NETMANAGE INC - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q


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

For the quarterly period ended September 30, 2003


[ ]		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 [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 November 10, 2003: 8,708,961.

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
	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
EXHIBIT INDEX
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1

NetManage, Inc.
Table of Contents


		Page

Part I.	Financial Information
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets at September 30, 2003 and December 31, 2002	3
	Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2003 and September 30, 2002 (as restated)	4
	Condensed Consolidated Statements of Comprehensive Loss for the Three and Nine Months ended September 30, 2003 and September 30, 2002 (as restated)	5
	Condensed Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2003 and September 30, 2002 (as restated)	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	36
Item 4	Controls and Procedures	36
PART II.	OTHER INFORMATION	37
Item 1.	Legal Proceedings	37
Item 2.	Changes in Securities	37
Item 3.	Defaults upon Senior Securities	38
Item 4.	Submission of Matters to a Vote of Security Holders	38
Item 5.	Other Information	38
Item 6.	Exhibits and Reports on Form 8-K	38
	Signatures	39

NetManage, Inc.
Condensed Consolidated Balance Sheets
(In thousands, except per share amounts)
(Unaudited)


					September 30,			December 31,
					2003			2002

ASSETS
Current Assets:
	Cash and cash equivalents				$	21,529		$	24,014
	Short-term investments					221			80
	Accounts receivable, net of allowances of $856 and $1,077, respectively					5,392			18,332
	Prepaid expenses and other current assets					2,840			2,933

				Total current assets		29,982			45,359

Property and equipment, at cost
			Computer software and equipment			1,027			1,106
			Furniture and fixtures			5,446			4,598
			Leasehold improvements			1,346			1,273

						7,819			6,977
			Less-accumulated depreciation			(5,841	)		(4,654	)

				Net property and equipment		1,978			2,323
Goodwill						1,762			1,762
Other intangibles, net						2,087			3,573
Other assets						133			221

				Total assets	$	35,942		$	53,238

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
	Accounts payable				$	1,848		$	2,431
	Accrued liabilities					6,429			9,549
	Accrued payroll and related expenses					2,552			3,693
	Deferred revenue					11,670			18,551
	Income taxes payable					1,473			1,346

				Total current liabilities		23,972			35,570
Long-term liabilities						1,278			1,581

				Total liabilities		25,250			37,151

Commitments and contingencies (Note 5)
Stockholders’ equity:
	Common stock, $0.01 par value -
		Authorized - 125,000,000 shares
		Issued - 10,741,748 and 10,698,025 shares, respectively
		Outstanding - 8,664,900 and 8,693,108 shares, respectively				107			107
	Treasury stock, at cost - 2,076,848 and 2,004,917 shares, respectively					(20,804	)		(20,629	)
	Additional paid in capital					177,935			177,836
	Accumulated deficit					(142,916	)		(138,157	)
	Accumulated other comprehensive loss					(3,630	)		(3,070	)

				Total stockholders’ equity		10,692			16,087

				Total liabilities and stockholders’ equity	$	35,942		$	53,238

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,

			2003			2002			2003			2002

						(As restated,						(As restated,
						see Note 7)						see Note 7)
Net revenues:
	License fees		$	4,022		$	5,338		$	14,258		$	23,391
	Services			7,355			8,616			23,109			25,777

		Total net revenues		11,377			13,954			37,367			49,168
Cost of revenues:
	License fees			277			378			1,353			1,761
	Services			1,066			1,562			3,593			4,877
	Amortization of developed technology			294			562			953			1,684

		Total cost of revenues		1,637			2,502			5,899			8,322

Gross margin				9,740			11,452			31,468			40,846

Operating expenses:
	Research and development			1,831			3,130			6,547			10,319
	Sales and marketing			5,805			8,244			19,440			27,695
	General and administrative			2,958			3,729			8,727			8,699
	Restructuring charges, net			339			4,614			1,829			4,614
	Amortization of intangible assets			150			201			449			605

		Total operating expenses		11,083			19,918			36,992			51,932

Loss from operations				(1,343	)		(8,466	)		(5,524	)		(11,086	)
Loss on investments, net				—			(2,534	)		(32	)		(2,534	)
Interest income (expense) and other, net				(109	)		69			11			271
Foreign currency transaction gains (losses)				(401	)		(79	)		489			(1,387	)

Loss before income taxes				(1,853	)		(11,010	)		(5,056	)		(14,736	)
Provision (benefit) for income taxes				4			330			(297	)		917

Net loss			$	(1,857	)	$	(11,340	)	$	(4,759	)	$	(15,653	)

Net loss per share
	Basic and diluted		$	(0.21	)	$	(1.28	)	$	(0.55	)	$	(1.74	)
Weighted average common shares
	Basic and diluted			8,665			8,878			8,646			8,980

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,

		2003			2002			2003			2002

					(As restated,						(As restated,
					see Note 7)						see Note 7)
Net loss		$	(1,857	)	$	(11,340	)	$	(4,759	)	$	(15,653	)
Other comprehensive income (loss):
	Unrealized gain (loss) on investments, net		36			629			83			(1	)
	Foreign currency translation adjustments, net		407			(184	)		(643	)		1,827

Total comprehensive loss		$	(1,414	)	$	(10,895	)	$	(5,319	)	$	(13,827	)

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,

					2003			2002

								(As restated,
								see Note 7)
Cash flows from operating activities:
	Net loss				$	(4,759	)	$	(15,653	)
	Adjustments to reconcile net loss to net cash (used in ) operating activities:
		Depreciation and amortization				2,289			3,707
		Provision for doubtful accounts and returns				95			24
		Stock option compensation expense				67			—
		Loss on disposal of fixed assets				22			526
		Loss on exchange of marketable securities				—			758
		Loss on investments				32			1,773
		Changes in operating assets and liabilities:
			Accounts receivable			12,845			10,673
			Prepaid expenses and other current assets			203			190
			Other assets			88			(15	)
			Accounts payable			(699	)		(779	)
			Accrued liabilities, payroll and payroll-related expenses			(4,554	)		3,692
			Deferred revenue			(7,130	)		(7,214	)
			Income taxes payable			210			458
			Long-term liabilities			(303	)		(615	)

				Net cash used in operating activities		(1,594	)		(2,475	)

Cash flows from investing activities:
	Purchases of short-term investments					(193	)		(11	)
	Proceeds from maturities of short-term investments					133			11
	Purchases of property and equipment					(454	)		(563	)

				Net cash used in investing activities		(514	)		(563	)

Cash flows from financing activities:
	Proceeds from sale of common stock, net of issuance costs					32			342
	Repurchase of common stock					(175	)		(1,954	)

				Net cash used in financing activities		(143	)		(1,612	)

Effect of exchange rate changes on cash						(234	)		420

Net decrease in cash and cash equivalents						(2,485	)		(4,230	)
Cash and cash equivalents, beginning of the period						24,014			33,038

Cash and cash equivalents, end of the period					$	21,529		$	28,808

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 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 the Company’s 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 loss.

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, or 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 September 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 September 30, 2003 and December 31, 2002 (in thousands):


	September 30,		December 31,
Description	2003		2002

Time deposits	$	61	$	—
KANA Software, Inc*		160		80

Total	$	221	$	80

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

Goodwill and other intangible assets, net

Effective January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangibles Assets. 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 and at least annually thereafter, SFAS No. 142 was adopted on January 1, 2002.

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).


		September 30,			December 31,
		2003			2002

Carrying amount of:
	Developed technology	$	11,249		$	11,332
	Customer base		3,177			3,177
	RUMBA ® trade name		1,492			1,492
	Patents & copyrights		399			399

Gross carrying amount of other intangibles			16,317			16,400
Less accumulated amortization:
	Developed technology		(9,857	)		(8,903	)
	Customer base		(2,741	)		(2,461	)
	RUMBA trade name		(1,287	)		(1,156	)
	Patents & copyrights		(345	)		(307	)

Net carrying amount of other intangibles		$	2,087		$	3,573

The aggregate amortization expense for the three and nine months ended September 30, 2003 was $444,000, and $1,402,000, respectively. The aggregate amortization expense for the three and nine months ended September 30, 2002 was $763,000, and $2,289,000, respectively.

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


Remainder 2003		$	467
Fiscal 2004			1,620

	Total	$	2,087

Accrued liabilities and restructuring

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


		September 30,		December 31,
Description		2003		2002

Restructuring (see Note 4)		$	2,412	$	4,593
Other accruals			4,017		4,956

	Total	$	6,429	$	9,549

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 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 three and nine month periods ended September 30, 2003 and 2002.

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 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 loss and loss 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):


	Three Months Ended						Nine Months Ended
	September 30,						September 30,

	2003			2002			2003			2002

Net loss as reported	$	(1,857	)	$	(11,340	)	$	(4,759	)	$	(15,653	)
Less: Stock-based employee compensation expense included in reported net loss		—			—			—			—
Add: Total stock-based employee compensation expense determined under fair value based method for all awards		(385	)		(776	)		(1,087	)		(2,586	)

Pro forma net loss	$	(2,242	)	$	(12,116	)	$	(5,846	)	$	(18,239	)

Basic and diluted loss per share, as reported	$	(0.21	)	$	(1.28	)	$	(0.55	)	$	(1.74	)
Basic and diluted loss per share, pro forma	$	(0.26	)	$	(1.36	)	$	(0.68	)	$	(2.03	)

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:


	Three Months Ended			Nine Months Ended			Three Months Ended			Nine Months Ended
	September 30, 2003			September 30, 2003			September 30, 2002			September 30, 2002

Volatility		63.82	%		82.35	%		148.50	%		111.19	%
Risk-free interest rate		1.24-3.03	%		1.00-3.03	%		1.23-3.28	%		1.23-4.69	%
Dividend yield		0.00	%		0.00	%		0.00	%		0.00	%
Expected term	3 - 4 months			3 - 4 months			3 - 4 months			3 - 4 months
	beyond vest date			beyond vest date			beyond vest date			beyond vest date

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 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 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. In addition, 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 an aggregate of 542,150 shares in connection with the Offer. These options were cancelled under the Company’s 1992 Stock Option Plan as amended and restated, and the 1999 Non-statutory Stock Option Plan as amended following their exchange. Subject to the continued employment of the employees who exchanged options, replacement options are expected to be granted on or around December 16, 2003. As of September 30, 2003, the number of tendered options eligible for replacement has been reduced to 531,047 due to the termination of certain employees after June 13, 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 nine month periods ended September 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 nine month periods ended September 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.

Three Months Ended September 30,

Nine Months Ended September 30,

2003

2002

2003

2002

Potentially dilutive shares

96,844

29,918

1,201

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 $4,000 for the quarter ended September 30, 2003 resulted primarily from an international tax benefit of $134,000 (consisting of French tax refunds of $142,000 net of international tax expense of $8,000) and U.S. state tax expense of $138,000. The income tax provision of $330,000 for the quarter ended September 30, 2002 resulted primarily from international tax expense of $254,000 and U.S. tax expense of $76,000. The income tax benefit of $297,000 for the nine months ended September 30, 2003 resulted primarily from German tax refunds of $481,000, France tax refunds of $142,000, net of international tax expense of $180,000 and U.S. tax expense of $146,000. The income tax provision of $917,000 for the nine months ended September 30, 2002 resulted primarily from international tax expense of $939,000, net of U.S. tax benefits of $22,000.

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, 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. In October 2003 the FASB elected to defer the effective date for applying the provisions of FIN 46 for interests held by public entities in variable interest entities or potential variable interest entitites until the end of the first interim or annual period ending after December 15, 2003. The adoption of FIN 46 is not expected to have an 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 the adoption did not have a material affect on the financial statements.

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 operations 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 recorded a $3.3 million charge to

operating expenses in the nine month period ending September 30, 2003. The Company anticipates that an additional $0.1 million in employee related costs will be recorded in the fourth quarter of 2003. The distribution of the reduction in workforce was as follows:


	Terminations		Replacements		Net Reduction

Operations		10		6		4
Services		16		1		15
Research and development		19		—		19
Sales and marketing		45		4		41
General and administrative		24		5		19

Total		114		16		98

The restructuring charge for the three month period ended September 30, 2003 includes approximately $0.4 million of employee severance and related expenses plus approximately $40,000 facility expenses related to the closure of a leased facility in Germany. The restructuring charge for the nine month period ended September 30, 2003 includes approximately $0.6 million of expenses related to leased facilities no longer needed for the Company’s operations and $2.7 million of employee severance and other related expenses. The Company anticipates that the execution of the restructuring actions will require total cash expenditures of $3.4 million, which is expected to be funded from operations and existing cash balances. As of September 30, 2003, the Company had incurred costs totaling $3.3 million related to the restructuring, which required $2.4 million in cash expenditures. The remaining reserve related to this restructuring is approximately $0.9 million, and is included in accrued liabilities as of September 30, 2003.

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


	Employee			Excess
	Costs			Facilities			Total

Balance at December 31, 2002	$	—		$	—		$	—
Reserve established		2,662			630			3,292
Reserve utilized in nine months ended September 30, 2003		(2,098	)		(274	)		(2,372	)

Balance at September 30, 2003	$	564		$	356		$	920

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, the Company recorded an additional $40,000 in restructuring expense relating to employee severance and other related expenses in Latin America. In September 2003, the Company recorded a reduction in obligations of approximately $25,000. This reduction resulted from the following: i) a reduction of the estimate of excess facility costs of approximately $851,000 from the continued use of facilities scheduled for closure; ii) an offsetting change in estimate of approximately $955,000 resulting from the Company’s inability to sublet its excess space at certain facilities as the result of the short remaining lease term for these facilities and the slow real estate market that does not support subleasing of the facilities; iii) a reduction of approximately $46,000 in estimated property and equipment costs used in on-going operations instead of disposal; iv) a reduction in the estimated exit costs (moving, broker fees, travel, temporary labor costs) of approximately $64,000; and v) a reduction in expected employee related costs of approximately $19,000.

The distribution of the reduction in workforce was as follows:


	Terminations		Retained		Net Reduction

Operations		6		—		6
Services		17		—		17
Research and development		53		—		53
Sales and marketing		22		8		14


	Terminations		Retained		Net Reduction

General and administrative		11		1		10

Total		109		9		100

As of September 30, 2003, the Company had incurred costs totaling $2.3 million related to this restructuring accrual which required $2.3 million in cash expenditures. The remaining reserve related to this restructuring is approximately $1.1 million, and is included in accrued liabilities as of September 30, 2003.

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


	Employee			Excess
	Costs			Facilities			Total

Balance at December 31, 2002	$	1,122		$	2,156		$	3,278
Net change in estimate recorded as a reduction of restructuring expense		(848	)		(400	)		(1,248	)
Reserve utilized in nine months ended September 30, 2003		(204	)		(771	)		(975	)

Balance at September 30, 2003	$	70		$	985		$	1,055

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 the Company does not plan to use. In September 2002, based on a review of its continuing obligations associated with the original restructuring charge, the Company 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, the Company recorded a further reduction in the estimate for facilities of approximately $65,000 and in the estimate for equipment of approximately $15,000. In September 2003, the Company recorded an additional increase in the estimate of other expenses of approximately $3,000. As of September 30, 2003, total cash expenditures incurred with respect to this restructuring reserve were $5.2 million and the reserve for this restructuring has been fully utilized.

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


	Excess
	Facilities			Other			Total

Balance at December 31, 2002	$	88		$	119		$	207
Net change in estimate recorded as a reduction of restructuring expense		(65	)		(12	)		(77	)
Reserve utilized in nine months ended September 30, 2003		(23	)		(107	)		(130	)

Balance at September 30, 2003	$	—		$	—		$	—

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 September 30, 2003, total cash expenditures incurred with respect to this restructuring reserve were approximately $3.7 million. The remaining reserve is approximately $0.1 million, and is included in accrued liabilities as of September 30, 2003.

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


	Excess
	Facilities

Balance at December 31, 2002	$	435
Change in estimate recorded to restructuring expense		157
Reserve utilized in nine months ended September 30, 2003		(443	)

Balance at September 30, 2003	$	149

In August 1998, following the acquisition of FTP Software Inc., the Company initiated a plan to restructure its worldwide operations as a result of business conditions and in connection with the integration of the operations of FTP. In connection with this plan, the Company recorded a $7.0 million charge to operating expenses in 1998. Additionally, prior to the acquisition, FTP had recorded a restructuring charge. The Company 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. In 2002, based on a review of all obligations, the Company recorded an increase in this reserve, primarily for facilities expense of approximately $691,000. In the six month period ended June 30, 2003, based on a review of its continuing facilities obligations, the Company recorded a $295,000 reduction in the restructuring reserve with a corresponding reduction of restructuring expense. No adjustments other than payments of facilities expenses were recorded in the three month period ended September 30, 2003. The remaining reserve related to this restructuring at September 30, 2003 is approximately $0.3 million and is included in accrued liabilities.

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


	Excess
	Facilities

Balance at December 31, 2002	$	673
Change in estimate recorded as a reduction of restructuring expense		(295	)
Reserve utilized in nine months ended September 30, 2003		(90	)

Balance at September 30, 2003	$	288

5. 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 the Company and its affiliates Network Software Associates, Inc., or NSA, and NetSoft Inc., or NetSoft, in the United States District Court of the District of Columbia. Mr. Fisher purported to file the action on behalf of himself and the United States federal government. NetManage acquired NSA and NetSoft in 1997. The United States government declined to pursue the action on its own behalf and, therefore, the action was pursued by Kenneth Fisher, as relator, on behalf of himself and the government. NetManage, and its affiliates, first learned of the action when the Company was served with the amended complaint in May 2001. On September 5, 2001, Mr. Fisher agreed to voluntarily dismiss the Company from this action, without prejudice, in exchange for an agreement to suspend applicable statutes of limitation as to Mr. Fisher’s claims.

On January 31, 2002, on an order of the court granting in part and denying in part defendant’s motion to dismiss the May 2001 amended complaint, Mr. Fisher filed a Second Amended Complaint, or Second Complaint, in the United States District Court of the District of Columbia against NSA and NetSoft among numerous other defendants. On May 13, 2002, on an order of the court following defendants’ successful motion to strike the Second Complaint, 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 1993 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 addition, the complaint alleges that NSA, NetSoft and the other defendants conspired to defraud the government by working to fraudulently continue NSA’s certification as a Section 8 (a) entity for alleged use by NSA’s Federal Systems Division and by getting fraudulent claims allowed and paid by virtue of the alleged fraudulent Section 8(a) status, in violation of 31 U.S.C. § 3729 (a) (3). NetManage did not acquire NSA until July 1997 and had no involvement with the events alleged by Mr. Fisher. According to the earlier amended complaint (although

not alleged in the current complaint), Mr. Fisher’s theory was that the liabilities of NSA and NetSoft, including alleged liability in this suit, passed to NetManage. On May 31, 2002, NSA and NetSoft and the other defendants answered the complaint. The Company and its affiliates, dispute Mr. Fisher’s allegations and discovery is presently continuing in this matter. The Company has insufficient information at this time to estimate the possible loss, if any, which might result from this lawsuit.

In addition, the Company may be contingently liable with respect to certain asserted and unasserted claims that arise during the normal course of business. Management believes the impact, if any, resulting from these matters would not have a material impact on the Company’s financial statements.

Leases

Facilities and equipment are leased under non-cancelable operating leases expiring on various dates through the year 2011. The company does not have any capital leases. As of September 30, 2003, future minimum rental and lease payments, net of any sublease income, under non-cancelable operating leases are as follows:


	Amount of Commitment Expiration Per Period (in thousands)

			Less than 1
	Total		year		2 to 3 years		4 to 5 years		After 5 years

Operating leases	$	7,488	$	3,255	$	981	$	1,253	$	1,999

Other

As an element of its standard commercial terms, the Company includes an indemnification clause in its software licensing agreements that indemnifies the licensee against liability and damages (including legal defense costs) arising from any claims of patent, copyright, trademark, or trade secret infringement by the Company’s software. The Company’s indemnification limitation is the cost to defend any third party claim brought against our customers and to the maximum a refund of the purchase price. The Company licenses software on a perpetual basis.

6. Segment information

The Company operates in two market segments: Host Access and Host Integration. The Company’s Chief Executive Officer evaluates these market segments at the sales and bookings level.

The Company’s Host Access product line is designed to provide the technology to make the connection between personal computers and large corporate computers possible. These products are designed to leverage the strengths and popularity of the Internet, as well as corporate private networks, and offer features to improve network manageability. 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 presentations, applications, and solutions. These two product lines have similar economic characteristics and are similar with respect to the nature of the products, the nature of the production processes, the type of customer that the products are sold to and the methods used to distribute the products. Net revenues for the Host Access and Host Integration product lines was as follows for the three and nine month periods ended September 30, 2003 and 2002 (in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,

	2003		2002		2003		2002

Host Access	$	11,049	$	13,704	$	34,348	$	47,150
Host Integration		328		250		3,019		2,018

Total	$	11,377	$	13,954	$	37,367	$	49,168

7. Restatement of financial statements

Subsequent to the issuance of the Company’s interim unaudited condensed consolidated financial statements for the three and nine months ended September 30, 2002, management determined that the accounting treatment was inappropriate for certain transactions, and that the following adjustments were required (in thousands):


		Three Months			Nine Months
		Ended			Ended
		September 30,			September 30,
		2002			2002
Total net revenues:
	As previously reported	$	14,093		$	49,365
	Correction for rebate expense previously recorded as a selling expense		(139	)		(319	)
	Release of excess returns reserves		—			122

	As restated	$	13,954		$	49,168

Cost of revenues
	As previously reported*	$	2,514		$	8,360
	Decrease in amortization expense associated with purchase price adjustments recorded in 2000 for developed technology with respect to the acquisition of Wall Data		(12	)		(38	)

	As restated	$	2,502		$	8,322

Sales and marketing
	As previously reported	$	8,448		$	28,234
	Correction for rebate expense charged against net revenues		(139	)		(319	)
	Correction for rebate expense charged against reserves		—			(101	)
	Adjustments for sales meeting expense held in the first quarter of 2002		(65	)		98
	Decrease in commission expenses charged in 2002 that should have been expensed in 2001		—			(216	)
	Other miscellaneous expense adjustments		—			(1	)

	As restated	$	8,244		$	27,695

Amortization of intangible assets
	As previously reported*	$	219		$	656
	Purchase price adjustments recorded in 2000 with respect to the acquisition of Wall Data		(18	)		(51	)

	As restated	$	201		$	605

Interest income and other, net
	As previously reported	$	69		$	272
	Other miscellaneous expense adjustments		—			(1	)

	As restated	$	69		$	271

Provision for income taxes
	As previously reported	$	160		$	361
	Increase in the quarterly income tax provision to account for the utilization of pre-acquisition net operating losses and tax credits of Simware which had been previously recognized as a reduction of the provision for income taxes instead of a reduction of goodwill and intangibles.		170			556

	As restated	$	330		$	917

Net loss
	As previously reported	$	(11,265	)	$	(15,527	)

	As restated	$	(11,340	)	$	(15,653	)

Net loss per share — basic and diluted
	As previously reported	$	(1.27	)	$	(1.73	)
	As restated	$	(1.28	)	$	(1.74	)
	Weighted average common shares — basic and diluted		8,878			8,980

(*) reflects certain reclassifications to conform to the current period presentation

As a result of the adjustments described above, the accompanying interim condensed consolidated financial statements for the three and nine months ended September 30, 2002 have been restated to reflect the correction of the matters as described above.

A summary of the significant effects of the restatement is as follows (in thousands, except per share amounts):


		Three Months Ended September 30,						Nine Months Ended September 30,

		2002			2002			2002			2002

		(As previously						(As previously
		*reported)**			(As restated)			*reported)**			(As restated)
Statement of Operations Data:
	Total net revenues	$	14,093		$	13,954		$	49,365		$	49,168
	Cost of revenues		2,514			2,502			8,360			8,322
	Gross margin		11,579			11,452			41,005			40,846
	Sales and marketing		8,448			8,244			28,234			27,695
	Amortization of intangible assets		219			201			656			605
	Interest income and other, net		69			69			272			271
	Provision for income taxes		160			330			361			917
	Net loss		(11,265	)		(11,340	)		(15,527	)		(15,653	)
	Net loss per share — basic and diluted		(1.27	)		(1.28	)		(1.73	)		(1.74	)

(*) Reflects certain reclassifications to conform to the current period presentation.

8. Related party transactions

On May 28, 2003, the Company entered into an independent contractor services agreement with Dr. Shelley Harrison (a member of the Company’s Board of Directors), pursuant to which Dr. Harrison will receive compensation in consideration for consultancy and advisory services he is providing the Company over a two year period. The terms of the agreement require the Company to pay Dr. Harrison a fixed fee of $138,000 per year and a one time grant to Dr. Harrison of an option to purchase 146,800 shares of the Company’s common stock, at an exercise price of $1.92 per share (which represents the quoted market price of the stock at the date of grant). The option vests on a monthly basis over the two year term of the agreement. The option expires five years from the date of issuance. The fair value of the option was determined using the Black-Scholes option pricing model with the following assumptions: stock price $2.95 - $4.00; no dividends; risk free interest rate of 2.00% - 2.41%; volatility of 63% - 90%; and a contractual life of five years. The fair value of the option is subject to change over the vesting period of the option based on changes in the underlying assumptions (variable award accounting). Through September 30, 2003 the Company had recorded approximately $67,000 in compensation expense under this agreement, based on the aggregate fair value of $402,000. In connection with his entering into the agreement, Dr. Harrison resigned from the Company’s Audit Committee effective May 28, 2003.

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 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.

Overview

We have operations worldwide with sales offices located in the United States, Europe, Canada, 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 their 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 Web-based business processes, 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 processes, 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 external users, 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 Corporation (IBM) corporate mainframe computers and compatibles, IBM midrange computers such as iSeries (formerly AS/400), and on UNIX based servers. We provide professional support, maintenance, and technical consultancy services to our customers in association with the products we develop and market.

Our principal products are compatible with Microsoft Windows Sever 2003, Windows XP, Windows 2000, Windows NT, Windows 98, Windows 95, and Windows 3.x operating systems, on IBM operating systems, Novell, Inc. operating systems and various implementations of the industry standard UNIX operating system such as IBM’s AIX, Hewlett-Packard Company’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 sold under the brand name of RUMBA® for client-side solutions. We also sell Host Access solutions under the OnWeb® brand name that deliver connectivity for web browser users without requiring software on the user’s device other than the browser, collectively known as “zero footprint” solutions. 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. These products also allow our customers to integrate existing legacy

applications with new platform solutions such as those built using Microsoft’s .NET Framework, IBM’s WebSphere, or BEA’s WebLogic.

In order to ensure that our product line is as simple as possible for our customers to understand, and to ensure that purchasing decisions with respect to NetManage products are as straightforward as possible, in the first quarter of 2003 we revised and updated our product packaging and market messaging. We believe that different solutions can converge to provide new and extended value from host applications. Because our customers require a suite of solutions to address the spectrum of needs that they have, we have broadened the market promotion of the Rumba and OnWeb products to our NetManage Host Access Platform (HAP). The Host Access Platform ties together the NetManage Rumba desktop host access technologies and our server-based OnWeb solution for access, presentation, and integration services. As a result, customers can extend host applications to support new Web-based business initiatives, consolidate and integrate host-based information, and operate normal business processes as they migrate to packaged applications using a variety of Web services.

Results of 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 worldwide restructurings of our operations.

For the nine month period ended September 30, 2003, we continued to experience a reduction in revenues, which we believe relate to the continuing depressed North American and European economies. Customers, because of uncertainties within their own businesses, have postponed or canceled decisions to purchase technology. We do not anticipate any improvements in the current business environment through the remainder of 2003 and into 2004. Therefore, we felt it was necessary to refocus our operations and reduce our operating expenses to bring them more in line with our revised anticipated revenue levels. On January 31, 2003, NetManage announced a restructuring of its operations designed to meet those goals. As part of the restructuring, NetManage reduced its workforce in excess of 30% and has recorded a $3.3 million charge to operating expenses as of September 30, 2003, consisting of approximately $0.6 million of expenses related to leased facilities no longer needed for the Company’s operations and $2.7 million of employee severance and other related expenses (See Note 4 to Financial Statements- 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 this restructuring, we intended to reduce our workforce by approximately 20% 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 for employee terminations. In March 2003, based on a review of current operations, we decided 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. In September 2003, the Company recorded a reduction in obligations of approximately $25,000 associated with the August 2002 restructuring. The reduction resulted from the following: (i) a reduction of facility costs of approximately $851,000 from the continued use of facilities scheduled for closure; (ii) an offsetting change in estimate of approximately $955,000 resulting from the Company’s inability to sublet its excess space as a result of the short remaining lease term for these facilities and the slow real estate market that does not support subleasing of the facilities; (iii) a reduction of approximately $46,000 in estimated property, plant, and equipment costs used in on-going operations instead of being disposed; (iv) a reduction in the estimated exit costs (moving, broker fees, travel, temporary labor costs) of approximately $64,000, and ; (v) a reduction in expected employee related costs of approximately $19,000.

We initiated restructuring plans as a result of our acquisitions of Wall Data, Simware, and Aqueduct Software, Inc, including a $5.6 million restructuring plan announced on August 3, 2000. As part of the restructuring, we reduced our workforce by approximately 20%, 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. 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. In June 2003, we recorded a further reduction in the estimate for facilities of approximately $65,000 and in the estimate for equipment of approximately $15,000. In September 2003, we recorded an increase in reserves of approximately $3,000 for professional/legal expenses. All expenses associated with this restructuring event have now been captured and there is no remaining balance of this restructuring obligation as of September 30, 2003. (See Note 4 to Financial Statements — Restructuring of operations).

Since the latter half of 2000 and through the third quarter of 2001 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 2002, compared to the same quarter of the previous year. 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 buying decisions due to budget constraints. Our second quarter 2003 revenues were approximately 27% less than the amount recorded in the second quarter of 2002. Our third quarter revenues of 2003 were approximately 19% less than the amount recorded in the third quarter of 2002 and less than the amount recorded in the second quarter of 2003. There can be no assurance that revenues will increase at all in future periods, but we are encouraged about recent positive changes to the North America economy.

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 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 2003, operating expenses, excluding restructuring charges, continued to decline when compared to the first and second quarters of 2003 and the third quarter of 2002, and may fluctuate as a percentage of net revenues as we develop and introduce new products.

As described herein, 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, 2003 compared to September 30, 2002 (dollars in millions):


			Three months ended September 30,

			2003			2002			Change

						(As restated)
Net revenues
	License fees		$	4.0		$	5.3		$	(1.3	)	-25	%
	Services			7.4			8.7			(1.3	)	-15	%

		Total net revenues		11.4			14.0			(2.6	)	-19	%
As a percentage of net revenues:
	License fees			35.1	%		37.9	%
	Services			64.9	%		62.1	%

		Total net revenues		100.0	%		100.0	%
Gross margin - license fees			$	3.7		$	5.0		$	(1.3	)	-26	%
Gross margin - service				6.3			7.1			(0.8	)	-11	%
Gross margin - amortization of developed technology				(0.3	)		(0.6	)		0.3		50	%

		Total gross margin	$	9.7		$	11.5		$	(1.8	)	-16	%
As a percentage of net revenue
	Gross margin - license fees			32.5	%		35.7	%
	Gross margin - service			55.3	%		50.6	%
	Gross margin - amortization of developed technology			-2.6	%		-4.3	%

		Total gross margin		85.2	%		82.0	%
Research and development			$	1.8		$	3.1		$	(1.3	)	-42	%
	As a percentage of net revenue			15.8	%		22.1	%
Sales and marketing			$	5.8		$	8.3		$	(2.5	)	-30	%
	As a percentage of net revenue			50.9	%		59.3	%
General and administrative			$	3.0		$	3.7		$	(0.7	)	-19	%
	As a percentage of net revenue			26.3	%		26.4	%
Restructuring charge, net			$	0.3		$	4.6		$	(4.3	)	-93	%
	As a percentage of net revenue			2.6	%		32.9	%
Amortization of intangibles			$	0.2		$	0.2		$	—		0	%
	As a percentage of net revenue			1.8	%		1.4	%
Interest income (expense) and other, net			$	(0.1	)	$	0.0		$	(0.1	)	0	%
	As a percentage of net revenue			-0.9	%		0.7	%
Loss on investment, net			$	—		$	(2.5	)	$	2.5		-100	%
	As a percentage of net revenue			0.0	%		-17.9	%
Foreign currency transaction losses			$	(0.4	)	$	(0.1	)	$	(0.3	)	300	%
	As a percentage of net revenue			-3.5	%		-0.7	%
Provision for income taxes			$	—		$	0.3		$	(0.3	)	-100	%
	Effective tax rate			0.0	%		2.1	%
Net loss			$	(1.9	)	$	(11.3	)	$	9.4		83	%
	As a percentage of net revenue			-16.7	%		-80.7	%

[Additional columns below]

[Continued from above table, first column(s) repeated]


			Nine months ended September 30,

			2003			2002			Change

			(As restated)
Net revenues
	License fees		$	14.3		$	23.4		$	(9.1	)	-39	%
	Services			23.1			25.8			(2.7	)	-10	%

		Total net revenues		37.4			49.2			(11.8	)	-24	%
As a percentage of net revenues:
	License fees			38.2	%		47.6	%
	Services			61.8	%		52.4	%

		Total net revenues		100.0	%		100.0	%
Gross margin - license fees			$	12.9		$	21.6		$	(8.7	)	-40	%
Gross margin – service				19.5			20.9			(1.4	)	-7	%
Gross margin - amortization of developed technology				(1.0	)		(1.7	)		0.7		-41	%

		Total gross margin	$	31.4		$	40.8		$	(9.4	)	-23	%
As a percentage of net revenue
	Gross margin - license fees			34.5	%		43.9	%
	Gross margin - service			52.1	%		42.5	%
	Gross margin - amortization of developed technology			-2.7	%		-3.5	%

		Total gross margin		83.9	%		82.9	%
Research and development			$	6.5		$	10.3		$	(3.8	)	-37	%
	As a percentage of net revenue			17.4	%		20.9	%
Sales and marketing			$	19.5		$	27.7		$	(8.2	)	-30	%
	As a percentage of net revenue			52.1	%		56.3	%
General and administrative			$	8.7		$	8.7		$	0.0		0	%
	As a percentage of net revenue			23.3	%		17.7	%
Restructuring charge, net			$	1.8		$	4.6		$	(2.8	)	-61	%
	As a percentage of net revenue			4.8	%		9.3	%
Amortization of intangibles			$	0.4		$	0.6		$	(0.2	)	-33	%
	As a percentage of net revenue			1.1	%		1.2	%
Interest income and other, net			$	—		$	0.2		$	(0.2	)	-100	%
	As a percentage of net revenue			0.0	%		0.4	%
Loss on investment, net			$	—		$	(2.5	)	$	2.5		-100	%
	As a percentage of net revenue			0.0	%		-5.1	%
Foreign currency transaction gains (losses)			$	0.5		$	(1.4	)	$	1.9		-136	%
	As a percentage of net revenue			1.3	%		-2.8	%
Provision (benefit) for income taxes			$	(0.3	)	$	0.9		$	(1.2	)	-133	%
	Effective tax rate			-0.8	%		1.8	%
Net loss			$	(4.8	)	$	(15.7	)	$	10.9		69	%
	As a percentage of net revenue			-12.8	%		-31.9	%

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 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.

Services 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 the services are included in the initial licensing fee, the fair value of the services is unbundled and recognized ratably over the related service period. Service revenues derived from consulting and training are deferred and subsequently recognized when the services are performed, and the collection is deemed probable.

License fees decreased $1.3 million and $9.1 million, and services revenues decreased $1.3 million and $2.7 million, respectively, for the three and nine month periods ended September 30, 2003 as compared to the same periods in 2002. Total net revenues for the three and nine month periods ended September 30, 2003 decreased $2.6 million and $11.8 million, respectively, from those recorded in the three and nine month periods ended September 30, 2002. We believe these decreases result primarily from customer decisions to cancel or postpone purchases of our products, due to the sluggish North American and European economies, competitive pressures on our average selling prices, and financial pressures experienced by our customers and targeted customers.

We have operations worldwide with sales offices located in the United States, Europe, Canada and support and R&D facilities in Canada and Israel. Revenues outside of the United States and Canada as a percentage of total net revenues were approximately 29% and 28% for the three months ended September 30, 2003 and 2002, respectively, and 28% for each of the nine month periods ended September 30, 2003 and 2002.

There were no customers that accounted for more than 10% of consolidated revenues in each of the three and nine month periods ended September 30, 2003 and 2002.

Gross margin

Gross margin increased as a percentage of net revenues to 85% from 82%, for the three months ended September 30, 2003, compared to September 30, 2002 and to 84% from 83% for the nine months ended September 30, 2003, compared to September 30, 2002. Cost of revenues decreased for the three and nine month periods ended September 30, 2003 by $0.9 million and $2.4 million, respectively, as compared to the three and nine month periods ended September 30, 2002. Cost of revenues declined in the third quarter of 2003 compared to the second quarter of 2003 primarily as a result of a reduction in headcount in our operations group and a VAT refund of approximately $50,000 received in the quarter. Cost of revenues includes all direct expenses associated with both license and service revenues as well as the amortization of developed technology purchased through our acquisition of Wall Data and Simware.

Cost of license revenues primarily includes costs associated with order processing, product packaging, documentation and software duplication, amortization and write-down of acquired technology, and royalties paid to third parties for licensed software incorporated into our products. Cost of service 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, as a percentage of net license revenues, were 6.9% and 9.5% respectively for the three and nine month periods ended September 30, 2003 compared to 7.1% and 7.5% for the same periods in 2002, and declined in dollar amounts of $0.1 million and $0.4 million, respectively, for both the three and nine month periods ended September 30, 2003 as compared to the same periods in 2002. The decrease was a result of a reduction in headcount of 8 full-time employees in operations from the third quarter of 2002 compared to the third quarter of 2003, and continuing cost reduction efforts.

Cost of revenues for services decreased to 14.5% and 15.5% respectively as a percentage of net services revenues for the three and nine month periods ended September 30, 2003 compared to 18.1% and 18.9% for the same periods in 2002 and declined in dollar

amounts of $0.5 million and $1.3 million, respectively, for both the three and nine month periods ended September 30, 2003 as compared to the same periods in 2002. The decline in cost of revenue for services primarily resulted from a reduction in headcount of 14 full-time employees in customer service and consulting from the third quarter of 2002 to the third quarter of 2003 and the ongoing cost reduction efforts in 2002 and 2003. This was offset in part by a reduction in services revenues of $1.2 million and $2.7 million for the three and nine month periods ended September 30, 2003, respectively.

Amortization of developed technology consists of developed software capitalized in our acquisitions and is amortized using the straight-line method over the useful life, generally five years. Beginning in 2003, we revised the classification of amortization of developed technology from operating expenses to cost of revenue. The revision in expense classification has been applied to all periods presented. Amortization decreased for the three and nine month periods ended September 30, 2003, by approximately $0.3 million and $0.7 million, respectively, compared to the same periods in 2002 due to the reduction of the carrying mount of developed technology resulting from the utilization of pre-acquisition ITC credits from the acquisition of Simware. Current tax accounting requires the utilization of the ITC credits first be applied against any remaining intangible assets resulting from the acquisition of Simware before applying the credits to our tax provision.

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 distribution channels, 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 dollar amounts and as a percentage of net revenues for the three and nine month periods ended September 30, 2003 as compared to the same periods in 2002, primarily as a result of a reduction in headcount of 39 full-time employees, and the ongoing cost reduction efforts in 2003 and 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 categorize as a working model and 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 either of the three or nine month periods ended September 30, 2003 or September 30, 2002.

Sales and marketing

Sales and marketing expenses consist primarily of the salaries of sales and marketing personnel, commissions, advertising and promotional expenses, occupancy and related costs. Sales and marketing expenses decreased in dollar amounts and as a percentage of net revenues for the three and nine month periods ended September 30, 2003 as compared to the same periods in 2002, primarily due to a reduction in headcount of 54 full-time sales employees and support staff from the third quarter of 2002 to the third quarter of 2003 and our ongoing cost reduction efforts in 2002 and 2003. Sales and marketing expenses for the three and nine month periods ended September 30, 2003 also include an allocation of approximately $111,000 and $334,000, respectively, for a Company sales incentive goal for 2003. An additional $139,000 and $416,000 related to this sales incentive is included in other functional areas for the three and nine month periods ended September 30, 2003, respectively. We anticipate the total expense for this sales incentive, if achieved, to approximate $1.0 million for the year ending December 31, 2003.

General and administrative

General and administrative expenses consist primarily of salaries, benefits, accounting, operating, legal, and proportionate shares of occupancy and IT expenses for our human resources, legal, finance and general management functions. General and administrative expenses decreased in the third quarter to $3.0 million from $3.7 million in the same period in 2002, and were comparable as a percentage of net revenues for the three month period ended September 30, 2003 as compared to the same periods in 2002. General and administrative expenses increased as a percentage of net revenues for the nine month period ended September 30, 2003, as compared to the same period in 2002. This increase in percentage of net revenues is attributable to the decrease in net revenues over the same

period of time. The primary reason for the decrease in general and administrative expenses was the reduction of 22 full-time general and administrative employees from the third quarter of 2002 to the third quarter of 2003, our continuing cost reduction efforts, and a VAT refund in France, offset in part by higher legal expenses.

Interest income (expense) and other, net

Interest income (expense) and other, net for the three and nine month periods ended September 30, 2003 and 2002, respectively, are comprised of the following table:


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

		2003			2002			2003			2002

Interest income:
	On cash and investments	$	39		$	72		$	160		$	268
	On tax refunds		—			—			—			2
Interest expense			(148	)		(3	)		(148	)		(25	)
Other income (expense)			—			—			(1	)		26

Total		$	(109	)	$	69		$	11		$	271

The reduction in earned interest results from a reduction of our cash balances, and approximately 26% lower effective annual interest rates during the nine month period ended September 30, 2003 as compared to the same period in 2002.

For the three and nine month periods ended September 30, 2002 interest income of $2,000 was related to an income tax refund. For the same periods in 2003, the Company did not record any interest income on tax refunds.

Interest expense of $148,000 in the third quarter of 2003 resulted from a VAT assessment in France relating to the 1997 and 1998 fiscal years.

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

Foreign currency transaction gains (losses)

For the three and nine month periods ended September 30, 2003, we recorded a transaction loss of approximately $0.4 million and a net transaction gain of $0.5 million, respectively. For the three and nine month periods ended September 30, 2002, we recorded transaction losses of approximately $0.1 million and $1.4 million, respectively. These transaction gains and losses are attributable to fluctuations related primarily to the Israeli Shekel. For the three and nine month periods ended September 30, 2003 and 2002, the relationship of the Israeli Shekel to the Euro and to the USD was as follows:


	Three months ended September 30,						Nine months ended September 30,
	2003			2002			2003			2002

USD % Change		2.4	%		0.4	%		-6.3	%		10.2	%
Euro % Change		3.8	%		0.8	%		3.7	%		22.0	%

In those periods where the foreign currency change is positive, we recorded a transaction loss related to fluctuations related primarily to the Israeli Shekel. Conversely, in those periods where the foreign currency change is negative, we recorded a transaction gain.

Provision for income taxes

Our effective tax rate for 2003 is less than 1% due to our current tax loss position. Income taxes primarily include international withholding taxes and state taxes. The income tax provision of $4,000 for the quarter ended September 30, 2003 resulted primarily from an international tax benefit of $134,000 (consisting of French tax refunds of $142,000 net of international tax expense of

$8,000), and U.S. state tax expense of $138,000. The income tax benefit of $297,000 for the nine months ended September 30, 2003 resulted primarily from tax refunds in Germany and France of $481,000 and $142,000, respectively, net of international tax expense of $180,000, and U.S. state tax expense of $146,000. The income tax provision of $330,000 for the three months ended September 30, 2002 resulted primarily from international tax expense of $254,000 and U.S. state tax expense of $76,000. The income tax provision of $917,000 for the nine months ended September 30, 2002 resulted primarily from international tax expense of $939,000, net of U.S. state tax benefits of $22,000.

Liquidity and capital resources


		September 30,
(In millions)		2003

Consists of:
	Cash and cash equivalents	$	21.6
	Short-term investments		0.2
For the nine month period:
	Net cash used in operating activities		(1.6	)
	Net cash used in investing activities		(0.5	)
	Net cash used in financing activities		(0.1	)

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.

Our aggregate cash, cash equivalents and short-term investments decreased from $24.1 million as of December 31, 2002 to $21.8 million as of September 30, 2003. The decrease from operating activities, resulted primarily from the net loss, the reduction in accounts payable, accrued liabilities, payroll and payroll-related expenses, deferred revenues, and long-term liabilities, offset in part by the reduction in accounts receivable and the increase in income taxes payable.

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 material commitments with regard to future capital expenditures at this time.

Net cash used in financing activities in the three and nine month periods ended September 30, 2003 reflects our repurchase of our common stock in the first quarter of 2003, offset by proceeds from the sale of common stock through our Employee Stock Purchase Plan.

Our Board of Directors has authorized the purchase from time to time of up to 2,142,857 shares of our common stock through open market purchases. During the three months ended September 30, 2003, we did not repurchase any shares of our common stock. For the nine month period ended September 30, 2003, we repurchased 71,932 shares of our common stock at an average price of $2.44 per share for a total cost of approximately $175,456. Cumulatively as of September 30, 2003, we have repurchased 2,076,848 shares of our common stock at an average price of $10.02 per share for an approximate total cost of $20.8 million.

At September 30, 2003, we had working capital of $6.0 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 at least the next twelve months. We do not use off balance sheet financing arrangements as a source of liquidity or financing.

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 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.

The Company has issued options under the Company Plans to provide employees with an opportunity to acquire or increase their ownership interest in NetManage, thereby creating a stronger incentive for them to continue their employment with the Company and to contribute to the attainment of the Company’s business and financial objectives and the creation of value for all the Company’s stockholders. The reason for this offer was that many of the outstanding options, whether or not they were currently exercisable, had exercise prices that were significantly higher than the current market price of the Company’s Common Stock. For this reason, the Company believed that these options did not effectively retain and motivate employees and were unlikely to be exercised in the foreseeable future. By making the offer to exchange outstanding options for replacement options that will have an exercise price equal to the market value of our Common Stock on the grant date, the Company intends to provide its employees with the benefit of owning options that over time may have a greater potential to increase in value and thereby provide them with a more meaningful incentive to remain with the Company and to contribute to the attainment of the Company’s business and financial objectives and to create value for all the Company’s stockholders.

On June 13, 2003, employees tendered options to purchase a total of 542,150 shares in connection with the Offer, which were cancelled under our 1992 Stock Option Plan as amended, and our 1999 Non-statutory Stock Option Plan following their exchange. Subject to the continued employment of the employees who exchanged options, replacement options are expected to be granted on or around December 16, 2003. As of September 30, 2003, the number of tendered options eligible for replacement has been reduced to 531,476 due to the termination of certain NetManage employees after June 13, 2003.

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

Critical accounting policies

Reference is made to “Critical Accounting Policies” included in our Annual Report on Form 10-K for the year ended December 31, 2002 as filed with the SEC on February 27, 2003. As of the date of the filing of this Quarterly Report, the Company has not identified any critical accounting policies other than those discussed in our Annual Report for the year ended December 31, 2002.

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 transact business in various foreign currencies, primarily in Europe and Israel and are subject to the risks resulting from the fluctuations of those currencies in relation to the U.S. dollar. We have not entered into any foreign currency forward contracts in either 2003 or 2002.

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, Europe, 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, and the amortization of acquired intangible assets.

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 $22.0 million for the year ended December 31, 2002. We have not been profitable in the first three quarters of 2003 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 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 to 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. This could occur despite our efforts to introduce and enhance our existing products.

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 may 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.

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 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; and

• the difficulty of presenting a unified corporate image.

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

In early December 1999, following our acquisition 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, primarily in North America, in August 2000, August 2002 and again in January 2003. All 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, and personnel with diverse business backgrounds and corporate cultures. We believe 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 and the fourth quarter of 2002. 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 shareholders 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 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. 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 software products compete with major computer system, and software vendors, including Microsoft, IBM, and Sun Microsystems, Inc., as well as software companies such as Jacada Ltd, Seagull, Hummingbird Communications Ltd, 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. 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 purchases of our products. 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. Occasionally, we have experienced difficulty 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. 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 the ability of these parties 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 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.

Complex software products may contain undetected errors or failures when first introduced, or as new versions are released. The likelihood of errors or failures 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.

Furthermore, 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 two patents pending and we have been issued approximately thirty-five 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 29% and 28% of our net revenues from sales outside of North America (United States and Canada) during the three and nine month periods ended September 30, 2003, respectively. 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;

• 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.

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, and the related decline in consumer confidence, and continued economic weakness have had an adverse impact on our operations. If consumer confidence continues to decline or does not recover, our revenues and results of operations may continue to be adversely impacted in the remainder of 2003 and beyond. Any escalation in these events or any 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. In addition 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 the increased volatility in the market 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 2003 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 price per share, our stockholders’ 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.

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

As of September 30, 2003, our officers, directors and entities affiliated with them, in the aggregate, beneficially owned approximately 1.5 million shares, or approximately 17.4% 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 plan, our stockholder 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 and our 1999 Nonstatutory Stock Option Plan currently provide that, in the event of a change of control of NetManage, all options outstanding under those plans would become fully vested and exercisable for at least 10 days prior to the consummation of such a change of control transaction. This 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

There have been no material changes in reported market risks since December 31, 2002. Information regarding interest rate risk and foreign currency risk is discussed herein in Item 2 under “Disclosure of Market Risk.”

Item 4. Controls and procedures

Evaluation of disclosure controls and procedures.

As of the end of the period covered by this filing, we performed an evaluation under the supervision and with the participation of NetManage’s management, including NetManage’s Chief Financial Officer (CFO), of the effectiveness of the design and operation of NetManage’s 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”), as amended). Following that evaluation, NetManage’s management, including the CFO, concluded that based on the evaluation, the design and operation of NetManage’s disclosure controls and procedures were effective at that time.

An internal control system is designed to provide reasonable, but not absolute, assurance that the objectives of our control system are met, including, but not limited to, ensuring that our transactions are properly authorized, our assets are safeguarded against unauthorized or improper use and our transactions are properly recorded and reported.

Changes in internal controls.

There have been no significant changes in our internal controls during the Company’s most recent quarter, or in other factors that could significantly affect these controls, including any corrective actions with regard to significant deficiencies and material weaknesses.

PART II OTHER INFORMATION

Item 1. Legal Proceedings

Legal proceedings

Item 2. Changes in Securities

On May 16, 2003 the Company announced a voluntary stock option exchange program for certain of its employees. The offer to 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 accordingly 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 our 1992 Stock Option Plan as amended, and our 1999 Non-statutory Stock Option Plan following their exchange. Subject to the continued employment of the employees who exchanged options, replacement options are expected to be granted on or around December 16, 2003. As of September 30, 2003, the number of tendered options eligible for replacement has been reduced to 531,047 due to the termination of certain NetManage employees after June 13, 2003.

Item 3. Defaults upon Senior Securities

Not applicable

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable

Item 5. Other Information

We file electronically with the Securities and Exchange Commission (“SEC”) our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K pursuant to Section 13(a) or 15(d) of the 1934 Act. The public may read or copy any materials we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is http:// www.sec.gov.

On October 27, 2003, the Company filed a current report on Form 8-K, announcing its third quarter fiscal 2003 financial results for the three and nine months ended September 30, 2003. Subsequent to filing the earnings release and prior to filing this Form 10-Q, the Company determined that options granted to Dr. Harrison on May 28, 2003 for consulting services should be accounted for using the fair value based method under SFAS No. 123. The effect of accounting for the option grant under the fair value based method on the October 27, 2003 earnings release is as follows (in thousands, except per share amounts):

Three Months Ended Nine Months Ended

September 30, 2003 September 30, 2003

General and administrative

As reported in the earnings release $ 2,891 $ 8,660

As reported in Form 10-Q $ 2,958 $ 8,727

Net loss

As reported in the earnings release $ (1,790 ) $ (4,692 )

As reported in Form 10-Q $ (1,857 ) $ (4,759 )

Net loss per share — basic and diluted

As reported in the earnings release $ (0.21 ) $ (0.54 )

As reported in Form 10-Q $ (0.21 ) $ (0.55 )

Item 6. Exhibits and Reports on Form 8-K

a. Exhibits


31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14(a).

31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14(a).

32.1		Chief Executive Officer and Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

b. Reports on Form 8-K.

1. On July 28, 2003, the Company filed a current report on Form 8-K, announcing its second quarter fiscal 2003 financial results for the three months ended June 30, 2003.

2. On October 27, 2003, the Company filed a current report on Form 8-K, announcing its third quarter fiscal 2003 financial results for the three months ended September 30, 2003.

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 13, 2003	By:	/s/ Michael Peckham

		Chief Financial Officer and Senior Vice President
		(On behalf of the registrant and as Principal
		Financial and Accounting Officer)

EXHIBIT INDEX


Exhibit
Number		Description

31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14(a).

31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14(a).

32.1		Chief Executive Officer and Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley act of 2002.

	•		general economic conditions, in particular, the recent slowdown of purchases of information technology due to current economic conditions in North America, Europe, 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 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; and

	•		the difficulty of presenting a unified corporate image.

	•		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;

	•		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.