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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

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 December 31, 2002

OR

[    ]    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 000-26934

Hyperion Solutions Corporation

1344 Crossman Avenue, Sunnyvale, California 94089

(408) 744-9500

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    [ü]   No    [   ]

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

As of February 3, 2003, there were 34,877,906 shares of the Registrant’s common stock, $0.001 par value, outstanding.

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Hyperion Solutions Corporation

Form 10-Q

Hyperion, the Hyperion “H” logo, Essbase, Hyperion Essbase XTD, Hyperion Planning, Hyperion Financial Management, Hyperion Performance Scorecard, Hyperion Business Modeling, Hyperion Pillar, and Hyperion Enterprise are registered trademarks or trademarks of Hyperion Solutions Corporation. All other trademarks and company names mentioned are the property of their respective owners. All rights reserved.

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HYPERION SOLUTIONS CORPORATION

     See accompanying notes to condensed consolidated financial statements.

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HYPERION SOLUTIONS CORPORATION

     See accompanying notes to condensed consolidated financial statements.

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HYPERION SOLUTIONS CORPORATION

     See accompanying notes to condensed consolidated financial statements.

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HYPERION SOLUTIONS CORPORATION

1. Basis of Presentation

The accompanying condensed consolidated financial statements have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to these rules and regulations. However, management believes that the disclosures are adequate to ensure the information presented is not misleading. The balance sheet at June 30, 2002 has been derived from the audited financial statements, but does not include all disclosures required by generally accepted accounting principles. These unaudited condensed consolidated financial statements should be read in conjunction with the audited financial statements and the notes thereto included in our annual report on Form 10-K for the fiscal year ended June 30, 2002.

In the opinion of management, all adjustments, consisting only of normal recurring items, considered necessary for a fair presentation have been included in the accompanying unaudited financial statements. The results of operations for the interim periods presented are not necessarily indicative of the operating results to be expected for any subsequent interim period or for our fiscal year ending June 30, 2003. Certain prior period balances have been reclassified to conform to the current period presentation.

2. Significant Accounting Policies

Revenue Recognition

Hyperion derives revenues from licensing its software products and providing maintenance and professional services. Hyperion’s standard software license agreement is a perpetual license to use its products on an end user, concurrent user or central processing unit basis. Hyperion records revenue from licensing of software products to end users provided there is persuasive evidence of an arrangement, the fee is fixed or determinable, collection is reasonably assured and delivery of the product has occurred as prescribed by Statement of Position (“SOP”) No. 97-2, “Software Revenue Recognition,” issued by the American Institute of Certified Public Accountants. For arrangements with multiple elements, and for which vendor specific objective evidence (“VSOE”) of fair value exists for the undelivered elements, revenue is recognized for the delivered elements based upon the residual method in accordance with SOP No. 98-9, “Modifications of SOP 97-2 with Respect to Certain Transactions.” VSOE of fair value for all elements of an arrangement is based upon the normal pricing and discounting practices for those products and services when sold separately. VSOE of fair value for services is based upon the standard hourly rate Hyperion charges for such services when sold separately. VSOE of fair value for maintenance is measured by the stated renewal rates included in the contracts. If the fair value of any undelivered element included in a multiple-element arrangement cannot be objectively determined, revenue is deferred until all elements are delivered, services have been performed or until fair value can be objectively determined. License revenue from resellers or distributors is recognized upon sell-through to the end customer. Amounts billed or payments received in advance of revenue recognition are recorded as deferred revenue.

Maintenance agreements are generally a twelve-month prepaid contract that is recognized ratably over the period. Customers may also enter into professional services arrangements that are typically on a time and materials basis and include consulting and training services. Consulting and training revenues are typically recognized as earned. Consulting revenues are generated primarily from implementation services related to the installation of Hyperion’s products. These arrangements are generally accounted for separately from the license revenue because the arrangements qualify as “service transactions” as defined in SOP No. 97-2. Hyperion’s services are generally not essential to the functionality of the software. Hyperion’s products are fully functional upon delivery of the product and implementation does not require any significant modification or alteration. Hyperion’s services often include assistance with product adoption. Other significant factors considered in determining whether the revenue should be accounted for separately include degree of risk, availability of services from other vendors, timing of payments and impact of milestones or acceptance criteria on the realizability of the software license fee. Customers generally purchase these services to facilitate the adoption of Hyperion’s products and obtain dedicated personnel to participate in the services being performed, but they may also decide to use their own internal resources or appoint other professional service organizations to provide these services. Payments related to the software product to which the services relate are typically billed independently from the services and, therefore, are not coincident with performance of such services. License agreements generally do not include acceptance provisions. If an arrangement does not qualify for separate accounting of the license and service elements, license revenue is generally recognized together with the consulting services using the percentage-of-completion method of contract accounting in accordance with SOP No. 81-1, “Accounting for Performance of Construction-Type and Certain Product-Type Contracts” and Accounting Research Bulletin No. 45, “Long-Term Construction-Type Contracts.”

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Allowance for Doubtful Accounts

Hyperion makes judgments as to its ability to collect outstanding receivables and provides allowances for a portion of receivables when collection becomes doubtful. Provisions are made based upon a specific review of all significant outstanding invoices. For those invoices not specifically reviewed, provisions are made at differing rates, based upon the age of the receivable. In determining these percentages, Hyperion analyzes its historical collection experience, customer concentrations, customer credit-worthiness and current economic trends. If the historical data used to calculate the allowance provided for doubtful accounts does not reflect the future ability to collect outstanding receivables, additional provisions for doubtful accounts may be needed.

Comprehensive Income

Comprehensive income includes foreign currency translation gains and losses and unrealized gains and losses on available-for-sale securities. The net unrealized gains and losses on available-for-sale securities for the three and six months ended December 31, 2002 and 2001 were not material.

Earnings Per Share

Earnings per share (“EPS”) is computed in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 128, “Earnings Per Share.” Basic EPS is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS is computed using the weighted average number of common shares outstanding and potentially dilutive securities outstanding during the period. Potentially dilutive securities include stock options and shares issuable upon conversion of Hyperion’s convertible subordinated notes. Potentially dilutive securities are excluded from the computation of diluted EPS if their effect would be antidilutive.

The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts):

For the three and six months ended December 31, 2002, stock option rights totaling 2.2 million shares and 2.7 million shares, respectively, have been excluded from the diluted EPS calculations because their effect would have been antidilutive. For the three and six months ended December 31, 2001, stock option rights totaling 5.4 million shares and 5.7 million shares, respectively, have been excluded from the diluted EPS calculations because their effect would have been antidilutive.

For the three and six months ended December 31, 2002, 1.2 million and 1.3 million shares of common stock, respectively, issuable upon conversion of the convertible subordinated notes have been excluded from the diluted EPS calculations because their effect would have been antidilutive. For the three and six months ended December 31, 2001, 1.6 million shares of common stock issuable upon conversion of the convertible subordinated notes have been excluded from the diluted EPS calculations because their effect would have been antidilutive.

Recent Accounting Pronouncements

In January 2002, the Emerging Issues Task Force (“EITF”) issued EITF Issue No. 01-14 “Income Statement Characterization of Reimbursements Received for Out of Pocket Expenses Incurred,” which requires that reimbursements received for “out-of-pocket” expenses be reflected as revenues in the statement of income. EITF No. 01-14 is effective for financial reporting periods beginning after December 15, 2001. Hyperion adopted EITF No. 01-14 on January 1, 2002 and reclassified the statements of income for the three and six months ended December 31, 2001 to conform to the current presentation. As a result, approximately $2.3 million and $4.9 million have been reclassified primarily from cost of maintenance and services into maintenance and services revenue for the three and six months ended December 31, 2001, respectively.

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In July 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which nullifies EITF Issue No. 94-3. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, whereas EITF No. 94-3 had required recognition of the liability as of the commitment date of an exit plan. This statement is effective for exit or disposal activities initiated after December 31, 2002. Hyperion is currently assessing the impact of SFAS No. 146 on its financial position and results of operations.

In November 2002, the FASB issued Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. FIN 45 also requires additional disclosure by a guarantor in its interim and annual financial statements about its obligations under certain guarantees. The initial recognition and measurement provisions of FIN 45 are applicable for guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. Hyperion believes that the adoption of FIN 45 will not have a material impact on its financial position or results of operations.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the pro forma effect in interim financial statements. The transition and annual disclosure requirements of SFAS No. 148 are effective for fiscal years ended after December 15, 2002. The interim disclosure requirements are effective for interim periods ending after December 15, 2002. Hyperion will adopt the disclosure requirements of SFAS No. 148 in its March 31, 2003 quarterly financial statements.

In January 2003, the FASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. Hyperion believes that the adoption of FIN 46 will not have a material impact on its financial position or results of operations.

3. Contingencies

On July 11, 1997, Gentia Software filed a request for reexamination of Hyperion’s U.S. Patent No. 5,359,724 (“’724 patent”) with the United States Patent and Trademark Office (“PTO”) arguing that the ‘724 patent was anticipated and obvious in light of certain prior art references. On September 11, 1997, the PTO granted the request for reexamination. On February 27, 1998, Gentia Software filed with the PTO a request for a second reexamination of the ‘724 patent based on additional prior art references. On May 22, 1998, the PTO granted that request for reexamination, which was later consolidated with the first reexamination. On March 31, 1999, the PTO issued a non-final office action rejecting the claims of the ‘724 patent. Hyperion filed its response to the office action on May 31, 1999. No final office action has been issued by the PTO. Hyperion believes that the outcome of such action will not have a material adverse effect on its financial position, results of operations or cash flows.

From time to time, in the normal course of business, various claims are made against Hyperion. At this time, in the opinion of management, there are no pending claims the outcome of which is expected to result in a material adverse effect on the financial position, results of operations or cash flows of Hyperion.

4. Segment and Geographic Information

SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” established standards for reporting information about operating segments in a company’s financial statements. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. Hyperion has identified one industry segment: the development and marketing of business performance management software and related services. This segment operates in three geographic regions: the Americas (United States, Canada and Latin America), EMEA (Europe, Middle East and Africa) and APAC (Asia Pacific). Hyperion’s products are marketed internationally through Hyperion’s direct sales force, independent distributors and application resellers.

Enterprise-wide information is provided in accordance with SFAS No. 131. Geographic revenue information is primarily based on the ordering location of the customer, and long-lived asset information is based on the physical location of the assets.

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The following table presents revenues and long-lived assets by geographic region (in thousands):

The following table presents revenues for groups of similar products and services (in thousands):

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

FORWARD-LOOKING STATEMENTS

Certain information contained in this report on Form 10-Q is forward-looking in nature. All statements included in this report on Form 10-Q or made by management of Hyperion Solutions Corporation and its subsidiaries, other than statements of historical fact, are forward-looking statements. Examples of forward-looking statements include statements regarding Hyperion’s future financial results, operating results, business strategies, projected costs, products, competitive positions and plans and objectives of management for future operations. In some cases, forward-looking statements can be identified by terminology such as “may,” “will,” “should,” “would,” “expect,” “plan,” “anticipate,” “intend,” “believe,” “estimate,” “predict,” “potential,” “continue,” or the negative of these terms or other comparable terminology. Any expectations based on these forward-looking statements are subject to risks and uncertainties and other important factors, including those discussed in the section entitled “Factors That May Affect Future Results.” These and many other factors could affect Hyperion’s future financial and operating results, and could cause actual results to differ materially from expectations based on forward-looking statements made in this document or elsewhere by Hyperion or on its behalf. Hyperion does not undertake an obligation to update its forward-looking statements to reflect future events or circumstances.

OVERVIEW

Hyperion delivers business performance management software solutions that enable companies to continually measure performance, anticipate results and drive profitability across key business activities. Our customers use our products to help them collaborate enterprise-wide, focus resources, improve operational efficiencies and leverage opportunities for growth.

Our business performance management solutions provide comprehensive support for the entire process of goal setting, business modeling, planning, budgeting, performance monitoring, analyzing and reporting throughout organizations. Our products complement existing enterprise resource planning, customer relationship management, supply chain management and transaction systems by integrating data from multiple sources, providing a common view across the enterprise and enabling an integrated business performance management process that aligns individual goals with corporate objectives.

We provide applications along with a development and deployment platform to enable business performance management across a wide variety of functional and business activity areas. We use our online analytical processing technology, Hyperion Essbase, as the foundation for our platform, Hyperion Essbase XTD. Components within Hyperion Essbase XTD can be used individually to create tailored applications or in conjunction with our packaged applications to support the entire business performance management process. With our platform and our packaged business performance management applications, we provide customers some of the deepest and broadest product offerings in the market. In addition, we offer support and services from offices in 20 countries and work with over 330 partners to provide solutions to more than 6,000 customer organizations worldwide. Hyperion was formed in August 1998 when Arbor Software, founded in 1991, acquired Hyperion Software, founded in 1981.

RESULTS OF OPERATIONS

REVENUES

Software licenses. Software license revenues increased 11% in the three months ended December 31, 2002 compared to the three months ended December 31, 2001 and increased 13% in the six months ended December 31, 2002 compared to the six months ended December 31, 2001. The increase in license revenue in the second quarter and first half of fiscal 2003 was primarily due to increased revenues from two of our newer suite-based application products, Hyperion Planning and Hyperion Financial Management, in the first half of fiscal 2003 as well as several significant Essbase XTD platform sales in the second quarter of fiscal 2003. However, these factors were offset to some extent by declines in revenue from our older, standalone application products, Hyperion Pillar and Hyperion Enterprise.

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We separate license revenue into two main components- application license revenue and platform license revenue. Application license revenue is generated from our packaged business performance management applications, and platform license revenue is generated from our Hyperion Essbase XTD platform and its component products. In the second quarter of fiscal 2003, application revenue represented 45% of license revenue and platform revenue represented 55% of license revenue, compared to 51% application revenue and 49% platform revenue in the second quarter of fiscal 2002. A 33% increase in suite-based application sales, which include Hyperion Planning and Hyperion Financial Management, combined with a 50% decrease in standalone application sales, which include Hyperion Pillar and Hyperion Enterprise, resulted in an overall 2% decrease in total application license revenue for the second quarter of fiscal 2003 compared to the second quarter of fiscal 2002. However, platform sales increased 24% in the second quarter of fiscal 2003 compared to the second quarter of fiscal 2002 as a result of several large Essbase XTD platform sales during the second quarter of fiscal 2003. The slight decrease in application license revenue and the substantial increase in platform license revenue resulted in the decrease in the ratio of application license revenue to platform license revenue in the second quarter of fiscal 2003.

For the first half of fiscal 2003, license revenue was comprised of 49% application revenue and 51% platform revenue, compared to 46% application revenue and 54% platform revenue for the first half of fiscal 2002. A 103% increase in suite-based application sales, partially offset by a 53% decrease in standalone application sales, resulted in an overall 19% increase in total application license revenue for the first half of fiscal 2003 compared to the first half of fiscal 2002. Two of our newer suite-based application products, Hyperion Planning and Hyperion Financial Management, were still in the early stages of their product life cycles in the first half of fiscal 2002, but these products began making significant contributions to total license revenue later in fiscal 2002 and into fiscal 2003. The 19% increase in application license revenue, compared with a 7% increase in platform license revenue, resulted in the increase in the ratio of application license revenue to platform license revenue in the first half of fiscal 2003.

We market our products through our direct sales force and through channel partners. To date, we have generated the majority of our license revenue through our direct sales force, but we continue to focus on complementing our direct sales force with channel partners, which include original equipment manufacturers, value added resellers, system integrators, independent distributors and sales agents. License revenue from channel partners comprised 27% of total license revenue in the second quarter of fiscal 2003 compared to 24% in the second quarter of fiscal 2002. For the first half of fiscal 2003 and 2002, license revenue from channel partners comprised 26% of total license revenue. Effectively leveraging our channel partners continues to be one of our key strategies, and our goal is to derive 33% of our license revenue through our channel partners. Consistent with fiscal 2002, no single channel partner represented more than 10% of total revenue during the second quarter or first half of fiscal 2003.

Maintenance and services. Maintenance and services revenue increased 3% in the three months ended December 31, 2002 compared to the three months ended December 31, 2001. This increase was due to a 17% increase in maintenance revenue, which was caused by year-over-year growth of our installed customer base. Partially offsetting this increase in maintenance revenue was a 19% decrease in consulting and training revenue, which resulted from our increased use of channel partners to provide consulting services to our customers. In the six months ended December 31, 2002, maintenance and services revenue decreased 1% compared to the six months ended December 31, 2001. The slight decrease in maintenance and services revenue was due to a 26% decrease in consulting and training revenue, which was partially offset by a 17% increase in maintenance revenue.

COST OF REVENUES

Cost of software license revenue. Cost of software license revenue consists primarily of royalty expenses, amortization of capitalized software development costs, amortization of acquired technologies and the cost of product packaging and documentation materials. Cost of software license revenue in the three and six months ended December 31, 2002 remained relatively flat compared to the three and six months ended December 31, 2001 despite the respective increases in software license revenue. This was partially attributable to different product mixes in the second quarter and first half of fiscal 2003, which resulted in lower third-party royalty expenses as a percentage of software license revenue. For the three and six months ended December 31, 2002, the total cost of software license revenue as a percentage of total license revenue was 7%. For the three and six months ended December 31, 2001, the total cost of software license revenue as a percentage of total license revenue was 8%.

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In the first half of fiscal 2003 and 2002, we capitalized $0.7 million and $0.3 million of software product development costs, respectively, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed.” The amounts capitalized relate to localization costs for our software products. Capitalized software product development costs are amortized over the estimated economic life of the products, which is generally three years. The amortization of capitalized software product development costs begins upon the general release of the software to customers.

Cost of maintenance and services revenue. Cost of maintenance and services revenue consists largely of compensation and benefits for consulting, training and support personnel. Cost of maintenance and services revenue decreased 6% in the three months ended December 31, 2002 compared to the three months ended December 31, 2001 and decreased 9% in the six months ended December 31, 2002 compared to the six months ended December 31, 2001. The decrease in cost of maintenance and services revenue is primarily attributable to our continued focus on leveraging our channel partners to perform consulting services for our customers. As a result of this effort, we reduced headcount in our North American consulting organization by approximately 75 employees in the fourth quarter of fiscal 2002. This reduction in headcount contributed to a $2.2 million decrease in employee expenses for maintenance and services personnel in the second quarter of fiscal 2003 compared to the second quarter of fiscal 2002 and a $3.8 million decrease in employee expenses in the first half of fiscal 2003 compared to the first half of fiscal 2002. Further, independent contractor and temporary staffing expenses decreased $0.3 million and $1.2 million in the three and six months ended December 31, 2002 compared to the three and six months ended December 31, 2001 due to our decreased use of external personnel for product implementations.

Gross margin on maintenance and services revenue increased to 57% in the second quarter and first half of fiscal 2003 compared to 53% in the second quarter and first half of fiscal 2002. These increases in gross margin on maintenance and services revenue are primarily due to the increases in maintenance revenue as a percentage of total maintenance and services revenue, as margins on the maintenance revenue stream are higher than margins on the services revenue stream.

OPERATING EXPENSES

Sales and marketing. Sales and marketing expense increased 12% in the three months ended December 31, 2002 compared to the three months ended December 31, 2001. This increase was due in part to a $2.5 million increase in marketing expenses, which resulted from increased advertising and tradeshow activities during the quarter, and a $2.1 million increase in employee expenses, primarily due to increased commissions resulting from the increase in license revenue. Sales and marketing expense increased 6% in the six months ended December 31, 2002 compared to the six months ended December 31, 2001 primarily due to a $4.1 million increase in marketing expenses resulting from increased advertising and tradeshow activities.

Research and development. Research and development expense increased 8% in the three months ended December 31, 2002 compared to the three months ended December 31, 2001. This increase was primarily due to a $0.5 million increase in employee expenses. In the six months ended December 31, 2002, research and development expense increased 1% compared to the six months ended December 31, 2001.

General and administrative. General and administrative expense decreased 23% in the three months ended December 31, 2002 compared to the three months ended December 31, 2001 due in part to a $1.4 million decrease in outsourcing costs, as we ended the outsourcing of our North American accounting department in the fourth quarter of fiscal 2002, and a $1.2 million decrease in occupancy and equipment costs primarily due to a decrease in depreciation and amortization expense, as many fixed assets have become fully depreciated in the past year. These decreases were partially offset by a $0.8 million increase in employee expenses resulting primarily from headcount increases as we brought our North American accounting function in-house. General and administrative expense decreased 22% in the first half of fiscal 2003 compared to the first half of fiscal 2002 primary due to a $2.4 million decrease in outsourcing costs, a $3.0 million decrease in occupancy and equipment costs, and a $1.5 million decrease in charges related to property and sales tax audits. These decreases were partially offset by a $1.4 million increase in employee expenses resulting from the headcount increases discussed above.

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RESTRUCTURING CHARGES

Restructuring charges totaled $0.6 million and $0.2 million in the three months ended December 31, 2002 and 2001, respectively, and totaled $0.6 million and $0.5 million in the six months ended December 31, 2002 and 2001, respectively. These restructuring charges resulted from adjustments made to the restructuring charge we recorded in the fourth quarter of fiscal 2001.

INTEREST INCOME AND EXPENSE

Interest income consists of interest earned on cash, cash equivalent and short-term investment balances. Although we had higher average cash and investment balances during the three and six months ended December 31, 2002 compared to the three and six months ended December 31, 2001, interest income decreased due to declines in short-term interest rates during fiscal 2002 and 2003.

Interest expense consists primarily of interest paid and amortization of deferred issuance costs related to our convertible subordinated notes. During the three and six months ended December 31, 2002, we repurchased convertible subordinated notes with face values totaling $23.7 million and $28.7 million, respectively, which resulted in the decreases in interest expense compared to the three and six months ended December 31, 2001.

GAIN ON REDEMPTION OF DEBT

During the three months ended December 31, 2002, we repurchased convertible subordinated notes with face value of $23.7 million for a total cost of approximately $23.2 million, resulting in a net gain of approximately $0.2 million. During the six months ended December 31, 2002, we repurchased convertible subordinated notes with face value of $28.7 million for a total cost of approximately $27.9 million, resulting in a net gain of approximately $0.5 million. Any further purchases of our convertible notes will be determined based on an evaluation of market conditions and other factors.

PROVISION FOR INCOME TAXES

Our effective income tax rate for the three and six months ended December 31, 2002 was 37% compared to an effective income tax rate of 36% for the three and six months ended December 31, 2001. We expect our effective tax rate to remain at 37% for the remainder of fiscal 2003.

NET INCOME

As a result of the above factors, we generated net income of $7.6 million, or $0.21 per diluted share, for the three months ended December 31, 2002 compared to net income of $3.7 million, or $0.11 per diluted share, for the three months ended December 31, 2001. For the six months ended December 31, 2002, our net income was $16.7 million, or 0.48 per diluted share, compared to net income of $5.7 million, or $0.17 per diluted share, for the six months ended December 31, 2001.

LIQUIDITY AND CAPITAL RESOURCES

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