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For the quarterly period ended June 30, 2003

OR

For the transition period from __________ to __________

Commission file number 0-22158

NetManage, Inc.

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 [ X ]   NO [   ]

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

Number of shares of registrant’s common stock outstanding as of August 5, 2003: 8,664,900.

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NetManage, Inc.
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NetManage, Inc.

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

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NetManage, Inc.

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

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NetManage, Inc.

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

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NetManage, Inc.

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

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NETMANAGE, INC.

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 2003 could differ materially from those reported in this quarterly report on 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. The financial statements should be read in conjunction with the audited financial statements and notes thereto, included in our annual report on Form 10-K for the year ended December 31, 2002, as filed with the Securities and Exchange Commission.

2. Consolidation

     The interim unaudited condensed consolidated financial statements include the Company’s accounts and those of its 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 generally accepted accounting principles 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 the Company’s 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. Gains and losses resulting from foreign currency transactions are included in net income.

     The Company currently does not enter into financial instruments for either trading or speculative purposes.

     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 classified as available for sale.

Short-term investments

     The Company accounts for its 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, the Company’s investments classified as available-for-sale securities are reported at fair value, with unrealized gains and losses, net of tax, reported in the balance sheet as “Accumulated other comprehensive loss”. Held-to-maturity securities are valued using the amortized cost method. At June 30, 2003 and December 31, 2002, the fair value of the time deposit investments, which have original maturities in excess of 90 days, 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. The carrying value of the Company’s short-term investments by major security type consisted of the following as of June 30, 2003 and December 31, 2002 (in thousands):

     *KANA Software, Inc. is a publicly traded company in which the Company owns a minority interest of less than 1%.

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Goodwill and other intangible assets, net

     Effective January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangibles Assets (SFAS No. 142). Under SFAS No. 142, goodwill is no longer subject to amortization over its estimated useful life. Rather, SFAS No. 142 requires that goodwill and other intangible assets deemed to have an indefinite useful life be reviewed for impairment upon adoption of SFAS No. 142 (January 1, 2002) and at least annually thereafter.

     Intangible assets with determinable useful lives are amortized on a straight-line basis over their estimated useful lives ranging from two to seven years. The following table provides a summary of the carrying amounts of other intangible assets (in thousands).

     The aggregate amortization expense for the three and six months ended June 30, 2003 was $499,000, and $958,000, respectively. The aggregate amortization expense for the three and six months ended June 30, 2002 was $763,000, and $1,526,000, respectively.

     Minimum future amortization expense at June 30, 2003 is as follows:

Accrued liabilities and restructuring

     Accrued liabilities at June 30, 2003 and December 31, 2002 consisted of the following (in thousands):

     In June 2002, the Financial Accounting Standards Board, or FASB, issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally 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 the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF No. 94-3, a liability for an exit cost was recognized at the date of the commitment to an exit plan. SFAS No. 146 also requires that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146, which the Company adopted for restructuring activities initiated after December 31, 2002, may affect the timing of recognizing future restructuring costs as well as the amounts recognized.

Concentrations of credit risk

     Financial instruments which subject the Company to concentrations of credit risk consist principally of cash investments and trade receivables. The Company has 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 creditworthy. Concentrations of credit risk with respect to trade receivables are limited due to

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the large number of customers comprising the Company’s customer base and their dispersion across many different industries and geographies. There were no customers that accounted for more than 10% of consolidated revenues in the second quarter of 2003, and in the six month period ended June 30, 2003. For the three and six month periods ended June 30, 2002 there were no customers that accounted for more than 10% of consolidated revenues.

Accounting for stock based compensation

     In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure-an Amendment of FASB Statement No.123, which provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has adopted the amended annual and interim disclosure requirements of SFAS No. 123.

     SFAS No. 123, Accounting for Stock-Based Compensation, encourages all entities to adopt a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the fair value of the award which is recognized over the service period, which is usually the vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. Stock options issued under the Company’s stock option plans have no intrinsic value at the grant date. Accordingly, under APB Opinion No. 25, no compensation cost is recognized. The Company has elected to continue with the method of accounting prescribed in APB Opinion No. 25 and, as a result, must provide pro forma disclosures of net income and earnings per share and other disclosures as if the fair value based method of accounting had been applied. Had compensation cost for the Company’s outstanding stock options been determined based on the fair value at the grant dates for awards under those plans consistent with the method prescribed by SFAS No. 123, the Company’s net loss and loss per share would have been adjusted to the pro forma amounts indicated below (in thousands except per share data):

     The fair value of each option granted is estimated on the date of grant using the Black-Scholes model with the following assumptions used for grants during the applicable periods:

Stock option exchange offer

     On May 16, 2003 the Company announced a voluntary stock option exchange program for certain of its employees. The offer to

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exchange options, or Offer, was open to eligible option holders, excluding non-employee members of the board of directors and non-exempt employees, holding options to purchase shares of the Company’s common stock with an exercise price per share of $1.50 or greater. In accordance with the terms of the Offer, participating employees tendered eligible options in exchange for replacement options. These replacement options will then be granted to employees at least six months and one day following the date their original options were exchanged and cancelled. Under the terms of the Offer, replacement options will vest and become exercisable for the balance of the option shares in accordance with the same type of installment vesting schedule that was in effect for the cancelled options, but measured from the grant date of the replacement options, and no vesting credit will be provided for the period between the date the original options were tendered and the date the replacement options are granted.

     On June 13, 2003, employees tendered options to purchase a total of 542,150 shares in connection with the Offer, which were cancelled under the Company’s 1992 Stock Option Plan as amended, and the 1999 Non-statutory Stock Option Plan following their exchange. Subject to the continued employment of the employees who exchanged options, replacement options to purchase a total of 542,150 shares are expected to be granted on or around December 16, 2003.

     The exercise price of the replacement options will be based on the fair market value of the Company’s common stock on the date the replacement options are granted. The fair market value of the Company’s common stock will be equal to the last reported sale price of its common stock on the Nasdaq National Market on the date it grants the replacement options.

     The exchange program is being accounted for in accordance with FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation—an Interpretation of APB Opinion No. 25 and results in no compensation expense.

Net loss per share

     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 six month periods ended June 30, 2003 and 2002, the number of shares used in the computation of diluted loss per share was the same as those used for the computation of basic loss per share. For the three and six month periods ended June 30, 2003 and 2002, potentially dilutive securities (primarily stock options) are as shown in the following table and were not included in the computation of diluted net loss per share because to do so would have been anti-dilutive.

Income taxes

     As part of the process of preparing its consolidated financial statements, the Company is required to estimate its income taxes in each of the jurisdictions in which the Company operates. This process involves estimating the Company’s 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 the Company’s consolidated balance sheet. The Company must then assess the likelihood that its deferred tax assets will be recovered from future taxable income and to the extent the Company believes that recovery is not likely, it must establish a valuation allowance. To the extent the Company establishes a valuation allowance or its allowance in a period changes, the amount recognized as a provision for income taxes in the statement of operations could change. The income tax provision of $16,000 for the quarter ended June 30, 2003 resulted primarily from international tax expense of $6,000 and U.S. state tax expense of $10,000. The income tax provision of $340,000 for the quarter ended June 30, 2002 resulted primarily from international tax expense of $382,000 and U.S. state tax benefits of $42,000. The income tax benefit of $301,000 for the six months ended June 30, 2003 resulted primarily from German tax refunds of $481,000, net of international tax expense of $172,000 and U.S. state tax expense of $8,000. The income tax provision of $587,000 for the six months ended June 30, 2002 resulted primarily from international tax expense of $685,000, net of U.S. state tax benefits of $98,000.

Recent accounting pronouncements

     In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. This Statement is effective for financial instruments entered into or modified after May 31,

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2003, and otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The Company currently has no financial instruments which meet these requirements.

     In April 2003 the FASB issued SFAS No. 149, Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities. This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts. The Statement clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, clarifies when a derivative contains a financing component, amends the definition of an underlying derivative to conform it to language used in FASB Interpretation FIN No. 45, and amends certain other existing pronouncements. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. All provisions of the Statement, except those related to forward purchases or sales of “when-issued” securities, should be applied prospectively. The Company currently has no instruments that meet the definition of a derivative, and therefore, the adoption of this Statement will have no impact on the Company’s financial position or results of operations.

     In January 2003, the FASB issued Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, which addresses consolidation by business enterprises of variable interest entities that either: (i) do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (ii) the equity investors lack an essential characteristic of a controlling financial interest. FIN 46 requires disclosure of Variable Interest Entities (VIEs) in financial statements issued after January 31, 2003, if it is reasonably possible that as of the transition date: (i) the company will be the primary beneficiary of an existing VIE that will require consolidation, or (ii) the company will hold a significant variable interest in, or have significant involvement with, an existing VIE. The adoption of FIN 46 had no impact on the Company’s financial statements.

     In November 2002, the FASB issued FIN 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, which addresses the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees. FIN 45 also requires the recognition of a liability by a guarantor at the inception of certain guarantees that are entered into or modified after December 31, 2002. The Company has adopted the disclosure requirements of FIN 45 and will apply the recognition and measurement provision for all material guarantees entered into or modified after December 31, 2002.

Reclassifications

     Certain reclassifications have been made to the 2002 financial statements to conform to the current year presentation.

4. Restructuring of operations

     On January 31, 2003, the Company announced a restructuring of operations designed to refocus its business units around its core business functions, to relocate certain of its functional operations to the Company’s corporate headquarters, and to reduce operating expenses. As part of the restructuring, the Company reduced its workforce in excess of 30% and has recorded a $2.9 million charge to operating expenses in the first half of 2003. The Company anticipates that an additional $0.2 million in employee related costs will be recorded in the second half of 2003. The distribution of the reduction in workforce was as follows:

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     The restructuring charge for the six month period ended June 30, 2003 includes approximately $0.6 million of expenses related to leased facilities no longer needed for the Company’s operations and $2.3 million of employee severance and other related expenses. The Company anticipates that the execution of the restructuring actions will require total cash expenditures of $3.1 million, which is expected to be funded from internal operations and existing cash balances. As of June 30, 2003, the Company had incurred costs totaling $2.9 million related to the restructuring, which required $1.6 million in cash expenditures. The remaining reserve related to this restructuring is approximately $1.3 million, and is included in accrued liabilities as of June 30, 2003.

     The following table lists the components of the January 2003 restructuring reserve for the six month period ended June 30, 2003 (in thousands):

     On August 8, 2002, the Company announced a restructuring of its operations designed to re-align its core business functions and reduce operating expenses. As part of the restructuring, the Company intended to reduce its workforce by approximately 26% 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 severance and other related expenses. In March 2003, based on a review of current operations, the decision was made to revise the original restructuring plan by retaining certain personnel in European locations who had been identified for termination and certain related offices that had been identified for closure. This decision resulted in a $1.2 million reversal of the restructuring accrual as of March 31, 2003, and a corresponding reduction of restructuring expense for the three months then ended. Such reversal was comprised of expected employee costs of approximately $0.8 million and expected facilities expenses of approximately $0.4 million. In June 2003, NetManage recorded an additional $40,000 in restructuring expense relating to employee termination costs in Latin America. The distribution of the reduction in workforce was as follows:

     As of June 30, 2003, NetManage had incurred costs totaling $2.0 million related to this restructuring accrual which required $2.0 million in cash expenditures. The remaining reserve related to this restructuring is approximately $1.4 million, and is included in accrued liabilities as of June 30, 2003.

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     The following table lists the components of the August 2002 restructuring reserve for the six month periods ended June 30, 2003 (in thousands):

     On August 3, 2000, the Company announced a restructuring of its operations designed to re-focus on its core business functions and reduce operating expenses. In connection with the restructuring, the Company reduced its workforce by approximately 20% 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 NetManage does not plan to use. In September 2002, based on a review of its continuing obligations associated with the original restructuring charge, NetManage recorded a reduction in estimate for facilities of approximately $521,000 and an increase in estimate for other charges of approximately $249,000. In June 2003, NetManage recorded a further reduction in the estimate for facilities of approximately $65,000 and in the estimate for equipment of approximately $15,000. As of June 30, 2003, total cash expenditures incurred with respect to this restructuring reserve were $5.2 million. The remaining balance of the reserve was approximately $51,000, which is included in accrued liabilities as of June 30, 2003.

     The following table lists the components of the August 2000 restructuring reserve for the six month period ended June 30, 2003 (in thousands):

     In the fourth quarter of 1999, following the acquisitions of Wall Data, Incorporated and Simware Inc., the Company initiated a plan to restructure its worldwide operations in order to integrate the operations of the two acquired companies. In connection with this plan, the Company recorded a $3.8 million charge to operating expenses in 1999. The restructuring charge included 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. The Company anticipated that the execution of the restructuring actions would require total cash expenditures of approximately $3.6 million, which the Company expected to be funded from internal operations. In 2002, in connection with a review of its obligations for facilities, the Company recorded a reduction in the estimated expenses of approximately $128,000. In the six month period ended June 30, 2003, based on a review of its continuing facilities obligations, the Company recorded a $157,000 increase in the restructuring reserve with a corresponding increase of restructuring expense. As of June 30, 2003, total cash expenditures incurred with respect to this restructuring reserve were approximately $3.6 million. The remaining reserve is approximately $0.2 million, and is included in accrued liabilities as of June 30, 2003.

     The following table lists the components of the restructuring reserve for the six month period ended June 30, 2003 (in thousands):