**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,DC  20549**

 

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**FORM 10-Q**

 

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| **(Mark One)**                               |
|----------------------------------------------|
|                                         |   |   |
| **ý**                                   |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                         |   |   |
| **For the Quarter ended September 30, 2003** |
|                                         |   |   |
| **OR**                                       |
|                                         |   |   |
| **o**                                        |   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                         |   |   |
| **0-28252**                                  |
| **(Commission File Number)**                 |

 

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**BROADVISION,INC.**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                                                    |   | **94-3184303**                           |
|-----------------------------------------------------------------|--------|------------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification Number) |
|                                                            |   |                                     |
| **585 Broadway,**                                               |   |                                     |
| **Redwood City, California**                                    |   | **94063**                                |
| (Address of principal executive offices)                        |   | (Zip code)                               |
|                                                            |   |                                     |
| **(650) 542-5100**                                              |
| (Registrant’s telephone number, including  area code)      |

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15 (d) of the Securities ExchangeAct of 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes   ýNo   o

 

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

 

As of November 7, 2003 there were 33,083,844 shares of the Registrant’sCommon Stock issued and outstanding.

 

 

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**BROADVISION, INC. AND SUBSIDIARIESFORM 10-QQuarter Ended September 30, 2003**

 

**TABLEOF CONTENTS**

** **
| **PART I.**    |   | **FINANCIAL INFORMATION**                                                                                                        |   |
|----------------|--------|----------------------------------------------------------------------------------------------------------------------------------|--------|
| Item 1.        |   | Financial Statements                                                                                                             |   |
|           |   | Condensed Consolidated Balance  Sheets-September 30, 2003 and December 31, 2002                                             |   |
|           |   | Condensed Consolidated Statements of  Operations and Comprehensive Loss-Three and nine months ended September 30,  2003 and 2002 |   |
|           |   | Condensed Consolidated Statements of Cash  Flows-Nine months ended September 30, 2003 and 2002                                   |   |
|           |   | Notes to Condensed Consolidated Financial  Statements                                                                            |   |
| Item 2.        |   | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                      |   |
| Item 3.        |   | Quantitative and Qualitative Disclosures  About Market Risk                                                                      |   |
| Item 4.        |   | Controls and Procedures                                                                                                          |   |
|           |   |                                                                                                                             |   |
| **PART II.**   |   | **OTHER INFORMATION**                                                                                                            |   |
| Item 1.        |   | Legal Proceedings                                                                                                                |   |
| Item 2.        |   | Changes in Securities and Use of Proceeds                                                                                        |   |
| Item 3.        |   | Defaults Upon Senior Securities                                                                                                  |   |
| Item 4.        |   | Submission of Matters to a Vote of Security  Holders                                                                             |   |
| Item 5.        |   | Other Information                                                                                                                |   |
| Item 6.        |   | Exhibits and Reports on Form 8-K                                                                                                 |   |
|           |   |                                                                                                                             |   |
| **SIGNATURES** |   |

 

2

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**PART I. FINANCIAL INFORMATION**

**Item 1. Financial Statements**

 

**BROADVISION,INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCESHEETS****(In thousands, except per share data)**

 
|                                                                                                                                                                                           |   | **September  30,  2003** |       | **December 31,  2002** |       |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|------------|-----------------------------|------------|
|                                                                                                                                                                                           |   | **(unaudited)**          | ** ** |                        | ** ** |
| **ASSETS**                                                                                                                                                                                     |   |                     |       |                        |       |
|                                                                                                                                                                                           |   |                     |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                      |   | $                        | 80,620     |                        | $          | 77,386 |   |
| Short-term investments                                                                                                                                                                         |   | 1,054                    |       | 24,484                      |       |
| Accounts receivable, less allowance for  doubtful accounts and reserves of   $3,329 as of September 30, 2003 and $5,502 as of December 31, 2002                                           |   | 11,079                   |       | 22,917                      |       |
| Prepaids and other                                                                                                                                                                             |   | 5,404                    |       | 9,181                       |       |
|                                                                                                                                                                                           |   |                     |       |                        |       |
| Total current assets                                                                                                                                                                           |   | 98,157                   |       | 133,968                     |       |
|                                                                                                                                                                                           |   |                     |       |                        |       |
| Property and equipment, net                                                                                                                                                                    |   | 17,205                   |       | 26,600                      |       |
| Long-term investments                                                                                                                                                                          |   | —                   |       | 587                         |       |
| Restricted cash                                                                                                                                                                                |   | 20,958                   |       | 16,704                      |       |
| Equity investments                                                                                                                                                                             |   | 1,624                    |       | 2,083                       |       |
| Goodwill and other intangibles, net                                                                                                                                                            |   | 56,434                   |       | 57,320                      |       |
| Other assets                                                                                                                                                                                   |   | 2,483                    |       | 2,874                       |       |
|                                                                                                                                                                                           |   |                     |       |                        |       |
| Total assets                                                                                                                                                                                   |   | $                        | 196,861    |                        | $          | 240,136 |   |
|                                                                                                                                                                                           |   |                     |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                  |   |                     |       |                        |       |
|                                                                                                                                                                                           |   |                     |       |                        |       |
| Bank borrowings and current portion of  long-term debt                                                                                                                                         |   | $                        | 27,977     |                        | $          | 25,977 |   |
| Accounts payable                                                                                                                                                                               |   | 11,167                   |       | 8,105                       |       |
| Accrued expenses                                                                                                                                                                               |   | 36,482                   |       | 55,787                      |       |
| Unearned revenue                                                                                                                                                                               |   | 7,098                    |       | 14,158                      |       |
| Deferred maintenance                                                                                                                                                                           |   | 16,477                   |       | 24,325                      |       |
|                                                                                                                                                                                           |   |                     |       |                        |       |
| Total current liabilities                                                                                                                                                                      |   | 99,201                   |       | 128,352                     |       |
|                                                                                                                                                                                           |   |                     |       |                        |       |
| Long-term debt, net of current portion                                                                                                                                                         |   | 1,213                    |       | 1,945                       |       |
| Other noncurrent liabilities                                                                                                                                                                   |   | 70,023                   |       | 68,206                      |       |
|                                                                                                                                                                                           |   |                     |       |                        |       |
| Total liabilities                                                                                                                                                                              |   | 170,437                  |       | 198,503                     |       |
|                                                                                                                                                                                           |   |                     |       |                        |       |
| Commitments and Contingencies (Note 4)                                                                                                                                                         |   |                     |       |                        |       |
|                                                                                                                                                                                           |   |                     |       |                        |       |
| Stockholders’ equity:                                                                                                                                                                     |   |                     |       |                        |       |
| Convertible preferred stock, $0.0001 par  value; 10,000 shares authorized; none issued and outstanding                                                                                         |   | —                   |       | —                      |       |
| Common stock, $0.0001 par value; 2,000,000  shares authorized; 33,047 shares issued and outstanding as of September 30,  2003 and 32,440 shares issued and outstanding as of December 31, 2002 |   | 3                        |       | 3                           |       |
| Additional paid-in capital                                                                                                                                                                     |   | 1,212,194                |       | 1,210,797                   |       |
| Accumulated other comprehensive loss, net  of tax                                                                                                                                              |   | (46                      | )          | 37                          |       |
| Accumulated deficit                                                                                                                                                                            |   | (1,185,727               | )          | (1,169,204                  | )          |
| Total stockholders’ equity                                                                                                                                                                |   | 26,424                   |       | 41,633                      |       |
|                                                                                                                                                                                           |   |                     |       |                        |       |
| Total liabilities and stockholders’ equity                                                                                                                                                |   | $                        | 196,861    |                        | $          | 240,136 |   |

 

*See Accompanying Notes to CondensedConsolidated Financial Statements*

 

3

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**BROADVISION,INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTSOF OPERATIONSAND COMPREHENSIVE LOSS(In thousands, except per share data; unaudited)**

 
|                                                                                                                                                         |   | **Three Months Ended  September 30,** |       | **Nine Months Ended  September 30,** |       |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|------------|--------------------------------------|------------|
|                                                                                                                                                         |   | **2003**                              |       | **2002**                             | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                                                                                                                         |   |                                  |       |                                 |       |   |   |   |   |
| **Revenues:**                                                                                                                                                |   |                                  |       |                                 |       |   |   |   |   |
| Software  licenses                                                                                                                                           |   | $                                     | 5,076      |                                 | $          | 10,756 |   | $ | 19,875 |   | $ | 29,244 |   |
| Services                                                                                                                                                     |   | 13,493                                |       | 16,483                               |       | 44,954 |   | 57,869 |   |
| Total  revenues                                                                                                                                              |   | 18,569                                |       | 27,239                               |       | 64,829 |   | 87,113 |   |
|                                                                                                                                                         |   |                                  |       |                                 |       |   |   |   |   |
| **Cost of revenues:**                                                                                                                                        |   |                                  |       |                                 |       |   |   |   |   |
| Cost  of software licenses                                                                                                                                   |   | 666                                   |       | 1,414                                |       | 1,549 |   | 3,417 |   |
| Cost  of services                                                                                                                                            |   | 5,915                                 |       | 8,751                                |       | 19,650 |   | 31,507 |   |
| Total  cost of revenues                                                                                                                                      |   | 6,581                                 |       | 10,165                               |       | 21,199 |   | 34,924 |   |
|                                                                                                                                                         |   |                                  |       |                                 |       |   |   |   |   |
| Gross  profit                                                                                                                                                |   | 11,988                                |       | 17,074                               |       | 43,630 |   | 52,189 |   |
|                                                                                                                                                         |   |                                  |       |                                 |       |   |   |   |   |
| **Operating expenses:**                                                                                                                                      |   |                                  |       |                                 |       |   |   |   |   |
| Research  and development                                                                                                                                    |   | 4,467                                 |       | 7,774                                |       | 16,681 |   | 34,755 |   |
| Sales  and marketing                                                                                                                                         |   | 6,710                                 |       | 9,384                                |       | 19,585 |   | 41,365 |   |
| General  and administrative                                                                                                                                  |   | 2,885                                 |       | 2,573                                |       | 7,586 |   | 13,775 |   |
| Litigation  settlement costs                                                                                                                                 |   | 4,250                                 |       | —                               |       | 4,250 |   | — |   |
| Other  intangible amortization                                                                                                                               |   | —                                |       | 887                                  |       | 887 |   | 2,661 |   |
| Restructuring  charge                                                                                                                                        |   | 4,509                                 |       | 63,205                               |       | 13,361 |   | 103,150 |   |
| Impairment  of assets                                                                                                                                        |   | —                                |       | 853                                  |       | — |   | 3,129 |   |
| Total  operating expenses                                                                                                                                    |   | 22,821                                |       | 84,676                               |       | 62,350 |   | 198,835 |   |
|                                                                                                                                                         |   |                                  |       |                                 |       |   |   |   |   |
| Operating  loss                                                                                                                                              |   | (10,833                               | )          | (67,602                              | )          | (18,720 | ) | (146,646 | ) |
|                                                                                                                                                         |   |                                  |       |                                 |       |   |   |   |   |
| Interest  income, net                                                                                                                                        |   | 81                                    | ** ** | 658                                  |       | 673 |   | 1,908 |   |
| Other  income (expense), net                                                                                                                                 |   | 574                                   |       | (651                                 | )          | 1,780 |   | (8,588 | ) |
|                                                                                                                                                         |   |                                  |       |                                 |       |   |   |   |   |
| Loss  before provision for income taxes                                                                                                                      |   | (10,178                               | )          | (67,595                              | )          | (16,267 | ) | (153,326 | ) |
|                                                                                                                                                         |   |                                  |       |                                 |       |   |   |   |   |
| Provision  for income taxes                                                                                                                                  |   | (87                                   | )          | (138                                 | )          | (256 | ) | (7,219 | ) |
|                                                                                                                                                         |   |                                  |       |                                 |       |   |   |   |   |
| Net  loss                                                                                                                                                    |   | $                                     | (10,265    | )                                    | $          | (67,733 | ) | $ | (16,523 | ) | $ | (160,545 | ) |
|                                                                                                                                                         |   |                                  |       |                                 |       |   |   |   |   |
| Basic  and diluted loss per share                                                                                                                            |   | $                                     | (0.31      | )                                    | $          | (2.11 | ) | $ | (0.51 | ) | $ | (5.02 | ) |
|                                                                                                                                                         |   |                                  |       |                                 |       |   |   |   |   |
| **Shares used in computing:**                                                                                                                                |   |                                  |       |                                 |       |   |   |   |   |
| Basic  and diluted shares                                                                                                                                    |   | 32,906                                |       | 32,171                               |       | 32,706 |   | 31,961 |   |
|                                                                                                                                                         |   |                                  |       |                                 |       |   |   |   |   |
| **Comprehensive loss:**                                                                                                                                      |   |                                  |       |                                 |       |   |   |   |   |
| Net  loss                                                                                                                                                    |   | $                                     | (10,265    | )                                    | $          | (67,733 | ) | $ | (16,523 | ) | $ | (160,545 | ) |
| Other  comprehensive gain (loss), net of tax: Unrealized investment gains (losses)  less reclassification adjustment for gains (losses) included in net loss |   | (46                                   | )          | 17                                   |       | (83 | ) | 3,957 |   |
| Total  comprehensive loss                                                                                                                                    |   | $                                     | (10,311    | )                                    | $          | (67,716 | ) | $ | (16,606 | ) | $ | (156,588 | ) |

 

*See Accompanying Notes to CondensedConsolidated Financial Statements*

 

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**BROADVISION, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS(In thousands; unaudited)**

 
|                                                                          |   | **Nine  Months Ended September 30,** |    |
|-------------------------------------------------------------------------------|--------|--------------------------------------|---------|
|                                                                          |   | **2003**                             |    | **2002** | ** ** |
| **Cash flows from operating activities:**                                     |   |                                 |    |   |   |
| Net loss                                                                      |   | $                                    | (16,523 | ) | $ | (160,545 | ) |
| Adjustments to reconcile net loss to net  cash used for operating activities: |   |                                 |    |   |   |
| Depreciation and amortization                                                 |   | 9,386                                |    | 14,512 |   |
| Provision (credit) for doubtful accounts  and reserves                        |   | 684                                  |    | (1,945 | ) |
| Provision for sales returns                                                   |   | (1,070                               | )       | 1,524 |   |
| Amortization of prepaid royalties                                             |   | 973                                  |    | 2,730 |   |
| Loss on cost method investments                                               |   | 326                                  |    | 10,328 |   |
| Amortization of other intangible assets                                       |   | 887                                  |    | 2,661 |   |
| Stock-based compensation charge                                               |   | 230                                  |    | 847 |   |
| Restructuring charge, non-cash                                                |   | (382                                 | )       | 18,651 |   |
| Loss on sale of assets                                                        |   | —                               |    | 344 |   |
| Impairment of assets                                                          |   | —                               |    | 3,129 |   |
| Provision for deferred tax asset valuation                                    |   | —                               |    | 6,279 |   |
| Changes in operating assets and  liabilities:                                 |   |                                 |    |   |   |
| Accounts receivable                                                           |   | 12,224                               |    | 21,286 |   |
| Prepaids and other                                                            |   | 3,142                                |    | 3,151 |   |
| Accounts payable and accrued expenses                                         |   | (3,679                               | )       | (6,877 | ) |
| Accrued restructuring expenses                                                |   | (10,442                              | )       | 7,583 |   |
| Unearned revenue and deferred maintenance                                     |   | (14,908                              | )       | (13,668 | ) |
| Other noncurrent assets                                                       |   | 344                                  |    | (464 | ) |
| Net cash used for operating activities                                        |   | (18,808                              | )       | (90,474 | ) |
|                                                                          |   |                                 |    |   |   |
| **Cash flows from investing activities:**                                     |   |                                 |    |   |   |
| Purchase of property and equipment                                            |   | (131                                 | )       | (1,065 | ) |
| Transfer from (to) restricted cash                                            |   | (4,254                               | )       | 13,304 |   |
| Proceeds from sale of assets                                                  |   | 186                                  |    | 247 |   |
| Purchase of long-term investments                                             |   | (2,729                               | )       | (2,349 | ) |
| Sales/maturity of long-term investments                                       |   | 3,403                                |    | 22,519 |   |
| Purchase of short-term investments                                            |   | (2,917                               | )       | (31,141 | ) |
| Sales/maturity of short-term investments                                      |   | 26,288                               |    | 69,198 |   |
| Net cash provided by investing activities                                     |   | 19,846                               |    | 70,713 |   |
|                                                                          |   |                                 |    |   |   |
| **Cash flows from financing activities:**                                     |   |                                 |    |   |   |
| Proceeds from issuance of common stock, net                                   |   | 1,166                                |    | 2,849 |   |
| Proceeds from borrowings, net                                                 |   | 2,000                                |    | 25,000 |   |
| Repayments of borrowings                                                      |   | (970                                 | )       | (732 | ) |
| Net cash provided by financing activities                                     |   | 2,196                                |    | 27,117 |   |
|                                                                          |   |                                 |    |   |   |
| Net increase in cash and cash equivalents                                     |   | 3,234                                |    | 7,356 |   |
| Cash and cash equivalents at beginning of  period                             |   | 77,386                               |    | 75,758 |   |
| Cash and cash equivalents at end of period                                    |   | $                                    | 80,620  |   | $ | 83,114 |   |
|                                                                          |   |                                 |    |   |   |
| **Supplemental disclosures of cash flow  information:**                       |   |                                 |    |   |   |
| Cash paid for interest                                                        |   | $                                    | 170     |   | $ | 164 |   |
| Cash paid for income taxes                                                    |   | $                                    | 849     |   | $ | 941 |   |

 

*See Accompanying Notes to Condensed Consolidated Financial Statements*

 

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**BROADVISION, INC. AND SUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

 

**Note 1.   Organization and Summary of Significant AccountingPolicies**

 

***Nature of Business***

 

BroadVision,Inc. (“BroadVision” or the “Company”) is a global provider of enterpriseself-service web applications. Our integrated solutions for process, commerce,portal and content help our customers increase revenues and streamline costs.As of September 30, 2003, BroadVision had approximately 1,000 customers andgovernment entities around the globe using the Company’s applications tofacilitate their portal-based commerce and information access initiatives.

 

BroadVisionwas founded in 1993 and has been a publicly traded corporation since 1996.BroadVision pioneered web-based e-commerce and was among the first to offerpre-integrated, packaged applications to power enterprise business portals.

 

BroadVision’senterprise portal applications allow organizations to unify and extend theirkey business applications, information, and business processes by takingadvantage of the power of the web and new wireless and mobile devices to allowcustomers, partners, and employees to do business on their own terms, in apersonalized and collaborative way. BroadVision solutions allow multiple constituents to serve themselvesfrom anywhere, at anytime, through any web device.  BroadVision enterprise portal applications enable organizationsto create business value by transforming the way they do business; movingbusiness interactions and transactions from a manual, human-assisted paradigmto an automated, personalized self-service model that enhances growth, reducescosts and improves productivity.

 

TheCompany believes its products improve its customers’ revenue opportunities byenabling them to establish more effective and efficient one-to-onerelationships with their customers and business partners. Web and wirelessusers are engaged by highly personalized real-time interactions, able totransact business securely and encouraged to remain online and make returnvisits.  The Company’s applications alsoimprove the cost-effectiveness of one-to-one relationship management byenabling non-technical managers to modify business rules and content inreal-time and by helping to reduce the cost of customer acquisition andretention, business development, technical support and employee workplaceinitiatives. Because the Company provides pre-integrated, packaged solutions,time to deployment is shorter and customers are able to manage and maintaintheir web and wireless applications in a cost-effective manner. Because of theCompany’s commitment to open standards and open architecture, BroadVisionapplications integrate with its customers’ existing systems and expand as itscustomers’ needs and businesses grow.

 

Supporting this application infrastructure, as of September 30, 2003,are more than 100 partner firms around the world who are working to ensure theCompany’s joint customers’ success through complementary technology,applications, tools and services offerings that extend and enhance BroadVisioncustomers’ implementations.

 

BroadVisionmarkets its products and services worldwide through a direct sales force andindependent distributors, value-added resellers (“VARs”) and applicationservice providers (“ASPs”). In addition, its sales are promoted throughindependent professional consulting organizations, known as systemsintegrators. The Company has operations in North America, Europe andAsia/Pacific.

 

BroadVisionGlobal Services (“BVGS”) organization provides a full spectrum of globalservices to help ensure success for businesses, including strategic services,implementation services, migration services and ongoing training andmaintenance.

 

***Basis ofPresentation and Use of Estimates***

 

Theaccompanying consolidated financial statements include the accounts of theCompany and its wholly-owned subsidiaries. All significant intercompany transactionshave been eliminated in consolidation.  In the Company’s opinion, theconsolidated financial statements presented herein include all necessaryadjustments, consisting of normal recurring adjustments, to fairly state theCompany’s financial position, results of operations and cash flows forthe periods indicated.  The preparation of consolidated financialstatements in conformity with generally accepted accounting principles in theUnited States of America requires management to make certain assumptions andestimates that affect reported amounts of assets and liabilities as of the dateof the financial statements and the reported amount of revenues and expensesduring the

 

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reporting period.  Actualresults could differ from estimates.  The financial results and relatedinformation as of September 30, 2003 and for the three and nine months endedSeptember 30, 2003 and 2002 are unaudited. The consolidated balance sheet atDecember 31, 2002 has been derived from the audited consolidated financialstatements as of that date but does not necessarily reflect all of theinformational disclosures previously reported in accordance with generallyaccepted accounting principles in the United States of America.

 

The accompanying condensedconsolidated financial statements should be read in conjunction with theconsolidated financial statements and notes thereto included with the Company’sForm 10-K and other documents that have been filed with the Securities and ExchangeCommission (“SEC”). The results of the Company’s operations for the interimperiods presented are not necessarily indicative of operating results for thefull fiscal year or any future periods.

 

***Revenue Recognition***

 

*Overview*

 

TheCompany’s revenue consists of fees for licenses of the Company’s softwareproducts, maintenance, consulting services and customer training. The Companygenerally charges fees for licenses of its software products either based onthe number of persons registered to use the product or based on the number ofCentral Processing Units (“CPUs”) on which the product is installed. TheCompany’s revenue recognition policies comply with the provisions of Statementof Position (“SOP”) No. 97-2, *SoftwareRevenue Recognition*, as amended; SOP No. 98-9, *Software Revenue Recognition, With Respect to CertainTransactions*and the SEC’s Staff Accounting Bulletin No. 101, *Revenue Recognition in Financial Statements*.

 

*Software License Revenue*

 

TheCompany licenses its products through its direct sales force and indirectlythrough resellers. In general, software license revenues are recognized when anon-cancelable license agreement has been signed under which the customeracknowledges an unconditional obligation to pay, the software product has beendelivered, there are no uncertainties surrounding product acceptance, the feesare fixed and determinable and collection is considered probable. Delivery isconsidered to have occurred when title and risk of loss have been transferredto the customer, which generally occurs when media containing the licensedprograms is provided to a common carrier. In the case of electronic delivery,delivery occurs when the customer is given access to the licensed programs. Ifcollectibility is not considered probable, revenue is recognized when the feeis collected.  Subscription-basedlicense revenues are recognized ratably over the subscription period. TheCompany enters into reseller arrangements that typically provide for sublicensefees payable to the Company based upon a percentage of list price. The Companydoes not grant its resellers the right of return.

 

TheCompany recognizes revenue using the residual method pursuant to therequirements of SOP No. 97-2, as amended by SOP No. 98-9. Revenues recognizedfrom multiple-element software arrangements are allocated to each element ofthe arrangement based on the fair values of the elements, such as licenses forsoftware products, maintenance, consulting services or customer training. Thedetermination of fair value is based on objective evidence, which is specificto the Company. The Company limits its assessment of objective evidence foreach element to either the price charged when the same element is soldseparately or the price established by management having the relevant authorityto do so, for an element not yet sold separately. If evidence of fair value ofall undelivered elements exists but evidence does not exist for one or moredelivered elements, then revenue is recognized using the residual method. Underthe residual method, the fair value of the undelivered elements is deferred andthe remaining portion of the arrangement fee is recognized as revenue.

 

TheCompany records deferred revenue for software license agreements when cash hasbeen received from the customer and the agreement does not qualify for revenuerecognition under the Company’srevenue recognition policy. The Company records accounts receivable forsoftware license agreements when the agreement qualifies for revenuerecognition but cash or other consideration has not been received from thecustomer.

 

*Services Revenue*

 

Consultingservices revenues and customer training revenues are recognized as suchservices are performed. Maintenance revenues, which include revenues bundledwith software license agreements that entitle the customers to technicalsupport and future unspecified enhancements to the Company’s products, aredeferred and recognized ratably over the related agreement period, generallytwelve months.  The Company’s consultingservices, which consist of consulting, maintenance and training, are deliveredthrough BVGS. This group provides consulting services, manages projectsand client relationships, manages the needs of our partner community, providestraining-related services to employees, customers and partners, and alsoprovides software maintenance services, including technical support, to ourcustomers and partners. We

 

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record reimbursement by our customers for out-of-pocket expenses as acomponent of services revenue.  Servicesthat the Company provides are not essential to the functionality of thesoftware.

 

***Stock Split***

 

OnJuly 24, 2002, the Company announced that its Board of Directors had approved aone-for-nine reverse split of the Company’s common stock. The reverse split waseffective July 29, 2002. Each nine shares of outstanding common stock of theCompany automatically converted into one share of common stock. Theaccompanying consolidated financial statements and related financialinformation contained herein have been retroactively restated to give effectfor this stock split.

 

***Employee StockOption and Purchase Plans***

 

The Company accounts for employee stock-based awards in accordance withthe provisions of Accounting Principles Board (“APB”) Opinion No. 25, *Accounting for Stock Issued to Employees*,Financial Accounting Standards Board Interpretation No. 44 (“FIN 44”), *Accounting for Certain Transactions Involving StockCompensation—an Interpretation of APB No. 25, and related interpretations*.As such, compensation expense is recorded on the date of grant only if thecurrent market price of the underlying stock exceeded the exercise price onsuch date. Pursuant to Statement of Financial Accounting Standards (“SFAS”)No. 123, *Accounting for Stock-BasedCompensation*, the Company discloses the pro forma effects of usingthe fair value method of accounting for stock-based compensation arrangements.The Company accounts for equity instruments issued to non-employees inaccordance with the provisions of SFAS No. 123 and Emerging Issues TaskForce (“EITF”) 96-18, *Accounting for EquityInstruments That Are Issued to Other Than Employees For Acquiring or inConjunction with Selling Goods or Services*.

 

The Company applies APB Opinion Number 25, *Accounting for Stock Issued to Employees*, and relatedinterpretations when accounting for its stock option and stock purchase plans.In accordance with APB No. 25, the Company applies the intrinsic valuemethod in accounting for employee stock options. Accordingly, the Companygenerally recognizes no compensation expense with respect to stock-based awardsto employees.

 

Duringthe nine months ended September 30, 2003, the Company recorded compensationexpense of $279,000 as a result of granting a third-party consultant commonstock in the Company and a vesting modification to a grant for a terminatedemployee.  These charges were calculatedbased upon the market value of the underlying stock.  During the nine months ended September 30, 2002, the Companyrecorded compensation expense of $846,000 as a result of granting terminatedemployees continued vesting of their stock options for a period beyond theiractual termination date. This compensation charge was calculated using theBlack-Scholes model.

 

TheCompany has determined pro forma information regarding net loss and net lossper share as if it had accounted for employee stock options under the fairvalue method as required by SFAS Number 123, Accounting for Stock Compensation.The fair value of these stock-based awards to employees was estimated using theBlack-Scholes option pricing model. Had compensation cost for the Company’sstock option plan and employee stock purchase plan been determined consistentwith SFAS No. 123, the Company’s reported net loss and net loss per sharewould have been changed to the amounts indicated below (in thousands, exceptper share data, unaudited):

 
|                                                                                                                                          |   | **Three Months Ended  September 30,** |    | **Nine Months Ended  September 30,** |       |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|---------|--------------------------------------|------------|
|                                                                                                                                          |   | **2003**                              |    | **2002**                             | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net loss as reported                                                                                                                          |   | $                                     | (10,265 | )                                    | $          | (67,733 | ) | $ | (16,523 | ) | $ | (160,545 | ) |
| Add: Stock-based employee compensation  expense included in reported net loss, net of related tax effects                                     |   | 231                                   |    | 77                                   |       | 279 |   | 846 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |   | (2,734                                | )       | (4,917                               | )          | (6,739 | ) | (39,949 | ) |
| Pro forma net loss                                                                                                                            |   | $                                     | (12,768 | )                                    | $          | (72,573 | ) | $ | (22,983 | ) | $ | (199,648 | ) |
|                                                                                                                                          |   |                                  |    |                                 |       |   |   |   |   |
| Loss per share:                                                                                                                               |   |                                  |    |                                 |       |   |   |   |   |
| Basic—as reported                                                                                                                        |   | $                                     | (0.31   | )                                    | $          | (2.11 | ) | $ | (0.51 | ) | $ | (5.02 | ) |
| Basic—pro forma                                                                                                                          |   | $                                     | (0.39   | )                                    | $          | (2.26 | ) | $ | (0.70 | ) | $ | (6.25 | ) |
|                                                                                                                                          |   |                                  |    |                                 |       |   |   |   |   |
| Diluted—as reported                                                                                                                      |   | $                                     | (0.31   | )                                    | $          | (2.11 | ) | $ | (0.51 | ) | $ | (5.02 | ) |
| Diluted—pro forma                                                                                                                        |   | $                                     | (0.39   | )                                    | $          | (2.26 | ) | $ | (0.70 | ) | $ | (6.25 | ) |

 

8

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***Net Loss Per Share***

 

SFAS No. 128, *Earnings PerShare*, requires the presentation of basic and diluted earnings orlosses per share. Earnings or losses per share are calculated by dividing netincome or loss available to common stockholders by a weighted average number ofshares outstanding for the period. Basic earnings or losses per share aredetermined solely on common shares whereas diluted earnings or losses per shareinclude common equivalent shares, unless anti-dilutive as determined under thetreasury stock method.

 

The followingtable sets forth basic and diluted losses per share computational data for theperiods presented (in thousands, except per share amounts, unaudited):

 
|                                                                                |   | **Three  Months Ended  September 30,** |    | **Nine  Months Ended  September 30,** |       |
|-------------------------------------------------------------------------------------|--------|----------------------------------------|---------|---------------------------------------|------------|
|                                                                                |   | **2003**                               |    | **2002**                              | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net loss                                                                            |   | $                                      | (10,265 | )                                     | $          | (67,733 | ) | $ | (16,523 | ) | $ | (160,545 | ) |
|                                                                                |   |                                   |    |                                  |       |   |   |   |   |
| Weighted average common shares outstanding  utilized for basic net loss per share   |   | 32,906                                 |    | 32,171                                |       | 32,706 |   | 31,961 |   |
| Potential common shares                                                             |   | —                                 |    | —                                |       | — |   | — |   |
| Weighted average common shares outstanding  utilized for diluted net loss per share |   | 32,906                                 |    | 32,171                                |       | 32,706 |   | 31,961 |   |
| Basic net loss per share                                                            |   | $                                      | (0.31   | )                                     | $          | (2.11 | ) | $ | (0.51 | ) | $ | (5.02 | ) |
| Diluted net loss per share                                                          |   | $                                      | (0.31   | )                                     | $          | (2.11 | ) | $ | (0.51 | ) | $ | (5.02 | ) |

 

There were 127,938 and 136,825 potential common shares excluded fromthe determination of diluted net loss per share for the three and nine monthsended September 30, 2003, respectively, as the effect of such shares isanti-dilutive. There were 31,937 and 266,844 potential common shares excludedfrom the determination of diluted net loss per share for the three and ninemonths ended September 30, 2002, respectively, as the effect of such shares isanti-dilutive.

 

***Allowances and Reserves***

 

Occasionally,the Company’s customers experience financial difficulty after the Companyrecords the revenue but before payment has been received. The Company maintainsallowances for doubtful accounts for estimated losses resulting from theinability of its customers to make required payments. The Company’s normalpayment terms are 30 to 90 days from invoice date. If the financialcondition of the Company’s customers was to deteriorate, resulting in animpairment of their ability to make payments, additional allowances may berequired. The Company records reductions to revenue for estimated returns ofproducts by our customers and related allowances. If market conditions were todecline, we may experience larger volumes of returns resulting in an incrementalreduction of revenue at the time the return occurs.

 

***Restructuring***

 

The Company has approved certain restructuring plans to, among otherthings, reduce its workforce and consolidate facilities. These restructuringcharges were taken to align the Company’s cost structure with changing marketconditions and to create a more efficient organization. The Company’srestructuring charges are comprised primarily of: (i) severance andbenefits termination costs related to the reduction of the Company’s workforce;(ii) lease termination costs and/or costs associated with permanentlyvacating its facilities; (iii) other incremental costs incurred as a directresult of the restructuring plan; and (iv) impairment costs related tocertain long-lived assets abandoned. The Company accounts for each of thesecosts in accordance with SEC Staff Accounting Bulletin No. 100, *Restructuring and Impairment Charges.*

 

9

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The Company accounts for severance and benefits termination costs inaccordance with EITF Issue No. 94-3, *LiabilityRecognition for Certain Employee Termination Benefits and Other Costs to Exitan Activity (Including Certain Costs Incurred in a Restructuring)*for exit or disposal activities initiated prior to December 31, 2002.Accordingly, the Company records the liability related to these terminationcosts when the following conditions have been met: (i) management with theappropriate level of authority approves a termination plan that commits theCompany to such plan and establishes the benefits the employees will receiveupon termination; (ii) the benefit arrangement is communicated to theemployees in sufficient detail to enable the employees to determine thetermination benefits; (iii) the plan specifically identifies the number ofemployees to be terminated, their locations and their job classifications; and(iv) the period of time to implement the plan does not indicate changes tothe plan are likely. The termination costs recorded by the Company are not associatedwith nor do they benefit continuing activities.  The Company accounts for severance and benefits termination costsfor exit or disposal activities initiated after December 31, 2002 in accordancewith SFAS No. 146, *Accounting for CostsAssociated with Exit Activities*. SFAS No. 146 requires that a liability for a cost associated with anexit or disposal activity be recognized and measured initially at fair valueonly when the liability is incurred. This differs from EITF 94-3, which required that a liability for an exitcost be recognized at the date of an entity’s commitment to an exit plan.

 

Prior to theadoption on January 1, 2003 of SFAS No. 146, the Company accounted for thecosts associated with lease termination and/or abandonment in accordance withEITF 88-10, *Costs Associated with LeaseModification or Termination*. Accordingly, the Company recorded thecosts associated with lease termination and/or abandonment when the leasedproperty has no substantive future use or benefit to the Company.

 

Inherent inthe estimation of the costs related to the Company’s restructuring efforts areassessments related to the most likely expected outcome of the significantactions to accomplish the restructuring. In determining the charge related tothe restructuring, the majority of estimates made by management related tocharges for excess facilities. In determining the charges for excessfacilities, the Company was required to estimate future sublease income, futurenet operating expenses of the facilities, and brokerage commissions, amongother expenses. The most significant of these estimates related to the timingand extent of future sublease income in which to reduce the Company’s leaseobligations. Specifically, in determining the restructuring obligations relatedto facilities as of September 30, 2003, the Company reduced its leaseobligations by estimated sublease income of $45.4 million. The Companybased its estimates of sublease income, in part, on the opinions of independentreal estate experts, current market conditions and rental rates, an assessmentof the time period over which reasonable estimates could be made, the status ofnegotiations with potential subtenants, and the location of the respectivefacility, among other factors.

 

Theseestimates, along with other estimates made by management in connection with therestructuring, may vary significantly depending, in part, on factors that maybe beyond the Company’s control. Specifically, these estimates will depend onthe Company’s success in negotiating with lessors, the time periods required tolocate and contract suitable subleases and the market rates at the time of suchsubleases. Adjustments to the facilities reserve will be required if actuallease exit costs or sublease income differ from amounts currently expected. TheCompany will review the status of restructuring activities on a quarterly basisand, if appropriate, record changes to its restructuring obligations in currentoperations based on management’s most current estimates.

 

***Legal Matters***

 

The Company’scurrent estimated range of liability related to pending litigation is based onclaims for which it is probable that a liability has been incurred and theCompany can estimate the amount and range of loss. The Company has recorded theminimum estimated liability related to those claims, where there is a range ofloss. Because of the uncertainties related to both the determination of theprobability of an unfavorable outcome and the amount and range of loss in theevent of an unfavorable outcome, the Company is unable to make a reasonableestimate of the liability that could result from the remaining pendinglitigation. As additional information becomes available, the Company willassess the potential liability related to its pending litigation and revise itsestimates, if necessary. Such revisions in the Company’s estimates of thepotential liability could materially impact the Company’s results of operationsand financial position.

 

***Foreign Currency Transactions***

 

The functional currency of the Company’s foreign subsidiaries is theU.S. dollar. Foreign exchange gains and losses resulting from the remeasurementof foreign currency assets and liabilities are included in other income(expense), net in the Condensed Consolidated Statements of Operations.

 

10

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***Valuation of Long-Lived Assets***

 

The Company periodically assesses the impairment of long-lived assetsin accordance with the provisions of SFAS No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets*. The Company assesses the impairment

 

11

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of goodwill and identifiable intangible assets in accordance with SFASNo. 141, Business Combinations and SFAS No. 142, Goodwill and Other IntangibleAssets.

 

***Fair Value of Financial Instruments***

 

TheCompany’s financial instruments consist of cash and cash equivalents,short-term investments, restricted cash, long-term investments, equityinvestments, accounts receivable, accounts payable and debt. The Company doesnot have any derivative financial instruments. The Company believes thereported carrying amounts of its financial instruments approximates fair value,based upon the maturities and nature of its cash equivalents, short-term investments,long-term investments, accounts receivable and payable, and based on thecurrent rates available to it on similar debt issues. Additionally, the Companyperiodically evaluates the carrying value of all of its investments forother-than-temporary impairment when events and circumstances indicate that thebook value of an asset may not be recoverable. If such assets are considered tobe impaired, the impairment to be recognized is measured by the amounts bywhich the carrying amount exceeds its fair market value. The Company’s equityinvestments are comprised of investments in public and non-publictechnology-related companies. The Company may record future impairment chargesdue to continued economic decline and the potential resulting negative impact onthese companies.

 

***New AccountingPronouncements***

 

In April 2002, the FASB issued Statement of Financial AccountingStandards No. 145 (“SFAS 145”), “Rescission of FASB StatementsNo. 4, 44 and 64, Amendment of FASB Statement No. 13 and TechnicalCorrections.” Among other provisions, SFAS 145 rescinds SFAS 4, “ReportingGains and Losses from Extinguishment of Debt.” Accordingly, gains or lossesfrom extinguishment of debt shall not be reported as extraordinary items unlessthe extinguishment qualifies as an extraordinary item under the criteria of APBNo. 30. Gains or losses from extinguishment of debt that do not meet thecriteria of APB 30 should be reclassified to income from continuing operationsin all prior periods presented. SFAS 145 is effective for fiscal yearsbeginning after May 15, 2002. The adoption of SFAS 145, at thebeginning of our fiscal year 2003, did not have a material impact on ourconsolidated financial position, results of operations or cash flows.

 

In July 2002, the FASB issued Statement of Financial AccountingStandards No. 146 (“SFAS 146”), “Accounting for Costs Associated withExit or Disposal Activities.” SFAS 146 addresses financial accounting andreporting for costs associated with exit or disposal activities. This statementrequires that a liability for a cost associated with an exit or disposalactivity be recognized when the liability is incurred. Previous guidance,provided under EITF No. 94-3, “Liability Recognition for Certain EmployeeTermination Benefits and Other Costs to Exit an Activity (including certaincosts incurred in a restructuring),” required that an exit cost liability berecognized at the date of an entity’s commitment to an exit plan. The adoptionof SFAS 146, at the beginning of our fiscal year 2003, did not have amaterial impact on our consolidated financial position, results of operationsor cash flows. See “Restructuring” for additional disclosure.

 

In November 2002,the FASB issued FIN 45, which expands on the accounting guidance of Statementsof Financial Accounting Standards No. 5, 57 and 107 and incorporateswithout change the provisions of FASB Interpretation No. 34, which hasbeen superseded. FIN 45 affects, among other things, leasing transactionsinvolving residual guarantees, vendor and manufacturer guarantees and tax andenvironmental indemnities. All such guarantees are required to be disclosed inthe notes to the financial statements starting with the period ending afterDecember 15, 2002. For guarantees issued after December 31, 2002, thefair value of the obligation must be reported on the balance sheet. Existingguarantees are permitted to be grandfathered and are not recognized on thebalance sheet. The adoption of FIN 45, at the beginning of our fiscal year2003, did not have a material impact on our consolidated financial position,results of operations or cash flows. See “Warranties and Indemnification” foradditional disclosures.

 

In December 2002, the FASB issued SFAS 148, which providesalternative methods of transition for a voluntary change to the fair valuebased method of accounting for stock-based employee compensation. In addition,SFAS No. 148 amends the disclosure requirements of Statement 123 torequire more prominent and more frequent disclosures in financial statementsabout the effects of stock-based compensation. The transition guidanceand annual disclosure provisions of SFAS 148 are effective for fiscalyears ending after December 15, 2002. The interim disclosure provisionsare effective for financial reports containing financial statements for interimperiods beginning after December 15, 2002. The adoption of SFAS 148did not have a material impact on our consolidated financial position, resultsof operations or cash flows. See “Stock-Based Incentive Compensation” for theimpact to our required pro forma disclosures.

 

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InJanuary 2003, the FASB issued Interpretation No. 46 (“FIN 46”),“Consolidation of Variable Interest Entities.” FIN 46 expands upon andstrengthens existing accounting guidance that addresses when a company shouldinclude in its financial statements the assets, liabilities and activities ofanother entity. A variable interest entity is a corporation, partnership,trust, or any other legal structure used for business purposes that either(i) does not have equity investors with voting rights or (ii) hasequity investors that do not provide sufficient financial resources for theentity to support its activities. FIN 46 requires a variable interest entity tobe consolidated by a company if that company is subject to a majority of therisk of loss from the variable interest entity’s activities or is entitled toreceive a majority of the entity’s residual returns or both. The consolidationrequirements of FIN 46 apply immediately to variable interest entities createdafter January 31, 2003. The consolidation requirements apply to olderentities in the first fiscal year or interim period beginning afterDecember 15, 2003. Disclosure requirements apply to any financial statementsissued after January 31, 2003. We do not expect the adoption ofSFAS 146 to have a material impact on our consolidated financial position,results of operations or cash flows.

 

In April 2003, the FASB issued SFAS No. 149, “Amendment ofStatement 133 on Derivative Instruments and Hedging Activities.” SFAS 149amends and clarifies the accounting for derivative instruments, includingcertain derivative instruments embedded in other contracts, and for hedgingactivities under SFAS 133, “Accounting for Derivative Instruments andHedging Activities.” SFAS 149 is generally effective for contracts enteredinto or modified after June 30, 2003 and for hedging relationshipsdesignated after June 30, 2003. We are currently evaluating the impact ofSFAS 149 on our consolidated financial position and results of operations.We do not expect the adoption of SFAS 149 to have a material impact on ourconsolidated financial position, results of operations or cash flows.

 

InMay 2003, the FASB issued SFAS 150, “Accounting for Certain FinancialInstruments with Characteristics of both Liabilities and Equity.” SFAS 150requires that certain financial instruments, which under previous guidance wereaccounted for as equity, must now be accounted for as liabilities. The financialinstruments affected include mandatorily redeemable stock, certain financialinstruments that require or may require the issuer to buy back some of itsshares in exchange for cash or other assets and certain obligations that can besettled with shares of stock. SFAS 150 is effective for all financialinstruments entered into or modified after May 31, 2003, and otherwise iseffective at the beginning of the first interim period beginning afterJune 15, 2003. We do not expect the adoption of SFAS 150 to have amaterial impact on our consolidated financial position, results of operationsor cash flows.

 

**Note 2.   SelectiveBalance Sheet Detail**

 

Property and equipment consisted of the following (in thousands):

 
|                                            |   | **September  30,  2003** |       | **December 31,  2002** |       |
|-------------------------------------------------|--------|--------------------------|------------|-----------------------------|------------|
|                                            |   | **(unaudited)**          | ** ** |                        | ** ** |
| Furniture and fixtures                          |   | $                        | 9,149      |                        | $          | 9,138 |   |
| Computers and software                          |   | 49,444                   |       | 49,579                      |       |
| Leasehold improvements                          |   | 21,525                   |       | 21,456                      |       |
|                                            |   | 80,118                   |       | 80,173                      |       |
| Less accumulated depreciation and  amortization |   | (62,913                  | )          | (53,573                     | )          |
|                                            |   | $                        | 17,205     |                        | $          | 26,600 |   |

 

Accrued expenses consisted of the following (in thousands):

 
|                       |   | **September  30,  2003** |       | **December  31,  2002** |       |
|----------------------------|--------|--------------------------|------------|-------------------------|------------|
|                       |   | **(unaudited)**          | ** ** |                    | ** ** |
| Employee benefits          |   | $                        | 1,772      |                    | $          | 2,081 |   |
| Commissions and bonuses    |   | 2,138                    |       | 2,027                   |       |
| Sales and other taxes      |   | 7,496                    |       | 11,956                  |       |
| Restructuring (See Note 6) |   | 19,749                   |       | 29,056                  |       |
| Other                      |   | 5,327                    |       | 10,667                  |       |
|                       |   | $                        | 36,482     |                    | $          | 55,787 |   |

 

Other noncurrent liabilities consisted of the following (in thousands):

 
|                       |   | **September  30,  2003** |       | **December 31,  2002** |       |
|----------------------------|--------|--------------------------|------------|-----------------------------|------------|
|                       |   | **(unaudited)**          | ** ** |                        | ** ** |
| Restructuring (See Note 6) |   | $                        | 69,110     |                        | $          | 67,139 |   |
| Other                      |   | 913                      |       | 1,067                       |       |
|                       |   | $                        | 70,023     |                        | $          | 68,206 |   |

 

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**Note 3.   CommercialCredit Facilities**

 

The Companyhas various credit facilities with a commercial lender which include term debtin the form of notes payable and a revolving line of credit. The amountavailable under the revolving line of credit is $27.0 million.Borrowings are collateralized by all of the Company’s assets and bear interestat the bank’s prime rate (floating with a floor of 4.25%). Interest is duemonthly and principal is due at expiration in February 2004. The amended andrestated loan and security agreement requires us to maintain certain levels incash and cash equivalents, short-term investments and long-term investments(excluding equity investments). Additionally, the amended and restated loan andsecurity agreement requires us to maintain certain levels on deposit with ourcommercial lender and certain quarterly operating levels and ratios.  At September 30, 2003 and December 31, 2002,$27.0 million and $25.0 million was outstanding under the line of credit,respectively.

 

As of September 30, 2003, the Company was not in compliance with theprofitability and financial covenants of its commercial credit facilities.  Subsequently, the Company received a waiverfrom the bank regarding non-compliance.

 

As ofSeptember 30, 2003 and December 31, 2002, outstanding term debt borrowings wereapproximately $2.3 million and $2.9 million, respectively.  Borrowings bear interest at the bank’s primerate (4.00% as of September 30, 2003 and December 31, 2002) and prime rate plus1.25%. Principal and interest are due in monthly payments through maturitybased on the terms of the facilities. Principal payments of $977,000 are dueannually from 2000 through 2004, $611,000 due in 2005, and a final payment of$357,000 due in 2006.

 

Commitmentstotaling $21.0 million and $16.7 million in the form of standby letters ofcredit were issued on the Company’s behalf from financial institutions as ofSeptember 30, 2003 and December 31, 2002, respectively, in favor of theCompany’s various landlords to secure obligations under the Company’s facilityleases.

 

**Note 4.   Commitmentsand Contingencies**

 

On February 15, 2002,BroadVision and Hewlett-Packard signed an agreement that terminatedHewlett-Packard’s rights to resell BroadVision software effective February 15,2002.  Under the terms of thetermination agreement, the Company is required to pay back to Hewlett-Packardprepaid royalty payments of approximately $2.4 million that were received fromHewlett-Packard in prior periods. These amounts payable have been paid in fullas of September 30, 2003.  In addition,in the event BroadVision becomes insolvent, files a petition for relief underthe United States Bankruptcy Code, or materially breaches the agreement,Hewlett-Packard will have rights to a limited term license for BroadVision’sbusiness-to-business customer portals software products and a limited uselicense for BroadVision’s One-to-One Enterprise software product.  Such license will be limited in term untilsuch time as Hewlett-Packard has received monies for sale of the products up toa maximum of $12.0 million.

 

In November 2002, the FASBissued FASB Interpretation No. 45 (“FIN 45”), *Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others—an interpretation of FASB Statements No.5, 57 and 107 and rescission of FIN 34*.  FIN 45 requires that disclosures be made by a guarantor in itsinterim and annual financial statements about its obligations under certainguarantees that it has issued and clarifies that a guarantor is required torecognize, at the inception of a guarantee, a liability for the fair value ofthe obligation undertaken in issuing the guarantee.  FIN 45 does not apply to certain guarantee contracts, such asresidual value guarantees provided by lessees in capital leases, guaranteesthat are accounted for as derivatives, guarantees that represent contingentconsideration in a business combination, guarantees issued between eitherparents and their subsidiaries or corporations under common control, a parent’sguarantee of a subsidiary’s debt to a third party, and a subsidiary’s guaranteeof the debt owed to a third party by either its parent or another subsidiary ofthat parent.  This interpretation iseffective on a prospective basis for guarantees issued or modified afterDecember 31, 2002 and for financial statements of interim or annual periodsending after December 15, 2002.  Thisinterpretation did not have a material impact on the Company’s financialposition or results of operations.

 

14

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*Warrantiesand Indemnification*

 

The Company provides a warranty to its customers that its software willperform substantially in accordance with documentation typically for a periodof 90 days following receipt of the software. The Company also indemnifiescertain customers from third-party claims of intellectual property infringementrelating to the use of its products. Historically, costs related to these guarantees have not beensignificant and the Company is unable to estimate the maximum potential impactof these guarantees on its future results of operations.

 

The Companyhas agreements whereby it indemnifies its officers and directors for certainevents or occurrences while the officer is, or was, serving in such capacity.The term of the indemnification period is for so long as such officer ordirector is subject to an indemnifiable event by reason of the fact that suchperson was serving in such capacity. The maximum potential amount of futurepayments the Company could be required to make under these indemnificationagreements is unlimited; however, the Company has a director and officerinsurance policy that limits its exposure and enables the Company to recover aportion of any future amounts paid. As a result of the Company’s insurancepolicy coverage, the Company believes the estimated fair value of theseindemnification agreements is insignificant. Accordingly, the Company has noliabilities recorded for these agreements as of either September 30, 2003 orDecember 31, 2002. The Company assesses the need for an indemnification reserveon a quarterly basis and there can be no guarantee that an indemnificationreserve will not become necessary in the future.

 

*Leases*

 

The Company leases itsheadquarters facility and its other facilities under non-cancelable operatinglease agreements expiring through the year 2013. Under the terms of theagreements, the Company is required to pay lease costs, property taxes,insurance and normal maintenance costs.

 

A summary of total futureminimum lease payments as of September 30, 2003, under noncancelable operatinglease agreements is as follows (in thousands):

 
| **Years Ending December 31,** |   | **Operating  Leases** |    |
|------------------------------------|--------|-----------------------|---------|
| 2003                               |   | $                     | 5,767   |   |
| 2004                               |   | 23,312                |    |
| 2005                               |   | 23,579                |    |
| 2006                               |   | 21,223                |    |
| 2007                               |   | 18,695                |    |
| 2008 and thereafter                |   | 89,661                |    |
|                               |   |                  |    |
| Total minimum lease payments       |   | $                     | 182,237 |   |

 

As of September 30, 2003, the Company has accrued $87.6 million ofestimated future facilities costs as a restructuring accrual. See Note 6 below.

 

*Equity Investment*

 

InJanuary 2000, the Company entered into a limited partnership agreement with aventure capital firm under which it is obligated to contribute capital basedupon the periodic funding requirements. The total capital commitment is $2.0 million, of which $900,000 has beencontributed through September 30, 2003. The remaining $1.1 million will be contributed in future periods basedupon the capital requirements of the fund.

 

*Standby Letter of Credit Commitments*

 

Asof September 30, 2003, the Company had $21.0 million of outstanding commitmentsin the form of standby letters of credit in favor of the Company’s variouslandlords to secure obligations under the Company’s facility leases.

 

*Legal Proceedings*

 

During the first quarter of 2003, the Company settled a dispute withAvalon Partners, Inc., doing business as Cresa Partners (“Cresa”) with respectto broker commissions related to the Company’s termination and restructuring of

 

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certain facilities leases associated with the Company’s restructuringplans taken during the second quarter of 2002. Under the terms of the settlement,the Company made a one-time payment of $2.2 million to Cresa in April 2003.

 

During the third quarter of 2003, the Company reached a confidentialsettlement with Verity, Inc. (“Verity”) with respect to our outstandinglitigation. The detailed terms and conditions of this settlement areconfidential and cannot be disclosed without the consent of each party.  The settlement is not expected to have amaterial effect on the Company’s business, financial condition or results ofoperations. 

 

TheCompany is also subject to various other claims and legal actions arising inthe ordinary course of business. In the opinion of management, afterconsultation with legal counsel, the ultimate disposition of these matters isnot expected to have a material effect on the Company’s business, financialcondition or results of operations. Although management currently believes thatthe outcome of other outstanding legal proceedings, claims and litigationinvolving the Company will not have a material adverse effect on its business,results of operations or financial condition, litigation is inherentlyuncertain, and there can be no assurance that existing or future litigationwill not have a material adverse effect on the Company’s business, results ofoperations or financial condition.

 

**Note 5.   Geographic,Segment and Significant Customer Information**

 

The Company operates in one segment, electronic business commercesolutions. The Company’s reportable segment includes the Company’s facilitiesin North and South America (“Americas”), Europe and Asia Pacific and the MiddleEast (“Asia/Pacific”). The Company’s chief operating decision maker isconsidered to be the Company’s Chief Executive Officer (“CEO”). The CEO reviewsfinancial information presented on a consolidated basis accompanied bydisaggregated information about revenues by geographic region and by productfor purposes of making operating decisions and assessing financial performance.

 

The disaggregated revenue information reviewed by the CEO is as follows(unaudited, in thousands):

 
|                |   | **Three  months ended  September 30,** |   | **Nine  months ended  September 30,** |       |
|---------------------|--------|----------------------------------------|--------|---------------------------------------|------------|
|                |   | **2003**                               |   | **2002**                              | ** ** | **2003** | ** ** | **2002** | ** ** |
| Software licenses   |   | $                                      | 5,076  |                                  | $          | 10,756 |   | $ | 19,875 |   | $ | 29,244 |   |
| Consulting services |   | 4,692                                  |   | 7,092                                 |       | 17,038 |   | 28,532 |   |
| Maintenance         |   | 8,801                                  |   | 9,391                                 |       | 27,916 |   | 29.337 |   |
| Total revenues      |   | $                                      | 18,569 |                                  | $          | 27,239 |   | $ | 64,829 |   | $ | 87,113 |   |

 

The Company sells its products and provides services worldwide througha direct sales force and through a channel of independent distributors, VARsand ASPs. In addition, the licenses of the Company’s products are promotedthrough independent professional consulting organizations known as systemsintegrators. The Company provides services worldwide through its BroadVisionGlobal Services Organization and indirectly through distributors, VARs, ASPs,and systems integrators.

 

Disaggregated financial information regarding the Company’s productsand services and geographic revenues is as follows (in thousands):

 
|               |   | **Three  months ended  September 30,** |   | **Nine  months ended  September 30,** |       |
|--------------------|--------|----------------------------------------|--------|---------------------------------------|------------|
|               |   | **2003**                               |   | **2002**                              | ** ** | **2003** | ** ** | **2002** | ** ** |
|               |   | **(unaudited)**                        |   | **(unaudited)**                       |       | **(unaudited)** |   | **(unaudited)** |   |
| Revenues:          |   |                                   |   |                                  |       |   |   |   |   |
| Americas           |   | $                                      | 9,073  |                                  | $          | 16,319 |   | $ | 32,750 |   | $ | 53,373 |   |
| Europe             |   | 7,997                                  |   | 9,005                                 |       | 25,966 |   | 28,846 |   |
| Asia/Pacific       |   | 1,499                                  |   | 1,915                                 |       | 6,113 |   | 4,894 |   |
| Total Company      |   | $                                      | 18,569 |                                  | $          | 27,239 |   | $ | 64,829 |   | $ | 87,113 |   |
|               |   |                                   |   |                                  |       |   |   |   |   |   |   |   |   |
|               |   |                                   |   |                                  |       |   |   | **September  30,  2003** |   | **December  31,  2002** |   |
|               |   |                                   |   |                                  |       |   |   | **(unaudited)** |   |   |   |
| Long-Lived Assets: |   |                                   |   |                                  |       |   |   |   |   |   |   |
| Americas           |   |                                   |   |                                  |       |   |   | $ |  74,841 |   | $ |  84,727 |   |
| Europe             |   |                                   |   |                                  |       |   |   | 604 |   | 1,175 |   |
| Asia/Pacific       |   |                                   |   |                                  |       |   |   | 677 |   | 892 |   |
| Total Company      |   |                                   |   |                                  |       |   |   | $ |  76,122 |   | $ |  86,794 |   |
|                    |        |                                        |        |                                       |            |  |  |  |  |  |  |  |  |  |  |

 

16

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During the three months and nine months ended September 30, 2003 and2002, no single customer accounted for more than 10% of the Company’s revenues.

 

17

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**Note 6.   RestructuringCharges**

 

The Company has approved restructuring plans to, among other things,reduce its workforce and consolidate facilities in an effort to respond tochanging market conditions and to create a more efficient organization.  As a result, pre-tax restructuring chargesof $4.5 million and $63.2 million were recorded during the three months endedSeptember 30, 2003 and 2002, respectively, to provide for these actions andother related items. The Company recorded the low-end of a range of assumptionsmodeled for the restructuring charges, in accordance with SFAS No. 5, *Accounting for Contingencies*.  Adjustments to the restructuring accrualswill be made in future periods, if necessary, based upon the then-currentactual events, estimates and circumstances.

 

The following table summarizes the restructuring accrual activityrecorded during the three months ended September 30, 2003 (unaudited, inthousands):

** **
|                                 |   | **Severance  and Benefits** |   | **Facilities** |   | **Total** |   |
|--------------------------------------|--------|-----------------------------|--------|----------------|--------|-----------|--------|
| Accrual balances, June 30, 2003      |   | $                           | 1,041  |           | $      | 89,216    |   | $ | 90,257 |   |
| Restructuring charges                |   | 1,478                       |   | 3,031          |   | 4,509     |   |
| Cash payments                        |   | (1,234                      | )      | (4,672         | )      | (5,906    | )      |
| Accrual balances, September 30, 2003 |   | $                           | 1,285  |           | $      | 87,575    |   | $ | 88,860 |   |

 

The nature of thecharges summarized above is as follows:

 

Severance and benefits– As of September 30, 2003, the Company has accrued $1.3 million of estimatedseverance and benefits costs as a restructuring accrual.  These costs represent severance, payrolltaxes and COBRA benefits related to restructuring plans implemented prior toSeptember 30, 2003.  The Companyrecorded a related charge of $1.5 million during the three months endedSeptember 30, 2003.  This charge related to workforce reductions as acomponent of the Company’s restructuring plans executed during thequarter.  The Company estimates that the $1.3 million accrual will be paidin full by September 2004.

 

Facilities – As ofSeptember 30, 2003, the Company has accrued $87.6 million of estimated futurefacilities costs as a restructuring accrual. Of this accrual, $68.6 million relates to future minimum lease payments,net of estimated sublease income and planned company occupancy, and theremaining $19.0 million relates to estimated allowances, fees andexpenses.  The estimated sublease incomenetted against the restructuring accrual consists of the following (unaudited,in millions):

 
| Sublease income to be received under  non-cancelable sublease agreements signed prior to September 30, 2003 |   | $    | 17.0   |   |
|-------------------------------------------------------------------------------------------------------------|--------|------|--------|--------|
| Estimated sublease income for sublease  agreements yet to be negotiated                                     |   | 28.4 |   |
| Total estimated sublease income                                                                             |   | $    | 45.4   |   |

 

We expect to pay the following future minimum lease payment amounts,net of estimated sublease income, related to restructured or abandoned leasedspace and the related allowances, fees and expenses through October 2013 (inmillions):

 
| **Years Ending December 31,** |   |   |   |
|-------------------------------|--------|--------|--------|
| 2003                          |   | $      | 4.7    |   |
| 2004                          |   | 16.7   |   |
| 2005                          |   | 15.6   |   |
| 2006                          |   | 14.5   |   |
| 2007                          |   | 5.9    |   |
| 2008 and thereafter           |   | 30.2   |   |
| Total minimum lease payments  |   | $      | 87.6   |   |

 

Of these amounts, $18.5 million is due within the twelve months endingSeptember 30, 2004, and has been classified as a current liability in theaccompanying condensed consolidated balance sheet.  Actual future cash requirements may differ materially from theaccrual at September 30, 2003, particularly if actual sublease income issignificantly different from prospective estimates.

 

18

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During the three months ended September 30, 2003, the Company recordeda facilities-related restructuring charge of $3.3 million. This chargeprimarily related to the Company’s revision of some of its estimates withrespect to anticipated future subleases.  This revision was necessary dueto a further decline in the market for commercial real estate.  TheCompany estimated future sublease timing and rates based upon current marketindicators and information obtained from a third party real estate expert.

 

**Note 7.   Goodwilland Other Intangible Assets**

 

Goodwill and other intangibles consist of the following (in thousands):

 
|                                |   | **September  30,  2003** |       | **December  31,  2002** |       |
|-------------------------------------|--------|--------------------------|------------|-------------------------|------------|
|                                |   | **(unaudited)**          | ** ** |                    | ** ** |
| Goodwill                            |   | $                        | 437,207    |                    | $          | 437,206 |   |
| Less: Accumulated amortization |   | (380,773                 | )          | (379,886                | )          |
| Goodwill, net                       |   | 56,434                   |       | 57,320                  |       |
|                                |   |                     |       |                    |       |
| Other intangibles                   |   | 22,732                   |       | 22,732                  |       |
| Less: Accumulated amortization |   | (22,732                  | )          | (22,732                 | )          |
| Other intangibles, net              |   | —                   |       | —                  |       |
|                                |   |                     |       |                    |       |
| Goodwill and other intangibles, net |   | $                        | 56,434     |                    | $          | 57,320 |   |

 

On January 1, 2002, the Company adopted SFAS No. 142, *Goodwill and Intangible Assets.*Under SFASNo. 142, goodwill and intangible assets with indefinite lives are nolonger subject to amortization but are tested for impairment at least annuallyusing a fair value approach, and whenever there is an impairment indicator.Other intangible assets continue to be valued and amortized over theirestimated lives.

 

Pursuant to SFAS No. 142, the Company is required to test itsgoodwill for impairment upon adoption and annually or more often if events orchanges in circumstances indicate that the asset might be impaired. While therewas no accounting charge to record upon adoption, at September 30, 2002,the Company concluded that, based on the existence of impairment indicators,including a decline in its market value, it would be required to test goodwillfor impairment. SFAS No. 142 provides for a two-stage approach todetermining whether and by how much goodwill has been impaired. Since theCompany has only one reporting unit for purposes of applying SFAS No. 142,the first stage requires a comparison of the fair value of the Company to itsnet book value. If the fair value is greater, then no impairment is deemed tohave occurred. If the fair value is less, then the second stage must becompleted to determine the amount, if any, of actual impairment. The Companycompleted the first stage and has determined that its fair value atSeptember 30, 2002 exceeded its net book value on that date, and as aresult, no impairment of goodwill was recorded in the consolidated financialstatements. The Company obtained an independent appraisal of fair value tosupport its conclusion. Additionally, the Company concluded that, based uponthe market value of its stock in relation to the Company’s net book value atSeptember 30, 2003 and December 31, 2002, there was no additionalimpairment of goodwill warranted.

 

The process of evaluating the potential impairment of goodwill ishighly subjective and requires significant judgment. In estimating the fairvalue of the Company, the Company made estimates and judgments about futurerevenues and cash flows. The Company’s forecasts were based on assumptions thatare consistent with the plans and estimates the Company is using to manage thebusiness. Changes in these estimates could change the Company’s conclusionregarding impairment of goodwill and potentially result in a non-cash goodwillimpairment charge for all or a portion of the goodwill balance at September 30,2003.

 

Upon adoption of SFAS No. 142, on January 1, 2002, theCompany no longer amortizes goodwill. Additionally, upon adoption of SFASNo. 141 and 142, the Company no longer amortizes its non-technology basedintangible asset, or assembled workforce. The remaining other intangible assetshave been fully amortized as of September 30, 2003.

 

**Item 2. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations**

 

*This report on Form 10-Q containsforward-looking statements within the meaning of Section 27A of the SecuritiesAct of 1933, as amended, and within the meaning of Section 21E of theSecurities Exchange Act of 1934, as amended, which are subject to the “safeharbor” created by those sections. These forward-looking statements aregenerally identified by words such as “expect,” “anticipate,” “intend,” “believe,”“hope,” “assume,” “estimate,” “plan,” “will” and other*

 

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*similar words and expressions. Theseforward-looking statements involve risks and uncertainties that could cause ouractual results to differ materially from those expressed or implied in theforward-looking statements as a result of certain factors, including thosedescribed herein and in the Company’s Annual Report on Form 10-K and otherdocuments filed with the Securities and Exchange Commission.  We undertake no obligation to publiclyrelease any revisions to the forward-looking statements or to reflect eventsand circumstances after the date of this document.*

 

**Overview**

 

BroadVisionis a global provider of enterprise self-service web applications. Ourintegrated solutions for process, commerce, portal and content help ourcustomers increase revenues and streamline costs.  As of September 30, 2003, BroadVision had approximately 1,000customers and government entities around the globe using the Company’sapplications to facilitate their portal-based commerce and information accessinitiatives.

 

BroadVisionwas founded in 1993 and has been a publicly traded corporation since 1996.BroadVision pioneered web-based e-commerce and was among the first to offerpre-integrated, packaged applications to power enterprise business portals.

 

BroadVision’senterprise portal applications allow organizations to unify and extend theirkey business applications, information, and business processes by taking advantageof the power of the web and new wireless and mobile devices to allow customers,partners, and employees to do business on their own terms, in a personalizedand collaborative way.  BroadVisionsolutions allow multiple constituents to serve themselves from anywhere, atanytime, through any web device. BroadVision enterprise portal applications enable organizations tocreate business value by transforming the way they do business; moving businessinteractions and transactions from a manual, human-assisted paradigm to anautomated, personalized self-service model that enhances growth, reduces costsand improves productivity.

 

The Companybelieves its products improve its customers’ revenue opportunities by enablingthem to establish more effective and efficient one-to-one relationships withtheir customers and business partners. Web and wireless users are engaged byhighly personalized real-time interactions, able to transact business securelyand encouraged to remain online and make return visits.  The Company’s applications also improve thecost-effectiveness of one-to-one relationship management by enablingnon-technical managers to modify business rules and content in real-time and byhelping to reduce the cost of customer acquisition and retention, businessdevelopment, technical support and employee workplace initiatives. Because theCompany provides pre-integrated, packaged solutions, time to deployment isshorter and customers are able to manage and maintain their web and wirelessapplications in a cost-effective manner. Because of the Company’s commitment toopen standards and open architecture, BroadVision applications integrate withits customers’ existing systems and expand as its customers’ needs andbusinesses grow.

 

**Supportingthis application infrastructure, as of September 30, 2003, are more than 100partner firms around the world who are working to ensure the Company’s jointcustomers’ success through complementary technology, applications, tools andservices offerings that extend and enhance BroadVision customers’implementations.**

 

BroadVisionmarkets its products and services worldwide through a direct sales force andindependent distributors, value-added resellers (“VARs”) and applicationservice providers (“ASPs”). In addition, its sales are promoted throughindependent professional consulting organizations, known as systemsintegrators. The Company has operations in North America, Europe, andAsia/Pacific.

 

BroadVisionGlobal Services (“BVGS”) organization provides a full spectrum of globalservices to help ensure success for businesses, including strategic services,implementation services, migration services and ongoing training andmaintenance.

 

**Recent Events**

 

We have experienced a general downturn in the economy, our industry andour business since the beginning of 2001. This downturn is likely to continuein the future and has had and is likely to continue to have an impact on ourfinancial results. As discussed in Note 6 of Notes to CondensedConsolidated Financial Statements, we have recorded significant restructuringcharges in connection with our reduction in workforce and abandonment ofcertain operating facilities as part of our program to restructure ouroperations and related facilities initiated in the second quarter of fiscal2001. Pre-tax charges of $4.5 million and $63.2 million were recordedduring the three months ended September 30, 2003 and September 30, 2002,respectively, to provide for these actions and other related items. Costs forthe abandoned facilities

 

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were estimated to include the impairment of assets, remaining leaseliabilities and brokerage fees, partially offset by estimated sublease income.Estimates related to sublease costs and income are based on assumptionsregarding the period required to locate and contract with suitable sublesseesand sublease rates based upon market trend information analyses. Adjustments tothe restructuring accrual will be made in future periods, if necessary, basedupon the then current actual events and circumstances.

 

During the second quarter of 2003, the Company settled a dispute with Avalon Partners, Inc., doingbusiness as Cresa Partners (“Cresa”), with respect to broker commissionsrelated to the Company’s termination and restructuring of certain facilitiesleases associated with the Company’s restructuring plans taken during thesecond quarter of 2002. Under the terms of the settlement the Company made aone-time payment of $2.2 million to Cresa in April 2003.

 

During the third quarter of 2003, the Company settled outstandinglitigation which resulted in a charge of $4.3 million.  The settlement involved a third-quarterpayment for past royalties and certain legal expenses and license fee that aredue and payable in future quarters. These payments are not expected to have amaterial effect on the Company’s business, financial condition or results ofoperations.

 

We renewed and amended our revolving credit facility in June2003. Borrowings under the revolving line of credit are collateralized by allof our assets and bear interest at the bank’s prime rate (floating with a floorof 4.25%). Interest is due monthly and principal is due at expiration inFebruary 2004. The amended and restated loan and security agreement requires usto maintain certain levels in cash and cash equivalents, short-term investmentsand long-term investments (excluding equity investments). Additionally, theamended and restated loan and security agreement requires us to maintaincertain levels on deposit with our commercial lender and certain quarterlyoperating levels and ratios.  Asof September 30, 2003, the Company was not in compliance with the profitabilityand financial covenants of the commercial credit facilities.  Subsequently, the Company received a waiverfrom the bank regarding non-compliance. At September 30, 2003 andDecember 31, 2002, $27.0 million and $25.0 million, respectively, wasoutstanding under the line of credit.

 

**Critical Accounting Policies**

 

This management’s discussion and analysis of our financial conditionand results of operations is based upon our condensed consolidated financialstatements, which have been prepared in accordance with generally acceptedaccounting principles in the United States of America. In preparing thesefinancial statements, we are required to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenues and expenses, andrelated disclosures of contingent assets and liabilities. On an ongoing basis,we evaluate our estimates, including those related to doubtful accounts,product returns, investments, goodwill and intangible assets, income taxes andrestructuring, as well as contingencies and litigation. We base our estimateson historical experience and on various other assumptions that we believe arereasonable, the results of which form the basis for making judgments about thecarrying values of assets and liabilities that are not readily apparent fromother sources. Actual results may differ from these estimates using differentassumptions or conditions. We believe the following critical accountingpolicies reflect the more significant judgments and estimates used in thepreparation of our consolidated financial statements.

 

*Revenue Recognition*

 

*Overview*— Ourrevenue consists of fees for licenses of our software products, maintenance,consulting services and customer training. We generally charge fees forlicenses of our software products either based on the number of personsregistered to use the product or based on the number of Central ProcessingUnits (“CPUs”) on which the product is installed. Our revenue recognitionpolicies comply with the provisions of Statement of Position (“SOP”)No. 97-2, *Software Revenue Recognition*,as amended; SOP No. 98-9, *Software RevenueRecognition, With Respect to Certain Transactions*and the Securitiesand Exchange Commission’s Staff Accounting Bulletin No. 101, *Revenue Recognition in Financial Statements.*

 

*Software License Revenue*—We license our products through our direct sales force and indirectly throughresellers. In general, software license revenues are recognized when anon-cancelable license agreement has been signed under which the customeracknowledges an unconditional obligation to pay, the software product has beendelivered, there are no uncertainties surrounding product acceptance, the feesare fixed and determinable and collection is considered probable. Delivery isconsidered to have occurred when title and risk of loss have been transferredto the customer, which generally occurs when media containing the licensedprograms is provided to a common carrier. In the case of electronic delivery,delivery occurs when the customer is given access to the licensed programs. Ifcollectibility is not considered probable, revenue is recognized when the feeis collected. Subscription-based license revenues are recognized ratably overthe subscription period. We enter into reseller arrangements that typicallyprovide for sublicense fees payable to us based upon a percentage of listprice. We do not grant our resellers the right of return.

 

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We recognize revenue using the residual method pursuant to therequirements of SOP No. 97-2, as amended by SOP No. 98-9. Revenuesrecognized from multiple-element software arrangements are allocated to eachelement of the arrangement based on the fair values of the elements, such aslicenses for software products, maintenance, consulting services or customertraining. The determination of fair value is based on objective evidence, whichis specific to us. We limit our assessment of objective evidence for eachelement to either the price charged when the same element is sold separately orthe price established by management having the relevant authority to do so, foran element not yet sold separately. If evidence of fair value of allundelivered elements exists but evidence does not exist for one or moredelivered elements, then revenue is recognized under the residual method. Underthe residual method, the fair value of the undelivered elements is deferred andthe remaining portion of the arrangement fee is recognized as revenue.

 

We record deferred revenue for software arrangements when cash has beenreceived from the customer and the arrangement does not qualify for revenuerecognition under our revenue recognition policy. We record accounts receivablefor software arrangements when the arrangement qualifies for revenuerecognition but cash or other consideration has not been received from the customer.

 

*Services Revenue*—Consulting services revenues and customer training revenues are recognized assuch services are performed. Maintenance revenues, which include revenuesbundled with software license agreements that entitle the customers to technicalsupport and future unspecified enhancements to our products, are deferred andrecognized ratably over the related agreement period, generally twelve months.Our professional services which consist of consulting, maintenance and trainingare delivered through BVGS. This group provides consulting services, managesprojects and client relationships, manages the needs of our partner community,provides training-related services to employees, customers and partners, andalso provides software maintenance services, including technical support, toour customers and partners. We record reimbursement by our customers forout-of-pocket expenses as a component of services revenue.  Services that we provide are not essentialto the functionality of our software.

 

*Allowances andReserves*

 

Occasionally, our customers experience financial difficulty after werecord the revenue but before we are paid. We maintain allowances for doubtfulaccounts for estimated losses resulting from the inability of our customers tomake required payments. Our normal payment terms are 30 to 90 days frominvoice date. If the financial condition of our customers were to deteriorate,resulting in an impairment of their ability to make payments, additionalallowances may be required. We record reductions to revenue for estimatedreturns of products by our customers and related allowances. If marketconditions were to decline, we may experience larger volumes of returnsresulting in an incremental reduction of revenue at the time the return occurs.

 

*ImpairmentAssessments*

 

We adopted Statement of Financial Accounting Standard (“SFAS”)No. 142, “Goodwill and Other Intangible Assets,” on January 1, 2002.This standard requires that goodwill no longer be amortized, and instead, betested for impairment on a periodic basis.

 

Pursuant to SFAS No. 142, we are required to test goodwill forimpairment upon adoption and annually or more often if events or changes incircumstances indicate that the asset might be impaired. While there was noaccounting charge to record upon adoption, at September 30, 2002, weconcluded that, based on the existence of impairment indicators, including adecline in our market value, we would be required to test goodwill forimpairment. SFAS No. 142 provides for a two-stage approach to determiningwhether and by how much goodwill has been impaired. Since we have only onereporting unit for purposes of applying SFAS No. 142, the first stagerequires a comparison of the fair value of the Company to its net book value.If the fair value is greater, then no impairment is deemed to have occurred. Ifthe fair value is less, then the second stage must be completed to determinethe amount, if any, of actual impairment. We completed the first stage anddetermined that our fair value at September 30, 2002 exceeded our net bookvalue on that date and, as a result, no impairment of goodwill was recorded inthe consolidated financial statements. We obtained an independent appraisal offair value to support our conclusion. We also determined that our fair valueexceeded our net book value as of September 30, 2003 and December 31, 2002 and,therefore, no additional impairment was warranted.

 

The process of evaluating the potential impairment of goodwill ishighly subjective and requires significant judgment. In estimating our fairvalue, we made estimates and judgments about future revenues and cash flows.Our forecasts were based on assumptions that are consistent with the plans andestimates we are using to manage our business. Changes in these estimates couldchange our conclusion regarding impairment of goodwill and potentially resultin a non-cash goodwill

 

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impairment charge, for all or a portion of the goodwill balance atSeptember 30, 2003. For long-lived assets, accounting standards dictate thatassets become impaired when the undiscounted future cash flows expected to begenerated by them are less than their carrying amounts. When that occurs, theaffected assets are written down to their estimated fair value.

 

*Deferred Tax Assets*

 

We analyze our deferred tax assets with regard to potentialrealization. We have established a valuation allowance on our deferred taxassets to the extent that we determined that it is more likely than not that someportion or all of the deferred tax assets will not be realized based upon theuncertainty of their realization. We have considered estimated future taxableincome and ongoing prudent and feasible tax planning strategies in assessingthe amount of the valuation allowance. Based upon this analysis, we recorded acharge of $6.3 million as an additional valuation allowance for ourdeferred tax assets during the three months ended June 30, 2002.

 

*Accounting forStock-Based Compensation*

 

We apply Accounting Principles Board (“APB”) Opinion Number 25, *Accounting for Stock Issued to Employees*,and related interpretations when accounting for our stock option and stockpurchase plans. In accordance with APB No. 25, we apply the intrinsicvalue method in accounting for employee stock options. Accordingly, wegenerally recognize no compensation expense with respect to stock-based awardsto employees.

 

During the nine months ended September 30, 2003, the Company recordedcompensation expense of $279,000 as a result of granting a third-partyconsultant common stock in the Company and a vesting modification to a grantfor a terminated employee. These charges were calculated based upon the marketvalue of the underlying stock.  Duringthe nine months ended September 30, 2002, the Company recorded compensationexpense of $846,000 as a result of granting terminated employees continuedvesting of their stock options for a period beyond their actual terminationdate. This compensation charge was calculated using the Black-Scholes model.

 

We have determined pro forma information regarding net loss and netloss per share as if we had accounted for employee stock options under the fairvalue method as required by SFAS Number 123, *Accountingfor Stock Compensation*. The fair value of these stock-based awardsto employees was estimated using the Black-Scholes option pricing model. Hadcompensation cost for the Company’s stock option plan and employee stockpurchase plan been determined consistent with SFAS No. 123, the Company’sreported net loss and net loss per share would have been changed to the amountsindicated below (in thousands, except per share data):

 
|                                                                                                                                          |   | **Three  Months Ended  September 30,** |    | **Nine  Months Ended  September 30,** |       |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|---------|---------------------------------------|------------|
|                                                                                                                                          |   | **2003**                               |    | **2002**                              | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net loss as reported                                                                                                                          |   | $                                      | (10,265 | )                                     | $          | (67,733 | ) | $ | (16,523 | ) | $ | (160,545 | ) |
| Add: Stock-based employee compensation  expense included in reported net loss, net of related tax effects                                     |   | 231                                    |    | 77                                    |       | 279 |   | 846 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |   | (2,734                                 | )       | (4,917                                | )          | (6,739 | ) | (39,949 | ) |
| Pro forma net loss                                                                                                                            |   | $                                      | (12,768 | )                                     | $          | (72,573 | ) | $ | (22,983 | ) | $ | (199,648 | ) |
|                                                                                                                                          |   |                                   |    |                                  |       |   |   |   |   |
| Loss per share:                                                                                                                               |   |                                   |    |                                  |       |   |   |   |   |
| Basic—as reported                                                                                                                        |   | $                                      | (0.31   | )                                     | $          | (2.11 | ) | $ | (0.51 | ) | $ | (5.02 | ) |
| Basic—pro forma                                                                                                                          |   | $                                      | (0.39   | )                                     | $          | (2.26 | ) | $ | (0.70 | ) | $ | (6.25 | ) |
|                                                                                                                                          |   |                                   |    |                                  |       |   |   |   |   |
| Diluted—as reported                                                                                                                      |   | $                                      | (0.31   | )                                     | $          | (2.11 | ) | $ | (0.51 | ) | $ | (5.02 | ) |
| Diluted—pro forma                                                                                                                        |   | $                                      | (0.39   | )                                     | $          | (2.26 | ) | $ | (0.70 | ) | $ | (6.25 | ) |

 

*Restructuring*

 

The Company has approved certain restructuring plans to, among otherthings, reduce its workforce and consolidate facilities. These restructuringcharges were taken to align the Company’s cost structure with changing marketconditions and to create a more efficient organization. The Company’srestructuring charges are comprised primarily of: (i) severance and

 

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benefits termination costs related to the reduction of the Company’sworkforce; (ii) lease termination costs and/or costs associated withpermanently vacating its facilities; (iii) other incremental costs incurred asa direct result of the restructuring plan; and (iv) impairment costsrelated to certain long-lived assets abandoned. The Company accounts for eachof these costs in accordance with SEC Staff Accounting Bulletin No. 100, *Restructuring and Impairment Charges.*

 

The Company accounts for severance and benefits termination costs inaccordance with EITF Issue No. 94-3, *LiabilityRecognition for Certain Employee Termination Benefits and Other Costs to Exitan Activity (Including Certain Costs Incurred in a Restructuring)*for exit or disposal activities initiated prior to December 31, 2002.Accordingly, the Company records the liability related to these terminationcosts when the following conditions have been met: (i) management with theappropriate level of authority approves a termination plan that commits theCompany to such plan and establishes the benefits the employees will receiveupon termination; (ii) the benefit arrangement is communicated to theemployees in sufficient detail to enable the employees to determine thetermination benefits; (iii) the plan specifically identifies the number ofemployees to be terminated, their locations and their job classifications; and(iv) the period of time to implement the plan does not indicate changes tothe plan are likely. The termination costs recorded by the Company are notassociated with nor do they benefit continuing activities.  The Company accounts for severance and benefitstermination costs for exit or disposal activities initiated after December 31,2002 in accordance with SFAS No. 146, *Accountingfor Costs Associated with Exit Activities*.  SFAS No. 146 requires that a liability for a cost associated withan exit or disposal activity be recognized and measured initially at fair valueonly when the liability is incurred. This differs from EITF 94-3, which required that a liability for an exitcost be recognized at the date of an entity’s commitment to an exit plan.

 

Prior to the adoption on January 1, 2003 of SFAS No. 146, the Companyaccounted for the costs associated with lease termination and/or abandonment inaccordance with EITF 88-10, *Costs Associatedwith Lease Modification or Termination*. Accordingly, the Companyrecorded the costs associated with lease termination and/or abandonment whenthe leased property has no substantive future use or benefit to the Company.

 

Inherent in the estimation of the costs related to the Company’srestructuring efforts are assessments related to the most likely expectedoutcome of the significant actions to accomplish the restructuring. Indetermining the charges related to the restructuring, the majority of estimatesmade by management related to charges for excess facilities. In determining thecharge for excess facilities, the Company was required to estimate futuresublease income, future net operating expenses of the facilities, and brokeragecommissions, among other expenses. The most significant of these estimatesrelated to the timing and extent of future sublease income in which to reducethe Company’s lease obligations. Specifically, in determining the restructuringobligations related to facilities as of September 30, 2003, the Company reducedits lease obligations by estimated sublease income of $45.4 million. TheCompany based its estimates of sublease income, in part, on the opinions ofindependent real estate experts, current market conditions and rental rates, anassessment of the time period over which reasonable estimates could be made,the status of negotiations with potential subtenants, and the location of therespective facility, among other factors.

 

These estimates, along with other estimates made by management inconnection with the restructuring, may vary significantly depending, in part,on factors that may be beyond the Company’s control. Specifically, theseestimates will depend on the Company’s success in negotiating with lessors, thetime periods required to locate and contract suitable subleases and the marketrates at the time of such subleases. Adjustments to the facilities reserve willbe required if actual lease exit costs or sublease income differ from amountscurrently expected. The Company will review the status of restructuringactivities on a quarterly basis and, if appropriate, record changes to itsrestructuring obligations in current operations based on management’s mostcurrent estimates.

 

The following table summarizes the restructuring accrual activityrecorded during the three months ended September 30, 2003 (in thousands):

 
|                                 |   | **Severance  and Benefits** |   | **Facilities** |   | **Total** |   |
|--------------------------------------|--------|-----------------------------|--------|----------------|--------|-----------|--------|
| Accrual balances, June 30, 2003      |   | $                           | 1,041  |           | $      | 89,216    |   | $ | 90,257 |   |
| Restructuring charges                |   | 1,478                       |   | 3,031          |   | 4,509     |   |
| Cash payments                        |   | (1,234                      | )      | (4,672         | )      | (5,906    | )      |
| Accrual balances, September 30, 2003 |   | $                           | 1,285  |           | $      | 87,575    |   | $ | 88,860 |   |

 

The nature of the charges summarized above is as follows:

 

Severance and benefits – As of September 30, 2003, the Company hasaccrued $1.3 million of estimated severance and benefits costs as a restructuringaccrual.  These costs representseverance, payroll taxes and COBRA benefits related to

 

24

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restructuring plans implemented prior to September 30, 2003.  The Company recorded a related charge of$1.5 million during the three months ended September 30, 2003.  Thischarge related to workforce reductions as a component of the Company’srestructuring plans executed during the quarter.  The Company estimatesthat the $1.3 million accrual will be paid in full by September 2004.

 

Facilities – As of September 30, 2003, the Company has accrued $87.6million of estimated future facilities costs as a restructuring accrual.  Of this accrual, $68.6 million relates tofuture minimum lease payments, net of estimated sublease income and plannedcompany occupancy, and the remaining $19.0 million relates to estimatedallowances, fees and expenses.  Theestimated sublease income netted against the restructuring accrual consists ofthe following (in millions):

 
| Sublease income to be received under  non-cancelable sublease agreements signed prior to September 30, 2003 |   | $    | 17.0   |   |
|-------------------------------------------------------------------------------------------------------------|--------|------|--------|--------|
| Estimated sublease income for sublease  agreements yet to be negotiated                                     |   | 28.4 |   |
| Total estimated sublease income                                                                             |   | $    | 45.4   |   |

 

We expect to pay the following future minimum lease payment amountsrelated to restructured or abandoned leased space through October 2013 (inmillions):

 
| **Years Ending December 31,** |   |   |   |
|-------------------------------|--------|--------|--------|
| 2003                          |   | $      | 4.7    |   |
| 2004                          |   | 16.7   |   |
| 2005                          |   | 15.6   |   |
| 2006                          |   | 14.5   |   |
| 2007                          |   | 5.9    |   |
| 2008 and thereafter           |   | 30.2   |   |
| Total minimum lease payments  |   | $      | 87.6   |   |

 

Of these amounts, $18.5 million is due within the twelve months endingSeptember 30, 2004, and has been classified as a current liability in theaccompanying condensed consolidated balance sheet.  Actual future cash requirements may differ materially from theaccrual at September 30, 2003, particularly if actual sublease income issignificantly different from prospective estimates.

 

During the three months ended September 30, 2003, the Company recordeda facilities-related restructuring charge of $3.3 million.  This charge primarily related to theCompany’s revision of some of its estimates with respect to anticipated futuresubleases.  This revision was necessary due to a further decline in themarket for commercial real estate.  The Company estimated future subleasetiming and rates based upon current market indicators and information obtainedfrom a third party real estate expert.

 

***Legal Matters***

 

The Company’s current estimated range of liability related to pendinglitigation is based on claims for which it is probable that a liability hasbeen incurred and the Company can estimate the amount and range of loss. TheCompany has recorded the minimum estimated liability related to those claims,where there is a range of loss. Because of the uncertainties related to boththe determination of the probability of an unfavorable outcome and the amountand range of loss in the event of an unfavorable outcome, the Company is unableto make a reasonable estimate of the liability that could result from theremaining pending litigation. As additional information becomes available, theCompany will assess the potential liability related to its pending litigationand revise its estimates, if necessary. Such revisions in the Company’sestimates of the potential liability could materially impact the Company’sresults of operations and financial position.

 

***Resultsof Operations***

 

Three and nine months ended September 30,2003 and 2002

 

*Revenues*

 

*Total revenues*decreased 32% during the quarter ended September 30, 2003 to $18.6 million ascompared to $27.2 million for the quarter ended September 30, 2002.   A summary of our revenues by geographicregion is as follows (dollars in thousands, unaudited):

 

25

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|                |   | **Software  Licenses** |       | **%**  |       | **Services** |       | **%**  |       | **Total** |       | **%**  |       |
|---------------------|--------|------------------------|------------|--------|------------|--------------|------------|--------|------------|-----------|------------|--------|------------|
| Three Months Ended: |   |                   |       |   |       |         |       |   |       |      |       |   |       |
|                |   |                   |       |   |       |         |       |   |       |      |       |   |       |
| September  30, 2003 |   |                   |       |   |       |         |       |   |       |      |       |   |       |
| Americas            |   | $                      | 2,058      |   | 41         | %            | $          | 7,015  |       | 52        | %          | $      | 9,073      |   | 49 | % |
| Europe              |   | 2,404                  |       | 47     |       | 5,593        |       | 41     |       | 7,997     |       | 43     |       |
| Asia Pacific        |   | 614                    |       | 12     |       | 885          |       | 7      |       | 1,499     |       | 8      |       |
| Total               |   | $                      | 5,076      |   | 100        | %            | $          | 13,493 |       | 100       | %          | $      | 18,569     |   | 100 | % |
|                |   |                   |       |   |       |         |       |   |       |      |       |   |       |
| September  30, 2002 |   |                   |       |   |       |         |       |   |       |      |       |   |       |
| Americas            |   | $                      | 6,511      |   | 61         | %            | $          | 9,808  |       | 60        | %          | $      | 16,319     |   | 60 | % |
| Europe              |   | 3,508                  |       | 32     |       | 5,497        |       | 33     |       | 9,005     |       | 33     |       |
| Asia Pacific        |   | 737                    |       | 7      |       | 1,178        |       | 7      |       | 1,915     |       | 7      |       |
| Total               |   | $                      | 10,756     |   | 100        | %            | $          | 16,483 |       | 100       | %          | $      | 27,239     |   | 100 | % |
|                |   |                   | ** ** |   | ** ** |         | ** ** |   | ** ** |      | ** ** |   | ** ** |
| Nine Months Ended:  |   |                   |       |   |       |         |       |   |       |      |       |   |       |
|                |   |                   |       |   |       |         |       |   |       |      |       |   |       |
| September  30, 2003 |   |                   |       |   |       |         |       |   |       |      |       |   |       |
| Americas            |   | $                      | 8,879      |   | 45         | %            | $          | 23,871 |       | 53        | %          | $      | 32,750     |   | 51 | % |
| Europe              |   | 7,492                  |       | 38     |       | 18,474       |       | 41     |       | 25,966    |       | 40     |       |
| Asia Pacific        |   | 3,504                  |       | 17     |       | 2,609        |       | 6      |       | 6,113     |       | 9      |       |
| Total               |   | $                      | 19,875     |   | 100        | %            | $          | 44,954 |       | 100       | %          | $      | 64,829     |   | 100 | % |
|                |   |                   |       |   |       |         |       |   |       |      |       |   |       |
| September  30, 2002 |   |                   |       |   |       |         |       |   |       |      |       |   |       |
| Americas            |   | $                      | 16,855     |   | 58         | %            | $          | 36,518 |       | 63        | %          | $      | 53,373     |   | 61 | % |
| Europe              |   | 11,087                 |       | 38     |       | 17,759       |       | 31     |       | 28,846    |       | 33     |       |
| Asia Pacific        |   | 1,302                  |       | 4      |       | 3,592        |       | 6      |       | 4,894     |       | 6      |       |
| Total               |   | $                      | 29,244     |   | 100        | %            | $          | 57,869 |       | 100       | %          | $      | 87,113     |   | 100 | % |

 

The Company operates in a competitive industry.  There have been declines in both thetechnology industry and in general economic conditions since the beginning of2001.  These declines may continue.  Financial comparisons discussed herein maynot be indicative of future performance.

 

*Software license revenues*decreased 53% during the quarter ended September 30, 2003 to $5.1 million ascompared to $10.8 million for the quarter ended September 30, 2002. Softwarelicense revenue decreased 32% during the nine months ended September 30, 2003to $19.9 million as compared to $29.2 million for the nine months endedSeptember 30, 2002. These decreases are largely attributable to declines inspending in the information technology market due to economic and geopoliticaluncertainties. As a result, the Company has experienced a decline in licensetransactions and related revenue from new customers, while the proportion ofrevenue from existing customers has increased.

 

*Services revenues*decreased 18% during the quarter ended September 30, 2003 to $13.5 millionas compared to $16.5 million for the quarter ended September 30, 2002.  Services revenue decreased 22% during thenine months ended September 30, 2003 to $45.0 million as compared to $57.9million for the nine months ended September 30, 2002. These declines werealmost entirely due to decreases in consulting services revenue.  Consulting services revenues decreased 34%for the three months ended September 30, 2003 to $4.7 million as compared to$7.1 million for the three months ended September 30, 2002, and 40% during thenine months ended September 30, 2003 to $17.0 million as compared to $28.5million for the nine months ended September 30, 2002. These decreases are aresult of a corresponding decline in license revenues and of economic andgeopolitical uncertainties.

 

*Cost of Revenues*

 

Cost of license revenues include the costs of product media,duplication, packaging and other manufacturing costs, as well as royaltiespayable to third parties for software that is either embedded in, or bundledand licensed with, our products.

 

Cost of services consists primarily of employee-related costs,third-party consultant fees incurred on consulting projects, post-contractcustomer support and instructional training services.

 

26

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A summary of the cost of revenues for the periods presented is asfollows, (in thousands):

 
|                          |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|-------------------------------|--------|---------------------------------------------|--------|---------------------------------------|--------|
|                          |   | **2003**                                    |   | **%**                                 |   | **2002** |   | **%** | ** ** | **2003** | ** ** | **%** | ** ** | **2002** | ** ** | **%** | ** ** |
| Cost of software licenses (1) |   | $                                           | 666    |                                  | 13     | % | $ | 1,414 |   | 13 | % | $ | 1,549 |   | 8 | % | $ | 3,417 |   | 12 | % |
| Cost of services (2)          |   | 5,915                                       |   | 44                                    |   | 8,751 |   | 53 |   | 19,650 |   | 44 |   | 31,507 |   | 54 |   |
|                          |   |                                        |   |                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total cost of revenues (3)    |   | $                                           | 6,581  |                                  | 35     | % | $ | 10,165 |   | 37 | % | $ | 21,199 |   | 33 | % | $ | 34,924 |   | 40 | % |

 

----

(1)           Percentages arecalculated based on total software license revenues for the period indicated

(2)           Percentages arecalculated based on total services revenues for the period indicated

(3)           Percentagesare calculated based on total revenues for the period indicated

 

*Cost ofsoftware licenses* decreased 53% in absolute dollarterms during the quarter ended September30, 2003 to $666,000 as compared to $1.4 million for the quarter ended September 30, 2002.  The cost of software licenses decreased 55%in absolute dollar terms during the nine months ended September 30, 2003 to$1.5 million as compared to $3.4 million for the nine months ended September30, 2002. These decreases were principally a result of lower software licenserevenue, including revenue generated from the Company’s products that embed orinclude third-party products.

 

*Cost ofservices* decreased 32% in absolute dollar terms duringthe quarter ended September 30,2003 to $5.9 million as compared to $8.8 million for the quarter ended September 30, 2002. The cost ofservices decreased 38% in absolute dollar terms during the nine months endedSeptember 30, 2003 to $19.7 million as compared to $31.5 million for the ninemonths ended September 30, 2002.  These decreaseswere the result of reductions in force that occurred primarily throughout thefirst three quarters of 2002, resulting in decreased salary and relatedexpenses, in addition to a decrease in the use of third party consultants.  The declines in cost of services as a percentageof services revenue for the three and nine month periods were principally dueto improved operating efficiencies.  Also contributing to the nine-month declinewas an aggregate $1.4 million credit related to telecommunications costsrenegotiated and recorded during the three months ended March 31, 2003, ofwhich $473,000 was recorded in cost of services**.**

 

*Operating Expensesand Other Income, net*

 

Research and development expenses consist primarily of salaries,employee-related benefit costs and consulting fees incurred in association withthe development of our products. Costs incurred for the research anddevelopment of new software products are expensed as incurred untiltechnological feasibility, in the form of a working model, is established, at whichtime such costs are capitalized and recorded at the lower of unamortized costor net realizable value. The costs incurred subsequent to the establishment ofa working model but prior to general release of the product have not beensignificant. To date, we have not capitalized any costs related to thedevelopment of software for external use.

 

Sales and marketing expenses consist primarily of salaries,employee-related benefit costs, commissions and other incentive compensation,travel and entertainment and marketing program-related expenditures, such ascollateral materials, trade shows, public relations, advertising and creativeservices.

 

General and administrative expenses consist primarily of salaries,employee-related benefit costs, provisions and credits related to uncollectibleaccounts receivable and professional service fees.

 

Operating expenses consisted of the following: (in thousands)

 
|                                 |   | **Three  Months Ended September 30,** |   | **Nine  Months Ended September 30,** |   |
|--------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------|--------|
|                                 |   | **2003**                                   |   | **% (1)**                                 |   | **2002** |   | **% (1)** | ** ** | **2003** | ** ** | **% (1)** | ** ** | **2002** | ** ** | **% (1)** | ** ** |
| Research and development             |   | $                                          | 4,467  |                                      | 24     | % | $ | 7,774 |   | 29 | % | $ | 16,681 |   | 26 | % | $ | 34,755 |   | 40 | % |
| Sales and marketing                  |   | 6,710                                      |   | 36                                        |   | 9,384 |   | 34 |   | 19,585 |   | 30 |   | 41,365 |   | 47 |   |
| General and administrative           |   | 2,885                                      |   | 16                                        |   | 2,573 |   | 9 |   | 7,586 |   | 12 |   | 13,775 |   | 16 |   |
| Litigation settlement costs          |   | 4,250                                      |   | 23                                        |   | — |   | — |   | 4,250 |   | 7 |   | — |   | — |   |
|                                 |   |                                       |   |                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Goodwill and intangible amortization |   | —                                     |   | —                                    |   | 887 |   | 3 |   | 887 |   | 1 |   | 2,661 |   | 3 |   |
| Restructuring charge                 |   | 4,509                                      |   | 24                                        |   | 63,205 |   | 233 |   | 13,361 |   | 21 |   | 103,150 |   | 118 |   |
| Impairment of assets                 |   | —                                     |   | —                                    |   | 853 |   | 3 |   | — |   | — |   | 3,129 |   | 4 |   |
| Total operating expenses             |   | $                                          | 22,821 |                                      | 123    | % | $ | 84,676 |   | 311 | % | $ | 62,350 |   | 96 | % | $ | 198,835 |   | 228 | % |

 

27

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----

(1)           Expressedas a percent of total revenues for the period indicated

 

*Research anddevelopment expenses* decreased 43% during the quarterended September 30, 2003 to $4.5 million as compared to $7.8 million for thequarter ended September 30, 2002. Research and development expenses decreased  52% during the nine months ended September 30, 2003 to $16.7million as compared to $34.8 million for the nine months ended September 30,2002.  The decreases in research anddevelopment expenses were primarily attributable to compensation reductionsthrough reductions in force as well as other cost-cutting efforts put in place,including reductions in facilities and communications costs. The Companyrecorded a one-time credit of $0.9 million in the quarter ended September 30,2003, related to funding recognized under a third-party developmentarrangement.

 

*Sales andmarketing expenses* decreased 28% during the quarterended September 30, 2003 to $6.7 million as compared to $9.4 million for thequarter ended September 30, 2002.  Salesand marketing expenses decreased 53% during the nine months ended September 30,2003 to $19.6 million as compared to $41.4 million for the nine months endedSeptember 30, 2002.  The decreases wereprimarily due to decreased salary expense as a result of reductions in force,decreased variable compensation due to lower revenues, and decreased facility,travel and marketing program costs as a result of various cost-cutting actions.

 

*General andadministrative expenses* increased 12% during thequarter ended September 30, 2003 to $2.9 million as compared to $2.6 millionfor the quarter ended September 30, 2002. General and administrative expenses decreased 45% during the nine monthsended September 30, 2003 to $7.6 million as compared to $13.8 million for thenine months ended September 30, 2002. The increase for the three-month period was primarily due to increasedlegal costs related to the pending litigation. The decrease for the nine-monthperiod was primarily attributable to decreases in salary expense as a result ofreductions in force, reserves of accounts receivable, and facilities andprofessional services expenses as a result of cost cutting measures.  Also contributing to the nine-month declinewas a non-recurring compensation-related credit of $0.4 million recorded in thequarter ended June 30, 2003.

 

*Amortization of goodwill and otherintangibles.*****Asdescribed in Note 7 in the Notes to the Condensed Consolidated FinancialStatements, we no longer amortize goodwill or the assembled workforce as wehave identified the assembled workforce as an intangible asset which does notmeet the criteria of recognizable intangible asset as defined by SFAS No.142.  The remaining other intangibleassets have been fully amortized as of September30, 2003.  We periodically assessgoodwill and other intangibles for impairment as discussed in Note 7 of Notesto the Condensed Consolidated Financial Statements.  The remaining intangible assets that are being amortized are aresult of the acquisition of Interleaf, Inc. that was completed in April of2000.  We accounted for the acquisitionas a purchase business combination.  Itis possible that we may continue to expand our business through acquisitionsand internal development.  Anyadditional acquisitions or impairment of goodwill and other purchasedintangibles could result in additional merger and acquisition related expenses.

 

*Restructuring charges***.**** **The Company has approved restructuringplans to, among other things, reduce its workforce and consolidate facilitiesin an effort to respond to changing market conditions and to create a moreefficient organization.  As a result,pre-tax restructuring charges of $4.5 million and $63.2 million were recordedduring the three months ended September 30, 2003 and 2002, respectively, toprovide for (i) severance and benefits termination costs related to thereduction of the Company’s workforce; (ii) lease termination costs and/orcosts associated with permanently vacating its facilities; (iii) otherincremental costs incurred as a direct result of the restructuring plan; and(iv) impairment costs related to certain long-lived assets abandoned. TheCompany recorded the low-end of a range of assumptions modeled for therestructuring charges, in accordance with SFAS No. 5, *Accounting for Contingencies*.  Adjustments to the restructuring accrualswill be made in future periods, if necessary, based upon the then-currentactual events, estimates and circumstances. See Note 6 of the accompanyingNotes to Condensed Consolidated Financial Statements.

 

Restructuring charges consisted of the following (in thousands):

 
|                |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |       |
|---------------------|--------|----------------------------------------|--------|---------------------------------------|------------|
|                |   | **2003**                               |   | **2002**                              | ** ** | **2003** | ** ** | **2002** | ** ** |
| Facilities          |   | $                                      | 3,269  |                                  | $          | 60,465 |   | $ | 11,887 |   | $ | 95,040 |   |
| Severance and other |   | 1,240                                  |   | 2,740                                 |       | 1,474 |   | 8,110 |   |
| Total               |   | $                                      | 4,509  |                                  | $          | 63,205 |   | $ | 13,361 |   | $ | 103,150 |   |

 

28

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Therestructuring accrual at September 30, 2003, included in the accompanyingCondensed Consolidated Financial Statements was approximately $88.9million.  Of this, $87.6 million relatedto facilities and $1.3 million related to severance and other.  The severance and other accrual is expectedto be paid in full by September 30, 2004. The facilities accrual is expected to be paid as follows (in millions):

 
| **Years Ending December 31,** |   |   |   |
|-------------------------------|--------|--------|--------|
| 2003                          |   | $      | 4.7    |   |
| 2004                          |   | 16.7   |   |
| 2005                          |   | 15.6   |   |
| 2006                          |   | 14.5   |   |
| 2007                          |   | 5.9    |   |
| 2008 and thereafter           |   | 30.2   |   |
| Total minimum lease payments  |   | $      | 87.6   |   |

 

Actual future cash requirements may differ materially from the accrualat September 30, 2003, particularly if actual sublease income is significantlydifferent from historical estimates. Adjustments to the restructuring accruals will be made in futureperiods, if necessary, based upon the then current actual events andcircumstances.

 

*Litigation Settlement Charges*.  During the third quarter of 2003, theCompany settled outstanding litigation which resulted in a charge of $4.3million.  The settlement involved athird-quarter payment for past royalties and certain legal expenses and licensefee payments that are due and payable in future quarters. These payments arenot expected to have a material effect on the Company’s business, financialcondition or results of operations.

 

*Interest and other income (expense), net,*forthe three months ended September 30, 2003 was income of $655,000 as compared toincome of $7,000 in 2002.  Interest andother income (expense), net**forthe nine months ended September 30, 2003 was income of $2.5 million as comparedto expense of $6.7 million in 2002. For the three months ended September 30,2003, there was $1.0 million of other income from the sale of common stockoffset by a loss in currency fluctuations and other miscellaneous expenses.Interest income has declined year-over-year due to lower cash balances.  Other expense in 2002 included a realized loss on cost method investments of$8.5 million that did not recur in 2003**.**

 

*Impairment of assets*—Duringthe first quarter of 2002, we engaged a third party firm to conduct a physicalinventory of our computer hardware assets located in North America. Weconducted an internal physical inventory on computer hardware assets locatedoutside of North America. The objective of the physical inventory was to verifythe amount and location of our computer hardware. As a result of the findingsof the physical inventory and related reconciliation with our asset records, werecorded an asset impairment charge of approximately $2.3 million net bookvalue related to computer hardware during the first quarter of fiscal2002.  During the third quarter of 2002,we conducted an additional review of remaining computer and communicationrelated assets not reviewed during the first quarter inventory and recorded anasset impairment charge of $853,000 as a result of the findings of ourinventory and related reconciliation with our asset records.

 

*Income Taxes*

 

During the quarter ended September30, 2003, we recognized tax expense of $87,000.   Thetax expense mainly relates to income taxes in foreign jurisdictions that arenot available to credit against US income taxes.

 

*Liquidity andCapital Resources*

 
|                                                      |   | **September  30,  2003** |   | **December  31,  2002** |   |
|-----------------------------------------------------------|--------|--------------------------|--------|-------------------------|--------|
|                                                      |   |                     |   |                    |   |
| Cash, cash equivalents and liquid  short-term investments |   | $                        | 81,674 |                    | $      | 101,870 |   |
| Long-term liquid investments                              |   | $                        | — |                    | $      | 587 |   |
| Restricted cash and investments                           |   | $                        | 20,958 |                    | $      | 16,704 |   |
| Working capital                                           |   | $                        | (1,044 | )                       | $      | 5,616 |   |
| Working capital ratio                                     |   | 1.0                      |   | 1.0                     |   |

 

29

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Asof September 30, 2003, cash, cash equivalents, liquid short-term investments,liquid long-term investments and restricted cash and investments totaled $102.6million, which represents a decrease of $16.6 million as compared to a balanceof $119.2 million on December 31, 2002. This decrease was attributable to netcash used for operations, partially offset by a $2 million increase in bankborrowings. We have a credit facility with Silicon Valley Bank that includesterm loans in the form of promissory notes and a revolving line of credit (the“SVB Facilities”) for up to $29.3 million as of September 30, 2003. Under therevolving line of credit portion of the SVB Facilities, amounts borrowed bearinterest at the bank’s prime rate with a floor minimum rate of 4.25% andinterest is due monthly, with the principal due in February 2004. The amendedand restated loan and security agreement requires us to maintain certain levelsin cash and cash equivalents, short-term investments and long-term investments(excluding equity investments). Additionally, the amended and restated loan andsecurity agreement requires us to maintain certain levels on deposit with ourcommercial lender and certain quarterly net income (loss) levels.  At September 30, 2003 and December 31, 2002,$27.0 million and $25.0 million were outstanding under the SVB Facilities,respectively.

 

As of September 30, 2003, the Company was not in compliance with theprofitability and financial covenants of the SVB Facilities.  Subsequently, the Company received a waiverfrom the bank regarding non-compliance.

 

Under the term loan portionof the SVB Facilities, we have two outstanding loans and the total outstandingamounts of these loans were $2.3 million as of September 30, 2003 and $2.9million as of December 31, 2002. Interest on these term loans are at the bank’sprime rate (4.00% as of September 30, 2003 and December 31, 2002) and primerate plus 1.25%.  Principal and interestare due in consecutive monthly payments through maturity of these term loans inMarch 31, 2005 and September 30, 2006, respectively. Principal payments of$977,000 are due annually from 2000 through 2004, $611,000 is due in 2005, anda final payment of $357,000 is due in 2006.

 

Our exposure to market riskfor changes in interest rates relates primarily to our investment portfolio. Wehad no derivative financial instruments as of September 30, 2003 and December31, 2002. We place our investments in instruments that meet high credit qualitystandards and the amount of credit exposure to any one issue, issuer and typeof instrument is limited.  Our interestrate risk related to borrowings historically has been minimal as interestexpense related to borrowings has been immaterial for the three months endedSeptember 30, 2003 and 2002.

 

As of September 30, 2003and December 31, 2002, commitments totaling $21.0 million and $16.7million, respectively, in the form of standby letters of credit were issued andoutstanding from financial institutions in favor of our various landlords tosecure obligations under our facility leases. These letters of credit arecollateralized by a security agreement, under which we are required to maintainan equal amount of cash in a restricted specified interest bearingaccount.  Accordingly,$21.0 million and $16.7 million have been presented as restrictedcash in the accompanying condensed consolidated balance sheets at September 30, 2003 andDecember 31, 2002, respectively.

 

*Cash Provided Used For Operating Activities*

 

Cash used for operating activities was $18.8 million and $90.5 millionfor the nine months ended September 30,2003 and 2002, respectively. The primary reason for the net cash used byoperating activities for the nine months ended September 30, 2003 is due to the net loss of $16.5 million, adecrease in accounts payable and accrued expenses ($3.7 million), a decrease inaccrued restructuring expenses ($10.4 million) and a decrease in unearnedrevenue and deferred maintenance ($14.9 million).   Offsetting these uses of cash was $11.0 million of net non-cashitems, such as depreciation expense, amortization of prepaid royalties, andamortization of intangibles, a decrease in accounts receivable ($12.2 million)and a decrease in prepaids and other ($3.1 million).  The primary reason for the cash used for operating activities forthe nine months ended September 30, 2002 was due to the net loss of $160.5million, adjusted by approximately $59.1 million for certain non-cash itemssuch as depreciation expense, amortization of intangibles, impairment ofassets, non-cash restructuring charge, realized losses on cash investments andprovision for deferred tax asset valuation. Also contributing to the cash decline was a decrease in accounts payableand accrued expenses of $6.9 million, a decrease in unearned revenues and deferredmaintenance of $13.7 million, partially offset by decreases in accountsreceivable of $21.3 million and in prepaids and other of $3.2 million, and anincrease in accrued restructuring expenses of $7.6 million.

 

*Cash Provided By Investing Activities*

 

Cash provided by investing activities was $19.8 million for thenine months ended September 30,2003 and was primarily due to net sales/maturities of investments of$26.8 million. Cash provided by investing activities was $70.7 million forthe nine months ended September 30,2002, and was primarily due to net sales/maturities of investments of $60.6million and $13.3 million released from restricted cash and investments.

 

30

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*Cash Provided By Financing Activities*

 

Cash provided by financing activities was $2.2 million for the ninemonths ended September 30, 2003,consisting of $1.2 million in proceeds from the issuance of common stock and$1.0 million from proceeds from borrowings, net of repayments.  Cash provided by financing activities was$27.1 million for the nine months ended September 30, 2002, consisting of $2.8million on net proceeds from the issuance of common stock and $25.0 million inproceeds from borrowings less $732,000 of repayments on borrowings.

 

Capital expenditures were $131,000 and $1.1 million during the ninemonths ended September 30, 2003and 2002, respectively.  Our capitalexpenditures consisted of purchases of operating resources to manage ouroperations and consisted primarily of computer hardware and software.

 

On May 9, 2002, the Company and Pacific Shores Development(“PacShores”) entered into (i) the Buildings 4 and 5 Termination Agreementand (ii) the Building 6 Amendment. Under the Buildings 4 and 5 TerminationAgreement, the Triple Net Building Lease dated April 12, 2000 betweenPacShores, as Lessor, and the Company, as Lessee, for Premises at PacificShores Center, Building 4, Redwood City, California and the Triple Net BuildingLease dated February 16, 2000 between PacShores, as Lessor, and theCompany, as Lessee, for Premises at Pacific Shores Center, Building 5, RedwoodCity, California, were terminated. In conjunction with the termination,PacShores released all security deposits held by it relating to those premisesin exchange for our payment to PacShores a total of $45.0 million as thetermination fee. Under the Building 6 Amendment, the parties released eachother from all claims and we agreed to provide an additional $3.5 millionas security deposit in the form of letters of credit. This letter of credit isincluded as restricted cash in our Condensed Consolidated Balance Sheets as of June 30, 2003 and December 31,2002. We paid the termination fee in full during the second quarter of 2002 bypayment of approximately $20.0 million from existing cash and investmentsand by drawing down approximately $25.0 million from our line of credit.The $25.0 million line of credit, was amended during the second quarter of2003 to increase the facility by $2.0 million to $27.0 million, and is due inFebruary 2004.

 

We expect to incur significant operating expenses for the foreseeablefuture in order to execute our business plan. A summary of total future minimumlease payments as of September 30, 2003, under noncancelable operating leaseagreements, together with amounts included in restructuring reserves is asfollows (in thousands):

 
| **Years Ended December 31,** |   | **Operating  Leases** |    |
|-----------------------------------|--------|-----------------------|---------|
|                              |   |                  |    |
| 2003                              |   | $                     | 5,767   |   |
| 2004                              |   | 23,312                |    |
| 2005                              |   | 23,579                |    |
| 2006                              |   | 21,223                |    |
| 2007                              |   | 18,695                |    |
| 2008 and thereafter               |   | 89,661                |    |
| Total minimum lease payments      |   | $                     | 182,237 |   |

 

As of September 30, 2003, the Company has accrued $87.6 million ofestimated future facilities costs as a restructuring accrual. See Note 6 in theNotes to Condensed Consolidated Financial Statements.

 

The following table summarizes our letters of credit and the effectsuch letters of credit could have on our liquidity and cash flows in futureperiods if the letters of credit were drawn upon (in thousands):

 
| Less than 1 year |   | $      | 3,956  |   |
|------------------|--------|--------|--------|--------|
| 1-3 years        |   | 676    |   |
| 4-5 years        |   | 1,922  |   |
| Over 5 years     |   | 14,404 |   |
| Total            |   | $      | 20,958 |   |

 

Restricted cash and investments represent collateral for these lettersof credit.

 

Our net cash flows will depend heavily on the level of future revenues,our ability to restructure operations successfully and our ability to manageinfrastructure costs.

 

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We currentlyexpect to fund our short-term working capital and operating resourceexpenditure requirements, for at least the next twelve months, from ourexisting cash and cash equivalents and short-term investment resources, ouranticipated cash flows from operations and anticipated cash flows fromsubleases. However, we could experience unforeseen circumstances, such as aworsening economic downturn, lease settlements and less than anticipated cashinflows from operations, invested assets, and subleases that may increase ouruse of available cash or need to obtain additional financing. Also, we may findit necessary to obtain additional equity or debt financing in order to supportmore rapid expansion, develop new or enhanced services, respond to competitivepressures, acquire complementary businesses or technologies or respond tounanticipated requirements.

 

We may seek to raise additional funds through private or public salesof securities, strategic relationships, bank debt, financing under leasingarrangements or otherwise. If additional funds are raised through the issuanceof equity securities, the percentage ownership of our stockholders will bereduced, stockholders may experience additional dilution or such equitysecurities may have rights, preferences or privileges senior to those of theholders of our common stock. There can be no assurance that additionalfinancing will be available on acceptable terms, if at all. If adequate fundsare not available or are not available on acceptable terms, we may be unable todevelop our products, take advantage of future opportunities or respond tocompetitive pressures or unanticipated requirements, which could have amaterial adverse effect on our business, financial condition and futureoperating results.

 

*Factors That May Affect Future OperatingResults*

 

Wemay experience significant fluctuations in quarterly operating results that maybe caused by many factors including, but not limited to, those discussed belowand herein, as set out in Items 7 and 7A in our annual report on Form 10-K forthe year ended December 31, 2002 and elsewhere therein and as disclosed inother documents filed with the Securities and Exchange Commission.

 

Significant fluctuations in future quarterly operating results may becaused by many factors including, among others, the timing of introductions orenhancements of products and services by us or our competitors, marketacceptance of new products, the mix of our products sold, changes in pricingpolicies by us or our competitors, our ability to retain customers, changes inour sales incentive plans, budgeting cycles of our customers, customer orderdeferrals in anticipation of new products or enhancements by us or ourcompetitors, nonrenewal of maintenance agreements (which generallyautomatically renew for one year terms unless earlier terminated by eitherparty upon 90-days notice), product life cycles, changes in strategy, seasonaltrends, the mix of distribution channels through which our products are sold,the mix of international and domestic sales, the rate at which new sales peoplebecome productive, changes in the level of operating expenses to supportprojected growth and general economic conditions. We anticipate that asignificant portion of our revenues will be derived from a limited number oforders, and the timing of receipt and fulfillment of any such orders isexpected to cause material fluctuations in our operating results, particularlyon a quarterly basis. Due to the foregoing factors, quarterly revenues andoperating results are difficult to forecast, and we believe thatperiod-to-period comparisons of our operating results will not necessarily bemeaningful and should not be relied upon as any indication of futureperformance. It is likely that our future quarterly operating results from timeto time will not meet the expectations of market analysts or investors, whichmay have an adverse effect on the price of our common stock.

 

Weare continuing efforts to reduce and control our expense structure. We believestrict cost containment and expense reductions are essential to achievingpositive cash flow and profitability. A number of factors could preclude usfrom successfully bringing costs and expenses in line with our revenues,including unplanned uses of cash, the inability to accurately forecast businessactivities and further deterioration of our revenues. If we are not able toeffectively reduce our costs and achieve an expense structure commensurate withour business activities and revenues, we may have inadequate levels of cash foroperations or for capital requirements, which could significantly harm ourability to operate our business.

 

Werenewed and amended the SVB Facility during the second quarter of fiscal 2003.The SVB Facility is secured by substantially all of our owned assets.  Theprimary financial covenant under the SVB Facility obligates us to maintaincertain levels of available cash, cash equivalents, short-term investments and long-terminvestments (excluding equity investments). Falling below such levels would bean event of default for which Silicon Valley Bank may, among other things,accelerate the payment of the facility. As of September 30, 2003, the Company was not in compliance withthe profitability and financial covenants of the commercial creditfacilities.  Subsequently, the Companyreceived a waiver from the bank regarding non-compliance.  Whilewe plan to adhere to the financial covenants of the SVB Facility and avoid anevent of default in future periods, in the event that we are unable to avoidanother event of default, it may be necessary or advisable to retire andterminate the SVB Facility and pay off all remaining balances borrowed. Such apayoff would further limit our available cash and cash equivalents.

 

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Our success depends largely on the skills, experience and performanceof key personnel. If we lose one or more key personnel, our business could beharmed. Our future success depends on our ability to continue attracting andretaining highly skilled personnel. We may not be successful in attracting,assimilating and retaining qualified personnel in the future. Furthermore, thesignificant downturn in our business environment had a negative impact on ouroperations. We are currently restructuring our operations and have takenactions to reduce our workforce and implement other cost containmentactivities. These actions could lead to disruptions in our business, reducedemployee morale and productivity, increased attrition and problems withretaining existing employees and recruiting future employees and increasedfinancial costs.

 

Weeffected a one-for-nine reverse stock split in July 2002.  Prior to theeffective time of the reverse stock split, our common stock was trading below$1.00 per share.  The Nasdaq National Market has a $1.00 per share minimumbid requirement, pursuant to which our common stock could be de-listed fromNasdaq if it trades below $1.00 for thirty consecutive trading days and doesnot subsequently trade above $1.00 for 10 consecutive days.  There can beno assurance that our trading price will remain above the $1.00 per sharerequirement for the necessary time period mandated by Nasdaq.  If we donot meet the Nasdaq requirements to maintain our listing on The Nasdaq NationalMarket, our common stock could trade on the OTC Bulletin Board or in the “pinksheets” maintained by the National Quotation Bureau, Inc.  Such alternatives are generally consideredto be less efficient markets, and our stock price, as well as the liquidity ofour common stock, would be adversely impacted by a Nasdaq delisting.

 

Some of these risks and uncertainties relate to the rapidly evolvingnature of the markets in which we operate. These related market risks include,among other things, the evolution of the online commerce market, the dependenceof online commerce on the development of the Internet and its relatedinfrastructure, the uncertainty pertaining to widespread adoption ofonline commerce and the risk of government regulation of the Internet. Otherrisks and uncertainties relate to our ability to, among other things,successfully implement our marketing strategies, respond to competitivedevelopments, continue to develop and upgrade our products and technologiesmore rapidly than our competitors, and commercialize our products and servicesby incorporating these enhanced technologies. There can be no assurance that wewill succeed in addressing any or all of these risks.

 

Therehas been a general downturn in the Unites States of America and globaleconomy.  If the economic environmentcontinues to decline or if the current global slowdown worsens or becomesprolonged, our future results may be significantly impacted. We believe thatthe current economic decline has increased the average length of our salescycle and our operating results could suffer and our stock price could declineif we do not achieve the level of revenues we expect.  Financial comparisons discussed herein may not be indicative offuture performance.

 

Like other U.S. companies, our business and operating results aresubject to uncertainties arising out of the terrorist attacks on the UnitedStates, including the economic consequences of military actions or additionalterrorist activities and associated political instability, and the impact ofheightened security concerns on domestic and international travel and commerce.Such uncertainties could also lead to delays or cancellations of customerorders, a general decrease in corporate spending or our inability toeffectively market and sell our products. Any of these results couldsubstantially harm our business and results of operations, causing a decreasein our revenues.

 

***Related Party Transactions***

 

Mr.Pehong Chen, our CEO and Chairman of the Board, served as a director ofBrience, Inc. (“Brience”) a provider of software products.  From February2001 to February 2002, we had a reseller relationship with Brience whereby weagreed to resell the Brience product licenses with our product.  Oneend-customer installation that resulted from the reseller relationship was notconcluded until the three months ended September 30, 2002.  During thethree and nine months ended September 30, 2002, we paid to Brienceapproximately $175,000 in license fees for the resell of the Brience product tothat end-customer.  During the three and nine months ended September 30,2003, we paid no royalties to Brience.  Mr. Chen resigned from the Brienceboard of directors on September 12, 2002.

 

We also have an investment of 19.9% in Roundarch, a CRM servicescompany. We have a reseller relationship with Roundarch whereby Roundarch is animplementation partner who integrates our software products with otherthird-party software products into CRM customer installations.  During thethree months ended September 30, 2003 and 2002, transactions involvingRoundarch comprised $17,000 and $330,000 of our revenue, respectively.  For the nine months ended September 30, 2003and 2002, revenues were $219,000 and $383,000, respectively.

 

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**Item 3.  Quantitativeand Qualitative Disclosures About Market Risk**

 

Our exposure to market risk for changes in interest rates relatesprimarily to our investment portfolio. We had no derivative financialinstruments as of September 30, 2003 and December 31, 2002.We place our investments in instruments that meet high credit quality standardsand the amount of credit exposure to any one issue, issuer and type ofinstrument is limited.

 

***Cash and Cash Equivalents, Short-TermInvestments, Long-Term Investments***

 

We consider all debt and equity securities with maturities of threemonths or less at the date of purchase to be cash equivalents. Our short-term investmentsconsist of debt and equity securities that are classified asavailable-for-sale. Our debt securities are carried at fair value with relatedunrealized gains or losses reported as other comprehensive income (loss), netof tax. Our long-term investments include debt securities that are classifiedas available-for-sale. These securities have remaining maturities greater thanone year from September 30, 2003. These investments are carried at fair valuewith related unrealized gains or losses reported as other comprehensive income,net of tax.

 

**All short-term investments have aremaining maturity of twelve months or less. Total short-term and long-terminvestment unrealized gains (losses) were approximately $5,000 and ($1.5million) for the nine months ended September 30, 2003 and 2002, respectively.**

 

Our cash and cash equivalents, short-term investments and long-terminvestments consisted of the following as of September 30, 2003(in thousands):

 
|                      |   | **Amortized  costs** |    | **Unrealized  gains** |   | **Unrealized  losses** |   | **Fair  value** |   |
|---------------------------|--------|----------------------|---------|-----------------------|--------|------------------------|--------|-----------------|--------|
| Cash                      |   | $                    | 67,319  |                  | $      | —                 |   | $               | — |   | $ | 67,319 |   |
| Money market              |   | 33,900               |    | —                |   | —                 |   | 33,900          |   |
| Corporate notes/bonds     |   | 1,005                |    | 5                     |   | —                 |   | 1,010           |   |
| Government notes/bonds    |   | 408                  |    | —                |   | —                 |   | 408             |   |
|                      |   | 102,632              |    | 5                     |   | —                 |   | 102,637         |   |
|                      |   |                 |    |                  |   |                   |   |            |   |
| Cash and cash equivalents |   | 101,578              |    | —                |   | —                 |   | 101,578         |   |
| Short-term investments    |   | 1,054                |    | 5                     |   | —                 |   | 1,059           |   |
| Long-term investments     |   | —               |    | —                |   | —                 |   | —          |   |
|                      |   | $                    | 102,632 |                  | $      | 5                      |   | $               | — |   | $ | 102,637 |   |

 

Includedin the table above in cash and cash equivalents are $21.0 million ofnon-current restricted cash and investments.

 

Ourcash and cash equivalents, short-term investments and long-term investmentsconsisted of the following as of December 31, 2002 (in thousands):

 
|                      |   | **Amortized  costs** |    | **Unrealized  gains** |   | **Unrealized  losses** |   | **Fair  value** |   |
|---------------------------|--------|----------------------|---------|-----------------------|--------|------------------------|--------|-----------------|--------|
| Cash                      |   | $                    | 36,070  |                  | $      | —                 |   | $               | — |   | $ | 36,070 |   |
| Money market              |   | 36,232               |    | —                |   | —                 |   | 36,232          |   |
| Corporate notes/bonds     |   | 23,369               |    | 50                    |   | (1                     | )      | 23,418          |   |
| Government notes/bonds    |   | 23,430               |    | 11                    |   | —                 |   | 23,441          |   |
|                      |   | $                    | 119,101 |                  | $      | 61                     |   | $               | (1     | ) | $ | 119,161 |   |
|                      |   |                 |    |                  |   |                   |   |            |   |
| Cash and cash equivalents |   | $                    | 94,090  |                  | $      | —                 |   | $               | — |   | $ | 94,090 |   |
| Short-term investments    |   | 24,428               |    | 57                    |   | (1                     | )      | 24,484          |   |
| Long-term investments     |   | 583                  |    | 4                     |   | —                 |   | 587             |   |
|                      |   | $                    | 119,101 |                  | $      | 61                     |   | $               | (1     | ) | $ | 119,161 |   |

 

Includedin the table above in short-term investments are non-current restricted cashand investments of $16.7 million.

 

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***Concentrations of Credit Risk***

 

Financial assets that potentially subject us to significantconcentrations of credit risk consist principally of cash, cash equivalents,short-term investments, and trade accounts receivable. We maintain our cash andcash equivalents and short-term investments with four separate financialinstitutions. We market and sell our products throughout the world and performongoing credit evaluations of our customers. We maintain reserves for potentialcredit losses. For the three months and nine months ended September 30,2003 and 2002, no one customer accounted for more than 10% of totalrevenue.  For the three months and ninemonths ended September 30,2003, no one customer accounted for more than 10% of accounts receivable. Forthe three months and nine months ended September30, 2002, one customer accounted for more than 10% of accountsreceivable.

 

***Fair Value of Financial Instruments***

 

Ourfinancial instruments consist of cash equivalents, short-term investments,accounts receivable, long-term investments, accounts payable and debt. We donot have any derivative financial instruments. We believe the reported carryingamounts of its financial instruments approximates fair value, based upon theshort maturity of cash equivalents, short-term investments, long-terminvestments, accounts receivable and payable, and based on the current ratesavailable to it on similar debt issues.

 

***Equity Investments***

 

Ourequity investments consist of investments in public and non-public companiesthat are accounted for under the cost method of accounting. Equity investmentsare accounted for under the cost method of accounting when we have a minorityinterest and do not have the ability to exercise significant influence. Theseinvestments are classified as available for sale and are carried at fair valuewhen readily determinable market values exist or at cost when such marketvalues do not exist. Adjustments to fair value are recorded as a component ofother comprehensive income unless the investments are considered permanentlyimpaired in which case the adjustment is recorded as a component of otherincome (expense), net in the condensed consolidated statement of operations.

 

The total fair value of our cost method long-term equity investments inpublic and non-public companies as of September 30, 2003 was $1.6 million.We recorded an other than temporary write-down of $298,000 during the threemonths ended September 30, 2003 related to long-term equity investments.

 

Ourexposure to market risk for changes in interest rates relates primarily to ourinvestment portfolio. We had no derivative financial instruments as ofSeptember 30, 2003 and December 31, 2002. We place our investments ininstruments that meet high credit quality standards and the amount of creditexposure to any one issue, issuer and type of instrument is limited.  Ourinterest rate risk related to borrowings historically has been minimal as interestexpense related to borrowings has been immaterial for the nine months endedSeptember 30, 2003 and 2002.

 

Duringthe third quarter of fiscal 2003, we drew down $27.0 million on our revolvingline of credit.  Interest is payable monthly at the bank’s prime rate witha floor minimum of 4.25% (4.25% annually as of September 30, 2003) andprincipal is due in full in February 2004.  Additionally, we have twooutstanding term loans as of September 30, 2003.  Interest on those termloans are at the bank’s prime rate (4.00% as of September 30, 2003) and primerate plus 1.25%.

 

**ITEM 4. Controls and Procedures**

 

Based on their evaluation of our disclosure controls and procedures (asdefined in the rules promulgated under the Securities Exchange Act of 1934),our Chief Executive Officer and our Chief Financial Officer concluded that ourdisclosure controls and procedures were effective as of the end of the periodcovered by this report, subject to the improvement of our internal controlssubsequent to the end of the third quarter as described below.

 

*Changes in Internal Control Over FinancialReporting*

 

Subsequent to the end of the quarter ended September 30, 2003, theCompany implemented the following changes to our internal control overfinancial reporting:

•      We implemented more formal processes forthe review of significant licensing contracts, and

•      We implemented additional procedures toensure that transactions affecting common stock are properly documented and theappropriate accounting applied.

 

These additional procedures were implemented, in part, due to amaterial weakness letter we received from our independent accountants inOctober 2003.  Management believes thenew controls address the key issues raised in the material weaknessletter.  We will continue to monitor theeffectiveness of our internal controls and procedures on an ongoing basis andwill take further action, as appropriate.

 

*Limitations on the Effectiveness of Controls*

 

Our management, including our Chief Executive Officer and ChiefFinancial Officer, does not expect that our disclosure controls and proceduresor our internal controls will prevent all error and fraud. A control system, nomatter how well conceived and operated, can provide only reasonable, notabsolute, assurance that the objectives of the control system are met. Further,the design of a control system must reflect the fact that there are resourceconstraints, and the benefits of controls must be considered relative to theircosts. Because of the inherent limitations in all control systems, noevaluation of controls can provide absolute assurance that all control issuesand instances of fraud, if any, within the company have been

 

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detected. These inherent limitations include the realities thatjudgments in decision-making can be faulty, and that breakdowns can occurbecause of simple error or mistake. Additionally, controls can be circumventedby the individual acts of some persons, by collusion of two or more people, orby management override of the control. The design of any system of controlsalso is based in part upon certain assumptions about the likelihood of futureevents, and there can be no assurance that any design will succeed in achievingits stated goals under all potential future conditions; over time, control maybecome inadequate because of changes in conditions, or the degree of compliancewith the policies or procedures may deteriorate. Because of the inherentlimitations in a cost-effective control system, misstatements due to error orfraud may occur and not be detected. The Company’s disclosure controls andprocedures are designed to provide reasonable assurance of achieving theirobjectives, and the Chief Executive Officer and the Chief Financial Officerhave concluded that these controls and procedures are effective at the“reasonable assurance” level.

 

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**PART II.  OTHERINFORMATION**

 

**Item 1.    Legal Proceedings**

 

**During Q2 2003, the Company settleda dispute with Avalon Partners, Inc., doing business as Cresa Partners(“Cresa”) with respect to broker commissions related to the Company’stermination and restructuring of certain facilities leases associated with theCompany’s restructuring plans taken during the second quarter of 2002. Underthe terms of the settlement the Company made a one-time payment of $2.2 millionto Cresa in April 2003.**

 

During the third quarter of 2003, the Company reached a confidentialsettlement with Verity, Inc. with respect to our outstanding litigation. Thedetailed terms and conditions of this settlement are confidential and cannot bedisclosed without the consent of each party. The settlement did not have a material effect on the Company’s business,financial condition or results of operations.

 

The Company is also subject to various other claims and legal actionsarising in the ordinary course of business. In the opinion of management, afterconsultation with legal counsel, the Company has adequate defenses for each ofthe claims and actions, and believes that their ultimate disposition is notexpected to have a material effect on our business, financial condition orresults of operations. Although management currently believes that the outcomeof other outstanding legal proceedings, claims and litigation involving us willnot have a material adverse effect on our business, results of operations orfinancial condition, litigation is inherently uncertain, and there can be noassurance that existing or future litigation will not have a material adverseeffect on our business, results of operations or financial condition.

 

**Item 2.    Changes in Securities and Use of Proceeds**

Notapplicable.

 

**Item 3.    Defaults Upon Senior Securities**

Notapplicable.

 

**Item 4.    Submission of Matters to a Vote of SecurityHolders**

Not applicable.

 

**Item 5.    Other Information**

Notapplicable.

 

**Item 6.    Exhibits and Reports on Form 8-K**

(a)           Exhibits

 
| **Exhibits** |   | **Description**                                                                                                                                     |
|--------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.4          |   | Certificate of Correction of Certificate of Amendment of Amended and  Restated Certificate of Incorporation                                         |
| 4.1          |   | References are hereby made to Exhibits 3.1, 3.2, 3.3 and 3.4.                                                                                       |
| 31.1         |   | Certification of the Chief Executive Officer of BroadVision                                                                                         |
| 31.2         |   | Certification of the Chief Financial Officer of BroadVision                                                                                         |
| 32.1         |   | Certification of the Chief Executive Officer and Chief Financial  Officer of BroadVision pursuant to Section 906 of the Sarbanes-Oxley Act of  2002 |

 

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(b)           Reports on Form 8-K

 

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| On July 23, 2003, the Company filed a current report on Form 8-K  related to the announcement of its financial results for the quarter ended  June 30, 2003.         |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| On October 22, 2003, the Company filed a current report on Form 8-K  related to the announcement of its financial results for the quarter ended  September 30, 2003. |

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|                     |   | **BROADVISION, INC.**                                                                               |
|--------------------------|--------|-----------------------------------------------------------------------------------------------------|
|                     |   |                                                                                                |
| Date:  November 14, 2003 | By:    | /s/   Pehong Chen                                                                              |   |
|                     |   | Pehong  Chen                                                                                        |
|                     |   | Chairman  of the Board, President and Chief Executive Officer (Principal Executive  Officer)        |
|                     |   |                                                                                                |
| Date:  November 14, 2003 | By:    | /s/   William E. Meyer                                                                         |   |
|                     |   | William  E. Meyer                                                                                   |
|                     |   | Executive  Vice President and Chief Financial Officer  (Principal Financial and Accounting Officer) |
|                          |        |                                                                                                     |  |  |

 

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**BROADVISION, INC. QUARTERLY REPORT ONFORM 10-Q SEPTEMBER 30, 2003**

 

**INDEX TO EXHIBITS**

 
| **Exhibit** |   | **Description**                                                                                                                                     |
|-------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.4         |   | Certificate of Correction of Certificate of Amendment of Amended and  Restated Certificate of Incorporation                                         |
| 4.1         |   | References are hereby made to Exhibits 3.1, 3.2, 3.3 and 3.4.                                                                                       |
| 31.1        |   | Certification of the Chief Executive Officer of BroadVision                                                                                         |
| 31.2        |   | Certification of the Chief Financial Officer of BroadVision                                                                                         |
| 32.1        |   | Certification of the Chief Executive Officer and Chief Financial  Officer of BroadVision pursuant to Section 906 of the Sarbanes-Oxley Act of  2002 |

 

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