of operations



On January 31, 2003, the
Company announced a restructuring of operations designed to refocus its operations around its core business functions, to relocate certain of its functional operations to the Companys corporate headquarters, and to reduce operating



11



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##### Table of Contents

expenses. As part of the restructuring, the Company reduced its workforce in excess of 30%. The distribution of the
reduction in workforce was as follows:



|                           |  |              |  |              |  |              
|-------------------------- |  | ------------ |  | ------------ |  | -------------
|                           |  | Terminations |  | Replacements |  | Net Reduction
|Operations                 |  | 10           |  | 6            |  | 4            
|Services                   |  | 14           |  | 1            |  | 13           
|Research and development   |  | 19           |  |             |  | 19           
|Sales and marketing        |  | 44           |  | 4            |  | 40           
|General and administrative |  | 24           |  | 5            |  | 19           
|                           |  |              |  |              |  |              
|Total                      |  | 111          |  | 16           |  | 95           
|                           |  |              |  |              |  |              



The restructuring
charge for the nine month period ended September 30, 2004 includes approximately $34,000 of employee severance and related expenses, and the reduction of approximately $173,000 of facility expenses related to the reversal of restructuring costs for
the Companys leased facility in Ottawa, resulting from a partial sublease of space and reduction in other obligations related to the lease. The Company anticipates that the execution of the restructuring actions will require total cash
expenditures of $3.1 million, which is expected to be funded from operations and existing cash balances. As of September 30, 2004, the Company had incurred net costs totaling $3.1 million related to the restructuring, which required $2.8 million in
cash expenditures. The remaining reserve related to this restructuring is approximately $308,000, and is included in accrued liabilities as of September 30, 2004.



The following table lists the components of the January 2003 restructuring reserve for the nine month period ended September
30, 2004 (in thousands):



|                                                         |  |               |     |   |                  |   |      |       |  |   |      |  
|-------------------------------------------------------- |  | ------------- | --- | - | ---------------- | - | ---- | ----- |  | - | ---- | -
|                                                         |  | EmployeeCosts |     |   | ExcessFacilities |   |      | Total | 
|Balance at December 31, 2003                             |  | $             | 222 |   |                  | $ | 324  |       |  | $ | 546  |  
|Net change in estimate recorded in restructuring expense |  |               | 34  |   |                  |   | (173 | )     |  |   | (139 | )
|Reserve utilized in nine months ended September 30, 2004 |  |               | (40 | ) |                  |   | (59  | )     |  |   | (99  | )
|                                                         |  |               |     |   |                  |   |      |       |  |   |      |  
|Balance at September 30, 2004                            |  | $             | 216 |   |                  | $ | 92   |       |  | $ | 308  |  
|                                                         |  |               |     |   |                  |   |      |       |  |   |      |  



On August 8, 2002, the
Company announced a restructuring of its operations designed to re-align its core business functions and reduce operating expenses. As part of the restructuring, the Company intended to reduce its workforce by approximately 26% and recorded a $4.6
million charge to operating expenses in the third quarter of 2002. The restructuring charge included approximately $2.6 million of expenses related to facilities no longer needed for Company operations and $2.0 million of employee severance and
other related expenses. In March 2003, based on a review of current operations, the decision was made to revise the original restructuring plan by retaining certain personnel in European locations who had been identified for termination and certain
related offices that had been identified for closure. This decision resulted in a $1.3 million reversal of the restructuring accrual as of March 31, 2003, and a corresponding reduction of restructuring expense for the three months then ended. Such
reversal was comprised of expected employee costs of approximately $0.9 million and expected facilities expenses of approximately $0.4 million. In June 2003, the Company recorded an additional $40,000 in restructuring expense relating to employee
severance and other related expenses in Latin America. In September 2003, the Company recorded a reduction in obligations of approximately $25,000. This reduction resulted from the following: i) a reduction of the estimate of excess facility costs
of approximately $0.9 million from the continued use of facilities scheduled for closure; ii) an offsetting change in estimate of approximately $1.0 million, resulting from the Companys inability to sublet its excess space at certain
facilities as the result of the short remaining lease term for these facilities and the slow real estate market that did not support subleasing of the facilities; iii) a reduction of approximately $46,000 in estimated property and equipment costs
used in on-going operations instead of disposal; iv) a reduction in the estimated exit costs (moving, broker fees, travel, temporary labor costs) of approximately $64,000; and v) a reduction in expected employee related costs of approximately
$19,000. In March 2004, the Company recorded a reduction in restructuring expenses composed of approximately $36,000 in reduced employee severance costs in Belgium and approximately $6,000 in facilities expenses primarily as a result of foreign
exchange adjustments on future commitments. In June 2004, the Company recorded an additional reduction in restructuring expenses of approximately $19,000 in facilities expenses principally as a result of foreign exchange adjustments on future
commitments. In September 2004, the Company recorded an increase in restructuring expense derived basically from the Companys inability to sublet its excess space at certain facilities.



The distribution of the reduction in workforce was as follows:



|                           |  |              |  |          |  |              
|-------------------------- |  | ------------ |  | -------- |  | -------------
|                           |  | Terminations |  | Retained |  | Net Reduction
|Operations                 |  | 6            |  |         |  | 6            
|Services                   |  | 17           |  |         |  | 17           
|Research and development   |  | 53           |  |         |  | 53           
|Sales and marketing        |  | 22           |  | 8        |  | 14           
|General and administrative |  | 11           |  | 1        |  | 10           
|                           |  |              |  |          |  |              
|Total                      |  | 109          |  | 9        |  | 100          
|                           |  |              |  |          |  |              



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##### Table of Contents

As of September 30, 2004, the Company had incurred costs totaling $3.1 million related to this
restructuring accrual which required $2.9 million in cash expenditures. The remaining reserve related to this restructuring is approximately $160,000, and is included in accrued liabilities as of September 30, 2004.



The following table lists the components of the August 2002 restructuring
reserve for the nine month period ended September 30, 2004 (in thousands):



|                                                         |  |               |      |   |                  |   |      |       |  |   |      |  
|-------------------------------------------------------- |  | ------------- | ---- | - | ---------------- | - | ---- | ----- |  | - | ---- | -
|                                                         |  | EmployeeCosts |      |   | ExcessFacilities |   |      | Total | 
|Balance at December 31, 2003                             |  | $             | 156  |   |                  | $ | 674  |       |  | $ | 830  |  
|Net change in estimate recorded in restructuring expense |  |               | (36  | ) |                  |   | (17  | )     |  |   | (53  | )
|Reserve utilized in nine months ended September 30, 2004 |  |               | (120 | ) |                  |   | (497 | )     |  |   | (617 | )
|                                                         |  |               |      |   |                  |   |      |       |  |   |      |  
|Balance at September 30, 2004                            |  | $             |     |   |                  | $ | 160  |       |  | $ | 160  |  
|                                                         |  |               |      |   |                  |   |      |       |  |   |      |  



In the fourth quarter
of 1999, following the acquisitions of Wall Data, Incorporated and Simware Inc., the Company initiated a plan to restructure its worldwide operations in order to integrate the operations of the two acquired companies. In connection with this plan,
the Company recorded a $3.8 million charge to operating expenses in 1999. The reserve has been fully utilized as of March 31, 2004 and all restructuring activities have been completed.



The following table lists the components of the restructuring reserve for the nine month period ended September 30, 2004 (in
thousands):



|                                                         |  |                  |      |  
|-------------------------------------------------------- |  | ---------------- | ---- | -
|                                                         |  | ExcessFacilities |     
|Balance at December 31, 2003                             |  | $                | 104  |  
|Reserve utilized in nine months ended September 30, 2004 |  |                  | (104 | )
|                                                         |  |                  |      |  
|Balance at September 30, 2004                            |  | $                |     |  
|                                                         |  |                  |      |  



In August 1998,
following the acquisition of FTP Software Inc., the Company initiated a plan to restructure its worldwide operations as a result of business conditions and in connection with the integration of the operations of FTP. In connection with this plan,
the Company recorded a $7.0 million charge to operating expenses in 1998. In March 2004, the Company recorded an increase in the restructuring expense of approximately $19,000 related to the Companys inability to sublease excess space and
approximately $9,000 related to foreign exchange adjustments on long term lease commitments. In June 2004, the Company recorded an increase in the restructuring expense of approximately $25,000 of which approximately $17,000 related to the
Companys inability to sublease excess space and approximately $8,000 related to foreign exchange adjustments on long term lease commitments. In September 2004, the Company recorded an additional increase in restructuring expense of
approximately $32,000 composed primarily of foreign exchange adjustments and the continuing inability to sublease excess space. The remaining reserve related to this restructuring at September 30, 2004 is approximately $313,000 and is included in
accrued liabilities and long-term liabilities.



The following
table lists the components of the FTP restructuring reserve for the nine month period ended September 30, 2004 (in thousands):



|                                                         |  |                  |     |  
|-------------------------------------------------------- |  | ---------------- | --- | -
|                                                         |  | ExcessFacilities |    
|Balance at December 31, 2003                             |  | $                | 313 |  
|Change in estimate recorded in restructuring expense     |  |                  | 86  |  
|Reserve utilized in nine months ended September 30, 2004 |  |                  | (86 | )
|                                                         |  |                  |     |  
|Balance at September 30, 2004                            |  | $                | 313 |  
|                                                         |  |                  |     |  



5. Commitments and contingencies



The Company may be contingently liable with respect to
certain asserted and unasserted claims that arise during the normal course of business. Management believes the impact, if any, resulting from these matters would not have a material impact on the Companys financial statements.



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##### Table of Contents

Leases



Facilities and equipment are leased under non-cancelable operating leases expiring on various dates through the year 2011. The Company does not have any
capital leases. As of September 30, 2004, future minimum rental and lease payments, net of any sublease income, under non-cancelable operating leases are as follows:



|                 |  |                                                           |        |                   |   |                 |  |                 |       |                    |   |       |  |   |      
|---------------- |  | --------------------------------------------------------- | ------ | ----------------- | - | --------------- |  | --------------- | ----- | ------------------ | - | ----- |  | - | -----
|                 |  | Amount of Commitment Expiration Per Period (in thousands)
|                 |  | Total                                                     |        | 12 months or less |   | 13 to 24 months |  | 25 to 36 months |       | More than 36months
|Operating leases |  | $                                                         | 11,778 |                   | $ | 2,530           |  | $               | 2,029 |                    | $ | 1,972 |  | $ | 5,247



Other



As an element of its standard commercial terms, the Company includes an
indemnification clause in its software licensing agreements that indemnifies the licensee against liability and damages (including legal defense costs) arising from any claims of patent, copyright, trademark, or trade secret infringement by the
Companys software. The Companys indemnification limitation is the cost to defend any third party claim brought against the Companys customers and to the maximum a refund of the purchase price.



6. Segment information



The Company determines its segments based on how its Chief Executive Officer assesses performance and allocates resources.
Through the fourth quarter of 2003, the Company presented segment information based on two reportable segments: Host Access and Host Integration. Beginning in January 2004, NetManages Chief Executive Officer no longer evaluates the business by
those former segments but views the business within a single segment.



The Company now markets its products under the NetManage Host Services Platform, or HSP, formerly referred to as the Host Access Platform, which incorporates the Companys complete range of products offering access, presentation and
integration services designed to provide NetManages customers with flexibility when addressing their evolving business needs. NetManages HSP includes solutions from both of the Companys major product lines: RUMBA providing
client-side solutions and OnWeb providing server-side solutions and also features common services such as user management, monitoring and reporting of system usage and events, and end-to-end communications security. These two product lines have
similar economic characteristics and are similar with respect to the nature of the products, the nature of the production processes, the type of customer that the products are sold to and the methods used to distribute the products.



7. Related party transactions



On May 28, 2003, the Company entered into an independent contractor services
agreement with Dr. Shelley Harrison, a director of the Company, pursuant to which Dr. Harrison will receive compensation in consideration for consultancy and advisory services he is providing the Company over a two-year period. The terms of the
agreement require the Company to pay Dr. Harrison a fixed fee of $138,000 per year, and a one time grant to Dr. Harrison of an option to purchase 146,800 shares of the Companys common stock, at an exercise price of $1.92 per share, which
represents the quoted market price of the stock at the date of grant. The option vests on a monthly basis over the two-year term of the agreement and expires five years from the date of issuance. The fair value of the option was determined using the
Black-Scholes option pricing model with the following assumptions: stock price $2.95$9.65; no dividends; risk free interest rate of 2.00%3.27%; volatility of 63%99%; and a contractual life of five years. The fair value of the
option is subject to change over the vesting period of the option based on changes in the underlying assumptions (variable award accounting). For the three months ended September 30, 2004, the Company recorded a credit of approximately $73,000 to
compensation expense under this agreement and for the nine months ended September 30, 2004, the Company has recorded approximately $458,000 in compensation expense under this agreement, based on an aggregate option fair value of $657,000.
Compensation expense of $67,000 was recorded by the Company under this agreement for the three and nine months ended September 30, 2003. In connection with his entering into the agreement, Dr. Harrison resigned from the Companys Audit
Committee effective May 28, 2003. For the nine months ended September 30, 2004, the Company recorded total aggregate cash and non-cash compensation of $561,000 related to this arrangement under General and Administrative expense in the Condensed
Consolidated Statements of Operations.



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##### Table of Contents

Item 2  Managements discussion and analysis of financial condition and results of operations.



Some of the statements contained in this Quarterly Report on Form 10-Q are forward-looking statements, including, but not limited to, those
specifically identified as such, that involve risks and uncertainties, including those set forth below under the heading Factors that may affect our future results and financial condition and elsewhere in this report. The statements
contained in this report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act, including, without limitation, statements regarding our expectations,
beliefs, intentions or strategies regarding the future. These statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results to differ materially from those implied by the forward-looking statements.
In some cases, you can identify forward-looking statements by terminology such as may, will, should, expects, plans, anticipates, believes, estimates,
predicts, potential, or continue or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot
guarantee future results, levels of activity, performance or achievements. All forward-looking statements included in this Report are based on information available to us on the date hereof, and we assume no obligation to update any such
forward-looking statements.



Overview



We have operations worldwide with sales offices located in the United
States, Europe, Canada, and Israel. We develop and market software and service solutions under NetManages Host Services Platform that are designed to enable our customers to access and leverage the considerable investment they have in their
host-based business applications, processes and data. Our business is primarily focused on providing a broad spectrum of specific personal computer and network or application server-based software, software tools and related services. These products
are designed to allow our customers to access and use their mission-critical line-of-business host applications and resources; to publish information from existing host systems in a web presentation, particularly to new users via the Internet; and
to create new applications that leverage their existing host-based business processes.



Our business is also targeted at taking advantage of the trend of many corporations worldwide to adopt a services approach to leveraging their investment in host-based applications. Through a Services Oriented
Architecture, or SOA, approach to application integration, which is delivered by one of the core components of the NetManage Host Services Platform, or HSP, we help our customers bridge between their existing systems and new applications based
around the Java framework or the Microsoft .NET framework. By allowing our customers to deliver existing business processes as standards-based components and services via HSP, NetManage contributes to a corporations ability to gain a greater
return on investment from, and extend the life of, their existing host-based applications and core business information systems. We also focus on taking advantage of major current industry trends: the continued expansion of the Internet and its
adoption as a business infrastructure; the continued mobilization of personal computer users and the adoption of mobile information access and display devices; and the availability of broader access to corporate data and information for people
internal and external to an organization.



We develop and
market software solutions that allow our customers to access and leverage applications, business processes and data on International Business Machines Corporation (IBM) corporate mainframe computers and compatibles, IBM midrange computers such as
iSeries (formerly AS/400), and on UNIX based servers. We provide professional support, maintenance, and technical consultancy services to our customers in association with the products we develop and market.



Our principal products are compatible with Microsoft Windows Server 2003,
Windows XP, Windows 2000, Windows NT, and Windows 98 operating systems, IBM operating systems, Novell, Inc. operating systems and various implementations of the industry standard UNIX operating system such as IBMs AIX, Hewlett-Packard
Companys HP/UX, Sun Microsystems Inc.s Solaris, and the open source Linux system.



We market our products under the NetManage HSP, formerly referred to as the Host Access Platform, which incorporates our complete range of access, presentation and integration services designed to provide our
customers with a wide range of flexible options to help address their evolving business needs. Both our RUMBA® products and OnWeb® products are integral components of the NetManage HSP.



HSP ties together our RUMBA desktop host access technologies and our server-based OnWeb solutions for access, presentation, and integration services and features common services such as user management, monitoring and
reporting of system usage and events, and end-to-end communications security. As a result, customers can, through HSP, deliver to their end users traditional access to existing host-based applications directly from the desktop or from the web,
extend and rejuvenate host applications to support new Web-based business initiatives or consolidate and integrate host-based information with new applications and services through a SOA approach. In addition, for those customers who are moving from
traditional in-house developed applications to packaged applications, HSP provides for a co-existence strategy allowing customers to continue to operate and deliver new value-add services while they migrate to a new environment.



15



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##### Table of Contents

Results of operations



During the past several years, we have implemented initiatives designed to control costs and reduce operating expenses,
including the discontinuance of several low revenue-generating products and the implementation of worldwide restructurings of our operations.



For the three month period ended September 30, 2004 as compared to September 30, 2003, our net revenues increased approximately 2% and increased
approximately 6% sequentially from the second quarter of 2004. This growth in net revenues resulted primarily from increased license fees, up approximately 20% from the third quarter of 2003. Until we have positive reinforcement on the improving
economy and sustained improvement in net revenues, we will continue to focus on making our operations more efficient and reducing operating expenses.



During the third quarter of 2004, we entered into a definitive agreement with Librados, Inc., or Librados, and its shareholders to purchase all of the
outstanding common shares of Librados. The transaction closed on October 22, 2004. The Librados adaptor technology will allow our OnWeb product to access information in such packaged applications as SAP, Siebel, Oracle, J.D. Edwards, IBMs
CICS, PeopleSoft and many others. Besides incorporating this technology into our OnWeb product line, the Company intends to continue to market these adaptors under the Librados brand name to Independent Software Vendors, or ISVs, and other end-user
customers.



On January 31, 2003, NetManage announced a
restructuring of its operations designed to improve efficiency and reduce operating expenses. As part of the restructuring, NetManage reduced its workforce in excess of 30%. As of September 30, 2004, we have recorded a total of $3.1 million in
charges to operating expenses related to these restructuring activities, consisting of approximately $0.5 million of expenses related to leased facilities no longer needed for the Companys operations and $2.6 million of employee severance and
other related expenses (See Note 4 to Condensed Consolidated Financial Statements - Restructuring of operations).



On August 8, 2002, we announced a restructuring of our operations designed to re-align our core business functions and reduce operating expenses. As part
of this restructuring, we intended to reduce our workforce by approximately 26% and recorded a $4.6 million charge to operating expenses in the third quarter of 2002. The restructuring charge included approximately $2.6 million of expenses related
to facilities no longer needed for Company operations and $2.0 million of employee severance and other related expenses for employee terminations. We have adjusted the restructuring accrual in subsequent quarters in line with changes we have made to
the originally planned restructuring activities (See Note 4 to Condensed Consolidated Financial Statements - Restructuring of operations).



The Company has recorded other restructuring charges in the past as described in Note 4 to Condensed Consolidated Financial Statements 
Restructuring of operations.



Because we generally ship
software products within a short period after receipt of an order, we do not have a material backlog of unfilled orders, and revenues in any quarter are substantially dependent on orders booked in that quarter. Our operating expense levels are
based, in part, on our expectation of future revenues and, to a large extent, are fixed. In the third quarter of 2004, operating expenses, excluding restructuring charges, declined when compared to the third quarter of 2003, and may fluctuate as a
percentage of net revenues on a quarterly basis.



As described
herein, under the heading Factors that may affect our future results and financial condition, acquisitions involve a number of risks, including risks relating to the integration of the acquired companys operations, personnel, and
products. There can be no assurance that the integration of previously acquired companies, or the integration of any future acquisitions, will be accomplished successfully, and the failure to effectively accomplish any of these integrations could
have a material adverse effect on our results of operations and financial condition.



16



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##### Table of Contents

Three months ended September 30, 2004 compared to September 30, 2003 (dollars in millions):



|                                                    |  |                                  |       |   |      |   |       |        |  |   |      |   |  |      |  
|--------------------------------------------------- |  | -------------------------------- | ----- | - | ---- | - | ----- | ------ |  | - | ---- | - |  | ---- | -
|                                                    |  | Three months ended September 30, |      
|                                                    |  | 2004                             |       |   | 2003 |   |       | Change | 
|Net revenues                                        |  |                                  |       |   |      |   |       |        |  |   |      |   |  |      |  
|License fees                                        |  | $                                | 4.8   |   |      | $ | 4.0   |        |  | $ | 0.8  |   |  | 20   | %
|Services                                            |  |                                  | 6.8   |   |      |   | 7.4   |        |  |   | (0.6 | ) |  | -8   | %
|                                                    |  |                                  |       |   |      |   |       |        |  |   |      |   |  |      |  
|Total net revenues                                  |  |                                  | 11.6  |   |      |   | 11.4  |        |  |   | 0.2  |   |  | 2    | %
|As a percentage of net revenues:                    |  |                                  |       |   |      |   |       |        |  |   |      |   |  |      |  
|License fees                                        |  |                                  | 41.4  | % |      |   | 35.1  | %      |  |   |      |   |  |      |  
|Services                                            |  |                                  | 58.6  | % |      |   | 64.9  | %      |  |   |      |   |  |      |  
|                                                    |  |                                  |       |   |      |   |       |        |  |   |      |   |  |      |  
|Total net revenues                                  |  |                                  | 100.0 | % |      |   | 100.0 | %      |  |   |      |   |  |      |  
|Gross margin - license fees                         |  | $                                | 4.4   |   |      | $ | 3.7   |        |  | $ | 0.7  |   |  | 19   | %
|Gross margin - services                             |  |                                  | 5.9   |   |      |   | 6.3   |        |  |   | (0.4 | ) |  | -6   | %
|Gross margin - amortization of developed technology |  |                                  | (0.3  | ) |      |   | (0.3  | )      |  |   |     |   |  |     |  
|                                                    |  |                                  |       |   |      |   |       |        |  |   |      |   |  |      |  
|Total gross margin                                  |  | $                                | 10.0  |   |      | $ | 9.7   |        |  | $ | 0.3  |   |  | 3    | %
|As a percentage of net revenues:                    |  |                                  |       |   |      |   |       |        |  |   |      |   |  |      |  
|Gross margin - license fees                         |  |                                  | 37.9  | % |      |   | 32.5  | %      |  |   |      |   |  |      |  
|Gross margin - services                             |  |                                  | 50.9  | % |      |   | 55.3  | %      |  |   |      |   |  |      |  
|Gross margin - amortization of developed technology |  |                                  | -2.6  | % |      |   | -2.6  | %      |  |   |      |   |  |      |  
|                                                    |  |                                  |       |   |      |   |       |        |  |   |      |   |  |      |  
|Total gross margin                                  |  |                                  | 86.2  | % |      |   | 85.2  | %      |  |   |      |   |  |      |  
|Research and development                            |  | $                                | 1.7   |   |      | $ | 1.8   |        |  | $ | (0.1 | ) |  | -6   | %
|As a percentage of net revenues:                    |  |                                  | 14.7  | % |      |   | 15.8  | %      |  |   |      |   |  |      |  
|Sales and marketing                                 |  | $                                | 5.7   |   |      | $ | 5.8   |        |  | $ | (0.1 | ) |  | -2   | %
|As a percentage of net revenues:                    |  |                                  | 49.1  | % |      |   | 50.9  | %      |  |   |      |   |  |      |  
|General and administrative                          |  | $                                | 2.0   |   |      | $ | 3.0   |        |  | $ | (1.0 | ) |  | -33  | %
|As a percentage of net revenues:                    |  |                                  | 17.2  | % |      |   | 26.3  | %      |  |   |      |   |  |      |  
|Restructuring charge, net                           |  | $                                |      |   |      | $ | 0.3   |        |  | $ | (0.3 | ) |  | -100 | %
|As a percentage of net revenues:                    |  |                                  | 0.0   | % |      |   | 2.6   | %      |  |   |      |   |  |      |  
|Amortization of intangibles                         |  | $                                | 0.1   |   |      | $ | 0.2   |        |  | $ | (0.1 | ) |  | -50  | %
|As a percentage of net revenues:                    |  |                                  | 0.9   | % |      |   | 1.8   | %      |  |   |      |   |  |      |  
|Interest income (expense) and other, net            |  | $                                | 0.1   |   |      | $ | (0.1  | )      |  | $ | 0.2  |   |  | -200 | %
|As a percentage of net revenues:                    |  |                                  | 0.9   | % |      |   | -0.9  | %      |  |   |      |   |  |      |  
|Foreign currency transaction gains (losses)         |  | $                                | 0.3   |   |      | $ | (0.4  | )      |  | $ | 0.7  |   |  | -175 | %
|As a percentage of net revenues:                    |  |                                  | 2.6   | % |      |   | -3.5  | %      |  |   |      |   |  |      |  
|Provision for income taxes                          |  | $                                |      |   |      | $ |      |        |  | $ |     |   |  |     |  
|Net income (loss)                                   |  | $                                | 0.9   |   |      | $ | (1.9  | )      |  | $ | 2.8  |   |  | -147 | %
|As a percentage of net revenues:                    |  |                                  | 7.8   | % |      |   | -16.7 | %      |  |   |      |   |  |      |  



[Additional columns
below]



17



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##### Table of Contents

[Continued from above table, first column(s) repeated]



|                                                    |  |                                 |       |   |      |   |       |        |  |   |      |   |  |      |  
|--------------------------------------------------- |  | ------------------------------- | ----- | - | ---- | - | ----- | ------ |  | - | ---- | - |  | ---- | -
|                                                    |  | Nine months ended September 30, |      
|                                                    |  | 2004                            |       |   | 2003 |   |       | Change | 
|Net revenues                                        |  |                                 |       |   |      |   |       |        |  |   |      |   |  |      |  
|License fees                                        |  | $                               | 13.6  |   |      | $ | 14.3  |        |  | $ | (0.7 | ) |  | -5   | %
|Services                                            |  |                                 | 20.9  |   |      |   | 23.1  |        |  |   | (2.2 | ) |  | -10  | %
|                                                    |  |                                 |       |   |      |   |       |        |  |   |      |   |  |      |  
|Total net revenues                                  |  |                                 | 34.5  |   |      |   | 37.4  |        |  |   | (2.9 | ) |  | -8   | %
|As a percentage of net revenues:                    |  |                                 |       |   |      |   |       |        |  |   |      |   |  |      |  
|License fees                                        |  |                                 | 39.4  | % |      |   | 38.2  | %      |  |   |      |   |  |      |  
|Services                                            |  |                                 | 60.6  | % |      |   | 61.8  | %      |  |   |      |   |  |      |  
|                                                    |  |                                 |       |   |      |   |       |        |  |   |      |   |  |      |  
|Total net revenues                                  |  |                                 | 100.0 | % |      |   | 100.0 | %      |  |   |      |   |  |      |  
|Gross margin - license fees                         |  | $                               | 12.5  |   |      | $ | 12.9  |        |  | $ | (0.4 | ) |  | -3   | %
|Gross margin - services                             |  |                                 | 18.2  |   |      |   | 19.5  |        |  |   | (1.3 | ) |  | -7   | %
|Gross margin - amortization of developed technology |  |                                 | (0.9  | ) |      |   | (1.0  | )      |  |   | 0.1  |   |  | -10  | %
|                                                    |  |                                 |       |   |      |   |       |        |  |   |      |   |  |      |  
|Total gross margin                                  |  | $                               | 29.8  |   |      | $ | 31.4  |        |  | $ | (1.6 | ) |  | -5   | %
|As a percentage of net revenues:                    |  |                                 |       |   |      |   |       |        |  |   |      |   |  |      |  
|Gross margin - license fees                         |  |                                 | 36.2  | % |      |   | 34.5  | %      |  |   |      |   |  |      |  
|Gross margin - services                             |  |                                 | 52.8  | % |      |   | 52.1  | %      |  |   |      |   |  |      |  
|Gross margin - amortization of developed technology |  |                                 | -2.6  | % |      |   | -2.7  | %      |  |   |      |   |  |      |  
|                                                    |  |                                 |       |   |      |   |       |        |  |   |      |   |  |      |  
|Total gross margin                                  |  |                                 | 86.4  | % |      |   | 83.9  | %      |  |   |      |   |  |      |  
|Research and development                            |  | $                               | 5.2   |   |      | $ | 6.5   |        |  | $ | (1.3 | ) |  | -20  | %
|As a percentage of net revenues:                    |  |                                 | 15.1  | % |      |   | 17.4  | %      |  |   |      |   |  |      |  
|Sales and marketing                                 |  | $                               | 16.4  |   |      | $ | 19.5  |        |  | $ | (3.1 | ) |  | -16  | %
|As a percentage of net revenues:                    |  |                                 | 47.5  | % |      |   | 52.1  | %      |  |   |      |   |  |      |  
|General and administrative                          |  | $                               | 7.0   |   |      | $ | 8.7   |        |  | $ | (1.7 | ) |  | -20  | %
|As a percentage of net revenues:                    |  |                                 | 20.3  | % |      |   | 23.3  | %      |  |   |      |   |  |      |  
|Restructuring charge, net                           |  | $                               | (0.1  | ) |      | $ | 1.8   |        |  | $ | (1.9 | ) |  | -106 | %
|As a percentage of net revenues:                    |  |                                 | -0.3  | % |      |   | 4.8   | %      |  |   |      |   |  |      |  
|Amortization of intangibles                         |  | $                               | 0.5   |   |      | $ | 0.5   |        |  | $ | 0.0  |   |  |     |  
|As a percentage of net revenues:                    |  |                                 | 1.4   | % |      |   | 1.1   | %      |  |   |      |   |  |      |  
|Interest income (expense) and other, net            |  | $                               | 0.1   |   |      | $ |      |        |  | $ | 0.1  |   |  |     |  
|As a percentage of net revenues:                    |  |                                 | 0.3   | % |      |   | 0.0   | %      |  |   |      |   |  |      |  
|Foreign currency transaction gains (losses)         |  | $                               | (0.1  | ) |      | $ | 0.5   |        |  | $ | (0.6 | ) |  | -120 | %
|As a percentage of net revenues:                    |  |                                 | -0.3  | % |      |   | 1.3   | %      |  |   |      |   |  |      |  
|Provision (benefit) for income taxes                |  | $                               | 0.1   |   |      | $ | (0.3  | )      |  | $ | 0.4  |   |  | -133 | %
|Net income (loss)                                   |  | $                               | 0.7   |   |      | $ | (4.8  | )      |  | $ | 5.5  |   |  | -115 | %
|As a percentage of net revenues:                    |  |                                 | 2.0   | % |      |   | -12.8 | %      |  |   |      |   |  |      |  



Net revenues



Our revenues are derived from the sale of software licenses and related
services, which include maintenance and support, consulting and training services. License fees are earned under software license agreements with end-users and resellers and are generally recognized as revenue upon shipment of the software if
collection of the resulting receivable is probable, the fee is fixed and determinable and vendor-specific objective evidence exists to allocate the total fee to all undelivered elements of the arrangement. Certain of our sales are made to domestic
distributors under agreements allowing right-of-return and price protection on unsold merchandise. Accordingly, we defer recognition of such sales until the distributor sells the merchandise. Our international distributors do not have return rights
and, as such, we generally recognize sales to international distributors upon shipment, if all other revenue recognition criteria have been met.



Services revenues are derived from software updates for existing software products, user documentation and technical support, generally under annual
service agreements. These revenues are recognized ratably over the terms of such agreements. If the services are included in the initial licensing fee, the fair value of the services is unbundled and recognized ratably over the related service
period. Service revenues derived from consulting and training are deferred and subsequently recognized when the services are performed, and the collection is deemed probable.



License fees increased $791,000, or approximately 20%, and services revenues decreased $535,000, or approximately 8%,
resulting in a net increase of $256,000, or 2%, in net revenues for the three month period ended September 30, 2004 as compared to the same period in 2003. License fees included one large order, which represented approximately 48% of license fees
and more than 10% of net revenues for the quarter.



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We have operations worldwide with sales offices located in the United States, Europe, Canada, and
customer support and research and development facilities in Canada and Israel. Revenues outside of the United States and Canada as a percentage of total net revenues were approximately 25% and 29% for the three months ended September 30, 2004 and
2003, respectively and 26% for each of the nine months ended September 30, 2004 and 2003.



One customer accounted for approximately 23% of net revenues in the three month period ended September 30, 2004. There were no customers which accounted for 10% or more of net revenues in the three month period ended
September 30, 2003 and in the nine month period periods ended September 30, 2004 and 2003.



Gross margin



Gross margin for license fees increased in both absolute dollars and as a percentage of net revenues and services decreased in absolute dollars and as a percentage of net revenues for the three months ended September 30, 2004 as compared to
the third quarter of 2003, primarily because of the 20% increase in license fee revenues, the reduction in the cost of sales related to license fees and services, offset in part by the decrease in services revenue of 8% and the amortization of
developed technology.



Gross margin for license fees as a
percentage of net revenues increased from 32.5% to 37.9% for the three month period ended September 30, 2004 as compared to the same period in 2003, primarily because of the increased license fees offset in part by higher cost of revenues for
license fees. Cost of license fees in the third quarter of 2003 included a VAT refund. No similar refund was included in the third quarter of 2004. The gross margin for services decreased from 55.3% to 50.9% for the three month period ended
September 30, 2004 as compared to the same period in 2003, primarily because of the reduction in services revenues of approximately 8%, offset in part by cost reductions.



Gross margin for amortization of intangibles consists of the amortization of developed technology recorded as a result of
software and developed technology acquired through several acquisitions. Amortization of developed technology is recorded on a straight-line basis over the estimated life of five years.



Gross margin as a percentage of net revenues may fluctuate in the future due to increased price competition, the mix of
distribution channels that we use, the mix of license fee revenues versus service revenues, the mix of products sold, and the mix of international versus domestic revenues. We typically recognize higher gross margins on direct sales than sales
through our indirect distribution channels, which generally carry lower margins.



Research and development



Research and
development, or R&D, expenses consist primarily of salaries and benefits, occupancy and travel expenses, and fees paid to outside consultants. R&D expenses decreased in absolute dollar amounts and as a percentage of net revenues for the
three month period ended September 30, 2004 as compared to the same period in 2003, primarily as a result of a reduction in headcount of three full-time employees, and ongoing cost reduction efforts.



Software development costs are accounted for in accordance with SFAS No. 86,
Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed,under which we are required to capitalize software development costs after technological feasibility is established, which we categorize as a working
model and beta version of the software. The establishment of technological feasibility and the ongoing assessment of the recoverability of these costs requires considerable judgment by management with respect to certain external factors; including,
but not limited to, anticipated future gross product revenue, estimated economic life, and changes in technology. Costs that do not qualify for capitalization are charged to R&D expense when incurred. We did not capitalize any software
development costs in the three or nine months ended September 30, 2004 or 2003.



Sales and marketing



Sales and
marketing expenses consist primarily of the salaries of sales and marketing personnel, commissions, advertising and promotional expenses, occupancy and related costs. Sales and marketing expenses decreased in dollar amounts and as a percentage of
net revenues for the three month period ended September 30, 2004 as compared to the same period in 2003, primarily due to our ongoing cost reduction efforts.



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General and administrative



General and administrative expenses consist primarily of salaries, benefits, accounting, legal, and a proportionate share of
occupancy and IT expenses for our human resources, legal, finance and general management functions. General and administrative expenses decreased in absolute dollar amounts and as a percentage of net revenues for the three month period ended
September 30, 2004 compared to the same period in 2003, primarily as a result of a reduction in headcount of three full-time employees, the elimination of certain dormant entities, and ongoing cost reduction efforts.



Interest income (expense) and other, net



Interest income (expense) and other, net for the three and nine months ended
September 30, 2004 and 2003, respectively, are comprised of the following:



|                        |  |                                  |    |      |                                 |      |      |  |   |      |   |  |   |      |  
|----------------------- |  | -------------------------------- | -- | ---- | ------------------------------- | ---- | ---- |  | - | ---- | - |  | - | ---- | -
|                        |  | Three months ended September 30, |    |      | Nine months ended September 30, |     
|                        |  | 2004                             |    | 2003 |                                 |      | 2004 |  |   | 2003 |  
|Interest income:        |  |                                  |    |      |                                 |      |      |  |   |      |   |  |   |      |  
|On cash and investments |  | $                                | 39 |      | $                               | 39   |      |  | $ | 90   |   |  | $ | 160  |  
|Interest expense        |  |                                  |   |      |                                 | (148 | )    |  |   | (24  | ) |  |   | (148 | )
|Other income (expense)  |  |                                  | 1  |      |                                 |     |      |  |   | 6    |   |  |   | (1   | )
|                        |  |                                  |    |      |                                 |      |      |  |   |      |   |  |   |      |  
|Total                   |  | $                                | 40 |      | $                               | (109 | )    |  | $ | 72   |   |  | $ | 11   |  
|                        |  |                                  |    |      |                                 |      |      |  |   |      |   |  |   |      |  



The reduction in
earned interest for the nine month period ended September 30, 2004 as compared to the same period in 2003 results from an approximate 0.07% lower effective annual interest rate on lower investment balances. For the three month period ended September
30, 2004 as compared to the same period in 2003, interest rates were slightly higher, 0.18%, on lower investment balances. Interest expense recorded in the nine month periods ended September 30, 2004 and September 30, 2003 resulted principally from
VAT related tax assessments in France.



Foreign currency transaction
gains (losses)



For the three and nine month periods
ended September 30, 2004, we recorded a transaction gain of approximately $293,000 and a transaction loss of $66,000, respectively. The transaction gains and losses for the three and nine month periods ended September 30, 2004 include transaction
gains of $425,000 and $366,000 related to the liquidation of certain dormant entities. For the three and nine month periods ended September 30, 2003, we recorded a transaction loss of $401,000 and a transaction gain of $489,000, respectively. The
transaction gain for the nine month period ended September 30, 2003 includes a transaction gain of $58,000 related to the liquidation of dormant entities. The dormant entities were companies related to the acquisitions of FTP Software Limited, Wall
Data Incorporated and Simware Inc. which ceased all operating activities and have been wound-up as a result. Except as noted, transaction gains and losses are attributable to fluctuations related primarily to the Israeli Shekel in relation to the
Euro and U.S. dollar (USD). For the three and nine month periods ended September 30, 2004 and 2003, the relationship of the Israeli Shekel to the Euro and to the USD was as follows:



|              |  |                                 |   |  |                                |   |  |      |   |  |      |  
|------------- |  | ------------------------------- | - |  | ------------------------------ | - |  | ---- | - |  | ---- | -
|              |  | Three months endedSeptember 30, |   |  | Nine months endedSeptember 30, |  
|              |  | 2004                            |   |  | 2003                           |   |  | 2004 |   |  | 2003 |  
|USD % Change  |  | -0.6                            | % |  | 2.4                            | % |  | 2.4  | % |  | -6.3 | %
|Euro % Change |  | 2.1                             | % |  | 3.8                            | % |  | 1.3  | % |  | 3.7  | %



In those periods where
the foreign currency change is positive, we recorded a transaction loss related primarily to fluctuations in the Israeli Shekel. Conversely, in those periods where the foreign currency change is negative, we recorded a transaction gain.



Provision for income taxes



The income taxes recorded include primarily international taxes and state
taxes. The income tax benefit of $40,000 for the quarter ended September 30, 2004 includes an international tax benefit of $24,000 and a U.S. state tax benefit of $16,000. The income tax provision of $4,000 for the quarter ended September 30, 2003
is comprised of a U.S. state tax expense of $138,000 offset by an international tax benefit of $134,000. The income tax provision of $66,000 for the nine months ended September 30, 2004 consists of an international tax expense of $54,000 and a U.S.
state tax expense of $12,000. The income tax benefit of $297,000 for the nine months ended September 30, 2003 resulted primarily from tax refunds of $481,000 in Germany, net of international tax expense of $38,000 and U.S. state tax expense of
$146,000. Our effective tax rate for 2004 is estimated to be approximately 5% due to our current tax loss position.



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Liquidity and capital resources



|                                          |  |                   |      |  
|----------------------------------------- |  | ----------------- | ---- | -
|                                          |  | September 30,2004 |     
|                                          |  | (in millions)     |     
|Consists of:                              |  |                   |      |  
|Cash and cash equivalents                 |  | $                 | 25.9 |  
|Short-term investments                    |  |                   | 0.2  |  
|For the three month period:               |  |                   |      |  
|Net cash provided by operating activities |  |                   | 6.4  |  
|Net cash used in investing activities     |  |                   | (1.6 | )
|Net cash provided by financing activities |  |                   | 0.8  |  



Since our inception,
our operations have been financed primarily through cash provided by operations and sales of capital stock. Our primary financing activities to date consist of our initial and secondary stock offerings and preferred stock issuances, from which we
derived aggregated net proceeds of approximately $72.5 million. We do not have a bank line of credit.



Our aggregate cash, cash equivalents and short-term investments increased from $20.3 million as of December 31, 2003 to $26.1 million as of September 30,
2004. Cash provided by operating activities, resulted primarily from collections of accounts receivable, various non-cash expenses included in net income for the nine months ended September 30, 2004, increases in accounts payable, payroll and
payroll-related expenses, and long-term liabilities, offset by reductions in accrued liabilities, deferred revenue and income taxes payable.



Our principal investing activities to date have been the purchase of short-term and long-term investments, business acquisitions, and equipment purchases.
We do not have any material commitments with regard to future capital expenditures as of September 30, 2004.



Net cash provided by financing activities in the nine months ended September 30, 2004 reflects the exercise of options by our employees as governed by our
employee stock option plans and the purchase of our common stock through the employee stock purchase plan.



Our Board of Directors has authorized the purchase from time to time of up to 2,142,857 shares of our common stock through open market purchases. During
the three and nine month periods ended September 30, 2004, we did not repurchase any shares of our common stock. Cumulatively, from the inception of the program through September 30, 2004, we have repurchased 2,076,848 shares of our common stock at
an average price of $10.02 per share for an approximate total cost of $20.8 million.



At September 30, 2004, we had working capital of $11.9 million. We believe that our current cash balances and future operating cash flows will be sufficient to meet our working capital and capital expenditure
requirements for at least the next twelve months.



Contractual obligations



A table of our contractual obligations as of September
30, 2004 is included in Note 5 to Condensed Consolidated Financial Statements - Commitments and contingencies.



Off-balance sheet arrangements



As of September 30, 2004, we did not engage in any off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K promulgated by the Commission under the Securities Exchange Act of 1934, as amended.



Stock option exchange offer



On May 16, 2003 the Company announced a voluntary stock option exchange
program for certain of its employees. The offer to exchange options, or Offer, was open to eligible option holders, excluding non-employee members of the board of directors and non-exempt employees, holding options to purchase shares of the
Companys common stock with an exercise price per share of $1.50 or greater. In accordance with the terms of the Offer, participating employees tendered eligible options in exchange for replacement options. These replacement options were then
granted to employees at least six months and one day following the date their original options were tendered and cancelled. Under the terms of the Offer, replacement options vest and become exercisable for the balance of the option shares in
accordance with the same type of installment vesting schedule that was in effect for the cancelled options, but measured from the grant date of the replacement options, and no vesting credit was provided for the period between the date the original
options were tendered and the date the replacement options were granted.



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The Company has issued options under the Company Plans to provide employees with an opportunity to
acquire or increase their ownership interest in NetManage, thereby creating a stronger incentive for them to continue their employment with the Company and to contribute to the attainment of the Companys business and financial objectives and
the creation of value for all the Companys stockholders. The reason for this offer was that many of the outstanding options, whether or not they were currently exercisable, had exercise prices that were significantly higher than the then
current market price of the Companys common stock. For this reason, the Company believed that these options did not effectively retain and motivate employees and were unlikely to be exercised in the foreseeable future. By making the offer to
exchange outstanding options for replacement options that had an exercise price equal to the market value of our common stock on the grant date, the Company wanted to provide its employees a benefit of owning options that over time may have a
greater potential to increase in value, thereby providing them with a more meaningful incentive to remain with the Company, to contribute to the attainment of the Companys business and financial objectives, and to create value for all the
Companys stockholders.



On June 13, 2003, employees
tendered options to purchase a total of 542,150 shares in connection with the Offer, which were cancelled under our 1992 Stock Option Plan as amended, and our 1999 Non-statutory Stock Option Plan following their exchange. Subject to the continued
employment of the employees who exchanged options, replacement options were granted on December 16, 2003. As of December 16, 2003, the number of tendered options eligible for replacement were reduced to 531,047 due to the termination of certain
NetManage employees after June 13, 2003.



The exercise price of
the replacement options were based on the fair market value of the Companys common stock on the date the replacement options were granted. The fair market value of the Companys common stock was $4.78 per share which was equal to the last
reported sale price of its common stock on the Nasdaq National Market on December 16, 2003.



The exchange program was accounted for in accordance with FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensationan Interpretation of APB Opinion No. 25and resulted
in no compensation expense.



Critical accounting policies



Reference is made to Critical Accounting
Policies included in our Annual Report on Form 10-K for the year ended December 31, 2003 as filed with the SEC on March 26, 2004. As of the date of the filing of this Quarterly Report, the Company has not identified any critical accounting
policies other than those discussed in our Annual Report for the year ended December 31, 2003.



Disclosures about market risk



Interest rate risk



Our exposure to
market risk for changes in interest rates relates primarily to our investment portfolio. We place our investments with high credit quality issuers and, by policy, limit our credit exposure with any one issuer. As stated in our policy, we are averse
to principal loss, and seek to preserve our invested funds by limiting default risk, liquidity risk, and territory risk.



We mitigate default and liquidity risks by investing only in high credit quality securities, and by positioning our portfolio to respond appropriately to
a significant reduction in the credit rating of any investment issuer or guarantor. To ensure portfolio liquidity the portfolio includes only marketable securities with active secondary or resale markets. We mitigate territory risk by only allowing
up to 25% of the portfolio to be placed outside of the United States.



Foreign currency risk



We are exposed
to foreign currency exchange rate risk inherent in our sales commitments, anticipated sales, anticipated purchases and assets and liabilities in currencies other than the U.S. dollar. We transact business in approximately ten foreign currencies
worldwide, of which the most significant to our operations are the euro, the Canadian dollar, the Israeli shekel, and the British pound. For most currencies, we are the net receiver of foreign currencies and therefore benefit from a weaker U.S.
dollar and are adversely affected by a stronger U.S. dollar relative to those foreign currencies in which we transact significant amounts of business. The net results of the transaction gains or losses appear in the line entitled foreign currency
transaction gain or loss in the Condensed Consolidated Statements of Operations. At the end of each period, the translation of Condensed Consolidated Balance Sheets from local currency to the group currency appear in the Condensed Consolidated
Statements of Comprehensive Loss under the foreign currency translation adjustments line.



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The following table presents the potential impact on cash flow of changes in exchange rates as noted (in
thousands):



|                            |  |                                              |        |   |            |   |      |            |  |   |            |   |  |            |      |   |  |   |      |  
|--------------------------- |  | -------------------------------------------- | ------ | - | ---------- | - | ---- | ---------- |  | - | ---------- | - |  | ---------- | ---- | - |  | - | ---- | -
|                            |  | Cash flow impact on change in exchange rates |       
|                            |  | Fair Value as ofSeptember 30, 2004           |        |   | -15%Change |   |      | -10%Change |  |   | +10%Change |   |  | +15%Change |     
|Accounts receivable (1)     |  | $                                            | 5,794  |   |            | $ | (319 | )          |  | $ | (201       | ) |  | $          | 164  |   |  | $ | 236  |  
|Accounts payable (1)        |  |                                              | (2,104 | ) |            |   | 163  |            |  |   | 103        |   |  |            | (84  | ) |  |   | (120 | )
|Inter-company with U.S. (2) |  |                                              | (2,744 | ) |            |   | 532  |            |  |   | 335        |   |  |            | (274 | ) |  |   | (393 | )

---

|(1) | The offset entry for this change in exchange rates would be to Accumulated other comprehensive loss in the Condensed Consolidated Balance Sheets.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | This assumes the change in exchange rates applies only to the relationship between the U.S. dollar and the local currency as of September 30, 2004 and that there is no change in
rates between the various non U.S. dollar currencies. The offset entry for this change in exchange rates would be to Foreign currency transaction gain (loss) in the Condensed Consolidated Statements of Operations.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Factors that may affect our future results and financial condition



Our business is subject to a number of risks and uncertainties. You should
carefully consider the risks described below, in addition to the other information contained in this Report and in our other filings with the SEC. The risks and uncertainties described below are not the only ones facing our company. Additional risks
and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations. If any of these risks actually occur, our business, financial condition or results of operations could be seriously harmed. In
that event, the market price for our common stock could decline and you may lose part or all of your investment.



Our operating results have fluctuated significantly in the past and may continue to do so in the future, which could cause our stock price to decline.



We have experienced, and expect to experience in
future periods, significant fluctuations in operating results that may be caused by many factors including, among others:



| |  | general economic conditions, in particular, the slowdown of purchases of information technology due to current economic conditions in North America and internationally;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | changes in demand for our products;
| | - | -----------------------------------



| |  | introduction or enhancements to our products and those of our competitors;
| | - | --------------------------------------------------------------------------



| |  | technological changes in computer networking;
| | - | ---------------------------------------------



| |  | competitive pricing pressures;
| | - | ------------------------------



| |  | market acceptance of new products;
| | - | ----------------------------------



| |  | customer order deferrals in anticipation of new products and product enhancements;
| | - | ----------------------------------------------------------------------------------



| |  | the size and timing of individual product orders;
| | - | -------------------------------------------------



| |  | mix of international and domestic revenues;
| | - | -------------------------------------------



| |  | mix of distribution channels through which our products are sold;
| | - | -----------------------------------------------------------------



| |  | loss of, or failure to enter into, strategic alliances to develop or promote our products;
| | - | ------------------------------------------------------------------------------------------



| |  | quality control of our products;
| | - | --------------------------------



| |  | changes in our operating expenses;
| | - | ----------------------------------



| |  | personnel changes;
| | - | ------------------



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



| |  | seasonality; and
| | - | ----------------



| |  | adverse business conditions in specific industries.
| | - | ---------------------------------------------------



In addition, our acquisition of complementary businesses, products or technologies has in the past caused and many continue to cause fluctuations in our
operating results due to in-process research and development charges, the amortization of acquired intangible assets, and integration costs recorded in connection with acquisitions.



Since we generally ship software products within a short period after receipt of an order, we do not typically have a
material backlog of unfilled orders, and our revenues in any one-quarter are substantially dependent on orders booked in that quarter and particularly in the last month of that quarter. Our expenses are based in part on our expectations as to future
revenues and to a large extent are fixed. Therefore, we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall. Accordingly, any significant shortfall of demand for our products in relation to our
expectations or any material delay of customer orders would have an almost immediate adverse impact on our operating results and on our ability to achieve profitability.



As a result, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful and
should not be relied upon as indications of future performance. Fluctuations in our operating results have caused, and may in the future cause us to perform below the expectations of public market analysts and investors. If our operating results
fall below market expectations, the price of our common stock may fall.



We have not been profitable on an annual basis since 1995 and may never achieve profitability in the future.



We earned net income for the nine month period ended September 30, 2004 of $0.7 million and reported a net loss of approximately $2.7 million for the year
ended December 31, 2003. We have not achieved profitability on an annual basis since 1995, and we may never obtain sufficient revenues to sustain profitability in any future period. In addition, price competition may make it difficult for us to
achieve profitability. Increasing competition may cause our prices to decline, which would harm our operating results. We expect prices for our software products to decline over the next few years. We expect to face increased competition in markets
where we sell our products, which will make it more difficult to increase or maintain our revenues or to maintain our prices and profit margins. We need to increase our sales volume and/or reduce our costs to be profitable in future periods. If
anticipated increases in sales volume do not keep pace with anticipated pricing pressures, our revenues would decline and our business could be harmed. This could occur despite our efforts to introduce and enhance our existing products.



We rely significantly on third parties for sales of our products and our revenues
could decline significantly with little or no notice.



We rely significantly on our independent distributors, systems integrators, and value-added resellers for marketing and distribution of our products. The agreements in place with these organizations are generally non-exclusive, of limited
duration, are terminable with little or no notice by either party and generally do not contain minimum purchase requirements. These distributors of our products are not within our control and generally represent competing product lines of other
companies in addition to our products. There can be no assurance that these organizations will give a high priority to the marketing of our products, and they may give a higher priority to the products of our competitors.



Furthermore, our results of operations may also be materially adversely
affected by changes in the inventory strategies of our distributors, which can occur rapidly and may not be related to end-user demand. As part of our continued strategy of selling through multiple distribution channels, we expect to continue using
indirect distribution channels, particularly value-added resellers and system integrators, in addition to distributors and original equipment manufacturers. Any material increase in our indirect sales as a percentage of revenues may adversely affect
our average selling prices and gross margins due to lower unit costs that are typically charged when selling through indirect channels. There can be no assurance that we will be able to attract or retain resellers and distributors who will be able
to market our products effectively, will be qualified to provide timely and cost-effective customer support and service, or will continue to represent our products. If we are unable to recruit or retain important resellers or distributors or if they
decrease their sales of our products, we may suffer a material adverse effect on our business, financial condition or results of operations.



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We have undergone significant restructuring, which may have a material adverse effect on our operating results.



We undertook restructurings of our operations in
August 2000, August 2002 and again in January 2003. These restructuring plans involved reductions in our worldwide workforce and the consolidation of certain of our sales, customer support, and research and development operations. We have also had
to write-down assets as part of the restructuring effort that lowered our operating results. These restructuring plans may not be successful and may not improve future operating results. Completion of the restructuring plans may disrupt our
operations and have a material adverse effect on our business, financial condition and results of operations. We may also be required to implement additional restructuring plans in the future.



We may not be able to successfully make acquisitions of or investments in other
companies or technologies.



We have limited experience
in acquiring or making investments in companies, technologies or services. We regularly evaluate product and technology acquisition opportunities and anticipate that we may make additional acquisitions in the future if we determine that an
acquisition would further our corporate strategy. Acquisitions in our industry are particularly difficult to assess because of the rapidly changing technological standards in our industry. If we make any acquisitions, we will be required to
assimilate the personnel, operations and products of the acquired business and train, retain and motivate key personnel from the acquired business. However, the key personnel of the acquired business may decide not to work for us. Moreover, if the
operations of an acquired company or business do not meet our expectations, we may be required to restructure the acquired business, or write-off the value of some or all of the assets of the acquired business. No assurance can be given that any
acquisition by us will or will not occur, that if an acquisition does occur, that it will not materially and adversely affect us, or that any such acquisition will be successful in enhancing our business.



We are dependent upon our key management for our future success, and few of our
managers are obligated to stay with us.



Our success
depends on the efforts and abilities of our senior management and certain other key personnel. Many of our key employees are employed on an at-will basis. If any of our key employees left or were unable to work and we were unable to find a suitable
replacement, then our business, financial condition and results from operations could be materially harmed.



We face significant competition and competition in our market is likely to increase and could harm our business.



The markets for our products are intensely competitive and characterized by rapidly changing technology, evolving industry standards, price erosion,
changes in customers needs, and frequent new product introductions. We anticipate continued growth and competition in our industry and the entrance of new competitors into our markets, and accordingly, the markets for our products will remain
intensely competitive. We expect that competition will increase in the near term and that our primary long-term competitors may not yet have entered the market. Several key factors contribute to the continued growth of our marketplaces including the
proliferation of Microsoft Windows client server technology, and the continued implementation of web-based access to corporate mainframe and midrange computer systems. Our connectivity software products compete with major computer and communication
systems vendors, including Microsoft, IBM, and Sun Microsystems, Inc., as well as smaller networking software companies such as Jacada Ltd. and Seagull Holding HV. We also face competition from makers of terminal emulation software such as
Attachmate Corporation and WRQ, Inc.



Many of our current
competitors have, and many of our future competitors may have, substantially greater financial, technical, sales, marketing and other resources, in addition to greater name recognition and a larger customer base than us. The markets for our products
are characterized by significant price competition and we anticipate that we will face increasing pricing pressures from our competitors in the future. In addition, our current and future competitors may be able to respond more quickly to new or
emerging technologies and changes in customer requirements than we can. Increased competition could result in price reductions, fewer customer orders, reduced gross profit margins and loss of market share, any of which could harm our business.



Furthermore, our competitors could seek to expand their
product offerings by designing and selling products using technology that could render obsolete or adversely affect sales of our products. These developments may adversely affect sales of our products either by directly affecting customer-purchasing
decisions or by causing potential customers to delay their purchases of our products. Several of our competitors have developed proprietary networking applications and certain of such vendors, including Novell, provide a TCP/IP protocol suite in
their products at little or no additional cost. In particular, Microsoft has embedded a TCP/IP protocol suite in its Windows 98, Windows 2000, Windows ME, Windows NT, Windows XP, and Windows .NET operating systems. We have products, which are
similar to connectivity products marketed by Microsoft. Microsoft is expected to increase development of such products, which could have a material adverse effect on our business, financial condition or results of operations.



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If we fail to manage technological change, respond to consumer demands or evolving industry standards or if we fail
to enhance our products interoperability with the products of our customers, demand for our products will decrease and our business will suffer.



From time to time many of our customers have delayed purchase decisions due to confusion in the marketplace relating to rapidly changing technology and
product introductions. To maintain or improve our position in this industry, we must successfully develop, introduce, and market new products and product enhancements on a timely and cost-effective basis. We have experienced difficulty from time to
time in developing and introducing new products and enhancing existing products, in a manner which satisfies customer requirements and changing market demands. Any failure by us to anticipate or respond adequately to changes in technology and
customer preferences, or any significant delays in product development or introduction, could have a material adverse effect on our business, financial condition, and results of operations. The failure to develop products or product enhancements
incorporating new functionality on a timely basis could cause customers to delay purchase of our current products or cause customers to purchase products from our competitors; either situation would adversely affect our business, financial
condition, and results of operations. We may not be successful in developing new products or enhancing our existing products on a timely basis, and any new products or product enhancements developed by us may not achieve market acceptance. In
addition, we incorporate software and other technologies owned by third parties and as a result, we are dependent upon such third parties ability to enhance their current products, to develop new products that will meet changing customer needs
on a timely and cost-effective basis, and to respond to emerging industry standards and other technological changes.



We depend upon technology licensed from third parties, and if we do not maintain these license arrangements, we will not be able to ship many of our products and
our business will be seriously harmed.



Certain of our
products incorporate software and other technologies developed and maintained by third parties. We license these technologies from third parties under agreements with a limited duration and we may not be able to maintain these license arrangements.
If we fail to maintain our license arrangements or find suitable replacements, we would not be able to ship many of our products and our business would be materially harmed. For example, we have a license agreement with Dart Technologies, Inc.,
renewable annually, for Power TCP Telnet and Power TCP VT320, which we use in our OnWeb product line. There can be no assurance that we would be able to replace the functionality provided by the third-party technologies currently offered in
conjunction with our products if those technologies become unavailable to us or obsolete or incompatible with future versions of our products or market standards.



We depend upon the compatibility of our products with applications operating on Microsoft Windows to sell our products.



Substantially all of our net revenues have been
derived from the sales of products that provide internetworking applications for the Microsoft Windows environment and are marketed primarily to Windows users. As a result, sales of certain of our products would be negatively impacted by
developments adverse to Microsofts Windows products. In addition, our strategy of developing products based on the Windows operating environment is substantially dependent on our ability to gain pre-release access to, and to develop expertise
in, current and future Windows developments by Microsoft. If we are unable to gain such access our ability to develop new products compatible with future Windows release in a timely manner could be harmed.



The loss of any of our strategic relationships would make it more difficult to keep
pace with evolving industry standards and to design products that appeal to the marketplace.



Our future success depends on our ability to maintain and enter into new strategic alliances and OEM relationships to develop necessary products or
technologies, to expand our distribution channels or to jointly market or gain market awareness for our products. We currently rely on strategic relationships, such as those with Microsoft, to provide us with state of the art technology, to assist
us in integrating our products with leading industry applications, and to help us make use of economies of scale in manufacturing and distribution. However, we do not have written agreements with many of our strategic partners and cannot ensure
these relationships will continue for a significant period of time. Many of our agreements with these partners are informal and may be terminated by them at any time. There can be no assurance that we will be successful in maintaining current
alliances or developing new alliances and relationships or that such alliances and relationships will achieve their intended purposes.



We may be subject to product returns, product liability claims and reduced sales because of defects in our products.



Software products as complex as those offered by us may contain undetected
errors or failures when first introduced or as new versions are released. The likelihood of errors is higher when a new product is introduced or when new versions or enhancements are released. Errors may also arise as a result of defects in
third-party products or components, which are incorporated into our products. There can be no assurance that, despite testing by us and by current and potential customers, errors will not be found in new products or product enhancements after
commencement of commercial shipments, which could result in loss of or delay in market acceptance. We may be required to devote significant financial resources and personnel to correct any defects. Known or unknown errors or



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defects that affect the operation of our products could result in the following, any of which could have a material
adverse effect on our business, financial condition, and results of operations:



| |  | delay or loss or revenues;
| | - | --------------------------



| |  | cancellation of a purchase order or contract due to defects;
| | - | ------------------------------------------------------------



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



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



| |  | failure of our products to achieve market acceptance;
| | - | -----------------------------------------------------



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



| |  | litigation costs.
| | - | -----------------



Although some of our licenses with customers contain provisions designed to limit our exposure to potential product liability claims, these contractual
limitations on liability may not be enforceable or may only limit, rather than eliminate potential liability. In addition, our product liability insurance may not be adequate to cover our losses in the event of a product liability claim resulting
from defects in our products and may not be available to us in the future.



Our business depends upon licensing our intellectual property, and if we fail to protect our proprietary rights, our business could be harmed.



Our ability to compete depends substantially upon our internally developed proprietary technology. We rely primarily on a
combination of copyright and trademark laws, trade secrets, confidentiality procedures, and contractual provisions to protect our proprietary rights. We seek to protect our software, documentation and other written materials under trade secret and
copyright laws and contractual confidentiality agreements, which afford only limited protection, and, to a lesser extent, patent laws. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our
products or to obtain and use information that we regard as proprietary. Policing unauthorized use of our products and technology is difficult and, while we are unable to determine the extent to which piracy of our software products exists, software
piracy can be expected to be a persistent problem. In selling our products, we rely primarily on shrink-wrap and click-wrap licenses that are not signed by licensees and, therefore, may be unenforceable under the laws of
certain jurisdictions. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States. If we are not successful in protecting our intellectual property, our business
could be substantially harmed.



We rely upon trademarks, copyrights and
trade secrets to protect our proprietary rights, which are only of limited value.



There can be no assurance that our means of protecting our proprietary rights will be adequate or that our competitors will not independently develop similar technology. In addition, the number of patents applied and
granted for software inventions is increasing. Despite any precautions which we have taken:



| |  | laws and contractual restrictions may not be sufficient to prevent misappropriation of our technology or deter others from developing similar technologies;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | other companies may claim common law trademark rights based upon state or foreign law which precede our federal registration of such marks; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  | current federal laws that prohibit software copying provide only limited protection from software pirates, and effective trademark, copyright and trade secret protection
may be unavailable or limited in certain foreign countries.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Our pending patent applications may never be issued, and even if issued, may provide us with little protection.



We regard the protection of patentable inventions as important to our business. However, it is possible that:



| |  | our pending patent applications may not result in the issuance of patents;
| | - | --------------------------------------------------------------------------



| |  | our patents may not be broad enough to protect our proprietary rights;
| | - | ----------------------------------------------------------------------



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| |  | any issued patent could be successfully challenged by one or more third parties, which could result in our loss of the right to prevent others from exploiting the inventions claimed
in those patents;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | current and future competitors may independently develop similar technology, duplicate our products or design around any of our patents; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------



| |  | effective patent protection, if any, may not be available in every country in which we do business.
| | - | ---------------------------------------------------------------------------------------------------



If we are not successful in asserting our patent rights, our business could be substantially harmed. At the present time, we
have one patent pending and we have been issued approximately 18 patents from the U.S. Patent Office.



We have received notices of claims that may result in litigation and we may become involved in costly and time-consuming litigation over proprietary rights.



Substantial litigation regarding intellectual property rights exists in our
industry. We expect that software in our industry may be increasingly subject to third party infringement claims as the number of competitors grows and the functionality of products in different areas of the industry overlaps. Third parties may
currently have, or may eventually be issued, patents that would be infringed by our products or technology. We cannot be certain that any of these third parties will not make a claim of infringement against us with respect to our products and
technology. We have received, and may receive in the future, communications from third parties asserting that our products infringe, or may infringe, the proprietary rights of third parties seeking indemnification against such infringement or
indicating that we may be interested in obtaining a license from such third parties. Any claims or actions asserted against us could result in the expenditure of significant financial resources and the diversion of managements time and
efforts. In addition, litigation in which we are accused of infringement may cause product shipment delays, require us to develop non-infringing technology or require us to enter into royalty or license agreements even before the issue of
infringement has been decided on the merits. If any litigation were not to be resolved in our favor, we could become subject to substantial damage claims and be prohibited from using the technology at issue without a royalty or license agreement.
These royalty or license agreements, if required, might not be available on acceptable terms, or at all, and could result in significant costs and harm our business. If a successful claim of infringement is made against us and we cannot develop
non-infringing technology or license the infringed or similar technology on a timely and cost-effective basis, our business could be significantly harmed.



Our business is subject to risks from international operations such as legal uncertainty, tariffs, trade barriers and political and economic instability.



We derived approximately 25% of our net revenues from
sales outside of North America (United States and Canada) during the quarter ended September 30, 2004. While we expect that international sales will continue to account for a significant portion of our net revenues, there can be no assurance that we
will be able to maintain or increase international market demand for our products or that our distributors will be able to effectively meet that demand. Risks inherent in our international business activities generally include, among others:



| |  | unexpected changes in regulatory requirements;
| | - | ----------------------------------------------



| |  | legal uncertainty, particularly regarding intellectual property rights and protection;
| | - | --------------------------------------------------------------------------------------



| |  | costs and risks of localizing products for foreign countries;
| | - | -------------------------------------------------------------



| |  | costs and risks related to local employment practices;
| | - | ------------------------------------------------------



| |  | longer accounts receivable payment cycles;
| | - | ------------------------------------------



| |  | language barriers in business discussions;
| | - | ------------------------------------------



| |  | cultural differences in the negotiation of contracts and conflict resolution;
| | - | -----------------------------------------------------------------------------



| |  | time zone differences;
| | - | ----------------------



| |  | the limitations imposed by U.S. export laws (see Government Regulation and Legal Uncertainties below);
| | - | ------------------------------------------------------------------------------------------------------



| |  | changes in markets caused by a variety of political, social and economic factors;
| | - | ---------------------------------------------------------------------------------



| |  | tariffs and other trade barriers;
| | - | ---------------------------------



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| |  | difficulties in managing international operations;
| | - | --------------------------------------------------



| |  | currency exchange rate fluctuations;
| | - | ------------------------------------



| |  | potentially adverse tax consequences;
| | - | -------------------------------------



| |  | repatriation of earnings; and
| | - | -----------------------------



| |  | the burdens of complying with a wide variety of foreign laws.
| | - | -------------------------------------------------------------



Many of our customers are subject to many of the risks described above. These factors may have an adverse effect on our international sales and,
consequently, on our business, financial condition or results of operations.



Terrorist attacks and threats or actual war could adversely affect our operating results and the price of our common stock.



The terrorist attacks in the United States, the United States response to these attacks, the current instability in the Middle East, and the related
decline in consumer confidence and continued economic weakness have had an adverse impact on our operations. If consumer confidence continues to decline or does not recover, our revenues and results of operations may continue to be adversely
impacted in 2004 and beyond. Any escalation in these events, or similar future events may disrupt our operations or those of our customers. These events have had and may continue to have an adverse impact on the United States and world economy in
general and consumer confidence and spending in particular, which has and could continue to harm our sales. Any of these events could increase volatility in the United States and worldwide financial markets and economy, which could harm our stock
price and may limit the capital resources available to us and our customers. This could have a significant impact on our operating results, revenues and costs and may result in increased volatility in the market price of our common stock and on the
future price of our common stock.



It may be difficult to raise needed
capital in the future, which could significantly harm our business.



We may require substantial additional capital to finance growth and fund ongoing operations in future years. Our capital requirements will depend on many factors including, among other things:



| |  | our results of operations;
| | - | --------------------------



| |  | acceptance of and demand for our products;
| | - | ------------------------------------------



| |  | the number and timing of any acquisitions and the cost of these acquisitions;
| | - | -----------------------------------------------------------------------------



| |  | the costs of developing new products;
| | - | -------------------------------------



| |  | the costs associated with our refocusing on core products and technologies; and
| | - | -------------------------------------------------------------------------------



| |  | the extent to which we invest in new technology and research and development projects.
| | - | --------------------------------------------------------------------------------------



Although our current business plan does not foresee the need for further financing activities to fund our operations for the
foreseeable future, due to risks and uncertainties in the marketplace as well as a potential of pursuing further acquisitions, we may need to raise additional capital. If we issue additional stock to raise capital, your percentage ownership in us
would be diluted. If we raise capital through debt; our debt servicing costs will increase. Additional financing may not be available when needed and, if such financing is available, it may not be available on terms favorable to us.



Because of their significant stock ownership, our officers and directors can exert
significant control over our future direction.



As of
October 31, 2004, our officers, directors and entities affiliated with them, in the aggregate, beneficially owned approximately 2.2 million shares, or approximately 23.0% of our outstanding common stock. These stockholders, if acting together, would
be able to exert significant influence on all matters requiring approval by our stockholders, including the election of directors, the approval of mergers or other business combination transactions or a sale of all or substantially all of our
assets.



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Certain provisions of our stock option plan, our stockholder rights plan, and our certificate of incorporation and
bylaws make changes of control difficult even if they would be beneficial to stockholders.



Our 1992 Stock Option Plan and our 1999 Nonstatutory Stock Option Plan currently provide, subject to certain limitations as defined in the plans, that in
the event of a change of control of NetManage, all options outstanding under those plans would become fully vested and exercisable for at least 10 days prior to the consummation of such a change of control transaction. This acceleration of vesting
provisions may have the effect of deterring or reducing the price that a potential acquirer would be willing to pay to acquire NetManage.



We have adopted a stockholder rights plan that would cause substantial dilution to a stockholder, and substantially increase the cost paid by a
stockholder, who attempts to acquire us on terms not approved by our board of directors. This could prevent us from being acquired. In addition, our board of directors has the authority without any further vote or action on the part of the
stockholders to issue up to 1,000,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions of the preferred stock. This preferred stock, if it is ever issued, may have preference over, and harm the
rights of the holders of, our common stock. Although the issuance of this preferred stock will provide us with flexibility in connection with possible acquisitions and other corporate purposes, the issuance of the preferred stock may make it more
difficult for a third party to acquire a majority of our outstanding voting stock. We currently have no plans to issue preferred stock.



Our certificate of incorporation and bylaws include provisions that may have the effect of deterring an unsolicited offer to purchase our stock. These
provisions, coupled with the provisions of the Delaware General Corporation Law, may delay or impede a merger, tender offer or proxy contest involving us. Furthermore, our board of directors is divided into three classes, only one of which is
elected each year. Directors are only capable of being removed by the affirmative vote of two thirds or greater of all classes of voting stock. These factors may further delay or prevent a change of control.



We face risks from the uncertainties of current and future governmental regulation.



We are not currently subject to direct regulation by
any government agency, other than regulations applicable to businesses generally, and there are currently few laws or regulations directly applicable to access to or commerce on the Internet. However, due to the increasing popularity and use of the
Internet, it is possible that various laws and regulations may be adopted with respect to the Internet, covering issues such as user privacy, pricing and characteristics and quality of products and services. The adoption of any such laws or
regulations may decrease the growth of the Internet, which could in turn decrease the demand for our products, increase our cost of doing business or otherwise have an adverse effect on our business, financial condition or results of operations.
Moreover, the applicability to the Internet of existing laws governing issues such as property ownership, libel and personal privacy is uncertain. Further, due to the encryption technology contained in certain of our products, such products are
subject to U.S. export controls. There can be no assurance that such export controls, either in their current form or as may be subsequently enacted, will not limit our ability to distribute products outside of the United States or electronically.
While we take precautions against unlawful exportation, there can be no assurance that inadvertent violations will not occur, and the global nature of the Internet makes it virtually impossible to effectively control the distribution of our
products. In addition, future federal or state legislation or regulation may further limit levels of encryption or authentication technology. Any such export restriction, new legislation or regulation or unlawful exportation could have a material
adverse effect on our business, financial condition, or results of operations.



Our efforts to comply with Section 404 of the Sarbanes-Oxley Act are expensive and time-consuming and may not ultimately result in a favorable outcome



In order to achieve compliance with Section 404 of the Sarbanes-Oxley Act of 2002 (the S-O Act) within the
prescribed period described under Item 4 below, the Company has been engaged in a process to document and evaluate its internal controls over financial reporting. In this regard, the Company has dedicated internal resources, engaged outside
consultants and adopted a detailed work plan to (i) assess and document the adequacy of internal control over financial reporting, (ii) take steps to improve control processes where appropriate, (iii) validate through testing that controls are
functioning as documented and (iv) implement a continuous reporting and improvement process for internal control over financial reporting. These efforts have resulted in, and may continue to result in, significant expenditures and the diversion of
management attention from the Companys business. In addition, the Company cannot assure you that its management will be able to conclude that the Companys internal controls over financial reporting are effective as of December 31, 2005
or any subsequent date.



Item 3. Quantitative and qualitative disclosures about market risk



There have been no material changes in reported market risks since December 31, 2003. Information regarding interest rate risk and foreign currency risk
is discussed herein in Item 2 under Disclosure of Market Risk.



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Item 4. Controls and procedures



Evaluation
of disclosure controls and procedures.



As of the end
of the period covered by this filing, we performed an evaluation under the supervision and with the participation of NetManages management, including NetManages Chief Financial Officer (CFO), of the effectiveness of the design and
operation of NetManages disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended, or the Exchange Act. Following that evaluation, NetManages management,
including the CFO, concluded that based on the evaluation, the design and operation of NetManages disclosure controls and procedures were effective at that time.



An internal control system is designed to provide reasonable, but not absolute, assurance that the objectives of the control
system are met, including, but not limited to, ensuring that transactions are properly authorized, assets are safeguarded against unauthorized or improper use and transactions are properly recorded and reported.



Changes in internal controls.



As indicated on the cover page of this report, NetManage is not an
accelerated filer within the meaning of Rule 12b-2 under the Exchange Act. Accordingly, NetManage will be required to include in its periodic filings under the Exchange Act the disclosures contemplated by Section 404 of the S-O Act
beginning with its Annual Report on Form 10-K for the year ended December 31, 2005, to be filed in 2006. Section 404 will require the Company to include an internal control report of management in its Annual Report on Form 10-K. The internal control
report must contain (1) a statement of managements responsibility for establishing and maintaining adequate internal control over financial reporting, (2) a statement identifying the framework used by management to conduct the required
evaluation of the effectiveness of our internal control over financial reporting, (3) managements assessment of the effectiveness of our internal control over financial reporting as of the end of its most recent fiscal year, including a
statement as to whether or not internal control over financial reporting is effective, and (4) a statement that the Companys independent auditors have issued an attestation report on managements assessment of internal control over
financial reporting.



There have been no significant changes in
our internal controls during the Companys most recent quarter, or in other factors that could significantly affect these controls, including any corrective actions with regard to significant deficiencies and material weaknesses.



PART II OTHER INFORMATION



Item 1. Legal Proceedings



The
information required by this item is incorporated herein by reference from the information contained in our Form 10-K for the fiscal year ended December 31, 2003 under the caption Legal Proceedings.



In addition, the Company may be contingently liable with respect to certain
asserted and unasserted claims that arise during the normal course of business. Management believes the impact, if any, resulting from these matters would not have a material impact on the Companys financial statements.



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



We made no repurchases of our common stock during three and nine month periods ended September 30, 2004.



Item 3. Defaults upon Senior Securities



Not applicable



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



Not applicable



Item 5. Other Information



We
file electronically with the Securities and Exchange Commission (SEC) our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K pursuant to Section 13(a) or 15(d) of the 1934 Act. The public may read
or copy any materials we file with the SEC at the SECs Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
The SEC maintains an Internet site that contains reports, proxy and information statements, and other information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is http://
www.sec.gov.



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On September 27, 2004, the Company furnished a current report on Form 8-K, announcing that on September
22, 2004, it entered into a definitive Stock Purchase Agreement, or the Purchase Agreement, with Librados, Inc., and each of David James Richards, James Milton Campigli, Mohammad Naeem Akhtar, Vincent Eagen, Keith Graham, Chris Walton, Satish N. N.
Numburi, Madhuri Suda, Vivian Stark, Susan Poulter, and Larry Webster, or the Shareholders . The Company and its affiliates have no material relationship with Librados and the Shareholders other than in respect of the Purchase Agreement.



On November 12, 2004, in connection with the Purchase Agreement, the
Company furnished a current report on Form 8-K, announcing that on October 22, 2004, it acquired all of the issued and outstanding capital stock of Librados and offered employment to substantially all of the current employees of Librados. The
purchase price for the acquired Librados stock was a combination of cash and shares of the common stock of the Company totaling approximately $3.4 million, which was delivered to the Shareholders at closing. The Purchase Agreement also provides that
certain Shareholders will not compete with the acquired business for certain specified periods of time.



On October 25, 2004, the Company furnished a current report on Form 8-K, announcing its third quarter fiscal 2004 financial results for the three and nine
month periods ended September 30, 2004.



Item 6. Exhibits and Reports on Form 8-K



a. Exhibits



|      |  |                                                                                                                                                                           
|----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.20 |  | Lease between the Registrant and Stevens Creek Office Center Associates dated June 15, 2004.                                                                              
|      | 
|10.21 |  | Stock Purchase Agreement by and among the Registrant, Librados Inc., a Delaware corporation, and holders of securities of Librados Inc., dated as of September 22, 2004.  
|      | 
|10.22 |  | Registration Rights Agreement by and among the Registrant, and holders of securities of Librados Inc. dated October 22, 2004.                                             
|      | 
|31.1  |  | Certification of Chief Executive Officer pursuant to Rule 13a-14(a).                                                                                                      
|      | 
|31.2  |  | Certification of Chief Financial Officer pursuant to Rule 13a-14(a).                                                                                                      
|      | 
|32.1  |  | Chief Executive Officer and Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.



b.
Reports on Form 8-K.



1. On September 27, 2004, the Company furnished a
current report on Form 8-K, announcing that on September 22, 2004, it entered into a definitive Stock Purchase Agreement with Librados, Inc. and each of David James Richards, James Milton Campigli, Mohammad Naeem Akhtar, Vincent Eagen, Keith Graham,
Chris Walton, Satish N. N. Numburi, Madhuri Suda, Vivian Stark, Susan Poulter, and Larry Webster .



2. On October 25, 2004, the Company furnished a current report on Form 8-K, announcing its third quarter fiscal 2004 financial results for the three and nine month periods ended September 30, 2004.



3. On November 12, 2004, the Company furnished a current report on Form 8-K, announcing that
on October 22, 2004, it had completed the acquisition of Librados, Inc.



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SIGNATURES



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



|                        |  |                 |  |                                                                                                                                                  
|----------------------- |  | --------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------
|                        |  | NETMANAGE, INC.
|                        |  | (Registrant)   
|                        |  |                
|DATE: November 12, 2004 |  | By:             |  | /s/ Michael Peckham                                                                                                                              
|                        |  |                 |  | Michael Peckham Chief Financial Officer and Senior
Vice President (On behalf of the registrant and as Principal Financial and Accounting Officer)



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EXHIBIT INDEX



|              |  |                                                                                                                                                                           
|------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                               
|10.20         |  | Lease between the Registrant and Stevens Creek Office Center Associates dated June 15, 2004.                                                                              
|              | 
|10.21         |  | Stock Purchase Agreement by and among the Registrant, Librados Inc, a Delaware corporation, and holders of securities of Librados Inc, dated as of September 22, 2004.    
|              | 
|10.22         |  | Registration Rights Agreement by and among the Registrant, and holders of securities of Librados Inc. dated October 22, 2004.                                             
|              | 
|31.1          |  | Certification of Chief Executive Officer pursuant to Rule 13a-14(a).                                                                                                      
|              | 
|31.2          |  | Certification of Chief Financial Officer pursuant to Rule 13a-14(a).                                                                                                      
|              | 
|32.1          |  | Chief Executive Officer and Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley act of 2002.



34