**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM10-Q**

 

**ý****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**FOR THE QUARTERLY PERIOD ENDED NOVEMBER 30, 2003**

 

o**TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**FOR THE TRANSITION PERIODFROM          TO          **

 

**Commission file number 000-25249**

 

**INTRAWARE,INC.**

(Exactname of Registrant as specified in its charter)

 

**DELAWARE**

(Stateor other jurisdiction of incorporation or organization)

 

**68-0389976**

(I.R.S.Employer Identification Number)

 

**25 ORINDA WAYORINDA, CA 94563**

(Addressof principal executive offices)

 

**(925) 253-4500**

(Registrant’stelephone number, including area code)

 

Indicate by check (X) whether the registrant: (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes  ý      No  o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act). Yes o  No ý

 

As of December 31, 2003there were 59,478,109 shares of the registrant’s Common Stock outstanding.

 

 

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**PARTI—FINANCIAL INFORMATION**

 

**ITEM 1.CONSOLIDATED FINANCIAL STATEMENTS**

 

**INTRAWARE, INC.CONSOLIDATED BALANCE SHEETS(in thousands, except per share amounts)**

 
|                                                                                                                                                                                                                              |   | **November 30, 2003** |   | **February 28, 2003** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------|--------|-----------------------|--------|
|                                                                                                                                                                                                                              |   | **(unaudited)**       |   |                  |   |
| **ASSETS**                                                                                                                                                                                                                        |   |                  |   |                  |   |
| Current assets:                                                                                                                                                                                                                   |   |                  |   |                  |   |
| Cash and cash equivalents                                                                                                                                                                                                         |   | $                     | 12,324 |                  | $      | 6,841 |   |
| Accounts receivable, net                                                                                                                                                                                                          |   | 1,338                 |   | 1,521                 |   |
| Prepaid licenses, services  and cost of deferred revenue                                                                                                                                                                          |   | 258                   |   | 329                   |   |
| Other current assets                                                                                                                                                                                                              |   | 436                   |   | 338                   |   |
| Total current assets                                                                                                                                                                                                              |   | 14,356                |   | 9,029                 |   |
| Cost of deferred revenue,  less current portion                                                                                                                                                                                   |   | 53                    |   | 37                    |   |
| Property and equipment,  net                                                                                                                                                                                                      |   | 955                   |   | 1,859                 |   |
| Other assets                                                                                                                                                                                                                      |   | 35                    |   | 11                    |   |
| Total assets                                                                                                                                                                                                                      |   | $                     | 15,399 |                  | $      | 10,936 |   |
|                                                                                                                                                                                                                              |   |                  |   |                  |   |
| **LIABILITIES,  REDEEMABLE CONVERTIBLE PREFERRED STOCK & STOCKHOLDERS’ EQUITY**                                                                                                                                          |   |                  |   |                  |   |
| Current liabilities:                                                                                                                                                                                                              |   |                  |   |                  |   |
| Accounts payable                                                                                                                                                                                                                  |   | $                     | 724    |                  | $      | 683 |   |
| Accrued expenses                                                                                                                                                                                                                  |   | 1,291                 |   | 1,189                 |   |
| Notes payable                                                                                                                                                                                                                     |   | 989                   |   | —                |   |
| Deferred revenue                                                                                                                                                                                                                  |   | 2,000                 |   | 2,495                 |   |
| Related party deferred  revenue                                                                                                                                                                                                   |   | 748                   |   | 525                   |   |
| Capital lease and other  obligations                                                                                                                                                                                              |   | 1                     |   | 1,495                 |   |
| Total current liabilities                                                                                                                                                                                                         |   | 5,753                 |   | 6,387                 |   |
| Deferred revenue, less  current portion                                                                                                                                                                                           |   | 202                   |   | 183                   |   |
| Related party deferred  revenue, less current portion                                                                                                                                                                             |   | 25                    |   | 223                   |   |
| Notes payable, less  current portion                                                                                                                                                                                              |   | 979                   |   | —                |   |
| Capital lease obligations,  less current portion                                                                                                                                                                                  |   | —                |   | 906                   |   |
| Total liabilities                                                                                                                                                                                                                 |   | 6,959                 |   | 7,699                 |   |
| Contingencies (Note 6)                                                                                                                                                                                                            |   |                  |   |                  |   |
| Redeemable convertible  preferred stock; $0.0001 par value; 10,000 shares authorized:                                                                                                                                             |   |                  |   |                  |   |
| Series A; 552 and 1,298  shares issued and outstanding at November 30 and February 28, 2003,  respectively (aggregate liquidation preference of $1,000 and $2,350 at  November 30 and February 28, 2003, respectively). |   | 897                   |   | 2,109                 |   |
| Series B-1; 1 and 49  shares issued and outstanding at November 30 and February 28, 2003,  respectively (aggregate liquidation preference of $3 and $486 at November 30  and February 28, 2003, respectively).                    |   | 2                     |   | 364                   |   |
| Total redeemable  convertible preferred stock                                                                                                                                                                                     |   | 899                   |   | 2,473                 |   |
| Stockholders’ equity:                                                                                                                                                                                                        |   |                  |   |                  |   |
| Common stock; $0.0001 par  value; 250,000 shares authorized; 59,473 and 52,101 shares issued and  outstanding at November 30 and February 28, 2003, respectively.                                                                 |   | 6                     |   | 5                     |   |
| Additional paid-in-capital                                                                                                                                                                                                        |   | 162,013               |   | 152,870               |   |
| Unearned stock-based  compensation                                                                                                                                                                                                |   | —                |   | (32                   | )      |
| Accumulated deficit                                                                                                                                                                                                               |   | (154,478              | )      | (152,079              | )      |
| Total stockholders’ equity                                                                                                                                                                                                   |   | 7,541                 |   | 764                   |   |
| Total liabilities,  redeemable convertible preferred stock and stockholders’ equity                                                                                                                                          |   | $                     | 15,399 |                  | $      | 10,936 |   |

 

Seenotes to unaudited interim consolidated financial information.

 

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**INTRAWARE, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

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

**(unaudited)**

 
|                                               |   | **For the  Three Months Ended** |   | **For the  Nine Months Ended** |   |
|----------------------------------------------------|--------|---------------------------------|--------|--------------------------------|--------|
|                                               |   | **November 30, 2003**      |   | **November 30, 2002**     |   | **November 30, 2003** |   | **November 30, 2002** |   |
| Revenues:                                          |   |                            |   |                           |   |   |   |   |   |
| Software product sales                             |   | $                               | 89     |                           | $      | 193 |   | $ | 291 |   | $ | 2,491 |   |
| Online services and technology                     |   | 1,661                           |   | 1,699                          |   | 4,901 |   | 4,958 |   |
| Alliance and reimbursement                         |   | 662                             |   | 926                            |   | 2,326 |   | 3,183 |   |
| Related party online services and technology       |   | 114                             |   | 125                            |   | 346 |   | 152 |   |
| Total revenues                                     |   | 2,526                           |   | 2,943                          |   | 7,864 |   | 10,784 |   |
|                                               |   |                            |   |                           |   |   |   |   |   |
| Cost of revenues:                                  |   |                            |   |                           |   |   |   |   |   |
| Software product sales                             |   | 77                              |   | 189                            |   | 244 |   | 1,851 |   |
| Online services and technology                     |   | 545                             |   | 649                            |   | 1,804 |   | 1,681 |   |
| Alliance and reimbursement                         |   | 405                             |   | 469                            |   | 1,317 |   | 1,510 |   |
| Total cost of revenues                             |   | 1,027                           |   | 1,307                          |   | 3,365 |   | 5,042 |   |
| Gross profit                                       |   | 1,499                           |   | 1,636                          |   | 4,499 |   | 5,742 |   |
|                                               |   |                            |   |                           |   |   |   |   |   |
| Operating expenses:                                |   |                            |   |                           |   |   |   |   |   |
| Sales and marketing                                |   | 573                             |   | 972                            |   | 2,037 |   | 4,627 |   |
| Product development                                |   | 560                             |   | 1,219                          |   | 2,236 |   | 5,226 |   |
| General and administrative                         |   | 845                             |   | 528                            |   | 2,502 |   | 2,334 |   |
| Amortization of intangibles                        |   | —                          |   | —                         |   | — |   | 1,085 |   |
| Restructuring                                      |   | —                          |   | —                         |   | — |   | 1,391 |   |
| Impairment of assets                               |   | —                          |   | —                         |   | — |   | 792 |   |
| Total operating expenses                           |   | 1,978                           |   | 2,719                          |   | 6,775 |   | 15,455 |   |
| Loss from operations                               |   | (479                            | )      | (1,083                         | )      | (2,276 | ) | (9,713 | ) |
| Interest expense                                   |   | (40                             | )      | (92                            | )      | (170 | ) | (2,569 | ) |
| Interest and other income and expenses, net        |   | 21                              |   | 31                             |   | 47 |   | 513 |   |
| Gain on sale of Asset Management software business |   | —                          |   | —                         |   | — |   | 2,656 |   |
| Net loss                                           |   | $                               | (498   | )                              | $      | (1,144 | ) | $ | (2,399 | ) | $ | (9,113 | ) |
| Basic and diluted net loss per share               |   | $                               | (0.01  | )                              | $      | (0.02 | ) | $ | (0.04 | ) | $ | (0.20 | ) |
| Weighted average shares - basic and diluted        |   | 58,491                          |   | 51,546                         |   | 54,726 |   | 46,317 |   |

 

Seenotes to unaudited interim consolidated financial information.

 

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**INTRAWARE, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**

**(unaudited)**

 

 
|                                                                         |   | **For the Nine Months Ended** |   |
|------------------------------------------------------------------------------|--------|-------------------------------|--------|
|                                                                         |   | **November 30, 2003**    |   | **November 30, 2002** |   |
| Cash flows from operating activities:                                        |   |                          |   |   |   |
| Net loss                                                                     |   | $                             | (2,399 | ) | $ | (9,113 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities: |   |                          |   |   |   |
| Depreciation and amortization                                                |   | 1,438                         |   | 3,039 |   |
| Amortization of unearned stock-based compensation                            |   | 28                            |   | 1,027 |   |
| Provision for (recovery of) doubtful accounts                                |   | 13                            |   | (50 | ) |
| Amortization of discount on note payable                                     |   | 14                            |   | 1,571 |   |
| Amortization of goodwill and intangibles                                     |   | —                        |   | 1,085 |   |
| Gain on sale of fixed assets                                                 |   | —                        |   | (2 | ) |
| Gain on sale of Asset Management software business                           |   | —                        |   | (2,656 | ) |
| Warrants adjustment to fair value                                            |   | —                        |   | (460 | ) |
| Impairment of assets                                                         |   | —                        |   | 792 |   |
| Amortization of warrant charge offset against  revenue                       |   | —                        |   | 936 |   |
| Options to purchase common stock issued for  services                        |   | —                        |   | 64 |   |
| Changes in assets and liabilities:                                           |   |                          |   |   |   |
| Accounts receivable                                                          |   | 170                           |   | 1,629 |   |
| Prepaid licenses, services and cost of deferred  revenue                     |   | 55                            |   | 3,468 |   |
| Other assets                                                                 |   | (122                          | )      | 324 |   |
| Accounts payable                                                             |   | (114                          | )      | (4,558 | ) |
| Accrued expenses                                                             |   | 103                           |   | 434 |   |
| Deferred revenue                                                             |   | (476                          | )      | (2,487 | ) |
| Related party deferred revenue                                               |   | 25                            |   | 873 |   |
| Net cash used in operating activities                                        |   | (1,265                        | )      | (4,084 | ) |
|                                                                         |   |                          |   |   |   |
| Cash flows from investing activities:                                        |   |                          |   |   |   |
| Purchases of property and equipment                                          |   | (379                          | )      | (95 | ) |
| Proceeds from sale of Asset Management software  business                    |   | —                        |   | 9,500 |   |
| Proceeds from sale of fixed assets                                           |   | —                        |   | 7 |   |
| Net cash provided by (used in) investing activities                          |   | (379                          | )      | 9,412 |   |
|                                                                         |   |                          |   |   |   |
| Cash flows from financing activities:                                        |   |                          |   |   |   |
| Principal payments on notes payable                                          |   | (165                          | )      | (5,700 | ) |
| Proceeds from notes payable                                                  |   | 2,165                         |   | — |   |
| Proceeds from common stock and warrants, net of  issuance costs              |   | 7,528                         |   | 7,281 |   |
| Principal payments on capital lease obligations                              |   | (2,401                        | )      | (1,193 | ) |
| Net cash provided by financing activities                                    |   | 7,127                         |   | 388 |   |
| Net increase in cash and cash equivalents                                    |   | 5,483                         |   | 5,716 |   |
| Cash and cash equivalents at beginning of the  period                        |   | 6,841                         |   | 2,979 |   |
| Cash and cash equivalents at end of the period                               |   | $                             | 12,324 |   | $ | 8,695 |   |
|                                                                         |   |                          |   |   |   |
| Supplemental disclosure of cash flow information:                            |   |                          |   |   |   |
| Cash paid for interest                                                       |   | $                             | 148    |   | $ | 415 |   |
| Supplemental non-cash activity:                                              |   |                          |   |   |   |
| Property and equipment leases                                                |   | $                             | — |   | $ | 16 |   |
| Common stock issued for preferred stock and warrant  conversions             |   | $                             | 1,584  |   | $ | 630 |   |
| Purchases of property and equipment in accounts  payable                     |   | $                             | 155    |   | $ | 165 |   |
| Issuance of warrant to purchase common stock                                 |   | $                             | 46     |   | $ | — |   |

 

Seenotes to unaudited interim consolidated financial information.

 

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**INTRAWARE, INC.**

**NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL INFORMATION**

** **

**NOTE 1.BASIS OF PRESENTATION**

 

**INTRAWARE**

 

The accompanying unauditedconsolidated financial statements have been prepared pursuant to the rules andregulations of the Securities and Exchange Commission.  Certain information and footnote disclosuresnormally included in financial statements prepared in accordance withaccounting principles generally accepted in the United States of America havebeen condensed or omitted pursuant to these rules and regulations.  However, management believes that thedisclosures are adequate to ensure the information presented is notmisleading.  The balance sheet atFebruary 28, 2003, has been derived from the audited financial statements,but does not include all disclosures required by generally accepted accountingprinciples.  These unauditedconsolidated financial statements should be read in conjunction with theaudited consolidated financial statements and notes thereto included in our annualreport on Form 10-K, as amended by Amendment One thereto on Form 10-K/A, forthe fiscal year ended February 28, 2003.

 

In the opinion ofmanagement, all adjustments, consisting only of normal recurring items,considered necessary for a fair presentation have been included in theaccompanying unaudited consolidated financial statements.  The results of operations for the interimperiods presented are not necessarily indicative of the operating results to beexpected for any subsequent interim period or for the fiscal year endingFebruary 29, 2004.  Certain priorperiod balances have been reclassified to conform to the current periodpresentation.

 

**NOTE 2.SIGNIFICANT ACCOUNTING POLICIES**

 

**Revenuerecognition**

 

We derive online servicesand technology revenues primarily from electronic software delivery andmanagement (ESDM) services (our SubscribeNet service), from professionalservices, and from the sale of proprietary software licenses and relatedmaintenance.  In the past, theproprietary software licenses we sold were primarily licenses to use our assetmanagement software; however, we may recognize future revenues as a result ofour plan to sell licenses for our proprietary software underlying ourSubscribeNet service and related maintenance.

 

We derive alliance andreimbursement revenue from our alliance agreement with Software Spectrum, Inc.(“Software Spectrum”) (see Note 9). This revenue consists of a percentage of the gross profit derived fromthe sales of Sun ONE software licenses and maintenance services, andreimbursement for the costs of maintaining a sales team dedicated to sellingSun ONE software for Software Spectrum. This revenue is recognized as weprovide the services to Software Spectrum. The reimbursement revenue isrecognized in accordance with Emerging Issues Task Force (“EITF”) No. 01-14,“Income Statement Characterization of Reimbursements Received for Out-of-PocketExpenses Incurred,” which generally requires that a company recognize asrevenue travel expense and other reimbursable expenses billed to customers.

 

We derive software productrevenues from resold licenses and maintenance for multiple business softwareproduct lines.

 

We defer online services andtechnology revenues related to ESDM and related professional services, andgenerally recognize them ratably over the term of the service arrangement.  Some SubscribeNet services provided to newcustomers involve significant implementation or customization essential to thefunctionality of our SubscribeNet services. In those cases, we defer revenue recognition until the services go-livedate is reached and recognize the revenue on a ratable basis over the longer ofthe

 

5

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remaining estimated customerlife or remaining contract term.  Thego-live date is the date on which the essential functionality has beendelivered or on which the website through which the service is provided entersthe production environment, or the point at which no additional customizationis required, whichever is later.  Whenwe sell additional services related to the original SubscribeNet agreement,revenue is recognized ratably over the longer of the remaining estimatedcustomer life or the remaining contract term, commencing with the delivery ofthe additional services.  The revenue isincluded in online services and technology.

 

We recognize revenue whenall of the following conditions 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.

 

We obtain vendor specificobjective evidence of fair value for the maintenance element of the resold andproprietary software arrangements based on historical and contractual renewalrates for maintenance.  In such cases,we defer the maintenance revenue at the outset of the arrangement and recognizeit ratably over the period during which the maintenance is to be provided(generally 12 months), which normally commences on the date the software isdelivered.

 

**Stock-BasedCompensation**

 

We account for stock-basedemployee compensation arrangements in accordance with provisions of AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued to Employees,”(“APB No. 25”) and its related interpretations and comply with the disclosureprovisions of Statement of Financial Accounting Standards (“SFAS”) No. 123,“Accounting for Stock-Based Compensation” and related SFAS No. 148, “Accountingfor Stock-Based Compensation—Transition and Disclosure.”  Under APB No. 25, compensation expenseis based on the difference, if any, on the date of the grant between the fairvalue of our stock and the exercise price of the option.  We account for equity instruments issued tonon-employees in accordance with the provisions of SFAS No. 123 and EITFNo. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employeesfor 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,** |   | **For the  Nine Months Ended,** |   |
|------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|--------|---------------------------------|--------|
|                                                                                                                   |   | **November  30, 2003**           |   | **November  30, 2002**          |   | **November  30, 2003** |   | **November  30, 2002** |   |
| Net loss                                                                                                               |   | $                                | (498   | )                               | $      | (1,144 | ) | $ | (2,399 | ) | $ | (9,113 | ) |
| Add:  Stock-based employee compensation expense  included in reported net loss                                    |   | 4                                |   | 148                             |   | 28 |   | 1,027 |   |
|                                                                                                                   |   |                             |   |                            |   |   |   |   |   |
| Deduct:  Total stock-based employee compensation  expense determined under fair value based method for all awards |   | (851                             | )      | (1,114                          | )      | (2,760 | ) | (3,738 | ) |
| Pro forma                                                                                                              |   | $                                | (1,345 | )                               | $      | (2,110 | ) | $ | (5,131 | ) | $ | (11,824 | ) |
| Net loss per  share — basic and diluted                                                                           |   |                             |   |                            |   |   |   |   |   |
| As reported                                                                                                            |   | $                                | (0.01  | )                               | $      | (0.02 | ) | $ | (0.04 | ) | $ | (0.20 | ) |
| Pro forma                                                                                                              |   | $                                | (0.02  | )                               | $      | (0.04 | ) | $ | (0.09 | ) | $ | (0.26 | ) |

 

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We calculated the fair valueof each option grant on the date of grant, using the Black-Scholes optionpricing model as prescribed by SFAS No. 123 using the following assumptions:

 
|                      |   | **For the  Three Months Ended,** |   | **For the  Nine Months Ended,** |   |
|---------------------------|--------|----------------------------------|--------|---------------------------------|--------|
|                      |   | **November  30, 2003**           |   | **November  30, 2002**          |   | **November  30, 2003** |   | **November  30, 2002** |   |
| Risk-free interest rates  |   | 1.51 - 3.37                      | %      | 2.52 - 4.74                     | %      | 1.51 - 3.37 | % | 2.52 - 4.74 | % |
| Expected lives (in years) |   | 4                                |   | 4                               |   | 4 |   | 4 |   |
| Dividend yield            |   | 0                                | %      | 0                               | %      | 0 | % | 0 | % |
| Expected volatility       |   | 134                              | %      | 146                             | %      | 134 | % | 146 | % |

 

We calculated the fair valueof the stock issued under the employee stock purchase plan using theBlack-Scholes option pricing model as prescribed by SFAS No. 123 using thefollowing assumptions:

 
|                       |   | **For the  Three Months Ended,** |   | **For the  Nine Months Ended,** |   |
|----------------------------|--------|----------------------------------|--------|---------------------------------|--------|
|                       |   | **November  30, 2003**           |   | **November  30, 2002**          |   | **November  30, 2003** |   | **November  30, 2002** |   |
| Risk-free interest rates   |   | 1.01                             | %      | 1.22                            | %      | 1.01 - 1.64 | % | 1.22 - 1.96 | % |
| Expected lives (in months) |   | 6                                |   | 6                               |   | 6 |   | 6 |   |
| Dividend yield             |   | 0                                | %      | 0                               | %      | 0 | % | 0 | % |
| Expected volatility        |   | 58                               | %      | 102                             | %      | 58 - 120 | % | 102 - 151 | % |

 

**Net LossPer Share**

 

Basic net loss per share iscomputed by dividing the net loss available to common stockholders for theperiod by the weighted average number of common shares outstanding during theperiod excluding shares subject to repurchase. Diluted net loss per share is computed by dividing the net lossavailable to common stockholders for the period by the weighted average numberof common shares outstanding and potentially dilutive securities outstanding duringthe period if the effect is dilutive. Potential common shares are composed of common stock subject torepurchase rights and incremental shares of common stock issuable upon theexercise of stock options and warrants and upon conversion of redeemableconvertible preferred stock.

 

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The following table setsforth the computation of basic and diluted net loss per share as well assecurities that are not included in the diluted net loss per share calculationbecause to do so would be antidilutive (in thousands, except per shareamounts):

 
|                                                           |   | **For the  Three Months Ended** |   | **For the  Nine Months Ended** |   |
|----------------------------------------------------------------|--------|---------------------------------|--------|--------------------------------|--------|
|                                                           |   | **November  30, 2003**          |   | **November  30, 2002**         |   | **November  30, 2003** |   | **November  30, 2002** |   |
| Numerator:                                                     |   |                            |   |                           |   |   |   |   |   |
| Net loss                                                       |   | $                               | (498   | )                              | $      | (1,144 | ) | $ | (2,399 | ) | $ | (9,113 | ) |
|                                                           |   |                            |   |                           |   |   |   |   |   |
| Denominator:                                                   |   |                            |   |                           |   |   |   |   |   |
| Weighted average shares                                        |   | 58,491                          |   | 51,546                         |   | 54,726 |   | 46,319 |   |
| Weighted average unvested  common shares subject to repurchase |   | —                          |   | —                         |   | — |   | (2 | ) |
| Denominator for basic and  diluted calculation                 |   | 58,491                          |   | 51,546                         |   | 54,726 |   | 46,317 |   |
|                                                           |   |                            |   |                           |   |   |   |   |   |
| Basic and diluted net loss  per share                          |   | $                               | (0.01  | )                              | $      | (0.02 | ) | $ | (0.04 | ) | $ | (0.20 | ) |
|                                                           |   |                            |   |                           |   |   |   |   |   |
| Effect of antidilutive  securities:                            |   |                            |   |                           |   |   |   |   |   |
| Redeemable convertible  preferred stock                        |   | 556                             |   | 2,278                          |   | 556 |   | 2,278 |   |
| Warrants to purchase  common stock                             |   | 2,215                           |   | 3,556                          |   | 2,215 |   | 3,556 |   |
| Options to purchase common  stock                              |   | 8,633                           |   | 8,594                          |   | 8,633 |   | 8,594 |   |
|                                                           |   |                            |   |                           |   |   |   |   |   |
|                                                           |   | 11,404                          |   | 14,428                         |   | 11,404 |   | 14,428 |   |

 

**RecentAccounting Pronouncements**

 

In November 2002, EITFreached a consensus on issue No. 00-21, “Accounting for Revenue Arrangementswith Multiple Deliverables” (“EITF No. 00-21”) on a model to be used todetermine when a revenue arrangement with multiple deliverables should bedivided into separate units of accounting and, if separation is appropriate,how the arrangement consideration should be allocated to the identifiedaccounting units.  The EITF also reacheda consensus that this guidance should be effective for all revenue arrangementsentered into in fiscal periods beginning after June 15, 2003.  We adopted EITF No. 00-21 during the threemonths ended November 30, 2003.

 

In January 2003, theFinancial Accounting Standards Board (“FASB”) issued Interpretation Number“FIN” 46, “Consolidation of Variable Interest Entities.”  In general, a variable interest entity is acorporation, partnership, trust, or any other legal structure used for businesspurposes that either (a) does not have equity investors with voting rights or(b) has equity investors that do not provide sufficient financial resources forthe entity to support its activities. FIN 46 requires certain variable interestentities to be consolidated by the primary beneficiary of the entity if theinvestors do not have the characteristics of a controlling financial interestor do not have sufficient equity at risk for the entity to finance itsactivities without additional subordinated financial support from otherparties.  The consolidation requirementsof FIN 46 apply immediately to variable interest entities created afterJanuary 31, 2003.  Theconsolidation requirements apply to older entities in interim periods beginningafter December 15, 2003.  Certainof the disclosure requirements apply to all financial statements issued afterJanuary 31, 2003, regardless of when the variable interest entity wasestablished.  The effective dates ofcertain elements of FIN 46 have been deferred. Since we do not have an interest in variable interest entities, whenfinalized, our adoption of FIN 46 is not expected to have a material impact onour financial position or results of operations.

 

In May 2003, the FASBissued SFAS No. 150, “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity” (“SFAS No. 150”).  SFAS No. 150 establishes standards for theclassification and measurement of financial instruments with characteristics ofboth liabilities and equity.  Theeffective date of certain elements of SFAS No. 150 have beendeferred.  When finalized, the adoptionof SFAS No. 150 is not expected to have a material impact on our financialposition, results of operations or cash flows.

 

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

 

During the nine months endedNovember 30, 2003, our stockholders’ equity changed as follows (inthousands):

 
|                                                                           |       | **Common  Stock** |       | **Additional  Paid-In  Capital** |   | **Unearned  Stock-Based  Compensation** |   | **Accumulated  Deficit** |   | **Stockholders’  Equity** |   | **Comprehensive  Loss** |   |
|--------------------------------------------------------------------------------|------------|-------------------|------------|----------------------------------|--------|-----------------------------------------|--------|--------------------------|--------|--------------------------------|--------|-------------------------|--------|
|                                                                           |       |              |       |                             |   |                                    |
|                                                                           | **Shares** |              | **Amount** |                             |   |                                    |   |                     |   |
| Balance at February 28, 2003                                              |       | 52,101            |       | $                                | 5      |                                    | $      | 152,870                  |   | $                              | (32    | )                       | $      | (152,079 | ) | $ | 764 |   |   |   |
| Exercise of stock options                                                      |       | 1,290             |       | —                           |   | 1,281                                   |   | —                   |   | —                         |   | 1,281                   |   |   |   |
| Issuance of common stock for employee stock  purchase program                  |       | 183               |       | —                           |   | 125                                     |   | —                   |   | —                         |   | 125                     |   |   |   |
|                                                                           |       |              |       |                             |   |                                    |   |                     |   |                           |   |                    |   |   |   |
| Issuance of common stock, net of issuance costs of  $89                        |       | 4,000             |       | 1                                |   | 6,111                                   |   | —                   |   | —                         |   | 6,112                   |   |   |   |
|                                                                           |       |              |       |                             |   |                                    |   |                     |   |                           |   |                    |   |   |   |
| Amortization of unearned stock-based compensation                              |       | —            |       | —                           |   | —                                  |   | 28                       |   | —                         |   | 28                      |   |   |   |
|                                                                           |       |              |       |                             |   |                                    |   |                     |   |                           |   |                    |   |   |   |
| Deferred stock-based compensation for options  forfeited                       |       | —            |       | —                           |   | (4                                      | )      | 4                        |   | —                         |   | —                  |   |   |   |
| Issuance of warrant to purchase common stock in  connection with notes payable |       | —            |       | —                           |   | 46                                      |   | —                   |   | —                         |   | 46                      |   |   |   |
| Conversion of preferred stock and warrants into  common stock                  |       | 1,899             |       | —                           |   | 1,584                                   |   | —                   |   | —                         |   | 1,584                   |   |   |   |
| Net loss                                                                       |       | —            |       | —                           |   | —                                  |   | —                   |   | (2,399                         | )      | (2,399                  | )      | $ | (2,399 | ) |
| Other comprehensive loss                                                       |       |              |       |                             |   |                                    |   |                     |   |                           |   |                    |   | — |   |
| Total comprehensive loss                                                       |       |              |       |                             |   |                                    |   |                     |   |                           |   |                    |   | $ | (2,399 | ) |
|                                                                           |       |              |       |                             |   |                                    |   |                     |   |                           |   |                    |   |   |   |
| Balance at November 30, 2003                                              |       | 59,473            |       | $                                | 6      |                                    | $      | 162,013                  |   | $                              | — |                    | $      | (154,478 | ) | $ | 7,541 |   |   |   |

 

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**NOTE 4.ABILITY TO CONTINUE OPERATIONS**

 

Our Annual Report on Form10-K, as amended by Amendment One thereto on Form 10-K/A, for our fiscal yearended February 28, 2003, contains a disclosure expressing substantialdoubt regarding our ability to continue as a going concern as a result of ourrecurring losses and negative cash flows from operations. We narrowed our netloss to $2.4 million for the nine months ended November 30, 2003, ascompared to a net loss of $9.1 million for the nine months endedNovember 30, 2002.  In addition, wereduced our usage of operating cash to approximately $1.3 million for the ninemonths ended November 31, 2003, as compared to $4.1 million for the ninemonths ended November 31, 2002.  InSeptember 2003, we raised $6.2 million in new capital (see Note 10).  Despite these improvements, we continued toexperience recurring losses and negative cash flows from operations for thenine months ended November 30, 2003. In addition, there remains no assurance that we will succeed ingenerating sufficient revenue to enable us to continue operations over thelonger term.

 

Our futurecapital requirements will depend on many factors, including our ability toincrease revenue levels and/or reduce costs of operations to generate positivecash flows, the timing and extent of expenditures to support expansion of salesand marketing efforts, market acceptance of our services, and timeliness ofcollections of our accounts receivable. Any projections of future cash needs are subject to substantialuncertainty. Our ability to generate increased revenues and cash flows and, ifnecessary, raise additional capital is also subject to substantialuncertainty.  The bid price of ourcommon stock has been below $1.00 several times over the past 12 months.  If we fail to meet the $1.00 minimum bidprice requirement or the other standards for continued listing on the NasdaqSmallCap Market, our common stock will likely be de-listed and our ability togenerate both sales and additional capital will be subject to furtheruncertainty.

 

We have historically beenable to satisfy our cash requirements through revenues combined with financingand investing activities.  Nevertheless,we continued to suffer recurring losses and negative cash flows from operationsfor the period ended November 30, 2003, and there is no assurance that wewill succeed in generating sufficient cash from operations on a regular basis,achieving profitability, or obtaining additional capital if needed.

 

**NOTE 5.ASSET SALE**

 

In May 2002, we soldsubstantially all of the assets related to our Asset Management softwarebusiness to Computer Associates International, Inc. for approximately $9.5million in cash. In connection with this sale, our July 2001 agreementwith Computer Associates for its resale of our Argis suite of software productswas terminated. In addition, as part of that asset sale, we assigned toComputer Associates our May 2001 agreement with CorpSoft, Inc. (“CorporateSoftware”) for its resale of our Argis suite of software products.  Because of the asset sale, CorporateSoftware’s successor-in-interest, Software Spectrum, Inc., has the right toterminate that agreement.  If it doesso, all of the shares subject to the warrant that we issued to Corporate Softwarein May 2001 will immediately become exercisable. The fair value of thewarrant had been recorded as prepaid distribution costs and was beingrecognized as a reduction of revenue over the lesser of a ratable charge overthe 24-month term of the agreement with Corporate Software or the period ittook Corporate Software to generate revenue to Intraware of $1.6 million fromCorporate Software’s resale of our asset management software.  As no additional revenue would be generatedfor us under this distribution agreement, the remaining unamortized prepaiddistribution costs of $936,000 were recorded as a reduction to revenue duringthe three months ended May 31, 2002.

 

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The total proceeds from thesale of $9.5 million, less the book value of transferred equipment, intangibleassets including goodwill, deferred revenue, and transaction costs, based ontheir respective carrying values at the sale date, were recorded as a gain onsale of assets in the quarter ended May 31, 2002.

 

The calculation of the gainon the sale was determined as follows (in thousands):

 
| Total consideration                                                  |   | $      | 9,500 |   |
|----------------------------------------------------------------------|--------|--------|-------|--------|
| Net book value of equipment, intangible assets and  deferred revenue |   | (6,536 | )     |
| Transaction costs                                                    |   | (308   | )     |
| Gain on sale                                                         |   | $      | 2,656 |   |

 

In connection with ourdisposition of the Asset Management software business, we announced arestructuring and workforce reduction to reduce our operating expenses.  We recorded a charge of $1.8 millionrelating to this restructuring and the impairment of assets during the threemonths ended May 31, 2002.  Theimpairment of assets includes the write-off of approximately $403,000 inprepaid licenses that were held for resale. The restructuring charge consisted of approximately $345,000 forseverance and benefits relating to the involuntary termination of 14 employeeswho were not hired by Computer Associates. We terminated an additional 33 employees, all of whom were based inNorth America.  These 33 terminatedemployees were all hired by Computer Associates and therefore received noseverance payments.  Overall, we reducedour workforce to 71 employees from 118 in connection with the asset sale toComputer Associates.  Of the 47terminated employees, 22 were in Sales and Marketing, 10 were in ProductDevelopment and 15 were directly involved in our product support.  We also closed our Pittsburgh, Pennsylvania,office and various satellite offices.

 

We accrued for lease andrelated costs of approximately $983,000, principally pertaining to the estimatedfuture obligations of non-cancelable lease payments for excess facilities thatwere vacated due to our reductions in work force.  We also recognized $63,000 relating to other restructuringexpenses.  Due to changes inmanagement’s estimates relating to the restructuring during the three monthsended August 31, 2002, we recognized an additional expense of $106,000pertaining to the estimated future obligations of non-cancelable lease paymentsfor excess facilities that were vacated due to our reductions in workforce.  In addition, we did not incurseverance and benefits of $106,000 and reduced the reserve accordingly. Duringthe three months ended February 28, 2003, we terminated our Pittsburgh,Pennsylvania, lease and realized a savings of approximately $152,000 in rentthat would otherwise have been payable, and which was included in therestructuring line item on the consolidated statement of operations.

 

In our December 2000restructuring, we closed our Fremont, California, office and assigned our leaseto a new tenant while acting as guarantor for that tenant.  In May 2002, the new tenant defaultedon its

 

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lease.  During the three months endedNovember 30, 2002, we made a cash payment of approximately $214,000 toterminate this lease.

 

The following table setsforth an analysis of the components of the restructuring and impairment ofassets charges recorded for the nine months ended November 30, 2003, (inthousands):

 

 
|                                      |   | **Excess  lease  and related costs** |   |
|-------------------------------------------|--------|--------------------------------------|--------|
| Reserve balance at February 28, 2003 |   | $                                    | 10     |   |
| Cash paid                                 |   | (10                                  | )      |
| Reserve balance at November, 2003         |   | $                                    | — |   |

 

As of November 30,2003, we have settled all liabilities associated with the May 2002restructuring and sale of the Asset Management software business, subject tothe ongoing indemnification obligation discussed in Note 6.

 

**NOTE 6.CONTINGENCIES**

 

**Indemnifications**

 

In the course of ourbusiness, we have given indemnities and made commitments and guarantees underwhich we may be required to make payments. These indemnities include:

 

•                  *Intellectual PropertyIndemnities to Customers. *Our service agreements with our customerstypically contain provisions that indemnify our customers for damages and costsresulting from claims alleging that our services infringe the intellectualproperty rights of a third party.  Wehave also entered into software license agreements indemnifying the licenseesfor damages and costs resulting from claims alleging that the software infringesthird-party intellectual property rights. The duration of these indemnities is typically unlimited.  Our potential payments under theseindemnities are in some cases limited (e.g., to the fees paid to us under thecontract 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 receivedsimilar indemnities from the software publishers.  We plan to continue to license software and provide industry-standardindemnities to our licensees and our service customers.

 

•                  *Intellectual PropertyIndemnity to Acquiror of Asset Management Business.  *In theMay 2002 sale of our Asset Management software business to ComputerAssociates (see Note 5), we agreed to indemnify Computer Associates for damagesand costs incurred by it in connection with claims alleging that the softwareand technology we sold to them infringes the intellectual property rights ofthird parties.  This indemnity willremain in effect until May 2007. Our maximum potential payment under this indemnity is $9.5 million.

 

•                  *Indemnities to PrivateInvestors. *In our private placements of stock, we havemade representations and warranties to the investors and placement agents, andhave agreed to indemnify them for any damages and costs they incur as a resultof our breach of those representations and warranties.  We also have signed registration rightsagreements with private investors under which we indemnify them for damagesthey incur as a result of our failure to maintain the effectiveness ofregistration statements.  The durationof our indemnities to our investors under the respective stock and warrantpurchase agreements ranges from one to two years from the respective closingdates, other than the purchase agreements for our June 2000 warrants andour January 2001 Series A Preferred Stock and warrants, which provide for

 

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indemnities of unlimitedduration.  Our indemnities to ourinvestors under the respective registration rights agreements expire upontermination of our registration obligations, which is typically the date thesecurities are salable under Rule 144(k) under the Securities Act of 1933. Ourpotential payments under these 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 our potential paymentsunder, these indemnities are unlimited, subject to Delaware law.  We have historically received only a verylimited number of requests for indemnification under these agreements and havenot been required to make material payments under them.  Accordingly, we have not recorded aliability related to these indemnification provisions.

 

**LegalProceedings**

 

In October 2001, wewere served with a summons and complaint in a purported securities class actionlawsuit.  On or about April 19,2002, we were served with an amended complaint in this action, which is nowtitled In re Intraware, Inc. Initial Public Offering Securities Litigation,Civ. No. 01-9349 (SAS) (S.D.N.Y.), related to In re Initial Public OfferingSecurities Litigation, 21 MC 92 (SAS) (S.D.N.Y.).  The amended complaint is brought purportedly on behalf of allpersons who purchased our common stock from February 25, 1999 (the date ofour 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 the registrationstatement for the offerings did not disclose that: (1) the underwriters hadagreed to allow certain customers to purchase shares in the offerings inexchange 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.

 

Lawsuits containing similarallegations have been filed in the Southern District of New York challengingover 300 other initial public offerings and secondary offerings conducted in1999 and 2000.  All of these lawsuitshave been consolidated for pretrial purposes before United States DistrictCourt Judge Shira Scheindlin of the Southern District of New York. OnJuly 15, 2002, an omnibus motion to dismiss was filed in the coordinatedlitigation on behalf of the issuer defendants, of which Intraware and its threenamed current and former officers and directors are a part, on common pleadingsissues.  On or about October 9,2002, the Court entered and ordered a Stipulation of Dismissal, which dismissedthe three named current and former officers and directors from the litigationwithout prejudice.  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.  No discovery has beenserved on us to date.  A specialcommittee of our Board has approved a tentative settlement proposal fromplaintiffs.  There is no guarantee thatthe settlement will become final, as it is subject to a number of conditions,including court approval; however, based on this proposed settlement, we do notbelieve we will suffer material future losses related to this lawsuit andtherefore have not accrued for any losses.

 

We are also subject to legalproceedings, claims and litigation arising in the ordinary course of business.We do not expect that the ultimate costs to resolve these matters will have amaterial adverse effect on our consolidated financial position, results ofoperations, or cash flows.

 

**NOTE7.  REDEEMABLE CONVERTIBLE PREFERRED STOCK**

 

We are authorized, subjectto limitations prescribed by Delaware law, to provide for the issuance ofpreferred stock in one or more series, to establish from time to time thenumber of shares included within each series, to fix the rights, preferences andprivileges of the shares of each wholly unissued series and any qualifications,limitations or restrictions thereon, and to increase or decrease the number ofshares of any

 

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such series (but not below thenumber of shares of such series then outstanding) without any further vote oraction by the stockholders.

 

Redeemable convertiblepreferred stock (“Preferred Stock”) activity for the nine months endedNovember 30, 2003, was as follows (in thousands):

 
|                                                        |   | **Preferred  Stock** |   |
|-------------------------------------------------------------|--------|----------------------|--------|
|                                                        |   | **Shares**           |   | **Amount** |   |
| Balance at February 28, 2003                                |   | 1,347                |   | $ | 2,473 |   |
| Conversion of Series B-1 Preferred Stock  into common stock |   | (48                  | )      | (362 | ) |
| Conversion of Series A Preferred Stock into  common stock   |   | (746                 | )      | (1,212 | ) |
| Balance at November 30, 2003                                |   | 553                  |   | $ | 899 |   |

 

**NOTE8.  NOTES PAYABLE**

 

In August 2003, weissued a note payable to a bank for proceeds of approximately $2.0million.  The note bears an annualinterest rate of the greater of 1% in excess of the bank’s prime rate (4.00% atNovember 30, 2003) or 5.25%.  Theinterest rate on the note payable at November 30, 2003, was 5.25%.  The note payable is payable in fixed monthlyprincipal installments plus interest through September 2005.  In connection with the note payable, weissued a warrant to purchase 41,730 shares of our common stock at an exerciseprice of $1.19 per share.  The warrantwas immediately exercisable and expires in August 2010.  We estimated the allocated fair value ofsuch warrant at approximately $46,000, using the Black-Scholes valuation modelwith the following assumptions: expected volatility of 136%, risk-free interestrate of 4.01%, expected life of seven years and no dividends.  The value of the warrant was recorded as a debtdiscount and is being amortized as interest expense using the effectiveinterest method over the life of the note payable.  For the three and nine months ended November 30, 2003,interest expense related to such warrant amounted to approximately $9,000 and$14,000, respectively.  The unamortizedbalance is presented as a discount against the principal balance of the notepayable outstanding.  AtNovember 30, 2003, the warrants had not been exercised.

 

In August 2003, we alsoentered into a line of credit with the same bank. The line of credit bearsannual interest at the greater of the bank’s prime rate plus 1% or 5.25%.  The agreement provides for borrowings of upto $500,000 through August 2004 and is limited to equipment purchases.  As of November 30, 2003, we hadborrowed approximately $182,000 under this agreement and the interest rate atthat date was 5.25%.  Monthly paymentsof interest only are payable through August 2004, after which fixedmonthly principal installments plus interest will be made throughAugust 2006.

 

All of this debt iscollateralized by a senior security interest in substantially all of ourassets.  We are also required tomaintain compliance with some financial covenants.

 

Scheduled maturities of debtat November 30, 2003, are as follows (in thousands):

 
| Years ending:          |   |   |   |
|------------------------|--------|--------|--------|
| February 29, 2004 |   | $      | 248    |   |
| February 28, 2005 |   | 1,037  |   |
| February 28, 2006 |   | 669    |   |
| February 28, 2007 |   | 45     |   |
|                   |   | $      | 1,999  |   |

 

**NOTE 9.ALLIANCES**

 

On August 12, 2002, weentered into a strategic alliance agreement with Zomax Incorporated (“Zomax”),an international outsource provider of process management services.  The agreement provides

 

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for Zomax’ marketing and resaleof our SubscribeNet ESDM service to its global customer base.  Under the agreement, Zomax was required topay a minimum license fee totaling $15 million to us over 10 years, subject tosome conditions, including Zomax’ right to cancel the agreement at any timewith one year’s notice.  The annual minimumlicense fee is based on a graduated scale, beginning with $0.5 million in thefirst year of the agreement and escalating to $2.2 million in the final year ofthe agreement.  Zomax will also pay usnon-refundable quarterly service fees, based on sales of the SubscribeNetservice by Zomax, over the term of the agreement.  Under this agreement, our SubscribeNet service is the only ESDMsolution Zomax may sell and Zomax is the only supply chain managementoutsourcing industry company we may authorize to resell our SubscribeNetservice.  Under the agreement, onSeptember 3, 2002, Zomax paid to us a $1 million prepayment to be appliedagainst future fees.  As part of theagreement, we are also a non-exclusive lead generator for Zomax’ products andservices, through which we can receive fees based on the generation ofcompleted leads for Zomax.  Lastly, wewill reimburse Zomax for one-half of the base salary of a product salesmanager, up to a maximum amount.  On theday we entered into that strategic alliance agreement with Zomax, we alsocompleted a private placement of approximately 6.1 million shares of our commonstock to Zomax for gross proceeds of approximately $5.0 million.  Upon completion of that private placement,Zomax held approximately 12% of our outstanding common stock.  On September 18, 2003, we filedan amended registration statement to register the resale of the common stockissued to Zomax.  The SEC declared thatregistration statement effective on September 25, 2003.

 

On August 29, 2003, weamended our strategic alliance agreement with Zomax to: (1) allow Zomax toterminate the agreement as of August 12, 2004, or as of any datethereafter, with or without cause, by delivery of 30 days prior written notice;(2) accelerate the due date of the payment of $0.4 million by Zomax to us for thesecond year of the agreement; and 3) reduce the minimum license fee for thethird year of the agreement, which begins August 12, 2004, from $1.0million to $0.6 million if Zomax has not terminated the agreement.  During the three months endedNovember 30, 2003, and in accordance with that amendment, we received $0.4million from Zomax all of which was recorded as deferred revenue at November30, 2003, and will be applied to future services.

 

At November 30, 2003,deferred revenue and accounts receivable balances related to this agreementtotaled approximately $0.8 million and zero, respectively.  During the three and nine months endedNovember 30, 2003, we recognized approximately $0.1 million and $0.3million of revenue, related to this agreement, respectively.  During the three and nine months endedNovember 30, 2002, we recognized approximately $0.1 million and $0.2million of revenue, related to this agreement, respectively.

 

**NOTE10.  COMMON STOCK**

 

On September 9, 2003,we completed a private placement of common stock to investment funds andaccounts managed by Apex Capital, LLC. Under the terms of the financing, we issued 4.0 million shares of commonstock at a price of $1.55 per share for gross proceeds of $6.2 million.  As part of this transaction, we incurred andexpect to incur approximately $89,000 in legal, accounting, and othercosts.  Including shares previouslyacquired on the open market, as of September 9, 2003, investment funds andaccounts managed by Apex Capital, LLC held approximately 9% of our outstandingcommon stock.

 

The common stock was issuedin a private placement without registration under the Securities Act of 1933and may not be offered or sold in the United States of America absentregistration or an applicable exemption from registration requirements. Inissuing the securities, we relied on the exemption from registration providedby Section 4(2) of the Securities Act of 1933 and Regulation D promulgatedthereunder, based in part on the purchasers being institutional type investorsand on their representations in the purchase agreement.  As part of the agreement, we agreed to filewith the SEC a registration statement to register the resale of the commonstock issued under this private placement within 45 days of closing, and to usecommercially reasonable efforts to cause the registration statement to bedeclared effective by the SEC as promptly as practicable, but in no case morethan one year, thereafter.

 

On October 24, 2003, wefiled with the SEC a registration statement for the resale of the common stockissued in connection with our September 9, 2003 private placement.  The SEC declared this registration statementeffective on November 4, 2003.

 

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The September 9, 2003,common stock financing resulted in anti-dilution adjustments to the warrantsissued in connection with our issuance of redeemable convertible preferredstock on June 30, 2000.  Theexercise price of the warrants issued in connection with our preferred stock onJune 30, 2000, was adjusted from $1.43 to $1.41.

 

**ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

 

The following discussion ofour financial condition and results of operations should be read in conjunctionwith our consolidated financial statements and related notes included in ourAnnual Report on Form 10-K, as amended by Amendment One thereto on Form 10-K/A,for the fiscal year ended February 28, 2003.  This discussion contains forward-looking statements that involverisks and uncertainties. Forward-looking statements include statementsregarding our future cash and liquidity position, the extent and timing offuture revenues and expenses and customer demand, the deployment of ourproducts and services, and our reliance on third parties.  All forward-looking statements included inthis document are based on information available to us as of the date hereof,and we assume no obligation to update any forward-looking statement.  Our actual results could differ materiallyfrom those anticipated in these forward-looking statements as a result ofcertain factors, including but not limited to, those discussed in “RiskFactors” below and elsewhere in this Quarterly Report on Form 10-Q.

 

**INTRAWAREOVERVIEW**

 

Intraware, Inc. wasincorporated in Delaware on August 14, 1996.  We are a leading provider of global electronic software deliveryand management (ESDM) solutions.  OurESDM solutions help software publishers reduce operational and support costs,increase customer satisfaction and retention, accelerate and strengthensoftware revenue recognition processes, and comply with U.S. exportregulations.  We also offercomplementary products and services, including enterprise software sales andmarketing, and global web-based content caching and delivery.

 

We have a limited operatinghistory upon which investors may evaluate our business and prospects. Sinceinception, we have incurred significant losses, and, as of November 30,2003, had an accumulated deficit of approximately $154 million.  We expect to incur additional net lossesduring our fiscal year ending February 29, 2004.  There can be no assurance that our gross profit will increase orcontinue at its current level.  Therealso can be no assurance that we will generate cash from operations in futureperiods, or achieve or maintain profitability, or that we will be able tofinance our operations without raising additional capital.  Our future must be considered in light ofour liquidity issues and the risks frequently encountered by companies in anearly stage of development, particularly companies in new and rapidly evolvingmarkets such as Internet-based services. To address these risks, we must, among other things, implement andsuccessfully execute our business and marketing strategy, continue to developand upgrade our technology, provide superior customer service, respond tocompetitive developments and attract, retain and motivate qualifiedpersonnel.  There can be no assurance wewill be successful in addressing those risks, and our failure to do so wouldhave a material adverse effect on us. Our current and future expense levels are based largely on our plannedoperations and estimates of future sales. Sales and operating results generally depend on the volume and timing oforders received, which are difficult to forecast.  We may be unable to adjust spending in a timely manner tocompensate for any unexpected revenue shortfall.  Accordingly, any significant shortfall in sales would have animmediate adverse effect on us and our cash flows.  In view of the rapidly evolving nature of our business and ourlimited operating history, we are unable to accurately forecast our sales andbelieve that period-to-period comparisons of our operating results are notnecessarily meaningful and should not be relied upon as an indication of futureperformance.

 

**CriticalAccounting Policies and Estimates**

 

Management’s Discussion andAnalysis of Financial Condition and Results of Operations discusses ourconsolidated financial statements, which have been prepared in accordance withgenerally accepted accounting principles in the United States of America.  The preparation of these financial

 

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statements requires managementto 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 anongoing basis, management evaluates its estimates and judgments.  We base our estimates and judgments onhistorical experience and on various other factors believed to be reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying values of assets and liabilities not readilyapparent from other sources.  Actualresults may differ from these estimates under different assumptions orconditions.

 

We consider accountingpolicies related to revenue recognition, prepaid licenses, allowance fordoubtful accounts, goodwill and intangibles, and income taxes to be criticalaccounting policies due to the estimation process involved in each.

 

*Revenuerecognition*

 

Online services andtechnology revenue results primarily from three types of arrangements.  First, it results from sales of ourSubscribeNet electronic software delivery and management service to softwarevendors and other companies that distribute software as part of theirbusiness.  Second, it results from thesale of our proprietary software licenses and related maintenance to companiesusing those products internally or using those products to provide web-basedservices to their customers.  Third, itresults from professional services that we provide to integrate our proprietarysoftware, to convert data for customers, and to customize our SubscribeNetservice for individual customer needs. As a result of the sale of our Asset Management software business in May 2002(discussed below in Results of Operations), we are not currently derivingsignificant revenue from licenses for our proprietary software; however, we mayrecognize future revenues as a result of our plan to sell licenses for ourproprietary software underlying our SubscribeNet service and relatedmaintenance.  We sell our SubscribeNetservice and our proprietary software licenses primarily through our directsales force or through authorized resellers.

 

Alliance and reimbursementrevenue primarily relates to our alliance agreement with Software Spectrum forsales of Sun ONE software licenses and maintenance.  This revenue consists of a percentage of the gross profit derivedfrom the sales of Sun ONE software licenses and maintenance services, and reimbursementfor the costs of maintaining a sales team dedicated to selling Sun ONE softwarefor Software Spectrum.  This revenue isrecognized as we provide the services to Software Spectrum.

 

We derive software productrevenues from resold licenses and maintenance for multiple business software productlines.  Although as of July 1,2001, we no longer resell third party software licenses and maintenance, wecontinue to recognize revenue from third party software licenses and relatedmaintenance contracts over the life of the arrangements made prior toJuly 1, 2001.  Vendor specificobjective evidence of fair value for the maintenance element of the resoldsoftware arrangements is based on historical and contractual renewal rates formaintenance.  We defer the maintenancerevenue at the outset of the arrangement and recognize it ratably over theperiod during which the maintenance is to be provided (generally 12 months),which normally commences on the date the software is delivered.

 

We defer services revenuerelated to our SubscribeNet service and generally recognize it ratably over theterm of the service arrangement. Professional service fees revenue related to our SubscribeNet service isdeferred until completion of the professional services, then recognized ratablyover the longer of the remaining estimated customer life or the remainingSubscribeNet contract term.

 

We recognize revenue whenall of the following conditions 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 isprobable; and

 

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

 

Revenue from transactionsthrough authorized resellers has been recognized when the licenses andmaintenance have been resold or utilized by the reseller or when our relatedobligations have been satisfied.  Weprovided for sales allowances for authorized resellers and direct sales on anestimated basis. This estimation was based on prior history as well ascontractual requirements.  We basevendor specific objective evidence of fair value for the maintenance element ofthe proprietary software arrangements on historical and contractual renewalrates for maintenance.  We defer themaintenance revenue at the outset of the arrangement and recognize it ratablyover the period during which the maintenance is to be provided (generally 12months), which normally commences on the date the software is delivered.

 

As mentioned above, adetermination that the collection of fees is probable is a precursor torecognizing revenue.  Determination ofcollectibility of payments requires judgment on the part of management andincludes periodically evaluating customers’ credit (see “Allowance for doubtfulaccounts” below).

 

*Prepaidlicenses*

 

We write down our prepaidlicenses for estimated obsolescence equal to the difference between the cost ofthe prepaid licenses and the estimated recoverable value based on assumptionsabout future demand, market conditions and our rights to return under stockrotation agreements.  If actual futuredemand or market conditions are less favorable than those we project,additional prepaid license write-downs may be required.  These prepaid licenses were originallyobtained as a result of our third party reseller business.  As of July 1, 2001, we ceased resellingthird party software licenses (see “Revenue recognition” above).   During the nine months endedNovember 2003 and 2002, we recorded approximately zero and $403,000 inprepaid license write-downs, respectively.

 

*Allowancefor doubtful accounts*

 

We maintain an allowance fordoubtful accounts for estimated losses from our inability to collect requiredpayments from our customers.  We analyzespecific accounts receivable, historical bad debts, customer credit-worthiness,current economic trends and changes in our customer payment history whenevaluating the adequacy of the allowance for doubtful accounts.  Changes in the above factors could have amaterial impact on actual bad debts incurred.

 

*Goodwilland intangibles*

 

As discussed in Note 1 ofour “Notes to Consolidated Financial Statements” in our Annual Report on Form10-K, as amended by Amendment One thereto on Form 10-K/A, for the year endedFebruary 28, 2003, we are required to regularly review all of ourlong-lived assets, including goodwill and other intangible assets, forimpairment whenever events or changes in circumstances indicate that thecarrying value may not be recoverable. Factors we consider important which could trigger an impairment reviewinclude, but are not limited to, significant underperformance relative tohistorical or projected future operating results, significant changes in themanner of use of the acquired assets or the strategy for our overall business,significant negative industry or economic trends, a significant decline in ourstock price for a sustained period, and our market capitalization relative tonet book value.  When we determine thatan impairment review for intangible and long-lived assets is necessary basedupon the existence of one or more of the above indicators of impairment, wecompare the book value of such assets to the future undiscounted cash flowsattributable to those assets.  If thebook value is greater than the future undiscounted cash flows, we measure anyimpairment based on a projected discounted cash flow method using a discountrate commensurate with the risk inherent in our current business model.  When we determine an impairment review ofgoodwill is necessary based on an impairment indicator or based on our annualtesting requirements, we compare the fair value of the reporting unit to thecarrying value of the reporting unit. If the carrying value of the reporting unit is greater than the fairvalue of the reporting unit, an impairment may be necessary.  Significant judgment is required in thedevelopment of projected cash

 

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flows for these purposesincluding assumptions regarding the appropriate level of aggregation of cashflows, their term and discount rate as well as the underlying forecasts ofexpected future revenue and expense.  Duringfiscal year 2003, our remaining goodwill and intangibles were included in ourcalculation of the gain on sale of our Asset Management software business, asdiscussed in Note 13 of our “Notes to Consolidated Financial Statements”in our Annual Report on Form 10-K, as amended by Amendment One thereto on Form10-K/A, for the year ended February 28, 2003.

 

*Incometaxes*

 

In conjunction withpreparing our financial statements, we must estimate our income taxes in eachof the jurisdictions in which we operate. This process involves estimating our actual current tax expense togetherwith assessing temporary differences resulting from differing treatment ofitems for tax and accounting purposes. These differences result in deferred tax assets and liabilities.  We must then assess the likelihood that ourdeferred 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 incurredlosses since inception and therefore have not been required to pay incometaxes, we have fully reserved our deferred tax assets at February 28,2003.  In the event that we are able torealize our deferred tax assets in the future, an adjustment to the deferredtax asset would increase income in the period that this is determined.

 

**RESULTS OFOPERATIONS**

 

**Totalrevenue**

 

Revenue decreased to $2.5million for the three months ended November 30, 2003, from $2.9 millionfor the three months ended November 30, 2002.  Combined online services and technology and related party onlineservices and technology revenue for the three months ended November 30,2003, accounted for $1.8 million or 70% of revenue compared to $1.8 million or62% of revenue for the three months ended November 30, 2002.  Alliance and reimbursement revenue for thethree months ended November 30, 2003, accounted for $0.7 million or 26% ofrevenue compared to $0.9 million or 31% of revenue for the three months endedNovember 30, 2002.  For the threemonths ended November 30, 2003, software product revenue accounted forapproximately $89,000 or 4% of revenue, compared to $0.2 million or 7% ofrevenue for the three months ended November 30, 2002.

 

Revenue decreased to $7.9million for the nine months ended November 30, 2003, from $10.8 millionfor the nine months ended November 30, 2002.  Combined online services and technology and related party onlineservices and technology revenue for the nine months ended November 30,2003, accounted for $5.2 million or 67% of revenue compared to $5.1 million or47% of revenue for the nine months ended November 30, 2002.  Alliance and reimbursement revenue for thenine months ended November 30, 2003, accounted for $2.3 million or 30% ofrevenue compared to $3.2 million or 30% of revenue for the nine months endedNovember 30, 2002.  For the ninemonths ended November 30, 2003, software product revenue accounted for$0.3 million or 4% of revenue, compared to $2.5 million or 23% of revenue forthe nine months ended November 30, 2002.

 

Revenues for combined onlineservices and technology and related party online services and technology forthe three months ended November 30, 2003, remained consistent with theprior year. Revenues for combined online services and technology and relatedparty online service and technology revenue for the nine months endedNovember 30, 2003, increased from the prior year.  This increase is primarily due to theincrease in related party online services and technology revenue derived fromour relationship with Zomax Incorporated. The increases in combined online services and technology revenue fromnew customers were offset by a reduction in online services and technologyrevenue under our services agreement with Sun Microsystems, Inc. of $0.5million and $1.2 million for the three and nine months ended November 30,2003, respectively.  As ofMarch 31, 2003, Sun no longer receives the SubscribeNet service.  The portion of that agreement related to ourelectronic fulfillment of initial Sun software license sales will remain in effectthrough June 2004; however, the fees payable by Sun for our fulfillmentservices were reduced substantially effective March 1, 2003.  We expect our combined online

 

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services and technology revenueand related party online services and technology revenue for our fiscal quarterending February 29, 2004, to be at slightly higher levels than those inour fiscal quarter ended November 30, 2003.  The previous sentence is a forward-looking statement and actualresults could differ materially from those anticipated. In particular, ourexpected growth in revenue from the introduction of new products and servicesis subject to the risk that these new products and services may not beintroduced in a timely manner, or may be canceled altogether, or even if theyare introduced, customers may not be willing to buy them (see “Risk Factors”beginning on page 26 below).

 

Alliance andreimbursement revenue primarily relates to our alliance agreement with SoftwareSpectrum for sales of Sun ONE software licenses and maintenance.  This revenue consists of a percentage of thegross profit derived from the sales of Sun ONE software licenses andmaintenance services, and reimbursement for the costs of maintaining a salesteam dedicated to selling Sun ONE software for Software Spectrum.  The decrease in alliance and reimbursementrevenue for the three and nine months ended November 30, 2003, wasprimarily due to a reduction of the shared gross profit derived from the salesof Sun ONE software licenses and maintenance services, of $0.7 million and $0.2million, respectively.  We expect ouralliance and reimbursement revenues in our fiscal quarter ending February 29,2004 to be slightly higher than those in our three months endedNovember 30, 2003.  The previoussentence is a forward-looking statement and actual results could differmaterially from those anticipated.

 

The decline in softwareproduct revenue and the majority of the decline in total revenue for the threeand nine months ended November 30, 2003, was due to our transition out ofthe business of reselling third-party software products and relatedmaintenance.  We expect our exitedthird-party product revenue to continue to decrease. However, we may recognizefuture revenues from products and services complementary to our SubscribeNetservice, which originate with other companies and are sold to customers throughus as part of a comprehensive ESDM business solution.  The previous two sentences are forward-looking statements andactual results could differ materially from those anticipated.

 

**Costs andExpenses**

 

The following table setsforth certain items from our consolidated statements of operations as apercentage of total revenue for the periods indicated:

 
|                                               |   | **For the Three  Months Ended** |   | **For the  Nine Months Ended** |   |
|----------------------------------------------------|--------|---------------------------------|--------|--------------------------------|--------|
|                                               |   | **November 30,  2003**     |   | **November 30,  2002**    |   | **November 30,  2003** |   | **November 30,  2002** |   |
|                                               |   |                            |   |                           |   |   |   |   |   |
| Gross margin                                       |   | 59                              | %      | 56                             | %      | 57 | % | 53 | % |
| Operating expenses:                                |   |                            |   |                           |   |   |   |   |   |
| Sales and marketing                                |   | 23                              | %      | 33                             | %      | 26 | % | 43 | % |
| Product development                                |   | 22                              | %      | 41                             | %      | 28 | % | 48 | % |
| General and administrative                         |   | 33                              | %      | 18                             | %      | 32 | % | 22 | % |
| Amortization of intangibles                        |   | 0                               | %      | 0                              | %      | 0 | % | 10 | % |
| Restructuring                                      |   | 0                               | %      | 0                              | %      | 0 | % | 13 | % |
| Impairment of assets                               |   | 0                               | %      | 0                              | %      | 0 | % | 7 | % |
| Total operating expenses                           |   | 78                              | %      | 92                             | %      | 86 | % | 143 | % |
| Loss from operations                               |   | -19                             | %      | -37                            | %      | -29 | % | -90 | % |
| Interest expense                                   |   | -2                              | %      | -3                             | %      | -2 | % | -24 | % |
| Interest and other income and expenses, net        |   | 1                               | %      | 1                              | %      | 1 | % | 5 | % |
| Gain on sale of Asset Management software business |   | 0                               | %      | 0                              | %      | 0 | % | 25 | % |
| Net loss                                           |   | -20                             | %      | -39                            | %      | -31 | % | -85 | % |

 

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**Cost ofRevenues**

 

Total cost of revenuesdecreased to $1.0 million for the three months ended November 30, 2003,from $1.3 million for the three months ended November 30, 2002. Our grossmargin increased to 59% for the three months ended November 30, 2003, from56% for the three months ended November 30, 2002. Total cost of revenuesdecreased to $3.4 million for the nine months ended November 30, 2003,from $5.0 million for the nine months ended November 30, 2002.  Our gross margin increased to 57% for thenine months ended November 30, 2003, from 53% for the nine months endedNovember 30, 2002.

 

The decrease in cost ofrevenues for the three and nine months ended November 30, 2003, isprimarily due to the phasing out of our software reseller business, whichresulted in a reduction in cost of revenues of $0.1 million and $1.6 million,respectively.  The margin percentageincrease for the three and nine months ended November 30, 2003, primarilyreflects our focus on the sale of our own services and technology, whichgenerate higher margins than third-party products we resold.

 

Cost of revenues primarilyconsist of certain allocated costs related to our Internet connectivity, assetssupporting cost of revenues, and customer support, as well as the costsassociated with maintaining our sales team dedicated to selling Sun ONEsoftware for which we are reimbursed by Software Spectrum. Cost of revenuesalso consists of professional services personnel costs and the cost ofthird-party products sold.  We purchasedthird-party products at a discount from the third-party’s established listprices according to standard reseller terms. We expect the overall cost of revenues in the current fiscal year to belower than, and gross profit margin percentage to be greater than, our fiscalyear 2003 levels.  The previous sentenceis a forward-looking statement.  Theactual mix of sales transactions and the timing of the transactions may causeour cost of revenues and gross profit margins to fluctuate materially fromthose anticipated.

 

**Sales andMarketing Expenses**

 

For the three months endedNovember 30, 2003, sales and marketing expenses were $0.6 million or 23%of revenue, a decrease from $1.0 million or 33% of revenue for the three monthsended November 30, 2002.  For thenine months ended November 30, 2003, sales and marketing expenses were$2.0 million or 26% of revenue, a decrease from $4.6 million or 43% of revenuefor the nine months ended November 30, 2002.

 

Sales and marketing expensesconsist primarily of employee salaries, benefits and commissions, advertising,promotional materials, trade show expenses and certain allocated overheadcosts.

 

The decrease in the dollaramount and percentage of revenue of our sales and marketing expenses for thethree months ended November 30, 2003, compared to the three months endedNovember 30, 2002, is primarily due to reductions in payroll related expensesof $0.3 million.

 

The decrease in the dollaramount and percentage of revenue of our sales and marketing expenses for thenine months ended November 30, 2003, compared to the nine months endedNovember 30, 2002, is primarily due to our restructuring efforts in connectionwith the sale of our Asset Management software business in May 2002, whichreduced expenditures on salaries and marketing, and eliminated rent on closedoffices for a total of approximately $1.8 million in reduced expenses.  The decrease is also attributable to reducedstock-based employee compensation expense of $0.3 million.

 

We expect our investment insales and marketing for our current fiscal year to be lower in total and as apercentage of revenue than the investment made in fiscal year 2003.  We plan to continue to market and sell ourservice and proprietary software licenses directly to customers using ourexisting sales force. We also plan to continue to develop additional businessrelationships to sell our services to a broader customer base.  The previous three sentences areforward-looking statements and actual results could differ materially fromthose anticipated.

 

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**ProductDevelopment Expenses**

 

For the three months endedNovember 30, 2003, product development expenses were $0.6 million or 22%of revenue, a decrease from $1.2 million or 41% of revenue for the three monthsended November 30, 2002.  For thenine months ended November 30, 2003, product development expenses were$2.2 million or 28% of revenue, a decrease from $5.2 million or 48% of revenuefor the nine months ended November 30, 2002.

 

Product development expensesprimarily consist of personnel, consulting, software and related maintenance,equipment depreciation expenses and allocated overhead costs.  Costs related to research, design anddevelopment of products and services have been charged to product developmentexpense as incurred.

 

The decrease in the dollaramount and percentage of revenue of our product development expenses for thethree months ended November 30, 2003, compared to the three months endedNovember 30, 2002, is primarily due to a decrease in employee expenses of $0.2million and a decrease in software and related maintenance and equipmentdepreciation expense of $0.5 million, as many fixed assets have become fullydepreciated during the past several quarters.

 

The decrease in the dollaramount and percentage of revenue of our product development expenses for thenine months ended November 30, 2003, compared to the nine months endedNovember 30, 2002, is primarily due to our restructuring efforts in connectionwith the sale of our Asset Management software business in May 2002, whicheliminated expenditures on salaries and consulting fees for Asset Managementsoftware development personnel of $0.4 million, reduced software and relatedmaintenance and equipment depreciation expenses through the sale or retirementof software and equipment of $1.2 million, and reduced stock-based employeecompensation expense of $0.3 million.

 

We anticipate continuing toinvest in additional functionality for our SubscribeNet service and underlyingproprietary software.  However, weexpect those investments to fluctuate over time, and expect our productdevelopment expenses to fluctuate accordingly. Total product development expenditures are expected to be lower infiscal year 2004 than fiscal year 2003 levels in total and as a percentage ofrevenue. We cannot give assurance that our product development efforts willresult in new or improved products, features or functionality or that themarket will accept the improvements to existing or new products, features orfunctionality developed.

 

**General andAdministrative Expenses**

 

For the three months endedNovember 30, 2003, general and administrative expenses were $0.8 millionor 33% of revenue, an increase from $0.5 million or 18% of revenue for thethree months ended November 30, 2002. For the nine months ended November 30, 2003, general andadministrative expenses were $2.5 million or 32% of revenue, an increase from$2.3 million or 22% of revenue for the nine months ended November 30,2002.

 

General and administrativeexpenses consist primarily of compensation for administrative and executivepersonnel, fees for professional services and certain overhead costs.

 

A significant part of theincrease in our general and administrative expenses for the three months endedNovember 30, 2003, is due to the reduction in recovery of accountspreviously written off, as compared to our recovery of such accounts during thethree months ended November 30, 2002. During our 2001 fiscal year, we wrote off accounts that were deemed tobe uncollectible at that time.  However,we continued to pursue collection efforts and ultimately succeeded inrecovering $0.4 million in such accounts during the three months endedNovember 30, 2002.  These recoveredaccounts were credited against general and administrative expenses for thethree months ended November 30, 2002. During the three months ended November 30, 2003, we had no suchrecovered accounts, and therefore no such credit against general andadministrative expenses.  The increasein percentage of revenue for the three months ended November 30, 2003, isprimarily due to the recoveries explained above as well as to the decrease inour total revenues as compared to the prior year.

 

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The increase in our generaland administrative expenses for the nine months ended November 30, 2003,compared to the nine months ended November 30, 2002, is primarily due toreduced recoveries of accounts previously written off (as further described inthe preceding paragraph) of approximately $0.9 million during the nine monthsended November 30, 2003.  Thesedecreases were partially offset by reductions in payroll related expenses of$0.4 million and external personnel costs and state fees of $0.2 million.  The increase in percentage of revenue forthe nine months ended November 30, 2003, is primarily due to the reductionin total revenue from the prior year.

 

Total expenditures in fiscalyear 2004 are expected to be higher than fiscal year 2003 levels in total andas a percentage of revenue, partly because we do not expect significantrecovery, in the current fiscal year, of accounts previously written off asuncollectible.  The previous sentence isa forward-looking statement and actual results could differ materially fromthose anticipated.

 

**May 2002Restructuring and Sale of Asset Management Software Business**

 

In May 2002, we soldsubstantially all of the assets related to our Asset Management softwarebusiness to Computer Associates International, Inc. for approximately $9.5million in cash.  In connection withthis sale, our July 2001 agreement with Computer Associates for its resaleof our Argis suite of software products was terminated.  In addition, as part of that asset sale, weassigned to Computer Associates our May 2001 agreement with CorporateSoftware (now Software Spectrum) for its resale of our Argis suite of softwareproducts.  Because of the asset sale,Software Spectrum has the right to terminate that agreement.  If it does so, all of the shares subject tothe warrant that we issued to Software Spectrum in May 2001 willimmediately become exercisable.  Thefair value of the warrant had been recorded as prepaid distribution costs andwas being recognized as a reduction of revenue over the lesser of a ratablecharge over the 24-month term of the agreement with Software Spectrum or theperiod it took Software Spectrum to generate revenue to Intraware of $1.6million from Software Spectrum’s resale of our asset management software.  As a result of the asset sale, the remainingunamortized prepaid distribution costs of $936,000 were recorded as a reductionto revenue during the three months ended May 31, 2002.

 

The total proceeds from thesale of $9.5 million, less the book value of transferred equipment, intangibleassets, goodwill, deferred revenue, and transaction costs, based on theirrespective carrying values at the sale date, were recorded as a gain on sale ofassets in the quarter ended May 31, 2002.

 
| Total consideration                                                  |   | $      | 9,500 |   |
|----------------------------------------------------------------------|--------|--------|-------|--------|
| Net book value of equipment, intangible assets and  deferred revenue |   | (6,536 | )     |
| Transaction costs                                                    |   | (308   | )     |
| Gain on sale                                                         |   | $      | 2,656 |   |

 

In connection with ourdisposition of the Asset Management software business, we announced arestructuring and workforce reduction to reduce our operating expenses.  We recorded a charge of $1.8 millionrelating to this restructuring and the impairment of assets during the threemonths ended May 31, 2002.  Theimpairment of assets includes the write-off of approximately $403,000 inprepaid licenses that were held for resale. The restructuring charge consisted of approximately $345,000 forseverance and benefits relating to the involuntary termination of 14 employeeswho were not hired by Computer Associates. We terminated an additional 33 employees, all of whom were based inNorth America. These 33 terminated employees were all hired by ComputerAssociates and therefore received no severance payments.  Overall, we reduced our workforce to 71employees from 118 in connection with the asset sale to ComputerAssociates.  Of the 47 terminatedemployees, 22 were in Sales and Marketing, 10 were in Product Development and15 were directly involved in our product support.  We also closed our Pittsburgh, Pennsylvania, office and varioussatellite offices.

 

We accrued for lease andrelated costs of approximately $983,000, principally pertaining to theestimated future obligations of non-cancelable lease payments for excessfacilities that were vacated due to our reductions in work force.  We also recognized $63,000 relating to otherrestructuring expenses. Due to changes in management’s estimates relating tothe restructuring during the three months ended August 31, 2002,

 

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we recognized an additional expense of $106,000 pertaining to theestimated future obligations of non-cancelable lease payments for excessfacilities that were vacated due to our reductions in work force. In addition,we did not incur severance and benefits of $106,000 and reduced the reserveaccordingly. During the three months ended February 28, 2003, we agreedwith the landlord to terminate our Pittsburgh, Pennsylvania, lease and realizeda savings of approximately $152,000 that would otherwise have been payable asrent under the lease.

 

In our December 2000restructuring, we closed our Fremont, California, office and assigned our leaseto a new tenant while acting as guarantor for that tenant. In May 2002,the new tenant defaulted on its lease. During the three months endedNovember 30, 2002, we made a cash payment of approximately $214,000 toterminate this lease.

 

The following table setsforth an analysis of the components of the restructuring and impairment ofassets charges recorded for the nine months ended November 30, 2003, (inthousands):

 
|                                      |   | **Excess  lease  and related costs** |   |
|-------------------------------------------|--------|--------------------------------------|--------|
| Reserve balance at February 28, 2003 |   | $                                    | 10     |   |
| Cash paid                                 |   | (10                                  | )      |
| Reserve balance at November, 2003         |   | $                                    | — |   |

 

As of November 30,2003, we have settled all liabilities associated with the May 2002restructuring and sale of Asset Management business, subject to the ongoingindemnification obligation discussed in Note 6 of our “Notes to UnauditedInterim Consolidated Financial Information” in this Quarterly Report on Form10-Q.

 

**Amortizationof Intangibles**

 

For the three months endedNovember 30, 2003 and 2002, there was no amortization of intangibles andgoodwill. For the nine months ended November 30, 2003, amortization ofintangibles was zero, a decrease from $1.1 million for the nine months endedNovember 30, 2002.

 

Amortization of intangiblesrelated to our acquisitions of BitSource, Inc. in October 1999 and JanusTechnologies, Inc. in July 2000. On March 1, 2002, we ceased amortization of our goodwill balance.Subsequently, in May 2002, as part of our Asset Management softwarebusiness sale to Computer Associates, we included our remaining intangibleassets and goodwill in the determination of the gain on sale.

 

**InterestExpense**

 

For the three months endedNovember 30, 2003, interest expense was approximately $40,000, a decreasefrom $92,000 for the three months ended November 30, 2002.  For the nine months ended November 30,2003, interest expense was $0.2 million, a decrease from $2.6 million for thenine months ended November 30, 2002.

 

Interest expense relates toobligations under capital leases and notes payable.  The decrease in interest expense for the three months endedNovember 30, 2003, is primarily due to the reduction of the principalbalance on our capital lease obligations. We also replaced certain capital leases with a note payable bearing alower interest rate.  The decrease ininterest expense for the nine months ended November 30, 2003, is primarilythe result of accrued interest and accretion to redemption value related to 

 

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our $7.0 million in notes payable, which were fully converted or paidoff in the first quarter of the prior fiscal year.

 

**Interestand Other Income and Expenses, Net**

 

For the three months endedNovember 30, 2003, interest and other income and expenses, net wasapproximately a $21,000 credit, a decrease from a $31,000 credit for the threemonths ended November 30, 2002. For the nine months ended November 30, 2003, interest and otherincome and expenses, net was approximately a $47,000 credit, a decrease from a$0.5 million credit for the nine months ended November 30, 2002.

 

Interest and other incomeand expenses, net primarily relates to interest earned on our investmentbalances and warrants recorded as liabilities adjusted to fair value.  The decrease in interest and other incomeand expenses, net for the three months ended November 30, 2003, isprimarily the result of decreased returns on cash balances held for use inoperations.  The decrease in interestand other income and expenses, net for the nine months ended November 30,2003, is primarily the result of charges we recorded during the nine monthsended November 30, 2002, to adjust the warrants we issued in connectionwith our November 30 and September 20, 2001 and May 2002financings, which were classified as liabilities, to fair value.  The charge recorded to adjust the warrantsto fair value was $0.5 million during both the three and nine months ended November 30,2002.  All warrants were reclassified topermanent equity during the year ended February 28, 2003, and are nolonger being adjusted to fair value.

 

**IncomeTaxes**

 

From inception throughFebruary 28, 2003, we incurred net losses for federal and state taxpurposes and have not recognized any tax provision or benefit.  As of February 28, 2003, we hadapproximately $125 million of federal and $58 million of state net operatingloss carryforwards available to offset future taxable income, which expire invarying amounts between 2012 and 2022. Because of cumulative ownership changes, federal loss carry forwardstotaling approximately $93 million and state loss carry-overs totalingapproximately $43 million are subject to limitation.  At February 28, 2003, $32 million and $15 million of federaland state net operating losses, respectively, were available, withoutlimitation to offset future taxable income. Should there be a change of ownership in the future, the available netoperating losses may be further limited. Given our limited operating history, losses incurred to date and thedifficulty in accurately forecasting our future results, management does notbelieve that the realization of the related deferred income tax asset meets thecriteria required by generally accepted accounting principles.  Accordingly, we have recorded a 100%valuation allowance.

 

**Liquidityand Capital Resources**

 

Since inception, we havefinanced our operations primarily through private sales of preferred and commonstock, the initial public offering of our common stock and the issuance ofdebt.  We will continue to use ourcapital raised to date to support our operations until we become cash flowpositive on a regular basis.  While wehave made progress toward becoming cash flow positive, there can be noassurance that we will be successful in becoming regularly cash flow positivewithout additional capital financing or at all.

 

Our cash and cashequivalents at November 30, 2003, were $12.3 million, an increase of $5.5million from $6.8 million at February 28, 2003.  This increase was due to $7.1 million provided by financingactivities, partially offset by $1.2 million used in operating activities and$0.4 million used in investing activities.

 

The net cash used inoperating activities of $1.2 million for the nine months endedNovember 30, 2003, was primarily due to our net loss and decreases indeferred revenue, operating accounts payable and total other assets, offset bydecreases in accounts receivable. Investing activities used $0.4 million for the nine months endedNovember 30, 2003, due to purchases of property and equipment.  Financing activities provided $7.1 millionfor the nine months ended November 30, 2003, primarily due to our commonstock financing for aggregate gross proceeds of $6.2 million and issuance of anote payable for $2.0 million, offset by payments on capital lease arrangementsof $2.4 million.

 

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Our Annual Report on Form10-K, as amended by Amendment One thereto on Form 10-K/A, for our fiscal yearended February 28, 2003, contains a disclosure expressing substantialdoubt regarding our ability to continue as a going concern as a result of ourrecurring losses and negative cash flows from operations.  We narrowed our net loss to $2.4 million forthe nine months ended November 30, 2003, as compared to a net loss of $9.1million for the nine months ended November 30, 2002.  In addition, we reduced our usage ofoperating cash to approximately $1.2 million for the nine months endedNovember 30, 2003, as compared to $4.1 million for the nine months endedNovember 30, 2002.  InSeptember 2003, we also raised $6.2 million in new capital (see Note 10 ofour “Notes to Unaudited Interim Consolidated Financial Information” in Item Iof Part I). Despite these improvements, we continued to experience recurringlosses and negative cash flows from operations for the nine months endedNovember 30, 2003.  In addition,there remains no assurance that we will succeed in generating sufficientrevenue to enable us to continue operations over the longer term.

 

Our future capitalrequirements will depend on many factors, including our ability to increaserevenue levels and/or reduce costs of operations to generate positive cashflows, the timing and extent of expenditures to support expansion of sales andmarketing efforts, market acceptance of our services, and timeliness ofcollections of our accounts receivable. Any projections of our future cashneeds are subject to substantial uncertainty. Our ability to generate increased revenues and cash flows and, ifnecessary, raise additional capital is also subject to substantialuncertainty.  The bid price of ourcommon stock has been below $1.00 several times over the past 12 months.  If we fail to meet the $1.00 minimum bidprice requirement or the other standards for continued listing on the NasdaqSmallCap Market, our common stock will likely be delisted and our ability togenerate both sales and additional capital will be subject to furtheruncertainty.

 

We have historically beenable to satisfy our cash requirements through financing and investingactivities, and our cash position and net losses from operations have improvedsubstantially during the nine months ended November 30, 2003.  Nevertheless, we continued to sufferrecurring losses and negative cash flows from operations for that period, andthere is no assurance that we will succeed in generating sufficient cash fromoperations on a regular basis, achieving profitability, or obtaining additionalcapital if needed.

 

At November 30, 2003,we did not have any other relationships with unconsolidated entities orfinancial partnerships, such as entities often referred to as structuredfinance or special purpose entities, which would have been established for thepurpose of facilitating off-balance sheet arrangements or other contractuallynarrow or limited purposes. As such, we are not materially exposed to anyfinancing, liquidity, market or credit risk that could arise if we had engagedin such relationships.

 

The following summarizes ourobligations at November 30, 2003, and the effect such obligations areexpected to have on our liquidity and cash flow in future periods (inthousands):

 
|             |   | **Payments  due by period** |   |
|------------------|--------|-----------------------------|--------|
|             |   | **2004**                    |   | **2005** |   | **2006** |   | **2007** |   | **Total** |   |
| Long-term debt   |   | $                           | 273    |   | $ | 1,104 |   | $ | 684 |   | $ | 46 |   | $ | 2,107 |   |
| Operating leases |   | 134                         |   | 560 |   | 284 |   | — |   | 978 |   |
|             |   | $                           | 407    |   | $ | 1,664 |   | $ | 968 |   | $ | 46 |   | $ | 3,085 |   |

 

As of November 30,2003, our Redeemable Convertible Preferred Stock had a liquidation value of$1.0 million.

 

**RecentAccounting Pronouncements**

 

In November 2002, EITFreached a consensus on issue No. 00-21, “Accounting for Revenue Arrangementswith Multiple Deliverables” (“EITF No. 00-21”) on a model to be used todetermine when a 

 

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revenue arrangement with multiple deliverables should be divided intoseparate units of accounting and, if separation is appropriate, how thearrangement consideration should be allocated to the identified accountingunits.  The EITF also reached aconsensus that this guidance should be effective for all revenue arrangementsentered into in fiscal periods beginning after June 15, 2003.  We adopted the provisions of EITF No. 00-21during the three months ended November 30, 2003.

 

In January 2003, theFinancial Accounting Standards Board (“FASB”) issued Interpretation Number“FIN” 46, “Consolidation of Variable Interest Entities.”  In general, a variable interest entity is acorporation, partnership, trust, or any other legal structure used for businesspurposes that either (a) does not have equity investors with voting rights or(b) has equity investors that do not provide sufficient financial resources forthe entity to support its activities. FIN 46 requires certain variable interestentities to be consolidated by the primary beneficiary of the entity if theinvestors do not have the characteristics of a controlling financial interestor do not have sufficient equity at risk for the entity to finance its activitieswithout additional subordinated financial support from other parties.  The consolidation requirements of FIN 46apply immediately to variable interest entities created after January 31,2003.  The consolidation requirementsapply to older entities in interim periods beginning after December 15,2003.  Certain of the disclosurerequirements apply to all financial statements issued after January 31,2003, regardless of when the variable interest entity was established.  The effective dates of certain elements ofFIN 46 have been deferred.  Since we donot have an interest in variable interest entities, when finalized, ouradoption of FIN 46 is not expected to have a material impact on our financialposition or results of operations.

 

In May 2003, the FASBissued SFAS No. 150, “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity” (“SFAS No. 150”).  SFAS No. 150 establishes standards for theclassification and measurement of financial instruments with characteristics ofboth liabilities and equity.  While theeffective date of certain elements of SFAS No. 150 have been deferred, theadoption of SFAS No. 150 when finalized is not expected to have a materialimpact on our financial position, results of operations or cash flows.

 

**RISK FACTORS**

 

You should carefullyconsider the risks described below before making a decision to invest in ourcommon stock.  The risks anduncertainties described below are not the only ones facing Intraware.Additional risks and uncertainties not presently known to us or that we do notcurrently believe are important to an investor may also harm our businessoperations.  If any of the events,contingencies, circumstances or conditions described in the following risksactually occur, our business, financial condition or our results of operationscould be seriously harmed.  If thatoccurs, the trading price of our common stock could decline, and you may losepart or all of your investment.

 

**Revenues tous under our Sun ONE software resale arrangement with Software Spectrum arelikely to decline over the long term. In addition, any termination of our relationship with Software Spectrumwould cause a substantial immediate decrease in our revenues.**

 

Under our Sales AllianceAgreement with Software Spectrum dated June 28, 2001, we have transitionedto Software Spectrum our reseller relationship with Sun Microsystems, Inc. forSun ONE products.  Software Spectrumshares with us a portion of its gross profit from resales of Sun ONE softwarelicenses and maintenance, and reimburses us for a substantial portion of ourcost of maintaining a team dedicated to sales of Sun ONE software licenses andmaintenance.  This contract accountedfor substantially 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 2003 fiscal year. However, revenues to us under thiscontract are likely to decrease over the long term, as sales and market shareof Sun ONE software generally decline. In addition, the term of this agreement will expire in June 2004and is renewable for subsequent one-year terms.  It is possible that Software Spectrum will choose not to renewthis agreement at any of those points. It is also possible that Sun Microsystems will choose to stop permittingSoftware Spectrum to resell Sun ONE software. Any non-renewal of our agreement with 

 

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Software Spectrum, or termination of Software Spectrum’s rights toresell Sun ONE software, would likely cause a substantial and immediatedecrease in our revenues.

 

**The loss ofone or more of our key customers, partners or resellers could cause our revenuegrowth to slow or cause our revenues to decline.**

 

A substantial amount ofrevenue from our SubscribeNet service comes from a relatively small number ofcompanies.  These include softwaremanufacturers whose software we distribute electronically, as well as SoftwareSpectrum, with whom we jointly resell third party software as described above,and Zomax Incorporated, who resells our SubscribeNet service.  Our contracts with most of these companiesare subject to renewal or cancellation annually, and our contract with Zomax iscancelable by Zomax on 30 days’ notice beginning in August 2004.  If any of these companies elected to canceltheir agreements with us, our revenues growth could slow substantially or ourrevenues could decline.

 

**Our revenuegrowth could be limited and our gross margins reduced as a result of competitionfrom other electronic software delivery service providers and potentialcustomers’ development of their own electronic software delivery systems.**

 

The market for sellingelectronic software delivery services is highly competitive.  Some of our competitors have longeroperating histories, greater financial, technical, marketing and otherresources, larger product and service offerings, better name recognition, and alarger installed base of customers than we do. Some of our competitors also have well-established relationships withour potential customers and with third-party information technology orconsulting firms that help market our competitors’ services.  We expect competition to intensify ascurrent competitors expand and improve their service offerings and newcompetitors enter the market.  Mergersand consolidation in the information technology industry may also increasecompetition by enlarging our competitors and their product and service offerings,and/or by reducing the pool of potential customers.

 

In addition, our current andpotential customers are primarily information technology companies with strongsoftware development expertise.  Whenconsidering their alternatives for implementing an electronic software deliveryand management system, these companies sometimes elect to develop such systemsin-house.

 

We believe we competeeffectively against our competitors, and that the value proposition of ourelectronic software delivery and management service compares favorably withproposed in-house systems.  However, wehave at times experienced reduced prices, reduced gross margins and lost salesas a result of such competitive factors, and it is possible that these negativeconsequences will become more generalized over time.

 

**Our quarterlyfinancial results are subject to significant fluctuations because of manyfactors and any of these could cause rapid declines in our stock price.**

 

Our operating results havefallen below the expectations of public market analysts and investors in the past.  It is likely that in future quarters ouroperating results will again be below the expectations of public marketanalysts and investors and as a result, the price of our common stock may fall.  Our operating results have varied widely inthe past, and we expect that they will continue to vary significantly fromquarter to quarter due to a number of factors, including:

 

•                  potential cancellations of SubscribeNetcontracts due to development of in-house electronic software download systems,or purchase of competitive systems, by our customers;

 

•                  potential weakening of demand for ourSubscribeNet services and Sun ONE products we sell jointly with SoftwareSpectrum;

 

•                  unwillingness of potential customers topurchase our services due to concerns about our financial strength;

 

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•                  the timing of sales of our services;

 

•                  potential additional cost cutting in oursales and marketing, product development and support areas;

 

•                  potential loss of strategic relationshipswith major customers and resellers;

 

•                  potential delays in introducing our productsand services according to planned release schedules;

 

•                  changes in our pricing policies;

 

•                  reluctance among software companies to acceptor outsource electronic delivery of their software;

 

•                  potential technical difficulties, systemfailures or Internet downtime;

 

•                  potential changes in the regulatoryenvironment;

 

•                  our ability to upgrade and develop ourinformation technology systems and infrastructure;

 

•                  costs related to acquisitions of technologyor businesses; and

 

•                  general economic conditions, as well as thosespecific to the software, Internet and related industries.

 

In addition, our operatingexpenses, which include sales and marketing, product development and generaland administrative expenses, are based on our expectations of future grossprofits and are relatively fixed in the short term.  If gross profits fall below our expectations and we are not ableto quickly reduce our spending in response, our operating results would beadversely affected.

 

**Our marketis subject to rapid technological change. If we are unable to quickly adapt to these changes and meet the demandsof our current and potential customers, we will likely lose sales and market share, and our revenue growth willbe limited.**

 

Our market is characterizedby rapidly changing technology, evolving industry standards and new demands bycustomers and potential customers.  Tobe successful, we must adapt to our rapidly changing market by continuallyimproving the performance, features and reliability of our services.  If we cannot or do not respond quicklyenough to changing industry standards or the demands of customers and potentialcustomers, we will likely lose sales and market share to competitors and ourgrowth prospects will be limited.  Inaddition, we could incur substantial costs to modify our services orinfrastructure in order to adapt to changing standards and demands.  If we incur such costs but our investmentsdo not yield adequate results, our goals of sustained profitability andpositive operating cash flow could become more difficult to achieve.

 

**Viruses,potential security breaches, and other risks associated with business use ofthe Internet may hinder acceptance of Internet-based electronic softwaredelivery and management, which could in turn limit our revenue growth.**

 

Use of theInternet for business purposes poses a number of risks that could inhibitacceptance by information technology professionals of Web-based electronic softwaredelivery and management.  Theproliferation of software viruses is a key risk.  Any well-publicized transmission of a computer virus by us oranother company using electronic software delivery could deter informationtechnology professionals from utilizing electronic software delivery technologyand our business could be adversely affected. Our SubscribeNet service enables our customers to upload their softwareproducts directly onto our systems for downloading by their end-users. Oursystems automatically scan our customers’ software products for 

 

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known computer viruses on anongoing basis while they are on our systems. However, it is possible that, in spite of those periodic virus scans,our system could transmit the virus to one or more end-users.  Any such virus transmission could result indisputes and litigation and could adversely affect our business.

 

Concerns over the securityof transactions conducted on the Internet and the privacy of users may alsoinhibit the growth of our SubscribeNet service.  If we fail to prevent security breaches, our business and resultsof operations could be harmed.  Advancesin computer capabilities, new discoveries in the field of cryptography, orother developments could result in a compromise or breach of the algorithms weuse to protect our customers’ transaction data or our software vendors’products. Anyone who is able to circumvent our security measures couldmisappropriate proprietary information or cause interruptions in ouroperations. We may be required to incur significant costs to protect againstsecurity breaches or to alleviate problems caused by breaches.  Any well-publicized compromise of securitycould deter people from using the Web to conduct transactions involvingtransmission of confidential information or download of sensitive materials.

 

Other factors that couldhinder the growth and market acceptance of electronic software delivery andmanagement include:

 

•                  the potential for state and local authoritiesto levy taxes on Internet transactions;

 

•                  the cost of maintaining sufficient networkbandwidth to enable purchasers to rapidly download software;

 

•                  the limited number of software packagesavailable for electronic software delivery as compared to those availablethrough traditional delivery methods; and

 

•                  customer unfamiliarity with and resistance tothe process of downloading software.

 

**We have ahistory of negative operating cash flow and net losses.  It remains possible that in the future wewill need to raise additional capital to fund our operations.  Any such capital financing would likelydilute our shareholders’ investments, and if we need but cannot obtain suchfinancing, we will need to curtail or cease operations.**

 

We have not achievedprofitability and may incur net losses through our fiscal year endingFebruary 29, 2004.  We incurred anet loss of $0.5 million for the quarter ended November 30, 2003, $2.4million for the nine months ended November 30, 2003, $9.7 million for the fiscalyear ended February 28, 2003, $37.4 million for the fiscal year endedFebruary 28, 2002, and $68.4 million for the fiscal year endedFebruary 28, 2001.  As ofNovember 30, 2003, we had an accumulated deficit of approximately $154million.  We will need to generatesignificant additional revenues and/or reduce operating costs to achieveprofitability.

 

Our Annual Report on Form10-K, and Amendment One thereto on Form 10-K/A, for our fiscal year endedFebruary 28, 2003, contain a disclosure expressing substantial doubtregarding our ability to continue as a going concern as a result of ourrecurring losses and negative cash flows from operations.  Since that time, we have significantlyimproved our cash and cash equivalents, our working capital and our cash flowsfrom operations.  As ofNovember 30, 2003, we had approximately $12.3 million in cash and cashequivalents and working capital of approximately $8.6 million.  However, we continue to experience recurringlosses and negative cash flows from operations.

 

To achieve sustainedpositive net earnings and operating cash flow, we will need to significantlyincrease revenues while maintaining or increasing gross margins and avoidingsignificant increases in operating costs. While we believe we will be able to achieve this goal, there can be noassurance that we will do so, and our history of recurring net losses andnegative operating cash flow warrants caution. If we are unable to achieve sustained profitability and positive cashflow in the medium term, we may be required to obtain additional capitalfinancing.  Any such additionalfinancing would likely dilute the investments of our current shareholders. Ifsuch financing is required and we cannot obtain it, we will have tosubstantially curtail or discontinue operations.

 

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**If Nasdaqdetermines that we have failed to meet its SmallCap Market listingrequirements, our common stock may be delisted.**

 

Our common stock is listedon the Nasdaq SmallCap Market. Nasdaq has requirements a company must meet inorder to remain listed on the Nasdaq SmallCap Market.  One requirement is that the bid price of a company’s stock remainat $1.00 or above.  The bid price of ourcommon stock fell and remained below $1.00 on several occasions during fiscalyear 2003 and on a number of occasions during the first quarter of fiscal year2004.  If the bid price of our commonstock remains below $1.00 for an extended period, our grace period forregaining compliance with the minimum bid price requirement may be limited to 6months because we may be unable to meet the requirements for extension of thatgrace period.  If as a result of theapplication of any of Nasdaq’s listing requirements, our common stock weredelisted from the Nasdaq SmallCap Market, our stock would become harder to buyand sell.  Further, our stock could besubject to what are known as the “penny stock” rules, which place additionalrequirements on broker-dealers who sell or make a market in suchsecurities.  Consequently, if we wereremoved from the Nasdaq SmallCap Market, the ability or willingness ofbroker-dealers to sell or make a market in our common stock might decline.  As a result, your ability to resell yourshares of our common stock could be adversely affected.

 

**Additionalgovernment regulations may harm demand for our services and increase our costsof doing business.**

 

Our business has benefitedfrom the tax laws of states in which purchases of software licenses are nottaxable if the software is received only electronically.  Some states currently experiencing revenueshortfalls are considering whether to change their laws to broaden thetaxability 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.

 

In delivering third-partysoftware through our SubscribeNet service, we must comply with U.S. exportcontrols on software generally and encryption technology in particular.  Changes in these laws could require us toimplement costly changes to our automated export compliance processes.

 

The European Union hasenacted its own data protection and privacy directive, which required all 15European Union Member States to implement laws relating to the processing andtransmission of personal data.  We must,at a minimum, comply with the data privacy “safe harbor” agreed upon by theEuropean Union and the U.S. Commerce Department, as well as any otherregulations adopted by other countries where we may do business.

 

The growth and developmentof the market for online commerce may prompt calls for more stringent consumerprotection laws, both in the United States and abroad. Compliance with anynewly adopted laws may prove difficult for us and may negatively affect ourbusiness.

 

**Claims bythird parties for intellectual property infringement could force us to stopselling our services, force us to pay royalties, and force us to indemnify ourcustomers.**

 

We electronically deliverthird-party software to end-users.  Thisactivity creates the potential for claims to be made against us, eitherdirectly or through our contractual indemnification obligations to ourcustomers.  Any claims could result incostly litigation and be time-consuming to defend, divert management’sattention and resources, cause delays in releasing new or upgrading existingservices or require us to enter into royalty or licensing agreements.  These claims could be made for defamation,negligence, patent, copyright or trademark infringement, personal injury,invasion of privacy or other legal theories based on the nature, content orcopying of these materials.

 

Litigation regardingintellectual property rights is common in the Internet and software industries.We expect that Internet technologies and software products and services may beincreasingly subject to 

 

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third-party infringement claims as the number of competitors in ourindustry segment grows and the functionality of products in different industrysegments overlaps.  There can be noassurance that our services do not infringe the intellectual property rights ofthird parties.  In addition, we may beinvolved in litigation involving the software of third-party vendors that wehave electronically distributed in the past. Royalty or licensing agreements,if required, may not be available on acceptable terms, if at all. A successfulclaim of infringement against us could adversely affect our business.  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.

 

We take steps to verify thatend-users who download third-party software through our SubscribeNet serviceare entitled to deploy and use that software. However, there can be no assurance that this verification procedure willhelp us defend against claims by, or protect us against liability to, theowners of copyrights in that third-party software.  Our success and ability to compete are substantially dependentupon our internally developed technology, which we protect through acombination of patent, copyright, trade secret and trademark law.  We are aware that certain other companiesare using or may have plans to use the name “Intraware” as a company name or asa trademark or service mark.  While wehave received no notice of any claims of trademark infringement from any ofthose companies, we cannot assure you that these companies may not claimsuperior rights to “Intraware” or to other marks we use.  Despite our efforts to protect ourproprietary rights, unauthorized parties may attempt to copy or otherwiseobtain and use our services or technology and we cannot be certain that thesteps we have taken will prevent misappropriation of our technology.

 

**If our key personnelleft the company, our product development, sales, and corporate managementcould suffer.**

 

Our future success dependsupon the continued service of our executive officers and other key technology,sales, marketing and support personnel. None of our officers or key employees is bound by an employment agreementfor any specific term.  If we lost theservices of one or more of our key employees, or if one or more of ourexecutive officers or key employees decided to join a competitor or otherwisecompete directly or indirectly with us, this could have a significant adverseeffect on our business.

 

**ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

At November 30, 2003,we had cash and cash equivalents of approximately $12.3 million.  We have not used derivative financialinstruments in our investment portfolio during the nine months endedNovember 30, 2003.  We place ourinvestments with high quality issuers, by policy, in an effort to limit theamount of credit exposure to any one issue or issuer.

 

Our exposure to market riskfor changes in interest rates relates primarily to our investment portfolio. Wehave not used derivative financial instruments in our investment portfolio. AtNovember 30, 2003, all of our cash, cash equivalents and investmentportfolio carried maturity dates of less than 90 days. The effect of changes ininterest rates of +/-10% over a nine-month horizon would not have a materialeffect on the fair market value of the portfolio.

 

**ITEM 4.CONTROLS AND PROCEDURES**

 

(a)                                  *Evaluation of DisclosureControls and Procedures*. Ourprincipal executive officer and principal financial officer, after evaluatingthe effectiveness of our disclosure controls and procedures (as defined inRules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the“Exchange Act”)) as of the end of the period covered by this quarterly report,have concluded that our disclosure controls and procedures are effective basedon their evaluation of the controls and procedures required by paragraph (b) ofthe Exchange Act Rules 13a-15 or 15d-15.

 

(b)                                 *Changes in Internal Controlsover Financial Reporting*. Nochanges in our internal control over financial reporting identified inconnection with the evaluation required by paragraph (d) of

 

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Exchange Act Rules 13a-15 or 15d-15 occurred during our last fiscalquarter that have materially affected or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

**PART II**

 

**OTHER INFORMATION**

 

**ITEM 1.LEGAL PROCEEDINGS**

 

In October 2001, wewere served with a summons and complaint in a purported securities class actionlawsuit.  On or about April 19,2002, we were served with an amended complaint in this action, which is nowtitled In re Intraware, Inc. Initial Public Offering Securities Litigation,Civ. No. 01-9349 (SAS) (S.D.N.Y.), related to In re Initial Public OfferingSecurities Litigation, 21 MC 92 (SAS) (S.D.N.Y.).  The amended complaint is brought purportedly on behalf of allpersons who purchased our common stock from February 25, 1999 (the date ofour initial public offering) through December 6, 2000. It names asdefendants Intraware; three of our present and former officers and directors,and several investment banking firms that served as underwriters of our initialpublic offering.  The complaint allegesliability under Sections 11 and 15 of the Securities Act of 1933 and Sections10(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 the underwriters misusedtheir securities analysts to manipulate the price of our stock.  No specific damages are claimed.

 

Lawsuits containing similarallegations have been filed in the Southern District of New York challengingover 300 other initial public offerings and secondary offerings conducted in1999 and 2000.  All of these lawsuitshave been consolidated for pretrial purposes before United States DistrictCourt Judge Shira Scheindlin of the Southern District of New York. OnJuly 15, 2002, an omnibus motion to dismiss was filed in the coordinatedlitigation on behalf of the issuer defendants, of which Intraware and its threenamed current and former officers and directors are a part, on common pleadingsissues.  On or about October 9,2002, the Court entered and ordered a Stipulation of Dismissal, which dismissedthe three named current and former officers and directors from the litigationwithout prejudice.  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.  No discovery has beenserved on us to date.  A specialcommittee of our Board recently approved a tentative settlement proposal fromplaintiffs.  There is no guarantee thatthe settlement will become final, as it is subject to a number of conditions,including court approval; however, based on this proposed settlement, we do notbelieve we will suffer material future losses related to this lawsuit andtherefore have not accrued for any losses.

 

We are also subject to legalproceedings, claims and litigation arising in the ordinary course of business.We do not expect that the ultimate costs to resolve these matters will have amaterial adverse effect on our consolidated financial position, results ofoperations, or cash flows.

 

**ITEM2.  CHANGES IN SECURITIES AND USE OFPROCEEDS**

 

On September 9, 2003,we completed a private placement of common stock to investment funds andaccounts managed by Apex Capital, LLC. Under the terms of the financing, we issued 4.0 million shares of commonstock at a price of $1.55 per share for gross proceeds of $6.2 million.  As part of this transaction, we incurred andexpect to incur approximately $89,000 in legal, accounting, and othercosts.  Including shares previouslyacquired on the open market, as of September 9, 2003, accounts managed byApex Capital, LLC held approximately 9% of our outstanding common stock.

 

The common stock was issuedin a private placement without registration under the Securities Act of 1933and may not be offered or sold in the United States of America absentregistration or an applicable exemption from registration requirements. Inissuing the securities, we relied on the exemption from 

 

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registration provided by Section 4(2) of the Securities Act of1933 and Regulation D promulgated thereunder, based in part on the purchasersbeing institutional type investors and on their representations in the purchaseagreement.  As part of the agreement, weagreed to file with the SEC a registration statement to register the resale ofthe common stock issued under this private placement within 45 days of closing,and to use commercially reasonable efforts to cause the registration statementto be declared effective by the SEC as promptly as practicable, but in no casemore than one year, thereafter.

 

On October 24, 2003, wefiled with the SEC a registration statement for the resale of the common stockissued in connection with our September 9, 2003 private placement.  The SEC declared this registration statementeffective on November 4, 2003.

 

**ITEM 3.DEFAULTS UPON SENIOR SECURITIES**

 

None.

 

**ITEM 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS**

 

None.

 

**ITEM 5.OTHER INFORMATION**

 

None.

 

**ITEM 6.EXHIBITS AND REPORT ON FORM 8-K**

 

**Exhibits**

 
| **Exhibit   Number** |   | **Description**                                                                                                                            |
|----------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------|
|                 |   |                                                                                                                                       |
| 10.1(1)              |   | Form  of Registration Rights Agreement, dated September 9, 2003, by and among  Intraware, Inc. and the investors set forth therein.   |
|                 |   |                                                                                                                                       |
| 10.2(1)              |   | Form  of Common Stock Purchase Agreement, dated September 9, 2003, by and  among Intraware, Inc. and the investors set forth therein. |
|                 |   |                                                                                                                                       |
| 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                                                                      |

 

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(1)          Incorporatedby reference to Intraware’s Current Report on Form 8-K datedSeptember 9, 2003 (File No. 000-25249) and filed with the Securitiesand Exchange Commission on September 12, 2003.

 

**Reports on Form 8-K**

 

OnSeptember 9, 2003, we filed a Current Report on Form 8-K reporting underItem 5—Other Events our issuance of an aggregate of 4,000,000 shares of ourcommon stock in a private placement to investment funds and accounts managed byApex Capital, LLC, at a price of $1.55 per share.

 

OnSeptember 18, 2003, we furnished a Current Report on Form 8-K reportingunder Item 7–Financial Statements and Exhibits and Item 12—Results ofOperations and Financial Condition in connection with our press releaseannouncing results for our fiscal quarter ended November 30, 2003. Nofinancial statements were filed, although we furnished the financialinformation included in the press release we furnished with the Form 8-K.

 

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**SIGNATURE**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, as amended, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized. 

 
|   | **INTRAWARE, INC.** |
|--------|---------------------|
|   |                |   |
| Dated: | January  13, 2004   |   | By: |       /s/  WENDY  A. NIETO |   |
|   |                | Wendy A. Nieto |   |
|   |                | *Chief Financial Officer and  Executive Vice President of  Technology and Operations* |   |
|        |                     |  |  |  |  |

 

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