NETMANAGE INC - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

[ü] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2002

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ___________________ to __________________

Commission file number 0-22158

NetManage, Inc.

(Exact name of registrant as specified in its charter)


Delaware		77-0252226




(State or other jurisdiction of		(IRS employer




Incorporation or organization)		identification no.)

10725 North De Anza Boulevard
Cupertino, California 95014
(Address of principal executive offices, including zip code)

(408) 973-7171
(Registrant’s telephone number, including area code)

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

YES [ ] NO [ü]

Number of shares of registrant’s common stock outstanding as of November 15, 2002: 8,882,231

TABLE OF CONTENTS


	CONDENSED CONSOLIDATED BALANCE SHEETS
	CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
	CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
	CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
	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
CERTIFICATIONS
EXHIBIT INDEX
EXHIBIT 3.1

NETMANAGE, INC.
Table of Contents


		Page

PART I	FINANCIAL INFORMATION




Item 1	Financial Statements




	Condensed Consolidated Balance Sheets at September 30, 2002 and December 31, 2001 (As restated)		3




	Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2002 and September 30, 2001 (As restated)		4




	Condensed Consolidated Statements of Comprehensive Loss for the three and nine months ended September 30, 2002 and September 30, 2001 (As restated)		5




	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 and September 30, 2001 (As restated)		6




	Notes to Condensed Consolidated Financial Statements		7




Item 2	Management’s discussion and analysis of financial condition and results of operations		19




Item 3	Quantitative and qualitative disclosures about market risk		41




Item 4	Controls and procedures		42




PART II	OTHER INFORMATION




Item 1	Legal proceedings		42




Item 2	Changes in securities and use of proceeds		42




Item 3	Defaults upon senior securities		43




Item 4	Submission of matters to a vote of security holders		43




Item 5	Other information		43




Item 6	Exhibits and reports on Form 8-K		43




	Signatures		44




	Certifications		45

NETMANAGE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
(Unaudited)


		September 30, 2002			December 31, 2001

						(As restated, See Note 12)
ASSETS




Current assets:




	Cash and cash equivalents	$	28,536		$	32,766




	Short-term investments		33			792




	Accounts receivable, net of allowances of $2,111 and $2,448, respectively		6,912			17,801




	Prepaid expenses and other current assets		3,387			3,487

	Total current assets		38,868			54,846

Property and equipment, at cost:




	Computer software and equipment		1,364			9,259




	Furniture and fixtures		5,458			6,138




	Leasehold improvements		1,523			2,805

			8,345			18,202




	Less — Accumulated depreciation		(5,955	)		(14,319	)

	Net property and equipment		2,390			3,883
Goodwill, net			6,701			6,701




Other intangibles, net			5,153			7,530




Other assets			1,548			3,133

	Total assets	$	54,660		$	76,093

LIABILITIES AND STOCKHOLDERS’ EQUITY




Current liabilities:




	Accounts payable	$	1,811		$	2,691




	Accrued liabilities		10,321			7,261




	Accrued payroll and payroll-related expenses		2,972			3,279




	Deferred revenue		14,171			21,627




	Income taxes payable		1,493			1,861

	Total current liabilities		30,768			36,719
Long-term liabilities			160			286

	Total liabilities		30,928			37,005




Commitments and contingencies (Note 9)




Stockholders’ equity:




	Common stock, $0.01 par value




	Authorized -125,000,000 shares




	Issued - - 10,614,346 and 10,528,631 shares, respectively




	Outstanding - 8,847,340 and 9,140,115 shares, respectively		106			105




	Treasury stock, at cost - 1,767,006 and 1,388,516 shares, respectively		(20,221	)		(18,267	)




	Additional paid-in capital		177,762			177,421




	Accumulated deficit		(131,326	)		(115,799	)




	Accumulated comprehensive loss		(2,589	)		(4,372	)

	Total stockholders’ equity		23,732			39,088

	Total liabilities and stockholders’ equity	$	54,660		$	76,093

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

NETMANAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)


				Three months ended						Nine months ended
				September 30,						September 30,

				2002			2001			2002			2001

							(As restated, see Note 12)						(As restated, see Note 12)
Net revenues:




	License fees			$	5,477		$	7,873		$	23,588		$	28,681




	Services				8,616			9,795			25,777			31,045

		Total net revenues			14,093			17,668			49,365			59,726

Cost of revenues:




	License fees				379			791			1,761			2,598




	Services				1,561			1,948			4,877			6,211

		Total cost of revenues			1,940			2,739			6,638			8,809

Gross margin					12,153			14,929			42,727			50,917

Operating expenses:




	Research and development				3,130			3,817			10,319			14,317




	Sales and marketing				8,448			9,713			28,234			34,850




	General and administrative				3,729			2,065			8,699			8,747




	Restructuring charge				4,614			—			4,614			—




	Amortization of intangible assets				793			1,445			2,378			4,333

			Total operating expenses		20,714			17,040			54,244			62,247

Loss from operations					(8,561	)		(2,111	)		(11,517	)		(11,330	)




Loss on investments					(2,534	)		—			(2,534	)		(1,824	)




Interest income and other, net					69			237			272			2,082




Foreign currency transaction losses					(79	)		(231	)		(1,387	)		(429	)

Loss before provision for income taxes					(11,105	)		(2,105	)		(15,166	)		(11,501	)




Provision for income taxes					160			132			361			719

Net loss				$	(11,265	)	$	(2,237	)	$	(15,527	)	$	(12,220	)

Net loss per share:




	Basic and diluted			$	(1.27	)	$	(0.24	)	$	(1.73	)	$	(1.31	)




Weighted average common shares and equivalents:




	Basic and diluted				8,878			9,281			8,980			9,317

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

NETMANAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)
(Unaudited)


		Three months ended						Nine months ended
		September 30,						September 30,

		2002			2001			2002			2001

					(As restated, see Note 12)						(As restated see Note 12)
Net loss		$	(11,265	)	$	(2,237	)	$	(15,527	)	$	(12,220	)




Other comprehensive income (loss):




	Unrealized loss on investments, net		—			(684	)		—			(617	)




	Foreign currency translation adjustments, net		(235	)		38			1,784			435

Comprehensive loss		$	(11,500	)	$	(2,883	)	$	(13,743	)	$	(12,402	)

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

NETMANAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)


				Nine months ended
				September 30,

				2002			2001

							(As restated, see note 12)
Cash flows from operating activities:




	Net loss			$	(15,527	)	$	(12,220	)




	Adjustments to reconcile net loss to net cash used in operating activities:




		Depreciation and amortization			3,796			7,229




		Write-off of prepaid royalty, patents and copyrights			—			23




		Provision for doubtful accounts and returns			24			(43	)




		Loss on disposal of property, plant & equipment			526			—




		Loss on exchange of marketable securities			758			1,824




		Loss of investments			1,773			—




		Changes in assets and liabilities:




			Accounts receivable		10,896			11,682




			Prepaids and other current assets		233			328




			Refundable income taxes		—			7,467




			Other assets		(15)			381




			Accounts payable		(779	)		(1,674	)




			Accrued liabilities, payroll and payroll-related expenses		3,321			(9,373	)




			Deferred revenue		(7,214	)		(4,844	)




			Income taxes payable		(98	)		290




			Long-term liabilities		(126	)		(1,336	)

			Net cash used in operating activities		(2,432	)		(266	)

Cash flows from investing activities:




		Purchases of short-term investments			(11	)		(111,830	)




		Proceeds from sales and maturities of short term investments			11			112,683




		Purchase of property and equipment			(563	)		(398	)

			Net cash provided by (used in) investing activities		(563	)		455

Cash flows from financing activities:




		Proceeds from sale of common stock, net of issuance costs			342			539




		Purchases of common stock			(1,954	)		(964	)

			Net cash used in financing activities		(1,612	)		(425	)

Effect of exchange rate changes on cash					377			625

Net increase (decrease) in cash and cash equivalents					(4,230	)		389




Cash and cash equivalents, at beginning of period					32,766			35,015

Cash and cash equivalents, at end of period				$	28,536		$	35,404

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

NETMANAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Interim financial data

The accompanying interim unaudited condensed consolidated financial statements of NetManage, Inc. (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“generally accepted accounting principles”) for interim financial information and in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation. Actual results for fiscal year 2002 could differ materially from those reported in this Form 10-Q. The Company believes the results of operations for interim periods are subject to fluctuation and may not be an indicator of future financial performance. In the following notes to the condensed consolidated financial statements, the Company is also referred to as “Management”, “We”, or “Our”.

2. Consolidation

The interim unaudited condensed consolidated financial statements include our accounts and the accounts of our wholly owned subsidiaries. All inter-company accounts and transactions have been eliminated.

3. Summary of significant accounting policies:

Use of estimates

The preparation of the condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Foreign currency translation, foreign exchange contracts and comprehensive loss

The functional currency of our foreign subsidiaries is the local currency. Gains and losses resulting from the translation of the foreign subsidiaries’ financial statements are reported as a separate component of stockholders’ equity.

Comprehensive loss is comprised of net loss and other comprehensive items such as foreign currency translation gain/loss and unrealized gains or losses on marketable securities.

Cash and cash equivalents

We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents.

Short-term investments

We account for our investments under the provisions of Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities. Under SFAS No. 115, our investments are currently classified as available-for-sale securities and are reported at fair value, with unrealized gains and losses, net of tax, reported in our Consolidated Statement of Other Comprehensive Income. Held-to-maturity securities are valued using the amortized cost method. At September 30, 2002 and 2001, the fair value of the time deposit investments approximated amortized cost and, as such, gross unrealized holding gains and losses were not material. The fair value of the available-for-sale securities was determined based on quoted market prices at the reporting dates for those instruments.

Our investment in KANA Software Inc. is included in Short-term investments.

Prepaid expenses and other current assets

Prepaid expenses and other current assets as of September 30, 2002 include a $275,000 convertible bridge financing loan receivable, due December 31, 2002, from easyBASE, Ltd.

Other investments

Other investments mainly consist of equity interests in private companies with less than 20% ownership interests. These investments are accounted for under the cost method.

On May 4, 2000 we invested $1.5 million in 2,822 Series B Preferred shares of stock in easyBASE, Ltd. which is approximately 12% of the total ownership of easyBASE, Ltd. Our Chairman and Chief Executive Officer, Zvi Alon, also has a personal investment in easyBASE, Ltd. He is also a member of the easyBASE, Ltd. Board of Directors.

In May, June and December 1999 we invested a total of $275,000 in pcFirst, Inc. On April 28, 2001 pcFirst, Inc. was purchased by fusionOne, Inc., a development stage company, and we received 13,625 shares of common stock of fusionOne, Inc. Our investment represents less than 1% of the total ownership of fusionOne, Inc.

Property and equipment

Property and equipment are recorded at cost. Improvements, renewals and extraordinary repairs that extend the lives of the asset are capitalized, other repairs and maintenance are expensed. Depreciation is computed using the straight-line method over the following estimated useful lives:


Classification	Life

Computer software and equipment		2 to 3 years
Furniture and fixtures		5 years
Leasehold improvements		Shorter of the lease term or the estimated useful life

Accrued liabilities and restructuring

We account for restructuring charges under the provisions of Emerging Issues Task Force (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) and Staff Accounting Bulletin (SAB) No. 100 regarding the accounting for and disclosure of certain expenses commonly reported in connection with exit activities and business combinations.

Software development costs

Software development costs are accounted for in accordance with SFAS No. 86, Accounting for Computer Software to be Sold, Leased or Otherwise Marketed, under which capitalization of software development costs begins upon the establishment of technological feasibility of the product, which we define as the development of a working model and further define as the development of a beta version of the software. The establishment of technological feasibility and the ongoing assessment of the recoverability of these costs requires considerable judgment by management with respect to certain external factors, including, but not limited to, anticipated future gross product revenue, estimated economic life and changes in technology. Such costs are reported at the lower of amortized cost or net realizable value. Amortization of purchased software is generally computed on a straight-line basis over one to five years or, if less, the estimated remaining economic life of the underlying products. To date, software development costs that were eligible for capitalization have not been significant, and we charged all software development costs to research and development as incurred.

Concentrations of credit risk

Financial instruments which potentially subject us to concentrations of credit risk consist principally of cash investments and trade receivables. We have a cash investment policy that limits the amount of credit exposure to any one issuer and restricts placement of these investments to issuers evaluated as credit worthy. Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers comprising our customer base and their dispersion across many different industries and geographies.

We currently do not enter into financial instruments for either trading or speculative purposes.

Income taxes

As part of the process of preparing our consolidated financial statements we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or our allowance in a period changes, the amount recognized as provision for income taxes in the statement of operations could change.

Revenue recognition

We derive revenue primarily from two sources: (1) product revenue, which includes software license and royalty revenue, and (2) services and support revenue which includes software license maintenance and consulting.

We license our software products on a one and two-year term basis or on a perpetual basis. Our two-year term licenses include the first year of maintenance and support. To date such licenses have been insignificant.

We apply the provisions of Statement of Position 97-2, Software Revenue Recognition, and related amendments and interpretations to all transactions involving the sale of software products and to hardware transactions where the software is not incidental.

We recognize revenue from the sale of software licenses to end users and resellers when persuasive evidence of an arrangement exists, the product has been delivered, the fee is fixed and determinable and collection of the resulting receivable is reasonably assured. Delivery generally occurs when product is delivered to a common carrier.

Product is sold without the right of return, except for defective product that may be returned for replacement. To date, such returns have been insignificant. Certain of our sales are made to domestic distributors under agreements allowing rights of return and price protection on unsold merchandise. Accordingly, we defer recognition of such sales until the distributor sells the merchandise. Our international distributors generally do not have return rights and, as such, we generally recognize sales to international distributors upon shipment, provided all other revenue recognition criteria have been met.

At the time of the transaction, we assess whether the fee associated with our revenue transactions is fixed and determinable and whether or not collection is reasonably assured. We assess whether the fee is fixed and determinable based on the payment terms associated with the transaction. If a significant portion of a fee is due after our normal payment terms, we account for the fee as not being fixed and determinable. In these cases, we recognize revenue as the fees become due.

We assess collection based on a number of factors, including past transaction history with the customer and the credit-worthiness of the customer. We do not request collateral from our customers. If we determine that collection of a fee at the transaction date is not reasonably assured, we defer the fee and recognize revenue at the time collection becomes reasonably assured, which is generally upon receipt of cash.

For all sales, except those completed over the Internet, we use either a binding purchase order or signed license agreement as evidence of an arrangement. For sales over the Internet, we use a credit card authorization as evidence of an arrangement. Sales through our distributors are evidenced by a master agreement governing the relationship together with binding purchase orders on a transaction-by-transaction basis.

For arrangements with multiple elements (for example, undelivered maintenance and support), we allocate revenue to each component of the arrangement using the residual value method based on vendor specific objective evidence of the fair value of the undelivered elements. This means that we defer revenue from the arrangement fee equivalent to the fair value of the undelivered elements. Fair values for the ongoing maintenance and support obligations are generally based upon separate sales of renewals to other customers or upon renewal rates quoted in the contracts. Fair value of services, such as training or consulting, is based upon separate sales by us of these services to other customers.

Our arrangements do not generally include acceptance clauses. However, if an arrangement includes an acceptance provision, acceptance occurs upon the earlier of receipt of a written customer acceptance or expiration of the acceptance period.

Service revenues are derived from software updates for existing software products, user documentation and technical support, generally under annual service agreements. These revenues are recognized ratably over the terms of such agreements. If such services are included in the initial licensing fee, the value of the services determined based on vendor specific objective evidence is deferred and recognized ratably over the related service period. Service revenues derived from consulting and training are deferred and recognized when the services are performed and the collectibility is deemed probable. To date, consulting revenue has not been significant.

Cost of revenues

License cost of revenues primarily includes costs associated with order processing, product packaging, documentation and software duplication, the amortization and write-down of licensed technology and royalties paid to third parties for licensed software incorporated into our products. Services cost of revenues includes costs associated with both consulting and customer service, and consists primarily of salaries and commissions, benefits, travel, and occupancy expenses.

4. Recent accounting pronouncements

In June 2002, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standard, or SFAS, No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force, or 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). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF Issue 94-3, a liability for an exit cost as defined in EITF 94-3 was recognized at the date of an entity’s commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. We will adopt the provisions of SFAS No. 146 for exit or disposal activities that are initiated after December 31, 2002 and we do not expect that the adoption will have a material impact on our historical results of operations, our financial position or our liquidity. SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amounts recognized.

In August 2001, the Financial Accounting Standards Board issued SFAS No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 addresses financial accounting and reporting for the long-lived assets to be held and used, and disposed of. The statement will be effective for financial statements issued for fiscal years beginning after December 15, 2001. Although we do not currently expect the adoption of SFAS No. 144 to have a material impact on our financial statements, we will continue to assess any impairment of long-lived assets.

In June 2001, the Financial Accounting Standards Board issued SFAS No.’s 141 and 142, Business Combinations and Goodwill and Other Intangible Assets, respectively. SFAS No. 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. Under SFAS No. 142, effective January 1, 2002, goodwill is no longer subject to amortization over its estimated useful life. Rather, goodwill is subject to at least an annual assessment for impairment, applying a fair-value based test. Additionally, an acquired intangible asset should be separately recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented, or exchanged, regardless of the acquirer’s intent to do so.

5. Goodwill and other intangible assets, net

We adopted SFAS No. 142 beginning January 1, 2002 and discontinued amortization of all goodwill and assembled workforce intangible assets. The following table presents net loss had SFAS No. 142 been applied at the beginning of fiscal 2001 (In thousands, except loss per share):


		Three months ended						Nine months ended
		September 30,						September 30,

		2002			2001			2002			2001

Net loss, as reported		$	(11,265	)	$	(2,237	)	$	(15,527	)	$	(12,220	)




	Goodwill amortization		—			664			—			1,992




	Assembled workforce amortization		—			20			—			60

Net loss, as adjusted		$	(11,265	)	$	(1,553	)	$	(15,527	)	$	(10,168	)

Net loss per share (Basic and diluted):
	As reported	$	(1.27	)	$	(0.24	)	$	(1.73	)	$	(1.31	)




	Goodwill amortization		—			0.07			—			0.21




	Assembled workforce amortization		—			—			—			0.01

	As adjusted	$	(1.27	)	$	(0.17	)	$	(1.73	)	$	(1.09	)

Weighted average common shares and equivalents:
	Basic and diluted		8,878			9,281			8,980			9,317

Goodwill includes both the carrying amount of goodwill and assembled workforce less accumulated amortization, as follows (In thousands):


		September 30,			December 31,
		2002			2001

Carrying amount of:




	Goodwill	$	17,658		$	17,658




	Assembled workforce		1,035			1,035

Gross carrying amount of goodwill			18,693			18,693




Less accumulated amortization:




	Goodwill		(11,181	)		(11,181	)




	Assembled workforce		(811	)		(811	)

Net carrying amount of goodwill		$	6,701		$	6,701

The following table provides a summary of the carrying amounts of other intangible assets that will continue to be amortized (In thousands).


		September 30,			December 31,
		2002			2001

Carrying amount of:




	Developed technology	$	12,154		$	12,154




	Customer base		3,315			3,315




	RUMBA trade name		1,557			1,557




	Patents & copyrights		398			398

Gross carrying amount of other intangibles			17,424			17,424




Less accumulated amortization:




	Developed technology		(8,431	)		(6,709	)




	Customer base		(2,412	)		(1,991	)




	RUMBA trade name		(1,133	)		(936	)




	Patents & copyrights		(295	)		(258	)

Net carrying amount of other intangibles		$	5,153		$	7,530

SFAS No. 142 also requires companies to perform an impairment test within six months of adopting the statement. We conducted an impairment analysis of goodwill and other intangible assets and determined that no impairment existed at January 1, 2002 nor have there been any events or circumstances that would have created an impairment during the nine months ended September 30, 2002.

6. Net loss per share

On August 28, 2002, our stockholders approved a one-for-seven reverse stock split of our common stock. The reverse stock split became effective at the close of business on September 3, 2002. All share and per share information in the accompanying financial statements has been adjusted to retroactively give effect to the reverse stock split.

Basic net loss per share data has been computed using the weighted-average number of shares of common stock outstanding during the periods. Diluted net loss per share data has been computed using the weighted-average number of shares of common stock and potential dilutive common shares. Potential dilutive common shares include dilutive shares issuable upon the exercise of outstanding common stock options computed using the treasury stock method. For the three and nine month periods ended September 30, 2002 and 2001, the number of shares used in the computation of diluted loss per share were the same as those used for the computation of basic loss per share. For the three month periods ended September 30, 2002 and 2001, potentially dilutive securities of 141,694 and 991,858 shares respectively, were not included in the computation of diluted net loss per share because to do so would have been anti-dilutive. For the nine month periods ended September 30, 2002 and 2001, such potentially dilutive securities totaled 113,768 and 796,376, shares, respectively.

7. Loss on investments

In the third quarter of 2002, we determined that the investment in easyBASE, Ltd. and fusionONE, Inc. was permanently impaired, as a result of continued weakness in the software development industry and our analysis of data provided to us by both companies. In the past, we have invested in a number of companies which have developed technologies which we felt had related use with our products, and had significant opportunity in their own markets. In large part as a result of the current economy, we have determined that our investments in easyBASE and fusionONE have been permanently impaired and have written them down by $1.5 million and $0.3 million, respectively, to expected net realizable values. In addition, we realized a loss of approximately $700,000 on our investment in Kana Software, Inc. As a result, we recorded an aggregate loss on investments of approximately $2.5 million for the three months ended September 30, 2002.

8. Restructuring of operations

On August 8, 2002, we announced a restructuring of our operations designed to re-align our core business functions and reduce operating expenses. As part of the restructuring, we reduced our workforce by approximately 25% and recorded a $4.6 million charge to operating expenses in the third quarter of 2002. The restructuring charge included approximately $2.6 million of expenses related to facilities no longer needed for company operations and $2.0 million of employee and other-related expenses for employee terminations. We anticipate that the execution of the restructuring actions will require total cash expenditures of $4.6 million, which is expected to be funded from internal operations and existing cash balances. As of September 30, 2002, we had incurred costs totaling $4.6 million related to the restructuring, which required $0.7 million in cash expenditures. The remaining reserve related to this restructuring was approximately $3.9 million, and is included in accrued liabilities as of September 30, 2002.

On August 3, 2000, we announced a restructuring of our operations designed to re-focus on our core business functions and reduce operating expenses. In connection with the restructuring, we reduced our workforce by approximately 17% and made provisions for reductions in office space, related overhead expenses, and the write down of certain assets. The total amount of the restructuring charge was $5.6 million. The restructuring charge included approximately $3.0 million of estimated expenses for facilities-related charges, $1.6 million of employee-related expenses for employee terminations, approximately $200,000 in other equipment and professional services and an $800,000 settlement to Verity for a software license that we do not plan to use. In September 2002, based on a review of our continuing obligations associated with the original restructuring charge, we recorded a reduction in estimate for facilities of approximately $521,000 and an increase in estimate for other charges of approximately $249,000. As of September 30, 2002, our total cash expenditures incurred were $5.0 million. The remaining reserve related to this restructuring was approximately $0.3 million, which is included in accrued liabilities as of September 20, 2002.

The following table lists the components of the August 2000 restructuring reserve for the nine month period ended September 30, 2002 (In thousands):


	Excess
	Facilities			Other			Total

Balance at December 31, 2001	$	930		$	27		$	957




Reserve utilized in nine months ended September 30, 2002		(303	)		(97	)		(400	)




Change in estimate recorded to restructuring expense		(521	)		249			(272	)

Balance at September 30, 2002	$	106		$	179		$	285

In the fourth quarter of 1999, following the acquisitions of Wall Data, Inc., or Wall Data, and Simware Inc., or Simware, we initiated a plan to restructure our worldwide operations in order to integrate the operations of the two acquired companies. In connection with this plan, we recorded a $3.8 million charge to operating expenses in 1999. The restructuring charge includes approximately $1.9 million of estimated expenses for facilities-related charges associated with the consolidation of redundant operations, $1.4 million of employee-related expenses for employee terminations and $0.5 million for legal, accounting and other. We anticipated that the execution of the restructuring actions would require total cash expenditures of approximately $3.0 million, which we expected to be funded from internal operations. As of September 30, 2002, our total cash expenditures were approximately $3.0 million. The remaining reserve related to this restructuring is approximately $0.6 million,and is included in accrued liabilities as of September 30, 2002.

The following table lists the change in our restructuring reserve for the nine-month period ended September 30, 2002 (In thousands):


	Excess
	Facilities

Balance at December 31, 2001	$	958




Reserve utilized in nine months ended September 30, 2002		(184	)




Change in estimate recorded to restructuring expense		(212	)

Balance at September 30, 2002	$	562

Prior to the acquisition, Wall Data had initiated a plan to restructure its worldwide operations to re-focus Wall Data on its core business functions and to reduce operating expenses. In conjunction with the acquisition, we recorded as an accrued liability the remaining restructuring accrual of approximately $0.5 million for facilities-related expenses, net of a $0.2 million reduction for a change in estimate. We anticipated that the execution of the restructuring actions would require total cash expenditures of approximately $0.5 million, which were expected to be funded from internal operations. As of September 30, 2002, we had incurred costs of approximately $0.5 million. The remaining reserve related to this restructuring was approximately $6,000 and is included in accrued liabilities as of September 30, 2002.

The following table lists the change in the Wall Data restructuring reserve for the nine month period ended September 30, 2002 (In thousands):


	Excess
	Facilities

Balance at December 31, 2001	$	211




Reserve utilized in nine months ended September 30, 2002		(12	)




Change in estimate recorded to restructuring expense		(193	)

Balance at September 30, 2002	$	6

In August 1998, following the acquisition of FTP Software, or FTP, we initiated a plan to restructure our worldwide operations as a result of business conditions and in connection with the integration of the operations of FTP. In connection with this plan, we recorded a $7.0 million charge to operating expenses in 1998. Additionally, prior to the acquisition of FTP by us, FTP recorded a restructuring charge. We assumed the remaining restructuring liability of $9.7 million as of the date of the acquisition for a total restructuring liability of $16.7 million. The remaining reserve related to this restructuring was approximately $0.7 million and is included in accrued liabilities.

The following table lists the change in the FTP restructuring reserve for the nine month period ended September 30, 2002 (In thousands):


	Excess
	Facilities

Balance at December 31, 2001	$	465




Reserve utilized in nine months ended September 30, 2002		(477	)




Change in estimate recorded to restructuring expense		691

Balance at September 30, 2002	$	679

9. Commitments and contingencies

Legal proceedings

On November 22, 1999, Kenneth Fisher filed a complaint alleging violations of the False Claims Act, 31 U.S.C. § 3729 et seq., against us, and our affiliates Network Software Associates, Inc. or NSA, and NetSoft Inc., or NetSoft, in the United States District Court of the District of Columbia. The United States government declined to pursue the action on its own behalf and, therefore, the action is pursued by Kenneth Fisher. We, and our affiliates, first learned of the action when we were served with the amended complaint in May 2001. On September 5, 2001, Mr. Fisher agreed to voluntarily dismiss us from this action in exchange for our agreement to toll, or forego, applicable statutes of limitation as to Mr. Fisher’s claims.

On May 13, 2002, on an order of the court following defendants’ successful motion to strike the second amended complaint filed by Mr. Fisher on January 31, 2002, Mr. Fisher filed a Third Amended Complaint, or Complaint, in the United States District Court of the District of Columbia against NSA and NetSoft among numerous other defendants. The Complaint alleges that NSA, NetSoft and the other defendants made false claims to the government to obtain government contracts set aside for entities owned and controlled by disadvantaged persons admitted to the Section 8 (a) Minority Small Business Development Program. Specifically, the Complaint alleges that from 1987 to 1997, NSA, NetSoft, and the other defendants presented false or fraudulent claims for payment or approval to the government in violation of 31 U.S.C. § 3729 (a) (1), and used false records or statements to get claims paid or approved by the government in violation of 31 U.S.C. § 3729 (a) (2) in connection with NSA’s application and certification as a Section 8 (a) minority owned and controlled company. In addition, the Complaint alleges that NSA, NetSoft and the other defendants conspired to defraud the government by fraudulently obtaining NSA’s certification as a Section 8 (a) entity for alleged use by NSA’s Federal Systems Division, in violation of 31 U.S.C. § 3729 (a) (3). Mr. Fisher alleges damages in excess of $30,000,000.

We did not acquire NSA until July 1997 and had no involvement with the events alleged by Mr. Fisher. However, Mr. Fisher alleges that any liabilities of NSA and NetSoft passed to us. On May 31, 2002, NSA and NetSoft and the other defendants answered the complaint. We, and our affiliates, vigorously dispute Mr. Fisher’s allegations.

We may be contingently liable with respect to certain asserted and unasserted claims that arise during the normal course of business.

10. Treasury stock

During the first nine months of 2002, we repurchased 378,490 shares of our outstanding common shares on the open market for a total cost of approximately $2.0 million at an average price of $5.16 per share. In the third quarter of 2002, we repurchased 98,635 shares of our common stock on the open market at an average price per share of $3.15 for a total cost of approximately $0.3 million.

11. Correspondence from the Nasdaq National Market

We received a letter from the staff of the Nasdaq National Market, or Nasdaq, dated June 20, 2002 notifying us that we no longer complied with the minimum bid price requirement for continued listing, as set forth in Marketplace Rule 4450(a) (5), and that our stock was therefore subject to delisting from the Nasdaq National Market.

On August 21, 2002, we received a letter from Nasdaq, notifying us of our failure to timely file our Form 10-Q for the quarter ended June 30, 2002 as required by Nasdaq Marketplace Rule 4310(c)(14). This failure subjected our common stock to delisting by Nasdaq. Nasdaq indicated that it would consider this additional delinquency in determining whether continued listing of our common stock on the Nasdaq National Market was appropriate.

On September 12, 2002, we communicated with the Nasdaq Listing Qualifications Panel, or Panel, with an update as to the implementation of our reverse stock split and the re-audit of our financial results for the years ended December 31, 2001 and 2000. In the correspondence we mentioned that stockholders representing a majority of our outstanding common stock at the Special Meeting of Stockholders held on August 28, 2002 had approved our reverse stock split. Given the additional time needed to complete the re-audit work, we requested an extension to our September 13, 2002 compliance date.

On September 18, 2002, we received a letter from Nasdaq acknowledging that on September 4, 2002, we implemented a reverse stock split at a ratio of one-for-seven that resulted, as of September 17, 2002, in our regaining compliance with the minimum bid price of $1.00 per share by trading at or above the $1.00 per share minimum bid price for ten consecutive trading days. The Panel determined to continue the listing our common stock on Nasdaq on the condition that on or before November 1, 2002 we file our delinquent Form 10-Q for the period ended June 30, 2002 and all amended public reports required to be filed with the Securities and Exchange Commission, or Commission, and that we otherwise continue to comply with all other continued listing requirements of Nasdaq.

On November 5, 2002, we received additional correspondence from the Panel extending to November 14, 2002 the date by which we are required to comply with the continued listing requirements of Nasdaq by filing our Forms 10-Q for the quarters ending June 30, 2002 and September 30, 2002 and all amended public reports required to be filed with the Commission.

On November 14, 2002, we communicated with the Panel with respect to our failure to file our Forms 10-Q for the quarters ended June 30, 2002 and September 30, 2002 and all amended public reports required to be filed with the Commission, as required by the November 5, 2002 correspondence from the Panel, and requested an extension of our November 14, 2002 target date. As of the date of this report, the Panel has not responded to our request. In the event that the Panel does not grant our request for an extension or, if granted, we fail to comply with any terms of the Panel’s decision, our securities may be delisted from Nasdaq and may be traded over-the-counter or on the “Pink Sheets,” assuming we meet the qualification requirements for either or both of these markets.

Since regaining compliance with Nasdaq’s $1.00 minimum bid price listing requirement, the bid price for our common stock has, at times, fallen below $1.00. Even if we regain compliance with Nasdaq rules, if our common stock trades below $1.00 for thirty consecutive days, we may again be subject to delisting by Nasdaq.

12. Restatement of financial statements

Subsequent to the issuance of our interim unaudited condensed consolidated financial statements for the three months ended March 31, 2002, we determined that the accounting treatment was inappropriate for certain transactions that had been previously recorded in 2000, 2001, and the first three months of 2002. Those transactions for 2000 and 2001 are described below. Those transactions for the first three months of 2002 are described in the Form 10-Q/A for the quarter ended March 31, 2002.

2001 adjustments

A loss of approximately $1.6 million in the Company’s investment in Broadbase had been recorded as unrealized loss in accumulated comprehensive loss as of the business combination date between Broadbase and KANA in June 2001 rather than as a loss recorded in the consolidated results of operations in accordance with Emerging Issues Task Force Issue No. 91-5, Nonmonetary Exchange of Cost-Method Investments. Furthermore, we recorded a realized loss of $0.2 million on this investment in 2000 (see further discussion below), which should have been recognized as an unrealized loss within accumulated comprehensive loss until the date of the business combination between KANA and Broadbase, at which time it should have been recorded as a realized loss. As a result, we recorded an adjustment to recognize the total realized investment loss of $1.8 million for the year ended December 31, 2001 and the nine months ended September 30, 2001.

During 2001, we recorded an income tax benefit of approximately $2.6 million upon utilization of pre-acquisition net operating losses and tax credits of Simware in Canada to offset Canadian taxable income. We determined that the utilization of the related deferred tax assets, for which we had previously established a full valuation allowance, should have been recorded as a reduction to goodwill rather than as an income tax benefit. Additionally, tax liabilities were adjusted by approximately $1.9 million to reflect favorable tax settlement in 2001 of a tax audit at the Haifa, Israel subsidiary.

As a result of the adjustment to goodwill, amortization expense related to goodwill for the three and nine month periods ended September 30, 2001 and the year ended December 31, 2001, has been reduced by approximately $162,500, $487,500, and $650,000, respectively. The net change to the provision for income taxes resulting from the two tax adjustments described above was a decrease of $47,000, and an increase of $232,000 and $650,000 for the three and nine month periods ended September 30, 2001, and the year ended December 31, 2001, respectively.

Third party transactions were improperly included within accumulated comprehensive loss as of December 31, 2001. Consequently, we recorded an adjustment to remove these transactions from accumulated comprehensive loss, which decreased services revenue by approximately $355,000 in 2001. The net impact of this adjustment was a decrease to services revenue of $12,000 and $126,000 for the three and nine month periods ended September 30, 2001.

We recorded license and service revenue for certain software contracts that should have been deferred as of December 31, 2001. Accordingly, we recorded an adjustment to reduce license revenue by $316,000 and service revenue by $157,000 for 2001 with an offsetting increase to deferred revenue at December 31, 2001. The impact of this adjustment for both the three and nine month periods ended September 30, 2001 was a reduction of license and service revenue of $316,000 and $105,000, respectively.

We had previously not reported cost of services revenue as a component of cost of revenues. Accordingly, we recorded an adjustment to reclassify $8.1 million in operating expense to cost of services revenue for fiscal 2001 to reflect the cost of services revenue as a component of cost of revenues. The impact on cost of services revenue for the three and nine month periods ended September 30, 2001 was approximately $1.9 million and $6.2 million, respectively.

In the third quarter of fiscal 2000, we wrote-off $10.0 million of goodwill and other intangibles related to the 1998 acquisition of FTP. At that time, we should have reduced the amortization period of the remaining intangible assets from the FTP acquisition. Consequently, we recorded an adjustment in 2001 to increase amortization expense by $416,000, to recognize the impact of the reduced amortization period for that year. The increase in amortization expense for the three and nine month periods ended September 30, 2001 was $104,000 and $312,000, respectively.

In addition to the above adjustments: (i) income from marketable securities totaling $133,000 was adjusted from unrealized to realized income; (ii) certain general and administrative expenses were adjusted for excess accruals totaling $114,000 that were reversed in 2001 instead of 2000, and (iii) foreign currency amounts were adjusted for various foreign currency transactions.

2000 adjustments

As discussed above, an adjustment was made to reverse a $0.2 million loss that was recognized in 2000 on our investment in Broadbase and to present the loss as an unrealized loss as of December 31, 2000 within the consolidated statement of comprehensive loss.

An analysis of the purchase price allocation resulting from our acquisition of Wall Data in December 1999, indicated we had overstated deferred revenue at December 31, 1999 on certain software contracts that were acquired from Wall Data, on which Wall Data had recognized revenue prior to being acquired by us. The impact of the incorrect purchase price allocation was an overstatement of goodwill and deferred revenue at the acquisition date, and a resulting overstatement of revenue in 2000 upon the amortization of the deferred revenue. Consequently, we recorded a $2.3 million adjustment to reduce revenue in 2000 with an offsetting reduction of impairment expense, given goodwill resulting from the acquisition had been written-off in 2000.

During 2000, we incorrectly wrote-off $810,000 of trade receivables against liabilities that had been recorded in connection with the acquisition of Wall Data. Consequently, we recorded an adjustment of $810,000 to increase bad debt expense in 2000 and reduce identifiable intangibles relating to the acquisition.

Certain revenue, expense and gain transactions were recorded in accumulated comprehensive loss. Consequently, an adjustment was recorded in 2000 to remove the transactions from accumulated comprehensive loss with offsetting increases to revenue, selling expenses, and gain on investment, of $1,112,000, $756,000 and $116,000, respectively. In addition, corrections to the accumulated comprehensive loss account related to periods prior to 2000 increased accumulated deficit by $344,000 as of December 31, 1999.

Income from investment securities had been recorded as unrealized gains during 2000 instead of investment income. Consequently, we recorded an adjustment of $451,000 to recognize the investment income for fiscal 2000.

We had previously not reported cost of services revenue as a component of cost of revenues. Accordingly, we recorded an adjustment to reclassify $14.1 million in operating expense to cost of services revenue for fiscal 2000 to reflect the cost of services revenue as a component of cost of revenues.

The Company's accounts receivable reserve at December 31, 1999 was understated at that date by approximately $600,000. Consequently, we recorded an adjustment to decrease bad debt expense in 2000 by $600,000 and to increase accumulated deficit as of December 31, 1999 by the same amount, given that the shortfall in the reserve at December 31, 1999 resulted in an overstatement of bad debt expense for 2000.

In connection with the reduction of the amortization period for goodwill and other intangible assets related to our acquisition of FTP, as discussed above, we recorded an adjustment in 2000 to increase amortization expense by $173,000.

In addition to the above adjustments: (i) certain general and administrative expenses were adjusted for excess accruals totaling $114,000 (as discussed above), and (ii) foreign currency adjustments were recorded for various foreign currency transactions.

Restated financial statements

As a result of the adjustments described above, the accompanying interim condensed consolidated financial statements for the three and nine month periods ended September 30, 2001 have been restated from the amounts previously reported to reflect the correction of the matters described above.

In addition, we intend to restate our 2001 and 2000 consolidated financial statements to reflect the adjustments described above.

A summary of the significant effects of the restatements, as adjusted for the one-for-seven reverse stock split discussed in Note 6, is as follows (In thousands, except per share amounts):


	Three months ended September 30, 2001						Nine months ended September 30, 2001

	(As previously						(As previously
	reported)			(As restated)			reported)			(As restated)

Statement of Operations Data:




Total net revenues	$	18,094		$	17,668		$	60,174		$	59,726




Gross margin		17,303			14,929			57,576			50,917




Research and development		3,840			3,817			14,314			14,317




General and administrative		2,046			2,065			8,542			8,747




Sales and marketing		11,648			9,713			41,047			34,850




Amortization of goodwill and intangibles		1,503			1,445			4,508			4,333




Interest income and other, net		2			237			1,673			2,082




Foreign currency transaction losses		—			(231	)		—			(429	)




Loss on investment exchange		—			—			—			(1,824	)




Provision for income taxes		179			132			487			719




Net loss		(1,911	)		(2,237	)		(9,649	)		(12,220	)




Net loss per share — basic and diluted	$	(0.21	)	$	(0.24	)	$	(1.05	)	$	(1.31	)


	(As previously
	reported)			(As restated)

Balance Sheet Data as of December 31, 2001:




Goodwill and other intangibles, net	$	17,581		$	14,231




Total assets		79,436			76,093




Deferred revenue		21,154			21,627




Income taxes payable		3,811			1,861




Accumulated deficit		(112,668	)		(115,799	)




Accumulated other comprehensive loss		(5,639	)		(4,372	)




Total stockholders’ equity		40,952			39,088









Statement of Operations Data for the year ended December 31, 2001:




Total net revenues	$	79,970		$	79,249




Gross margin		76,516			67,664




Sales and marketing		53,220			45,104




General and administrative		10,579			10,792




Amortization of goodwill and intangibles		6,077			5,843




Interest income and other, net		2,104			2,636




Foreign currency transaction losses		—			(419	)




Loss on investments		—			(1,824	)




Provision for income taxes		78			728




Net loss		(9,294	)		(12,372	)




Net loss per share — basic and diluted	$	(1.00	)	$	(1.33	)


		(As previously
		reported)			(As restated)

Balance Sheet Data as of December 31, 2000:




	Goodwill and other intangibles, net	$	23,689		$	22,705




	Total assets		109,981			108,988




	Accounts payable		5,050			4,937




	Accumulated deficit		(103,374	)		(103,427	)




	Accumulated other comprehensive loss		(3,990	)		(4,822	)




	Total stockholders’ equity		53,029			52,144

Statement of Operations Data for the year ended December 31, 2000:




	Total net revenues	$	104,072		$	102,865




	Gross margin		99,845			84,510




	Research and development		24,394			24,517




	Sales and marketing		71,881			60,173




	General and administrative		18,740			17,047




	Goodwill and other intangible assets impairment		42,164			39,844




	Amortization of goodwill and intangibles		14,164			14,338




	Interest income and other, net		1,836			2,699








	Foreign currency transaction losses		—			(370	)
	Gain on investments		1,973			2,282




	Provision for income taxes		737			737




	Net loss		(71,910	)		(71,019	)




	Net loss per share — basic and diluted	$	(7.76	)	$	(7.66	)

The effect of the above adjustments also increased accumulated deficit as of December 31, 1999 by an aggregate of $944,000 from the amount previously reported.

NETMANAGE, INC.

Item 2. Management’s discussion and analysis of financial condition and results of operations.

Some of the statements contained in this quarterly report on Form 10-Q are forward-looking statements, including, but not limited to, those specifically identified as such, that involve risks and uncertainties, including those set forth below under the heading “Factors that may affect our future results and financial condition” and elsewhere in this report. The statements contained in this report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act, including, without limitation, statements regarding our expectations, beliefs, intentions or strategies regarding the future. These statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results to differ materially from those implied by the forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. All forward-looking statements included in this Report are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements.

The financial information for the three and nine month periods ended September 30, 2001 reflect the restatement adjustments described in Note 12 to the unaudited condensed consolidated financial statements.

Overview

We have operations worldwide with sales offices located in the United States, Europe, Canada, Latin America, and Israel. We develop and market software and service solutions that are designed to enable our customers to access and leverage the considerable investment they have in their host-based business applications, processes and data. Our business is primarily focused on providing a broad spectrum of specific personal computer and network or application server-based software and tools. These products are designed to allow our customers to access and use their mission-critical line-of-business host applications and resources; to publish information from existing host systems in a web presentation, particularly to new users, via the Internet; to create new web-based applications that leverage the corporation’s existing business processes and applications; and, to ensure the continued operation of these solutions through the incorporation and deployment of innovative, real-time, Internet-based support solutions.

Our business is targeted at taking advantage of the trend of many major corporations worldwide to adopt Business-to-Business, or B2B, or Business-to-Consumer, or B2C, initiatives. In this market, we aim to enable our customers to bridge between their existing access systems and technologies, Business-to-Employee, or B2E, and those required to compete in the B2B and B2C marketplaces. The corporate resources internal to the organization, those behind existing B2E solutions, are the basis of any eBusiness transformation for an existing company. Alongside these solutions, we are focused on providing products that are designed to allow existing corporate business processes to be extended to business partners in the supply and demand chains, and products that are designed to allow new business processes to be created in support of corporate eBusiness B2B and B2C initiatives. We also focus on taking advantage of major current industry trends: the expansion of the Internet and its adoption as the eCommerce and eBusiness infrastructure; the continued mobilization of personal computer users and the adoption of mobile information access and display devices; and the availability of broader access to corporate data and information for people internal and external to an organization.

We develop and market these software solutions to allow our customers to access and leverage applications, business processes and data on International Business Machines, or IBM, corporate mainframe computers, and IBM midrange computers such as AS/400 and on UNIX® based servers. We also develop and market software that is designed to allow real time application sharing on corporate networks and across the Internet for the purposes of application support, help and training. We provide professional support, maintenance, and technical consultancy services to our customers in association with the products we develop and market. We provide professional applications and management consultancy to our customers in association with the server-based products we deliver that are designed to allow customers to develop and deploy new web-based applications.

Our principal products are compatible with Microsoft Corporation’s, or Microsoft’s, Windows XP, Windows 2000, Windows NT, Windows 98, Windows 95, and Windows 3.x operating systems, IBM operating systems, Novell, Inc., or Novell, operating systems and various implementations of the industry standard UNIX operating system such as IBM’s AIX, Hewlett Packard Corporation’s HP/UX, Sun Microsystems Inc.’s Solaris, and the open source Linux system.

We have a range of host access, publishing and integration products. Our Host Access products are designed to provide the applications and solutions that allow end-user devices, including personal computers, and devices running web browsers, to communicate with large centralized corporate computer systems. Our Host Access products are marketed and sold under the brand name of RUMBA® for client-side solutions. Our Host Access solutions that deliver connectivity for web browser users without the requirement for software on the user’s device other than the browser, collectively known as “zero footprint” solutions are marketed and sold under the brand name of OnWeb®. Our Host Integration products provide server-side solutions that are designed to allow the integration of multiple host applications and business processes to create new applications for the web. Our Host Integration products also allow our customers to integrate existing legacy applications with new platform solutions such as those built using IBM’s WebSphere or BEA’s WebLogic. Our Host Integration products are marketed and sold under the OnWeb® brand name. We and our customers believe that we collectively benefit from the fact that the underlying technology employed by our server-side Host Access and server-side Host Integration solutions is the same.

Critical accounting policies

Revenue Recognition: We derive revenue from primarily two sources; (1) product revenue, which includes software license and royalty revenue, and (2) services and support revenue which includes software license maintenance and consulting.

We license our software products on a one or two year term basis or on a perpetual basis. Our two year term licenses include the first year of maintenance and support. To date, revenues from such licenses have been insignificant.

We apply the provisions of Statement of Position 97-2, Software Revenue Recognition, and related amendments and interpretations to all transactions involving the sale of software products and to hardware transactions where the software is not incidental.

Allowances for doubtful accounts and litigation: The preparation of financial statements requires management to make estimates and assumptions that affect the reported amount of assets and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Specifically, management must make estimates of the collectibility of our accounts receivables. We analyze accounts receivable and analyze historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment terms, when evaluating the adequacy of the allowance for doubtful accounts. Our accounts receivable balance was $9.0 million, net of allowance for doubtful accounts of $2.1 million as of September 30, 2002.

Management’s current estimated range of liability related to pending litigation is based on claims for which our management can estimate the amount and range of loss. Because of the uncertainties related to both the amount and range of loss on the remaining pending litigation, the actual outcome may significantly differ from management estimates. As additional information becomes available, we will assess the potential liability related to our pending litigation and revise our estimates. Such revisions, in our estimates of the potential liability, could materially impact our results of operation and financial position.

Accounting for income taxes: As part of the process of preparing our consolidated financial statements we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or our allowance in a period changes, the amount recognized as tax provision in the statement of operations could change.

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities, and any valuation allowance recorded against our net deferred tax assets. We have recorded a full valuation allowance as of September 30, 2002, due to uncertainties related to our ability to utilize some of our deferred tax assets, primarily consisting of certain net operating losses carried forward and foreign tax credits, before they expire. The valuation allowance is based on our history of losses and our judgement that it is more likely than not that our deferred tax assets will not be recoverable. In the event that actual results differ from these estimates, we will adjust these estimates in future periods.

Valuation of long-lived and intangible assets and goodwill: We assess the impairment of identifiable intangibles, long-lived assets and related goodwill and enterprise level goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include the following:

• significant underperformance relative to historical or projected future operating results;

• significant changes in the manner of our use of the acquired assets or the strategy for our overall business;

• significant negative industry or economic trends; and

• our market capitalization relative to net book value.

When we determine that the carrying value of intangibles, long-lived assets and related goodwill and enterprise level goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment, we measure impairment based on a projected discounted cash flow method using a discount rate determined by us to be commensurate with the risk inherent in our current business model. Goodwill and other intangible assets amounted to $11.9 million as of September 30, 2002, net of accumulated amortization.

On January 1, 2002, SFAS No. 142, Goodwill and Other Intangible Assets became effective and as a result, we ceased to amortize approximately $6.7 million of goodwill. We recorded approximately $2.7 million of amortization of goodwill during 2001 and would have recorded approximately $2.7 million of amortization during 2002. In lieu of amortization, we are required to perform an initial impairment review of our goodwill as of January 1, 2002, and on at least an annual basis thereafter. As required by SFAS No. 142, we conducted an impairment analysis of goodwill and other intangibles and determined that no impairment existed at January 1, 2002, nor do we believe there have been any events or circumstances that would have triggered an impairment during the nine months ended September 30, 2002.

Operations

During the past several years, we have implemented a number of initiatives designed to control costs and reduce operating expenses, including the discontinuance of several low revenue generating products and the

implementation of a worldwide restructuring of our operations due to the effect of acquisitions and prevailing market conditions.

In the first nine months of 2002, we continued to experience a reduction in revenues which we believe relates primarily to the worsening North American and European economies. Customers are postponing or canceling decisions to purchase technology products because of uncertainties within their own businesses. We do not anticipate any improvements in the current business environment through the remainder of 2002 and into 2003. As a result, we believed it was necessary to refocus our operations and reduce our operating expenses to bring them more in line with our revised anticipated revenue levels which we expect to be comparable or less than those of the previous twelve months.

On August 8, 2002, we announced a restructuring of our operations designed to re-align our core business functions and reduce operating expenses. As part of the restructuring, we reduced our workforce by approximately 25% and recorded a $4.6 million charge to operating expenses in the third quarter of 2002. The restructuring charge included approximately $2.6 million of expenses related to facilities no longer needed for company operations and $2.0 million of employee and other-related expenses for employee terminations. We anticipate that the execution of the restructuring actions will require total cash expenditures of $4.6 million, which is expected to be funded from internal operations and existing cash balances. As of September 30, 2002, we had incurred costs totaling $0.7 million related to the restructuring, which required $0.6 million in cash expenditures. As of September 30, 2002, the remaining reserve related to this restructuring was approximately $3.9 million which is included in accrued liabilities. (See Note 8 – Restructuring of operations).

We initiated restructuring plans as a result of our acquisitions of Wall Data, Simware, and Aqueduct Software, Inc, or Aqueduct, including the $5.6 million restructuring plan announced on August 3, 2000. As part of the restructuring, we reduced our workforce by approximately 17%, consisting mostly of Engineering and Customer Support personnel who were focused primarily on our older technologies, predominantly acquired through the Wall Data and FTP acquisitions. With the reduction in personnel, knowledge levels with respect to certain products and our ability to enhance and expand products acquired from Wall Data and FTP was reduced, thus impacting future expected revenues from these product families. In connection with the restructuring, we made provisions for reductions in office space, related overhead expenses, and the write-down of certain assets. The total amount of the restructuring charge was $5.6 million. The restructuring charge includes approximately $3.0 million of expenses for facilities-related charges, $1.6 million of employee-related expenses for employee terminations, approximately $200,000 in other equipment and professional service costs, and an $800,000 settlement to Verity for a software license that we no longer plan to use. As of September 30, 2002, our total cash expenditures incurred were approximately $5.3 million. (See Note 8 — Restructuring of operations).

In 2001, we focused on the core competencies of our key business lines — Host Access and Host Integration — each with dedicated development, sales, marketing, and support resources. These products aim to leverage the strengths and popularity of the Internet, as well as corporate private networks, and offer features to improve network manageability. The Host Access product line includes our products branded Rumba and ViewNow. The Host Integration product line is designed to provide the technology to allow customers to leverage the investment they have in existing host-based systems, applications and business processes for new web-based presentation, applications, and solutions. The Host Integration product line includes our products branded OnWeb. The Real-time Interactive Support functionality, previously sold as the standalone product SupportNow, is being incorporated into our full line of products and we believe adds value to the Host Access and Host Integration product lines.

We experienced a reduction in incoming orders from the latter half of 2000 through the third quarter of 2001, and incoming orders did not begin to increase until the fourth quarter of 2001. The slowdown in the North American economy, as well as the events associated with the September 11, 2001 disaster, influenced customers’ willingness to place new orders for our products. We experienced significant revenue reduction in each quarter of 2001, compared to the same quarter of the previous year and this trend continued into the third quarter of 2002. In some cases, customers chose to reduce the number of desktop units at the time of annual maintenance renewal to reflect a reduction-in-force at their facilities, or they continued to postpone their buying decisions due to budget constraints. The reduction in revenue in the third quarter of 2002 primarily was attributed to our North American operations. Our third quarter 2002 revenues were approximately 20% less than the amount recorded in the third quarter of 2001 and

approximately 13% less than the amount recorded in the second quarter of 2002. There can be no assurance that revenues will increase at all in future periods.

As a result of the slowdown experienced in the latter half of 2000 and throughout 2001, we took steps in fiscal 2001 to simplify our product offerings and messages to our customers. The result of the effort resulted in the consolidation of our products into two major product families — Rumba and OnWeb. While we believe these product simplification initiatives have rendered positive results by reducing the complexity of our products in our customers’ eyes, we also feel that the current economy has reduced the extent of the anticipated benefits that we may realize. We expect the positive results may become more apparent in fiscal 2003 and beyond.

Because we generally ship software products within a short period after receipt of an order, we do not have a material backlog of unfilled orders, and revenues in any one quarter are substantially dependent on orders booked in that quarter. Our operating expense levels are based, in part, on our expectation of future revenues and, to a large extent, are fixed. In the third quarter of fiscal year 2002, operating expenses, excluding one-time and unusual amounts recorded in the third quarter of 2002, continued to decline when compared to the second quarter of fiscal year 2002 and the third quarter of fiscal year 2001, and may fluctuate as a percentage of net revenues as we develop and introduce new products.

In the third quarter of 2000, based on our analysis of revised product directions, revenue forecasts and undiscounted future cash flows, taking into account the estimated impact on product development and customer support resulting from the reductions in personnel, we determined that there was a permanent impairment of the long-lived assets related to the acquisitions of Wall Data and FTP. In accordance with SFAS No. 121, we re-evaluated the fair value of these long-lived assets and intangibles using estimated discounted cash flows which was consistent with the methodology used at the time of the acquisition. As a result, we determined an impairment of $39.8 million in goodwill and other intangibles which was charged to operations in the third quarter of fiscal 2000. In the fourth quarter of 2000, we determined that we had overestimated the liabilities assumed in the FTP and Wall Data acquisitions by approximately $9.4 million. We reversed these liabilities against the remaining goodwill and other intangibles acquired.

On June 5, 2000, we completed our acquisition of Aqueduct, an early stage web-based application intelligence company. We issued 160,214 shares of our common stock and issued warrants and options to purchase an additional 103,891 shares of our common stock for all the outstanding stock of Aqueduct, including the retirement of $2.2 million of notes payable and accrued interest thereon. We also hired three employees of Aqueduct who subsequently left. The acquisition was accounted for as a purchase. The warrants and options, none of which were exercised, expired on December 5, 2001.

As described below, under the heading “Factors that may affect our future results and financial condition,” acquisitions involve a number of risks, including risks relating to the integration of the acquired company’s operations, personnel, and products. There can be no assurance that the integration of previously acquired companies, or the integration of any future acquisitions, will be accomplished successfully, and the failure to effectively accomplish any of these integrations could have a material adverse effect on our results of operations and financial condition.

Three and nine months ended September 30, 2002 compared to September 30, 2001 (dollars in millions):

This selected unaudited financial data for the three and nine months ended September 30, 2001 contains certain financial information that has been restated. (See Note 12 to the unaudited condensed consolidated financial statements for further discussion of this matter.)


				Three months ended September 30,											Nine months ended September 30,

				2002			2001			Change					2002			2001				Change

Net revenues




	License fees			$	5.5		$	7.9		$	(2.4	)	(30.4	%)	$	23.6		$	28.7		$	(5.1	)	(17.8	%)




	Services				8.6			9.8			(1.2	)	(12.2	%)		25.8			31.0		$	(5.2	)	(16.8	%)

			Total net revenues	$	14.1		$	17.7		$	(3.6	)	(20.3	%)	$	49.4		$	59.7		$	(10.3	)	(17.3	%)

As a percentage of revenues:




	License fees				39.0	%		44.6	%							47.8	%		48.1	%




	Services				61.0	%		55.4	%							52.2	%		51.9	%

			Total net revenues		100.0	%		100.0	%							100.0	%		100.0	%

Gross margin				$	12.1		$	14.9		$	(2.8	)	(18.8	%)	$	42.7		$	50.9		$	(8.2	)	(16.1	%)




		As a percentage of revenues:			85.8	%		84.2	%							86.4	%		85.3	%




Research and development				$	3.1		$	3.8		$	(0.7	)	(18.4	%)	$	10.3		$	14.3		$	(4.0	)	(28.0	%)




		As a percentage of revenues:			22.0	%		21.5	%							20.9	%		24.0	%




Sales and marketing				$	8.4		$	9.7		$	(1.3	)	(13.4	%)	$	28.2		$	34.9		$	(6.7	)	(19.2	%)




		As a percentage of revenues:			59.6	%		54.8	%							57.1	%		58.5	%




General and administrative				$	3.8		$	2.1		$	1.7		81.0	%	$	8.6		$	8.8		$	(0.2	)	(2.3	%)




		As a percentage of revenues:			26.8	%		12.3	%							17.6	%		15.2	%




Restructuring charge				$	4.6		$	—		$	4.6		—		$	4.6		$	—		$	4.6		—




		As a percentage of revenues:			32.6	%		—	%							9.3	%		—	%




Amortization of intangible assets				$	.8		$	1.4		$	(0.6	)	(42.9	%)	$	2.4		$	4.3		$	(1.9	)	(44.2	%)




		As a percentage of revenues:			5.7	%		7.9	%							4.9	%		7.2	%




Loss on investments				$	2.5		$	—		$	2.5		—		$	2.5		$	1.8		$	0.7		38.9	%




		As a percentage of revenues:			17.7	%		—	%							5.1	%		3.0	%




Foreign currency transactions losses				$	(0.1	)	$	(0.2	)	$	(0.1	)	(50.0	%)	$	(1.4	)	$	(0.4	)	$	(0.60	)	250	%




		As a percentage of revenues:			.1	%		1.1	%							2.8			(0.1	)%




Interest income and other, net				$	0.1		$	0.2		$	(0.1	)	(50.0	%)	$	.2		$	2.1		$	(1.9	)	(90.5	%)




		As a percentage of revenues:			0.0	%		1.1	%							0			3.5	%




Provision for income taxes				$	0.2		$	0.1		$	0.1		100.0	%	$	0.4		$	0.7		$	(0.3	)	(42.9	%)




		Effective tax rate			1.4	%		0.1	%					%		.1	%		1.2	%
Net loss				$	(11.3	)	$	(2.2	)	$	(9.0	)	409.1	%	$	(15.5	)	$	(12.2	)	$	(3.3	)	27	%
		As a percentage of revenue:			(80.1	)%		(12.4	)%							(31.4	)%		(20.4	)%

Net Revenues

Our revenues are derived from the sale of software licenses and related services, which include maintenance and support, consulting and training services. License fees are earned under software license agreements with end-users and resellers and are generally recognized as revenue upon shipment of the software if collection of the resulting receivable is probable, the fee is fixed and determinable and vendor-specific objective evidence exists to allocate the total fee to all undelivered elements of the arrangement. Certain of our sales are made to domestic distributors under agreements allowing right-of-return and price protection on unsold merchandise. Accordingly, we defer recognition of such sales until the distributor sells the merchandise. Our international distributors generally do not have return rights and, as such, we generally recognize sales to international distributors upon shipment, if all other revenue recognition criteria have been met.

License fees and service revenues decreased $2.4 million and $1.2 million, respectively, and $5.1 million and $5.3 million respectively, for the three and nine month periods ended September 30, 2002 as compared to the same periods in 2001. Total net revenues for the three and nine months periods ended September 30, 2002 decreased $3.6 million and $10.4 million, respectively, from those recorded in the three and nine month periods ended September 30, 2001. These decreases resulted primarily from customer decisions to cancel or postpone purchases of our products, due to the sluggish North American and European economies, to competitive pressures on our average selling prices and tom financial pressures experienced by our customers and targeted customers.

In fiscal year 2001, we experienced a general decline in revenues compared to the prior year, a trend that has continued into the third quarter of 2002. We believe that our revenues have been adversely impacted by the continued slowdown in technology purchases due to current economic conditions in North America and Europe. We continue to experience pricing pressures on our products. There can be no assurance that revenues will increase at all in future periods.

Service revenues are derived from software updates for existing software products, user documentation and technical support, generally under annual service agreements. These revenues are recognized ratably over the terms of such agreements. If such services are included in the initial licensing fee, the residual value of the services is deferred and recognized ratably over the related service period. Service revenues derived from consulting and training are deferred and recognized when the services are performed and the collectibility is deemed probable.

We have operations worldwide with sales offices located in the United States, Europe, Canada, Latin America and Israel. Revenues outside of North America (United States and Canada) as a percentage of total net revenues were approximately 28% and 32% for the three months ended September 30, 2002 and 2001, respectively, and 28% for each of the nine months ended September 30, 2002 and 2001.

No customer accounted for 10% or more of net revenues in any of the three or nine month periods ended September 30, 2002 or 2001.

Gross margin

Gross margin increased as a percentage of net revenues to 86% and 87% respectively but declined 20% and 16% respectively in absolute dollars for the three and nine month periods ended September 30, 2002 as compared to the three and nine month periods ended September 30, 2001. This decline in absolute dollars is primarily the result of reductions in cost of revenues for the three and nine month periods ended September 30, 2002 of $0.8 million and $2.2 million, respectively, as compared to the three and nine month periods ended September 30, 2001. Cost of revenues includes direct and indirect expenses associated with both license and service revenues.

License cost of revenues primarily includes costs associated with order processing, product packaging, documentation and software duplication, the amortization and write-down of acquired technology, and royalties paid to third parties for licensed software incorporated into our products. Service cost of revenues includes costs associated with both consulting and customer service, and consists primarily of salaries and commissions, benefits, travel, and occupancy expenses.

Cost of revenues for license fees decreased as a percentage of net license revenues to 6.9% and 7.5%, respectively, for the three and nine month periods ended September 30, 2002 as compared to 10.0% and 9.1% for the same periods in 2001, and declined in absolute dollars for both the three and nine month periods ended September 30, 2002 as compared to the same periods in 2001. These decreases in both percentage of revenue and in absolute dollars were primarily the result of reductions in headcount of six full-time employees in operations from the third quarter of 2001 to the third quarter of 2002, continuing cost reduction efforts, and a reduction in net license revenues of $2.4 million and $5.1 million, respectively, for the three and nine month periods ended September 30, 2002 as compared to the same periods in 2001.

Cost of revenues for services decreased to 18.1% and 18.9%, respectively, as a percentage of net services revenues for the three and nine month periods September 30, 2002 from 19.9% and 20.0% for the comparable periods in 2001 and declined in absolute dollars for both the three and nine month periods ended September 30,

2002 as compared to the same periods in 2001. The decline in cost of revenues for services primarily resulted from a reduction in head count of 26 full-time employees in customer service and consulting from the third quarter of 2001 to the third quarter of 2002.

Gross margin as a percentage of net revenues may fluctuate in the future due to increased price competition, the mix of distribution channels that we use, the mix of license fee revenues versus service revenues, the mix of products sold, and the mix of international versus domestic revenues. We typically recognize higher gross margins on direct sales than sales through our indirect channels of distribution, which generally carry lower margins.

Research and development

Research and development, or R & D, expenses primarily consist of salaries and benefits, occupancy and travel expenses, and fees paid to outside consultants. R & D expenses decreased, in absolute dollars and as a percentage of net revenues for the three and nine month periods ended September 30, 2002 as compared to the three and nine month periods ended September 30, 2001, primarily as a result of a reduction in headcount of 40 full-time employees for research and development activities from the third quarter of 2001 to the third quarter of 2002.

Software development costs are accounted for in accordance with SFAS No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed, under which we are required to capitalize software development costs after technological feasibility is established, which we define as a working model and further define as a beta version of the software. The establishment of technological feasibility and the ongoing assessment of the recoverability of these costs requires considerable judgment by management with respect to certain external factors; including, but not limited to, anticipated future gross product revenue, estimated economic life, and changes in technology. Costs that do not qualify for capitalization are charged to R&D expense when incurred. We did not capitalize any software development costs in any of the three or nine month periods ended September 30, 2002 or September 30, 2001.

Sales and marketing

Sales and marketing expenses consist primarily of salaries and commissions of sales and marketing personnel, advertising and promotional expenses, occupancy and related costs. Sales and marketing expenses decreased in absolute dollars for the three and nine month periods ended September 30, 2002 as compared to the same periods in 2001, primarily due to the reduction in sales and support staff of 59 full-time employees from the third quarter of 2001 to the third quarter of 2002 and our ongoing cost reduction efforts in 2001 and 2002. For the three month period ended September 30, 2002, these expenses increased as a percentage of net revenues as compared to the same period in 2001 primarily due to the decrease in net revenues. For the nine month period ended September 30, 2002, expenses decreased as a percentage of net revenues as compared to the same period in 2001 primarily as a result of ongoing cost reduction activities offset by the decline in revenues.

General and administrative

General and administrative expenses consist primarily of salaries, benefits, accounting, operating, legal, and proportionate shares of occupancy expenses for our human resources, legal, information technology, facilities and general management functions as well as bad debt expense. General and administrative expenses increased in absolute dollars for the three month period ended September 30, 2002 as compared to the same period in 2001. For the three month period ended September 30, 2002, expenses increased as a percentage of net revenues as compared to the same period in 2001 as a result of lower net revenue levels and increased legal and accounting expenses. The increased general and administrative expenses relate to on-going litigation and legal compliance expenses, and audit expenses relating to accounting activity associated with the change in independent accountants and the restatement of our 2001 and 2000 financial statements. For the nine month period ended September 30, 2002 expenses increased as a percentage of net revenues as compared to the same period in 2001, primarily as the result of the increase in legal and audit expenses noted above for the third quarter 2002.

Loss on investments

Interest income and other, net

Interest income and other, net for the three and nine month periods ended September 30, 2002 and 2001, respectively, are as shown in the following table (In thousands):


		Three months ended						Nine months ended
		September 30,						September 30,

		2002			2001			2002			2001

Interest income:




	On cash & investments	$	72		$	250		$	268		$	826




	On tax refunds		—			—			2			1,299




Interest expense			(3	)		(14	)		(25	)		(43	)




Other income (expense)			—			1			27			—

	Total	$	69		$	237		$	272		$	2,082

The reduction in earned interest results from a reduction of our cash balances and lower interest rates from 2001 to 2002.

Interest income on tax refunds for 2001 includes $0.9 million received on a $4.3 million income tax refund received in the first quarter of 2001 and $0.4 million received on a $3.1 million income tax refund received in the second quarter of 2001. For the nine month period ended September 30, 2002, interest income of $2,000 was received on an income tax refund of $20,000.

Transaction gains and losses from foreign currency activity excludes activity flowing through our inter-company accounts (see below).

Foreign currency transaction losses

For the three and nine month periods ended September 30, 2002, foreign currency transaction losses includes transaction losses associated with inter-company accounts of approximately $79,000 and $1.4 million, respectively, almost exclusively as a result of the decline in the value of the Israeli Shekel against the U.S. dollar and the Euro. For the comparable periods of fiscal year 2001, the transaction losses associated with inter-company accounts were approximately $0.2 million and $0.4 million respectively.

Provision for income taxes

Our provision for income taxes primarily relates to international and state taxes.

Liquidity and capital resources



	(In millions)	September 30, 2002


As of:




	Cash and cash equivalents	$	28.5




	Short-term investments		—








For the nine month period ended:




	Net cash used in operating activities		(2.4	)




	Net cash used in investing activities		(0.6	)




	Net cash used in financing activities		(1.6	)

Since our inception, our operations have been financed primarily through cash provided by operations and sales of capital stock. Our primary financing activities to date consist of our initial and secondary stock offerings and preferred stock issuances, from which we derived aggregated net proceeds of approximately $72.5 million. We do not have a bank line of credit.

During the nine months ended September 30, 2002, our aggregate cash, cash equivalents and short-term investments decreased from $33.6 million to $28.5 million. This decrease resulted primarily from operating losses, the reduction in accounts payable and deferred revenue and the purchase of approximately $2.0 million of our common stock offset by a reduction in accounts receivable and an increase in accrued liabilities primarily related to the restructuring charge recorded in the third quarter of 2002.

Our principal investing activities to date have been the purchase of short-term and long-term investments, business acquisitions, and equipment purchases. We do not have any specific commitments with regard to future capital expenditures.

Net cash provided by and used in financing activities in the three and nine month periods ended September 30, 2002 reflects our repurchase of our common stock, from time to time, through the open market.

Our Board of Directors, or Board, has authorized the purchase from time to time of up to 2,142,857 shares of our common stock through open market purchases. In the twelve months ended December 31, 2001, we repurchased 337,221 shares of our common stock on the open market at an average purchase price of $5.49 per share for a total cost of approximately $1.9 million. During the nine months ended September 30, 2002, we repurchased 378,490 shares of our common stock on the open market at an average purchase price of $5.16 per share for a total cost of approximately $2.0 million. Cumulatively, as of September 30, 2002, we had repurchased 1,767,005 shares of our common stock at an average price of $11.44 per share for a total cost of approximately $20.2 million.

At September 30, 2002, we had working capital of $8.1 million. We believe that our current cash balances and future operating cash flows will be sufficient to meet our working capital and capital expenditure requirements for the foreseeable future.

Disclosures about market risk

Interest rate risk

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. We place our investments with high credit quality issuers and, by policy, limit our credit exposure with any one issuer. As stated in our policy, we are averse to principal loss, and seek to preserve our invested funds by limiting default risk, liquidity risk, and territory risk.

We mitigate default and liquidity risks by investing only in high credit quality securities, and by positioning our portfolio to respond appropriately to a significant reduction in the credit rating of any investment issuer or guarantor. To ensure portfolio liquidity, the portfolio includes only marketable securities with active secondary or resale markets. We mitigate territory risk by only allowing up to 25% of the portfolio to be placed outside of the United States.

Foreign currency risk

We conduct business in various foreign currencies, primarily in Europe and Israel. Prior to 2000, we had established a foreign currency-hedging program, utilizing foreign currency forward exchange contracts (forward contracts) to hedge certain foreign currency exposures in certain European countries. Under this program, increases or decreases in our foreign currency transactions were partially offset by gains and losses on the forward contracts, so as to mitigate the possibility of short-term earnings volatility.

We have not entered into any foreign currency forward contracts in either 2002 or 2001.

Factors that may affect our future results and financial condition

Our business is subject to a number of risks and uncertainties. You should carefully consider the risks described below, in addition to the other information contained in this Report and in our other filings with the SEC. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations. If any of these risks actually occur, our business, financial condition or results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you may lose part or all of your investment.

Our operating results have fluctuated significantly in the past and may continue to do so in the future, which could cause our stock price to decline

We have experienced, and expect to experience in future periods, significant fluctuations in operating results that may be caused by many factors including, among others:

• general economic conditions, in particular, the recent slowdown of purchases of information technology due to current economic conditions in North America and financial pressures experienced by our customers and targeted customers;

• demand for our products;

• introduction or enhancements to our products and those of our competitors;

• technological changes in computer networking;

• competitive pricing pressures;

• market acceptance of new products;

• customer order deferrals in anticipation of new products and product enhancements;

• the size and timing of individual product orders;

• mix of international and domestic revenues;

• mix of distribution channels through which our products are sold;

• impact of, or failure to enter into, strategic alliances to promote our products;

• quality control of our products;

• changes in our operating expenses;

• personnel changes; and

• foreign currency exchange rates.

In addition, our acquisitions, including past acquisitions, of complementary businesses, products or technologies may cause fluctuations in our operating results due to in-process research and development charges, the amortization of acquired intangible assets, and integration costs such as those recorded in connection with the acquisitions of FTP, Wall Data, Simware, and Aqueduct.

Since we generally ship software products within a short period after receipt of an order, we do not typically have a material backlog of unfilled orders, and our revenues in any one quarter are substantially dependent on orders booked in that quarter and particularly in the last month of that quarter. Our expenses are based in part on our expectations as to future revenues and to a large extent are fixed. Therefore, we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall. Accordingly, any significant shortfall of demand for our products in relation to our expectations or any material delay of customer orders would have an almost immediate adverse impact on our operating results and on our ability to achieve profitability.

As a result, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. Fluctuations in our operating results have caused, and may in the future cause us to perform below the expectations of public market analysts and investors. If our operating results fall below market expectations, the price of our common stock may fall.

We have not been profitable on an annual basis since 1995 and may never achieve profitability in the future

We had a net loss from operations of approximately $12.4 million for the year ended December 31, 2001. Despite our operating profit in the first quarter of 2002, we were not profitable in the second or third quarters of 2002 and have not achieved profitability on an annual basis since 1995, and we may never obtain sufficient revenues to sustain profitability in any future period. In addition, price competition may make it difficult for us to achieve profitability. Increasing competition may cause our prices to decline, which would harm our operating results. We expect our prices for our software products to decline over the next few years. We expect to face increased competition in markets where we sell our products, which will make it more difficult to increase or maintain our revenues or maintain our prices and profit margins. We need to significantly increase our sales volume and/or reduce our costs to be profitable in future periods. If anticipated increases in sales volume do not keep pace with anticipated pricing pressures, our revenues would decline and our business could be harmed. Despite our efforts to introduce enhancements to our products, we may not be successful in maintaining our pricing.

We rely significantly on third parties for sales of our products and our revenues could decline significantly with little or no notice

We rely significantly on our independent distributors, systems integrators, and value-added resellers for marketing and distribution of our products. The agreements in place with these organizations are generally non-exclusive, of limited duration, are terminable with little or no notice by either party and generally do not contain minimum purchase requirements. These distributors of our products are not within our control and generally represent competing product lines of other companies in addition to our products. There can be no assurance that these organizations will give a high priority to the marketing of our products, and they may give a higher priority to the products of our competitors.

Furthermore, our results of operations can also be materially adversely affected by changes in the inventory strategies of our resellers, which can occur rapidly and may not be related to end-user demand. As part of our continued strategy of selling through multiple distribution channels, we expect to continue using indirect distribution channels, particularly value-added resellers and system integrators, in addition to distributors and original equipment manufacturers. Any material increase in our indirect sales as a percentage of revenues may adversely affect our average selling prices and gross margins due to lower unit costs that are typically charged when selling through indirect channels. There can be no assurance that we will be able to attract or retain resellers and distributors who will be able to market our products effectively, will be qualified to provide timely and cost-effective customer support and service, or will continue to represent our products. If we are unable to recruit or retain important resellers or distributors or if they decrease their sales of our products, we may suffer a material adverse effect on our business, financial condition or results of operations.

We had been notified by Nasdaq that our stock price had fallen below the minimum bid price listing requirement to maintain a listing on the Nasdaq National Market and had been subsequently notified that our failure to timely file our Form 10-Q for the quarter ended June 30, 2002 may subject our common stock to delisting; the low price of our common stock may impair its liquidity

We received a letter from the staff of the Nasdaq National Market, or Nasdaq, dated June 20, 2002 notifying us that we no longer complied with the minimum bid price requirement for continued listing, as set forth in Marketplace Rule 4450 (a)(5), and that our stock was therefore subject to delisting from the Nasdaq National Market.

On August 21, 2002, we received a letter from Nasdaq, notifying us of our failure to timely file our Form 10-Q for the quarter ended June 30, 2002 as required by Nasdaq Nasdaq Marketplace Rule 4310(c)(14). This failure subjected our common stock to delisting by Nasdaq. Nasdaq indicated that it would consider this additional delinquency in determining whether continued listing of our common stock on the Nasdaq National Market was appropriate.

On September 12, 2002, we communicated with the Nasdaq Listing Qualifications Panel, or Panel, with an update as to the implementation of our reverse stock split and the re-audit of our financial results for the years ended December 31, 2001 and 2000. In the correspondence we mentioned that stockholders representing a majority of our outstanding common stock at the Special Meeting of Stockholders held on August 28, 2002 had approved our reverse stock split. Given the additional time needed to complete the re-audit work by our independent accountants, we requested an extension to our September 13, 2002 compliance date.

On November 14, 2002, we communicated with the Panel with respect to our failure to file our Forms 10-Q for the quarters ended June 30, 2002 and September 30, 2002 and all amended public reports required to be filed with the Commission, as required by the November 5, 2002 correspondence from the Panel, and requested an extension of our November 14, 2002 target date. As of the date of this report, the Panel has not responded to our request. In the event that the Panel does not grant our request for an extension or, if granted, we fail to comply with any terms of the Panel's decision, our securities may be delisted from Nasdaq and may be traded over-the-counter or on the “Pink Sheets,” assuming we meet the qualification requirements for either or both of these markets.

Since regaining compliance with Nasdaq’s $1.00 minimum bid price listing requirement, the bid price for our common stock has at times fallen below $1.00. Even if we regain compliance with Nasdaq rules, if our common stock trades below $1.00 for thirty consecutive days, we may again be subject to delisting by Nasdaq.

Our acquisitions may have a material adverse effect on our operating results and financial condition

We consummated several merger and acquisition transactions, including the acquisitions of Wall Data and Simware in the fourth quarter of 1999, and the acquisition of Aqueduct in the second quarter of 2000. These acquisitions were motivated by various factors, including the desire to obtain new technologies, expand and enhance our product offerings, expand our customer base, attract key personnel, and strengthen our presence in the international and OEM marketplaces. Product and technology acquisitions entail numerous risks, including:

• the diversion of management’s attention away from day-to-day operations;

• difficulties in the assimilation of acquired operations and personnel (such as sales, engineering, and customer support);

• the integration of acquired products with existing product lines;

• the failure to realize anticipated benefits of cost savings and synergies;

• the loss of customers;

• undisclosed liabilities;

• adverse effects on reported operating results;

• the amortization of acquired intangible assets;

We have undergone significant restructurings, which may have a material adverse effect on our operating results

In early December 1999, following our acquisitions of Wall Data and Simware, we initiated a plan to restructure our worldwide operations in order to integrate the operations of Wall Data and Simware. We undertook further restructurings of our operations in August 2000, and again in August 2002. These restructuring plans involved reductions in our worldwide workforce and the consolidation of certain of our sales, customer support, and research and development facilities. These restructuring plans may not be successful and may not improve future operating results. Completion of the restructuring plans may disrupt our operations and have a material adverse effect on our business, financial condition and results of operations. We may also be required to implement additional restructuring plans in the future.

The successful combination of companies requires coordination of sales and marketing with research and development efforts, and can be difficult to accomplish. The integration of both Wall Data and Simware involved geographically separated organizations (in suburban Kirkland, Washington; Boston, Massachusetts; Cupertino and Irvine, California; Ottawa, Ontario, Canada; and Haifa, Israel), and personnel with diverse business backgrounds and corporate cultures. We believed that factors such as the ongoing attention and dedication of management and resources required to effect the complete integration of both Wall Data and Simware, and the consequent disruption in the business of all parties involved, contributed to interruptions and loss of momentum in our business activities. Our ability to maintain or increase revenues from the sale of products from Wall Data and Simware on an ongoing basis depends in part on our ability to effectively respond to these factors.

We may not be able to successfully make acquisitions of or investments in other companies or technologies

We have very limited experience in acquiring or making investments in companies, technologies or services. We regularly evaluate product and technology acquisition opportunities and anticipate that we may make additional acquisitions in the future if we determine that an acquisition would further our corporate strategy. Acquisitions in our industry are particularly difficult to assess because of the rapidly changing technological standards in our industry. If we make any acquisitions, we will be required to assimilate the personnel, operations and products of the acquired business and train, retain and motivate key personnel from the acquired business. However, the key personnel of the acquired business may decide not to work for us. Moreover, if the operations of an acquired company or business do not meet our expectations, we may be required to restructure the acquired business, or

write-off the value of some or all of the assets of the acquired business as we did in the third quarter of 2000. If any acquisitions are effected through the issuance of stock, our stockholders will suffer dilution and any cash used would weaken our balance sheet. No assurance can be given that any acquisition by us will or will not occur, that if an acquisition does occur, that it will not materially and adversely affect us, or that any such acquisition will be successful in enhancing our business. If any acquisitions are effected through the issuance of stock, our stockholders may suffer dilution and any cash used would weaken our balance sheet.

We are dependent upon our key management for our future success, and few of our managers are obligated to stay with us

Our success depends on the efforts and abilities of our senior management and certain other key personnel. Many of our key employees are employed on an at-will basis. If any of our key employees were to leave or were unable to work and we were unable to find a suitable replacement, then our business, financial condition and results from operations could be materially harmed.

We may not be able to hire and retain qualified employees, which would impair our ability to grow

The majority of our employee workforce is located in the competitive employment markets of Silicon Valley in California; the suburban Boston area; the suburban Seattle area; Ottawa, Ontario, Canada; and Haifa, Israel. From the latter half of 1996 until recently, we (and, prior to their acquisitions, both FTP and Wall Data) experienced high attrition at all levels and across all functions within our organization. The attrition we have experienced was attributable to various factors including, among others, industry-wide demand exceeding supply for experienced engineering and sales professionals, the effects of our restructurings and acquisitions and our results of operations. Managing employee attrition, integrating acquired operations and products, and expanding both the geographic areas of our customer base and operations have resulted in substantial demands on our management resources, and increased the difficulty of hiring, training, and assimilating new employees. Any failure by us to attract and retain qualified employees or to train or manage our management and employee base could have a material adverse effect on our business, financial condition, and results of operations.

We face significant competition and competition in our market is likely to increase and could harm our business

The market for our products is intensely competitive and characterized by rapidly changing technology, evolving industry standards, price erosion, changes in customers’ needs, and frequent new product introductions. We anticipate continued growth and competition in our industry and the entrance of new competitors into our market, and accordingly, the market for our products will remain intensely competitive. We expect that competition will increase in the near term and that our primary long-term competitors may not yet have entered the market. Several key factors contribute to the continued growth of our marketplace including the proliferation of Microsoft Windows client server technology, and the continued implementation of web-based access to corporate mainframe and midrange computer systems. Our connectivity software products compete with major computer and communication systems vendors, including Microsoft, IBM, and Sun Microsystems, Inc., as well as smaller networking software companies such as Jacada Ltd, Seagull, and Hummingbird Communications Ltd. We also face competition from makers of terminal emulation software such as Attachmate Corporation, and WRQ, Inc.

Many of our current competitors have, and many of our future competitors may have substantially greater, financial, technical, sales, marketing and other resources, in addition to greater name recognition and a larger customer base than us. The market for our products is characterized by significant price competition and we anticipate that, in the future, we will face increasing pricing pressures from our competitors. In addition, our current and future competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements than we can. Increased competition could result in price reductions, fewer customer orders, reduced gross profit margins, and loss of market share, any of which could harm our business.

Furthermore, our competitors could seek to expand their product offerings by designing and selling products using technology that could render obsolete or adversely affect sales of our products. These developments may adversely affect sales of our products either by directly affecting customer-purchasing decisions or by causing potential customers to delay their purchases of our products. Several of our competitors have developed proprietary networking applications and certain of such vendors, including Novell, provide a TCP/IP protocol suite in their

products at little or no additional cost. In particular, Microsoft has embedded a TCP/IP protocol suite in its Windows 95, Windows 98, Windows 2000, Windows ME, and Windows NT operating systems. We have products, which are similar to connectivity products marketed by Microsoft. Microsoft is expected to increase development of such products, which could have a material adverse effect on our business, financial condition or results of operations.

If we fail to manage technological change, respond to consumer demands or evolving industry standards or if we fail to enhance our products’ interoperability with the products of our customers, demand for our products will decrease and our business will suffer

From time to time many of our customers have delayed purchase decisions due to the confusion in the marketplace relating to rapidly changing technology and product introductions. To maintain or improve our position in our industry, we must successfully develop, introduce, and market new products and product enhancements on a timely and cost-effective basis. We have experienced difficulty from time-to-time in developing and introducing new products and enhancing existing products in a manner that satisfies customer requirements and changing market demands. Any further failure by us to anticipate or respond adequately to changes in technology and customer preferences, or any significant delays in product development or introduction, could have a material adverse effect on our business, financial condition, and results of operations. The failure to develop products or product enhancements incorporating new functionality on a timely basis could cause customers to delay the purchase of our current products or cause customers to purchase products from our competitors; either situation would adversely affect our business, financial condition, and results of operations. We may not be successful in developing new products or enhancing our existing products on a timely basis, and any new products or product enhancements developed by us may not achieve market acceptance. In addition, we incorporate software and other technologies owned by third parties into certain of our products and as a result, we are dependent upon such third parties’ ability to enhance their current products, to develop new products that will meet changing customer needs on a timely and cost-effective basis, and to respond to emerging industry standards and other technological changes.

We depend upon technology licensed from third parties, and if we do not maintain these license arrangements, we will not be able to ship many of our products and our business will be seriously harmed

Certain of our products incorporate software and other technologies developed and maintained by third parties. We license these technologies from third parties under agreements with a limited duration and we may not be able to maintain these license arrangements. If we fail to maintain our license arrangements or find suitable replacements, we would not be able to ship many of our products and our business would be materially harmed. For example, we have a license agreement with Dart Communications, Inc. for Power TCP Telnet and Power TCP VT320 for 5 years which we use in the OnWeb product line. There can be no assurance that we would be able to replace the functionality provided by the third party technologies currently offered in conjunction with our products if those technologies become unavailable to us or obsolete or incompatible with future versions of our products or market standards.

We depend upon the compatibility of our products with applications operating on Microsoft Windows to sell our products

Substantially all of our net revenues have been derived from the sales of products that provide internetworking applications for the Microsoft Windows environment and are marketed primarily to Windows users. As a result, sales of certain of our products might be negatively impacted by developments adverse to Microsoft’s Windows products. In addition, our strategy of developing products based on the Windows operating environment is substantially dependent on our ability to gain pre-release access to, and to develop expertise in, current and future Windows developments by Microsoft. If we are unable to provide on a timely basis products compatible with future Windows releases, our business could be harmed.

The loss of any of our strategic relationships would make it more difficult to keep pace with evolving industry standards and to design products that appeal to the marketplace

Our future success depends on our ability to maintain and enter into new strategic alliances and OEM relationships to develop necessary products or technologies, to expand our distribution channels or to jointly market or gain market awareness for our products. We currently rely on strategic relationships, such as those with

Microsoft, to provide us with state of the art technology, assist us in integrating our products with leading industry applications and help us make use of economies of scale in manufacturing and distribution. However, we do not have written agreements with many of our strategic partners that could ensure these relationships will continue for a significant period of time. Many of our agreements with these partners are informal and may be terminated by them at any time. There can be no assurance that we will be successful in maintaining current alliances or developing new alliances and relationships or that such alliances and relationships will achieve their intended purposes.

We may be subject to product returns, product liability claims and reduced sales because of defects in our products

Software products as complex as those offered by us may contain undetected errors or failures when first introduced or as new versions are released. The likelihood of errors is higher when a new product is introduced or when new versions or enhancements are released. Errors may also arise as a result of defects in the products that are incorporated into our products. There can be no assurance that, despite testing by us and by current and potential customers, errors will not be found in new products or product enhancements after commencement of commercial shipments, which could result in loss of or delay in market acceptance. We may be required to devote significant financial resources and personnel to correct any defects. Known or unknown errors or defects that affect the operation of our products could result in the following, any of which could have a material adverse effect on our business, financial condition, and results of operations:

• delay or loss of revenues;

• cancellation of a purchase order or contract due to defects;

• diversion of development resources;

• damage to our reputation;

• failure of our products to achieve market acceptance;

• increased service and warranty costs; and

• litigation costs.

Although some of our licenses with customers contain provisions designed to limit our exposure to potential product liability claims, these contractual limitations on liability may not be enforceable. In addition, our product liability insurance may not be adequate to cover our losses in the event of a product liability claim resulting from defects in our products and may not be available to us in the future.

Our business depends upon licensing our intellectual property, and if we fail to protect our proprietary rights, our business could be harmed

Our ability to compete depends substantially upon our internally developed technology. We rely primarily on a combination of copyright and trademark laws, trade secrets, confidentiality procedures, and contractual provisions to protect our proprietary rights. We seek to protect our software, documentation and other written materials under trade secret and copyright laws, which afford only limited protection, and, to a lesser extent, patent laws. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. Policing unauthorized use of our products and technology is difficult and, while we are unable to determine the extent to which piracy of our software products exists, software piracy can be expected to be a persistent problem. In selling our products, we rely primarily on “shrink-wrap” and “click-wrap” licenses that are not signed by licensees and, therefore, may be unenforceable under the laws of certain jurisdictions. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States. If we are not successful in protecting our intellectual property, our business could be substantially harmed.

We rely upon trademarks, copyrights and trade secrets to protect our proprietary rights, which are only of limited value

There can be no assurance that our means of protecting our proprietary rights will be adequate or that our competitors will not independently develop similar technology. In addition, the number of patents applied and granted for software inventions is increasing. Despite any precautions which we have taken:

• laws and contractual restrictions may not be sufficient to prevent misappropriation of our technology or deter others from developing similar technologies;

• other companies may claim common law trademark rights based upon state or foreign law which precede our federal registration of such marks; and

• current federal laws that prohibit software copying provide only limited protection from software “pirates,” and effective trademark, copyright and trade secret protection may be unavailable or limited in certain foreign countries.

Our pending patent applications may never be issued, and even if issued, may provide us with little protection

We regard the protection of patentable inventions as important to our business. It is possible that:

• our pending patent applications may not result in the issuance of patents;

• our patents may not be broad enough to protect our proprietary rights;

• any issued patent could be successfully challenged by one or more third parties, which could result in our loss of the right to prevent others from exploiting the inventions claimed in those patents;

• current and future competitors may independently develop similar technology, duplicate our products or design around any of our patents; and

• effective patent protection, if any, may not be available in every country in which we do business.

If we are not successful in asserting our patent rights, our business could be substantially harmed. At the present time, we have no patents pending and we have been issued approximately 100 patents from the U.S. Patent Office.

We have received notices of claims that may result in litigation and we may become involved in costly and time-consuming litigation over proprietary rights

Substantial litigation regarding intellectual property rights exists in our industry. We expect that software in our industry may be increasingly subject to third party infringement claims as the number of competitors grows and the functionality of products in different areas of the industry overlap. Third parties may currently have, or may eventually be issued, patents that would be infringed by our products or technology. Certain of these third parties may make a claim of infringement against us with respect to our products and technology. We have received, and may receive in the future, communications from third parties asserting that our products infringe, or may infringe, the proprietary rights of third parties seeking indemnification against such infringement or indicating that we may be interested in obtaining a license from such third parties. Any claims or actions asserted against us could result in the expenditure of significant financial resources and the diversion of management’s time and efforts. In addition, litigation in which we are accused of infringement may cause product shipment delays, require us to develop non-infringing technology or require us to enter into royalty or license agreements even before the issue of infringement has been decided on the merits. If any litigation were not to be resolved in our favor, we could become subject to substantial damage claims and be prohibited from using the technology at issue without a royalty or license agreement. These royalty or license agreements, if required, might not be available on acceptable terms, or at all, and could result in significant costs and harm our business. If a successful claim of infringement is made against us

and we cannot develop non-infringing technology or license the infringed or similar technology on a timely and cost-effective basis, our business could be significantly harmed.

Our business is subject to risks from international operations such as legal uncertainty, tariffs, trade barriers and political and economic instability

We derived approximately 28% of our net revenues from sales outside of North America (United States and Canada) during the three month period ended September 30, 2002 and 28% during the nine months ended September 30, 2002. While we expect that international sales will continue to account for a significant portion of our net revenues, there can be no assurance that we will be able to maintain or increase international market demand for our products or that our distributors will be able to effectively meet that demand. Risks inherent in our international business activities generally include, among others:

• unexpected changes in regulatory requirements;

• legal uncertainty, including reduced intellectual property protection;

• increased prevalence of intellectual property piracy and misappropriation;

• language barriers in business discussions;

• cultural differences in the negotiation of contracts and conflict resolution;

• time zone differences;

• the limitations imposed by U.S. export laws;

• changes in markets caused by a variety of political, social and economic factors;

• tariffs and other trade barriers;

• costs and risks of localizing products for foreign countries;

• longer accounts receivable payment cycles;

• difficulties in managing international operations;

• currency exchange rate fluctuations;

• potentially adverse tax consequences;

• repatriation of earnings; and

• the burdens of complying with a wide variety of foreign laws.

Many of our customers are subject to many of the risks described above. These factors may have an adverse effect on our international sales and, consequently, on our business, financial condition or results of operations. See “- We face risks from the uncertainties of current and future governmental regulation.”

Terrorist attacks and threats or actual war could adversely affect our operating results and the price of our common stock

The terrorist attacks in the U.S., the U.S. response to these attacks, the threat of war in Iraq, and the related decline in consumer confidence and continued economic weakness have had an adverse impact on our operations. Recent consumer reports indicate that consumer confidence has reached its lowest level since 1993. If consumer confidence continues to decline or does not recover, our revenues and results of operations may continue to be

adversely impacted in the fourth quarter of 2002 and beyond. Any escalation in these events, or similar future events may disrupt our operations or those of our customers. These events have had and may continue to have an adverse impact on the U.S. and world economy in general and consumer confidence and spending in particular, which has and could continue to harm our sales. Any of these events could increase volatility in the U.S. and worldwide financial markets and economy, which could harm our stock price and may limit the capital resources available to us and our customers. This could have significant impact on our operating results, revenues and costs and may result in increased volatility in the market price of our common stock and on the future price of our common stock.

Uncertainties exist regarding our stock repurchase program

Previously, we announced that our board of directors had approved the repurchase of up to 2,142,857 shares of our common stock. Stock repurchase activities are subject to certain pricing restrictions, stock market forces, management discretion and various regulatory requirements. In addition, such repurchases are at the discretion of our management and may be reduced or stopped altogether at any time. As a result, there can be no assurance as to the timing and/or amount of shares that we may repurchase under this stock repurchase program.

It may be difficult to raise needed capital in the future, which could significantly harm our business

We may require substantial additional capital to finance our future growth and fund our ongoing operations through the remainder of 2002 and beyond. Our capital requirements will depend on many factors including, among other things:

• acceptance of and demand for our products;

• the number and timing of acquisitions and the cost of such acquisitions;

• the costs of developing new products;

• the costs associated with our expansion; and

• the extent to which we invest in new technology and research and development projects.

Although our current business plan does not foresee the need for further financing activities to fund our operations for the foreseeable future, due to risks and uncertainties in the marketplace as well as a potential of pursuing further acquisitions, we may need to raise additional capital. If we issue additional stock to raise capital, particularly at our current low per share price, your percentage ownership in NetManage would be reduced. Additional financing may not be available when needed and, if such financing is available, it may not be available on terms favorable to us. In addition, our current inability to register any shares issued by us in connection with future financing activities or acquisitions on Form S-3 due to our recent failure to timely file our Form 10-Q for the period ended June 30, 2002 may increase the transaction costs of engaging in such activities and may delay the timing of the consummation of transactions.

Because of their significant stock ownership, our officers and directors can exert significant control over our future direction

As of August 28, 2002, our officers, directors and entities affiliated with them, in the aggregate, beneficially owned approximately 1.8 million shares, or approximately 19.8% of our outstanding common stock. These stockholders, if acting together, would be able to exert significant influence on all matters requiring approval by our stockholders, including the election of directors, the approval of mergers or other business combination transactions or a sale of all or substantially all of our assets.

Certain provisions of our stock option plans, our shareholder rights plan, and our certificate of incorporation and bylaws make changes of control difficult even if they would be beneficial to stockholders

Our 1992 Stock Option Plan currently provides that in the event a change in control of NetManage occurs, each outstanding option will automatically accelerate in full, unless: (i) the option is assumed by the successor corporation or otherwise continued in effect, or (ii) the option is replaced with a cash incentive program which preserves the spread existing on the unvested option shares (the excess of the fair market value of those shares over the option exercise price payable for such shares) and provides for subsequent payout in accordance with the same vesting

schedule in effect for those option shares. In addition, all unvested shares outstanding under the 1992 Stock Option Plan will immediately vest, except to the extent our repurchase rights with respect to those shares are to be assigned to the successor corporation or otherwise continued in effect. Furthermore, all options granted prior to the June 5, 2002 restatement of our 1992 Stock Option Plan will accelerate upon a change in control of NetManage. Our 1999 Nonstatutory Stock Option Plan currently provides that, in the event of a change of control of NetManage, all options outstanding under that plan would become fully vested and exercisable and would be terminated if not exercised prior to the closing of such change of control transaction. These acceleration of vesting provisions may have the effect of deterring or reducing the price that a potential acquirer would be willing to pay to acquire NetManage.

We have adopted a stockholder rights plan that would cause substantial dilution to a stockholder, and substantially increase the cost paid by a stockholder, who attempts to acquire us on terms not approved by our board of directors. This could prevent us from being acquired. In addition, our board of directors has the authority without any further vote or action on the part of the stockholders to issue up to 5,000,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions of the preferred stock. This preferred stock, if it is ever issued, may have preference over, and harm the rights of the holders of, our common stock. Although the issuance of this preferred stock will provide us with flexibility in connection with possible acquisitions and other corporate purposes, the issuance of the preferred stock may make it more difficult for a third party to acquire a majority of our outstanding voting stock. We currently have no plans to issue preferred stock.

Our certificate of incorporation and bylaws include provisions that may have the effect of deterring an unsolicited offer to purchase our stock. These provisions, coupled with the provisions of the Delaware General Corporation Law, may delay or impede a merger, tender offer or proxy contest involving us. Furthermore, our board of directors is divided into three classes, only one of which is elected each year. Directors are only capable of being removed by the affirmative vote of two thirds or greater of all classes of voting stock. These factors may further delay or prevent a change of control.

We face risks from the uncertainties of current and future governmental regulation

We are not currently subject to direct regulation by any government agency, other than regulations applicable to businesses generally, and there are currently few laws or regulations directly applicable to access to or commerce on the Internet. However, due to the increasing popularity and use of the Internet, it is possible that various laws and regulations may be adopted with respect to the Internet, covering issues such as user privacy, pricing and characteristics and quality of products and services. The adoption of any such laws or regulations may decrease the growth of the Internet, which could in turn decrease the demand for our products, increase our cost of doing business or otherwise have an adverse effect on our business, financial condition or results of operations. Moreover, the applicability to the Internet of existing laws governing issues such as property ownership, libel and personal privacy is uncertain. Further, due to the encryption technology contained in certain of our products, such products are subject to U.S. export controls. There can be no assurance that such export controls, either in their current form or as may be subsequently enacted, will not limit our ability to distribute products outside of the United States or electronically. While we take precautions against unlawful exportation, there can be no assurance that inadvertent violations will not occur, and the global nature of the Internet makes it virtually impossible to effectively control the distribution of our products. In addition, future federal or state legislation or regulation may further limit levels of encryption or authentication technology. Any such export restriction, new legislation or regulation or unlawful exportation could have a material adverse effect on our business, financial condition, or results of operations.

Item 3. Quantitative and qualitative disclosures about market risk

The information required by Item 3 is incorporated by reference from the section entitled “Disclosures about market risk” found above, under Item 2, “Management’s discussion and analysis of financial condition and results of operations”.

Item 4. Controls and procedures

a) Evaluation of disclosure controls and procedures. Based on their evaluation as of a date within 90 days of the filing date of this quarterly report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-14 (c) and 15d-14 (c) under the Securities Exchange Act of 1934 (the “Exchange Act”)) are effective.

b) Changes in internal controls. There have been no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

PART II OTHER INFORMATION

Item 1. Legal proceedings

Legal proceedings

On November 22, 1999, Kenneth Fisher filed a complaint alleging violations of the False Claims Act, 31 U.S.C. § 3729 et seq., against us, and our affiliates Network Software Associates, Inc. or NSA, and NetSoft Inc., or NetSoft, in the United States District Court of the District of Columbia. The United States government declined to pursue the action on its own behalf and, therefore, the action is pursued by Kenneth Fisher. We, and our affiliates, first learned of the action when we were served with the amended complaint in May 2001. On September 5, 2001, Mr. Fisher agreed to voluntarily dismiss us from this action in exchange for our agreement to toll, or forego, applicable statutes of limitation as to Mr. Fisher’s claims.

On May 13, 2002, on an order of the court following defendants’ successful motion to strike the second amended complaint filed by Mr. Fisher on January 31, 2002, Mr. Fisher filed a Third Amended Complaint, or Complaint, in the United States District Court of the District of Columbia against NSA and Net Soft among numerous other defendants. The Complaint alleges that NSA, NetSoft and the other defendants made false claims to the government to obtain government contracts set aside for entities owned and controlled by disadvantaged persons admitted to the Section 8 (a) Minority Small Business Development Program. Specifically, the Complaint alleges that from 1987 to 1997, NSA, NetSoft, and the other defendants presented false or fraudulent claims for payment or approval to the government in violation of 31 U.S.C. § 3729 (a) (1), and used false records or statements to get claims paid or approved by the government in violation of 31 U.S.C. § 3729 (a) (2) in connection with NSA’s application and certification as a Section 8 (a) minority owned and controlled company. In addition, the Complaint alleges that NSA, NetSoft and the other defendants conspired to defraud the government by fraudulently obtaining NSA’s certification as a Section 8 (a) entity for alleged use by NSA’s Federal Systems Division, in violation of 31 U.S.C. § 3729 (a) (3). Mr. Fisher alleges damages in excess of $30,000,000.

We may be contingently liable with respect to certain asserted and unasserted claims that arise during the normal course of business.

Item 2. Changes in securities and use of proceeds

Not applicable

Item 3. Defaults upon senior securities

Not applicable

Item 4. Submission of matters to a vote of security holders

A Special Meeting of Stockholders was held at our offices at 10725 N. DeAnza Boulevard, Cupertino, California on Wednesday August 28, 2002 at 9:00 a.m. Pacific Daylight Time, for the purpose of: i) to amend our Certificate of Incorporation to effect a reverse stock split of our common stock at a ratio of one-for-seven, and ii) to transact other business that may properly come before the meeting. Stockholders of record at the close of business on July 15, 2002 were entitled to vote at the meeting.

On the motion, with respect to amend the Certificate of Incorporation:


For		Against		Abstain

	56,393,304		302,632		18,296

Item 5. Other information

1. Ido Hardanog was appointed to the position of senior vice president, engineering in October 2002. In addition, in September 2002, Bob Fedorciow joined our management staff as vice president and general manager of Europe.

2. On November 14, 2002, we communicated with the Nasdaq Listing Qualifications Panel, or Panel, with respect to our failure to file our Forms 10-Q for the quarters ended June 30, 2002 and September 30, 2002 and all amended public reports required to be filed with the Commission, as required by the November 5, 2002 correspondence from the Panel, and requested an extension of our November 14, 2002 target date. As of the date of this report, the Panel has not responded to our request.

Item 6. Exhibits and reports on Form 8-K

a. Exhibits


Exhibit		Description

3.1		Certificate of Amendment to Certificate of Incorporation of NetManage, Inc.

b. Reports on Form 8-K.

1. On August 20, 2002, we filed a Current Report on Form 8-K reporting under Item 5 a delay in filing our Form 10-Q for the period ended June 30, 2002 with the Securities and Exchange Commission.

2. On September 3, 2002, we filed a Current Report on Form 8-K reporting under Item 5 that on August 21, 2002 we received a letter from The Nasdaq Stock Market, Inc. notifying us of our failure to comply with Nasdaq rules regarding the timely filing of our Form 10-Q for the quarter ended June 30, 2002, and that we will be restating certain financial results.

3. On September 5, 2002, we filed a Current Report on Form 8-K reporting under Item 5 that our stockholders approved a one-for-seven reverse split of our common stock at a Special Meeting held on August 28, 2002.

4. On September 30, 2002, we filed a Current Report on Form 8-K reporting under Item 5 that we received a letter from The Nasdaq Stock Market, Inc. confirming that we had met Nasdaq’s $1.00 minimum bid price requirement and stating that our securities would continue to be listed on the Nasdaq National Market, subject to certain conditions.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


		NETMANAGE, INC. (Registrant)









DATE: November 20, 2002	By:	/s/ Michael Peckham

		Michael Peckham Chief Financial Officer and Senior Vice President (Principal Financial and Accounting Officer)

CERTIFICATIONS

I, Zvi Alon, certify that:

1. I have reviewed this quarterly report on Form 10-Q of NetManage, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.


DATE: November 20, 2002		/s/ Zvi Alon

		Zvi Alon Chief Executive Officer

I, Michael Peckham, certify that:

1. I have reviewed this quarterly report on Form 10-Q of NetManage, Inc.;


Date: November 20, 2002




		/s/ Michael Peckham

		Michael Peckham Chief Financial officer

EXHIBIT INDEX


Exhibit		Description

3.1		Certificate of Amendment to Certificate of Incorporation of NetManage, Inc.

	•		significant underperformance relative to historical or projected future operating results;

	•		significant changes in the manner of our use of the acquired assets or the strategy for our overall business;

	•		significant negative industry or economic trends; and

	•		our market capitalization relative to net book value.

	•		general economic conditions, in particular, the recent slowdown of purchases of information technology due to current economic conditions in North America and financial pressures experienced by our customers and targeted customers;

	•		demand for our products;

	•		introduction or enhancements to our products and those of our competitors;

	•		technological changes in computer networking;

	•		competitive pricing pressures;

	•		market acceptance of new products;

	•		customer order deferrals in anticipation of new products and product enhancements;

	•		the size and timing of individual product orders;

	•		mix of international and domestic revenues;

	•		mix of distribution channels through which our products are sold;

	•		impact of, or failure to enter into, strategic alliances to promote our products;

	•		quality control of our products;

	•		changes in our operating expenses;

	•		personnel changes; and

	•		foreign currency exchange rates.

	•		the diversion of management’s attention away from day-to-day operations;

	•		difficulties in the assimilation of acquired operations and personnel (such as sales, engineering, and customer support);

	•		the integration of acquired products with existing product lines;

	•		the failure to realize anticipated benefits of cost savings and synergies;

	•		the loss of customers;

	•		undisclosed liabilities;

	•		adverse effects on reported operating results;

	•		the amortization of acquired intangible assets;

	•		delay or loss of revenues;

	•		cancellation of a purchase order or contract due to defects;

	•		diversion of development resources;

	•		damage to our reputation;

	•		failure of our products to achieve market acceptance;

	•		increased service and warranty costs; and

	•		litigation costs.

	•		laws and contractual restrictions may not be sufficient to prevent misappropriation of our technology or deter others from developing similar technologies;

	•		other companies may claim common law trademark rights based upon state or foreign law which precede our federal registration of such marks; and

	•		current federal laws that prohibit software copying provide only limited protection from software “pirates,” and effective trademark, copyright and trade secret protection may be unavailable or limited in certain foreign countries.

	•		our pending patent applications may not result in the issuance of patents;

	•		our patents may not be broad enough to protect our proprietary rights;

	•		any issued patent could be successfully challenged by one or more third parties, which could result in our loss of the right to prevent others from exploiting the inventions claimed in those patents;

	•		current and future competitors may independently develop similar technology, duplicate our products or design around any of our patents; and

	•		effective patent protection, if any, may not be available in every country in which we do business.

	•		unexpected changes in regulatory requirements;

	•		legal uncertainty, including reduced intellectual property protection;

	•		increased prevalence of intellectual property piracy and misappropriation;

	•		language barriers in business discussions;

	•		cultural differences in the negotiation of contracts and conflict resolution;

	•		time zone differences;

	•		the limitations imposed by U.S. export laws;

	•		changes in markets caused by a variety of political, social and economic factors;

	•		tariffs and other trade barriers;

	•		costs and risks of localizing products for foreign countries;

	•		longer accounts receivable payment cycles;

	•		difficulties in managing international operations;

	•		currency exchange rate fluctuations;

	•		potentially adverse tax consequences;

	•		repatriation of earnings; and

	•		the burdens of complying with a wide variety of foreign laws.

	•		acceptance of and demand for our products;

	•		the number and timing of acquisitions and the cost of such acquisitions;

	•		the costs of developing new products;

	•		the costs associated with our expansion; and

	•		the extent to which we invest in new technology and research and development projects.

	a)		Evaluation of disclosure controls and procedures. Based on their evaluation as of a date within 90 days of the filing date of this quarterly report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-14 (c) and 15d-14 (c) under the Securities Exchange Act of 1934 (the “Exchange Act”)) are effective.

	b)		Changes in internal controls. There have been no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

			a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

			b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

			c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

			a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

			b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and