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Item 1. Financial Statements 

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NOTE 1—BASIS OF PRESENTATION

           The accompanying Borland Software Corporation, or Borland, condensed consolidated financial statements at June 30, 2003 and December 31, 2002 and for the three and six months ended June 30, 2003 and 2002 are unaudited and have been prepared in accordance with generally accepted accounting principles for interim financial information and Rule 10-01 of Regulation S-X. Accordingly, they do not include all financial information and disclosures required by generally accepted accounting principles for complete financial statements and certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly Borland’s financial position at June 30, 2003 and December 31, 2002, and its results of operations and cash flows for the three and six months ended June 30, 2003 and 2002. Certain amounts in the June 30, 2002 and December 31, 2002 information have been reclassified in order to be consistent with current financial statement presentation. The preparation of condensed consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the related disclosure of contingent assets and liabilities. Actual results could differ from those estimates. The results of operations for interim periods are not necessarily indicative of the results to be expected for any subsequent quarter or for the full year. The condensed consolidated financial statements and notes should be read in conjunction with our audited financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2002 as filed with the Securities and Exchange Commission, or the SEC, on March 28, 2003.

NOTE 2—STOCK BASED COMPENSATION

Stock-Based Compensation Plans

           We account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board, or APB, Opinion No. 25, “Accounting for Stock Issued to Employees,” or APB 25, and related interpretations. Under APB 25, compensation expense is measured as the excess, if any, of the closing market price of our stock at the date of grant over the exercise price of the option granted. We recognize compensation cost for stock options, if any, ratably over the vesting period. Generally, we grant options with an exercise price equal to the closing market price of our stock on the grant date. We provide additional pro forma disclosures as required under Statement of Financial Accounting Standards, or SFAS, No. 123, “Accounting for Stock-Based Compensation,” or SFAS 123, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure an amendment of FASB Statement No. 123,” or SFAS 148.

Pro Forma Net Loss and Net Loss Per Share

           Compensation expense (included in pro forma net income (loss) and net income (loss) per share amounts) is recognized for the fair value of the awards granted under our stock option and stock purchase plans using the Black-Scholes option pricing model. The Black-Scholes model, as well as other currently accepted option valuation models, was developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from our stock option and stock purchase plan awards. These models also require highly subjective assumptions including future stock price volatility and expected time until exercise, which greatly affect the calculated fair value on the grant date. The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:

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           The weighted average fair value of the stock options granted under our employee stock option plans and the stock awarded under our employee stock purchase plan, as defined by SFAS 123, was $5.94 and $6.61 for the three months ended June 30, 2003 and 2002, respectively and $7.69 and $7.70 for the six months ended June 30, 2003 and 2002, respectively.

           Had we recorded compensation expenses based on the estimated fair value at grant date for awards granted under our stock option and stock purchase plans (as defined by SFAS 123), our pro forma net loss and net loss per share for the three and six months ended June 30, 2003 and 2002 would have been as follows (amounts in thousands, except per share data):

           The pro forma amounts include compensation expenses related to stock option grants and stock purchase rights for the three and six months ended June 30, 2003 and 2002. In future periods, the pro forma compensation expense may increase as a result of the fair value of stock options and stock purchase rights granted in those future periods.

           We account for stock options issued to non-employees, excluding non-employee directors, under SFAS 123 and Emerging Issues Task Force, or EITF, Issue No. 96-18, “Accounting for Equity Instruments with Variable Terms that are Issued for Consideration Other Than Employee Services under SFAS 123,” or EITF 96-18. We record the expense of such services based upon the estimated fair value of the equity instrument using the Black-Scholes option pricing model.

NOTE 3—NET INCOME (LOSS) PER SHARE

           We compute net income (loss) per share in accordance with SFAS No. 128, “Earnings per Share,” or SFAS 128. Under the provisions of SFAS 128, basic net income (loss) per share is computed by dividing the net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common and potentially diluted shares outstanding during the period. Potentially dilutive shares, which consist of incremental shares issuable upon exercise of stock options and warrants, are included in diluted net income per share to the extent such shares are dilutive.

           The following table sets forth the computation of basic and diluted net income (loss) per share for the three and six months ended June 30, 2003 and 2002 (in thousands, except per share amounts):

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           The diluted earnings per share calculation for the three and six months ended June 30, 2003 and 2002 excludes options to purchase approximately 14.7 million and 5.3 million shares, respectively, because their effect would have been antidilutive.

NOTE 4—ACQUISITIONS

TogetherSoft Corporation

           On January 14, 2003, we completed the acquisition of TogetherSoft Corporation, or TogetherSoft, which was a privately-held corporation. The consideration consisted of approximately $82.5 million in cash, 9,050,000 shares of Borland common stock and the assumption of certain liabilities and obligations of TogetherSoft, including those arising under its stock option plans. The consideration paid was reduced for certain legal expenses paid by TogetherSoft. Approximately $26.0 million of the total consideration is being held in escrow to indemnify us against, and reimburse us for, certain events and cover certain liabilities and transaction costs. Unused funds will be released from escrow at specified times between 2004 and 2007. We recorded $151.3 million in goodwill for the excess of the purchase price over the net assets acquired and $37.2 million for acquired technology. TogetherSoft was a provider of platform-neutral, design-driven development solutions designed to accelerate the software development process.

           During the three and six months ended June 30, 2003, we recorded approximately $4.1 million and $7.7 million in acquisition-related costs associated with the amortization of the purchased intangibles from the acquisition of TogetherSoft. During the three months ended June 30, 2003, we paid approximately $0.2 million in acquisition-related expenses, which were recorded as an adjustment to goodwill.

           The following table summarizes the short-term portion of our restructuring activity related to the TogetherSoft acquisition accounted for according to EITF Issue No. 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination,” or EITF 95-3, for the six months ended June 30, 2003 (in thousands):

           Our 2003 restructuring accrual included $3.2 million resulting from headcount reductions of 76 employees, including 71 in sales, general and administrative and five in research and development and $3.1 million resulting from reduction of certain facilities leases. In addition, we recorded a charge of $0.5 million for lease termination costs and other costs related to facilities in France and Germany. Due to the timing of payments under lease agreements, we have recorded these costs as part of long-term restructuring.

Starbase Corporation

           On October 8, 2002, we signed a merger agreement to purchase all of the outstanding shares of Starbase Corporation, or Starbase, for an aggregate consideration of approximately $24.0 million in cash and $2.0 million in bridge financing that was forgiven upon the consummation of the transaction. We recorded $31.7 million in goodwill for the excess of the purchase price over the net assets acquired and $12.0 million for acquired technology. Starbase is a provider of end-to-end enterprise software lifecycle solutions covering requirements definition and management, code and content development, and change and configuration management.

           Pursuant to the merger agreement, on October 11, 2002, we commenced an all-cash tender offer to acquire all outstanding shares of Starbase at a price of $2.75 per share. In the initial tender offer, which expired on November 22, 2002, we purchased approximately 78.9% of the outstanding shares of Starbase. Upon the completion of the initial tender, we began consolidating the operating results of Starbase. The initial tender offer was followed by the merger on January 7, 2003 of Starbase with Galaxy Acquisition Corp., a wholly-owned subsidiary of Borland formed for the purposed of making the acquisition. In the merger, holders of the remaining outstanding shares of Starbase common stock at the time of the merger received the same $2.75 cash price per share paid in the tender offer. As a result of the merger, Starbase is now a wholly-owned subsidiary of Borland. Accordingly, with the payment to the remaining stockholders, we eliminated the minority interest in the consolidated subsidiary during the three months ended March 31, 2003.

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           During the three and six months ended June 30, 2003, we recorded approximately $1.5 million and $3.1 million, respectively, in acquisition-related costs associated with the amortization of the purchased intangibles from the acquisition of Starbase.

           The following table summarizes our restructuring activity related to the Starbase acquisition accounted for according to EITF 95-3 for the six months ended June 30, 2003 (in thousands, unaudited):

           Our 2003 restructuring accrual included $0.3 million resulting from headcount reductions.

           Supplemental pro forma information reflecting the acquisitions of TogetherSoft and Starbase as if they occurred on December 31, 2001 is as follows for the three and six months ended June 30, 2003 and 2002 (in thousands, unaudited):

           Such information is not necessarily representative of the actual results that would have occurred for those periods.

VMGear

           On January 18, 2002, we completed our acquisition of Redline Software, Inc., or VMGear, which was a provider of performance assurance and testing solutions for Java developers. The transaction was accounted for as a purchase. Total fixed consideration of $2.0 million was paid upon the close of the transaction and acquisition-related costs were $0.2 million. The contingent consideration includes retention payments of $6.0 million to be earned through the continued employment of certain individuals and additional earnout payments of up to $10.0 million contingent upon future revenues derived from the sale of VMGear products and the retention of certain employees of VMGear. Contingent consideration, if any, will be earned and paid over a three-year period. We recorded this earnout as a component of restructuring, amortization of intangibles and acquisition-related expenses based upon our estimate of the total earnout on a straight-line basis. The results of operations for this acquisition were not material to our financial statements either on an individual or aggregate basis and accordingly pro forma results have not been presented.

           In accordance with the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets,” or SFAS 142, we did not amortize the excess of the purchase price over net assets acquired. The contingent consideration will be expensed when it is deemed probable that such payments will be made. For the three and six months ended June 30, 2003, we expensed $2.5 million and $4.5 million, respectively, in contingent consideration related to the VMGear acquisition.

NOTE 5—GOODWILL AND INTANGIBLE ASSETS

           The changes in the carrying amount of goodwill for the six months ended June 30, 2003 are as follows (in thousands):

           We performed a transitional impairment test of our goodwill and intangible assets as of January 1, 2002. At the time of the test, no impairment of our goodwill or intangible assets was noted. We performed our annual

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assessment of goodwill in December 2002, and concluded that there was no additional impairment. Due to the adoption of SFAS 142 on January 1, 2002, we ceased amortizing goodwill.

           The following tables summarize our intangible assets, net (in thousands):

           The intangible assets are all amortizable and have original estimated useful lives as follows: acquired technology – 2 to 3 years; maintenance contracts – 1 year; trademarks—3 years; other—1 to 3 years. Based on the current amount of intangibles subject to amortization, the estimated amortization expense for the remainder of 2003 and the succeeding four years is as follows: remainder of 2003: $11.7 million; 2004: $14.2 million; 2005: $12.1 million; 2006: $0.1 million; and 2007: $0 million.

NOTE 6—RESTRUCTURING

           Prior to January 1, 2003, we accounted for our restructuring and acquisition-related activity according to EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring),” or EITF 94-3. The following table summarizes our short-term restructuring and acquisition-related activity accounted for according to EITF 94-3 and SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” or SFAS 146, for the six months ended June 30, 2003 (amounts in thousands):

           Our 2003 restructuring accrual included $1.0 million resulting from headcount reductions of 28 employees, including 19 in sales and general and administrative and 9 in research and development, and $2.0 million resulting from reduction of certain facilities leases. This amount represents our estimate of the costs to exit the facilities and is recorded in current liabilities.

           In addition, we recorded a charge of $2.4 million during the six months ended June 30, 2003 for a change in estimate for lease termination costs related to a facility in the United Kingdom. Due to the timing of payments under the lease agreement, we have recorded these costs as a part of long-term restructuring. The total long-term lease termination obligation as of June 30, 2003 was $4.1 million.

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NOTE 7—INCOME TAXES

           During the three months ended June 30, 2003, we contemplated an election to achieve a step-up in basis of Starbase’s assets for income tax purposes. Our analysis led us to conclude that the additional benefits from the basis step-up did not justify the additional tax liabilities we would incur in order to make the election. Therefore, in accordance with SFAS No. 109, “Accounting for Income Taxes,” or SFAS 109, deferred tax liabilities of approximately $4.7 million have been recorded for the tax effect of the intangible assets which are not amortizable for tax purposes. Deferred tax assets of $4.7 million have also been recorded as we are releasing a portion of our previously established valuation allowance against our deferred tax assets. We are releasing a portion of the valuation allowance to the extent the realization of our deferred tax assets becomes assured as a result of the additional taxable income generated by the non-deductible amortizable intangible assets.

NOTE 8—REPURCHASES OF COMMON STOCK

           During September 2001, our Board of Directors authorized repurchases of up to $30.0 million of our outstanding common stock. As a part of this program, we repurchased 395,000 shares of our common stock for an average price of $9.91 per share for a total consideration of $3.9 million during the three months ended June 30, 2003. We repurchased 695,000 shares of our common stock for an average price of $9.78 per share for a total consideration of $6.8 million during the six months ended June 30, 2003. We repurchased 359,700 shares of our common stock for an average price of $9.53 per share for a total consideration of $3.4 million during the six months ended June 30, 2002, all of which were purchased during the three months ended June 30, 2002. This authorization is still deemed to be in effect and $12.7 million remains authorized for future repurchases. During August 2003, our Board of Directors authorized an additional repurchase of up to $15.0 million in Borland common stock. We expect to continue to repurchase shares under our repurchase program from time to time depending on market conditions, share price and availability and other factors at our discretion.

NOTE 9—LITIGATION

           On November 27, 2002, a stockholder class action and derivative lawsuit, Dieterich v. Harrer, et al., Case No. 02CC00350, was filed against Starbase Corporation and five former directors of Starbase in the Superior Court of the State of California for Orange County. The complaint alleged that the former directors had breached fiduciary duties owed to Starbase and stockholders of Starbase. Borland is paying the costs of defending this litigation pursuant to indemnification obligations under the merger agreement relating to the acquisition of Starbase by Borland. On January 23, 2003, defendants filed a demurrer seeking to have all the claims dismissed, and also filed a motion to stay discovery pending a ruling on the demurrer. On February 25, 2003, plaintiff filed its first amended class action complaint, or the amended complaint, naming as defendants the five former directors and the investment banking firm that provided financial services to Starbase, two law firms that provided legal services to Starbase and an individual and entity that helped arrange financing for Starbase. The amended complaint purported to be brought on behalf of Starbase stockholders who tendered shares of Starbase common stock in the tender offer commenced by Borland on October 11, 2002 and that ended on November 11, 2002, or in the merger that was completed on January 7, 2003. Plaintiff alleged that the five former directors breached their fiduciary duties owed to Starbase in connection with a proposed financing of Starbase in mid-2002, and that the other defendants aided and abetted the purported breach of fiduciary duty. The director defendants filed a demurrer seeking dismissal of the amended complaint. On June 6, 2003, the court sustained the demurrer of all defendants and dismissed the lawsuit against all defendants but granted the plaintiff leave to amend the complaint against the director defendants. On July 3, 2003, the plaintiff filed a second amended complaint. On July 8, 2003, plaintiff filed a request for voluntary dismissal of the action without prejudice. Defendants opposed that request on the ground that plaintiff wanted to refile the action in another jurisdiction while still being able to pursue the litigation in the Superior Court of the State of California of Orange County or appeal the court’s decision to the California Court of Appeal. On July 31, 2003, the court held that plaintiff’s request for dismissal was deficient, but permitted plaintiff to file another request. The court also stayed the litigation until October 29, 2003. The court has granted the motion of the director defendants to stay discovery. There is no indication at present that the lawsuit will have a material effect on Borland’s financial condition, results of operations or liquidity.

           From time to time, we may be involved in other lawsuits, claims, investigations and proceedings, consisting of intellectual property, commercial, employment and other matters, which arise in the ordinary course of business. In accordance with Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies,” or SFAS 5, we make a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts

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of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case. Litigation is inherently unpredictable. However, we believe that we have valid defenses with respect to the legal matters pending against us, as well as adequate provisions for any probable and estimable losses. If an unfavorable ruling were to occur in any specific period, there exists the possibility of a material adverse impact on the results of operations for that period. We believe that, given our current liquidity and cash and investment balances, even were we to receive an adverse judgment with respect to litigation that we are currently a party to, it is likely that such a judgment would not have a material impact on our financial condition, results of operations or liquidity.

NOTE 10—LOAN RECEIVABLE WRITE-OFF

           At December 31, 2002, we had a loan receivable with a book value of $2.2 million related to a loan to AltoWeb, Inc., or AltoWeb, a provider of J2EE applications. In April 2003, AltoWeb informed us that it had ceased substantially all of its operations. We recorded the write-off of this loan receivable of $2.2 million during the three months ended March 31, 2003. Since our investment in AltoWeb was related to AltoWeb’s attempt to extend their product development efforts for the Borland platform, we have included these expenses in research and development. This charge is reflected in the six-month period ended June 30, 2003.

NOTE 11—INDEMNIFICATIONS AND GUARANTEES

           As permitted under our Restated Certificate of Incorporation, Amended and Restated Bylaws and the Delaware General Corporation Law, we have entered into agreements whereby we indemnify our officers, directors and certain employees for certain events or occurrences while the officer, director or employee is, or was, serving at our request in such capacity.

           We have entered into an agreement for the outsourcing of our order fulfillment. As a component of this agreement, we guarantee that in the event we terminate the fulfillment agreement, we will purchase all inventory held by the vendor at the time of termination. We estimate and accrue reserves for excess inventory held by the fulfillment vendor. As of June 30, 2003, we had inventory in excess of the reserves of approximately $0.3 million, which represents the potential obligation relating to this guarantee.

           From time to time, we engage various professional service firms which require as a condition to their engagement that we undertake to indemnify them for all claims and damages arising out of their engagement. In the recent past, we have not been subject to any significant claims for such losses and have not incurred any material costs in defending or settling claims related to these indemnification obligations. Accordingly, we believe the estimated fair value of these obligations is not material.

           We undertake indemnification obligations in our ordinary course of business in connection with, among other things, the licensing of our products and the provision by us of consulting services. Pursuant to these agreements, we may indemnify the other party for certain losses suffered or incurred by the indemnified party, generally our business partners or customers, in connection with various types of claims, which may include, without limitation, claims of intellectual property infringement, certain tax liabilities, negligence and intentional acts in the performance of services and violations of laws. The term of these indemnification obligations is generally perpetual. In general, we attempt to limit the maximum potential amount of future payments we could be required to make under these indemnification obligations to the purchase price paid, but in some cases the obligation may not be so limited. In addition, we may, in certain situations, warrant that, for a certain period of time from the date of delivery, our software products will be free from defects in media or workmanship. From time to time, we may also warrant that our professional services will be performed in a good and workmanlike manner. In addition, it is our standard policy to seek to disclaim most warranties, including any implied or statutory warranties such as warranties of merchantability, fitness for a particular purpose, quality and non-infringement, as well as any liability with respect to incidental, consequential, special, exemplary, punitive or similar damages. In some states, such disclaimers may not be enforceable. If necessary, we would provide for the estimated cost of product and service warranties based on specific warranty claims and claim history. In the recent past, we have not been subject to any significant claims for such losses and have not incurred any material costs in defending or settling claims related to these indemnification obligations. Accordingly, we believe the estimated fair value of these agreements is not material.

           During the six months ended June 30, 2003, we entered into an operating lease for our U.S. regional sales headquarters office in Cupertino, California. In the event that we do not exercise our option to extend the term of the

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lease, we guarantee certain costs to restore the property to certain conditions in place at the time of lease. We are accruing the estimated lease restoration costs over the lease term.

NOTE 12—RECENT ACCOUNTING PRONOUNCEMENTS

           In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” or SFAS 150. SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires an issuer to classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. It is to be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of SFAS 150 and still existing at the beginning of the interim period of adoption. Restatement is not permitted. We do not expect the adoption of SFAS 150 to have a material impact upon our financial condition, cash flows or results of operations.

           In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” or SFAS 149, which amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” or SFAS 133, for certain decisions made by the FASB Derivatives Implementation Group. In particular, SFAS 149 (1) clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, (2) clarifies when a derivative contains a financing component, (3) amends the definition of “an underlying” to conform it to language used in term because it is within the scope of FASB Interpretation, or FIN, No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” or FIN 45, and (4) amends certain other existing pronouncements. SFAS 149 is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. In addition, most provisions of SFAS 149 are to be applied prospectively. We do not expect the adoption of SFAS 149 to have a material impact upon our financial condition, cash flows or results of operations.

           In January 2003, the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities,” or FIN 46. Until this interpretation, a company generally included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns. We have adopted the requirements of FIN 46.

           In December 2002, the FASB issued SFAS 148. SFAS 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS 148 is effective for financial statements for years ending after December 31, 2002. We have adopted the disclosure requirements of SFAS 148.

           In November 2002, the EITF reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables,” or EITF 00-21. EITF 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF 00-21 apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. We do not believe the adoption of EITF 00-21 will have a material impact on our financial condition or results of operations.

           In November 2002, the FASB issued FIN 45. FIN 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value, or market value, of the obligations it assumes under that guarantee. However, the provisions related to recognizing a liability at inception of the guarantee for the fair value of the guarantor’s obligations does not apply to product warranties or to guarantees accounted for as derivatives. The initial recognition and initial measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002.

           In June 2002, the FASB issued SFAS 146. SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF 94-3. SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability

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for an exit cost as defined in EITF 94-3 was recognized at the date of an entity’s commitment to an exit plan. SFAS 146 eliminates the definition and requirements for recognition of exit costs in EITF 94-3. SFAS 146 also establishes that fair value is the objective for initial measurement of the liability. SFAS 146 is applicable for all exit activity initiated after December 31, 2002. Our adoption of SFAS 146 did not have a material impact on our results of operation, financial condition or cash flows.

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

Safe Harbor

           The statements made throughout this Quarterly Report on Form 10-Q that are not historical facts are forward-looking statements and, accordingly, involve estimates, projections, goals, forecasts, assumptions and uncertainties that could cause actual results or outcomes to differ materially from those expressed or implied in the forward-looking statements.

           These forward-looking statements may relate to, without limitation, future capital expenditures, acquisitions, timing of the integration of acquired businesses, the ultimate cost of acquired businesses, revenue “pipeline,” revenues, including revenues from recently acquired businesses, cash flows, earnings, margins, costs, strategy, demand for our products, market and technological trends in the software industry, effective tax rates, interest rates, foreign currency exchange rates and inflation and various economic and business trends. Generally, you can identify forward-looking statements by the use of words such as “expect,” “estimate,” “project,” “budget,” “forecast,” “anticipate,” “goal,” “intend,” “plan,” “may,” “will,” “could,” “should,” “believes,” “predicts,” “potential,” “continue” and similar expressions or the negative or other variations thereof. These forward-looking statements involve substantial risks and uncertainties. Examples of such risks and uncertainties are described under “Factors That May Affect Future Results and Market Price of Stock” and elsewhere in this report, as well as in our other filings with the SEC or in materials incorporated by reference herein or therein. You should be aware that the occurrence of any of these risks and uncertainties may cause our actual results to differ materially from those anticipated in our forward-looking statements and have a material and adverse effect on our business, results of operations and financial condition. New factors may emerge from time to time, and it is not possible for us to predict new factors, nor can we assess the potential effect of any new factors on us.

           These forward-looking statements are found at various places throughout this Form 10-Q. We caution you not to place undue reliance on these forward-looking statements, which, unless otherwise indicated, speak only as of the date they were made. We do not undertake any obligation to update or release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date of this Form 10-Q, except as required by law.

General

           We were incorporated in California in 1983 and reincorporated in Delaware in 1989. We maintain our corporate headquarters at 100 Enterprise Way, Scotts Valley, California 95066-3249 , and our main telephone number at that location is 831-431-1000. We also maintain a Web site on the Internet at http://www.borland.com and a community site at http://bdn.borland.com.

           All Borland brand and product names are trademarks or registered trademarks of Borland Software Corporation, in the United States and other countries. This Form 10-Q also contains additional trade names, trademarks and service marks claimed by other companies. We do not intend our use or display of other parties’ trademarks, trade names or service marks to imply a relationship with, or endorsement or sponsorship of, us by these other parties.

Overview of the Operations

           We are a leading global provider of software development and deployment solutions. We provide our customers with a comprehensive solution designed to help them deliver better software faster by offering products that address the definition, design, development, testing and deployment phases of the application development lifecycle and products that help customers manage software development projects from beginning to end. Our standards-based solutions are designed to improve software quality, accelerate the delivery of software, lower the cost of ownership and reduce the risk of errors. We have an installed base of over three million users worldwide, including leading enterprises in the following industries: high technology, telecommunications, financial services and government contractors in the fields of space and defense.

           We believe that our customers turn to us because our products and services offer the following benefits:

Comprehensive Solution. We offer our customers products and services for each of the key phases of the application development lifecycle. We believe this comprehensive solution helps our customers

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rapidly and effectively create and implement applications critical to their businesses and offers those customers a single vendor to resolve their technological issues.  

Value Proposition. Our products are designed to allow companies to deploy their applications in environments that utilize a variety of technology platforms and to deploy web strategies for e-business applications integrated with legacy client-server software and hardware architecture. By doing so, our products enable businesses to increase the value of their existing infrastructure and minimize the need for new computing infrastructure investment.

Quality Enhancement. Our products are designed to enhance the quality of the applications our customers produce. By integrating requirements, modeling, development and optimization, we believe our products allow fewer iterations in the application development lifecycle and assist in the production of higher quality applications. Additionally, various products in our comprehensive solution are designed to help developers audit the quality of the code that they produce, enhance the performance and efficiency of their code and assure higher-quality code by testing it for defects and against required parameters.

Freedom of Choice. Our products are designed to work with most major technology platforms. Unlike software solutions from major system vendors that encourage customers to purchase all of their technology infrastructure on a particular platform, our products are designed to provide interoperability between competing technologies. This provides customers with the flexibility to choose the best solution, technology and vendors and still achieve a fully integrated solution for software implementation.

Deep Integration. We offer our customers a collection of deeply integrated, highly interconnected application lifecycle management solutions. These solutions are designed to help our customers learn our products quickly, get wider product adoption rates with their organizations sooner and build better software faster.

Accelerated Application Development and Deployment. Our products are designed to maximize developer productivity by simplifying the process of defining, designing, developing, testing and deploying software applications and by providing teams with valuable software configuration management, or SCM, capabilities. As a result, our customers can create higher-quality applications and deliver their applications faster.

Superior User Experience. We believe customers turn to us because our solutions provide them with a high-quality user experience. Our products have won numerous awards, and we maintain an installed base of more than three million users worldwide.

           Our goal is to become the leading provider of technology solutions for the rapid and effective creation and implementation of software applications, particularly in Java, .NET and C++. Key elements of our strategy to achieve this goal include:

delivering our comprehensive application lifecycle management solutions to large enterprises;

increasing the level of integration of our suite of products in a way that makes our solution more effective and easier to use;

developing leading solutions for the .NET platform;

strengthening our strong position in Java development solutions;

developing leading solutions for mobile platforms;

promoting platform independence and interoperability by offering products for the development of applications spanning multiple platforms and heterogeneous environments;

capitalizing on the strength of the “Borland” brand and our worldwide distribution network to sell our new solutions to a broader base of potential customers; and

focusing on the needs of our installed base.

           To achieve this goal, we offer products and services that address the definition, design, development, testing and deployment phases of the software development process and that help customers with their SCM needs. We support our growth strategy through our sales and marketing efforts and through particular attention to our research and development activities. We believe our platform-independent solutions maximize development team

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productivity, ensure higher-quality code and increase the value that enterprises can mine from their existing technology infrastructure.

           We also provide training, consulting and support services through our dedicated professional services organization. In addition, we provide service and support for software developers worldwide through an online developer community, http://bdn.borland.com, and an e-commerce site, http://shop.borland.com, which offers a range of technical information, value-added services and third-party products.

Overview of the Consolidated Statements of Operations

           The following table presents our Consolidated Statements of Operations data and the related percentage of revenues for the three and six months ended June 30, 2003 and 2002 (in thousands):

Overview of the Results of Operations for the Three and Six Months Ended June 30, 2003

           We believe our financial performance for the first six months of 2003 was solid, despite the challenging economic conditions for the software industry, due in part to the acquisitions of TogetherSoft and Starbase. Revenues from these acquisitions accounted for $20.2 million and $37.2 million of our total revenue for the three and six months ended June 30, 2003, respectively.

           When customers curtail their information technology, or IT, budgets, elect to purchase less software or delay such purchases indefinitely, our business—like that of competitors and software industry peers—suffers. However, we believe that we are well-positioned to improve our financial performance upon the eventual return to growth in IT spending worldwide because our solutions offer our customers a clear return on investment, or ROI. With many customers having invested significantly in computing hardware and network infrastructure in recent years, software development and deployments such as ours are valuable because they can be used to facilitate the efficient production and/or migration of software for systems currently in place.

           During the three months and six months ended June 30, 2003, we continued to focus on improving our operating model and on positioning Borland for success when corporate IT and software spending returns to healthier levels. Specifically, we focused on:

Leadership Across Platforms. We believe that our success hinges, in part, on our ability to deliver best-in-class solutions across a wide range of technology platforms, including Java and .NET. As part of this commitment, we released the following new products during the three months ended June 30, 2003:

Janeva, a new solution that is designed to enable cross-platform mobility by offering companies a secure and scalable means of linking J2EE and .NET;

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C#Builder, a completely new Borland product that offers a comprehensive, design-driven solution for the development of .NET applications; and

JBuilder 9, the most recent version of our leading Java development environment which offers users greater integration with our other application lifecycle components.

Solution Selling. Our move to selling entire application lifecycle solutions to our customers is designed to result in larger contracts with our customers. In the three months ended June 30, 2003, we entered into 102 sales contracts over $100,000, up from 93 such contracts in the three months ended March 31, 2003. In addition, a number of these transactions in the three months ended June 30, 2003 included multi-product sales. We believe our transition from single product sales to solution selling will provide us with an opportunity for growth in the future.

Cost Control and Financial Discipline. We continue to pay close attention to our cost structure in order to maintain and grow operating cash flow. As part of this commitment, we undertook a reduction in force in the three months ended March 31, 2003, which resulted in lower operating expenditures during the three months ended June 30, 2003. In addition, in an effort to minimize operating expenditures, we consolidated a number of our facilities during the three months ended June 30, 2003.

Selective Acquisitions. We continue to pursue acquisitions that better position us to increase revenue growth and serve our customers’ technology needs. During the first half of 2003, we completed the acquisitions of Starbase and TogetherSoft, and made substantial strides in our efforts to integrate Starbase and TogetherSoft, both of which contributed to our Design product group performance during the first half of 2003.

Balance Sheet Strength. We believe that our balance sheet strength—particularly in a weak capital markets environment—is a key factor that enables us to successfully and effectively pursue our major objectives, including sustained research and development, acquisitions, and investments in sales and marketing. We finished the second quarter of 2003 with approximately $205 million in cash and short-term investments and no long-term debt.

Strengthening Strategic Relationships. We are focused on developing closer relationships with leading technology providers, system integrators and other partners who may provide us with access to key technologies and a broader potential customer base. In furtherance of this goal, we entered into strategic relationships with Fujitsu, Microsoft, Nokia, SAP and Sony Ericsson during the three months ended June 30, 2003.

International Diversification. We market and sell our solutions worldwide, and we believe that our brand recognition in the IT community is strong both in the United States and internationally. As a result, we believe we are positioned to benefit from pockets of economic strength worldwide. In the three months ended June 30, 2003, approximately 54% of our revenue came from outside the United States. Our European region continued to perform well (representing 35% of our revenue for the three months ended June 30, 2003), despite economic weakness in selected countries. While generally our Asia-Pacific region experienced economic weakness (notably in Korea and Japan), Australia, New Zealand, China and India delivered their best quarters in recent history. We believe that our geographic diversification will continue to benefit us in the future.

           As a result of these efforts and the addition of Starbase and TogetherSoft to our operations, we achieved the following financial results during the first half of 2003:

For the three months ended June 30, 2003, net revenues grew 28% to $76.3 million, including $20.2 million in revenue associated with the operations we assumed in our acquisitions of Starbase and TogetherSoft, from $59.7 million for the three months ended June 30, 2002. For the six months ended June 30, 2003, net revenues grew 29% to $150.6 million, including $37.2 million in revenues associated with the operations we assumed in our acquisitions of Starbase and TogetherSoft, from $116.8 million for the six months ended June 30, 2002.

Licenses and other revenues increased 13% to $56.6 million for the three months ended June 30, 2003 from $50.1 million for the three months ended June 30, 2002. Licenses and other revenues increased 16% to $113.4 million for the six months ended June 30, 2003 from $97.8 million for the six months ended June 30, 2002.

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Service revenues increased 104% and 95% for the three and six months ended June 30, 2003, respectively, over the same periods in 2002. Service revenues increased 12% in the second quarter of 2003 as compared with the first quarter of 2003.

Gross margins increased to 86% for the three months ended June 30, 2003 from 85% for the three months ended June 30, 2002. Gross margins increased to 87% for the six months ended June 30, 2003 from 85% for the six months ended June 30, 2002.

Operating expenses increased 52% to $70.6 million for the three months ended June 30, 2003 from $46.4 million for the three months ended June 30, 2002. Operating expenses increased 68% to $152.7 million for the six months ended June 30, 2003 from $90.9 million for the six months ended June 30, 2002.

We had a net loss of $5.0 million for the three months ended June 30, 2003, compared to net income of $4.7 million for the three months ended June 30, 2002. We had a net loss of $22.7 million for the six months ended June 30, 2003, compared to net income of $9.3 million for the six months ended June 30, 2002.

Expenses from the amortization of intangible assets increased to $5.9 million and $11.2 million for the three and six months ended June 30, 2003, respectively, from $0.2 million and $0.4 million for the three and six months ended June 30, 2002, respectively, primarily as a result of our acquisitions of Starbase and TogetherSoft.

Cash, cash equivalents and short-term investments stood at $205.4 million as of June 30, 2003, a decrease of approximately $100 million from June 30, 2002. The decrease is primarily attributable to cash expended in connection with the acquisitions of Starbase and TogetherSoft.

We repurchased a total of 695,000 shares of our stock under our stock repurchase program for a total cost of $6.8 million during the first six months of 2003.

           For a more in-depth discussion of our business, including a discussion of our critical accounting policies and estimates, please read our Annual Report on Form 10-K for the year ended December 31, 2002 as filed with the SEC on March 28, 2003.

Net Revenues

           The following table presents our net revenues for the three and six months ended June 30, 2003 and 2002 (in thousands):

           Licenses and Other Revenues

           With the integration of the acquisitions of TogetherSoft and Starbase, we have aligned our presentation of licenses and other revenues to better reflect our application lifecycle management strategy. Specifically, we see three major product categories: Design, Develop and Deploy. Design includes the products from our recent acquisitions of TogetherSoft and Starbase: StarTeam, CaliberRM, Together and other related design and management products. Develop includes two major categories: Java, which includes JBuilder, Java Studio and Optimizeit, and .NET, which includes Delphi, C++Builder, Kylix and C++ Mobile Edition. Deploy is comprised of our Borland Enterprise Server products, InterBase and other enterprise products.

           Compared to our previous reporting, Design essentially encompasses the acquired products from Starbase and TogetherSoft, Develop encompasses our former Java and RAD product lines for which we break out revenues from Java and .NET, and Deploy encompasses the products that we previously described as the Enterprise product group. We have sought to provide comparability between historic product groups while updating our nomenclature to reflect new platforms and our emphasis on the application development lifecycle.

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           Licenses and other revenues represent amounts for license fees and royalties earned for granting customers the right to use our software products. Licenses and other revenues were $56.6 million and $50.1 million for the three months ended June 30, 2003 and 2002, respectively, and represented 74% and 84% of net revenues for the three months ended June 30, 2003 and 2002, respectively. Licenses and other revenues were $113.4 million and $97.8 million for the six months ended June 30, 2003 and 2002, respectively, and represented 75% and 84% of net revenues for the six months ended June 30, 2003 and 2002, respectively.

           The following table presents our licenses and other revenues by product category for the three and six months ended June 30, 2003 and 2002 (in thousands):

           Design.   Licenses and other revenues from our Design product group for the three and six months ended June 30, 2003 consisted of approximately $14.5 million and $26.2 million, respectively. There were no licenses and other revenues from our Design product group in the three or six months ended June 30, 2002, as we completed the acquisitions of TogetherSoft and Starbase and began consolidating their results in January 2003 and December 2002, respectively.  

           Develop.  Licenses and other revenues from our Develop product group included licenses and other revenues of $21.9 million and $25.9 million in the three months ended June 30, 2003 and 2002, respectively, from our Java product lines. The decrease in licenses and other revenues in our Java product lines was due to lower revenues from our JBuilder product. Licenses and other revenues from our Develop product group included licenses and other revenues of $43.2 million and $47.3 million in the six months ended June 30, 2003 and 2002, respectively, from our Java product lines. The decrease in licenses and other revenues in our Java product lines was due to lower revenues from our JBuilder product line partially offset by growth in our Optimizeit product line. The decrease in the JBuilder license revenue was due to lower upgrade revenues from our latest release, JBuilder 9, when compared with the release of JBuilder 7 in the three months ended June 30, 2002. We believe that licenses and other revenues from JBuilder will not be as dependent on future releases as the technology platform matures and more of our customers purchase software support services that provide customers with product upgrades. Licenses and other revenues from our Develop products group included licenses and other revenues of $10.7 million and $13.0 million in the three months ended June 30, 2003 and 2002, respectively, from our .NET product lines. Licenses and other revenues from our Develop products group included licenses and other revenues of $24.7 million and $28.0 million in the six months ended June 30, 2003 and 2002, respectively, from our .NET product lines. The decrease in licenses and other revenues from our .NET product lines was due to lower licenses and other revenues generated from our C++ products. This decrease was primarily attributable to the lack of a major product version release during the six months ended June 30, 2003 compared to the six months ended June 30, 2002, which included the release of C++Builder 6.

           Deploy.  Licenses and other revenues from our Deploy product group were $9.6 million and $11.2 million in the three months ended June 30, 2003 and 2002, respectively. Licenses and other revenues from our Deploy product group were $19.3 million and $22.5 million in the six months ended June 30, 2003 and 2002, respectively. The decrease in licenses and other revenues was due to lower revenues generated from our VisiBroker and application server products. Lower licenses and other revenues from these products resulted principally from a lower volume of sales in the Americas. We believe that this reduction in licenses and other revenues from our Deploy products was a result of general economic weakness and geopolitical uncertainty. Revenue growth from our Deploy products category will depend upon the recovery in corporate spending for deployment solutions, our ability to provide compelling technical solutions for software deployment to differentiate ourselves from our competitors and our ability to integrate our Deploy products with our Design and Develop products.

           Service Revenues

           Service revenues represent amounts earned for technical support, consulting and training services for our software products. Net service revenues were $19.6 million and $9.6 million for the three months ended June 30, 2003 and 2002, respectively, representing 26% and 16% of net revenues for those periods, respectively. Service revenues increased $10.0 million in the three months ended June 30, 2003 from the three months ended

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June 30, 2002 primarily as a result of an increase in technical support revenues and, to a lesser extent, an increase in consulting revenue. Technical support revenues were $12.9 million and $6.1 million in the three months ended June 30, 2003 and 2002, respectively, and represented 65% and 63% of total service revenues in the three months ended June 30, 2003 and 2002, respectively. The growth in the technical support revenues in the three months ended June 30, 2003 from the three months ended June 30, 2002 was due to the increase in support revenues associated with our assumption of the support obligations from the acquisitions of TogetherSoft and Starbase. Consulting revenues were $5.2 million and $1.9 million in the three months ended June 30, 2003 and 2002, respectively, and represented 27% and 20% of total service revenues in the three months ended June 30, 2003 and 2002, respectively. The increase in the consulting revenue for the three months ended June 30, 2003 when compared with the same period in the prior year was due to an increased emphasis on products with a greater process focus (our Design products) and approximately $2.5 million in consulting revenue recognized from large development projects with three technology partners. Based upon our progress to date on these projects, we expect consulting revenues from the development projects to decrease by approximately $1.2 million for the three months ended September 30, 2003 with substantially lower levels in the following quarters.

           Net service revenues were $37.2 million and $19.0 million for the six months ended June 30, 2003 and 2002, respectively, representing 25% and 16% of net revenues for those periods, respectively. Service revenues increased $18.2 million in the six months ended June 30, 2003 from the six months ended June 30, 2002 primarily as a result of an increase in technical support revenues and, to a lesser extent, an increase in consulting revenues. Technical support revenues were $24.9 million and $12.5 million in the six months ended June 30, 2003 and 2002, respectively, and represented 67% and 65% of total service revenues in the six months ended June 30, 2003 and 2002, respectively. The growth in the technical support revenues in the six months ended June 30, 2003 from the six months ended June 30, 2002 was due to the increase in support revenues associated with our assumption of the support obligations from the acquisitions of TogetherSoft and Starbase. Consulting revenues increased from $3.8 million for the six months ended June 30, 2002 to $9.2 million for the six months ended June 30, 2003. The increase in the consulting revenues for the six months ended June 30, 2003 when compared with the same period in the prior year was due to an increased emphasis on products with a greater process focus (our Design products) and approximately $4.0 million in consulting revenue recognized from large development projects with three technology partners. Over the longer term, we expect growth, if any, in our support revenues and our consulting revenues to depend on our success in selling our solutions into larger enterprises with greater frequency. Our service revenues may also grow as our new enterprise solution offerings increase in complexity and include more services as a component of larger sales contracts. We may experience decreases in our consulting revenue on a quarter-to-quarter basis as we complete large consulting engagements and if we are unsuccessful in expanding or renewing such engagements.

           International Net Revenues

           Revenues from sources outside the United States, or non-U.S. revenues, represented approximately 54% and 62% of net revenues for the three months ended June 30, 2003 and 2002, respectively. Non-U.S. revenues represented approximately 55% and 62% of net revenues for the six months ended June 30, 2003 and 2002, respectively. The decrease in the percentage of non-U.S. revenues for the three and six months ended June 30, 2003, as compared to the same periods in 2002, was principally due to net revenues generated from our newly-acquired Design products in the U.S. We expect non-U.S. revenues to continue to be a significant portion of our net revenues in future periods, though the U.S. percentage is expected to be higher in 2003 as compared with 2002 due to the acquisitions of Starbase and TogetherSoft which had sales channels with a greater U.S. focus.

           Fluctuations in foreign currency exchange rates did not have a material impact on our net revenues or operating results for the three- or six-month periods ended June 30, 2003 and 2002. However, our non-U.S. revenues would be harmed if the U.S. dollar were to strengthen against major foreign currencies, including the Japanese Yen, Euro and United Kingdom Pound Sterling. The following table presents our net revenues by region (in thousands):

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Cost of Revenues

           Cost of Licenses and Other Revenues

           Cost of licenses and other revenues consists primarily of production costs, product packaging costs and royalties paid to third-party vendors. Cost of licenses and other revenues were $3.0 million and $3.6 million for the three months ended June 30, 2003 and 2002, respectively, representing 4% and 6% of total licenses and other revenues in the three months ended June 30, 2003 and 2002, respectively. Cost of licenses and other revenues were $6.1 million and $7.1 million for the six months ended June 30, 2003 and 2002, respectively, representing 4% and 6% of total licenses and other revenues in the six months ended June 30, 2003 and 2002, respectively. The reduction in the cost of licenses and other revenues was principally attributable to a reduction in direct production costs as we had a larger percentage of our licenses and other revenues generated from large corporate contracts. Typically, large enterprise and corporate licenses are delivered electronically or represent additional licenses of software that have already been delivered. This has the impact of reducing our overall production costs. Royalty costs were 2% of licenses and other revenues for the three and six months ended June 30, 2003 and 2002. The level of royalty costs in future periods will depend on our ability to obtain favorable licensing terms for our products that include third-party technology and the extent to which we include such third-party technology in our product offerings.

           Cost of Service Revenues

           Cost of service revenues consists primarily of salaries and benefits, third-party contractor costs and related expenses incurred in providing customer support, consulting and training. Cost of service revenues were $7.3 million and $5.4 million for the three months ended June 30, 2003 and 2002, respectively, representing 37% and 56% of service revenues in the three months ended June 30, 2003 and 2002, respectively. Cost of technical support revenues represented 25% and 29% of the cost of service revenues for the three months ended June 30, 2003 and 2002, respectively, while cost of consulting and training revenues represented 75% and 71%, respectively, of the cost of service revenues for the same periods. Service revenues gross margins were 63% and 44% in the three months ended June 30, 2003 and 2002, respectively. Cost of service revenues were $13.9 million and $10.4 million for the six months ended June 30, 2003 and 2002, respectively, representing 37% and 55% of service revenues in the six months ended June 30, 2003 and 2002, respectively. Cost of technical support revenues represented 26% and 29% of the cost of service revenues for the six months ended June 30, 2003 and 2002, respectively, while cost of consulting and training revenues represented 74% and 71%, respectively, of the cost of service revenues for the same periods. Service revenues gross margins were 63% and 45% in the six months ended June 30, 2003 and 2002, respectively. The increase in gross margins for the three and six month periods ended June 30, 2003 when compared with the three and six month periods ended June 30, 2002 was due to an increase in support revenues resulting from the assumed support obligations from the acquisitions of TogetherSoft and Starbase. In future periods, we expect increases in our cost of service revenues as our service revenues grow and the consulting and training revenues become a larger component of service revenues.

Operating Expenses