**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**Washington, D.C. 20549

** **

----

** **

**FORM 10-Q**

 
| **(Mark One)** |
|----------------|
| ** **     | ** ** |
| **ý**     | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
| ** **     | ** ** |
| ** **     | **For the quarterly period ended May 31, 2005** |
| ** **     | ** ** |
| ** **     | **Or** |
| **o**          | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
| ** **     | ** ** |
| ** **     | **For the transition period from                             to                              ** |

 

**Commission filenumber: 000-25249**

 

**INTRAWARE, INC.**

**(Exact name ofregistrant as specified in its charter)**

 
| **Delaware**                                                        | ** ** | **68-0389976**                               |
|---------------------------------------------------------------------|------------|----------------------------------------------|
| **(State or other jurisdiction of  incorporation or organization)** | ** ** | **(I.R.S. Employer  Identification Number)** |
| ** **                                                          | ** ** | ** **                                   |
| **25 Orinda Way  Orinda, CA**                                       | ** ** | **94563**                                    |
| **(Address of principal executive offices)**                        | ** ** | **(Zip Code))**                              |

 

**Registrant’s telephone number, including area code:**(925) 253-4500

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  Yes ý   No o

 

Indicate by check mark whether the registrant is an accelerated filer (asdefined in Rule 12b-2 of the Exchange Act). Yes o   No ý

 

As of July 1, 2005 there were 60,583,519 shares of the registrant’scommon stock outstanding.

 

 

----

 

**INTRAWARE,INC.**

 

**INDEX**

 
|            | ** **                                                                                  | ** ** | **Page**   |
|------------|---------------------------------------------------------------------------------------------|------------|------------|
| ** ** | **PART I—FINANCIAL INFORMATION**                                                  | ** ** | ** ** |
| Item 1.    | Consolidated  Financial Statements                                                          |       | 2          |
|       | Consolidated  Balance Sheets                                                                |       | 2          |
|       | Consolidated  Statements of Operations                                                      |       | 3          |
|       | Consolidated  Statements of Cash Flows                                                      |       | 4          |
|       | Notes to Unaudited Interim Consolidated Financial Statements                                |       | 5          |
| Item 2.    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |       | 15         |
| Item  3.   | Quantitative  and Qualitative Disclosures about Market Risk                                 |       | 33         |
| Item 4.    | Controls and  Procedures                                                                    |       | 33         |
| ** ** | **PART II  OTHER  INFORMATION**                                              | ** ** | ** ** |
| Item 1.    | Legal Proceedings                                                                           |       | 33         |
| Item 2.    | Unregistered sales of Equity securities and  use of proceeds                                |       | 35         |
| Item 3.    | Defaults upon senior securities                                                             |       | 35         |
| Item  4.   | Submission  of Matters to a Vote of Security Holders                                        |       | 35         |
| Item 5.    | Other information                                                                           |       | 35         |
| Item 6.    | Exhibits                                                                                    |       | 35         |
| Signature  |                                                                                        |       | 36         |

 

----

 

**PARTI—FINANCIAL****INFORMATION**

 

**ITEM 1.CONS****OLIDATED FINANCIAL STATEMENTS**

 

**INTRAWARE, INC.**

**CONSOLIDATED****BALANCE SHEETS**

**(in thousands, except per share amounts)**

**(unaudited)**

 
| ** **                                                                                                                                                   | ** ** | **May 31, 2005** | ** ** | **February 28, 2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                   | ** ** | ** **       | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                   |       |             |       |                  |       |
| Current assets:                                                                                                                                              |       |             |       |                  |       |
| Cash and cash equivalents                                                                                                                                    |       | $                | 8,804      |                  | $          | 9,463 |   |
| Accounts receivable, net                                                                                                                                     |       | 1,630            |       | 1,765                 |       |
| Costs of deferred revenue                                                                                                                                    |       | 434              |       | 404                   |       |
| Other current assets                                                                                                                                         |       | 404              |       | 321                   |       |
| Total current assets                                                                                                                                         |       | 11,272           |       | 11,953                |       |
| Cost of deferred revenue, less current  portion                                                                                                              |       | 39               |       | 70                    |       |
| Property and equipment, net                                                                                                                                  |       | 741              |       | 863                   |       |
| Other assets, less current portion                                                                                                                           |       | 100              |       | 80                    |       |
| Total assets                                                                                                                                                 |       | $                | 12,152     |                  | $          | 12,966 |   |
|                                                                                                                                                         |       |             |       |                  |       |
| **LIABILITIES, REDEEMABLE CONVERTIBLE  PREFERRED STOCK & STOCKHOLDERS’ EQUITY**                                                                     |       |             |       |                  |       |
| Current liabilities:                                                                                                                                         |       |             |       |                  |       |
| Notes payable                                                                                                                                                |       | $                | 651        |                  | $          | 823 |   |
| Accounts payable                                                                                                                                             |       | 578              |       | 464                   |       |
| Accrued liabilities                                                                                                                                          |       | 761              |       | 967                   |       |
| Deferred revenue                                                                                                                                             |       | 2,417            |       | 2,450                 |       |
| Related party deferred revenue                                                                                                                               |       | —           |       | 2                     |       |
| Total current liabilities                                                                                                                                    |       | 4,407            |       | 4,706                 |       |
| Deferred revenue, less current portion                                                                                                                       |       | 120              |       | 164                   |       |
| Notes payable, less current portion                                                                                                                          |       | 326              |       | 342                   |       |
| Total liabilities                                                                                                                                            |       | 4,853            |       | 5,212                 |       |
| Contingencies (Note 4)                                                                                                                                       |       |             |       |                  |       |
| Redeemable convertible preferred stock; $0.0001  par value; 10,000 shares authorized:                                                                        |       |             |       |                  |       |
| Series A; 552 at May 31 and February 28,  2005 (aggregate liquidation preference of $1,000 at May 31 and February 28,  2005).                                |       | 897              |       | 897                   |       |
| Total redeemable convertible preferred  stock                                                                                                                |       | 897              |       | 897                   |       |
| Stockholders’ equity:                                                                                                                                   |       |             |       |                  |       |
| Common stock; $0.0001 par value; 250,000  shares authorized; 60,584 and 60,447 shares issued and outstanding at May 31  and February 28, 2005, respectively. |       | 6                |       | 6                     |       |
| Additional paid-in-capital                                                                                                                                   |       | 163,232          |       | 163,168               |       |
| Accumulated deficit                                                                                                                                          |       | (156,836         | )          | (156,317              | )          |
| Total stockholders’ equity                                                                                                                              |       | 6,402            |       | 6,857                 |       |
| Total liabilities, redeemable convertible  preferred stock and stockholders’ equity                                                                     |       | $                | 12,152     |                  | $          | 12,966 |   |

 

See notes to unaudited interim consolidated financial statements.

2

----

 

**INTRAWARE, INC.**

**CONSOLIDA****TED STATEMENTS OF OPERATIONS**

**(in thousands, except per share amounts)**

**(unaudited)**

 

| ** **                                    | ** ** | **For the three months ended** | ** ** |
|-----------------------------------------------|------------|--------------------------------|------------|
| ** **                                    | ** ** | **May 31, 2005**               | ** ** | **May 31, 2004** | ** ** |
|                                          |       |                           |       |   |   |
| Revenues:                                     |       |                           |       |   |   |
| Online services and technology                |       | $                              | 2,340      |   | $ | 1,695 |   |
| Alliance and reimbursement                    |       | 503                            |       | 576 |   |
| Related party online services and  technology |       | 3                              |       | 534 |   |
| Software product sales                        |       | —                         |       | 42 |   |
| Total revenues                                |       | 2,846                          |       | 2,847 |   |
| Cost of revenues:                             |       |                           |       |   |   |
| Online services and technology                |       | 1,122                          |       | 567 |   |
| Alliance and reimbursement                    |       | 401                            |       | 391 |   |
| Software product sales                        |       | —                         |       | 37 |   |
| Total cost of revenues                        |       | 1,523                          |       | 995 |   |
| Gross profit                                  |       | 1,323                          |       | 1,852 |   |
| Operating expenses:                           |       |                           |       |   |   |
| Sales and marketing                           |       | 682                            |       | 752 |   |
| Product development                           |       | 250                            |       | 403 |   |
| General and administrative                    |       | 944                            |       | 789 |   |
| Total operating expenses                      |       | 1,876                          |       | 1,944 |   |
| Loss from operations                          |       | (553                           | )          | (92 | ) |
| Interest expense                              |       | (19                            | )          | (29 | ) |
| Interest and other income and expenses, net   |       | 53                             |       | 16 |   |
| Net loss                                      |       | $                              | (519       | ) | $ | (105 | ) |
| Basic and diluted net loss per share          |       | $                              | (0.01      | ) | $ | (0.00 | ) |
| Weighted average shares - basic and diluted   |       | 60,521                         |       | 59,617 |   |

 

See notes to unaudited interim consolidated financial statements.

 

3

----

 

**INTRAWARE, INC.**

**CONSOLIDATED STATE****MENTS OF CASH FLOWS**

**(in thousands)**

**(unaudited)**

 

| ** **                                                                   | ** ** | **For the three months ended** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                   | ** ** | **May 31, 2005**               | ** ** | **May 31, 2004** | ** ** |
|                                                                         |       |                           |       |   |   |
| Cash flows from operating activities:                                        |       |                           |       |   |   |
| Net loss                                                                     |       | $                              | (519       | ) | $ | (105 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                           |       |   |   |
| Depreciation and amortization                                                |       | 148                            |       | 161 |   |
| Provision for (recovery of) doubtful  accounts                               |       | 3                              |       | (1 | ) |
| Gain on sale of fixed assets                                                 |       | —                         |       | (2 | ) |
| Amortization of discount on note payable                                     |       | 2                              |       | 6 |   |
| Changes in assets and liabilities:                                           |       |                           |       |   |   |
| Accounts receivable                                                          |       | 132                            |       | 268 |   |
| Costs of deferred revenue                                                    |       | 1                              |       | (12 | ) |
| Other assets                                                                 |       | (102                           | )          | (388 | ) |
| Accounts payable                                                             |       | 197                            |       | 51 |   |
| Accrued liabilities                                                          |       | (206                           | )          | (169 | ) |
| Deferred revenue                                                             |       | (77                            | )          | (52 | ) |
| Related party deferred revenue                                               |       | (2                             | )          | (634 | ) |
| Net cash used in operating activities                                        |       | (423                           | )          | (877 | ) |
| Cash flows from investing activities:                                        |       |                           |       |   |   |
| Purchases of property and equipment                                          |       | (110                           | )          | (89 | ) |
| Proceeds from sale of fixed assets                                           |       | —                         |       | 2 |   |
| Net cash used in investing activities                                        |       | (110                           | )          | (87 | ) |
| Cash flows from financing activities:                                        |       |                           |       |   |   |
| Principal payments on note payable                                           |       | (293                           | )          | (248 | ) |
| Proceeds from notes payable                                                  |       | 103                            |       | — |   |
| Proceeds from common stock and warrants                                      |       | 64                             |       | 263 |   |
| Net cash provided by (used in) financing  activities                         |       | (126                           | )          | 15 |   |
| Net decrease in cash and cash equivalents                                    |       | (659                           | )          | (949 | ) |
| Cash and cash equivalents at beginning of  the period                        |       | 9,463                          |       | 11,804 |   |
| Cash and cash equivalents at end of the  period                              |       | $                              | 8,804      |   | $ | 10,855 |   |
| Supplemental disclosure of cash flow  information:                           |       |                           |       |   |   |
| Cash paid for interest                                                       |       | $                              | 17         |   | $ | 23 |   |
| Supplemental non-cash activity:                                              |       |                           |       |   |   |
| Purchases of property and equipment  included in accounts payable            |       | $                              | 8          |   | $ | 82 |   |

 

See notes to unaudited interim consolidated financial statements.

 

4

----

 

**INTRAWARE, INC.**

 

**NOTES TO UNAUDITED INTERIM CO****NSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1. BASIS OF PRESENTATION**

 

**INTRAWARE**

 

Theaccompanying unaudited interim consolidated financial statements have beenprepared pursuant to the rules and regulations of the Securities and ExchangeCommission (“SEC”).  Certain information and footnote disclosures normallyincluded in financial statements prepared in accordance with accountingprinciples generally accepted in the United States of America have beencondensed or omitted pursuant to these rules and regulations.  However,management believes that the disclosures are adequate to ensure the informationpresented is not misleading.  The balance sheet at February 28, 2005, hasbeen derived from the audited financial statements, but does not include alldisclosures required by generally accepted accounting principles.  Theseunaudited interim consolidated financial statements should be read inconjunction with the audited consolidated financial statements and notes theretoincluded in our annual report on Form 10-K for the fiscal year ended February28, 2005, filed with the SEC on April 22, 2005.

 

Inthe opinion of management, all adjustments, consisting only of normal recurringitems, considered necessary for a fair statement have been included in theaccompanying unaudited interim consolidated financial statements.  Theresults of operations for the interim periods presented are not necessarilyindicative of the operating results to be expected for any subsequent interimperiod or for the fiscal year ending February 28, 2006.

 

Wehave incurred losses and negative cash flow from operations during each fiscalyear since inception. Net loss for the three months ended May 31, 2005, increasedfrom our prior year loss for the corresponding period and we reduced ournegative cash flows from operations to approximately $0.4 million. Our cashbalances may decline further, although we believe that the effects of ourcapital financing, strategic actions implemented to improve revenue, and costcontrols will be adequate to generate sufficient cash resources to fund ourfuture operations.  If we fail to generate sufficient revenues oradequately control spending, we may be unable to achieve key businessobjectives.

 

In addition, under our June2001 agreement with Software Spectrum, we provide Sales and Marketing Servicesto Software Spectrum to assist in its resale and marketing of Sun and Websensesoftware licenses and maintenance (See Note 7). On June 30, 2005, Intraware and Software Spectrum signed an amendment tothat agreement extending the term until July 31, 2005, while the companiesdiscuss the potential terms of any longer-term extension or replacement of thatagreement.  It is possible that theagreement will expire on July 31, 2005, and that the parties will not extend itfurther or replace it with a new agreement. In that event, we would likelyexperience a substantial and immediate decrease in our revenues and cash flowsunless and until we were able to fully implement a comparable relationship withanother business partner or fully transition to becoming an authorized Sunsoftware reseller ourselves (as we were before signing the June 2001 agreementwith Software Spectrum).

 

Certain prior year amounts have been reclassified to conform to thecurrent period presentation. The reclassifications did not change previouslyreported net loss, stockholders’ equity or cash flow.

 

**NOTE 2. SIGNIFICANT ACCOUNTING POLICIES**

 

**Revenuerecognition**

 

Online services and technology revenue resultsprimarily from four types of arrangements.  First, it results from salesof our SubscribeNet digital delivery service to software vendors and othercompanies that distribute software as part of their business.  Second, itresults from professional services that we provide to customize ourSubscribeNet service for customers, to convert data for customers, and tointegrate our proprietary software.  Third, it results from services orlicenses for third-party products complimentary to our SubscribeNet servicethat we resell. Fourth, it results from the sale of our proprietary softwarelicenses and related maintenance to companies using those products internallyor using those products to provide web-based services to their customers. As aresult of the sale of our Asset Management software business in May 2002,we are not currently deriving revenue from licenses, maintenance or integrationservices for our proprietary software; however, we may recognize such revenuesin the future if opportunities arise to sell licenses for our proprietarysoftware underlying our SubscribeNet service and related maintenance. We sellour SubscribeNet service, and will sell proprietary software licenses ifopportunities present themselves, primarily through our direct sales force andauthorized resellers.

 

Alliance and reimbursement revenue primarily relatesto our alliance agreement with Software Spectrum for sales and marketingservices. This revenue consists of a percentage of the gross profit derivedfrom Software Spectrum’s sales of the third-party software and maintenance forwhich we provide sales and marketing services, and reimbursement

 

5

----

 

forthe costs of maintaining a sales team dedicated to providing sales and marketingservices to Software Spectrum for that third-party software and maintenance.This revenue is recognized as we provide the services to Software Spectrum.

 

We derive software product revenues from our pastresales of licenses and maintenance for multiple business software productlines. As of July 1, 2001, we generally no longer resell third-partysoftware licenses and maintenance. Since July 1, 2001, we have continuedto recognize revenue from our resale of third-party software licenses andrelated maintenance contracts over the life of the arrangements made prior toJuly 1, 2001. Vendor specific objective evidence of fair value for themaintenance element of the resold software arrangements has been based onhistorical and contractual renewal rates for maintenance. We deferred themaintenance revenue at the outset of the arrangement and recognized it ratablyover the period during which the maintenance was to be provided.  Thisperiod normally commenced on the date the software was delivered and generallycontinued for 12 months, although certain maintenance contracts continued forlonger periods.  Since the three months ended May 31, 2004, we have nolonger recognized any revenue relating to software product sales.

 

We defer online services and technology revenuesrelated to our SubscribeNet digital delivery service and generally recognizethem ratably over the term of the service arrangement. Some SubscribeNetservice implementations for new customers involve customization essential tothe functionality of the service.  In those cases, we defer revenuerecognition until the service go-live date is reached and recognize the revenueon a ratable basis over the remaining contract term.  The go-live date isthe later of the date on which the essential functionality is delivered or thepoint at which no additional customization is required.  Our SubscribeNetcontracts with customers typically give the customer a period of time(generally five days) to evaluate a SubscribeNet implementation after we havecompleted it, and provide that the customer is deemed to have accepted theimplementation if it has not affirmatively rejected it within thatperiod.  We typically rely on such non-rejections by customers to indicatetheir acceptance of implementations.  Any subsequent indications by ourcustomers that their implementations have not been properly completed couldhave a material adverse impact on our financial condition or results ofoperations.

 

We also sell additional professional servicesrelated to SubscribeNet agreements.  Generally, these services do notprovide stand-alone value to a customer, and accordingly, we defer recognitionof that revenue until the go-live date for the professional services, similarto the manner in which we treat SubscribeNet service revenues as discussedabove.  Such professional services revenues are recognized ratably overthe longer of the remaining estimated customer life or the remaining contractterm, commencing with the completion of the professional services. Estimated customerlife requires that we periodically estimate the projected life of our existingcustomers, based on historical information, such as customer renewal rates.Since revenues generated from additional professional services represent lessthan 5% of our overall revenues for the three months ended May 31, 2005, anychange to our estimated customer life is unlikely to have a material adverseimpact on our financial condition or results of operations.

 

Online services and technology revenues related toservices or licenses for third-party products complimentary to our SubscribeNetservice that we resell are generally recognized as the service isprovided.  If the service or licenseresold involves customization essential to the functionality of the underlyingSubscribeNet service, the fees charged for the customization is recognized asrevenue in the same manner in which we treat the professional servicesdiscussed above. Revenue related to these resold services or licenses arerecognized as revenue based on the fee charged to the customer as we bear thecredit risk for resold services or licenses, have the latitude to establishpricing at our discretion, and are primarily responsible for acceptability ofthe services or licenses delivered.  Inaddition, costs paid to the third-party providers are recorded as cost ofrevenues and recognized in the same manner as the related revenue.

 

We recognize revenue when all of the followingconditions are met:

 

•                  There is persuasive evidence of anarrangement;

 

•                  We have provided the service to the customer,made the software available for customer download through our website, orshipped the software to the customer;

 

•                  We believe that collection of these fees isreasonably assured; and

 

•                  The amount of fees to be paid by the customeris fixed or determinable.

 

6

----

 

**Costs ofdeferred revenue**

 

We capitalize direct costsof revenues related to significant SubscribeNet service implementations and establishedprofessional services contracts associated with our SubscribeNet services.Direct costs include compensation and payroll-related fringe benefits directlyrelated to the time spent on significant implementation and professionalservices activities. These costs are recognized over the same term as theassociated revenue from those contracts (see “Revenue Recognition” above). Costsassociated with professional services involving significant new functionalityfor the SubscribeNet service that are partially or fully funded by customersbut do not qualify as funded research and development activities are expensedas cost of revenues as incurred until a working model is delivered to thecustomer. Once a working model has been delivered, all additional direct costsare capitalized in the same manner discussed above. Any change in our revenuerecognition estimates could result in corresponding changes to our recognitionof costs of deferred revenues. At May 31, 2005, we had approximately $0.5million in capitalized costs relating to deferred revenues. We expense customeracquisition costs, including sales commissions, as incurred.

 

**Stock-basedcompensation**

 

We account for stock-basedemployee compensation arrangements in accordance with provisions of AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued toEmployees,” (“APB No. 25”) and its related interpretations and comply withthe disclosure provisions of SFAS No. 123, “Accounting for Stock-BasedCompensation” and related SFAS No. 148, “Accounting for Stock-BasedCompensation—Transition and Disclosure.” Under APB No. 25, compensationexpense is based on the difference, if any, on the date of the grant betweenthe fair value of our stock and the exercise price of the option. We accountfor equity instruments issued to non-employees in accordance with theprovisions of SFAS No. 123 and Emerging Issues Task Force (“EITF”) 96-18, “Accountingfor Equity Instruments That Are Issued to Other Than Employees for Acquiring,or in conjunction with Selling Goods or Services.”

 

The following tableillustrates the effect on net loss and net loss per share if we had applied thefair value recognition provisions of SFAS No. 123, to stock-based employeecompensation (in thousands, except per share data).

 
| ** **                                                                                                       | ** ** | **For the three months ended,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                       | ** ** | **May 31, 2005**                | ** ** | **May 31, 2004** | ** ** |
| Net loss                                                                                                         |       | $                               | (519       | ) | $ | (105 | ) |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all awards |       | (628                            | )          | (870 | ) |
| Pro forma                                                                                                        |       | $                               | (1,147     | ) | $ | (975 | ) |
| Net loss per share — basic and diluted                                                                      |       |                            |       |   |   |
| As reported                                                                                                      |       | $                               | (0.01      | ) | $ | (0.00 | ) |
|                                                                                                             |       |                            |       |   |   |
| Pro forma                                                                                                        |       | $                               | (0.02      | ) | $ | (0.02 | ) |

 

Wecalculated the fair value of each option grant on the date of grant, using theBlack-Scholes option pricing model as prescribed by SFAS No. 123 using thefollowing assumptions:

 

7

----

 

| ** **                | ** ** | **For the three months ended,** | ** ** |
|---------------------------|------------|---------------------------------|------------|
| ** **                | ** ** | **May 31, 2005**                | ** ** | **May 31, 2004** | ** ** |
| Risk-free interest rates  |       | 3.72 - 4.17                     | %          | 2.00 - 3.85 | % |
| Expected lives (in years) |       | 4                               |       | 4 |   |
| Dividend yield            |       | 0                               | %          | 0 | % |
| Expected volatility       |       | 88                              | %          | 121 | % |

 

Wecalculated the fair value of the stock issued under the employee stock purchaseplan using the Black-Scholes option pricing model as prescribed by SFAS No. 123using the following assumptions:

 
| ** **                 | ** ** | **For the three months ended,** | ** ** |
|----------------------------|------------|---------------------------------|------------|
| ** **                 | ** ** | **May 31, 2005**                | ** ** | **May 31, 2004** | ** ** |
| Risk-free interest rates   |       | 3.12                            | %          | 1.12 | % |
| Expected lives (in months) |       | 6                               |       | 6 |   |
| Dividend yield             |       | 0                               | %          | 0 | % |
| Expected volatility        |       | 52                              | %          | 79 | % |

 

**Net lossper share**

 

Basic net loss per commonshare is computed by dividing the net loss for the period by the weightedaverage number of common shares outstanding during the period excluding sharessubject to repurchase. The terms of our redeemable convertible preferred stockinclude the right to participate in dividends declared to common stockholders.Our redeemable convertible preferred stock does not have a contractualobligation to share in the losses in any given period. As a result, thisparticipating security will not be allocated any losses in the periods of netlosses, but will be allocated in the periods of net income using the two-classmethod. The two-class method is an earnings allocation formula that determinesearnings per share for each class of common stock and participating securitiesaccording to dividends declared or accumulated and participation rights inundistributed earnings. Under the two-class method, net income is reduced bythe amount of dividends declared in the current period for each class of stockand by the contractual amounts of dividends that must be paid for the currentperiod. The remaining earnings are then allocated to common stock andparticipating securities to the extent that each security may share in earningsas if all of the earnings for the period had been distributed. The totalearnings allocated to each security are determined by adding together theamounts allocated for dividends and the amounts allocated for a participationfeature. The total earnings allocated to each security are then divided by thenumber of outstanding shares of the security to which the earnings areallocated to determine the earnings per share.

 

Diluted net loss per shareis computed by dividing the net loss for the period by the weighted averagenumber of common and potential common shares outstanding during the period ifthe effect is dilutive. Potential common shares are composed of common stocksubject to repurchase rights and incremental shares of common stock issuableupon the exercise of stock options and warrants and upon the conversion ofpreferred stock. The dilutive effect of outstanding stock options and warrantsis computed using the treasury stock method.

 

The following table setsforth the computation of basic and diluted net loss per share as well assecurities not included in the diluted net loss per share calculation becauseto do so would be antidilutive:

 

8

----

 

| ** **                                                        | ** ** | **For the three months ended** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                        | ** ** | **May 31, 2005**               | ** ** | **May 31, 2004** | ** ** |
|                                                              |       |                           |       |   |   |
| Numerator:                                                        |       |                           |       |   |   |
| Net loss                                                          |       | $                              | (519       | ) | $ | (105 | ) |
|                                                              |       |                           |       |   |   |
| Denominator:                                                      |       |                           |       |   |   |
| Weighted average shares                                           |       | 60,521                         |       | 59,617 |   |
|                                                              |       |                           |       |   |   |
| Basic and diluted net loss per share                              |       | $                              | (0.01      | ) | $ | (0.00 | ) |
|                                                              |       |                           |       |   |   |
| Antidilutive securities not included in weighted  average shares: |       |                           |       |   |   |
| Redeemable convertible preferred stock                            |       | 552                            |       | 552 |   |
| Warrants to purchase common stock                                 |       | 1,592                          |       | 2,215 |   |
| Employee stock options                                            |       | 10,951                         |       | 9,131 |   |
|                                                              |       |                           |       |   |   |
|                                                              |       | 13,095                         |       | 11,898 |   |

 

**Recent Accounting Pronouncements**

 

In December 2004, the FASBissued SFAS No. 123 (Revised 2004) “Share-Based Payment” (“SFAS No. 123R”).SFAS No. 123R addresses all forms of share-based payment (“SBP”) awards,including shares issued under employee stock purchase plans, stock options,restricted stock and stock appreciation rights. SFAS No. 123R will require usto expense SBP awards with compensation cost for SBP transactions measured atfair value. The FASB originally stated a preference for a lattice model becauseit believed that a lattice model more fully captures the unique characteristicsof employee stock options in the estimate of fair value, as compared to theBlack-Scholes model which we currently use for our pro forma disclosure. TheFASB decided to remove its explicit preference for a lattice model and notrequire a specific valuation methodology. In April 2005, the SEC issued arelease which amends the compliance dates for SFAS No. 123R.  Accordingly, we will be required to adopt thenew accounting provisions beginning in the first quarter of our fiscal yearending February 28, 2007.

 

On March 29, 2005, the SEC issuedStaff Accounting Bulletin (SAB) 107 which expresses the views of the SECregarding the interaction between SFAS No. 123R and certain SEC rules andregulations and provides the SEC’s views regarding the valuation of share-basedpayment arrangements for public companies. In particular, SAB 107 provides guidancerelated to share-based payment transactions with nonemployees, the transitionfrom nonpublic to public entity status, valuation methods (including assumptionssuch as expected volatility and expected term), the accounting for certainredeemable financial instrument issues under share-based payment arrangements,the classification of compensation expense, non-GAAP financial measures, first-timeadoption of SFAS No. 123R in an interim period, capitalization of compensationcosts related to share-based payment arrangements, the accounting for incometax effects of share-based payments arrangements upon adoption of SFAS No.123R, the modification of employee share options prior to adoption of SFAS No.123R, and disclosures in Management’s Discussion and Analysis of FinancialCondition and Results of Operations subsequent to adoption of SFAS No. 123R. Weexpect the adoption of SFAS No. 123R and SAB 107 will have a material adverseimpact on our results of operations and loss per share. We are currently in theprocess of evaluating the extent of such impact.

 

In May 2005,the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections”. SFASNo. 154 replaces APB Opinion No. 20 “Accounting Changes” and SFAS No. 3,“Reporting Accounting Changes in Interim Financial Statements”. SFAS No. 154requires retrospective application to prior periods’ financial statements ofchanges in accounting principle, unless it is impracticable to determine eitherthe period-specific effects or the cumulative effect of the change. We do notexpect the adoption of SFAS No. 154 to have a material impact on ourconsolidated financial statements.

 

**NOTE 3. CHANGES IN STOCKHOLDERS’ EQUITY**

 

Duringthe three months ended May 31, 2005, our stockholders’ equity changed asfollows (in thousands):

 

9

----

 
| ** **                                                    | ** ** | ** **       | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **             | ** ** | ** **        | ** ** | ** ** | ** ** |
|---------------------------------------------------------------|------------|------------------|------------|-------------|------------|-----------------|------------|------------------------|------------|-------------------|------------|------------|------------|
| ** **                                                    | ** ** | **Common stock** | ** ** | **paid-in** | ** ** | **Accumulated** | ** ** | **Stockholders’** | ** ** | **Comprehensive** | ** ** |
| ** **                                                    | ** ** | **Shares**       | ** ** | **Amount**  | ** ** | **capital**     | ** ** | **deficit**            | ** ** | **equity**        | ** ** | **loss**   | ** ** |
|                                                          |       |             |       |        |       |            |       |                   |       |              |       |       |       |
| Balance at February 28, 2005                                  |       | 60,447           |       | $           | 6          |            | $          | 163,168                |       | $                 | (156,317   | )          | $          | 6,857 |   |   |   |
| Exercise of stock options                                     |       | 8                |       | —      |       | 6               |       | —                 |       | 6                 |       |       |       |
| Issuance of common stock for employee stock  purchase program |       | 129              |       | —      |       | 58              |       | —                 |       | 58                |       |       |       |
| Net loss                                                      |       | —           |       | —      |       | —          |       | (519                   | )          | (519              | )          | $          | (519       | ) |
| Other comprehensive loss                                      |       |             |       |        |       |            |       |                   |       |              |       | —     |       |
| Comprehensive loss                                            |       |             |       |        |       |            |       |                   |       |              |       | $          | (519       | ) |
|                                                          |       |             |       |        |       |            |       |                   |       |              |       |       |       |
| Balance at May 31, 2005                                       |       | 60,584           |       | $           | 6          |            | $          | 163,232                |       | $                 | (156,836   | )          | $          | 6,402 |   |   |   |

 

 

**NOTE 4. CONTINGENCIES**

 

**Indemnifications**

 

Inthe course of our business, we have given indemnities and made commitments andguarantees under which we may be required to make payments. These indemnitiesinclude:

 

•                  *Intellectual PropertyIndemnities to Customers and Resellers.*Our customer and reseller agreements for our SubscribeNet servicetypically contain provisions that indemnify our customers or resellers fordamages and costs resulting from claims alleging that our services infringe theintellectual property rights of a third-party. We have also entered intosoftware license agreements indemnifying the licensees for damages and costsresulting from claims alleging that the software infringes third-partyintellectual property rights. The duration of these indemnities is typicallyunlimited. Our potential payments under these indemnities are in some caseslimited (e.g., to the fees paid to us under the contract or to another amount)and are in other cases unlimited. Where we have given such indemnities forthird-party software licenses that we resold, we have typically received similarindemnities from the software publishers. We plan to continue to enter intoSubscribeNet service agreements with customers and resellers, license software,and provide industry-standard indemnities to our service customers, resellersand licensees.

 

•                  *Intellectual PropertyIndemnity to Acquiror of Asset Management Business.*In the May 2002 sale of our AssetManagement software business to Computer Associates International, Inc., weagreed to indemnify Computer Associates for damages and costs incurred by it inconnection with claims alleging that the software and technology we sold tothem infringes the intellectual property rights of third parties. Thisindemnity will remain in effect until May 2007. Our maximum potentialpayment under this indemnity is $9.5 million.

 

•                  *Indemnities to PrivateInvestors.*In our privateplacements of stock, we have made representations and warranties to theinvestors and placement agents, and have agreed to indemnify them for anydamages and costs they incur as a result of our breach of those representationsand warranties. We also have signed registration rights agreements with privateinvestors under which we indemnify them for damages they incur as a result ofany material misstatements or omissions in our registration statements, and paypenalties in the event we fail to maintain the effectiveness of registrationstatements. The duration of our indemnities

 

10

----

 

toour investors under the respective stock and warrant purchase agreements rangesfrom one to two years from the respective closing dates, other than thepurchase agreements for our June 2000 warrants and our January 2001Series A Preferred Stock and warrants, which provide for indemnities ofunlimited duration. Our indemnities to our investors under the respectiveregistration rights agreements expire upon termination of our registrationobligations, which is typically the date the securities may be sold underRule 144(k) under the Securities Act of 1933. Our potential payments underthese indemnities are unlimited.

 

•                  *Indemnities to Directorsand Officers.*We indemnifyour directors and officers for damages and costs incurred in the performance oftheir duties, to the extent permitted by Delaware law. The duration of, and ourpotential payments under, these indemnities are unlimited, subject to Delawarelaw.

 

Wehave historically received only a very limited number of requests forindemnification under these agreements and have not been required to makematerial payments under them. Accordingly, we have not recorded a liabilityrelated to these indemnification provisions.

 

**Legal Proceedings**

 

*In re Intraware, Inc.Initial Public Offering Securities Litigation*

* *

InOctober 2001, we were served with a summons and complaint in a purportedsecurities class action lawsuit.  On orabout April 19, 2002, we were served with an amended complaint in thisaction, which is now titled *In re Intraware, Inc.Initial Public Offering Securities Litigation*, Civ. No. 01-9349(SAS) (S.D.N.Y.), related to *In re Initial PublicOffering Securities Litigation*, 21 MC 92 (SAS) (S.D.N.Y.).  The amended complaint is brought purportedlyon behalf of all persons who purchased our common stock from February 25,1999 (the date of our initial public offering) through December 6, 2000.  It names as defendants Intraware, three ofour present and former officers and directors, and several investment bankingfirms that served as underwriters of our initial public offering.  The complaint alleges liability underSections 11 and 15 of the Securities Act of 1933 and Sections 10(b)and 20(a) of the Securities Exchange Act of 1934, on the grounds that theregistration statement for the offerings did not disclose that: (1) theunderwriters had agreed to allow certain customers to purchase shares in theofferings in exchange for excess commissions paid to the underwriters; and (2)the underwriters had arranged for certain customers to purchase additionalshares in the aftermarket at predetermined prices.  The amended complaint also alleges that theunderwriters misused their securities analysts to manipulate the price of ourstock.  No specific damages are claimed.

 

Lawsuitscontaining similar allegations have been filed in the Southern District of NewYork challenging over 300 other initial public offerings and secondaryofferings conducted in 1999 and 2000. All of these lawsuits have been consolidated for pretrial purposesbefore United States District Court Judge Shira Scheindlin of the SouthernDistrict of New York.  On July 15,2002, an omnibus motion to dismiss was filed in the coordinated litigation onbehalf of the issuer defendants, of which Intraware and its three named currentand former officers and directors are a part, on common pleadings issues.  On or about October 9, 2002, the Courtentered and ordered a Stipulation of Dismissal, which dismissed the three namedcurrent and former officers and directors from the litigation withoutprejudice.  On February 19, 2003,the Court entered an order denying in part the issuer-defendants’ omnibusmotion to dismiss, including those portions of the motion to dismiss relatingto Intraware.

 

InJune 2004, a stipulation of settlement for the claims against the issuer-defendants,including us, was submitted to the Court. The underwriter-defendants in the *In re Initial PublicOffering Securities Litigation* (collectively, the “underwriter-defendants”),including the underwriters of our initial public offering, are not parties tothe stipulation of settlement.

 

Thesettlement provides that, in exchange for a release of claims against thesettling issuer-defendants, the insurers of all of the settlingissuer-defendants will provide a surety undertaking to guarantee plaintiffs a$1 billion recovery from the non-settling defendants, including theunderwriter-defendants.  The amount ourinsurers would be

 

11

----

 

requiredto pay to the plaintiffs could range from zero to approximately$3.5 million, depending on plaintiffs’ recovery from theunderwriter-defendants and from other non-settling parties.  If the plaintiffs recover at least$1 billion from the underwriter-defendants, our insurers would have noliability for settlement payments under the terms of the settlement.  If the plaintiffs recover less than$1 billion, we believe our insurance will likely cover our share of anypayments towards satisfying plaintiffs’ $1 billion recovery deficit.  Management estimates that its range of lossrelative to this matter is zero to $3.5 million.  Presently there is no more likely pointestimate of loss within this range.  As aconsequence of the uncertainties described above regarding the amount we willultimately be required to pay, if any, as of May 31, 2005, we have notaccrued a liability for this matter.

 

OnFebruary 15, 2005, the court granted preliminary approval of thesettlement, conditioned upon the parties’ modification of a proposed ban orderwith respect to potential contribution claims. There is no guarantee the settlement will become final as it is subjectto a number of conditions, including the final approval of the court.

 

*Leon Segen v. ComVest Venture Partners. LP. et al.*

* *

InJuly 2004, a complaint was filed in the United States District Court for theDistrict of Delaware, Civ. No. 04-822, against ComVest Venture Partners, LP;ComVest Management, LLC; Commonwealth Associates Management Company, Inc.;Commonwealth Associates, LP; RMC Capital, LLC; Michael S. Falk; RobertPriddy; Travis L. Provow; Keith Rosenbloom; and Intraware.  The complaint describes Intraware as a nominaldefendant.  The complaint alleges that,between August 2001 and January 2002, all of the defendants other thanIntraware were members of a group, and therefore should be treated as a single “person,”for purposes of Sections 13(d)(3) and 16(b) of the Securities Exchange Actof 1934 (the “1934 Act”).  The complaintfurther alleges that ComVest Venture Partners, LP and Mr. Priddy, whilethey and the other alleged group members collectively owned more man 10% of aclass of our equity securities, bought and sold our equity securities within a6-month period and failed to disgorge to us the profits allegedly realized inthose trades, thereby violating Section 16(b) of the 1934 Act.  Mr. Falk was a member of our Board ofDirectors from April 2001 to May 2002 and Mr. Provow was a member of ourBoard of Directors from October 2001 to May 2002.  The complaint demands that ComVest VenturePartners, LP and Mr. Priddy pay over to Intraware the profits theyallegedly realized and retained in violation of Section 16(b) of the 1934Act, together with interest and legal costs. According to the complaint, the amount of those alleged profits isunknown to the plaintiff, however, the information alleged in the complaintsuggests that amount may be approximately $1.3 million.  The complaint does not seek damages againstus.  After the complaint was filed, theplaintiff and Intraware signed a stipulation acknowledging that Intraware takesno position with respect to the claims in the action, and providing thatIntraware accepts service of the complaint, that Intraware is not required tofile an answer or other response to the complaint, and that Intraware willotherwise have the rights and responsibilities of a party to the action.  In June 2005, the court denied motions filedby the defendants other than Intraware to dismiss the plaintiff’s claims.  A trial in this case is currently scheduledto begin in July 2006.

 

Weare also subject to legal proceedings, claims and litigation arising in theordinary course of business.  We do notexpect that the ultimate costs to resolve these matters will have a materialadverse effect on our consolidated financial position, results of operations,or cash flows.

 

**NOTE 5.  REDEEMABLE CONVERTIBLE PREFERRED STOCK**

 

Weare authorized, subject to limitations prescribed by Delaware law, to providefor the issuance of preferred stock in one or more series, to establish fromtime to time the number of shares included within each series, to fix therights, preferences and privileges of the shares of each wholly unissued seriesand any qualifications, limitations or restrictions thereon, and to increase ordecrease the number of shares of any such series (but not below the number ofshares of such series then outstanding) without any further vote or action bythe stockholders.

 

Duringthe three months ended May 31, 2005 there was no activity in our redeemableconvertible preferred stock.

 

12

----

 

**NOTE 6.  NOTES PAYABLE**

 

InAugust 2003, we issued a note payable to Silicon Valley Bank for proceedsof approximately $2.0 million.  The note bears an annual interest rate ofthe greater of 1.00% in excess of the bank’s prime rate (6.00% at May 31, 2005)or 5.25%.  The interest rate on the note payable at May 31, 2005, was7.00%.  The note is payable in fixed monthly principal installments plusinterest through September 2005.  In connection with the notepayable, we issued a warrant to purchase 41,730 shares of our common stock atan exercise price of $1.19 per share.  The warrant was immediatelyexercisable and expires in August 2010.  We estimated the allocatedfair value of such warrant at approximately $46,000, using the Black-Scholesvaluation model with the following assumptions: expected volatility of 136%,risk-free interest rate of 4.01%, expected life of seven years and nodividends.  The value of the warrant was recorded as a debt discount andis being amortized as interest expense using the effective interest method overthe life of the note payable.  For the three months ended May 31, 2005,interest expense related to such warrant amounted to approximately$2,000.  The unamortized balance of approximately $1,000 at May 31, 2005,is presented as a discount against the principal balance of the note payableoutstanding.  At May 31, 2005, the warrants had not been exercised.

 

InAugust 2003, we also entered into an equipment advance agreement withSilicon Valley Bank. The equipment advance agreement bears an annual interestat the greater of the bank’s prime rate plus 1.00% or 5.50%.  Theagreement provided for borrowings of up to $500,000 through August 2004and was limited to equipment purchases.  As of May 31, 2005, we hadborrowed approximately $363,000 under this agreement and the interest rate atthat date was 7.00%.  Monthly payments of interest only were payablethrough August 1, 2004, after which fixed monthly principal installmentsplus interest will be made through August 2006.

 

InSeptember 2004, we entered into a second equipment advance agreement withSilicon Valley Bank.  This new equipment advance agreement bears an annualinterest at the greater of 5.50% or the bank’s prime rate plus 1.00%. This second equipment advance allows us to borrow up to $500,000 through August1, 2005, solely to finance equipment purchases.   As of May 31, 2005,we had borrowed approximately $421,000 under this agreement and the interestrate at that date was 7.00%.  Monthly payments of interest only arepayable through August 2005, after which fixed monthly principalinstallments plus interest will be made through August 2007.

 

Allof this debt is collateralized by a senior security interest in substantiallyall of our assets.  We are also required to maintain compliance withcertain financial covenants, with all of which we were in compliance at May 31,2005.

 

Scheduledmaturities of debt at May 31, 2005, are as follows (in thousands):

 
| **Years ending:** | ** ** | ** ** | ** ** |
|-------------------|------------|------------|------------|
| February 28, 2006 |       | $          | 554        |   |
| February 28, 2007 |       | 301        |       |
| February 29, 2008 |       | 123        |       |
|              |       | $          | 978        |   |

 

**NOTE 7. ALLIANCES**

 

**Provision of Sales and Marketing Services to SoftwareSpectrum for Resale of Third-Party Software**

 

Priorto June 2001, we resold Sun Microsystems, Inc. Internet-related applicationsoftware (marketed under the brands “Sun/Netscape Alliance” and “iPlanet”) andrelated maintenance services to end-users in North America under an agreementbetween us and Sun.  In June 2001, we signed an agreement with SoftwareSpectrum under which we transferred to Software Spectrum our Sun softwareresale business, including our agreement with Sun for resale of Sun softwareand maintenance services.  Software Spectrum assumed primaryresponsibility for resale of Sun software and related maintenance under itsagreement with Sun (which has since been replaced by an agreement betweenSoftware Spectrum and Sun’s distributor).  We continue to assist SoftwareSpectrum in its sales and marketing of the Sun software currently marketedunder the brands “Sun ONE” and “Java Enterprise System,” as well as relatedmaintenance, and also provide our SubscribeNet service to Software Spectrum toenable it to deliver that Sun software to its customers

 

13

----

 

electronically.As part of this arrangement, Software Spectrum pays us a percentage of thegross profit derived from its sales of Sun software licenses and maintenanceservices, and reimburses us for our cost in maintaining a team dedicated tosales of Sun software licenses and maintenance (included in the Alliance and reimbursementrevenue line item on our consolidated statements of operations).  The June2001 agreement with Software Spectrum was part of our transition out of thebusiness of generally reselling third-party software. At the time we announcedthis agreement, we also ceased reselling all third-party software except for alimited number of products that were complementary to our SubscribeNet service.

 

InDecember 2003 and August 2004, we amended our June 2001 agreement with SoftwareSpectrum to add Websense software to the set of products that Software Spectrumand Intraware jointly resell under that agreement. Under these arrangements,Software Spectrum pays us a percentage of the gross profit derived from ourjoint sales of Websense software licenses and maintenance services (included inthe Alliance and reimbursement revenue line item on our consolidated statementsof operations).

 

Thiscontract accounted for more than 10% of our total revenues in our 2005 fiscalyear and during the three months ended May 31, 2005. On June 30, 2005,Intraware and Software Spectrum signed an amendment to that agreement extendingthe term until July 31, 2005, while the companies discuss the potential termsof any longer-term extension or replacement of that agreement.  It is possible that the agreement will expireon July 31, 2005, and that the parties will not extend it further or replace itwith a new agreement. In that event, we would likely experience a substantialand immediate decrease in our revenues and cash flows unless and until we wereable to fully implement a comparable relationship with another business partneror fully transition to becoming an authorized Sun software reseller ourselves(as we were before signing the June 2001 agreement with Software Spectrum). Inaddition, we expect to receive lower margins on the resale of Sun software andmaintenance, thereby decreasing future shared gross profit and reimbursementassociated with our Software Spectrum Alliance.

 

14

----

 

**ITEM 2.MANAGEM****ENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS**

 

Thefollowing discussion of our financial condition and results of operationsshould be read in conjunction with our consolidated financial statements andrelated notes included in our annual report on Form 10-K for the fiscal yearended February 28, 2005, which was filed with the Securities and ExchangeCommission (“SEC”) on April 22, 2005, and the unaudited consolidated financial statementsand related notes contained in this quarterly report on Form 10-Q.  Thisdiscussion contains forward-looking statements that involve risks anduncertainties. Forward-looking statements include statements regarding trendsin the marketplace, our future cash and liquidity position, the extent andtiming of future revenues and expenses and customer demand, the deployment ofour products and services or**the anticipated performance of productsor services, gross margin expectations for Sun software and maintenanceresold through Software Spectrum, statementsregarding the financial statement impact of SFAS 123R, statements regardingfuture economic conditions or performance, and our reliance on thirdparties.  All forward-looking statements included in this document arebased on information available to us as of the date hereof, and we assume noobligation to update any forward-looking statement.  Our actual resultscould differ materially from those anticipated in these forward-lookingstatements as a result of certain factors, including but not limited to, thosediscussed in “Risk Factors” below and elsewhere in this quarterly report onForm 10-Q.

 

**INTRAWARE OVERVIEW**

 

Our goal is to become the defacto standard among digital delivery solution providers. We are pursuing a four-prongedstrategy to achieve this goal. First, we are working to become a profitable,cash-generating company by growing our SubscribeNet business and practicingstringent fiscal responsibility. Second, we are seeking to strengthenour technological advantage and extend the breadth of our functionality in theelectronic software delivery and management (“ESDM”) area by further improvingour ESDM solutions through internal research and development and throughalliances with adjacent technology providers. Third, we are preparing to release a new service called DigitalFastball, which will leverage our digital delivery expertise to enable smalland medium-sized businesses, as well as consumers, to send, receive and managevirtually all types and sizes of digital files over the Internet quickly,easily and securely. Fourth, weare seeking to extend and strengthen our customer base by executing on oursales and marketing plan and by providing exceptional customer service.

 

We currently see a number oftrends in the marketplace that are potentially important for our business.First, growth in the macroeconomy and the technology sector have improved inthe last year, but remain uneven. In the current climate, spending bytechnology companies remains cautious. Second, there appears to be anincreasing pace of mergers and acquisitions in the enterprise software sector.These consolidations pose both opportunities and risks for us, potentiallyleading either to growth in our contracts with those customers or tocancellation of customer contracts. Third, technology companies areincreasingly outsourcing operational functions to reduce costs. Our servicesenable enterprise software companies to outsource key operational functions ina manner that we believe is financially compelling. Therefore, we may benefitfrom this outsourcing trend. Fourth, the use of hosted web-based applications,which in the past has been limited by concerns about speed, reliability andsecurity, is now becoming more accepted among mainstream businesses, largelybecause of a desire for cost savings. This trend may benefit us because ourSubscribeNet service and planned Digital Fastball service are hosted web-basedapplications.  This paragraph containsforward-looking statements that are subject to risks and uncertainties, andactual results could differ materially from those anticipated (see “RiskFactors” beginning on page 25 below).

 

Our managementis focused on five key areas. The first is broadening our SubscribeNet serviceto meet expanding and more sophisticated requirements of the enterprisesoftware industry for digital delivery management systems, includingrequirements for license management and delivery, management of channel partnerrelationships, and electronic commerce. The second is taking advantage, through our planned Digital Fastballservice, of the growing acceptance by non-technology businesses and individualconsumers of the Internet as a medium for exchanging all types of digitalfiles.  The third is leveraging ourrelationships with our strategic allies, including HP and Software Spectrum, toreach new and larger customers for our SubscribeNet service. The fourth is totake advantage of the drive toward greater efficiency among large informationtechnology companies, as evidenced by the increasing consolidation in thatsector, by emphasizing the cost savings that can be realized through broadadoption of electronic software delivery and management. The fifth area is thedevelopment of new pricing packages for our services that emphasize shortersales cycles and strong profit margins.

 

We also face a number of keyrisks, which are described in the “Risk Factors” beginning on page 25 below.

 

We earn revenues andgenerate cash principally through recurring service fees charged for our SubscribeNetservice, professional services fees charged for customization of ourSubscribeNet service, and profit-sharing and cost

 

15

----

 

reimbursement received forour sales and marketing services. Historically, we have also raised substantialamounts of cash through private stock placements.

 

We have incurred losses andnegative cash flows during each fiscal year since inception.  For the three months ended May 31, 2005, ournet loss was approximately $0.5 million and we had negative cash flows fromoperations of approximately $0.4 million. Under our June 2001 agreement withSoftware Spectrum, we provide Sales and Marketing Services to Software Spectrumto assist in its resale and marketing of Sun and Websense software licenses andmaintenance. This contract accounted for more than 10% of our total revenues inour 2005 fiscal year. On June 30, 2005, Intraware and Software Spectrum signedan amendment to that agreement extending the term until July 31, 2005, while thecompanies discuss the potential terms of any longer-term extension orreplacement of that agreement.  It ispossible that the agreement will expire on July 31, 2005, and that the partieswill not extend it further or replace it with a new agreement. In that event,we would likely experience a substantial and immediate decrease in our revenuesand cash flows unless and until we were able to fully implement a comparablerelationship with another business partner or fully transition to becoming anauthorized Sun software reseller ourselves (as we were before signing the June2001 agreement with Software Spectrum). In addition, we expect to receive lowermargins on the resale of Sun software and maintenance, thereby decreasingfuture shared gross profit and reimbursement associated with our SoftwareSpectrum Alliance.  The precedingparagraph contains forward-looking statements that are subject to risks anduncertainties, and actual results could differ materially from thoseanticipated (see “Risk Factors” beginning on page 25 below).

 

We believe that the effectsof our capital financing, strategic actions implemented to improve revenue, andcost controls will be adequate to generate sufficient cash resources to fundour future operations. However, if we fail to sufficiently increase ourrevenues or control spending, our business could be materially adverselyaffected.  The preceding paragraphcontains forward-looking statements that are subject to risks anduncertainties, and actual results could differ materially from thoseanticipated (see “Risk Factors” beginning on page 25 below).

 

**Critical Accounting Policies and Estimates**

 

This MD&A discusses our consolidated financial statements,which have been prepared in accordance with generally accepted accounting principlesin the United States. In preparing these financial statements, we are requiredto make estimates and assumptions affecting the reported amounts of assets andliabilities and the disclosure of contingent assets and liabilities at the dateof the financial statements and the reported amounts of revenues and expensesduring the reporting period. On an ongoing basis, we evaluate our estimates andjudgments. We base our estimates and judgments on historical experience and onvarious other factors believed to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities not readily apparent from other sources. Actualresults may differ from these estimates under different assumptions orconditions.

 

We consider accounting policies related to revenuerecognition, costs of deferred revenue, stock-based compensation, allowance fordoubtful accounts, and income taxes to be critical accounting policies due tothe estimation process involved in each.

 

*Revenue Recognition*

 

We recognize revenue when all of the followingconditions are met:

 

•                  There is persuasive evidence of anarrangement;

 

•                  We have provided the service to the customer,made the software available for customer download through our website, orshipped the software to the customer;

 

•                  We believe that collection of these fees isreasonably assured; and

 

•                  The amount of fees to be paid by the customeris fixed or determinable.

 

Online services and technology revenue resultsprimarily from four types of arrangements.  First, it results from salesof our SubscribeNet digital delivery service to software vendors and othercompanies that distribute software as part of their business.  Second, itresults from professional services that we provide to customize ourSubscribeNet service for customers, to convert data for customers, and tointegrate our proprietary software.  Third, it results from services orlicenses for third-party products complimentary to our SubscribeNet servicethat we resell. Fourth, it results from the sale of our proprietary softwarelicenses and related maintenance to companies using those products internallyor using those products to provide web-based services to their customers. As aresult of the sale of our Asset Management software business in May 2002,we are not currently deriving revenue from licenses, maintenance or integrationservices for our proprietary software; however, we may recognize such revenuesin the future if opportunities arise to sell licenses

 

16

----

 

forour proprietary software underlying our SubscribeNet service and relatedmaintenance. We sell our SubscribeNet service, and will sell proprietarysoftware licenses if opportunities present themselves, primarily through ourdirect sales force and authorized resellers.

 

Alliance and reimbursement revenue primarily relatesto our alliance agreement with Software Spectrum for sales and marketingservices. This revenue consists of a percentage of the gross profit derivedfrom Software Spectrum’s sales of the third-party software and maintenance forwhich we provide sales and marketing services, and reimbursement for the costsof maintaining a sales team dedicated to providing sales and marketing servicesto Software Spectrum for that third-party software and maintenance. Thisrevenue is recognized as we provide the services to Software Spectrum.

 

We derive software product revenues from our pastresales of licenses and maintenance for multiple business software productlines. As of July 1, 2001, we generally no longer resell third-partysoftware licenses and maintenance. Since July 1, 2001, we have continuedto recognize revenue from our resale of third-party software licenses andrelated maintenance contracts over the life of the arrangements made priorto July 1, 2001. Vendorspecific objective evidence of fair value for the maintenance element of theresold software arrangements has been based on historical and contractualrenewal rates for maintenance. We deferred the maintenance revenue at theoutset of the arrangement and recognized it ratably over the period duringwhich the maintenance was to be provided.  This period normally commencedon the date the software was delivered and generally continued for 12 months,although certain maintenance contracts continued for longer periods.  Sincethe three months ended May 31, 2004, we have no longer recognized any revenuerelating to software product sales.

 

We defer online services and technology revenuesrelated to our SubscribeNet digital delivery service and generally recognizethem ratably over the term of the service arrangement. Some SubscribeNetservice implementations for new customers involve customization essential tothe functionality of the service.  In those cases, we defer revenuerecognition until the service go-live date is reached and recognize the revenueon a ratable basis over the remaining contract term.  The go-live date isthe later of the date on which the essential functionality is delivered or thepoint at which no additional customization is required.  Our SubscribeNetcontracts with customers typically give the customer a period of time(generally five days) to evaluate a SubscribeNet implementation after we have completedit, and provide that the customer is deemed to have accepted the implementationif it has not affirmatively rejected it within that period.  We typicallyrely on such non-rejections by customers to indicate their acceptance ofimplementations.  Any subsequent indications by our customers that theirimplementations have not been properly completed could have a material adverseimpact on our financial condition or results of operations.

 

We also sell additional professional servicesrelated to SubscribeNet agreements.  Generally, these services do notprovide stand-alone value to a customer, and accordingly, we defer recognitionof that revenue until the go-live date for the professional services, similarto the manner in which we treat SubscribeNet service revenues as discussedabove.  Such professional services revenues are recognized ratably overthe longer of the remaining estimated customer life or the remaining contractterm, commencing with the completion of the professional services. Estimated customerlife requires that we periodically estimate the projected life of our existingcustomers, based on historical information, such as customer renewal rates.Since revenues generated from additional professional services represent lessthan 5% of our overall revenues for the three months ended May 31, 2005, anychange to our estimated customer life is unlikely to have a material adverseimpact on our financial condition or results of operations.

 

Online services and technology revenues related toservices or licenses for third-party products complimentary to our SubscribeNetservice that we resell are generally recognized as the service isprovided.  If the service or licenseresold involves customization essential to the functionality of the underlyingSubscribeNet service, the fees charged for the customization is recognized asrevenue in the same manner in which we treat the professional servicesdiscussed above. Revenue related to these resold services or licenses arerecognized as revenue based on the fee charged to the customer as we bear thecredit risk for resold services or licenses, have the latitude to establishpricing at our discretion, and are primarily responsible for acceptability ofthe services or licenses delivered.  Inaddition, costs paid to the third-party providers are recorded as cost ofrevenues and recognized in the same manner as the related revenue.

 

17

----

 

As mentioned above, a determination that thecollection of fees is reasonably assured is a precursor to recognizing revenue.Determination of collectability of payments requires judgment on the part ofmanagement and includes periodically evaluating customers’ credit-worthiness (see“Allowance for Doubtful Accounts” below).

 

*Costs of Deferred Revenue*

 

We capitalize direct costs of revenues related tosignificant SubscribeNet service implementations and established professionalservices contracts associated with our SubscribeNet services.  Directcosts include compensation and payroll-related fringe benefits directly relatedto the time spent on significant implementation and professional servicesactivities.  These costs are recognized over the same term as theassociated revenue from those contracts (see “Revenue Recognition” above).Costs associated with professional services involving significant new functionalityfor the SubscribeNet service that are partially or fully funded by customersbut do not qualify as funded research and development activities are expensedas cost of revenues as incurred until a working model is delivered to thecustomer. Once a working model has been delivered, all additional direct costsare capitalized in the same manner discussed above. Any change in our revenuerecognition estimates could result in corresponding changes to our recognitionof costs of deferred revenues. At May 31, 2005, we had approximately$0.5 million in capitalized costs relating to deferred revenues.  Weexpense customer acquisition costs, including sales commissions, as incurred.

 

*Stock-based Compensation*

 

We account for stock-based compensation for ouremployees using the intrinsic value method presented in Accounting PrinciplesBoard (APB) No. 25, ”Accounting for Stock Issued to Employees,” andrelated interpretations, and comply with the disclosure provisions of Statementof Financial Accounting Standard (SFAS) No. 123, ”Accounting forStock-Based Compensation,” and with the disclosure provisions of SFAS No.148, ”Accounting for Stock-Based Compensation—Transition and DisclosureAmendment of SFAS No. 123.” Under APB No. 25, compensation expense is based onthe difference, as of the date of the grant, between the fair value of ourstock and the exercise price. For our fiscal quarter ended May 31, 2005, nostock-based compensation was recorded for stock options granted to ouremployees because the exercise price of all stock options granted to ouremployees was equal to the market price of the underlying stock on the date ofgrant.

 

In December 2004, the Financial AccountingStandards Board (FASB) issued SFAS No. 123 (Revised) “Share Based Payment”(SFAS No. 123R). The standard requires companies to value employee stockoptions and stock issued under employee stock purchase plans using the fairvalue based method on the grant date and record stock-based compensationexpense. The fair value based models that companies are allowed to use can bedifferent from the Black-Scholes option-pricing model, which we currently useto calculate the pro forma effect on net income and earnings per share if wehad applied SFAS No. 123 to employee option grants. Note 2 to our unauditedinterim consolidated financial statements shows what the pro forma net loss andloss per share for the fiscal quarter ended May 31, 2005 and May 31,2004 would have been if we had applied SFAS No. 123.  However, the actualimpact to our results of operations upon adoption of the standard couldmaterially differ from the pro forma information included in Note 2 to ourunaudited interim consolidated financial statements due to differences in theoption-pricing model used, estimates and assumptions required, and options tobe included in the calculation upon adoption. The fair value based modelsrequire the input of highly subjective assumptions and do not necessarilyprovide a reliable single measure of the fair value of our stock options. InApril 2005, the SEC issued a release which amends the compliance dates for SFASNo. 123R.  Accordingly, we will berequired to adopt the new accounting provisions beginning in our first quarterof our fiscal year ending February 28, 2007.

* *

*Allowance for Doubtful Accounts*

 

We maintain an allowance for doubtful accounts forestimated losses from our inability to collect required payments from ourcustomers. When evaluating the adequacy of this allowance, we analyze specificaccounts receivable, historical bad debts, customer credit-worthiness, currenteconomic trends and changes in our customers’ payment history.  We mayneed to record increases to our allowance balances in the future.  At May31, 2005, we have many accounts receivable balances and one large unbilledreceivable balance.  Any dispute, early contract termination or othercollection issue related to these receivable balances could have a materialadverse impact on our financial condition or result of operations. At May 31,2005, our unbilled receivable balance was $0.3 million. This balance relates toour Software Spectrum agreement (see “Revenue Recognition” above). There are noallowances for doubtful accounts related to this balance. This estimateinvolves management’s judgment, which takes into account Software Spectrum’s

 

18

----

 

priorpayment history, current credit-worthiness and overall business condition.Changes in the above factors could have a material impact on actual bad debtsincurred.

 

*Income Taxes*

 

In conjunction with preparing our financialstatements, we must estimate our income taxes in each of the jurisdictions inwhich we operate. This process involves estimating our actual current taxexpense together with assessing temporary differences resulting from differingtreatment of items for tax and accounting purposes. These differences result indeferred tax assets and liabilities. We must then assess the likelihood thatour deferred tax assets will be recovered from future taxable income and to theextent we believe that recovery is not likely, we must establish a valuationallowance. Given that we have incurred losses since inception and thereforehave not been required to pay income taxes, we have fully reserved our deferredtax assets at May 31, 2005.  In the event that we are able to realize ourdeferred tax assets in the future, an adjustment to the deferred tax assetwould increase income in the period that this is determined.

 

**Results of Operations**

 

*Total Revenue*

 

Thefollowing table sets forth the revenue, changes in revenue and percentage oftotal revenue for the periods indicated (in thousands, except percentageamounts):

 
| ** **                                    | ** ** | **For the three months ended** | ** ** |
|-----------------------------------------------|------------|--------------------------------|------------|
| ** **                                    | ** ** | **May 31, 2005**               | ** ** | **May 31, 2004** | ** ** |
| ** **                                    | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **% of** | ** ** |
| ** **                                    | ** ** | **Total**                      | ** ** | **Change** | ** ** | **% of Revenue** | ** ** | **Total** | ** ** | **Revenue** | ** ** |
| ** **                                    | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues:                                     |       |                           |       |   |   |   |   |   |   |   |   |
| Online services and technology                |       | $                              | 2,340      |   | $ | 645 |   | 82 | % | $ | 1,695 |   | 60 | % |
| Alliance and reimbursement                    |       | 503                            |       | (73 | ) | 18 | % | 576 |   | 20 | % |
| Related party online services and  technology |       | 3                              |       | (531 | ) | 0 | % | 534 |   | 19 | % |
| Software product sales                        |       | —                         |       | (42 | ) | 0 | % | 42 |   | 1 | % |
| Total revenues                                |       | $                              | 2,846      |   | $ | (1 | ) |   |   | $ | 2,847 |   |   |   |

 

Combined online services andtechnology revenue results primarily from sales of our SubscribeNet services. Revenues for online services and technology for the three months ended May 31,2005, increased from the three months ended May 31, 2004.  The onlineservices and technology revenue increase during the three months ended May 31,2005, as compared to the three months ended May 31, 2004, is primarily due totwo factors: 1) approximately $0.3 million in revenue recognized from newSubscribeNet customers whose go-live date has been achieved since May 31, 2004;and 2) approximately $0.3 million in additional revenue recognized fromexpanded contracts from existing customers.  The related party onlineservices and technology revenue decrease resulted from our recognition of theremaining deferred revenue under our strategic alliance agreement with ZomaxIncorporated, upon termination of that agreement in the prior year.  We expect our online services and technology revenue and related party onlineservices and technology revenues for our second quarter ending August 31, 2005,to be consistent with or slightly higher than the three months ended May 31,2005.  The previous sentence is a forward-looking statement that issubject to risks and uncertainties, and actual results could differ materiallyfrom those anticipated (see “Risk Factors” beginning on page 25 below).

 

Allianceand reimbursement revenue primarily relates to our alliance agreement withSoftware Spectrum for sales and marketing services. This revenue consists of apercentage of the gross profit derived from Software Spectrum’s sales of Sunand Websense software and maintenance for which we provide sales and marketingservices, and reimbursement for the costs of maintaining a team dedicated toproviding sales and marketing services to Software Spectrum for thatthird-party software and maintenance.  This alliance agreement withSoftware Spectrum accounted for

 

19

----

 

morethan 10% of our total revenue during the three months ended May 31, 2005(see “Risk Factors” beginning on page 25 below). The decrease in alliance andreimbursement revenue for the three months ended May 31, 2005, wasprimarily due to a $0.1 million reduction of the amount Software Spectrumreimburses us for our sales and marketing services.  We expect ouralliance and reimbursement revenues in our fiscal quarter ending August 31,2005, to be slightly lower than the three months ended May 31,2005.   The previous sentence is a forward-looking statement that issubject to risks and uncertainties, and actual results could differ materiallyfrom those anticipated (see “Risk Factors” beginning on page 25 below).  More generally, the Sun software we resell throughour alliance with Software Spectrum has experienced a decrease in market shareover the past several quarters, which has contributed to a reduction in ouralliance and reimbursement revenues.  Weexpect this product line to experience continued pressure in the marketplaceover the longer term.  In addition, weexpect to receive lower margins on the resale of Sun software and maintenance,thereby decreasing future shared gross profit and reimbursement associated withour Software Spectrum alliance.  Theprevious two sentences are forward-looking statements that are subject to risksand uncertainties, and actual results could differ materially from thoseanticipated (see “Risk Factors” beginning on page 25 below).

 

OnJune 30, 2005, Intraware and Software Spectrum signed an amendment to our June2001 agreement extending the term until July 31, 2005, while the companiesdiscuss the potential terms of any longer-term extension or replacement of thatagreement.  It is possible that theagreement will expire on July 31, 2005, and that the parties will not extend itfurther or replace it with a new agreement. In that event, we would likelyexperience a substantial and immediate decrease in our revenues and cash flowsunless and until we were able to fully implement a comparable relationship withanother business partner or fully transition to becoming an authorized Sunsoftware reseller ourselves (as we were before signing the June 2001 agreementwith Software Spectrum).  It is alsopossible that Sun and/or Websense will choose to stop permitting SoftwareSpectrum to resell their software. Any termination of the rights to resell Sunsoftware either through a partner or directly, would likely cause a substantialand immediate decrease in our revenues and cash flows.

 

Thedecline in software product revenue for the three months ended May 31,2005, was due to our transition out of the business of directly resellingthird-party software products and related maintenance in June 2001.  We donot expect to recognize future revenues from our exited third-party resalebusiness.  However, we may recognize future revenues from resales ofsoftware licenses and related services that are complementary to ourSubscribeNet service and which we resell as part of a comprehensive ESDMbusiness solution.  The previous sentences are forward-looking statementsthat are subject to risks and uncertainties, and actual results could differmaterially from those anticipated (see “Risk Factors” beginning on page 25below).

 

*Costs and Expenses*

 

Thefollowing table sets forth the costs and expenses, changes in costs andexpenses and percentage of total revenue for the periods indicated (inthousands, except percentage amounts):

 
| ** **                 | ** ** | **For the three months ended** | ** ** |
|----------------------------|------------|--------------------------------|------------|
| ** **                 | ** ** | **May 31, 2005**          | ** ** | **May 31, 2004** | ** ** |
| ** **                 | ** ** | **Total**                      | ** ** | **Change** | ** ** | **% of Revenue** | ** ** | **Total** | ** ** | **% of   Revenue** | ** ** |
|                       |       |                           |       |   |   |   |   |   |   |   |   |
| Total cost of revenues     |       | $                              | 1,523      |   | $ | 528 |   | 54 | % | $ | 995 |   | 35 | % |
| Gross margin               |       | 1,323                          |       | (529 | ) | 46 | % | 1,852 |   | 65 | % |
| Operating expenses:        |       |                           |       |   |   |   |   |   |   |   |   |
| Sales and marketing        |       | 682                            |       | (70 | ) | 24 | % | 752 |   | 26 | % |
| Product development        |       | 250                            |       | (153 | ) | 9 | % | 403 |   | 14 | % |
| General and administrative |       | 944                            |       | 155 |   | 33 | % | 789 |   | 28 | % |
| Total operating expenses   |       | $                              | 1,876      |   | $ | (68 | ) | 66 | % | $ | 1,944 |   | 68 | % |

 

*Cost of Revenues*

 

Theincrease in cost of revenues and decrease in margin percentage for the threemonths ended May 31, 2005, is primarily due to the $0.6 million increasein online services and technology cost of revenues.   Approximately $0.2 million of this increasewas due to variable support costs for higher bandwidth utilization rates andincremental investments in our SubscribeNet service infrastructure.  In addition, since May 31, 2004, we haveincreased our internal efforts from our product development teams in cost ofrevenues activities by approximately $0.2 million.

 

Costof revenues primarily consists of certain allocated costs related to ourInternet connectivity, assets supporting cost of revenues, and customersupport, as well as the costs associated with maintaining our team dedicated to

 

20

----

 

helpingSoftware Spectrum sell Sun and Websense software, for which we are reimbursedby Software Spectrum. Cost of revenues also consists of professional servicespersonnel costs and the cost of third-party products and services sold. When we were in the business of directly reselling third-party softwareproducts, we purchased those products at a discount from the third-parties’established list prices according to standard reseller terms.  We expecttotal cost of revenues for the current fiscal year to be higher than our fiscalyear 2005 amounts.  In addition, weexpect our gross profit margin percentage for the current fiscal year to be significantlylower than those for our fiscal year 2005. Our quarterly cost of revenues mayfluctuate based on multiple variables including but not limited to revenue mixfluctuations, levels of professional services activities, infrastructure costs,and variable external support utilization rates, and expect our margins tofluctuate accordingly. The previous sentences are forward-looking statementsthat are subject to risks and uncertainties. The actual mix of salestransactions and the timing of the transactions may cause our cost of revenuesand gross profit margins to fluctuate materially from those anticipated (see “RiskFactors” beginning on page 25 below).

 

*Sales and Marketing Expenses*

 

Salesand marketing expenses consist primarily of employee salaries, benefits andcommissions, advertising, consulting, promotional materials, trade showexpenses and certain allocated overhead costs.

 

Thedecrease in the dollar amount of our sales and marketing expenses for the threemonths ended May 31, 2005, is primarily due to a decrease of approximately$0.1 million in outside services related to marketing and advertising from ourprior year.

 

Weexpect our sales and marketing expenditures in fiscal year 2006 to beconsistent with those in fiscal year 2005. We plan to continue to market andsell our services, and may market and sell proprietary software licenses,directly to customers using our existing sales force and through resellers. Wealso plan to continue to develop alliances with other companies to sell ourservices to a broader customer base. The previous three sentences areforward-looking statements that are subject to risks and uncertainties, andactual results could differ materially from those anticipated (see “RiskFactors” beginning on page 25 below).

 

*Product Development Expenses*

 

Productdevelopment expenses primarily consist of personnel, consulting, software andrelated maintenance, equipment depreciation expenses and allocated overheadcosts.  Costs related to research, design and development of products andservices have been charged to product development expense as incurred.

 

Thedecrease in our product development expenses for the three months ended May 31,2005, compared to the three months ended May 31, 2004, is due primarily toa decrease in effort by our internal efforts on product development activitiesof approximately $0.2 million.  Duringthe three months ended May 31, 2005, the engineering department increasedtheir focus on cost of sales activities as noted above.

 

Weanticipate continuing to invest in additional functionality for ourSubscribeNet service and underlying proprietary software. However, we expectthose investments to fluctuate over time, and expect our product developmentexpenses to fluctuate accordingly. We expect total product developmentexpenditures in fiscal year 2006 to be higher than fiscal year 2005. Theprevious sentences are forward-looking statements that are subject to risks anduncertainties, and actual results could differ materially from thoseanticipated (see “Risk Factors” ” beginning on page 25 below ). We cannot giveassurance that our product development efforts will result in new or improvedproducts, features or functionality or that the market will accept theimprovements to existing or new products, features or functionality developed.

 

*General and Administrative Expenses*

 

Generaland administrative expenses consist primarily of compensation foradministrative and executive personnel, fees for professional services andcertain overhead costs.

 

Ourgeneral and administrative expenses increase for the three months ended May 31,2005, is primarily due to an increase in outside services for businessconsulting services of approximately $0.1 million.  In addition, during the

 

21

----

 

threemonths ended May 31, 2004, we collected approximately $0.1 million relatedto previously written off accounts receivable.

 

Weexpect total expenditures in fiscal year 2006 to slightly increase from ourfiscal year 2005 levels. The previous sentence is a forward-looking statementthat is subject to risks and uncertainties, and actual results could differmaterially from those anticipated (see “Risk Factors” beginning on page 25below).

 

*Interest Expense*

 

Forthe three months ended May 31, 2005, interest expense was approximately$19,000, a decrease from $29,000 for the three months ended May 31, 2004.

 

Interestexpense primarily relates to obligations under notes payable and our equipmentadvance.  The decrease in interest expense for the three months ended May 31,2005, is primarily due to the reduction of the principal balance on our notespayable.

 

*Interest and Other Income and Expenses, Net*

 

Forthe three months ended May 31, 2005, interest and other income andexpenses, net was approximately a $53,000 credit, an increase from a $16,000credit for the three months ended May 31, 2004.

 

Interestand other income and expenses, net primarily relates to interest earned on ourinvestment balances.  The increase in interest and other income andexpenses, net for the three months ended May 31, 2005, is primarily theresult increased returns on our cash balances from the prior year.

 

*Income Taxes*

 

From inception through February 28,2005, we incurred net losses for federal and state tax purposes and have notrecognized any tax provision or benefit. As of February 28, 2005, we hadapproximately $88 million of federal and $47 million of state net operatingloss carryforwards available to offset future taxable income, which expire invarying amounts between fiscal year 2006 and 2025. The Tax Reform Act of 1986limits the use of net operating losses and tax credit carryforwards in certaincircumstances where changes occur in the stock ownership of a company. Becauseof cumulative ownership changes in the past, the federal and state losscarryforwards have been reduced by the amount of the net operating losscarryforwards that will expire. Because of these cumulative ownership changes,federal loss carry forwards totaling approximately $44 million and state losscarry forwards totaling approximately $22 million are subject to limitation. AtFebruary 28, 2005, $44 million and $25 million of federal and state netoperating losses, respectively, are available without limitation to offsetfuture taxable income. Should there be a change of ownership in the future, theavailable net operating losses may be further limited. Given our limitedoperating history, losses incurred to date and the difficulty in accuratelyforecasting our future results, management does not believe that therealization of the related deferred income tax asset meets the criteriarequired by generally accepted accounting principles.

 

22

----

 

**Liquidityand Capital Resources**

 

The following table presentsour liquidity position at May 31, 2005 and 2004 (in thousands):

 
| ** **                                           | ** ** | **For the three months ended** | ** ** |
|------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                           | ** ** | **May 31, 2005**          | ** ** | **May 31, 2004** | ** ** |
|                                                 |       |                           |       |   |   |
| Cash and cash equivalents                            |       | $                              | 8,804      |   | $ | 10,855 |   |
| Working capital                                      |       | $                              | 6,865      |   | $ | 8,345 |   |
| Net cash used in operating activities                |       | $                              | (423       | ) | $ | (877 | ) |
| Net cash provided by (used in) financing  activities |       | $                              | (126       | ) | $ | 15 |   |
| Net cash used in investing activities                |       | $                              | (110       | ) | $ | (87 | ) |

 

Ournet cash used in operating activities was $0.4 million for the three monthsended May 31, 2005, down from $0.9 million net cash used inoperations in the three months ended May 31, 2004. This decrease wasprimarily due to approximately $0.2 million in incremental payments in theprior year for insurance policies.  Theseinsurance policies were financed during the three months ended May 31,2005.  In addition, we decreased cash outlaysfor marketing efforts from outside services by approximately $0.2 millionduring the three months ended May 31, 2005.  During the three months ended May 31,2004, we also made a one time payment of approximately $0.1 million to ZomaxIncorporated for their prepayment of future services in October 2003. Ouroverall net cash used in operating activities primarily resulted from our netloss for the year and the timing of our payments to vendors and receipts fromcustomers. The majority of our operating costs continue to relate to employeepayroll and related expenditures.  The net cash used in operatingactivities for the three months ended May 31, 2005, came from our existingcash and cash equivalents, and from our previous issuances of common stock inconnection with warrant exercises, our employee stock purchase plan and ouremployee stock option plans.  Our ability to improve our uses of cash andgenerate positive cash flows in future periods will largely depend on ourability to increase the number of customers of our SubscribeNet service whileincreasing existing subscriptions through strong contract renewals. Theprevious sentence is a forward-looking statement that is subject to risks anduncertainties, and actual results could differ materially from thoseanticipated (see “Risk Factors” beginning on page 25 below). It is alsoimportant for us to increase our current level of sales, and continue tocontrol our operational and customer support costs in future periods.

 

Ournet cash used in financing activities was approximately $0.1 million forthe three months ended May 31, 2005.  This primarily came fromprincipal payments on our notes payable of approximately $0.3 million.  These payments were partially offset byadditional borrowings under our equipment advance agreement (see below) of $0.1million and from the issuance of approximately 0.1 million shares of commonstock in connection with our stock option and employee stock purchase plan forapproximately $0.1 million.

 

Asof May 31, 2005, we have an agreement with Silicon Valley Bank under whichwe have a note payable and an equipment advance outstanding.  The note payable and the equipment advance bearan annual interest rate of the greater of 1% in excess of the bank’s prime rate(6.00% at May 31, 2005) or 5.25% and 5.50% respectively, and are payablein fixed monthly installments through September 2005 and 2006,respectively.  At May 31, 2005, the interest rate for the notepayable and the equipment advance was 7.00%.

 

Inaddition, in August 2004, we entered into a second equipment advanceagreement that allows us to draw for equipment purchases through August 1,2005, up to $500,000.   The second equipment advance agreementcarries the same interest rate that applies to the equipment advance referencedabove.  See the table titled “Paymentsdue by period” below for details regarding repayment of the above debtobligations.  At May 31, 2005,approximately $79,000 of the second equipment advance remains available to bedrawn upon.

 

Underthe agreement for the note payable and equipment advances, all borrowings arecollateralized by a senior security interest in substantially all of ourassets. The agreements also require us to comply with financial covenants, withwhich we were in compliance as of May 31, 2005. The agreements furtherrestrict us from incurring or assuming

 

23

----

 

additionalindebtedness outside of the note payable and equipment advances, excludingtrade payables and certain other liabilities incurred in the ordinary course ofbusiness.

 

Ournet cash used in investing activities during the three months ended May 31,2005, was $0.1 million. This amount was comprised of our purchases of fixedassets. We paid for these equipment purchases from our cash and cashequivalents, but later drew down approximately $0.1 million under theabove-mentioned second equipment advance agreement to finance these purchases.We used these fixed asset purchases primarily to upgrade and expand ourSubscribeNet infrastructure and corporate information systems. We expect tocontinue to use and renew our equipment advance agreement to finance additionalfixed asset purchases at levels that approximate or are slightly higher thanour prior year levels. The previous sentence is a forward-looking statementthat is subject to risks and uncertainties, and actual results could differmaterially from those anticipated (see “Risk Factors” beginning on page 25below).

 

Webelieve our existing cash and cash equivalents, together with any cashgenerated from future operations, will be sufficient to fund our operatingactivities, capital expenditures and financing arrangements for the foreseeablefuture. However, if our SubscribeNet business fails to grow significantly ordeclines from its current level, we could be forced to seek additional capital.The previous sentence is a forward-looking statement that is subject to risksand uncertainties, and actual results could differ materially from thoseanticipated (see “Risk Factors” beginning on page 25 below).

 

AtMay 31, 2005, we did not have any relationships with unconsolidatedentities or financial partnerships, such as entities often referred to asstructured finance or special purpose entities, which would have beenestablished for the purpose of facilitating off-balance sheet arrangements orother contractually narrow or limited purposes. As such, we are not materiallyexposed to any financing, liquidity, market or credit risk that could arise ifwe had engaged in such relationships.

 

Thefollowing table summarizes our debt and lease obligations at May 31, 2005,and the effect such obligations are expected to have on our liquidity and cashflow in future periods (in thousands). This table provides information throughour year ending February 28, 2010, as we do not have any debt or leaseobligations beyond that point.

 
| ** **       | ** ** | **Payments due by period** | ** ** |
|------------------|------------|----------------------------|------------|
| ** **       | ** ** | ** **                 | ** ** | **Less than** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **       | ** ** | **Total**                  | ** ** | **1 Year** | ** ** | **1-3 year (a)** | ** ** | **3-5 year (b)** | ** ** |
| Long-term debt   |       | $                          | 1,033      | (c) | $ | 588 |   | $ | 445 |   | $ | - |   |
| Operating leases |       | 2,507                      |       | 440 |   | 1,767 |   | 300 |   |
|             |       | $                          | 3,540      |   | $ | 1,028 |   | $ | 2,212 |   | $ | 300 |   |

 

----

(a)   Includespayments from March 1, 2006 through February 28, 2009.

 

(b)   Includespayments from March 1, 2009 through February 28, 2010.

 

(c)   Thisamount includes approximately $55,000 in interest.

 

Asof May 31, 2005, our Series A redeemable convertible preferred stockentitled its holders to a liquidation preference of $1.0 million in theevent of Intraware’s liquidation.

 

**Recent Accounting Pronouncements**

 

In December 2004, theFASB issued SFAS No. 123 (Revised 2004) “Share-Based Payment” (“SFAS No. 123R”).SFAS No. 123R addresses all forms of share-based payment (“SBP”) awards,including shares issued under employee stock purchase plans, stock options,restricted stock and stock appreciation rights. SFAS No. 123R will requireus to expense SBP awards with compensation cost for SBP transactions measuredat fair value. The FASB originally stated a preference for a lattice modelbecause it believed that a lattice model more fully captures the uniquecharacteristics of employee stock options in the estimate of fair value, ascompared to the Black-Scholes model which we currently use for our footnotedisclosure. The FASB decided to remove its explicit preference for a latticemodel and not require a specific valuation methodology. In April 2005, theSecurities and Exchange Commission (“SEC”) issued a release which amends thecompliance dates for SFAS No. 123R. Accordingly, we will be required to adopt the new accounting provisionsbeginning in the first quarter of our fiscal year ending February 28,2007. 

 

On March 29, 2005, the SECissued Staff Accounting Bulletin (SAB) 107 which expresses the views of the SECregarding the interaction between SFAS No. 123R and certain SEC rules andregulations and provides the SEC’s views regarding the valuation of share-basedpayment arrangements for public companies. In particular, SAB 107 providesguidance related to share-based payment transactions with nonemployees, thetransition from nonpublic to public entity status, valuation methods (includingassumptions such as expected volatility and expected term), the accounting forcertain redeemable financial instrument issues under share-based paymentarrangements, the classification of compensation expense, non-GAAP financialmeasures, first-time adoption of SFAS No. 123R in an interim period,capitalization of compensation costs related to share-based paymentarrangements, the accounting for income tax effects of share-based paymentsarrangements upon adoption of SFAS No. 123R, the modification of employee shareoptions prior to adoption of SFAS No. 123R, and disclosures in Management’sDiscussion and Analysis of Financial Condition and Results of Operationssubsequent to adoption of SFAS No. 123R. We expect the adoption of SFAS No. 123Rand SAB 107 will have a material adverse impact on our results of operationsand loss per share. We are currently in the process of evaluating the extent ofsuch impact.

 

In May 2005, the FASB issuedSFAS No. 154, "Accounting Changes and Error Corrections".  SFAS No. 154 replaces APB Opinion No. 20,"Accounting Changes", and SFAS No. 3, "Reporting AccountingChanges in Interim Financial Statements". SFAS No. 154 requires retrospective application to prior periods'financial statements of changes in accounting principle, unless it isimpracticable to determine either the period-specific effects or the cumulativeeffect of the change.  We do not expectthe adoption of SFAS No. 154 to have a material impact on our consolidatedfinancial statements.

 

24

----

 

**RISK FACTORS**

 

Youshould carefully consider the risks described below before making a decision toinvest in our common stock.  The risksand uncertainties described below are not the only ones facing Intraware.  Additional risks and uncertainties notpresently known to us or that we do not currently believe are important to aninvestor may also harm our business operations. If any of the events, contingencies, circumstances or conditions describedin the following risks actually occur, our business, financial condition or ourresults of operations could be seriously harmed.  If that occurs, the trading price of ourcommon stock could decline, and you may lose part or all of your investment.

 

**Revenues to us under ourSales and Marketing Services arrangement with Software Spectrum are likely todecline over the long term.  Also, anytermination of our relationship with Software Spectrum in the near term, withoutan adequate replacement, would cause a substantial decrease in our revenues.**

** **

Under our June 2001agreement with Software Spectrum, we provide Sales and Marketing Services toSoftware Spectrum to assist in its resale and marketing of Sun and Websensesoftware licenses and maintenance.  Software Spectrum shares with us a portion ofits gross profit from resales of Sun and Websense software licenses andmaintenance, and reimburses us for a substantial portion of our cost ofmaintaining a team dedicated to sales and marketing of that software andmaintenance.  This contract accounted forsubstantially all of our Alliance and reimbursement revenues, a significantportion of our Online services and technology revenues, and more than 10% ofour total revenues in our 2005 fiscal year. While this agreement covers resales of Sun and Websense software andmaintenance, most of the sales under the agreement are of Sun software andmaintenance.  In recent years, sales andmarket share of those Sun software product lines have generally declined.  If this trend continues, revenues to us underthis contract are likely to decrease over the long term.  In addition, we expect Sun to decrease theamount of gross profit it allows Software Spectrum to retain from customerrenewals of Sun software maintenance, which would in turn reduce the amount ofgross profit we would receive from such maintenance renewals.  Currently most of our Alliance andreimbursement revenues and a portion of our Online services and technology revenuesare derived from Sun maintenance renewals. On June 30, 2005, Intraware andSoftware Spectrum signed an amendment to the June 2001 agreement extending theterm until July 31, 2005, while the companies discuss the potential terms ofany longer-term extension or replacement of that agreement.  It is possible that the agreement will expireon July 31, 2005, and that the parties will not extend it further or replace itwith a new agreement. In that event, we would likely experience a substantialand immediate decrease in our revenues and cash flows unless and until we wereable to fully implement a comparable relationship with another business partneror fully transition to becoming an authorized Sun software reseller ourselves(as we were before signing the June 2001 agreement with Software Spectrum).  It is also possible that Sun and/or Websensewill choose to stop permitting Software Spectrum to resell their software. Anytermination of the rights to resell Sun software either through a partner ordirectly, would likely cause a substantial and immediate decrease in ourrevenues and cash flows.

 

**The loss of one or moreof our key customers or partners could cause our revenue growth to slow orcause our revenues to decline.**

** **

Asubstantial amount of the revenues from our SubscribeNet service come from arelatively small number of companies. These include software providers to whom we provide our SubscribeNetservice, as well as Software Spectrum, to whom we provide both our SubscribeNetservice and sales and marketing services. Our contracts with most of these companies are subject to renewal orcancellation annually.  If any of thesecompanies elected to cancel their agreements with us, our revenue growth wouldlikely slow or our revenues might decline. Either of these types of events could reduce our sales through loss ofexisting customers, or reduce our margins through increased price competition.

 

**Mergers and acquisitionsin the technology sector could harm us by causing cancellation of customercontracts where our customers are acquired, or by strengthening ourcompetitors.**

** **

Inrecent years, there has been an increase in mergers and acquisitions amongtechnology companies.  This trend posesrisks for us.  First, our customers aretechnology companies, and any acquisitions of our customers could lead tocancellation of our contracts with those customers by the acquiringcompanies.  This recently occurred whenOracle Corporation notified us of its cancellation of our contract with ourcustomer PeopleSoft, Inc., after Oracle acquired PeopleSoft.  (This contract accounted for less than 3% ofour total annual revenues for our 2005 fiscal year.)

 

25

----

 

Second,our competitors also are technology companies. Any acquisitions of other companies by our competitors, or acquisitionsof our competitors by other companies, are likely to result in strongercompanies competing against us.

 

**If the bid price of our stock does not close at or above $1.00 for 10consecutive business days before August 22, 2005, or before February 22, 2006,if our compliance period is extended, our stock may be delisted from the NasdaqSmallCap Market.**

 

On February23, 2005, we received a letter from The Nasdaq Stock Market indicating that,for 30 consecutive business days, the bid price of our stock had closed belowthe minimum $1.00 per share requirement for continued  listing on the Nasdaq SmallCap Market andthat, in accordance with NASD rules, we had 180 calendar days to regaincompliance. The letter also stated that if, at any time before August 22, 2005,the bid price of our stock closes at $1.00 per share or more for a minimum of10 consecutive business days, Intraware should regain compliance with thelisting requirements. As of July 6, 2005, the closing price of our common stockwas $0.36.  If we do not regaincompliance by August 22, 2005, we may be granted an additional 180-day period(until February 22, 2006) to regain compliance if we meet The Nasdaq SmallCapMarket initial listing criteria other than the minimum bid price requirement.If we do not regain compliance within the allotted compliance period (includingany extensions that may be granted by Nasdaq), Nasdaq staff will notify us thatour stock will be delisted from The Nasdaq SmallCap Market. At that time, wewould be entitled to appeal the staff’s determination to a Nasdaq ListingQualifications Panel. If our stock were delisted, it would become harder to buyand sell. Further, our stock could then potentially be subject to what areknown as the “penny stock” rules, which place additional requirements onbroker-dealers who sell or make a market in such securities. Consequently, ifwe were removed from the Nasdaq SmallCap Market, the ability or willingness ofbroker-dealers to sell or make a market in our stock might decline. As aresult, it could become more difficult for our shareholders to sell theirshares of our stock.

 

We plan toseek the approval of our shareholders, at our annual meeting of shareholders onSeptember 8, 2005, of a proposal to authorize our Board of Directors, in itsdiscretion, to implement a one-for-ten reverse split of our common stock on orbefore February 28, 2006.  There is noguarantee that our shareholders will approve the proposal or, if the proposal isapproved and the reverse stock split is implemented, that the reverse stocksplit will enable us to maintain a minimum bid price of $1.00.  This shareholder proposal and some of therelated risks are described in our preliminary Proxy Statement that we filedwith the SEC on July 1, 2005.

 

**The market for our SubscribeNet hosted electronic software delivery andmanagement service is immature and volatile and the market for our plannedDigital Fastball hosted digital delivery service is virtually untested.  If the market for either service does notdevelop or develops more slowly than we expect, our business will be harmed.**

 

The market forhosted digital delivery services, including both our SubscribeNet and plannedDigital Fastball services, is relatively new and unproven, and it is uncertainwhether these services will achieve and sustain high levels of demand andmarket acceptance. Our success will depend to a substantial extent on thewillingness of companies, large and small, to increase their use of hosteddigital delivery services. If companies do not increase their use of hosteddigital delivery services, our operating results will be hurt.  In addition, in this unproven market, we havelimited insight into trends that may develop and affect our business. We maymake errors in predicting and reacting to relevant business trends, which couldharm our business.

 

We market ourSubscribeNet service principally to software companies.  However, many software companies haveinvested substantial personnel and financial resources to develop their own digitaldelivery systems and therefore may be reluctant or unwilling to migrate to aremotely hosted service. In addition, some software companies have adoptedautomatic update, or “phone home,” technology for delivering software updates,whereby an end-user’s computer automatically contacts the software company’sserver to check whether updates are available and, if so, downloads andinstalls those updates. This method for delivering software updates could beviewed by our potential and existing customers as an alternative to our digitaldelivery technology, and therefore any increased adoption of this automaticupdate technology could hurt our business and results of operations.

 

We plan to market our Digital Fastball service principally to small andmedium-sized companies that need to send large digital files as part of theirbusinesses.  However, many systems arealready available for sharing files over the Internet, in some cases at littleor no cost.  In addition, some such systemshave been the targets of widely publicized litigation by copyright holders,which may make some companies reluctant to use Internet-based digital deliveryservices such as Digital Fastball.

 

Further, somecompanies may be reluctant to use either our SubscribeNet or our planned DigitalFastball hosted digital delivery services because they are concerned about thesecurity capabilities of these services.

 

**We have a history oflosses and negative cash flow, and we have yet to achieve sustainedprofitability or positive cash flow.**

 

Wehave incurred significant losses since we were formed in 1996, and have yet toachieve sustained profitability or positive cash flow.  As of May 31, 2005, we had anaccumulated deficit of approximately $157 million.  Also, with the exception of our quarter endedNovember 30, 2002, we have not achieved positive cash flow from operationssince our formation in 1996.  Ouroperating history makes it difficult to evaluate whether or when we will beable to achieve sustained profitability or positive cash flow in the future.

 

**Competition from otherdigital delivery service providers, and potential customers’ development oftheir own digital delivery systems, could limit our revenue growth and reduceour gross margins.**

** **

Themarket for selling digital delivery services is highly competitive.  Some of our competitors have longer operatinghistories, greater financial, technical, marketing and other resources, broaderproduct and service offerings, better name recognition, and a larger installedbase of customers than we do.  Some ofour competitors also have well-established relationships with our potentialcustomers and with third-party information technology or consulting firms thathelp market our competitors’ services. We expect competition to intensify as current competitors expand andimprove their service offerings and new competitors enter the market.  In addition, our current and potentialcustomers are primarily information technology companies with strong software developmentexpertise.  When considering theiralternatives for implementing a system for electronic delivery of software orlicense keys, these companies sometimes elect to develop such systemsin-house.  While we believe ourcompetitive position is strong against both external competitors and in-housedevelopment, we have at times experienced reduced prices, reduced gross marginsand lost sales as a result of such competitive factors.  Such competition is likely to intensify,which could limit the growth of our revenues or gross margins.

 

**Although oursubscription-based sales model for our SubscribeNet service limits thevolatility of our Online services and technology revenue, other factors maycause our operating results, and therefore our stock price, to fluctuate.**

** **

OurSubscribeNet service fees, which comprise most of our Online services andtechnology revenues, are recognized ratably over contract terms of generallyone year, thereby limiting the quarter-to-quarter volatility of thoserevenues.  Nevertheless, certain factorsmay cause our Online services and technology revenues to fluctuate.  In addition, our Alliance and reimbursementrevenues and overall operating results are subject to substantial quarterly andannual fluctuation.  In addition to theother risk factors described in this section, factors that could cause suchfluctuation include:

 

26

----

 

•                  Fluctuations in demand forthe software we resell jointly with Software Spectrum, which is the basis formost of our Alliance and reimbursement revenue and a portion of our Onlineservices and technology revenue;

 

•                  Deferral of SubscribeNetrevenue recognition due to delays by customers in implementing the SubscribeNetservice, due to new sales involving extensive implementations, or due to contractmodifications adding significant future deliverables;

 

•                  Lengthening of the salescycle for our SubscribeNet service due to macroeconomic or other factors;

 

•                  Actual events,circumstances, outcomes, and amounts differing from judgments, assumptions, andestimates used in determining the values of certain assets (including theamounts of related valuation allowances), liabilities and other items reflectedin our consolidated financial statements or unaudited interim consolidatedfinancial statements; and

 

•                  Changes in accounting rules,such as recording expenses for employee stock option grants.

 

Asa consequence, operating results for a particular future period are difficultto predict, and prior results are not necessarily indicative of results to beexpected in future periods.  Any of theforegoing factors, or any other factors discussed elsewhere herein, could havea material adverse effect on our business, results of operations, or financialcondition that could adversely affect our stock price.

 

**Our prospective customersmay delay purchasing, and our new customers may delay implementing, ourSubscribeNet service while they assess their internal controls in preparationfor compliance with Section 404 of the Sarbanes-Oxley Act of 2002.  This may delay our revenue growth.**

** **

Section 404of the Sarbanes-Oxley Act of 2002 requires most publicly traded companies toinclude in their annual reports an assessment by management of the companies’internal control structures and procedures for financial reporting, and anattestation by the companies’ independent registered public accounting firms ofthat management assessment.  To complywith this new requirement, many public companies are preparing detaileddocumentation of their information technology (“IT”) systems supporting theirinternal control structures and procedures. To minimize their risk of error, these companies may be reluctant to addnew IT systems until their Section 404 assessments are complete and havebeen filed with the SEC as part of their annual reports.  As a result, prospective purchasers of ourSubscribeNet service may delay completing their purchases of the service, andnew SubscribeNet customers may delay implementing the service, while theycomplete the Section 404 assessments over the next several months.  This could, in turn, cause delays in newsales of our SubscribeNet service and/or delays in recognition of revenue fromrecent sales of our service.

 

27

----

 

**The technological andfunctional requirements we must meet to stay competitive are subject to rapidchange.  If we are unable to quicklyadapt to these changes and meet the demands of our current and potentialcustomers, we will likely lose sales and market share and our revenue growthwill be limited.**

** **

Wemarket primarily to software providers, who generally demand that a servicelike ours meet high technological and functional standards.  To remain competitive in this market and meetthe demands of current and prospective customers, we must continually adapt andupgrade our technology and functionality. If we do not respond quickly enough to changing industry standards orthe demands of customers and potential customers, we will likely lose sales andmarket share to competitors and our growth prospects will be limited.  In addition, we could incur substantial coststo modify our services or infrastructure in order to adapt to changingstandards and demands.  If we incur suchcosts but our sales fail to increase commensurately, we may not be able toachieve sustained profitability and positive operating cash flow.

 

**Defects in ourSubscribeNet service could diminish demand for the service and subject us tosubstantial liability.**

** **

Becauseour service is complex, it may have errors or defects that users identify afterthey begin using it, which could harm our reputation and our business.  Internet-based services frequently containundetected errors when first introduced or when new versions or enhancements arereleased.  Despite taking precautions toavoid errors, we have from time to time found defects in our service and newerrors in our existing service may be detected in the future.  Since our customers use our service forimportant aspects of their business, any errors, defects or other performanceproblems with our service could hurt our reputation and may damage ourcustomers’ businesses.  If that occurs,customers could elect not to renew their agreements with us, could be eligiblefor credits under our service level agreements, and could delay or withholdpayment to us.  We could also lose futuresales, or customers may make warranty claims against us, which could result inan increase in our provision for doubtful accounts, an increase in collection cyclesfor accounts receivable or the expense and risk of litigation.

 

**Interruptions or delaysin service from our third-party Web hosting facilities could impair thedelivery of our service and harm our business.**

** **

Weprovide our service through computer hardware that is currently located in a third-partyWeb hosting facilities in Santa Clara, California operated by SAVVISCommunications, and in Ireland operated by Data Electronics.  We do not control the operation of thesefacilities, and they are subject to damage or interruption from earthquakes,floods, fires, power loss, telecommunications failures and similar events.  While physical security measures are inplace, they are also subject to break-ins, sabotage, intentional acts ofvandalism and similar misconduct. Despite precautions taken at the facilities, the occurrence of a naturaldisaster, a decision to close a facility without adequate notice or otherunanticipated problems at a facility could result in lengthy interruptions inour service.  In addition, the failure byeither facility to provide our required data communications capacity couldresult in interruptions in our service. We have an agreement with SBC E-Services, an affiliate of SBCCommunications, Inc., to provide access to a geographically remotedisaster recovery facility that would provide us access to hardware, softwareand Internet connectivity in the event the SAVVIS facility becomesunavailable.  Even with this disasterrecovery arrangement, however, our service would be interrupted during thetransition.  Any damage to, or failureof, our systems could result in interruptions in our service.

 

28

----

 

Interruptionsin our service may reduce our revenue, cause us to issue credits or paypenalties, cause customers to terminate their subscriptions and adverselyaffect our renewal rates.  Our businesswill be harmed if our customers and potential customers believe our service isunreliable.

 

**Viruses may hinderacceptance of Internet-based digital delivery, which could in turn limit ourrevenue growth.**

** **

Theproliferation of software viruses is a key risk that could inhibit acceptanceby information technology professionals of Web-based delivery of digitalgoods.  Any well-publicized transmissionof a computer virus by us or another company using digital delivery could deterinformation technology professionals from using and deter software providersfrom outsourcing digital delivery, thereby adversely affecting ourbusiness.  Our SubscribeNet serviceenables our customers to upload their software products directly onto oursystems for downloading by their end-users. Our systems automatically scan our customers’ software products forknown computer viruses on an ongoing basis while they are on our systems.  However, it is possible that, in spite ofthose periodic virus scans, our system could transmit the virus to one or moreend-users.  Any such virus transmissioncould result in disputes, litigation and negative publicity that couldadversely affect our business.

 

**If our security measuresare breached and unauthorized access is obtained to a customer’s data, ourservice may be perceived as not being secure and customers may curtail or stopusing our service.**

** **

Ourservice involves the storage and transmission of customers’ proprietary information,and security breaches could expose us to a risk of loss of this information,litigation and possible liability.  Ifour security measures are breached as a result of third-party action, employeeerror, malfeasance or otherwise, and, as a result, someone obtains unauthorizedaccess to one of our customers’ data, our reputation will be damaged, ourbusiness may suffer and we could incur significant liability.  Because techniques used to obtainunauthorized access or to sabotage systems change frequently and generally arenot recognized until launched against a target, we may be unable to anticipatethese techniques or to implement adequate preventative measures.  If an actual or perceived breach of oursecurity occurs, the market perception of the effectiveness of our securitymeasures could be harmed and we could lose sales and customers.

 

**We may raise additionalcapital to fund acquisitions, product development or general operations.  Any such capital financing would dilute ourshareholders’ investments.**

** **

Wemay raise additional capital in the future through private or public offeringsof stock, or through other means.  Thepurposes of any such financing would be to increase our cash reserves forpotential use in acquiring other businesses, product development activities,funding our operations and generally strengthening our balance sheet.  Any such additional financing would likelydilute the investments of our current shareholders.

 

**Additional governmentregulations may harm demand for our services and increase our costs of doingbusiness.**

** **

Ourbusiness has benefited from the tax laws of states in which purchases ofsoftware licenses are not taxable if the software is received onlyelectronically.  Some states currentlyexperiencing revenue shortfalls are considering whether to change their laws tobroaden the taxability of transactions executed over the Internet.  Any new imposition of taxes on sales ofsoftware licenses, where the software is received electronically, couldsubstantially harm demand for our services and thereby materially adverselyaffect our business, operating results and financial condition.  We have also benefited from implementing ourservices in Ireland, which offers tax advantages to software companiesdistributing their software from Ireland to other European countries.  Any regulatory change in Ireland or elsewherethat diminishes those advantages could harm our business.  Other changes in government regulations, inareas such as privacy and export compliance, could also require us to implementchanges in our services or operations that increase our cost of doing businessand thereby hurt our financial performance.

 

29

----

 

**Claims by third partiesfor intellectual property infringement could force us to stop selling ourservices, force us to pay royalties, and force us to indemnify our customers.**

** **

Ourbusiness involves a high risk that we will be the target of intellectualproperty infringement claims.  Theseclaims could take a number of forms, including:

 

•                  Claims by other technologycompanies alleging that current or future components of our digital deliveryservice or related services infringe their intellectual property rights;

 

•                  Claims by our customers’competitors alleging that our customers’ software, which we store andelectronically deliver for our customers, infringes those competitors’intellectual property rights (our customers would typically be required todefend and indemnify us against such claims, but the claims could neverthelessdisrupt our business); or

 

•                  Claims by our customers thatwe delivered their software to unauthorized third parties, thereby infringingour customers’ intellectual property rights.

 

Industryconsolidation is increasing the risk that we will become a target of the typesof claims described in the first two bullets above.  Consolidation among companies providingdigital delivery, licensing, e-commerce and related technologies is resultingin more direct competition among the surviving companies in that segment,heightening the risk of intellectual property infringement claims among thosecompanies, including us.  Similarly,consolidation in the enterprise software industry heightens the risk ofintellectual property infringement claims among the companies remaining in thatindustry, including most of our customers.

 

Theseintellectual property claims could be made for patent, copyright or trademarkinfringement or for misappropriation of trade secrets.  They could be made directly against us, or indirectlythrough our contractual indemnification obligations to our customers andchannel partners.  Any claims couldresult in costly litigation and be time-consuming to defend, divert management’sattention and resources, or cause delays in releasing new or upgrading existingservices.  Royalty or licensingagreements, if required, may be available only on onerous terms, if atall.  Although we carry general liabilityinsurance, our insurance may not cover all potential claims or may not beadequate to protect us from all liability that may be imposed.

 

Webelieve we own the rights in, or have the required rights to use, ourSubscribeNet technology.  However, therecan be no assurance that this technology does not infringe the rights of thirdparties.  In addition, we take steps toverify that end-users who download our customers’ software through ourSubscribeNet service are entitled to deploy and use that software.  However, there can be no assurance that thisverification procedure will help us defend against claims by, or protect usagainst liability to, our customers whose software is downloaded.

 

Weare aware that certain other companies are using the name “Intraware” as acompany name or as a trademark or service mark. While we have received no notice of any claims of trademark infringementfrom any of those companies, we cannot assure you that these companies may notclaim superior rights to “Intraware” or to other marks we use.

 

**If our export compliancesystem fails to prevent unauthorized exports of our customers’ software, wecould be sanctioned by the U.S. government.**

** **

Throughour SubscribeNet service we globally distribute software containing highencryption and other features restricted by U.S. laws and regulations fromexportation to certain countries, types of recipients, and specificend-users.  Our SubscribeNet solutionincorporates automated procedures to help ensure that the software we deliverelectronically is not downloaded in violation of U.S. export laws andregulations.  However, these proceduresmay not prevent unauthorized exports of restricted software in every case.  If an unauthorized export of software occursthrough the SubscribeNet service and the U.S. government determines that weviolated the U.S. export laws or regulations, we could be sanctioned underthose laws or regulations.  Sanctionsinclude fines, suspension or revocation of export privileges, and imprisonment.

 

30

----

 

**If our key personnel leftthe company, our product development, sales, and corporate management couldsuffer.**

** **

Ourfuture success depends upon the continued service of our executive officers andother key technology, sales, marketing and support personnel.  None of our officers or key employees isbound by an employment agreement for any specific term.  If we lost the services of one or more of ourkey employees, or if one or more of our executive officers or key employeesdecided to join a competitor or otherwise compete directly or indirectly withus, this could have a significant adverse effect on our business.

 

**Financial AccountingStandards Board (“FASB”)’s adoption of Statement 123 (Revised 2004) will cause,and changes to existing accounting pronouncements or taxation rules orpractices may cause, adverse revenue fluctuations and affect our reportedresults of operations and how we conduct our business.**

** **

InDecember 2004, FASB adopted Statement 123 (Revised 2004), “Share-BasedPayment,” which will require us to measure compensation costs for all stockbased compensation (including stock options and our employee stock purchaseplan) at fair value and take a compensation charge equal to that value.  The SEC has amended the deadline to adoptSFAS No. 123R.  As a result, we willbe required to adopt the provisions of SFAS No. 123R during the firstquarter of our fiscal year ending February 28, 2007.  Also, a change in accounting pronouncementsor taxation rules or practices can have a significant effect on ourreported results and may even affect our reporting of transactions completedbefore the change is effective.  Othernew accounting pronouncements or taxation rules and varyinginterpretations of accounting pronouncements or taxation practice have occurredand may occur in the future.  This changeto existing rules, future changes, if any, or the questioning of currentpractices may adversely affect our reported financial results or the way weconduct our business.

 

**Recent legislation,especially the Sarbanes Oxley Act of 2002, requires that we evaluate our internalcontrols, and while we believe that we currently have adequate internal controlprocedures in place, this exercise has no precedent available by which tomeasure the adequacy of our compliance, and in addition it may cause ouroperating expenses to increase.**

** **

TheSarbanes-Oxley Act of 2002, the California Disclosure Act and newly proposed orenacted rules and regulations of the SEC and the National Association ofSecurities Dealers impose new duties on us and our executives, directors,attorneys and independent registered public accounting firms.  In order to comply with the Sarbanes-OxleyAct and such new rules and regulations, we are evaluating our internalcontrols systems to allow management to report on, and our independentregistered public accounting firm to attest to, our internal controls over ourfinancial reporting.  We are performingthe system and process evaluation and testing (and any necessary remediation)required in an effort to comply with the management certification andindependent registered public accounting firm attestation requirements of Section 404of the Sarbanes-Oxley Act.  As a result,we are incurring additional expenses and diversion of management’s time and wemay be required to hire additional personnel as well as to use additionaloutside legal, accounting and advisory services.  Any of these developments could materiallyincrease our operating expenses and accordingly reduce our net income orincrease our net losses.  While weanticipate being able to fully implement the requirements relating to internalcontrols over our financial reporting and all other aspects of Section 404in a timely fashion, we cannot be certain as to the outcome of our testing andresulting remediation actions or the impact of the same on our operations sincethere is no precedent available by which to measure compliance adequacy.  If we are not able to implement therequirements of Section 404 in a timely manner or with adequatecompliance, we may be subject to sanctions or investigation by regulatoryauthorities, such as the SEC or The Nasdaq Stock Market and our reputation maybe harmed.  Any such action couldadversely affect our financial results and the market price of our commonstock.

 

Moreover,our management, including our CEO and CFO, does not expect that our disclosurecontrols or our internal controls over our financial reporting will prevent allerror and all fraud.  A control system,no matter how well conceived and operated, can provide only reasonable, notabsolute, assurance that the objectives of the control system are met.  Our disclosure controls or procedures can becircumvented by the individual acts of some persons, by collusion of two ormore people or by management override of the control.  Because of the inherent limitations in acost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

31

----

 

**If we acquire anycompanies or technologies in the future, they could prove difficult to integrate,disrupt our business, dilute stockholder value and adversely affect ouroperating results.**

** **

Wemay acquire or make investments in complementary companies, services andtechnologies in the future.  We areconsiderably smaller now than we were when we made our past acquisitions, andtherefore any new acquisitions or investments could be more disruptive to ourorganization than in the past. Acquisitions and investments involve numerous risks, including:

 

•                  difficulties in integratingoperations, technologies, services and personnel;

 

•                  diversion of financial andmanagerial resources from existing operations;

 

•                  risk of entering newmarkets;

 

•                  potential write-offs ofacquired assets;

 

•                  potential loss of keyemployees;

 

•                  inability to generatesufficient revenue to offset acquisition or investment costs; and

 

•                  delays in customer purchasesdue to uncertainty.

 

Inaddition, if we finance acquisitions by issuing convertible debt or equitysecurities, our existing stockholders may be diluted which could affect themarket price of our stock.  As a result,if we fail to properly evaluate and execute acquisitions or investments, ourbusiness and prospects may be seriously harmed.

 

32

----

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKETRISK**

 

AtMay 31, 2005, we had cash and cash equivalents of $8.8 million. We havenot used derivative financial instruments in our investment portfolio duringfiscal 2005 or the three months ended May 31, 2005. We place our investmentswith high quality issuers, by policy, in an effort to limit the amount ofcredit exposure to any one issue or issuer.

 

Ourexposure to market risk for changes in interest rates relates primarily to ourcash and cash equivalents portfolio, note payable and lines of credit. We havenot used derivative financial instruments. The effect of changes in interestrates of +/-10% over a six-month horizon would not have a material effect onthe fair value of the portfolio or our debt. Declines in interest rates will,over time, cause a decrease in our interest income from our portfolio.  Increases in interest rates will increase theinterest we pay on our credit facilities.

 

**ITEM 4.CONTROLS AND PROCEDURES**

 

(a) *Evaluation of Disclosure Controls and Procedures*.Our principal executive officer and principal financial officer, afterevaluating the effectiveness of our disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934 (the “Exchange Act”)) as of the end of the period coveredby this quarterly report, have concluded that our disclosure controls andprocedures are effective based on their evaluation of the controls andprocedures required by paragraph (b) of the Exchange Act Rules 13a-15or 15d-15.

 

(b) *Changes in Internal Controls over Financial Reporting*.No changes in our internal control over financial reporting identified inconnection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15or 15d-15 occurred during our last fiscal quarter that have materially affectedor are reasonably likely to materially affect, our internal control overfinancial reporting.

 

**PART II**

 

**OTHER INFORMATION**

 

**ITEM 1. LEGALPROCEEDINGS**

** **

*In re Intraware, Inc.Initial Public Offering Securities Litigation*

* *

InOctober 2001, we were served with a summons and complaint in a purportedsecurities class action lawsuit.  On orabout April 19, 2002, we were served with an amended complaint in thisaction, which is now titled *In re Intraware, Inc.Initial Public Offering Securities Litigation*, Civ. No. 01-9349(SAS) (S.D.N.Y.), related to *In re Initial PublicOffering Securities Litigation*, 21 MC 92 (SAS) (S.D.N.Y.).  The amended complaint is brought purportedlyon behalf of all persons who purchased our common stock from February 25,1999 (the date of our initial public offering) through December 6,2000.  It names as defendants Intraware,three of our present and former officers and directors, and several investmentbanking firms that served as underwriters of our initial public offering.  The complaint alleges liability underSections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and20(a) of the Securities Exchange Act of 1934, on the grounds that theregistration statement for the offerings did not disclose that: (1) theunderwriters had agreed to allow certain customers to purchase shares in theofferings in exchange for excess commissions paid to the underwriters; and (2) theunderwriters had arranged for certain customers to purchase additional sharesin the aftermarket at predetermined prices. The amended complaint also alleges that the underwriters misused theirsecurities analysts to manipulate the price of our stock.  No specific damages are claimed.

 

33

----

 

Lawsuitscontaining similar allegations have been filed in the Southern District of NewYork challenging over 300 other initial public offerings and secondaryofferings conducted in 1999 and 2000. All of these lawsuits have been consolidated for pretrial purposesbefore United States District Court Judge Shira Scheindlin of the SouthernDistrict of New York.  On July 15,2002, an omnibus motion to dismiss was filed in the coordinated litigation onbehalf of the issuer defendants, of which Intraware and its three named currentand former officers and directors are a part, on common pleadings issues.  On or about October 9, 2002, the Courtentered and ordered a Stipulation of Dismissal, which dismissed the three namedcurrent and former officers and directors from the litigation withoutprejudice.  On February 19, 2003,the Court entered an order denying in part the issuer-defendants’ omnibusmotion to dismiss, including those portions of the motion to dismiss relatingto Intraware.

 

InJune 2004, a stipulation of settlement for the claims against the issuer-defendants,including us, was submitted to the Court. The underwriter-defendants in the *In re Initial PublicOffering Securities Litigation* (collectively, the “underwriter-defendants”),including the underwriters of our initial public offering, are not parties tothe stipulation of settlement.

 

Thesettlement provides that, in exchange for a release of claims against thesettling issuer-defendants, the insurers of all of the settling issuer-defendantswill provide a surety undertaking to guarantee plaintiffs a $1 billionrecovery from the non-settling defendants, including theunderwriter-defendants.  The amount ourinsurers would be required to pay to the plaintiffs could range from zero toapproximately $3.5 million, depending on plaintiffs’ recovery from theunderwriter-defendants and from other non-settling parties.  If the plaintiffs recover at least$1 billion from the underwriter-defendants, our insurers would have noliability for settlement payments under the terms of the settlement.  If the plaintiffs recover less than$1 billion, we believe our insurance will likely cover our share of anypayments towards satisfying plaintiffs’ $1 billion recovery deficit.  Management estimates that its range of lossrelative to this matter is zero to $3.5 million.  Presently there is no more likely pointestimate of loss within this range.  As aconsequence of the uncertainties described above regarding the amount we willultimately be required to pay, if any, as of May 31, 2005, we have notaccrued a liability for this matter.

 

OnFebruary 15, 2005, the court granted preliminary approval of thesettlement, conditioned upon the parties’ modification of a proposed ban orderwith respect to potential contribution claims. There is no guarantee the settlement will become final as it is subjectto a number of conditions, including the final approval of the court.

 

*Leon Segen v. ComVest Venture Partners. LP. et al.*

* *

InJuly 2004, a complaint was filed in the United States District Court forthe District of Delaware, Civ. No. 04-822, against ComVest VenturePartners, LP; ComVest Management, LLC; Commonwealth Associates ManagementCompany, Inc.; Commonwealth Associates, LP; RMC Capital, LLC;Michael S. Falk; Robert Priddy; Travis L. Provow; Keith Rosenbloom; andIntraware.  The complaint describesIntraware as a nominal defendant.  Thecomplaint alleges that, between August 2001 and January 2002, all ofthe defendants other than Intraware were members of a group, and thereforeshould be treated as a single “person,” for purposes of Sections 13(d)(3) and16(b) of the Securities Exchange Act of 1934 (the “1934 Act”).  The complaint further alleges that ComVestVenture Partners, LP and Mr. Priddy, while they and the other allegedgroup members collectively owned more man 10% of a class of our equitysecurities, bought and sold our equity securities within a 6-month period andfailed to disgorge to us the profits allegedly realized in those trades,thereby violating Section 16(b) of the 1934 Act.  Mr. Falk was a member of our Board ofDirectors from April 2001 to May 2002 and Mr. Provow was amember of our Board of Directors from October 2001 to May 2002.  The complaint demands that ComVest VenturePartners, LP and Mr. Priddy pay over to Intraware the profits theyallegedly realized and retained in violation of Section 16(b) of the1934 Act, together with interest and legal costs.  According to the complaint, the amount ofthose alleged profits is unknown to the plaintiff, however, the informationalleged in the complaint suggests that amount may be approximately$1.3 million.  The complaint doesnot seek damages against us.  After the complaintwas filed, the plaintiff and Intraware signed a stipulation acknowledging thatIntraware takes no position with respect to the claims in the action, andproviding that Intraware accepts service of the complaint, that Intraware isnot required to file an answer or other response to the complaint, and thatIntraware will otherwise have the rights and responsibilities of a party to theaction.  In June 2005, the courtdenied motions filed by the defendants other than Intraware to dismiss theplaintiff’s claims.  A trial in this caseis currently scheduled to begin in July 2006.

 

34

----

 

Weare also subject to legal proceedings, claims and litigation arising in theordinary course of business.  We do notexpect that the ultimate costs to resolve these matters will have a materialadverse effect on our consolidated financial position, results of operations,or cash flows.

 

**ITEM2.  UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

** **

None.

 

**ITEM3. DEFAULTS UPON SENIOR SECURITIES**

** **

None.

 

**ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS**

** **

None.

 

**ITEM 5. OTHERINFORMATION**

** **

None.

 

**ITEM 6. EXHIBITS**

** **

**Exhibits**

 
| **Exhibit  Number** | ** ** | **Description** |
|---------------------|------------|-----------------|
| 3.1                 | (1)        |            | Amended and Restated Certificate of  Incorporation of Intraware, Inc. |
| 3.2                 | (1)        |            | Certificate of Designations, Preferences  and Rights of Series A Convertible Preferred Stock |
| 3.3                 | (2)        |            | Amended and Restated Bylaws of  Intraware, Inc. |
| 31.1                |       |            | Certification pursuant to Section 302  of the Sarbanes-Oxley Act — Peter H. Jackson |
| 31.2                |       |            | Certification pursuant to Section 302  of the Sarbanes-Oxley Act — Wendy A. Nieto |
| 32.1                |       |            | Certification pursuant to Section 906  of the Sarbanes-Oxley Act |

 

----

(1)          Incorporatedby reference to Intraware’s Current Report on Form 8-K dated April 2,2001 (File No. 000-25249) and filed with the SEC on April 13, 2001.

(2)          Incorporatedby reference to Intraware’s Current Report on Form 8-K dated June 13,2005 (File No. 000-25249) and filed with the SEC on June 17, 2005.

 

35

----

 

**SIGNATURE**

** **

Pursuantto the requirements of the Securities Exchange Act of 1934, as amended, theregistrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|                | **INTRAWARE, INC.** |
|---------------------|---------------------|
|                |                |
| Date:  July 7, 2005 | By:                 |   /s/  WENDY A. NIETO |
|                |                | Wendy A.  Nieto |
|                |                | *Chief Financial Officer and Executive Vice  President* |

 

36

----