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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON DC 20549

FORM 10-Q

For the quarterly period ended 31 March 2003

OR

For the transition period from                      to                     

Commission file number 0-26376

ON TECHNOLOGY CORPORATION

(Exact name of registrant as specified in its charter)

Waltham Woods

880 Winter Street, Building 4

Waltham, Massachusetts 02451-1449

(781) 487-3300

(Address and telephone of principal executive offices)

Indicate by check mark whether 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, 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 12-b-2 of the Exchange Act)  

YES  ¨  NO  x

23,825,406 shares of the registrant’s Common Stock, $0.01 par value, were outstanding as of May 13, 2003.

THIS DOCUMENT CONTAINS 32 PAGES.

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ON TECHNOLOGY CORPORATION

FORM 10-Q, March 31, 2003

CONTENTS

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PART I: FINANCIAL INFORMATION

Item 1: Financial Statements

ON TECHNOLOGY CORPORATION

CONSOLIDATED BALANCE SHEET

(in thousands, except share data)

(unaudited)

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

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ON TECHNOLOGY CORPORATION

CONSOLIDATED STATEMENT OF OPERATIONS

(in thousands, except per share data)

(unaudited)

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

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ON TECHNOLOGY CORPORATION

CONSOLIDATED STATEMENT OF CASH FLOWS

(in thousands)

(unaudited)

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

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ON TECHNOLOGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

1. Interim Financial Statements

The accompanying unaudited consolidated financial statements have been presented by ON Technology Corporation (together with its consolidated subsidiaries, the “Company”) in accordance with generally accepted accounting principles for interim financial statements and with the instructions to Form 10-Q and Regulation S-X pertaining to interim financial statements. Accordingly, these interim financial statements do not include all information and footnotes required by generally accepted accounting principles for complete financial statements. The financial statements reflect all adjustments and accruals, consisting only of normal and recurring adjustments, which management considers necessary for a fair presentation of financial position as of March 31, 2003 and results of operations for the three months ended March 31, 2003 and March 31, 2002. The results for the interim periods presented are not necessarily indicative of results to be expected for any future period. The financial statements should be read in conjunction with the audited financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K.

2. Accounting for Stock-Based Compensation

The Company accounts for stock-based awards to employees using the intrinsic value method as prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Accordingly, no compensation expense is recorded for options issued to employees in fixed amounts and with fixed exercise prices at least equal to the fair market value of the Company’s common stock at the date of grant. When the exercise price of stock options granted to employees is less than the fair market value of common stock at the date of grant, the Company records that difference multiplied by the number of shares under option as deferred stock-based compensation, which is then amortized over the vesting period of the options. The Company reverses deferred stock-based compensation associated with options issued at below fair market value upon the cancellation of such options for terminated employees. The Company follows the disclosure only provisions of SFAS No. 123, Accounting for Stock-Based Compensation, for employee awards. All stock-based awards to non-employees are accounted for at their fair value in accordance with SFAS No. 123.

The following table illustrates the effect on net income (loss) and income (loss) per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee awards (in thousands, except per share amounts):

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ON TECHNOLOGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

3. Concentration of Credit Risk

The financial instruments that subject the Company to credit risk consist of cash and cash equivalents and accounts receivable. The Company has no significant off-balance sheet risk such as foreign exchange contracts, option contracts or other foreign hedging arrangements. The Company maintains the majority of its cash balances with two highly rated financial institutions. For the quarters ended March 31, 2003 and 2002, international revenue was 87% and 64%, respectively. The Company typically experiences increased collection times of up to 30 days on international sales.

During the three months ended March 31, 2003, no customer represented more than 10% of the Company’s total revenue; during the three months ended March 31, 2002, two customers accounted for 44.5% of the Company’s total revenue.

As of March 31, 2003 and December 31, 2002, no customer represented more than 10% of the Company’s accounts receivable.

4. Comprehensive Income (Loss)

Total comprehensive loss was $1,751 for the three months ended March 31, 2003 and total comprehensive income was $33 for the three months ended March 31, 2002. Total comprehensive income (loss) consists of net income (loss) and the net change in the foreign currency translation adjustment, included in accumulated other comprehensive income, which is presented separately as a component of stockholders’ equity.

5. Foreign Currency Transaction Gains (Losses)

During the quarters ended March 31, 2003 and 2002, the Company incurred a net foreign exchange gain of $164 and a net foreign exchange loss of $102, respectively. These amounts primarily resulted from revaluing intercompany loans to foreign subsidiaries denominated in foreign currencies, U.S. dollar-denominated debt at a foreign subsidiary, and a foreign subsidiary investment in U.S. dollars. The net foreign exchange gains or losses are included in other income (loss), net in the accompanying consolidated statement of operations. As of March 31, 2003, the Company had not entered into any foreign currency contracts to hedge this exposure.

6. Net Income (Loss) per Share

Basic net income (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding for the period. Diluted net income (loss) per share is computed by dividing the net income (loss) by the weighted average number of shares of common stock and potential common stock outstanding during the period, if dilutive. For the three months ended March 31, 2003 and 2002, respectively, certain stock options and warrants have been excluded from the diluted weighted average shares outstanding calculation, as their effect would be anti-dilutive. For periods that the Company reports a net loss, all potential common stock is considered anti-dilutive; for periods when the Company reports net income, only potential common shares with exercise prices in excess of the Company’s average common stock fair value during the related period are considered anti-dilutive.

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ON TECHNOLOGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

Basic and diluted net income (loss) per share are as follows (in thousands, except per share amounts):

7. Segment Reporting

For all periods presented, the Company operated in one reportable segment.

8. Letter of Credit

As of March 31, 2003 and December 31, 2002, the Company had a $100 letter of credit guarantee outstanding securing its Waltham, Massachusetts leased facility, which expires on September 30, 2006. The letter of credit was issued by the Company’s bank and the Company is required to maintain a cash balance of $100 as collateral for this guarantee. This amount is shown as restricted cash as of March 31, 2003 and December 31, 2002 in the accompanying consolidated balance sheet. At March 31, 2003, the Company had no line of credit arrangement.

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ON TECHNOLOGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

9. Guarantees

In November 2002, the FASB issued FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34 (“FIN 45”). FIN 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. FIN 45 also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee.

The Company has identified the following guarantees for which it believes no liabilities are required at March 31, 2003:

As permitted under Delaware law, the Company has agreements whereby it indemnifies its officers and directors for certain events or occurrences while the officer or director is, or was serving, at the Company’s request in such capacity. The term of the indemnification period is for the officer or director’s lifetime. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has a Director and Officer insurance policy that limits its exposure and enables it to recover a portion of any future amounts paid.

The Company enters into standard indemnification agreements in its ordinary course of business. Pursuant to these agreements, the Company indemnifies, holds harmless, and agrees to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally its business partners or customers, in connection with any U.S. patent, or any copyright or other intellectual property infringement claim by any third party with respect to its products. The term of these indemnification agreements is generally perpetual any time after execution of the agreement. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. The Company has never incurred costs to defend lawsuits or settle claims related to these indemnification agreements.

The Company also enters into arrangements with its business partners, whereby the business partner agrees to provide implementation services as a subcontractor for the Company’s products. The Company may, at its discretion and in the ordinary course of business, subcontract the performance of any of its services. Accordingly, the Company enters into standard indemnification agreements with its customers, whereby it indemnifies them for other acts, such as personal property damage, of the Company’s subcontractors. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has general and umbrella insurance policies that enable it to recover a portion of any amounts paid. The Company has never incurred costs to defend lawsuits or settle claims related to these indemnification agreements.

The Company warrants that its software products will perform in all material respects in accordance with its standard published specifications in effect at the time of delivery of the licensed products to the customer for the life of the product. Additionally, the Company warrants that its maintenance services will be performed consistent with generally accepted industry standards through completion of the agreed upon services. If necessary, the Company would provide for the estimated cost of product and service warranties based on specific warranty claims and claim history, however, the Company has never incurred significant expense under its product or services warranties.

In addition, from time to time the Company may provide an end user a limited right of return if, after the Company’s commercially reasonable efforts, the Company’s software products do not perform to standard published specifications. To date, the Company has never had to accept such a return.

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ON TECHNOLOGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

10. Reclassifications

Certain amounts from prior periods have been reclassified to conform to the current period’s presentation.

11. Income Taxes

The Company recorded tax provisions of $493 and $205 during the three months ended March 31, 2003 and March 31, 2002, respectively. The tax provisions recorded in each of these periods principally reflect income taxes owed by the Company’s profitable foreign operations; no tax benefit was recorded on losses in the United States.

12. Recent Accounting Pronouncements

In November 2002, the Emerging Issues Task Force of the FASB reached a consensus on Issue 00-21, Accounting for Revenue Arrangements with Multiple Deliverables (“EITF 00-21”). EITF 00-21 requires that for revenue arrangements with multiple deliverables, those deliverables be divided into separate units of accounting if the deliverables meet certain criteria as defined by EITF 00-21. Arrangement consideration is to be allocated among the separate units of accounting based on their relative fair values and revenue recognition decisions should be considered separately for each separate unit of accounting. EITF 00-21 is effective for all arrangements entered into in fiscal periods beginning after June 15, 2003, with early adoption permitted. The Company is currently evaluating the scope of EITF 00-21 but management believes that the Company’s multiple element arrangements fall within the scope of SOP 97-2 and therefore, EITF 00-21 will not be applicable to the Company.

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Overview

ON Technology Corporation and its subsidiaries (“ON”, the “Company”, “Our” or “We”) provide remote software management solutions for desktops, mobile PCs, handhelds, retail POS devices, and servers. Our traditional product, ON Command CCM^® , or CCM, is used by enterprise IT organizations and service providers to rapidly deliver business-critical software over corporate networks. Our products are designed to reduce operational costs while enhancing both IT productivity and end-user satisfaction.

At March 31, 2003, we had approximately 200 employees worldwide, of which approximately 125 were located in Europe. Our headquarters is located in Waltham, Massachusetts and our main European office is located in Starnberg, Germany. For the quarter ended March 31, 2003, the United States accounted for approximately 13% of total revenue compared to 36% for the same period in 2002.

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, management evaluates its estimates, including those related to revenue recognition and bad debt reserve levels, income taxes and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Our significant accounting policies are described in Note 2 to the consolidated financial statements included in Item 15 of ON’s Annual Report on Form 10-K for the year ended December 31, 2002. We believe the following accounting policies are critical to an understanding of our consolidated financial statements and involve our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition

We recognize revenue in accordance with the American Institute of Certified Public Accountants’ (AICPA) Statement of Position (SOP) No. 97-2, Software Revenue Recognition, as amended by Statement of Position 98-9, Software Revenue Recognition with Respect to Certain Transactions, and Securities and Exchange Commission’s Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements. Software license revenue principally consists of revenue earned under perpetual software license agreements and is generally recognized upon delivery of the software, provided that the arrangement does not require significant modification or customization of the software, any services included in the arrangement are not considered essential to the functionality of the software, evidence of the arrangement exists, collection of the resulting receivable is reasonably assured, the fee is fixed or determinable, and vendor-specific objective evidence exists for all undelivered elements to allow allocation of the total fee to all delivered and undelivered elements of the arrangement.

Services and maintenance revenue primarily consists of fees for consulting services, training and support and maintenance services provided to end users. Consulting and training services are typically provided on a time and materials basis with revenue recognized as the services are performed. In the infrequent instances when fixed-fee consulting agreements are entered into, we recognize revenue using the percentage-of-completion method of accounting. In applying this method, we measure each arrangement’s percentage-of-completion by the ratio of labor hours incurred to date to estimated total labor hours to complete the project. We do not consider consulting and training services to be essential to the functionality of the other elements of the arrangement. Revenue related to maintenance and support arrangements is recognized ratably over the contract period.

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We occasionally, at the request of a single customer, sell hardware, which is recorded separately in our consolidated statement of operations. Resold hardware revenue is typically recognized upon delivery, provided that evidence of the arrangement exists, the fees are fixed or determinable, and all other revenue recognition criteria have been met.

We may sell, under one contract or a series of related contracts, software licenses, related professional services and a maintenance and support arrangement. The total contract value is attributed to both the maintenance and support arrangement based on their fair value, equal to the maintenance and support arrangement’s stated list price as a fixed percentage of the related software product’s price or based on a stated renewal rate for subsequent periods of maintenance included in the contract, as well as for professional services we are committed to provide based on the related fair value, equal to the price charged when such services are sold separately. The remainder of the contract value is then allocated to the software licenses, with the effect that discounts inherent in the total contract value are attributed to the software licenses.

Under our maintenance and support arrangements, we offer unspecified upgrades and enhancements on software products only on a when-and-if-available basis. Typically, we do not contract in advance for specified upgrades, enhancements or additional software products. In arrangements where we agree to provide additional products, specified upgrades or enhancements, we allocate revenue from the entire arrangement first to any undelivered elements including the specified future deliverables, professional services and the maintenance and support arrangement, based on the fee charged when products are sold separately. The remainder of the contract value is allocated to software licenses. We defer recognition of revenue allocated to the specified future deliverable until delivery has occurred and any remaining contractual terms relating to that element have been met. In situations where fair value does not exist for all elements to be delivered under the arrangement, we defer all revenue from the arrangement until the earlier of the date when all elements have been delivered or fair value exists for all undelivered elements. We do not offer rights of return to our customers. In situations where negotiated contracts require rights of return or contain acceptance criteria, we do not recognize revenue until all significant obligations have been delivered and accepted by the client.

We also sell products to resellers. There is generally no contractual right of return nor has the Company historically permitted returns notwithstanding the contractual arrangement. We typically do not ship products to resellers until an end user is identified, at which point we recognize revenue under the arrangement.

We record a returns reserve based on historical experience where we granted a right of return, although we were not contractually obligated to do so. Material differences may result in the amount and timing of our revenue from any period if management makes judgments or uses estimates that prove to be materially different from actual experience.

At the time of a sale transaction, we assess whether the fee associated with our revenue transaction is fixed or determinable based on the payment terms associated with the transaction. If a significant portion of the fee is due after our normal payment terms, which are 30 to 90 days from the invoice date, we account for the fee as not being fixed or determinable. In these cases, we recognize revenue as the fees become due.

We assess collectibility based on a number of factors, including past transaction history with the customer and the credit worthiness of the customer by reviewing credit reports, as well as bank and trade references. We do not require collateral from our customers. If we determine that collection of the fee is not reasonably assured, we defer the fee and recognize revenue at the time collection become reasonably assured, which is generally upon receipt of cash. Significant judgments and estimates are involved in assessing the collectibility of customer transactions. Different assumptions could yield materially different results.

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Accounts Receivable

Accounts receivable are reduced by an allowance for amounts that may become uncollectible in the future. The estimated allowance for uncollectible amounts is based primarily on historical write-off experience and management’s evaluation of the customers in the receivable portfolio. If collection is not deemed reasonably assured at the transaction date, revenue is deferred and typically recognized on a cash basis. While management believes the allowance is adequate, if the financial condition of our customers were to deteriorate, resulting in impairment of their ability to make payments, additional allowances may be required.

Accounting for Income Taxes

As part of the process of preparing our consolidated financial statements, management is required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves management estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets, which are included within our consolidated balance sheet. Management must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and if management does not believe we meet the more likely than not recoverability threshold, we must establish a valuation allowance for the amount deemed not likely to be realized. To the extent management establishes a valuation allowance or increases this allowance in a period, we must include a deferred tax provision in the consolidated statement of operations.

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We have recorded a valuation allowance of $22.7 million as of March 31, 2003, due to uncertainties related to our ability to utilize some of our deferred tax assets, primarily consisting of U.S. net operating loss carryforwards before they expire. The valuation allowance is based on management’s estimates of taxable income by jurisdiction in which we operate and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates or management adjusts these estimates in future periods, we may need to establish an additional valuation allowance, which could materially impact our financial position and results of operations.

The net deferred tax asset as of March 31, 2003 was $1.0 million, net of the aforementioned valuation allowance of $22.7 million, which relates to certain foreign deferred tax assets deemed more likely than not realizable.

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Results of Operations

The following table sets forth, for the periods indicated, certain financial data as percentages of our total revenue:

Net Software Licenses Revenue. Net software license revenue is derived from the licensing of proprietary and third party software products. For the three months ended March 31, 2003, this revenue decreased $200 thousand, or 5%, from the same period in 2002. This decrease is primarily due to a reduction in US license revenue of $1.9 million over the same period in 2002, which had included a large software license deal. This decrease was significantly offset by an increase in both proprietary and third party license revenue in Europe due to an increase in the number of European customers to 124 from 76 in the first quarter of 2002.

Service and Maintenance Revenue. Service and maintenance revenue consists of maintenance revenue, training and professional services. This revenue increased by $877 thousand, or 32%, from the three months ended March 31, 2002 as compared to the same period in 2003. The increase was primarily due to an increase in maintenance revenue of $780 thousand, resulting from an increase in the Company’s European customer base. Additionally, overall consulting and training revenue increased $100 thousand over the same period in 2002.

Hardware Revenue. For the three months ended March 31, 2003, hardware sales to one European customer decreased to $9 thousand, compared with $1.3 million for the same period in 2002. As previously reported, hardware sales diminished significantly from the prior year because the customer is now dealing with the supplier directly. The Company expects minimal hardware revenue in the future.

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Cost of Software License Revenue. Cost of software license revenue consists primarily of expenses associated with product documentation, production and fulfillment costs, and royalty and license fees associated with products that are licensed from third party developers. Cost of software license revenue, as a percentage of like revenue, was 15.9% and 8.4% for the three months ended March 31, 2003 and 2002, respectively. This percentage increase was primarily due to increased costs in Europe during the first quarter of 2003 due to a change in third party product mix.

Cost of Service and Maintenance Revenue. Cost of service and maintenance revenue consists primarily of expenses associated with direct consulting and training costs as well as costs of our help desk. Cost of service and maintenance, as a percentage of like revenue, was 28.3% and 24.5% for the three months ended March 31, 2003 and 2002, respectively. This increase was primarily attributable to increased consulting utilization in Europe resulting in increased allocated costs. Additionally, there was an increase in European royalties associated with third party maintenance renewals.

Cost of Hardware. Cost of hardware revenue consists of the expense of acquiring hardware for European hardware sales. Cost of hardware was $4 thousand and $754 thousand for the three months ended March 31, 2003 and 2002, respectively. The decrease was due to reduced hardware sales.

Sales and Marketing Expense. Sales and marketing expense primarily consists of compensation paid to sales and marketing personnel, the costs of direct mail and telemarketing campaigns and the costs of product trials requested by potential customers. Sales and marketing expense also includes the costs of trade shows, seminars, conferences, travel and telephone and information technology costs associated with sales activities. Sales and marketing expense increased $1.2 million for the three months ended March 31, 2003, over the comparable period in 2002. The increased spending is primarily due to an increase in sales compensation and recruiting expenses of $918 thousand as a result of 21 new employees in the worldwide sales organization over the comparable period in 2002. Additionally, corresponding travel expenses, occupancy and other allocated costs increased by $173 thousand and $118 thousand, respectively, principally due to this staffing increase.

Research and Development Expense. Research and development expense includes costs associated with the development of new products, the enhancement of existing products and costs associated with providing indirect technical support, training and consulting, as well as certain information technology costs. Research and development expenses decreased $31 thousand for the three months ended March 31, 2003, over the comparable period in 2002. The decrease was primarily due to a reduction in rent expense of $94 thousand, due primarily to the new US office lease executed in late 2002, partially offset by an increase in travel expenses of $62 thousand.

General and Administrative Expense. General and administrative expense includes executive compensation and the administrative expense associated with our foreign operations, executive support costs, accounting operations, planning, investor relations, other public company costs, and business development activities. General and administrative expense increased $295 thousand during the three months ended March 31, 2003 compared to the same period in 2002. This increase resulted from additional compensation costs principally associated with staffing our UK and Swiss subsidiaries of $144 thousand and increased accounting and tax expenses of $49 thousand for foreign tax planning and increased compliance costs. Additionally, annual report and proxy costs and directors and officers’ insurance costs increased by $53 thousand and $16 thousand, respectively.

Interest Income (Expense), Net. For the three months ended March 31, 2003, interest income (expense), net increased $28 thousand from the same period in 2002. This increase was due to a prior year interest expense of $30 thousand relating to settlement of an outstanding tax audit.

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Other Income (Expense), Net. Other income, net for the three months ended March 31, 2003 consisted primarily of a $164 thousand net non-cash gain due primarily to the strengthening Euro’s impact on intercompany balances and an exchange loss on US dollars held in overseas subsidiaries. Other expense, net for the first quarter in 2002 consisted primarily of a $105 thousand non-cash charge from the exchange rate impact on temporary intercompany obligations.

Management continues to evaluate hedging alternatives and is working with its advisors and financial institutions to maintain its strategy of repatriating funds while minimizing realizable foreign exchange losses and income taxes.

Income Taxes. For the three months ended March 31, 2003 and 2002, the Company recorded income tax provisions of $493 thousand and $205 thousand, respectively, primarily to reflect estimated foreign taxes due by its profitable foreign operations; no tax benefit was recorded on losses in the United States. The Company continues to work with its tax advisors to develop additional tax strategies to minimize foreign income taxes payable.

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Liquidity and Capital Resources

Through 2001, we funded our operations primarily through private and public placements of capital stock and the sale of certain product lines. During 2002 and the first quarter of 2003, we funded our operations with cash generated from operations. At March 31, 2003, we had available cash and cash equivalents of $13.4 million and working capital of $8.3 million. As of March 31, 2003, we also had restricted cash of $100 thousand securing our Waltham, Massachusetts facility lease.

Net cash provided by (used in) operating activities for the three months ended March 31, 2003 and 2002 was ($400) thousand and $878 thousand, respectively. In 2003, net cash used in operating activities consisted mainly of a net loss of ($1.8) million, an decrease in accounts receivable of $2.3 million and a change in other net assets of ($777) thousand. This was further impacted by $226 thousand in depreciation less a non-cash gain on intercompany loan revaluation of ($312) thousand. In 2002, net cash provided by operating activities consisted mainly of a decrease in accounts receivable of $1.5 million and depreciation expense of $179 thousand, offset by a decrease in accrued expenses of $769 thousand.

Net cash used in investing activities for the three months ended March 31, 2003 and 2002 was $219 thousand and $153 thousand, respectively. Both of these amounts related primarily to the purchase of computer equipment.

Net cash provided by financing activities for the three months ended March 31, 2003 and 2002 was $78 thousand and $197 thousand, respectively. In 2003, this cash activity resulted from the exercise of stock options of $22 thousand and the sale of stock under the Employee Stock Purchase Plan of $67 thousand, offset by capital lease repayments of $11 thousand. In 2002, this cash activity resulted from the exercise of stock options of $158 thousand, the sale of stock under the Employee Stock Purchase Plan of $35 thousand and the exercise of warrants of $4 thousand.

For the three months ended March 31, 2003, we experienced a decrease in cash and cash equivalents of $210 thousand compared to an increase in cash and cash equivalents of $780 thousand for the same period in 2002. Management believes that its available cash resources, including cash and cash equivalents and cash it expects to generate from sales of products and services, will be sufficient to finance presently anticipated operating expenses and capital expenditure requirements at least through the next twelve months. Our future liquidity is, however, dependent on a number of factors, including but not limited to, our ability to reach forecasted sales targets and to maintain current expense levels. There can be no assurance that we will not require additional capital resources during this period of time. If we do require additional capital resources, we may seek to sell additional equity or debt securities, secure a bank line of credit, or consider strategic alliances. The sale of additional equity or convertible debt securities could result in additional dilution to stockholders. There can be no assurance that additional financing, in any form, will be available at all or, if available, will be on terms acceptable to us.

Recent Accounting Pronouncement

In November 2002, the Emerging Issues Task Force of the FASB reached a consensus on Issue 00-21, Accounting for Revenue Arrangements with Multiple Deliverables (“EITF 00-21”). EITF 00-21 requires that for revenue arrangements with multiple deliverables, those deliverables be divided into separate units of accounting if the deliverables meet certain criteria as defined by EITF 00-21. Arrangement consideration is to be allocated among the separate units of accounting based on their relative fair values and revenue recognition decisions should be considered separately for each separate unit of accounting. EITF 00-21 is effective for all arrangements entered into in fiscal periods beginning after June 15, 2003, with early adoption permitted. The Company is currently evaluating the scope of EITF 00-21 but management believes that the Company’s multiple element arrangements fall within the scope of SOP 97-2 and therefore, EITF 00-21 will not be applicable to the Company.

For additional information concerning risks associated with the Company’s liquidity and capital resources see “Certain Factors That May Affect Future Results”.

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CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS

This Report on Form 10-Q contains forward-looking statements within the meaning of the Federal Securities Laws. In addition, from time to time, management may make forward-looking statements in press releases, in other public discussions and in other documents that we file with the Securities and Exchange Commission (including those documents incorporated by reference into this Annual Report on Form 10-Q). The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for these statements. For this purpose, a forward-looking statement is any statement that is not a statement of historical fact. You can identify forward-looking statements by the words “may,” “believes,” “anticipates,” “plans,” “expects,” “estimates” and similar expressions. Our forward-looking statements are based on currently available information and management’s expectations of future results but necessarily involve certain assumptions. We caution readers that our assumptions involve substantial risks and uncertainties. Consequently, any forward-looking statement could turn out to be wrong. Many factors could cause actual results to differ materially from our expectations. Moreover, the Company assumes no obligation to update forward-looking statements or update the reasons actual results could differ materially from those anticipated in forward-looking statements, except as required by law. Below we describe some of the important factors that could affect our revenue or results of operations.

WE HAVE EXPERIENCED CASH FLOW DEFICITS IN THE PAST AND MAY EXPERIENCE CASH FLOW DEFICITS IN THE FUTURE.

For the Quarter ended March 31, 2003, we had an operating loss of $1.5 million. At March 31, we had an accumulative deficit of $73.5 million. Management’s current 2003 operating forecast projects that the Company will be operationally profitable for the year. Based upon these assumptions, management believes the Company has sufficient cash to fund its operations during 2003. If the Company is unable to attain forecasted revenue levels and management is unsuccessful in controlling expenses, the Company may have to seek additional external equity or debt financing to continue its operations. There can be no assurance that we will be able to secure such external financing.

OUR BUSINESS COULD BE MATERIALLY ADVERSELY AFFECTED AS A RESULT OF GENERAL ECONOMIC AND BUSINESS CONDITIONS.

Our business is subject to the effects of general economic and business conditions. ON’s operating results have been affected by recent unfavorable economic conditions and reduced information technology spending. In addition, the continued fallout from the September 11 terrorist attacks, U.S. military action in Iraq and Afghanistan and the heavily publicized corporate transgressions and resulting investigations causing investor uncertainty about the integrity of US financial markets have added (or exacerbated) general economic, political and other uncertainties. If economic and market conditions do not improve and these uncertainties continue to exist, ON’s business, condition (financial or otherwise), prospects and results of operations could be adversely affected.

OUR SALES AND MARKETING REQUIRES SIGNIFICANT INVESTMENTS

Sales of products require significant up-front investments in marketing, technical and financial resources. We have adopted a sales and marketing strategy that relies significantly on a direct sales force, third-party resellers and in-house field service organization. This strategy requires significant investments in identifying and hiring qualified sales and technical personnel, ongoing product development, and expansion of an in-house field service organization. We have developed valuable marketing and service experience and expertise in Europe and, recently, in the United States. However, there can be no assurance that we will be able to continue to expand and apply such experience and expertise to our target market.

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WE DERIVE A SIGNIFICANT PORTION OF OUR REVENUE FROM A RELATIVELY SMALL NUMBER OF CUSTOMERS

For the three months ended March 31, 2003, no customer accounted for greater than 10% of total revenue. However, for the twelve months ended December 31, 2002, 2001 and 2000, two customers accounted for $6.2 million (17.8%), $4.3 million (17.7%), and $6.3 million (23.9%) of total revenue, respectively. It is possible that in the future other customers will account for a significant portion of ON’s total revenue. The loss of significant customers could have a material adverse effect on our business, condition (financial or otherwise), prospects and results of operations.

WE WILL NEED TO EXPAND OUR DISTRIBUTION CHANNELS IN ORDER TO DEVELOP OUR BUSINESS AND INCREASE REVENUE

We sell our products through our direct sales force and a number of distributors, and we provide maintenance and support services through our technical and customer support staff. We plan to continue to invest large amounts of resources in our direct sales force. For example, for the three months ended March 31, 2003, we added eight new employees to the worldwide sales organization. In addition, management is committed to developing additional sales and marketing channels through value added resellers, system integrators, original equipment manufacturers and other channel partners. We may not be able to attract channel partners that will be able to market our products effectively, or that will be qualified to provide timely and cost-effective customer support and service. If we establish distribution through such indirect channels, our agreements with channel partners may not be exclusive. As a result, such channel partners may also carry competing product lines. If we do not establish and maintain such distribution relationships, this could materially adversely affect our business, condition (financial or otherwise), prospects and results of operations.

IF WE DO NOT RESPOND ADEQUATELY TO OUR INDUSTRY’S EVOLVING TECHNOLOGY STANDARDS, OR DO NOT CONTINUE TO MEET THE SOPHISTICATED NEEDS OF OUR CUSTOMERS, SALES OF OUR PRODUCTS MAY DECLINE

As a result of rapid technological change in our industry, product advances can quickly erode our position in existing markets or other markets that we may enter. The life cycles of our products are difficult to estimate. Our growth and future financial performance depend in part upon our ability to improve existing products and develop and introduce new products that keep pace with technological advances, meet changing customer needs and respond to competitive products. The introduction during the first quarter of 2003 of our ON iCommand product is an example of our commitment to respond to these issues. Our product development efforts will continue to require substantial investments. We may not have sufficient resources to make the necessary investments.

We have experienced product development delays in the past and may experience delays in the future. Difficulties in product development could delay or prevent the successful introduction or marketing of new or improved products. Any such new or improved products, including the new ON iCommand product, may not achieve market acceptance. Our current or future products may not conform to industry requirements. Our ability to continue to enhance our current products to meet customer and market requirements will depend substantially on our ability to effectively manage this development effort, to attract and retain the required development personnel in Waltham, Massachusetts and Starnberg, Germany and to coordinate and manage geographically remote development efforts. If, for technological or other reasons, we are unable to develop and introduce new and improved products in a timely manner, our business, condition (financial or otherwise), prospects and results of operations could be adversely affected.

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ERRORS IN OUR PRODUCTS COULD RESULT IN SIGNIFICANT COSTS TO US AND COULD IMPAIR OUR ABILITY TO SELL OUR PRODUCTS

Because our software products are complex, these products may contain errors that could be detected at any point in a product’s life cycle. In the past, we have discovered software errors in certain of our products and have experienced delays in shipment of our products during the period required to correct these errors. Despite testing by ON and by current and potential customers, errors in our products may be found in the future. Detection of such errors may result in, among other things, loss of, or delay in, market acceptance and sales of our products, diversion of development resources, injury to our reputation, or increased service and warranty costs. If any of these results were to occur, our business, condition (financial or otherwise), prospects and results of operations could be materially adversely affected.

IN THE FUTURE, INCLUSION OF FUNCTIONS PROVIDED BY OUR PRODUCTS IN SYSTEM SOFTWARE AND APPLICATION SUITES MAY AFFECT OUR COMPETITIVE POSITION

In the future, vendors of operating system software and applications sold for a single price (generally referred to as application suites) may continue to enhance their products to include functions that are currently provided by our products. In addition, some vendors may bundle these products in their existing application suites at no additional charge. The widespread inclusion of the functions provided by our products as standard features of operating system software could render our products obsolete and unmarketable particularly if the quality of such functions were comparable to the functions offered by our products. Furthermore, even if the software functions provided as standard features by operating systems are more limited than those of our products, there is no assurance that a significant number of customers would not elect to accept such functions instead of purchasing additional software. If we were unable to develop new software products to further enhance operating systems and to successfully replace any obsolete products, our business, condition (financial or otherwise), prospects and results of operations could be materially adversely affected.

THE INTENSE COMPETITION IN THE MARKET FOR OUR PRODUCTS COULD ADVERSELY AFFECT OUR ABILITY TO SELL OUR PRODUCTS

The market for our products is highly competitive, and we expect competition to continue to increase in the future. We believe that the principal competitive factors affecting the market for our products include brand name recognition, company reputation, performance, functionality, ease-of-use, breadth of product line, quality, customer support, adherence to industry standards, integration with third-party solutions and price.

As is the case in many segments of the software industry, we may encounter increasing price competition in the future. This could reduce average selling prices and, therefore, profit margins. Competitive pressures could result not only in sustained price reductions but also in a decline in sales volume, which could adversely affect our business, condition (financial or otherwise), prospects and results of operations. There can be no assurance that we will continue to compete effectively against existing and potential competitors in our markets, many of whom have substantially greater financial, technical, marketing and support resources and name recognition than we have.

The widespread inclusion of the functionality of our products as standard features of Microsoft operating systems software could render our products obsolete and unmarketable, particularly if the quality of such functionality were comparable to that of our products. If we were unable to develop new functionality or unique applications for our technology to successfully replace any obsolete products, our business, condition (financial or otherwise), prospects and results of operations could be materially adversely affected.

The market for our products is highly competitive and diverse. The technology for remote software management products can change rapidly. New products are frequently introduced and existing products are continually enhanced. Competitors vary in size and in the scope and breadth of the products and services offered. The Company has faced competition from a number of sources, including:

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In addition, Microsoft has bundled new management capabilities in its Windows 2000 and XP operating systems that, in conjunction with its Systems Management Server (SMS) framework, directly compete with capabilities provided by ON.

Their latest version, SMS 2003 (code-named “Topaz”) is expected to be released during 2003 and includes additional capabilities that directly compete with capabilities provided by the ON product offering, including support for mobile and remote users as well as integration with Microsoft Active Directory. Even if the functionality provided with Microsoft’s operating system software were more limited than that of our software management products, customers or potential customers might elect to accept more limited functionality in lieu of purchasing additional software. Competition resulting from this type of bundling could lead to price reductions for our products, which would reduce our margins and correspondingly affect our business, condition (financial or otherwise), prospects and results of operations.

Some of our current and many of our potential competitors have much greater financial, technical, marketing, and other resources than we have. As a result, they may be able to respond more quickly to new or emerging technologies and changes in customer needs. They may also be able to devote greater resources to the development, promotion, and sale of their products than ON. The Company may not be able to compete successfully against current and future competitors. In addition, competitive pressures faced by the Company may materially adversely affect the Company’s business, condition (financial or otherwise), prospects and results of operations.

DUE TO THE TECHNOLOGICAL CHALLENGES ASSOCIATED WITH OUR CURRENT PRODUCTS, WE MAY NOT HAVE THE FINANCIAL RESOURCES NECESSARY TO CONDUCT THE BUSINESS AS PRESENTLY CONTEMPLATED

Based on management’s 2003 forecasts, product development, marketing and sales costs for our current products are approximately $2.15 million per month. Based on our existing cash and forecasted revenue, we believe that we have enough cash to fund these costs through 2003. There can be no assurance that our estimate of the marketing, sales and product development costs of our products or our revenue forecasts is correct, or that these costs will not exceed our available financial resources, or that we will be able to locate additional sources of financing, if and when needed.

OUR RELIANCE ON INTERNATIONAL REVENUE COULD ADVERSELY AFFECT OUR OPERATING RESULTS

For the three months ended March 31, 2003, international revenue was 87% of total revenue. For fiscal years 2002, 2001, and 2000, total international revenue from the Company’s foreign subsidiaries and other foreign sources was 73%, 71%, and 65% of total revenue, respectively. We expect that international revenue will continue to constitute a significant portion of our total revenue in the future. Accordingly, a significant percentage of our total revenue may be subject to the risks inherent in international sales, including the impact of fluctuating exchange rates, longer payment cycles, greater difficulty in protecting intellectual property, greater difficulty in accounts receivable collection, unexpected changes in legal and regulatory requirements, seasonality due to the slowdown of European business

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activity in the third quarter and tariffs and other trade barriers. There can be no assurance that these factors will not have a material adverse effect on our future international license revenue.

Our continued growth and profitability will require continued expansion of our international operations, particularly with continued expansion in Europe and initial inroads into Latin America and the Pacific Rim. Accordingly, we intend to expand our current international operations and enter additional international markets. Such expansion will require significant management attention and financial resources. We have only limited experience in developing local-language versions of our products and marketing and distributing our products internationally. We may not be able to successfully translate, market, sell and deliver our products internationally. If we are unable to expand our international operations successfully and in a timely manner, our business, condition (financial or otherwise), prospects and results of operations could be adversely affected.

AS OUR EXPANDING INTERNATIONAL OPERATIONS IN EUROPE AND ELSEWHERE ARE INCREASINGLY CONDUCTED IN CURRENCIES OTHER THAN THE U.S. DOLLAR, FLUCTUATIONS IN THE VALUE OF FOREIGN CURRENCIES COULD RESULT IN CURRENCY EXCHANGE LOSSES

A large portion of our business is conducted in foreign currencies. Fluctuations in the value of foreign currencies relative to the U.S. dollar have caused and will continue to cause currency transaction gains and losses. We cannot predict the effect of exchange rate fluctuations upon future operating results. We may experience currency losses in the future. Although we have no current plans to do so, we may, in the future, implement a foreign exchange hedging program, consisting principally of purchases of forward-rate currency contracts. However, if undertaken, our hedging activities may not adequately protect us against the risks associated with foreign currency fluctuations.

FUTURE FLUCTUATIONS IN OUR QUARTERLY OPERATING RESULTS DUE TO A NUMBER OF FACTORS, MANY OF WHICH ARE BEYOND OUR CONTROL, COULD ADVERSELY AFFECT OUR STOCK PRICE

Our quarterly operating results have varied significantly in the past and may vary significantly in the future depending upon a number of factors, many of which are beyond our control. These factors include, among others:

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We have often recognized a substantial portion of our revenue in the last month or weeks of a quarter. As a result, license revenue in any quarter is substantially dependent on orders booked and shipped in the last month or weeks of that quarter. Due to the foregoing factors, quarterly revenue and operating results are not predictable with any significant degree of accuracy. In particular, the timing of revenue recognition can be affected by many factors, including the timing of contract execution and delivery. The timing between initial customer contact and fulfillment of criteria for revenue recognition can be lengthy and unpredictable, and revenue in any given quarter can be adversely affected as a result of such unpredictability.

OUR SALES CYCLE IS LONG AND UNPREDICTABLE, AND POTENTIAL DELAYS IN THE CYCLE MAKE OUR REVENUE SUSCEPTIBLE TO FLUCTUATIONS

The licensing of our software generally requires us to engage in a sales cycle that typically takes approximately four to nine months to complete. The length of the sales cycle may vary depending on a number of factors over which we may have little or no control, including the size of the transaction and the level of competition that we encounter in our selling activities. During the sales cycle, we typically provide a significant level of education to prospective customers regarding the use and benefits of our products and, in some cases, permit the potential customer to utilize an evaluation version of our software products. Any delay in the sales cycle of a large license or a number of smaller licenses could have a material adverse effect on our business, condition (financial or otherwise), prospects and results of operations.

SEASONAL TRENDS IN SALES OF OUR SOFTWARE PRODUCTS MAY AFFECT OUR QUARTERLY OPERATING RESULTS

Our business has experienced and is expected to continue to experience seasonality. Our revenue and operating results in our December quarter typically benefit from purchase decisions made by the large concentration of customers with calendar year-end budgeting requirements, and from the efforts of our sales force to meet fiscal year-end sales quotas. In addition, we are currently attempting to further expand our presence in international markets, including Europe. International revenue comprises a significant percentage of our total revenue, and we may experience additional variability in demand associated with seasonal buying patterns in such foreign markets.

ANY FUTURE ACQUISITIONS PRESENT RISKS WHICH COULD ADVERSELY AFFECT OUR BUSINESS

In the future, ON may evaluate and make acquisitions of, or large investments in, other businesses that offer products, services, and technologies that further our goal of providing remote software management solutions to businesses or which complement our current business. Any future acquisitions or investments that we may evaluate or complete present risks commonly encountered with these types of transactions. The following are examples of such risks:

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The risks described above, either individually or in the aggregate, could materially adversely affect our business, operating results, and financial condition. Future acquisitions, if any, could provide for consideration to be paid in cash, shares of ON common stock, Company debt, or a combination of cash, ON common stock, and Company debt.

OUR ABILITY TO MANAGE GROWTH WILL AFFECT OUR ABILITY TO ACHIEVE AND MAINTAIN PROFITABILITY

Over the last 5 years, total CCM and related revenue has increased significantly from $11.3 million in fiscal 1998 to $34.8 million in fiscal 2002. If we achieve our future growth plans, such growth may burden our operating and financial systems. This burden will require significant senior management attention and will require the use of other ON resources. Our ability to compete effectively and to manage future growth (and our future operating results) will depend in part on our ability to implement and expand operational, customer support, and financial control systems and to expand, train, and manage our employees. We may not be able to augment or improve existing systems and controls or implement new systems and controls in response to future growth, if any. Any failure to do so could materially adversely affect our business, condition (financial or otherwise), prospects and results of operations.

OUR BUSINESS DEPENDS IN LARGE PART UPON THE PROTECTION OF OUR PROPRIETARY TECHNOLOGY, THE LOSS OF WHICH WOULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS

Our success is heavily dependent upon our proprietary software technology. We rely on a combination of contractual rights, trademarks, trade secrets and copyright to establish and protect our proprietary rights in software.

We use a printed “shrink-wrap” license for users of our products distributed through our reseller distribution channels in order to protect our copyrights and trade secrets in those products. Since the licensee does not sign these shrink-wrap licenses, many authorities believe that they may not be enforceable under many state laws and the laws of many foreign jurisdictions. If such licenses were not enforceable, the user would not be bound by the license terms, including the terms that seek to protect our proprietary technology. If the printed shrink-wrap licenses prove to be unenforceable, this may have a material adverse effect on our business, condition (financial or otherwise), prospects and results of operations.

The laws of some foreign countries either do not protect our proprietary rights or offer only limited protection for those rights. Furthermore, in countries with a high incidence of software piracy, we may experience a higher rate of piracy of our products.

We have obtained registrations in the United States for the following trademarks: ON Technology, CCM, ON Command, and ON Command CCM. We have only obtained registration for the trademark ON Command CCM in the European Union and Australia and for ON Technology and ON Command in Canada. As a result, we may not be able to prevent a third party from using our trademarks in many foreign jurisdictions. We have not to date registered any of our copyrights.

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There can be no assurance that the steps taken by ON to protect our proprietary software technology will be adequate. Lesser sensitivity by corporate, government or institutional users to avoiding infringement of propriety rights could have a material adverse effect on our business, condition (financial or otherwise), prospects and results of operations.

There has been substantial litigation in the software industry involving intellectual property rights of technology companies. We have not been involved in any such litigation. Although we do not believe that we are infringing the intellectual property rights of others, any involvement in this type of litigation may have a material adverse effect on our business, condition (financial or otherwise), prospects and results of operations. In addition, since we currently license, or may in the future license or acquire a portion of the software included in our products from third parties, our exposure to infringement actions may increase because we must rely upon these third parties for information as to the origin and ownership of any software. We generally obtain representations as to the origin and ownership of such acquired or licensed software and we generally obtain indemnification to cover any breach of such representations. However, there can be no assurance that these representations are accurate or that such indemnification will provide us with adequate compensation for a breach of these representations. In the future, we may need to initiate litigation to enforce and protect trade secrets and other intellectual property rights owned by us. We may also be subject to litigation to defend against claimed infringement of the rights of others or to determine the scope and validity of the proprietary rights of others. This litigation could be costly and cause diversion of management’s attention, either of which could have a material adverse effect on our business, condition (financial or otherwise), prospects and results of operations. Adverse rulings or findings in such litigation could result in the loss of our proprietary rights, subject us to significant liabilities, require us to seek licenses from third parties, or prevent us from manufacturing or selling our products. Any one of these items could have a material adverse effect on our business, condition (financial or otherwise), prospects and results of operations. Furthermore, there can be no assurance that any necessary licenses will be available to us on reasonable terms, or at all.

IF WE FAIL TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, COMPETITORS MAY BE ABLE TO USE OUR TECHNOLOGY OR TRADEMARKS AND THIS COULD WEAKEN OUR COMPETITIVE POSITION, REDUCE OUR REVENUE AND INCREASE COSTS

We rely primarily on a combination of copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect our proprietary rights. Such laws provide only limited protection. Despite precautions that we take, it may be possible for unauthorized third parties to copy aspects of our current or future products or to obtain and use information that we regard as proprietary. In particular, we may provide our licensees with access to our data model and other proprietary information underlying our licensed applications. Such means of protecting our proprietary rights may not be adequate. Policing unauthorized use of software is difficult and, while we do not expect software piracy to be a persistent problem, some foreign laws do not protect our proprietary rights to the same extent as United States laws. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Litigation could result in substantial costs and diversion of resources, and could materially adversely affect our business, condition (financial or otherwise), prospects and results of operations.

THIRD PARTIES COULD ASSERT, FOR COMPETITIVE OR OTHER REASONS, THAT OUR PRODUCTS INFRINGE THEIR INTELLECTUAL PROPERTY RIGHTS, AND SUCH CLAIMS COULD INJURE OUR REPUTATION, CONSUME TIME AND MONEY, AND ADVERSELY AFFECT OUR ABILITY TO SELL OUR PRODUCTS

While we are not aware that any of our software product offerings infringe the proprietary rights of third parties, third parties may claim infringement with respect to our current or future products. We expect that software product developers will increasingly be subject to infringement claims as the number of products and competitors in the software industry grows and the functionality of products in different industry segments overlaps. Any such claims, with or without merit, could be time consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. Royalty or licensing agreements may not be available on acceptable terms, or at all. As a result, infringement claims could have a material adverse effect on our business, condition (financial or otherwise), prospects and results of operations.

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WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS THAT COULD RESULT IN SIGNIFICANT COSTS TO US

Our license agreements with our customers typically contain provisions designed to limit exposure to potential product liability claims. Such limitation of liability provisions may, however, not be effective under the laws of certain jurisdictions. Although we have not experienced material product liability claims to date, the sale and support of our products entails the risk of such claims. We may be subject to such claims in the future. A material product liability claim could materially adversely affect our business, condition (financial or otherwise), prospects and results of operations.

OUR SENIOR MANAGEMENT AND OTHER KEY PERSONNEL ARE CRITICAL TO OUR BUSINESS, AND IF THEY CHOOSE TO LEAVE, IT COULD HARM OUR BUSINESS

Our success will depend to a significant extent on the continued service of our senior management and certain other key employees, including selected sales, consulting, technical and marketing personnel. While our employees are required to sign standard agreements concerning confidentiality and ownership of inventions and many of our employees are bound by an employment or non-competition agreement, enforcing these agreements may be difficult and costly, particularly with respect to provisions concerning non-competition. In addition, we do not generally maintain key man life insurance on any employee. The loss of the services of one or more of our executive officers or key employees or the decision of one or more such officers or employees to join a competitor or otherwise compete directly or indirectly with us could have a material adverse effect on our business, condition (financial or otherwise), prospects and results of operations.

WE WILL NEED TO RECRUIT AND RETAIN ADDITIONAL QUALIFIED PERSONNEL TO SUCCESSFULLY GROW OUR BUSINESS

Our future success will likely depend in large part on our ability to attract and retain additional highly skilled technical, sales, management and marketing personnel. Competition for such personnel in the computer software industry is intense, and in the past we have experienced difficulty in recruiting qualified personnel. New employees generally require substantial training in the use of our products. We may not succeed in attracting and retaining such personnel. If we do not, our business, condition (financial or otherwise), prospects and results of operations could be materially adversely affected.

PROVISIONS IN OUR CHARTER DOCUMENTS AND IN DELAWARE LAW MAY DISCOURAGE POTENTIAL ACQUISITION BIDS FOR ON AND PREVENT CHANGES IN OUR MANAGEMENT WHICH OUR STOCKHOLDERS FAVOR

Certain provisions of ON’s charter documents eliminate the right of stockholders to act by written consent without a meeting and specify certain procedures for nominating directors and submitting proposals for consideration at stockholder meetings. Such provisions are intended to increase the likelihood of continuity and stability in the composition of the ON board of directors and in the policies set by the board. These provisions also discourage certain types of transactions, which may involve an actual or threatened change of control transaction. These provisions are designed to reduce the vulnerability of ON to an unsolicited acquisition proposal. As a result, these provisions could discourage potential acquisition proposals and could delay or prevent a change in control transaction. These provisions are also intended to discourage certain tactics that may be used in proxy fights. However, they could have the effect of discouraging others from making tender offers for ON’s shares. As a result, these provisions may prevent the market price of ON common stock from reflecting the effects of actual or rumored takeover attempts. These provisions may also prevent changes in the management of ON.

ON’s board of directors has the authority to issue up to 2,000,000 shares of preferred stock in one or more series. The board of directors can fix the price, rights, preferences, privileges, and restrictions of such preferred stock without any further vote or action by ON’s stockholders. The issuance of preferred stock allows ON to have flexibility in connection with possible acquisitions and other corporate purposes. However, the issuance of shares of preferred stock may delay or prevent a change in control transaction

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without further action by the ON stockholders. As a result, the market price of the ON common stock and the voting and other rights of the holders of ON common stock may be adversely affected. The issuance of preferred stock may result in the loss of voting control to others. ON has no current plan to issue any shares of preferred stock.

ON is subject to the anti-takeover provisions of the Delaware General Corporation Law, which regulates corporate acquisitions. The Delaware law prevents certain Delaware corporations, including ON, from engaging, under certain circumstances, in a “business combination” with any “interested stockholder” for three years following the date that such stockholder became an interested stockholder. For purposes of Delaware law, a “business combination” includes, among other things, a merger or consolidation involving ON and the interested stockholder and the sale of more than 10% of ON’s assets. In general, Delaware law defines an “interested stockholder” as any entity or person beneficially owning 15% or more of the outstanding voting stock of a company and any entity or person affiliated with or controlling, or controlled by such entity or person. Under Delaware law, a Delaware corporation may “opt out” of the anti-takeover provisions. ON has not “opted out” of the anti-takeover provisions of Delaware law.

OUR STOCK WILL LIKELY BE SUBJECT TO SUBSTANTIAL PRICE AND VOLUME FLUCTUATIONS WHICH MAY PREVENT STOCKHOLDERS FROM RESELLING THEIR SHARES AT OR ABOVE THE PRICE AT WHICH THEY PURCHASED THEIR SHARES

In the past, the market price of our common stock has varied greatly and the volume of our common stock traded has fluctuated greatly as well. We expect such fluctuation to continue. The fluctuation results from a number of factors including:

In addition, the stock market may from time to time experience extreme price and volume fluctuations. Many technology companies, in particular, have experienced such fluctuations. Often, such fluctuations have been unrelated to the operating performance of the specific companies. The market price of our common stock may experience significant fluctuations in the future.

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RISK OF DELISTING BY NASDAQ STOCK MARKET

Under standards recently adopted by the NASDAQ Stock Market, companies with securities listed on the NASDAQ National Market must meet at least one of two Continued Listing Standards in order to maintain such listing. As applicable to ON, the primary requirements of Continued Listing Standard 1 are that (i) the issuer must maintain stockholders’ equity of at least $10 million, and (ii) the issuer must have at least 750,000 publicly held shares and such publicly held shares must have a minimum market value of $5 million. The primary requirements of Continued Listing Standard 2 are that (i) the issuer’s listed securities must have a minimum market value of $50 million, and (ii) the issuer must have at least 1.1 million publicly held shares and such publicly held shares must have a minimum market value of $15 million. Both listing standards require that the issuer’s listed securities maintain a minimum bid price of $1.00.

As of the date of filing this Quarterly Report on Form 10-Q, the Company is not in compliance with either of the Continued Listing Standards for the NASDAQ National Market. The NASDAQ Stock Market has notified the Company of such non-compliance and management is preparing a response. ON’s common stock may be delisted unless ON takes affirmative action to increase its stockholders’ equity above the required $10 million minimum (such as by issuing securities in an equity financing) or the market value of ON’s listed securities exceeds the $50 million minimum on a consistent basis. Alternatively, management also may consider transferring ON’s listing from the NASDAQ National Market to the NASDAQ Smallcap Market. Delisting could have a material adverse effect on the price of ON’s common stock and on the level of liquidity currently available to the Company’s shareholders.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company is exposed to the impact of interest rate changes, foreign currency fluctuations, and investment changes.

Interest Rate Risk. The Company’s exposure to market rate risk for changes in interest rates relates primarily to the Company’s cash equivalent investments. The Company has not used derivative financial instruments. The Company invests its excess cash in short-term floating rate instruments and senior secured floating rate loan funds, which carry a degree of interest rate risk. These instruments may produce less income than expected if interest rates fall.

Foreign Currency Risk. International revenue from the Company’s foreign subsidiaries and other foreign sources for the three months ended March 31, 2003 was 87% of total revenue. International sales are made primarily from the Company’s subsidiary in Germany and are denominated in the local currency. Accordingly, the Company’s German and other foreign subsidiaries use its local currency as its functional currency. The Company is exposed to foreign currency exchange rate fluctuations as the financial results of its foreign subsidiary are translated into U.S. dollars in consolidation. As exchange rates vary, these results, when translated, may vary from expectations and adversely impact overall profitability.

Investment Risk. The Company may invest in the future in the equity instruments of privately held companies for business and strategic purposes. However, as of March 31, 2003, the Company holds no such material investments. For these non-quoted investments, the Company’s policy is to regularly review the assumptions underlying the operating performance and cash flow forecasts in assessing the carrying values. The Company identifies and records impairment losses on long-lived assets when events or circumstances indicate that such assets might be impaired

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ON TECHNOLOGY CORPORATION AND SUBSIDIARIES

FORM 10-Q, March 31, 2003

Item 4: Controls and Procedures.

Evaluation of disclosure controls and procedures. Based on their evaluation of the Company’s disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934) as of a date within 90 days of the filing date of this Quarterly Report on Form 10-Q, the Company’s chief executive officer and chief financial officer have concluded that the Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and are operating in an effective manner.

Changes in internal controls. There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their most recent evaluation.

PART II: OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, the Company may be a party to litigation and claims incident to the ordinary course of its business. As of the date of this Quarterly Report on Form 10-Q, there is no litigation pending against the Company that would have a material adverse effect on the Company’s results of operations or financial position.

Item 2. Changes in Securities and Use of Proceeds

Not Applicable

Item 3. Defaults Upon Senior Securities

Not Applicable

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

Not Applicable

Item 5. Other Information

Not Applicable

Item 6. Exhibits and Reports on Form 8-K

Exhibits

The exhibits listed in the accompanying Exhibit Index on page 33 are filed or incorporated by reference as part of this Quarterly Report on Form 10-Q.

Reports on Form 8-K

None

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ON TECHNOLOGY CORPORATION AND SUBSIDIARIES

FORM 10-Q, March 31, 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.

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CERTIFICATIONS REQUIRED BY RULES 13A-14 AND 15D-14

UNDER THE SECURITIES EXCHANGE ACT OF 1934

Certification of President

I, Robert L. Doretti, certify that:

1. I have reviewed this quarterly report on Form 10-Q of ON Technology Corporation;

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

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

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

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

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

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

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

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

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

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

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Certification of Chief Financial Officer/Chief Accounting Officer

I, Steven R. Wasserman, certify that:

1. I have reviewed this quarterly report on Form 10-Q of ON Technology Corporation;

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

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

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

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

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

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

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

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

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

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

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INDEX TO.

EXHIBITS

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