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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549


FORM 10-Q

|  |  |                                                                                          |  | 
|- |  | ---------------------------------------------------------------------------------------- |  | 
|þ |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934  |  | 
|  |  | For the quarterly period ended June 30, 2002                                             |  | 
| 
|  |  | 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: 0-25612

STARBASE CORPORATION

(Exact name of Registrant as specified in its charter)

|                                                                                                |  |                                                   
|----------------------------------------------------------------------------------------------- |  | --------------------------------------------------
|Delaware
(State or other jurisdiction of
incorporation or organization)                         |  | 33-0567363
(I.R.S. Employer
Identification Number)
|                                                                                               
|4 Hutton Centre Drive, Suite 900
Santa Ana, California
(Address of principal executive offices) |  | 92707
(Zip code)                                  

(714) 445-4400
(Registrants telephone number, including area code)

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) been subject to such
filing requirements for the past 90 days.
Yes þ No  ̈

|                                                  |  |                  |  |  |           | 
|------------------------------------------------- |  | ---------------- |  |  | --------- | 
|Number of shares outstanding as of July 31, 2002: |  | Common Stock:    |  |  | 8,737,144 | 
|                                                  |  | Preferred Stock: |  |  | 0         | 



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TABLE OF CONTENTS



|                             |                                                                                              |                                                     |  |  |  |  |  | 
|---------------------------- | -------------------------------------------------------------------------------------------- | --------------------------------------------------- |  |  |  |  |  | 
|PART I FINANCIAL INFORMATION
|                             | ITEM 1 FINANCIAL STATEMENTS                                                                 
|                             |                                                                                              | CONSOLIDATED BALANCE SHEETS                        
|                             |                                                                                              | CONSOLIDATED STATEMENTS OF OPERATIONS              
|                             |                                                                                              | CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
|                             |                                                                                              | CONSOLIDATED STATEMENTS OF CASH FLOWS              
|                             |                                                                                              | Notes to Consolidated Financial Statements         
|                             | ITEM 2 MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                             | ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                           
|PART II OTHER INFORMATION   
|                             | ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURES                  
|EXHIBIT INDEX               
|EXHIBIT 99.1                
|EXHIBIT 99.2                



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STARBASE CORPORATION

TABLE OF CONTENTS

|           |  |                                                                                       |  |                                                                                                                          |    |  |   | 
|---------- |  | ------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------ | -- |  | - | 
|PART I.    |  | FINANCIAL INFORMATION                                                                 |  |                                                                                                                          |    | 
|          
|ITEM 1.    |  | Financial Statements                                                                  |  |                                                                                                                          |    | 
|          
|           |  |                                                                                       |  | Consolidated Balance Sheets (Unaudited) at June 30, 2002 and March 31, 2002                                              |    |  | 3 | 
|          
|           |  |                                                                                       |  | Consolidated Statements of Operations (Unaudited) for the three month
periods ended June 30, 2002 and 2001               |    |  | 4 | 
|          
|           |  |                                                                                       |  | Consolidated Statements of Comprehensive Operations (Unaudited) for the three
month periods ended June 30, 2002 and 2001 |    |  | 5 | 
|          
|           |  |                                                                                       |  | Consolidated Statements of Cash Flows (Unaudited) for the three month
periods ended June 30, 2002 and 2001               |    |  | 6 | 
|          
|           |  |                                                                                       |  | Notes to Consolidated Financial Statements (Unaudited)                                                                   |    |  | 7 | 
|          
|ITEM 2.    |  | Managements Discussion and Analysis of Financial Condition
and Results of Operations |  |                                                                                                                          | 15 | 
|          
|ITEM 3.    |  | Qualitative and Quantitative Disclosures about Market Risk                            |  |                                                                                                                          | 25 | 
|          
|PART II.   |  | OTHER INFORMATION                                                                     |  |                                                                                                                          |    | 
|          
|ITEM 6.    |  | Exhibits and Reports on Form 8-K                                                      |  |                                                                                                                          | 26 | 
|          
|Signatures |  |                                                                                       |  |                                                                                                                          | 27 | 

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PART I ITEM 1
FINANCIAL STATEMENTS

STARBASE CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

|                                           |                                                                                                                                                 |                             |        |             |        |           |        |          |        | 
|------------------------------------------ | ----------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------- | ------ | ----------- | ------ | --------- | ------ | -------- | ------ | 
|                                           |                                                                                                                                                 |                             |        | June 30,    |        | March 31,
|                                           |                                                                                                                                                 |                             |        | 2002        |        | 2002     
|                                           |                                                                                                                                                 |                             |        |             |        |          
|                                           |                                                                                                                                                 |                             |        | (Unaudited)
|Assets                                     |                                                                                                                                                 |                             |        |             |        |           |        |         
|Current Assets:                            |                                                                                                                                                 |                             |        |             |        |           |        |         
|                                           | Cash and cash equivalents                                                                                                                       |                             | $      | 1,861       |        |           | $      | 1,530    |       
|                                           | Restricted cash                                                                                                                                 |                             |        | 62          |        |           |        | 62       |       
|                                           | Marketable securities                                                                                                                           |                             |        | 8           |        |           |        | 9        |       
|                                           | Accounts receivable, net of allowances of $936 at June 30, 2002 and $1,561 at March 31, 2002                                                    |                             |        | 6,238       |        |           |        | 7,980    |       
|                                           | Notes and other receivables, net of allowances of $150 at June 30, 2002 and March 31, 2002                                                      |                             |        |            |        |           |        | 14       |       
|                                           | Prepaid expenses and other current assets                                                                                                       |                             |        | 487         |        |           |        | 704      |       
|                                           |                                                                                                                                                 |                             |        |             |        |           |        |         
|                                           |                                                                                                                                                 | Total current assets        |        |             | 8,656  |           |        |          | 10,299 | 
|Property and equipment, net                |                                                                                                                                                 |                             | 3,889  |             |        |           | 4,503  |         
|Intangible assets, net                     |                                                                                                                                                 |                             | 9,866  |             |        |           | 13,319 |         
|Goodwill                                   |                                                                                                                                                 |                             | 9,557  |             |        |           | 7,637  |         
|Note receivable from officer               |                                                                                                                                                 |                             | 110    |             |        |           | 109    |         
|Other non-current assets                   |                                                                                                                                                 |                             | 457    |             |        |           | 620    |         
|                                           |                                                                                                                                                 |                             |        |             |        |           |        |         
|Total assets                               |                                                                                                                                                 | $                           | 32,535 |             |        | $         | 36,487 |         
|                                           |                                                                                                                                                 |                             |        |             |        |           |        |         
|Liabilities and Stockholders Equity       |                                                                                                                                                 |                             |        |             |        |           |        |         
|Current Liabilities:                       |                                                                                                                                                 |                             |        |             |        |           |        |         
|                                           | Accounts payable                                                                                                                                |                             | $      | 2,359       |        |           | $      | 2,953    |       
|                                           | Accrued compensation                                                                                                                            |                             |        | 2,187       |        |           |        | 2,344    |       
|                                           | Other accrued liabilities                                                                                                                       |                             |        | 1,094       |        |           |        | 1,267    |       
|                                           | Deferred revenue                                                                                                                                |                             |        | 6,972       |        |           |        | 6,598    |       
|                                           | Current portion of long-term obligations                                                                                                        |                             |        | 119         |        |           |        | 144      |       
|                                           |                                                                                                                                                 |                             |        |             |        |           |        |         
|                                           |                                                                                                                                                 | Total current liabilities   |        |             | 12,731 |           |        |          | 13,306 | 
|Long-term liabilities:                     |                                                                                                                                                 |                             |        |             |        |           |        |         
|                                           | Long-term obligations, less current portion                                                                                                     |                             |        | 18          |        |           |        | 42       |       
|                                           | Convertible debentures                                                                                                                          |                             |        |            |        |           |        | 1,632    |       
|                                           |                                                                                                                                                 |                             |        |             |        |           |        |         
|                                           |                                                                                                                                                 | Total long-term liabilities |        |             | 18     |           |        |          | 1,674  | 
|                                           |                                                                                                                                                 |                             |        |             |        |           |        |         
|                                           |                                                                                                                                                 | Total liabilities           |        |             | 12,749 |           |        |          | 14,980 | 
|Commitments and contingencies              |                                                                                                                                                 |                             |        |             |        |           |        |         
|Stockholders equity:                      |                                                                                                                                                 |                             |        |             |        |           |        |         
|                                           | Preferred stock, $.01 par value; 10,000,000 shares authorized, none issued and outstanding
at June 30, 2002 and March 31, 2002                  |                             |        |            |        |           |        |         |       
|                                           | Common stock, $.01 par value; 150,000,000 authorized; 8,737,144 and 7,965,548 shares issued
and outstanding at June 30, 2002 and March 31, 2002 |                             |        | 87          |        |           |        | 80       |       
|                                           | Additional paid-in capital                                                                                                                      |                             |        | 203,552     |        |           |        | 201,747  |       
|                                           | Accumulated deficit                                                                                                                             |                             |        | (183,365    | )      |           |        | (179,770 | )     
|                                           | Deferred non-cash compensation                                                                                                                  |                             |        | (331        | )      |           |        | (397     | )     
|                                           | Notes receivable                                                                                                                                |                             |        | (36         | )      |           |        | (36      | )     
|                                           | Accumulated other comprehensive loss                                                                                                            |                             |        | (121        | )      |           |        | (117     | )     
|                                           |                                                                                                                                                 |                             |        |             |        |           |        |         
|                                           | Total stockholders equity                                                                                                                      |                             |        | 19,786      |        |           |        | 21,507   |       
|                                           |                                                                                                                                                 |                             |        |             |        |           |        |         
|Total liabilities and stockholders equity |                                                                                                                                                 | $                           | 32,535 |             |        | $         | 36,487 |         
|                                           |                                                                                                                                                 |                             |        |             |        |           |        |         

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

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STARBASE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)

|                         |                                                              |                          |        |        |                    |   |         |         |        |  | 
|------------------------ | ------------------------------------------------------------ | ------------------------ | ------ | ------ | ------------------ | - | ------- | ------- | ------ |  | 
|                         |                                                              |                          |        |        | Three months ended
|                         |                                                              |                          |        |        | June 30,          
|                         |                                                              |                          |        |        |                   
|                         |                                                              |                          |        |        | 2002               |   | 2001   
|                         |                                                              |                          |        |        |                    |   |        
|                         |                                                              |                          |        |        | (Unaudited)       
|Revenues:                |                                                              |                          |        |        |                    |   |         |        
|                         | License                                                      |                          | $      | 5,091  |                    |   | $       | 7,387   |       
|                         | Maintenance                                                  |                          |        | 2,430  |                    |   |         | 2,616   |       
|                         | Service                                                      |                          |        | 1,571  |                    |   |         | 2,051   |       
|                         |                                                              |                          |        |        |                    |   |         |        
|                         |                                                              | Total revenues           |        |        | 9,092              |   |         |         | 12,054 | 
|Cost of Revenues:        |                                                              |                          |        |        |                    |   |         |        
|                         | License                                                      |                          |        | 169    |                    |   |         | 1,577   |       
|                         | Service                                                      |                          |        | 1,328  |                    |   |         | 1,824   |       
|                         | Amortization and write-down of intangibles                   |                          |        | 1,292  |                    |   |         | 1,753   |       
|                         |                                                              |                          |        |        |                    |   |         |        
|                         |                                                              | Total cost of revenues   |        |        | 2,789              |   |         |         | 5,154  | 
|                         |                                                              |                          |        |        |                    |   |         |        
|Gross margin             |                                                              |                          | 6,303  |        |                    |   | 6,900   |        
|Operating Expenses:      |                                                              |                          |        |        |                    |   |         |        
|                         | Research and development                                     |                          |        | 2,646  |                    |   |         | 4,456   |       
|                         | Sales and marketing                                          |                          |        | 4,963  |                    |   |         | 8,639   |       
|                         | General and administrative                                   |                          |        | 1,561  |                    |   |         | 2,444   |       
|                         | Non-cash equity based compensation                           |                          |        | 176    |                    |   |         | 190     |       
|                         | Amortization and write-down of intangibles                   |                          |        | 240    |                    |   |         | 4,976   |       
|                         |                                                              |                          |        |        |                    |   |         |        
|                         |                                                              | Total operating expenses |        |        | 9,586              |   |         |         | 20,705 | 
|                         |                                                              |                          |        |        |                    |   |         |        
|                         | Operating loss                                               |                          |        | (3,283 | )                  |   |         | (13,805 | )     
|                         | Interest and other income (expense)                          |                          |        | (304   | )                  |   |         | 97      |       
|                         |                                                              |                          |        |        |                    |   |         |        
|Loss before income taxes |                                                              |                          | (3,587 | )      |                    |   | (13,708 | )      
|                         | Provision for income taxes                                   |                          |        | 8      |                    |   |         | 57      |       
|                         |                                                              |                          |        |        |                    |   |         |        
|Net loss                 |                                                              | $                        | (3,595 | )      |                    | $ | (13,765 | )      
|                         |                                                              |                          |        |        |                    |   |         |        
|Per share data:          |                                                              |                          |        |        |                    |   |         |        
|                         | Basic and diluted net loss per common share                  |                          | $      | (0.42  | )                  |   | $       | (2.02   | )     
|                         |                                                              |                          |        |        |                    |   |         |        
|                         | Basic and diluted weighted average common shares outstanding |                          |        | 8,564  |                    |   |         | 6,804   |       
|                         |                                                              |                          |        |        |                    |   |         |        

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

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STARBASE CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
(in thousands)

|                          |                                                  |   |                    |    |      |   |         |   | 
|------------------------- | ------------------------------------------------ | - | ------------------ | -- | ---- | - | ------- | - | 
|                          |                                                  |   | Three months ended
|                          |                                                  |   | June 30,          
|                          |                                                  |   |                   
|                          |                                                  |   | 2002               |    | 2001
|                          |                                                  |   |                    |    |     
|(in thousands)            |                                                  |   | (Unaudited)       
|Net loss                  |                                                  | $ | (3,595             | )  |      | $ | (13,765 | )
|Other comprehensive loss: |                                                  |   |                    |    |      |   |         |  
|                          | Foreign currency translation adjustments         |   |                    | (3 | )    |   |         | 5 | 
|                          | Unrealized loss on available for sale securities |   |                    | (1 | )    |   |         |  | 
|                          |                                                  |   |                    |    |      |   |         |  
|Total comprehensive loss  |                                                  | $ | (3,599             | )  |      | $ | (13,760 | )
|                          |                                                  |   |                    |    |      |   |         |  

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

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STARBASE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands)

|                                                             |                                                                                           |                                                                              |                                          |        |                    |       |        |         |       |        |  
|------------------------------------------------------------ | ----------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------- | ---------------------------------------- | ------ | ------------------ | ----- | ------ | ------- | ----- | ------ | -
|                                                             |                                                                                           |                                                                              |                                          |        | Three months ended
|                                                             |                                                                                           |                                                                              |                                          |        | June 30,          
|                                                             |                                                                                           |                                                                              |                                          |        |                   
|                                                             |                                                                                           |                                                                              |                                          |        | 2002               |       | 2001  
|                                                             |                                                                                           |                                                                              |                                          |        |                    |       |       
|                                                             |                                                                                           | (Unaudited)                                                                 
|Cash Flows from Operating Activities:                        |                                                                                           |                                                                              |                                          |        |                    |       |        |        
|                                                             | Net loss                                                                                  |                                                                              | $                                        | (3,595 | )                  |       | $      | (13,765 | )    
|                                                             | Adjustments to reconcile net loss to net cash provided by (used in)
operating activities: |                                                                              |                                          |        |                    |       |        |         |      
|                                                             |                                                                                           | Depreciation and amortization                                                |                                          |        | 2,174              |       |        |         | 7,528 |       
|                                                             |                                                                                           | Provision for doubtful accounts                                              |                                          |        | 134                |       |        |         | 440   |       
|                                                             |                                                                                           | Non-cash equity based compensation                                           |                                          |        | 176                |       |        |         | 190   |       
|                                                             |                                                                                           | Non-cash interest expense                                                    |                                          |        | 272                |       |        |         |      |       
|                                                             |                                                                                           | Changes in operating assets and liabilities, net of effects of
acquisitions: |                                          |        |                    |       |        |         |       |       
|                                                             |                                                                                           |                                                                              | Accounts receivable                      |        |                    | 1,608 |        |         |       | 3,138  |  
|                                                             |                                                                                           |                                                                              | Notes and other receivables              |        |                    | 14    |        |         |       | 4      |  
|                                                             |                                                                                           |                                                                              | Prepaid expenses and other assets        |        |                    | 217   |        |         |       | 204    |  
|                                                             |                                                                                           |                                                                              | Other non-current assets                 |        |                    | (81   | )      |         |       | 6      |  
|                                                             |                                                                                           |                                                                              | Accounts payable and accrued liabilities |        |                    | (883  | )      |         |       | (5,913 | )
|                                                             |                                                                                           |                                                                              | Deferred revenue                         |        |                    | 374   |        |         |       | (589   | )
|                                                             |                                                                                           |                                                                              |                                          |        |                    |       |        |        
|Net cash provided by (used in) operations                    |                                                                                           |                                                                              | 410                                      |        |                    |       | (8,757 | )      
|Cash Flows from Investing Activities:                        |                                                                                           |                                                                              |                                          |        |                    |       |        |        
|                                                             | Capital expenditures                                                                      |                                                                              |                                          | (27    | )                  |       |        | (290    | )    
|                                                             |                                                                                           |                                                                              |                                          |        |                    |       |        |        
|Net cash used in investing activities                        |                                                                                           |                                                                              | (27                                      | )      |                    |       | (290   | )      
|Cash Flows from Financing Activities:                        |                                                                                           |                                                                              |                                          |        |                    |       |        |        
|                                                             | Borrowings under line of credit                                                           |                                                                              |                                          |       |                    |       |        | 1,500   |      
|                                                             | Proceeds from issuance of common stock:                                                   |                                                                              |                                          |        |                    |       |        |         |      
|                                                             |                                                                                           | Exercise of options                                                          |                                          |        |                   |       |        |         | 263   |       
|                                                             | Payments on debt obligations                                                              |                                                                              |                                          | (49    | )                  |       |        | (113    | )    
|                                                             |                                                                                           |                                                                              |                                          |        |                    |       |        |        
|Net cash (used in) provided by financing activities          |                                                                                           |                                                                              | (49                                      | )      |                    |       | 1,650  |        
|Effect of exchange rate changes on cash and cash equivalents |                                                                                           |                                                                              | (3                                       | )      |                    |       | (22    | )      
|                                                             |                                                                                           |                                                                              |                                          |        |                    |       |        |        
|Net increase (decrease) in cash                              |                                                                                           |                                                                              | 331                                      |        |                    |       | (7,419 | )      
|Cash and cash equivalents, beginning of period               |                                                                                           |                                                                              | 1,530                                    |        |                    |       | 14,075 |        
|                                                             |                                                                                           |                                                                              |                                          |        |                    |       |        |        
|Cash and cash equivalents, end of period                     |                                                                                           | $                                                                            | 1,861                                    |        |                    | $     | 6,656  |        
|                                                             |                                                                                           |                                                                              |                                          |        |                    |       |        |        
|Supplemental Cash Flow Information:                          |                                                                                           |                                                                              |                                          |        |                    |       |        |        
|                                                             | Interest paid                                                                             |                                                                              | $                                        | 41     |                    |       | $      | 16      |      
|                                                             |                                                                                           |                                                                              |                                          |        |                    |       |        |        
|                                                             | Income taxes paid                                                                         |                                                                              | $                                        | 8      |                    |       | $      | 57      |      
|                                                             |                                                                                           |                                                                              |                                          |        |                    |       |        |        
|Non-cash investing and financing transactions:               |                                                                                           |                                                                              |                                          |        |                    |       |        |        
|                                                             | Conversion of convertible debentures to common stock                                      |                                                                              | $                                        | 1,701  |                    |       | $      |        |      
|                                                             |                                                                                           |                                                                              |                                          |        |                    |       |        |        

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

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STARBASE CORPORATION
Notes to Consolidated Financial Statements
(Unaudited)

1. Basis of presentation

The accompanying unaudited interim consolidated financial statements of
Starbase Corporation, a Delaware corporation (the Company), as of June 30,
2002, and for the three months ended June 30, 2002, and 2001, have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission. Accordingly, certain information and footnote disclosures normally
included in consolidated financial statements prepared in accordance with
accounting principles generally accepted in the United States of America have
not been presented. The interim consolidated financial statements reflect all
normal recurring adjustments that are, in the opinion of management, necessary
for a fair presentation of the Companys financial position, results of
operations and cash flows for the period presented. The results of operations
for the three months ended June 30, 2002 are not necessarily indicative of the
operating results for the full year. The accompanying unaudited consolidated
financial statements should be read in conjunction with the consolidated
financial statements and the notes thereto included in the Companys filing to
the Securities and Exchange Commission on Form 10-K, for the year ended March
31, 2002.

On July 29, 2002, the stockholders of the Company approved a one-for-ten
reverse split of the Companys common stock effective on July 31, 2002. The
consolidated financial statements and accompanying notes to the consolidated
financial statements have been adjusted to reflect the effect of the
one-for-ten reverse split.

Management plans and going concern

The accompanying consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. Management
believes, based upon projected operating needs, that the Companys working
capital is insufficient for the Company to maintain its current level of
operating activities through March 31, 2003. As shown in the consolidated
financial statement, the Company has also experienced recurring losses from
operations and has negative working capital at June 30, 2002. These factors,
among others, raise substantial doubt about the Companys ability to continue
as a going concern. The consolidated financial statements do not include any
adjustments relating to the recoverability and classification of recorded asset
amounts or the amounts and classification of liabilities that might be
necessary should the Company be unable to continue as a going concern.

The Companys continuation as a going concern is dependant upon its ability to
generate sufficient cash flow to meet its obligations on a timely basis, to
obtain additional financing, and ultimately, to obtain successful operations.
On May 22, 2002, the Company entered into a definitive agreement to raise
approximately $12.0 million through the sale of convertible preferred stock and
warrants to institutional investors in a private placement. On July 29, 2002,
the Companys stockholders approved the financing and a one-for-ten reverse
stock split at a special meeting of stockholders and called for those purposes.
Proceeds of the financing will be used for working capital. Management believes
that with the completion of the $12.0 million financing, the Company will have
sufficient working capital to fund its operations through at least March 31,
2003. While the Company has successfully raised equity capital in the past,
there can be no assurance that it will be successful in its efforts to obtain
additional financing in the future.

The Company received notification from some investors that they were
terminating their obligations under the purchase agreement, which was scheduled
to close on August 13, 2002. As a result the Company has postponed the closing
date of the private placement indefinitely and is analyzing its alternatives
related to the financing.

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STARBASE CORPORATION
Notes to the Consolidated Financial Statements (Continued)
(Unaudited)

2. New accounting pronouncements

In June 2001, the Financial Accounting Standards Board (FASB) issued two new
pronouncements: Statement of Financial Accounting Standards (SFAS) No. 141,
Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets.
SFAS No. 141 requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001. Goodwill and intangible
assets with indefinite lives will remain on the balance sheet and not be
amortized. On an annual basis, or when there is reason to suspect that their
values have been diminished or impaired, these assets must be tested for
impairment, and write-downs may be necessary. The Company implemented SFAS No.
141 on July 1, 2001. Such adoption had no impact on the Companys consolidated
financial position or results of operations though June 30, 2002. The Company
adopted SFAS No. 142 on April 1, 2002. As a result, the Company has ceased
amortization of goodwill and assembled workforce, reducing annual amortization
expense by approximately $10.4 million. The Company will continue to amortize
developed technology and customer lists over their remaining lives. The Company
expects to complete the transition impairment test for goodwill before
September 30, 2002. In addition, future impairment reviews may result in
charges against earnings to write-down the value of intangible assets.

A reconciliation of previously reported net loss and net loss per share to the
amounts adjusted for the exclusion of goodwill and assembled workforce
amortization is as follows:

|                                                             |  |                             |        |      |  |   |         |  
|------------------------------------------------------------ |  | --------------------------- | ------ | ---- |  | - | ------- | -
|                                                             |  | Three
months ended June 30,
|                                                             |  |                            
|                                                             |  | 2002                        |        | 2001
|(In thousands, except per share amounts)                     |  |                             |        |     
|Reported net loss                                            |  | $                           | (3,595 | )    |  | $ | (13,765 | )
|Goodwill and assembled workforce amortization                |  |                             |       |      |  |   | 4,593   |  
|                                                             |  |                             |        |      |  |   |         |  
|Adjusted net loss                                            |  | $                           | (3,595 | )    |  | $ | (9,172  | )
|                                                             |  |                             |        |      |  |   |         |  
|Reported basic and diluted net loss per share                |  | $                           | (0.42  | )    |  | $ | (2.02   | )
|Goodwill and assembled workforce amortization                |  |                             |       |      |  |   | 0.67    |  
|                                                             |  |                             |        |      |  |   |         |  
|Adjusted basic and diluted net loss per share                |  | $                           | (0.42  | )    |  | $ | (1.35   | )
|                                                             |  |                             |        |      |  |   |         |  
|Basic and diluted weighted average common shares outstanding |  |                             | 8,564  |      |  |   | 6,804   |  
|                                                             |  |                             |        |      |  |   |         |  

The components of amortized intangible assets as of June 30, 2002 are as
follows:

|                            |  |                |        |              |  |   |        | 
|--------------------------- |  | -------------- | ------ | ------------ |  | - | ------ | 
|                            |  | Gross Carrying |        | Accumulated 
|                            |  | Amount         |        | Amortization
|(In thousands)              |  |                |        |             
|Amortized intangible assets |  |                |        |              |  |   |        | 
|Patents and trademarks      |  | $              | 20     |              |  | $ | 20     | 
|Manufacturing license       |  |                | 385    |              |  |   | 107    | 
|Developed technology        |  |                | 19,489 |              |  |   | 10,464 | 
|Customer lists              |  |                | 1,969  |              |  |   | 1,406  | 
|                            |  |                |        |              |  |   |       
|Total                       |  | $              | 21,863 |              |  | $ | 11,997 | 
|                            |  |                |        |              |  |   |       

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##### Table of Contents



STARBASE CORPORATION
Notes to the Consolidated Financial Statements (Continued)
(Unaudited)

All identified intangible assets, required to be amortized under SFAS No. 142,
are amortized on a straight-line basis over their estimated lives. Estimated
future amortization expense relating to these identified intangible assets is
as follows:

|                          |  |   |       | 
|------------------------- |  | - | ----- | 
|(In thousands)            |  |   |       | 
|For years ended March 31, |  |   |       | 
|2003                      |  | $ | 6,029 | 
|2004                      |  | $ | 4,707 | 
|2005                      |  | $ | 560   | 
|2006                      |  | $ | 82    | 

Changes to goodwill during the three months ended June 30, 2002, including the
effects of adopting SFAS No. 141 and SFAS No. 142, are as follows:

|                                           |  |   |       | 
|------------------------------------------ |  | - | ----- | 
|(In thousands)                             |  |   |       | 
|Balance at March 31, 2002                  |  | $ | 7,637 | 
|Intangible assets reclassified to goodwill |  |   | 1,920 | 
|                                           |  |   |       | 
|Balance at June 30, 2002                   |  | $ | 9,557 | 
|                                           |  |   |       | 

In August 2001, the FASB issued SFAS No. 144, Accounting for Impairment or
Disposal of Long-Lived Assets.SFAS No. 144 addresses financial accounting and
reporting for the impairment of long-lived assets and for the disposal of
long-lived assets. SFAS No. 144 supersedes SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,
and is effective for fiscal year beginning after December 15, 2001. The Company
adopted SFAS No. 144 effective April 1, 2002. The adoption of this statement
did not have a material impact on the Companys consolidated financial position
or results of operations.

In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities, which addresses financial accounting and
reporting for costs associated with the exit or disposal activities and
supersedes Emerging Issued Task Force (EITF) Issue 94-3, Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in Restructuring). SFAS No. 146 requires that
a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. Under EITF Issue 94-3, a liability
for an exit cost, as defined in EITF 94-3, was recognized at the date of the
entitys commitment to an exit plan. SFAS No. 146 also establishes that the
liability should be measured and recorded at fair value. The Company will adopt
the provisions of SFAS No. 146 for exit or disposal activities that are
initiated after March 31, 2002.

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STARBASE CORPORATION
Notes to the Consolidated Financial Statements (Continued)
(Unaudited)

3. Composition of certain balance sheet captions

|                                               |  |             |         |           |  |   |         |  
|---------------------------------------------- |  | ----------- | ------- | --------- |  | - | ------- | -
|                                               |  | June 30,    |         | March 31,
|                                               |  | 2002        |         | 2002     
|                                               |  |             |         |           |  |   |         |  
|(In thousands)                                 |  | (Unaudited) |         |           |  |   |         |  
|Property and equipment:                        |  |             |         |           |  |   |         |  
|Computer hardware                              |  | $           | 2,549   |           |  | $ | 2,527   |  
|Furniture and fixtures                         |  |             | 1,335   |           |  |   | 1,330   |  
|Computer software                              |  |             | 3,970   |           |  |   | 3,970   |  
|Leasehold improvements                         |  |             | 707     |           |  |   | 707     |  
|                                               |  |             |         |           |  |   |         |  
|                                               |  |             | 8,561   |           |  |   | 8,534   |  
|Less accumulated depreciation and amortization |  |             | (4,672  | )         |  |   | (4,031  | )
|                                               |  |             |         |           |  |   |         |  
|                                               |  | $           | 3,889   |           |  | $ | 4,503   |  
|                                               |  |             |         |           |  |   |         |  
|Intangible assets:                             |  |             |         |           |  |   |         |  
|Patents and trademarks                         |  | $           | 20      |           |  | $ | 20      |  
|Manufacturing license                          |  |             | 385     |           |  |   | 385     |  
|Developed technology                           |  |             | 19,489  |           |  |   | 19,489  |  
|Customer lists                                 |  |             | 1,969   |           |  |   | 1,969   |  
|Assembled workforce                            |  |             |        |           |  |   | 2,907   |  
|                                               |  |             |         |           |  |   |         |  
|                                               |  |             | 21,863  |           |  |   | 24,770  |  
|Less accumulated amortization                  |  |             | (11,997 | )         |  |   | (11,451 | )
|                                               |  |             |         |           |  |   |         |  
|                                               |  | $           | 9,866   |           |  | $ | 13,319  |  
|                                               |  |             |         |           |  |   |         |  

4. Net loss per share

Basic and diluted net loss per share is computed by dividing net loss by the
weighted average number of common shares outstanding during the periods
presented. Potentially dilutive shares, stock options, warrants, and Escrow
Shares, have not been included where inclusion would be antidilutive. Escrow
Shares (141,863) would have been released to the founders upon attainment of
certain defined cash flow requirements by October 15, 2002. The release of the
Escrow Shares would have been deemed compensatory and, accordingly, would have
resulted in charges to earnings equal to the fair market value of these shares
recorded ratably over the period beginning on the date when management
determined that the cash flow requirements were probable of being met and
ending on the date when the goal was attained, causing the Escrow Shares to be
released. Such charges could have substantially reduced the Companys net
income or increased the Companys loss for financial reporting purposes in the
periods such charges were recorded. Based upon historical and expected results,
the Company has determined that the goal will not be met. On October 15, 2002,
the Escrow shares are scheduled to be returned to the Company.

On July 29, 2002, the stockholders of the Company approved a one-for-ten
reverse split of the Companys common stock effective on July 31, 2002. Net
loss per share for the periods presented reflect the one-for-ten reverse split.

Potentially dilutive securities, which consist of options to purchase 1,204,329
shares of common stock at prices ranging from $4.60 to $146.30 per share,
warrants to purchase 383,691 shares of common stock at prices ranging from
$3.20 to $68.13 per share and 141,863 common shares held in escrow were not
included in the computation of diluted loss per share because such inclusion
would have been antidilutive for the three month period ended June 30, 2002.
Potentially dilutive securities, which consist of options to purchase 784,010
shares of common stock at prices ranging from $6.25 to $146.30 per share,
warrants to purchase 89,308 shares of common stock at prices ranging from $7.30
to $68.13 per share and 141,863 common shares held in escrow were not included
in the computation of diluted loss per share because such inclusion would have
been antidilutive for the three month period ended June 30, 2001.

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STARBASE CORPORATION
Notes to the Consolidated Financial Statements (Continued)
(Unaudited)

5. Equity transactions

During the three months ended June 30, 2002, $1,632,050 of convertible
debentures were converted into 752,545 shares of common stock and 19,050 shares
of common stock were issued for $69,447 of accrued interest related to the
convertible debentures pursuant to terms.

Warrants
Warrant activity for the three month period ended June 30, 2002 is as follows:

|                              |  |  |         |  |  |                       
|----------------------------- |  |  | ------- |  |  | ----------------------
|                              |  |  | Shares  |  |  | Warrant PricePer Share
|                              |  |  |         |  |  |                       
|Outstanding at March 31, 2002 |  |  | 367,078 |  |  | $6.53  $68.13        
|Issued                        |  |  | 31,250  |  |  | $3.20                 
|Expired                       |  |  | 14,637  |  |  | $38.80                
|                              |  |  |         |  |  |                       
|Outstanding at June 30, 2002  |  |  | 383,691 |  |  | $3.20  $68.13        
|                              |  |  |         |  |  |                       

6. Stock option plans

1996 Plan
In September 1996, the stockholders of the Company approved the 1996 Stock
Option Plan (1996 Plan) as amended and restated. The 1996 Plan provides for the
grant of non-qualified and incentive stock options to employees, directors,
officers and consultants. Options are granted at exercise prices equal to the
fair market value of the common stock on the date of grant. Generally,
twenty-five percent of the options are available for exercise at the end of one
year, while the remainder of the grant is exercisable ratably over the next
thirty-six month period, provided the optionee remains in service to the
Company. A total of 283,333 shares of common stock have been authorized under
the 1996 Plan, of which 134,273 were outstanding and 31,825 are available for
future grants at June 30, 2002.

2001 Plan
In September 2001, the stockholders of the Company approved the 2001 Stock Plan
(2001 Plan). The 2001 Plan provides for the grant of non-qualified and
incentive stock options to employees, directors, officers and consultants.
Options are granted at exercise prices equal to the fair market value of the
common stock on the date of grant. Generally, twenty-five percent of the
options are available for exercise at the end of one year, while the remainder
of the grant is exercisable ratably over the next thirty-six month period,
provided the optionee remains in service to the Company. A total of 340,000
shares of common stock have been authorized under the 2001 Plan, of which
269,161 were outstanding and 70,839 are available for future grants at June 30,
2002.

Premia Plan
As a result of the acquisition of Premia Corporation, the Company assumed all
of the outstanding options granted under the Premia ISO stock option plan
(Premia Plan). At the date of acquisition, there were 27,008 options
outstanding at a weighted-average exercise price of $14.80, of which 21,345
were exercisable at a weighted-average exercise price of $14.80. As of June 30,
2002, there were 16,121 options outstanding at a weighted-average exercise
price of $14.80, of which 15,233 were exercisable at a weighted average
exercise price of $14.80. No further options will be granted under the Premia
Plan.

TBI Plan

As a result of the acquisition of Technology Builders, Inc., the Company
assumed all of the outstanding options granted under the Technology Builders,
Inc. Amended and Restated Stock Option and Incentive Stock Option Plan (TBI
Plan). At the date of acquisition, there were 122,049 options outstanding at a
weighted-average exercise price of $12.40, of which 78,795 were exercisable at
a weighted-average exercise price of $8.90. As of June 30, 2002, there were
63,390 options outstanding at a weighted-average exercise price of $13.33, of
which 51,562 were exercisable at a weighted-average exercise price of $11.35.
No further options will be granted under the TBI Plan.

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STARBASE CORPORATION
Notes to the Consolidated Financial Statements (Continued)
(Unaudited)

NSO Stock Option Program

The NSO Stock Option Program (NSO Program) allows the Company to grant
nonstatutory stock options for employees, directors and consultants. Options
are granted at exercise prices equal to the fair market value of the common
stock on the date of grant. Generally, twenty-five percent of the options are
available for exercise at the end of one year, while the remainder of the grant
is exercisable ratably over the next thirty-six month period, provided the
optionee remains in service to the Company. As of June 30, 2002, there were
1,743,911 options issued and outstanding at a weighted-average exercise price
of $30.52, of which 923,930 were exercisable at a weighted-average price of
$34.43.

Stock option activity for all plans for the three months ended June 30, 2002
was as follows:

|                              |  |        |           |       |  |                  |       | 
|----------------------------- |  | ------ | --------- | ----- |  | ---------------- | ----- | 
|                              |  |        |           |       |  | Weighted-       
|                              |  |        |           |       |  | Average Exercise
|                              |  | Shares |           | Price
|                              |  |        |           |      
|Outstanding at March 31, 2002 |  |        | 2,440,462 |       |  | $                | 25.32 | 
|Granted                       |  |        | 5,400     |       |  | $                | 2.61  | 
|Lapsed or canceled            |  |        | (219,006  | )     |  | $                | 19.04 | 
|                              |  |        |           |       |  |                  |       | 
|Outstanding at June 30, 2002  |  |        | 2,226,856 |       |  | $                | 25.88 | 
|                              |  |        |           |       |  |                  |       | 
|Exercisable at June 30, 2002  |  |        | 1,204,329 |       |  | $                | 28.98 | 
|                              |  |        |           |       |  |                  |       | 

Stock option summary information for stockholder approved plans (1996 Plan and
2001 Plan) at June 30, 2002 is as follows:

|                |  |        |         |                     |  |                     |  |           |       |           |  |  |         |                  |  |           |       |  |  |  |  | 
|--------------- |  | ------ | ------- | ------------------- |  | ------------------- |  | --------- | ----- | --------- |  |  | ------- | ---------------- |  | --------- | ----- |  |  |  |  | 
|                |  |        |         | Options Outstanding |  | Options Exercisable
|                |  |        |         |                     |  |                    
|                |  |        |         |                     |  |                     |  | Weighted- |       |           |  |  |         |                  |  |           |       |  |  | 
|                |  |        |         |                     |  |                     |  | Average   |       | Weighted- |  |  |         |                  |  | Weighted-
|Range of        |  |        |         |                     |  | Remaining           |  | Average   |       |           |  |  |         | Average Exercise
|Exercise Prices |  | Shares |         | Contractual Life    |  | Exercise Price      |  | Shares    |       | Price    
|                |  |        |         |                     |  |                     |  |           |       |          
|$0.00-$5.00     |  |        | 124,891 |                     |  | 9.5 years           |  | $         | 4.82  |           |  |  | 27,045  |                  |  | $         | 4.91  | 
|$5.01-$10.00    |  |        | 157,470 |                     |  | 8.9 years           |  | $         | 6.57  |           |  |  | 65,486  |                  |  | $         | 6.91  | 
|$10.01-$15.00   |  |        | 72,495  |                     |  | 3.7 years           |  | $         | 12.47 |           |  |  | 72,495  |                  |  | $         | 12.47 | 
|$15.01-$20.00   |  |        | 48,578  |                     |  | 5.0 years           |  | $         | 16.40 |           |  |  | 48,578  |                  |  | $         | 16.40 | 
|                |  |        |         |                     |  |                     |  |           |       |           |  |  |         |                  |  |           |       |  |  | 
|                |  |        | 403,434 |                     |  | 7.7 years           |  | $         | 8.27  |           |  |  | 213,604 |                  |  | $         | 10.70 | 
|                |  |        |         |                     |  |                     |  |           |       |           |  |  |         |                  |  |           |       |  |  | 

Stock option summary information for assumed plans (Premia Plan and TBI Plan)
at June 30, 2002 is as follows:

|                |  |        |        |                     |  |                     |           |         |           |       |  |  |        |                  |           |   |       |  |  |  | 
|--------------- |  | ------ | ------ | ------------------- |  | ------------------- | --------- | ------- | --------- | ----- |  |  | ------ | ---------------- | --------- | - | ----- |  |  |  | 
|                |  |        |        | Options Outstanding |  | Options Exercisable
|                |  |        |        |                     |  |                    
|                |  |        |        |                     |  |                     | Weighted- |         |           |       |  |  |        |                  |           |   |       |  | 
|                |  |        |        |                     |  |                     | Average   |         | Weighted- |       |  |  |        |                  | Weighted-
|Range of        |  |        |        |                     |  | Remaining           |           | Average |           |       |  |  |        | Average Exercise
|Exercise Prices |  | Shares |        | Contractual Life    |  | Exercise Price      |           | Shares  |           | Price
|                |  |        |        |                     |  |                     |           |         |           |      
|$5.01-$10.00    |  |        | 25,960 |                     |  | 4.4 years           |           | $       | 6.90      |       |  |  | 25,960 |                  |           | $ | 6.90  | 
|$10.01-$15.00   |  |        | 35,477 |                     |  | 6.5 years           |           | $       | 14.25     |       |  |  | 34,099 |                  |           | $ | 14.25 | 
|$20.01-$25.00   |  |        | 16,267 |                     |  | 7.9 years           |           | $       | 20.70     |       |  |  | 6,285  |                  |           | $ | 20.70 | 
|$30.01-$35.00   |  |        | 1,807  |                     |  | 8.6 years           |           | $       | 34.30     |       |  |  | 451    |                  |           | $ | 34.30 | 
|                |  |        |        |                     |  |                     |           |         |           |       |  |  |        |                  |           |   |       |  |  | 
|                |  |        | 79,511 |                     |  | 6.2 years           |           | $       | 13.63     |       |  |  | 66,795 |                  |           | $ | 12.13 | 
|                |  |        |        |                     |  |                     |           |         |           |       |  |  |        |                  |           |   |       |  |  | 

12



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STARBASE CORPORATION
Notes to the Consolidated Financial Statements (Continued)
(Unaudited)

Stock option summary information for the plan not approved by stockholders (NSO
Program) at June 30, 2002 is as follows:

|                 |  |        |           |                     |  |                     |           |                  |           |       |  |  |         |                  |           |   |        |  |  |  | 
|---------------- |  | ------ | --------- | ------------------- |  | ------------------- | --------- | ---------------- | --------- | ----- |  |  | ------- | ---------------- | --------- | - | ------ |  |  |  | 
|                 |  |        |           | Options Outstanding |  | Options Exercisable
|                 |  |        |           |                     |  |                    
|                 |  |        |           |                     |  |                     | Weighted- |                  |           |       |  |  |         |                  |           |   |        |  | 
|                 |  |        |           |                     |  |                     | Average   |                  | Weighted- |       |  |  |         |                  | Weighted-
|Range of         |  |        |           |                     |  | Remaining           |           | Average Exercise |           |       |  |  |         | Average Exercise
|Exercise Prices  |  | Shares |           | Contractual Life    |  | Price               |           | Shares           |           | Price
|                 |  |        |           |                     |  |                     |           |                  |           |      
|$0.00 - $5.00    |  |        | 53,900    |                     |  | 6.0 years           |           | $                | 4.22      |       |  |  | 20,000  |                  |           | $ | 4.70   | 
|$5.01 - $10.00   |  |        | 685,389   |                     |  | 8.9 years           |           | $                | 6.32      |       |  |  | 249,702 |                  |           | $ | 6.38   | 
|$10.01 - $15.00  |  |        | 202,882   |                     |  | 7.3 years           |           | $                | 13.20     |       |  |  | 135,967 |                  |           | $ | 13.20  | 
|$15.01 - $20.00  |  |        | 106,899   |                     |  | 6.8 years           |           | $                | 17.26     |       |  |  | 80,370  |                  |           | $ | 16.99  | 
|$20.01 - $25.00  |  |        | 47,365    |                     |  | 7.4 years           |           | $                | 21.69     |       |  |  | 34,127  |                  |           | $ | 21.20  | 
|$25.01 - $30.00  |  |        | 73,388    |                     |  | 8.2 years           |           | $                | 26.02     |       |  |  | 65,230  |                  |           | $ | 25.87  | 
|$30.01 - $35.00  |  |        | 135,903   |                     |  | 8.3 years           |           | $                | 33.44     |       |  |  | 49,177  |                  |           | $ | 33.36  | 
|$35.01 - $40.00  |  |        | 133,865   |                     |  | 7.7 years           |           | $                | 38.20     |       |  |  | 105,234 |                  |           | $ | 38.25  | 
|$40.01 - $45.00  |  |        | 10,000    |                     |  | 8.1 years           |           | $                | 40.96     |       |  |  | 4,592   |                  |           | $ | 40.90  | 
|$45.01 - $161.25 |  |        | 294,320   |                     |  | 6.9 years           |           | $                | 105.78    |       |  |  | 179,531 |                  |           | $ | 104.16 | 
|                 |  |        |           |                     |  |                     |           |                  |           |       |  |  |         |                  |           |   |        |  |  | 
|                 |  |        | 1,743,911 |                     |  | 7.9 years           |           | $                | 30.52     |       |  |  | 923,930 |                  |           | $ | 34.43  | 
|                 |  |        |           |                     |  |                     |           |                  |           |       |  |  |         |                  |           |   |        |  |  | 

7. Operating segment information

Operating segments are defined as components of an enterprise about which
separate financial information is available that is evaluated regularly by the
Companys chief operating decision-maker, or decision-making group, in deciding
how to allocate resources and in assessing performance. The operating segments
of the Company are managed separately because each segment represents a
strategic business unit that offers different products or services.

The Companys reportable operating segments include Starbase product licenses,
third party product licenses, maintenance and services. The Starbase product
licenses operating segment develops and markets the Companys software
management tools for managing the development of software projects from
beginning to end (Application Lifecycle Management). The third party product
licenses operating segment resells other companies products. The maintenance
operating segment provides after-sale support for software licenses. The
services operating segment provides fee-based training and consulting services
related to the Companys products.

The Company does not allocate operating expenses to these segments, nor does it
allocate specific assets to these segments. Therefore, segment information
reported includes only revenues, cost of revenues and gross margin.

Operating segment data for the three month ended June 30, 2002 and 2001 was as
follows:

|                                  |                  |              |   |          |       |             |   |             |     |          |   |       |       |  |   |       |     |  |   |        |       | 
|--------------------------------- | ---------------- | ------------ | - | -------- | ----- | ----------- | - | ----------- | --- | -------- | - | ----- | ----- |  | - | ----- | --- |  | - | ------ | ----- | 
|                                  |                  |              |   | Starbase |       | Third party |   |             |     |          |   |       |       |  |   |       |     | 
|                                  |                  |              |   | product  |       | product     |   |             |     |          |   |       |       |  |   |       |     | 
|                                  |                  |              |   | licenses |       | licenses    |   | Maintenance |     | Services |   | Total
|(In thousands)                    |                  |              |   |          |       |             |   |             |     |         
|Three months ended June 30, 2002: |                  |              |   |          |       |             |   |             |     |          |   |       |       |  |   |       |     |  |   |       
|                                  | Revenues         |              | $ | 4,941    |       |             | $ | 150         |     |          | $ | 2,430 |       |  | $ | 1,571 |     |  | $ | 9,092  |      
|                                  | Cost of revenues |              |   | 1,407    |       |             |   | 23          |     |          |   | 31    |       |  |   | 1,328 |     |  |   | 2,789  |      
|                                  |                  |              |   |          |       |             |   |             |     |          |   |       |       |  |   |       |     |  |   |       
|                                  |                  | Gross margin |   | $        | 3,534 |             |   | $           | 127 |          |   | $     | 2,399 |  |   | $     | 243 |  |   | $      | 6,303 | 
|                                  |                  |              |   |          |       |             |   |             |     |          |   |       |       |  |   |       |     |  |   |       
|Three months ended June 30, 2001: |                  |              |   |          |       |             |   |             |     |          |   |       |       |  |   |       |     |  |   |       
|                                  | Revenues         |              | $ | 6,203    |       |             | $ | 1,184       |     |          | $ | 2,616 |       |  | $ | 2,051 |     |  | $ | 12,054 |      
|                                  | Cost of revenues |              |   | 2,008    |       |             |   | 1,047       |     |          |   | 275   |       |  |   | 1,824 |     |  |   | 5,154  |      
|                                  |                  |              |   |          |       |             |   |             |     |          |   |       |       |  |   |       |     |  |   |       
|                                  |                  | Gross margin |   | $        | 4,195 |             |   | $           | 137 |          |   | $     | 2,341 |  |   | $     | 227 |  |   | $      | 6,900 | 
|                                  |                  |              |   |          |       |             |   |             |     |          |   |       |       |  |   |       |     |  |   |       

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STARBASE CORPORATION
Notes to the Consolidated Financial Statements (Continued)
(Unaudited)

8. Accounts receivable purchase agreement



| |  | On April 19, 2002, the Company entered into an Accounts Receivable Purchase
Agreement with Silicon Valley Bank. The term of the Agreement is for one year
and it allows the Company to sell up to $4.0 million of its accounts receivable
with a finance charge equal to 5.0% above Prime Rate for the gross average
daily outstanding balance and a collateral handling fee equal to 0.5% per month
of the average daily outstanding balance. There is a minimum finance charge of
$15,000 per month. In connection with this agreement, the Company issued to
Silicon Valley Bank warrants to purchase 31,250 shares of its common stock at
$3.20 per share. The fair value of these warrants, using the Black-Scholes
model at the date of grant, was $78,000 and was recorded as non-cash equity
compensation during the three months ended June 30, 2002. At June 30, 2002, the
Company had not sold any of its account receivables.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | 9. Subsequent events                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| |  | On July 29, 2002, the stockholders of the Company approved a one-for-ten
reverse split of the Companys common stock along with a proposed private
placement of $12 million to institutional investors. The reverse stock split
was effective on July 31, 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

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PART I




ITEM 2MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

The discussion in this Form 10-Q contains forward-looking statements that
involve risks and uncertainties. The statements that are not purely historical
are forward-looking statement within the meaning of the Private Securities
Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as
amended, and Sections 21E of the Securities Exchange Act of 1934, as amended.
We have based these forward-looking statements on currently available
information and our current beliefs, expectation and projections about future
events, including, among other things: successfully implementing our business
strategy; maintaining and expanding market acceptance of the products we offer;
and our ability to successfully compete in our marketplace. All forward-looking
statements included in this document are based on the information available to
us on the date hereof, and we assume no obligation to update any such
forward-looking statements. Actual results could differ materially from the
results discussed herein. Factors that might cause or contribute to such
differences include, but are not limited to, those discussed under the caption
Risk Factors of this document and in our other filing with the Securities and
Exchange Commission, including our Annual Report for the year ended March 31,
2002 on Form 10-K.

Overview

We provide software management tools and professional consulting services to
assist our customers in managing their development projects from beginning to
end (Application Lifecycle Management) and allowing them to develop their
software solutions and applications in a more efficient manner. Our tools
enable geographically dispersed software developers to work as a team over
corporate intranets and the Internet. Our flagship product, StarTeam, focuses
primarily on supporting joint development efforts regardless of the developers
location. Our Caliber products provide requirements management capabilities
that help customers define their software projects and meet end-user needs. Our
CodeWright product helps our customers developers edit their software code
with ease. In addition, we provide or resell other products to assist our
customers with their software projects. Our customers include management
information systems executives, software developers, sales and marketing
personnel, graphic designers and Webmasters.

Significant accounting policies

Revenue recognition

Revenue is recognized if the criteria of Statement of Position (SOP) 97-2,
Software Revenue Recognition,as amended, are met. If the arrangement does not
require significant production, modification, or customization of software,
revenue is recognized when all of the following criteria are met:



| |  |  | Persuasive evidence of an arrangement exists.
| | - |  | ---------------------------------------------
|
| |  |  | Delivery (passage of title) has occurred.    
|
| |  |  | The vendors fee is fixed or determinable.   
|
| |  |  | Collectibility is probable.                  

License revenues from sales of software licenses are recognized upon shipment
of the related products and transfer of title. Maintenance revenue is deferred
and recognized ratably over the contractual maintenance period, generally one
year. Service revenue from training and consulting is recognized after the
related services have been performed.

If the requirements of SOP 97-2, including evidence of an arrangement,
delivery, fixed or determinable fee, collectibility, or vendor-specific
objective evidence about the value of an element are not met at the date of
shipment, revenue recognition is deferred until such elements are known or
resolved.

License revenues from sales of software licenses through indirect channels are
recorded upon shipment when an end-user purchase order has been obtained and
collectibility is assured on standard payment terms. No provision for estimated
returns is recorded, as historically such returns have been minimal.

15



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Accounts Receivable

We sell our products worldwide. We perform ongoing credit evaluations of our
customers and generally do not require collateral. We maintain allowances for
doubtful accounts for estimated losses resulting from the inability of our
customers to make required payments. The amount of our reserves is based on
historical experience and our analysis of the accounts receivable balances
outstanding. If the financial condition of our customers were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances may be required which would result in an additional sales and
marketing expense in the period such determination was made. While such credit
losses have historically been within our expectations and the provisions
established, we couldnt guarantee that we will continue to experience the same
credit loss rates that we have in the past.

Intangible Assets

In June 2001, the Financial Accounting Standards Board (FASB) issued two new
pronouncements: Statement of Financial Accounting Standards (SFAS) No. 141,
Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets.
SFAS No. 141 requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001. Goodwill and intangible
assets with indefinite lives will remain on the balance sheet and not be
amortized. On an annual basis, or when there is reason to suspect that their
values have been diminished or impaired, these assets must be tested for
impairment, and write-downs may be necessary. We implemented SFAS No. 141 on
July 1, 2001. Such adoption had no impact on our consolidated financial
position or results of operations though June 30, 2002. We adopted SFAS No. 142
on April 1, 2002. As a result, we have ceased amortization of goodwill and
assembled workforce, reducing annual amortization expense by approximately
$10.4 million. We will continue to amortize developed technology and customer
lists over their remaining lives. We expect to complete the transition
impairment test for goodwill before September 30, 2002. In addition, future
impairment reviews may result in charges against earnings to write-down the
value of intangible assets.

A reconciliation of previously reported net loss and net loss per share to the
amounts adjusted for the exclusion of goodwill and assembled workforce
amortization is as follows:

|                                                             |  |                             |        |      |  |   |         |  
|------------------------------------------------------------ |  | --------------------------- | ------ | ---- |  | - | ------- | -
|                                                             |  | Three
months ended June 30,
|                                                             |  |                            
|                                                             |  | 2002                        |        | 2001
|(In thousands, except per share amounts)                     |  |                             |        |     
|Reported net loss                                            |  | $                           | (3,595 | )    |  | $ | (13,765 | )
|Goodwill and assembled workforce amortization                |  |                             |       |      |  |   | 4,593   |  
|                                                             |  |                             |        |      |  |   |         |  
|Adjusted net loss                                            |  | $                           | (3,595 | )    |  | $ | (9,172  | )
|                                                             |  |                             |        |      |  |   |         |  
|Reported basic and diluted net loss per share                |  | $                           | (0.42  | )    |  | $ | (2.02   | )
|Goodwill and assembled workforce amortization                |  |                             |       |      |  |   | 0.67    |  
|                                                             |  |                             |        |      |  |   |         |  
|Adjusted basic and diluted net loss per share                |  | $                           | (0.42  | )    |  | $ | (1.35   | )
|                                                             |  |                             |        |      |  |   |         |  
|Basic and diluted weighted average common shares outstanding |  |                             | 8,564  |      |  |   | 6,804   |  
|                                                             |  |                             |        |      |  |   |         |  

16



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##### Table of Contents



The following discussion should be read in conjunction with the consolidated
financial statements and notes thereto.

Results of Operations

The following table summarizes our results of operations as a percentage of
total revenue for the three months ended June 30, 2002 and 2001.

|                                    |                                            |                          |       |                             |       |      |        |      |       | 
|----------------------------------- | ------------------------------------------ | ------------------------ | ----- | --------------------------- | ----- | ---- | ------ | ---- | ----- | 
|                                    |                                            |                          |       | Three months ended June 30,
|                                    |                                            |                          |       |                            
|                                    |                                            |                          |       | 2002                        |       | 2001
|                                    |                                            |                          |       |                             |       |     
|Revenues:                           |                                            |                          |       |                             |       |      |        |     
|                                    | License                                    |                          |       | 56.0                        | %     |      |        | 61.3 | %    
|                                    | Maintenance                                |                          |       | 26.7                        |       |      |        | 21.7 |      
|                                    | Service                                    |                          |       | 17.3                        |       |      |        | 17.0 |      
|                                    |                                            |                          |       |                             |       |      |        |     
|                                    |                                            | Total revenues           |       |                             | 100.0 |      |        |      | 100.0 | 
|Cost of revenues:                   |                                            |                          |       |                             |       |      |        |     
|                                    | License                                    |                          |       | 1.9                         |       |      |        | 13.1 |      
|                                    | Service                                    |                          |       | 14.6                        |       |      |        | 15.1 |      
|                                    | Amortization and write-down of intangibles |                          |       | 14.2                        |       |      |        | 14.6 |      
|                                    |                                            |                          |       |                             |       |      |        |     
|                                    |                                            | Total cost of revenues   |       |                             | 30.7  |      |        |      | 42.8  | 
|                                    |                                            |                          |       |                             |       |      |        |     
|Gross profit                        |                                            |                          | 69.3  |                             |       |      | 57.2   |     
|Operating expenses:                 |                                            |                          |       |                             |       |      |        |     
|                                    | Research and development                   |                          |       | 29.1                        |       |      |        | 36.9 |      
|                                    | Sales and marketing                        |                          |       | 54.6                        |       |      |        | 71.7 |      
|                                    | General and administrative                 |                          |       | 17.2                        |       |      |        | 20.3 |      
|                                    | Non-cash equity based compensation         |                          |       | 1.9                         |       |      |        | 1.6  |      
|                                    | Amortization and write-down of intangibles |                          |       | 2.6                         |       |      |        | 41.3 |      
|                                    |                                            |                          |       |                             |       |      |        |     
|                                    |                                            | Total operating expenses |       |                             | 105.4 |      |        |      | 171.7 | 
|                                    |                                            |                          |       |                             |       |      |        |     
|Operating loss                      |                                            |                          | (36.1 | )                           |       |      | (114.5 | )   
|Interest and other income (expense) |                                            |                          | (3.3  | )                           |       |      | 0.8    |     
|                                    |                                            |                          |       |                             |       |      |        |     
|Loss before income taxes            |                                            |                          | (39.4 | )                           |       |      | (113.7 | )   
|Provision for income taxes          |                                            |                          | 0.1   |                             |       |      | 0.5    |     
|                                    |                                            |                          |       |                             |       |      |        |     
|Net loss                            |                                            |                          | (39.5 | )%                          |       |      | (114.2 | )%  
|                                    |                                            |                          |       |                             |       |      |        |     

Three Months Ended June 30, 2002 and 2001

Revenues

Revenues were $9.1 million and $12.1 million for the three month periods ended
June 30, 2002 and 2001, respectively, representing a decrease of $3.0 million
or 25%. International revenues accounted for less than 10% of total revenue in
the three months ended June 30, 2002 and 2001.

License License revenues were $5.1 million and $7.4 million for the three
month periods ended June 30, 2002 and 2001, respectively, representing a
decrease of $2.3 million or 31%. License revenues represented 56.0% and 61.3%
of total revenues for the three months ended June 30, 2002 and 2001,
respectively. The decrease in license revenues was due to decreased demand for
our CaliberRM, CodeWright and eXpressroom products and a decrease in the amount
of third party product we resold as a result of the worldwide decline in
information technology spending especially relating to software expenditures.

Maintenance Maintenance revenues were $2.4 million and $2.6 million for the
three month periods ended June 30, 2002 and 2001, respectively, representing a
decrease of $186,000 or 7%. Maintenance revenues represented 26.7% and 21.7% of
total revenues for the three months ended June 30, 2002 and 2001, respectively.
The decrease in maintenance revenues was due to fewer new sales of product
licenses partially offset by renewal maintenance contracts sold.

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Service Service revenues were $1.6 million and $2.1 million for the three
month periods ended June 30, 2002 and 2001, respectively, representing an
decrease of $480,000 or 23%. Service revenues represented 17.3% and 17.0% of
total revenues for the three months ended June 30, 2002 and 2001, respectively.
The decrease in service revenues was due to fewer billable headcount available
to perform training and consulting.

Cost of Revenues

License License cost of revenues consists primarily of manufacturing and
related costs such as media, documentation, product assembly and royalties.
License cost of revenues was $169,000 and $1.6 million for the three month
periods ended June 30, 2002 and 2001, respectively, representing a decrease of
$1.4 million or 89%. License cost of revenues as a percentage of license
revenue was 3.3% and 21.3% for the three months ended June 30, 2002 and 2001,
respectively. The decrease in license cost of revenues was due to lower third
party product sales resulting in a $1.0 million reduction in license cost of
sales and lower royalty costs due to lower CaliberRM license sales.

Service Service cost of revenues consists of the costs associated with
performing training and consulting services. Service cost of revenues were $1.3
million and $1.8 million for the three month periods ended June 30, 2002 and
2001, respectively, representing a decrease of $496,000 or 27%. Service cost of
revenues as a percentage of service revenue was 84.5% and 88.9% for the three
months ended June 30, 2002 and 2001, respectively. The decrease in service cost
of revenues was due to lower salary expense as a result of lower headcount in
the services organization along with the lower costs related to the decrease in
personnel.

Amortization and write-down of intangibles Amortization and write-down of
intangibles consists of the amortization of developed technology associated
with the Premia, Genitor, worldweb.net and Technology Builders acquisitions.
Amortization of intangibles was $1.3 million and $1.8 million for the three
months ended June 30, 2002 and 2001, respectively, representing a decrease of
$461,000 or 26%. Amortization of Intangibles as a percentage of total revenue
was 14.2% and 14.6% for the three months ended June 30, 2002 and 2001,
respectively.

Operating Expenses

Research and development expenses Research and development expenses include
salaries and other expenses related to the development of new products and the
enhancements of our current products. Research and development expenses were
$2.6 million and $4.5 million for the three months ended June 30, 2002 and
2001, respectively, representing a decrease of $1.8 million or 41%. The
decrease in research and development expenses was due to lower salary and other
personnel expenses associated with a 45% reduction in research and development
headcount from the prior year.

Sales and marketing Sales and marketing expenses were $5.0 million and $8.6
million for the three months ended June 30, 2002 and 2001, respectively,
representing a decrease of $3.7 million or 43%. The decrease in sales and
marketing expenses was due to lower salary and other personnel expenses
associated with a 39% reduction in sales and marketing headcount from the prior
year.

General and administrative General and administrative expenses were $1.6
million and $2.4 million for the three months ended June 30, 2002 and 2001,
respectively, representing a decrease of $883,000 or 36%. The decrease in
general and administrative expenses was due to lower salary and other personnel
expenses associated with a 26% reduction in general and administrative
headcount from the prior year.

Non-cash equity based compensation Non-cash equity based compensation was
$176,000 and $190,000 for the three months ended June 30, 2002 and 2001,
respectively, representing a decrease of $14,000. Non-cash equity based
compensation expense represents fair market value of stock options and warrants
granted to non-employees of the Companys common stock at the date of grant
amortized over the vesting period.

Amortization and write-down of intangibles Amortization and write-down of
intangibles was $240,000 and $5.0 million for the three months ended June 30,
2002 and 2001, respectively. On April 1, 2002, we adopted SFAS No. 142. As a
result, we ceased amortization of goodwill and subsumed assembled workforce
assets of $1.9 million into goodwill. The remaining balance of unamortized
goodwill is $9.5 million at June 30, 2002.

Interest and other income (expense) Interest and other income (expense) was
$(304,000) and 97,000 for the three months ended June 30, 2002 and 2001,
respectively, representing a decrease of $401,000. The decrease in interest and
other income (expense) was due to non-cash interest expense of $272,000 related
to the convertible debentures issued in November and December 2001, along with
lower interest income resulting from less cash being available to invest.

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Provision for income taxes Provision for income taxes was $8,000 and $57,000
for the three months ended June 30, 2002 and 2001, respectively, representing a
decrease of $49,000. This represents the minimum amount required for state
taxes. The Company has not recorded a current or deferred provision for
deferral income taxes for any period to date, as a result of losses incurred
since its inception.

Inflation

Inflation has not had a significant effect on our consolidated results of
operations or financial position for the three month periods ended June 30,
2002 and 2001.

Liquidity and Capital Resources

We have funded our business, to date, primarily from the issuance of equity and
debt securities. Cash and cash equivalents as of June 30, 2002 were $1.9
million and $1.5 million as of March 31, 2002. At June 30, 2002 the Company
had negative working capital of $4.1 million, compared to negative working
capital of $3.0 million at March 31, 2002.

Net cash provided by operating activities was $410,000 for the three months
ended June 30, 2002 and net cash used in operating activities was $8.8 million
for the three months ended June 30, 2001. The increase in cash provided by
operations was due to a lower net loss and a smaller decrease in accounts
payable and accrued liabilities partially offset by lower depreciation and
amortization and a smaller decrease in accounts receivable.

Net cash used in investing activities was $27,000 and $290,000 for the three
months ended June 30, 2002 and 2001, respectively. The decrease was due to
lower capital expenditures. We expect our capital expenditures to remain at
their current rate until the anticipated $12.0 million financing is completed.

Net cash used in financing activities was $49,000 for the three months ended
June 30, 2002 and net cash provided by financing activities was $1.7 million
for the three months ended June 30, 2001.

Management believes, based upon projected operating needs, that our working
capital is insufficient for us to maintain our current level of operating
activities through March 31, 2003. We have also experienced recurring losses
from operations and have negative working capital at June 30, 2002. These
factors, among others, raise substantial doubt about our ability to continue as
a going concern. On May 22, 2002, we entered into a definitive agreement to
raise approximately $12.0 million through the sale of convertible preferred
stock and warrants to institutional investors in a private placement. On July
29, 2002, our stockholders approved the financing and a one-for-ten reverse
stock split at a special meeting of stockholders and called for those purposes.
Proceeds of the financing will be used for working capital. Management believes
that with the completion of the $12.0 million financing, we will have
sufficient working capital to fund our operations through at least March 31,
2003. While we have successfully raised equity capital in the past, there can
be no assurance that we will be successful in our efforts to obtain additional
financing in the future.

We received notification from some investors that they were terminating their
obligations under the purchase agreement, which was scheduled to close on
August 13, 2002. As a result, we have postponed the closing date of the
private placement indefinitely and are analyzing our alternatives related to
the financing.

New Accounting Standards

In June 2001, the Financial Accounting Standards Board (FASB) issued two new
pronouncements: Statement of Financial Accounting Standards (SFAS) No. 141,
Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets.
SFAS No. 141 requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001. Goodwill and intangible
assets with indefinite lives will remain on the balance sheet and not be
amortized. On an annual basis, or when there is reason to suspect that their
values have been diminished or impaired, these assets must be tested for
impairment, and write-downs may be necessary. We implemented SFAS No. 141 on
July 1, 2001. Such adoption had no impact on our consolidated financial
position or results of operations though June 30, 2002. We adopted SFAS No. 142
on April 1, 2002. As a result, we have ceased amortization of goodwill and
assembled workforce, reducing annual amortization expense by approximately
$10.4 million. We will continue to amortize developed technology and customer
lists over their remaining lives. We expect to complete the transition

19



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impairment test for goodwill before September 30, 2002. In addition, future
impairment reviews may result in charges against earnings to write-down the
value of intangible assets.

In August 2001, the FASB issued SFAS No. 144, Accounting for Impairment or
Disposal of Long-Lived Assets.SFAS No. 144 addresses financial accounting and
reporting for the impairment of long-lived assets and for the disposal of
long-lived assets. SFAS No. 144 supersedes SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,
and is effective for fiscal year beginning after December 15, 2001. We adopted
SFAS No. 144 effective April 1, 2002. The adoption of this statement did not
have a material impact on our consolidated financial position or results of
operations.

In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities, which addresses financial accounting and
reporting for costs associated with the exit or disposal activities and
supersedes Emerging Issued Task Force (EITF) Issue 94-3, Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in Restructuring). SFAS No. 146 requires that
a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. Under EITF Issue 94-3, a liability
for an exit cost, as defined in EITF 94-3, was recognized at the date of the
entitys commitment to an exit plan. SFAS No. 146 also establishes that the
liability should measured and recorded at fair value. We will adopt the
provisions of SFAS No. 146 for exit or disposal activities that are initiated
after March 31, 2002.

Risk Factors

Our business is subject to a variety of risks and special considerations. As a
result, our prospective investors should carefully consider the risks described
below, and the other information in this document, before deciding to invest in
the shares.

Our business, financial condition and results of operations could be adversely
affected by any of the following risks. If we are adversely affected by such
risks, then the trading price of our common stock could decline, and you could
lose all or part of your investment.

RISKS ASSOCIATED WITH THE COMPANY

WE HAVE A HISTORY OF LOSSES AND WE EXPECT TO INCUR FUTURE LOSSES IF WE ARE
UNABLE TO SUCCESSFULLY AND COST EFFECTIVELY DEVELOP, MARKET AND DISTRIBUTE OUR
PRODUCTS

Since our inception, we have had a history of losses and, as of June 30, 2002,
we had an accumulated deficit of $183.1 million. Further, the cash requirements
to run our business have been and will continue to be significant. In the past,
we had negative cash flow from operations. We anticipate incurring additional
losses until we can successfully develop, market and distribute our products.
Developing our software products is difficult and time consuming and requires
the coordinated participation of various technical and marketing personnel and,
at times, independent third-party suppliers. If our personnel and third
parties are unable to work together and coordinate their efforts in order to
quickly and cost-efficiently develop our products, the development process may
encounter delays, which could lead to increased operating expenses and future
losses. The likelihood of the success of our business must be considered in
light of the problems, expenses, difficulties, complications and unforeseen
delays frequently encountered in connection with the development of new
software technologies. Further, our ability to achieve or sustain our revenue
or profit goals depends on a number of factors outside of our control,
including the extent to which:



| |  |  | there is market acceptance of commercial services utilizing our products;                       
| | - |  | ------------------------------------------------------------------------------------------------
|
| |  |  | our competitors announce and develop competing products or significantly lower their prices; and
|
| |  |  | our customers promote our product.                                                              

IF WE ARE UNABLE TO ACHIEVE POSITIVE OPERATING RESULTS, WE MAY NEED TO RAISE
ADDITIONAL CAPITAL AND MAY NOT BE ABLE TO CONTINUE TO OPERATE AS A GOING
CONCERN

In the past, we have used cash from outside financing to fund our operations.
If we cannot achieve positive operating results and positive cash flow, we may
need to raise additional funds. There can be no assurances that funds may be
raised on acceptable terms or when needed, if at all. If we cannot raise
necessary funds on acceptable terms, we may not
be able to develop or enhance our products, take advantage of future
opportunities or respond to competitive pressures or unanticipated capital
requirements, which could have a material adverse effect on our business,
operating results and

20



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financial condition. If we are unable to achieve
positive operating results and are unable to raise additional funds, we may
need, among other things, to sell our assets, to further reduce our workforce
or to close facilities.

At June 30, 2002, our current capital resources were $8.1 million and consisted
of $1.9 million of cash and $6.2 million of accounts receivable. We also had
$5.8 million in liabilities that will need to be paid with cash and negative
working capital of $4.1 million.

Management believes, based upon projected operating needs, that our working
capital is insufficient for us to maintain our current level of operating
activities through March 31, 2003. We have also experienced recurring losses
from operations and have negative working capital at June 30, 2002. These
factors, among others, raise substantial doubt about our ability to continue as
a going concern. On May 22, 2002, we entered into a definitive agreement to
raise approximately $12.0 million through the sale of convertible preferred
stock and warrants to institutional investors in a private placement. On July
29, 2002, our stockholders approved the financing and a one-for-ten reverse
stock split at a special meeting of stockholders and called for those purposes.
Proceeds of the financing will be used for working capital. Management believes
that with the completion of the $12.0 million financing, we will have
sufficient working capital to fund our operations through at least March 31,
2003. While we have successfully raised equity capital in the past, there can
be no assurance that we will be successful in our efforts to obtain additional
financing in the future.

We received notification from some investors that they were terminating their
obligations under the purchase agreement, which was scheduled to close on
August 13, 2002. As a result, we have postponed the closing date of the
private placement indefinitely and are analyzing our alternatives related to
the financing.

WE HAVE PREVIOUSLY INCURRED AND MAY INCUR FUTURE IMPAIRMENT LOSSES RELATED TO
INTANGIBLE ASSETS FROM PRIOR ACQUISITIONS WHICH COULD NEGATIVELY AFFECT OUR
FUTURE OPERATING RESULTS

During the year ended March 31, 2002, we had an impairment write-down of $64.8
million related to intangible assets from prior acquisitions. If our operating
performance and the overall market environment do not improve, we may incur
additional write-downs of our remaining intangible assets that could adversely
affect our financial position, our operating results and our ability to raise
additional financing.

WE RELY HEAVILY ON SALES OF STARTEAM AND IF IT DOES NOT SUSTAIN MARKET OR IT
DECREASES IN ACCEPTANCE, WE ARE LIKELY TO EXPERIENCE LARGER LOSSES

For the quarter ended June 30, 2002, we generated 56% of our total revenues and
75% of our licensing revenues from licenses of our StarTeam product line. We
believe that revenues generated from StarTeam will continue to account for a
large percentage of our revenues for the foreseeable future. A decline in the
price of, or demand for, StarTeam would have a material adverse effect on our
business, operating results and financial condition. The following events may
reduce the demand for StarTeam:



| |  |  | competition from other products;                                                                 
| | - |  | -------------------------------------------------------------------------------------------------
|
| |  |  | flaws in our software products or incompatibility with third-party hardware or software products;
|
| |  |  | negative publicity or evaluation of our company; or                                              
|
| |  |  | obsolescence of the hardware platforms or software environments in which our systems run.        

In addition, our future financial performance will depend upon successfully
developing and selling enhanced versions of StarTeam. If we fail to deliver
product enhancements or new products for our customers, it will be difficult
for us to succeed.

IF WE DO NOT CONTINUE TO RECEIVE REPEAT BUSINESS FROM EXISTING CUSTOMERS, OUR
REVENUE WILL SUFFER

We generate a significant amount of our software license revenues from existing
customers. Most of our current customers initially purchase a limited number
of licenses as they implement and adopt our products. Even if the customer
successfully uses our products, customers may not purchase additional licenses
to expand the use of our products. Purchases of expanded licenses by these
customers will depend on their success in deploying our products,
their satisfaction with our products and support services and their use of
competitive alternatives. A customers decision to widely deploy our products
and purchase additional licenses may also be affected by factors that are
outside of our control or which are not related to our products or services. In
addition, as we deploy new versions of our products or

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introduce new products, our current customers may not require the functionality of our new products and may decide not to license these products.

IF WE ARE UNABLE TO FURTHER INTEGRATE THE OPERATIONS OF TECHNOLOGY BUILDERS,
INC., WE MAY NOT BE ABLE TO SUCCESSFULLY CONTINUE TO DEVELOP AND MARKET
TECHNOLOGY BUILDERS PRODUCTS AND OUR REVENUES MAY SUFFER

We acquired Technology Builders, Inc. on February 23, 2001. The success of this
acquisition will depend on our ability to:



| |  |  | successfully integrate and manage its technology and operations;                          
| | - |  | ------------------------------------------------------------------------------------------
|
| |  |  | retain its software developers;                                                           
|
| |  |  | develop and market new products and enhance existing products based on its technology; and
|
| |  |  | retain its customer base.                                                                 

Our failure to successfully address the risks associated with our acquisition
of Technology Builders could hurt our ability to develop and market products
based on Technology Builders technology.

RISKS ASSOCIATED WITH THE INDUSTRY

WE FACE INTENSE COMPETITION FOR APPLICATION SOFTWARE WHICH COULD MAKE IT
DIFFICULT FOR US TO ACQUIRE AND RETAIN CUSTOMERS AND ADVERSELY AFFECT OUR
OPERATING RESULTS

The application software market is intensely competitive and rapidly evolving.
Our customers requirements and the technology available to satisfy those
requirements continually change. We expect competition to intensify in the
future. Our principal competitors include in-house development efforts by
potential customers or partners, vendors of code management software, and
vendors of content management software. Many of these companies have longer
operating histories and significantly greater financial, technical, marketing
and other resources than we do. Many of these companies can also leverage
extensive customer bases and adopt aggressive pricing policies to gain market
share. Potential competitors may bundle their products in a manner that may
discourage users from purchasing our products. In addition, it is possible that
new competitors or alliances among competitors may emerge and rapidly acquire
significant market share.

Competitive pressures may make it difficult for us to acquire and retain
customers and may require us to reduce the price of our software in order to
attract new customers and keep existing customers. If we have to reduce the
purchase price of our software, our revenues may decrease. If we fail to
compete successfully against current or future competitors, we could lose
customers and our business, operating results and financial condition would
suffer.

IF WE FAIL TO ESTABLISH AND MAINTAIN STRATEGIC RELATIONSHIPS, THE MARKET
ACCEPTANCE OF OUR PRODUCTS AND OUR FINANCIAL PERFORMANCE MAY SUFFER

To date, the majority of our revenue came from our direct sales efforts. To
offer products and services to a larger customer base, our direct sales force
depends on strategic partnerships and marketing alliances to obtain customer
leads, referrals and distribution. If we are unable to maintain our existing
strategic relationships or fail to enter into additional strategic
relationships, our ability to increase our sales will be harmed. We would also
lose anticipated customer introductions and co-marketing benefits. In addition,
our strategic partners may not regard us as significant for their own
businesses. Therefore, they could reduce their commitment to us or terminate
their relationships with us, pursue other partnerships or relationships, or
attempt to develop or acquire products or services that compete with our
products and services. Even if we succeed in establishing these relationships,
they may not result in additional customers or revenues.

WE HAVE LIMITED EXPERIENCE CONDUCTING OPERATIONS INTERNATIONALLY, WHICH MAY
MAKE OVERSEAS EXPANSION MORE DIFFICULT AND COSTLY

To date, we have derived most of our revenues from sales to North American
customers. We plan to expand our international operations in the future. There
are many barriers and risks to competing successfully in the international
marketplace, including:

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| |  |  | costs of customizing products for foreign countries;                                 
| | - |  | -------------------------------------------------------------------------------------
|
| |  |  | foreign currency risks;                                                              
|
| |  |  | dependence on local vendors;                                                         
|
| |  |  | compliance with multiple, conflicting and changing governmental laws and regulations;
|
| |  |  | longer sales cycles; and                                                             
|
| |  |  | import and export restrictions and tariffs.                                          

As a result of these competitive barriers to entry and risks, we cannot assure
you that we will be able to successfully market, sell and deliver our products
and services in international markets.

IF WE FAIL TO EFFECTIVELY MANAGE AND SUPPORT OUR ANTICIPATED GROWTH IN
OPERATIONS, WE MAY NOT ACHIEVE FUTURE REVENUE GROWTH AND PROFITABILITY

To succeed in the implementation of our business strategy, we must rapidly
execute our sales strategy, further develop and enhance products and expand our
service capabilities. To manage anticipated growth resulting from this
strategy, we must:



| |  |  | continue to implement and improve our operational, financial and management information systems;              
| | - |  | --------------------------------------------------------------------------------------------------------------
|
| |  |  | hire, train and retain qualified personnel;                                                                   
|
| |  |  | continue to expand and upgrade core technologies; and                                                         
|
| |  |  | effectively manage multiple relationships with our customers,
applications developers and other third parties.

If we fail to manage and support our growth as planned, our business strategy,
the anticipated growth in revenues and our profitability may not be achieved.

WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, WHICH
COULD RESULT IN THE USE OF OUR TECHNOLOGY BY COMPETITORS OR OTHER THIRD PARTIES
RESULTING IN LOWER SALES OF OUR PRODUCTS

Our success depends significantly on our ability to protect our proprietary
technologies. If we are not adequately protected, our competitors could use the
intellectual property that we have developed to enhance their products and
services to our detriment. We rely on a combination of trade secrets, patents,
confidentiality provisions and other contractual provisions to protect our
proprietary rights, but these legal means provide only limited protection.

OUR PRODUCTS USE TECHNOLOGY THAT MAY INFRINGE ON THE PROPRIETARY RIGHTS OF
THIRD PARTIES, WHICH MAY EXPOSE US TO LITIGATION AND OTHER COSTS

As the number of entrants into our market increases, the possibility of a
patent infringement claim against us grows. For example, we inadvertently may
be infringing a patent of which we are unaware. In addition, because patent
applications can take many years to issue, there may be a patent application
now pending of which we are unaware, which will cause us to infringe such
patent when it is issued in the future. To address any patent infringement
claims, we may have to enter into royalty or licensing agreements on commercial
terms that are not favorable to us. A successful claim of patent infringement
against us, or our failure to license the infringed or similar technology, may
cause us to delay or cancel shipment of our products or result in significant
costs. This could hurt our revenues and profitability and result in a material
adverse effect on our business, operating results and financial condition. In
addition, any infringement claims, with or without merit, would be
time-consuming and expensive to litigate or settle and could divert management
attention from administering our core business.

OUR FAILURE TO DELIVER DEFECT-FREE SOFTWARE COULD RESULT IN GREATER LOSSES AND
HARMFUL PUBLICITY

Our software products are complex and may contain defects or failures.
Moreover, third parties may develop and spread computer viruses that may damage
the functionality of our software products. Any of these events may result in
delayed or lost revenues, loss of market share, failure to achieve market
acceptance, reduced customer satisfaction, diversion of development resources, product liability or warranty claims against us, and damage to our reputation. Although we maintain liability insurance, this
insurance coverage may not be adequate to cover losses from claims against us.
Further, defending a product liability lawsuit, regardless of its merits, could
harm our business because it entails substantial expense and diverts the time
and attention of key management personnel.

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RISKS ASSOCIATED WITH OUR COMMON STOCK

IF THE PRICE OF OUR COMMON STOCK REMAINS BELOW $1.00, OUR COMMON STOCK MAY BE
DELISTED FROM NASDAQ

Prior to the one-for-ten reverse split of our common stock on July 31, 2002,
the price of our common stock was below $1.00. The National Association of
Securities Dealers, Inc. has established certain standards for the continued
listing of a security on the Nasdaq National Market and the Nasdaq SmallCap
Market. The standards for continued listing on either market require, among
other things, that the minimum bid price for the listed securities be at least
$1.00 per share. A deficiency in the bid price maintenance standard will be
deemed to exist if the issuer fails the individual stated requirement for
thirty consecutive trading days, with a 90-day cure period, with respect to the
Nasdaq National Market, and a 180-day cure period with respect to the Nasdaq
SmallCap Market. On February 14, 2002, we received a 30-day deficiency notice
from The Nasdaq Stock Market, Inc., for failure to comply with the $1.00
minimum bid price per share for the last 30 consecutive trading days. We
transferred to the Nasdaq SmallCap Market on May 28, 2002, in order to take
advantage of the longer 180-day cure period. If the price deficiency is cured
during the 180-day period, and we otherwise continue to comply with the Nasdaq
National Market maintenance standards, we could then transfer back to the
Nasdaq National Market by February 10, 2003. If we do not comply with the
$1.00 minimum bid price at the end of the 180-day cure period, we may also be
eligible for an additional 180-calendar day grace period provided we meet the
initial listing criteria for the Nasdaq SmallCap Market. If our common stock
were to be excluded from Nasdaq, the prices of our common stock and the ability
of holders to sell such stock would be adversely affected, and we would be
required to comply with the initial listing requirements to be relisted on
Nasdaq.

IF OUR OUTSTANDING WARRANTS AND OPTIONS ARE EXERCISED, THERE WILL BE FURTHER
DILUTION TO OUR COMMON STOCKHOLDERS

As of June 30, 2002, we had 383,691 warrants to purchase the equivalent number
of shares of our common stock outstanding at prices ranging from $3.20 to
$68.13. In addition, as of June 30, 2002, we had 2,226,856 stock options
granted outstanding with a weighted-average exercise price of $25.88, of which
1,204,329 are exercisable at a weighted-average exercise price of $28.98.
Exercise of either the outstanding warrants or granted stock options will
dilute the position of our common stockholders.

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ITEM 3QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We do not use derivative financial instruments for our investment purposes, nor
do we have any foreign exchange hedging contracts.

Exchange Rate Risk

We have minimal risk related to currency fluctuations. Less than 10% of our
revenues are from sources outside the United States and all sales are
denominated in U.S. dollars. We have subsidiaries in Canada and the United
Kingdom; therefore, we are subject to exchange rate risk related to the
translation and consolidation of our subsidiaries financial statements.

Interest Rate Risk

We may be exposed to interest rate risk related to the Accounts Receivable
Purchase Agreement that we entered into with Silicon Valley Bank in April 2002,
which allows us to sell up to $4.0 million of our accounts receivable with a
finance charge equal to 5.0% above Prime Rate.

Intangible Asset Risk

We have a substantial amount of intangible assets. During the 2002 fiscal year,
as a result of the deterioration of the economy, the decrease in information
technology spending, the lack of demand for the products obtained in the
worldweb.net acquisition and the significant reduction in headcount, we
recorded a write-down of intangible assets of $64.8 million. Future
deterioration of the economy could result in further impairment of our
intangible assets, requiring us to record an additional write down expense.

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PART II
ITEM 6EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

|        |  |                                          |  |      
|------- |  | ---------------------------------------- |  | -----
|Exhibit |  |                                          |  | Ref./
|Number  |  | Description Of Document                  |  | Page 
|        |  |                                          |  |      
|99.1    |  | Certification of Chief Executive Officer |  |      
|99.2    |  | Certification of Chief Financial Officer |  |      

(b) Reports on Form 8-K

None.

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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.

|                |  |                                                      
|--------------- |  | -----------------------------------------------------
|                |  | STARBASE CORPORATION
(Registrant)                    
|               
|August 14, 2002 |  | /s/ Douglas S. Norman                                
|                |  |                                                      
|Date            |  | Douglas S. Norman
Chief Financial Officer            
|               
|August 14, 2002 |  | /s/ James A. Harrer                                  
|                |  |                                                      
|Date            |  | James A. Harrer
Chief Executive Officer and President

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EXHIBIT INDEX

|        |  |                                         
|------- |  | ----------------------------------------
|Exhibit |  |                                         
|Number  |  | Description Of Document                 
|        |  |                                         
|99.1    |  | Certification of Chief Executive Officer
|99.2    |  | Certification of Chief Financial Officer

28