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SECURITIES AND EXCHANGE
COMMISSION

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003

OR

FROM                      TO                      .

COMMISSION FILE NUMBER 0-28121

RETEK INC.

(Exact Name of Registrant as Specified in its Charter)

(Address, including zip code, and telephone number, including area code, of Registrant’s Principal Executive Offices)

     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 Exchange Act)

     As of August 1, 2003, the number of shares of the Registrant’s common stock outstanding was 53,940,271.

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TABLE OF CONTENTS

RETEK INC.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2003

INDEX

SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION

     This Quarterly Report on Form 10-Q contains forward-looking statements in “Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Item 3 — Quantitative and Qualitative Disclosures About Market Risk,” and elsewhere. These statements relate to future events or our future financial performance. In some cases, forward-looking statements may be identified by terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continue” or the negative of these terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. Such risks, uncertainties and other factors include, among other things, the matters described in “Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Factors that May Impact Future Results of Operations.”

     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. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of these statements. We are under no duty to update any of the forward-looking statements after the date of this Quarterly Report on Form 10-Q to conform these statements to actual future results.

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PART I - FINANCIAL INFORMATION

     ITEM 1: FINANCIAL STATEMENTS

Retek Inc.
Consolidated Balance Sheet
(in thousands, except per share data)

See accompanying notes to consolidated financial statements.

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Retek Inc.
Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)

See accompanying notes to consolidated financial statements.

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Retek Inc.
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)

See accompanying notes to consolidated financial statements.

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RETEK INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – The Company and its Significant Accounting Policies

The Company

     Retek Inc. and its wholly owned subsidiaries, Retek Information Systems, Inc., Retek International, Inc. and HighTouch Technologies, Inc. (“we” “us” or the “Company”), develop application software that provides a complete information infrastructure solution to the global retail industry. We provide innovative technology solutions that help retailers create, manage and fulfill consumer demand. Our solutions and services have been developed specifically to meet the needs of the retail industry. We believe the processes and methodologies embedded in our solutions reflect the best retail practices of our customers and partners. By supporting core retail business processes, our solutions help retailers improve the efficiency of their operations and build stronger relationships with their customers. We are headquartered in Minneapolis, Minnesota.

Basis of Presentation

     We have prepared the accompanying interim consolidated financial statements, without audit, in accordance with the instructions to Form 10-Q and, therefore, the accompanying interim consolidated financial statements do not necessarily include all information and footnotes necessary for a fair presentation of our financial position, results of operations and cash flows in accordance with accounting principles generally accepted in the United States of America.

     We believe the accompanying unaudited financial information for interim periods presented reflects all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation. These consolidated financial statements and notes thereto should be read in conjunction with our audited financial statements and notes thereto presented in our Annual Report on Form 10-K for the year ended December 31, 2002. The interim financial information contained in this Quarterly Report on Form 10-Q is not necessarily indicative of the results to be expected for any other interim period or for an entire year.

Financial Statement Preparation

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

Note 2 - Stock-Based Compensation

     We measure compensation expense for our employee stock-based compensation awards using the intrinsic value method and provide pro forma disclosures of net income (loss) and earnings (loss) per share as if a fair value method had been applied. Therefore, compensation cost for employee stock awards is measured as the excess, if any, of the fair value of our common stock at the grant date over the amount an employee must pay to acquire the stock and is amortized over the related service periods using the straight-line method. Compensation expense previously recorded for unvested employee stock-based compensation awards that are forfeited upon employee termination is reversed in the period of forfeiture.

     The following table compares net income (loss) and earnings (loss) per share as reported to the pro forma amounts that would be reported had compensation expense been recognized for our stock-based compensation plans in accordance with the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation as amended by SFAS No. 148, Accounting for Stock-Based Compensation - Transition Disclosure, issued in December 2002 (in thousands except per share amounts):

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Note 3 - Per Share Data

     Basic earnings per share is calculated using the weighted average common shares outstanding during the period. Diluted earnings per share is computed on the basis of the weighted average basic shares outstanding plus the dilutive effect of outstanding stock options and warrants using the treasury stock method.

     For the three and six months ended June 30, 2003, the calculation of diluted earnings per share excludes the impact of the potential exercise of 11,829 stock options outstanding because their effect would be anti-dilutive. For the three and six months ended June 30, 2002, the calculation of diluted earnings per share includes the impact of the potential exercise of 7,440 and 7,496 stock options and warrants outstanding, respectively. In addition, the calculation of diluted earnings per share excludes the impact of the potential exercise of 3,009 and 2,703 stock options outstanding for the three and six months ended June 30, 2002, respectively, because their effect would be anti-dilutive.

Note 4 - Asset Acquisition

     On March 31, 2002, we acquired the intellectual property of Chelsea Market Systems, LLC (“Chelsea”) and certain other assets and liabilities for a net cash purchase price of $8.9 million, of which $8.9 million has been allocated to purchased software, an intangible asset. This purchased software is stated at the lower of cost or net realizable value and is being amortized over 36 months.

Note 5 - Reclassifications

     Certain prior period amounts have been reclassified to conform with current period presentation.

Note 6 – Contingencies

Federal Litigation in the U.S. District Court for the Southern District of New York

     Between June 11 and June 26, 2001, three class action complaints alleging violations of Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 were filed in the Southern District of New York against us, certain of our current and former officers and directors, and certain underwriters of our initial public offering (“IPO”). On August 9, 2001, these actions were consolidated for pre-trial purposes before a single judge along with similar actions involving the initial public offerings of numerous other issuers.

     On February 14, 2002, the parties signed and filed a stipulation dismissing the consolidated action without prejudice against us and the individual officers and directors, which the Court approved and entered as an order on March 1, 2002. On April 20, 2002, the plaintiffs filed an amended complaint in which they elected to proceed with their claims against us and the individual officers and directors only under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The amended complaint alleges that the prospectus filed in connection with the IPO was false or misleading in that it failed to disclose: (i) that the underwriters allegedly were paid excessive commissions by certain of the underwriters’ customers in return for receiving shares in the IPO and (ii) that certain of

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the underwriters’ customers allegedly agreed to purchase additional shares of our common stock in the aftermarket in return for an allocation of shares in the IPO. The complaint further alleges that the underwriters offered to provide positive market analyst coverage for the Company after the IPO, which had the effect of manipulating the market for our stock. Plaintiffs contend that, as a result of the omissions from the prospectus and alleged market manipulation through the use of analysts, the price of our common stock was artificially inflated between November 18, 1999 and December 6, 2000, and that the defendants are liable for unspecified damages to those persons who purchased our common stock during that period.

     On July 15, 2002, the Company and the individual defendants, along with the rest of the issuers and related officer and director defendants, filed a joint motion to dismiss based on common issues. Opposition and reply papers were filed. The Court rendered its decision on February 19, 2003, which granted dismissal in part of a claim against one of the individual defendants and denied dismissal in all other respects

     On June 30, 2003, a Special Litigation Committee of the Board of Directors of the Company approved a Memorandum of Understanding (the “MOU”) reflecting a settlement in which the plaintiffs agreed to dismiss the case against the Company with prejudice in return for the assignment by the Company of claims that the Company might have against its underwriters. The same offer of settlement was made to all issuer defendants involved in the litigation. No payment to the plaintiffs by the Company is required under the MOU. There can be no assurance that the MOU will result in a formal settlement or that the Court will approve the settlement that the MOU sets forth.

     The Company believes that it and the individual defendants have meritorious defenses to the claims made in the complaint and, if the MOU does not result in a formal settlement approved by the Court, intends to contest the lawsuit vigorously. Securities class action litigation can result in substantial costs and divert our management’s attention and resources, which may have a material adverse effect on our business and results of operations.

Federal Litigation in the U.S. District Court for the District of Minnesota

     Between October 30, 2002 and December 8, 2002, several purported shareholder class action suits were filed in federal district court in Minnesota. The Court has not yet certified any class. The federal court in Minnesota appointed a lead plaintiff and lead plaintiff’s counsel on February 14, 2003. The consolidated complaint (the “Consolidated Complaint”) alleges, among other things, violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 against us and certain of our current and former officers and directors. Specifically, the Consolidated Complaint alleges that, among other things, between June 19, 2001 and July 8, 2002 (the “Class Period”), defendants made false and misleading statements and/or concealed material adverse facts from the market in press releases, presentations and SEC disclosures. The Consolidated Complaint alleges that our Company and the individual defendants misled the market with respect to, among other things our alliance with IBM, our ability to develop certain software, and our expectations regarding certain customer sales. Plaintiffs further allege that defendants manipulated financial statements and failed to disclose problems with existing and potential customer deals, which led to the Company’s stock price being artificially inflated during the Class Period. The plaintiffs seek compensatory damages and other unspecified relief. On May 30, 2003, the Company and the individual defendants served a motion to dismiss the Consolidated Complaint. Briefing on the motion is currently in process. The Court has not yet set a hearing date on the motion.

     We dispute plaintiffs’ allegations in the consolidated federal class actions in Minnesota and believe that the allegations are subject to a variety of meritorious defenses. We intend to establish a vigorous defense. While there can be no assurance, and while the outcome of federal class action litigation cannot be predicted with certainty, our management currently believes that the ultimate outcome of the consolidated federal class action litigation in Minnesota is unlikely to have a material adverse affect on our financial position, results of operations or cash flows. Despite our belief that the consolidated federal class action is without merit, it is possible that the litigation could be resolved adversely. Were the federal court in Minnesota to issue a ruling or rulings unfavorable to us, such ruling or rulings could have a material adverse impact on the results of operations for the period in which the ruling occurs, or in a period thereafter.

State Derivative Litigation in the State of Minnesota, District Court, Hennepin County

     In addition to the above federal litigation, in December 2002 two shareholder derivative lawsuits were filed in state court in Hennepin County, Minnesota, against certain of our current and former officers and directors, naming us as a nominal defendant. Plaintiffs in both derivative cases have agreed to consolidate their respective actions, although the derivative plaintiffs have not yet filed a consolidated derivative complaint. The derivative suits claim that certain of our officers and directors breached their fiduciary duties to us and our stockholders by: (i) selling shares of our common stock while in possession of material adverse non-public

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information regarding our business and prospects, and (ii) disseminating inaccurate information regarding our business and prospects to the market and/or failing to correct such inaccurate information. The derivative complaints seek compensatory and other damages, restitution, disgorgement, and other legal and equitable relief. As stated above, the complaints are brought derivatively on our behalf, and consequently do not seek relief from us. We however, have entered into indemnification agreements in the ordinary course of business with certain of the officer and director defendants and may be obligated throughout the pendency of this action to advance payment of legal fees and costs incurred by those defendants pursuant to our obligations under the indemnification agreements and/or applicable Delaware law.

     While there can be no assurance, our management currently believes that the ultimate outcome of the derivative proceedings will not have a material adverse affect on our financial position, results of operations, or cash flows. However, we are unable to predict with certainty the results of the derivative litigation.

Legal Proceedings that Arise in the Ordinary Course of Business

     In addition to the matters discussed above, we are subject to various legal proceedings and claims that arise in the ordinary course of business. We believe that the resolution of such matters will not have a material impact on our financial position, results of operations or cash flows.

Note 7 – Restructuring and Other

     In the fourth quarter of 2002, we began implementation of a restructuring plan intended to bring our operating expenses in line with expected revenues due to concerns with a weakening global economy and decreasing capital expenditures by retailers. Actions taken included a reduction of our workforce and a reduction in the amount of leased space.

     The restructuring plan includes workforce reductions of 265 employees across most business functions and geographic regions and all employees were notified in 2002 of benefits to be received. We recorded a charge for severance and related benefits of $2.6 million in the fourth quarter of 2002. In the second quarter of 2003 we recorded an additional charge of $0.1 million to reflect adjustments to final severance benefits paid. As of June 30, 2003, substantially all payments had been made to the severed individuals.

     We recorded a net loss on lease abandonment of $17.0 million in the fourth quarter of 2002. This lease abandonment loss consists of the payments to be made for the remaining lease term of the abandoned space that aggregates $31.1 million, net of estimated sublease income of $14.1 million. The lease terms on the leased space to be abandoned range from five to eleven years. Management has made its best estimates of expected sublease income over the remaining term of the abandoned leases. The estimated sublease income amount is highly judgmental and includes assumptions regarding the periods of sublease and the price per square foot to be paid by the sublessors. Our plan calls for the affected space to be abandoned by us at various dates through the third quarter of 2003. As required by the applicable accounting standards, we will review these estimates each quarter and make adjustments, as necessary, to reflect management’s best estimates.

     The following table sets forth a summary of the restructuring charges, payment made against those charges and the remaining liabilities as of June 30, 2003.

     Related to the lease abandonment charge, we recorded $0.3 and $1.7 million of accelerated depreciation on fixed assets abandoned in the three and six-month periods ended June 30, 2003, which is recorded as general and administrative expense.

Note 8 – Income Taxes

     During the quarter ended September 30, 2002, we determined that it was appropriate to record a full valuation allowance for our deferred tax assets. The establishment of a full deferred tax valuation allowance was determined to be appropriate in light of the magnitude of the revenue decreases in the third quarter of 2002, our operating losses for the three and nine months ended September 30, 2002, our then current expectation of a significant loss for the full year 2002 and the added uncertainty of the market in which we

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operate. Despite the full valuation allowance, the income tax benefits related to these deferred tax assets will remain available to offset future taxable income.

     The income tax provision for the three and six months ended June 30, 2003 relates to state and foreign income taxes.

Note 9 – Comprehensive (Loss) Income

     The following table presents the calculation of comprehensive (loss) income:

Note 10 – Commitments

     In November 2002, the Financial Accounting Standards Board (FASB) issued FASB Interpretation (FIN) 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.” The Interpretation requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken by issuing the guarantee. The Interpretation also requires additional disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees it has issued. The initial recognition and initial measurement provisions of FIN No. 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year-end. The disclosure requirements of FIN No. 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. The adoption of FIN No. 45 did not have a material effect on our consolidated financial position. The following is a summary of our agreements that management has determined are within the scope of FIN No. 45.

     We license our software products to customers under end user license agreements and to certain resellers or other business partners under business partner agreements. These agreements generally include certain provisions for indemnifying the customer or business partner against losses, expenses and liabilities from damages that may be awarded against them if our software, or the third party-owned software we resell, is found to infringe a patent, copyright, trademark or other proprietary right of a third party. These agreements generally limit our indemnification obligations based on industry standards and geographical parameters, and give us the right to replace an infringing product. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we believe our internal development processes and other practices limit our exposure under these indemnification provisions. In addition, the invention and nondisclosure agreements signed by our employees, assign to us various intellectual property rights. We have not incurred significant costs payable to a customer or business partner to defend lawsuits or settle claims related to these indemnification agreements. As a result, management believes the estimated fair value of these agreements is not significant. Accordingly, there are no liabilities recorded for these agreements as of June 30, 2003.

     We enter into services agreements with customers for the implementation of our software. We also may subcontract those services to our business partners. From time to time, we include in those services agreements, certain provisions for indemnifying the customer against losses, expenses and liabilities from those services, including, for example, personal injury or tangible property damage. Lease agreements and other contracts with our vendors may also impose similar indemnification obligations on us for personal injury, tangible property damage or other claims. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have general liability and umbrella insurance policies that enable us to recover a portion of certain amounts paid. We have not incurred significant costs payable to a customer to defend lawsuits or settle claims related to these indemnification agreements. As a result, management believes the estimated fair value of these agreements is not significant. Accordingly, there are no liabilities recorded for these agreements as of June 30, 2003.

     We have arrangements with certain vendors whereby we guarantee the expenses incurred by certain of our employees. The term is from execution of the arrangement until cancellation and payment of any outstanding amounts. Unless otherwise limited in the contract, we would be required to pay any unsettled employee expenses upon notification from the vendor. The maximum potential

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amount of future payments we could be required to make under these indemnification agreements is not significant. As a result, management believes the estimated fair value of these agreements is not significant. Accordingly, there are no liabilities recorded for these agreements as of June 30, 2003.

     Delaware law and our certificate of incorporation and bylaws provide that we will, under certain circumstances and subject to certain limitations, indemnify any person made, or threatened to be made, a party to a proceeding by reason of that person’s former or present official capacity with us against judgments, penalties, fines, settlements and reasonable expenses. Any such person also is entitled, subject to limitations, to payment or reimbursement of reasonable expenses in advance of the final disposition of the proceeding. The maximum potential amount of future payments we could be required to make under these indemnification arrangements is unlimited; however, we have insurance policies that enables us to recover a portion of certain amounts paid. We have not incurred significant costs payable to an indemnitee to defend lawsuits or settle claims related to these indemnification arrangements. As a result, management believes the estimated fair value of these arrangements is minimal. Accordingly, there are no liabilities recorded for these agreements as of June 30, 2003.

     When a customer purchases support for our software products, we generally warrant that those products then eligible for support will operate materially and substantially as described in the documentation that is provided with that software. We also generally warrant that our services will be provided by trained personnel and in a professional manner using commercially reasonable efforts. If necessary, we provide for the estimated cost of product and service warranties based on specific warranty claims and claim history. Historically, these costs have not been significant.

Note 11 – Segment Information

     We operate in one reportable segment. Our operations are primarily conducted in the United States, our country of domicile. Geographic data, determined by references to the location of our operations for the three and six months ended June 30, 2003 and 2002 are as follows:

     The following is long-lived asset information by geographic area:

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

     The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes, and the other financial information included in this Quarterly Report on Form 10-Q. This discussion and analysis contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of specified factors, including those set forth in the section below entitled “Factors That May Impact Future Results of Operations” and elsewhere in this Quarterly Report on Form 10-Q.

Overview

     We generate revenue from the sale of software licenses, maintenance and support contracts, and professional consulting and contract development services. We generally provide technical advisory services after the delivery of our products to help customers exploit the full value and functionality of our products. Revenue from the sale of software licenses under these agreements is

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recognized over the period the technical advisory services are performed if all other criteria for recognition of revenue are met. These periods of technical advisory services generally range from 12 to 24 months, as determined by each customer’s objectives. Deferred revenue consists principally of the unrecognized portion of amounts received under license and maintenance service agreements. Deferred license revenue is recognized ratably over the technical advisory period (if applicable), or on a percentage of completion basis, or when all criteria for recognition of revenue are met based on the contract terms. Deferred maintenance revenue is recognized ratably over the term of the service agreement.

     Customers who license our software generally purchase maintenance contracts, typically covering renewable annual periods. In addition, customers may purchase consulting services, which are customarily billed at a fixed daily rate plus out-of-pocket expenses. Contract development services, including new product development services, are typically performed at a fixed daily rate plus out-of-pocket expenses or for a fixed fee. We also offer training services that are billed on a per student or per class session basis.

     We market our software solutions worldwide through direct and indirect sales channels. Indirect sales channels represent sales contracted by other entities on our behalf. Revenue generated from our direct sales channel accounted for approximately 97% and 98% of total revenue for the three and six-month periods ended June 30, 2003, respectively, compared to 98% for the corresponding prior year periods.

     Revenue attributable to customers outside of North America accounted for approximately 39% and 37% of total revenue for the three and six-month periods ended June 30, 2003, compared to 43% and 34% for the corresponding prior year periods, respectively. Approximately 26% and 25% of our sales were denominated in currencies other than the U.S. dollar for the three and six month periods ended June 30, 2003, compared to 36% and 27% for the corresponding prior year periods, respectively.

Acquisitions and Strategic Relationships

     On March 31, 2002, we acquired substantially all of the technology of Chelsea and assumed certain liabilities for a net cash purchase price of $8.9 million. The entire $8.9 million purchase price has been allocated to purchased software, an intangible asset. This purchased software is being amortized using the straight-line method over 36 months.

Critical Accounting Policies and Estimates

     For discussion on critical accounting policies and estimates, see our 2002 Annual Report on Form 10-K.

Results of Operations

     The following table presents selected financial data for the periods indicated as a percentage of our total revenue. Our historical reporting results are not necessarily indicative of the results to be expected for any future period.

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Three and Six Months Ended June 30, 2003 and 2002

Revenue

     Total revenue. Total revenue decreased 29% and 30% to $42.9 and $80.5 million for the three and six months ended June 30, 2003, respectively, from $60.8 and $114.3 million for the corresponding prior year periods. This decrease in total revenue was due to the decrease in license and maintenance revenue discussed below, which was partially offset by the increase in services and other revenue also discussed below.

     License and maintenance revenue. License and maintenance revenue decreased 53% and 52% to $21.7 and $41.9 million for the three and six months ended June 30, 2003, respectively, from $45.7 and $87.4 million for the corresponding prior year periods. The decrease was due to a slowdown in the U.S. and world economies and a more deliberate evaluation process by our potential customers, which has resulted in extended sales cycles. Maintenance revenues increased $1.0 million for the three months ended June 30, 2003 as compared to the corresponding prior year period. Maintenance revenues may vary on a quarterly basis primarily due to timing of contract execution during the quarter and other specific contract terms. Maintenance revenues decreased $0.1 million for the six-month period ended June 30, 2003 as compared to the corresponding prior year period. The decrease for the six months ended June 30, 2003 was primarily due to one customer that did not renew their maintenance agreement during the first quarter 2003, because the customer made a strategic decision to outsource all information technology functions to a third party provider.

     Services and other revenue. Services and other revenue increased 41% and 44% to $21.2 and $38.6 million for the three and six months ended June 30, 2003, respectively, from $15.0 and $26.9 million for the corresponding prior year periods. The increase in services and other revenue was due to our expanding customer base and the number of concurrent projects being serviced by us during the three and six-month period ended June 30, 2003. Consulting and custom development increased $7.8 and $12.4 million for the three and six months ended June 30, 2003, respectively, which were offset by various services and other revenues. We have relationships with third party integrators and consultants that contract either with us or directly with our customers for services and other integration needs. Our customer’s proportionate use of our services offerings or other third party integrators and consultants may cause our services revenue to vary independently of changes in license and maintenance revenue.

   Non-Cash Charges

     Non-Cash Charges. Certain non-cash expenses are presented separately on our statement of operations as components of cost of revenue, research and development, sales and marketing and general administrative. These non-cash charges consist of amortization of stock-based compensation and amortization of purchased software. Cost of license and maintenance revenue presents separately amortization of purchased software. We believe that the presentation of these charges separately on the face of the statement of operations facilitates the understanding of the individual statement of operations line items. Deferred stock-based compensation represents the difference between the exercise price and the fair value of our common stock for accounting purposes on the date that certain stock options were granted. This amount is included as a component of stockholders’ equity and is being amortized on an accelerated basis by charges to operations over the vesting period of the options, consistent with the method described in Financial Accounting Standards Board Interpretation No. 28. Amortization of stock-based compensation was $0.3 and $1.0 million for the three and six month periods ending June 30, 2003, respectively, compared to $0.8 and $1.6 million for the corresponding prior year periods. Amortization of purchased software results from our purchase of certain core technologies of WebTrak Limited and HighTouch Technologies, Inc. and the acquisition of substantially all of the technology of Chelsea. Amortization of intangible assets is included in non-cash cost of revenues license and maintenance and was $0.9 and $2.0 million for the three and six month periods ended June 30, 2003, respectively, compared to $1.6 and $2.4 million for the corresponding prior year periods.

   Cost of Revenue

     Cost of license and maintenance revenue. Cost of license and maintenance revenue consists of fees for third party software products that are integrated into our products, third party license development costs, salaries and related expenses of our customer

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support organization, other infrastructure costs, and an allocation of our facilities and depreciation expense. Cost of license and maintenance revenue decreased 36% to $7.6 and $14.3 million for the three and six months ended June 30, 2003, respectively, from $11.9 and $22.4 million for the corresponding prior year periods. The decrease was primarily due to a $3.2 and $7.9 million decrease in third party consultant costs for the three and six months ended June 30, 2003, respectively. Third party consultants were used in the prior year to help with several funded development contracts, which were mostly completed in prior year. Decreased usage of third party consultants was due to a different scale and scope of funded development projects during the three and six months ended June 30, 2003, as compared to the prior year. We anticipate the use of additional third party consultant resources to complete pending development contracts. As a percentage of license and maintenance revenue, cost of license and maintenance revenue increased to 35% for the three months ended June 30, 2003 from 26% for the corresponding prior year period and to 34% for the six months ended June 30, 2003 from 26% in prior year. The increase in percentage cost of license and maintenance revenues for the three and six months ended June 30, 2003 is due to funded development and maintenance revenues representing a larger proportion of total license and maintenance revenues over the prior year. Funded development and maintenance revenue typically have lower margins than license revenues.

     Cost of services and other revenue. Cost of services and other revenue includes salaries and related expenses of our consulting organization, cost of third parties contracted to provide consulting services to our customers, and an allocation of facilities and depreciation expense. Cost of services and other revenue increased 44% and 50% to $15.6 and $29.3 million for the three and six months ended June 30, 2003, respectively, from $10.8 and $19.6 million for the corresponding prior year periods. The increase in cost of services and other revenue for the three months ended June 30, 2003 was primarily due to a $3.6 million increase in third party consulting fees and a $1.4 million increase in personnel and related costs. The increase in cost of services and other revenue for the six-month period ended June 30, 2003 was primarily due to a $7.2 million increase in third party consulting costs and a $2.8 million increase in personnel and related costs. Third party consultants are used on an as-needed basis depending on the availability and skills of internal resources and our ability to leverage our relationships with third party integrators. The increase in personnel and related costs is due to our assigning other internal development resources to assist in custom development projects. As a percentage of services and other revenue, cost of services and other revenue increased to 73% for the three months ended June 30, 2003, from 72% for the corresponding prior year period and to 76% for the six months ended June 30, 2003, from 73% in prior year. This decrease in margins was due to using proportionately more third party contractors, which have a higher daily average cost.

   Operating Expenses

     Research and development. Research and development expenses, which are expensed as incurred, consist primarily of salaries and related costs of our engineering organization, fees paid to third party consultants and an allocation of facilities and depreciation expenses. Research and development expenses decreased 13% and 15% to $12.2 and $22.3 million for the three and six months ended June 30, 2003, respectively, from $13.9 and $26.3 million for the corresponding prior year periods. The decrease was primarily due to a $1.7 and $4.0 million decrease in personnel and related costs for the three and six months ended June 30, 2003, respectively, which was caused by a decrease in research and development personnel as a result of our restructuring efforts. In the future, if our internal resources are not sufficient to complete necessary development activities, we anticipate leveraging third party consultants to assist in development.

     Sales and marketing. Sales and marketing expenses consist primarily of salaries and related costs of the sales and marketing organization, sales commissions, costs of marketing programs, including public relations, advertising, trade shows and sales collateral and an allocation of facilities and depreciation expenses. Sales and marketing expenses decreased 40% and 33% to $8.6 and $18.7 million for the three and six months ended June 30, 2003, respectively, from $14.3 and $27.8 million for the corresponding prior year periods. The decrease for the three months ended June 30, 2003 was due to a $4.6 million decrease in employee and related costs, primarily due to a decrease in personnel due to our restructuring efforts and a $1.1 million decrease in direct allocation depreciation for an asset that was fully depreciated as of December 31, 2002. The decrease for the six months ended June 30, 2003 was due to a $6.5 million decrease in employee and related costs, primarily due to a decrease in personnel due to our restructuring efforts, $2.3 million decrease in direct allocation depreciation for an asset that was fully depreciated as of December 31, 2002, and $0.9 million decrease in marketing costs, primarily for trade shows and advertising. This decrease was partially offset by a $1.5 million increase in pre-sales consulting. We are increasingly investing in pre-sales consulting in order to more fully demonstrate the benefits to be derived from implementing our products to our potential customers.

     General and administrative. General and administrative expenses consist primarily of costs from our finance and human resources organizations, legal and other professional service fees and an allocation of facilities costs and depreciation expenses. General and administrative expenses decreased 24% to $3.4 million for the three months ended June 30, 2003, from $4.4 million for the corresponding prior year period and increased 3% to $8.3 million for the six months ended June 30, 2003, from $8.1 million in prior

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year. The decrease for the three months ended June 30, 2003 was primarily due to a $0.5 million decrease in employee and related costs and a $0.5 million decrease in professional fees. The increase for the six months ended Jun 30, 2003 was primarily due to a $1.1 million of accelerated depreciation charges for assets abandoned in connection with our restructuring efforts offset by a $0.9 million decrease in professional fees.

     Acquisition-related amortization of intangibles. Acquisition-related amortization of intangibles decreased 20% and 23% to $1.6 and $3.4 million for the three and six months ended June 30, 2003, respectively, from $2.0 million and $4.5 million for the corresponding prior year periods. The decrease was due to certain intangible assets being fully amortized in 2002.

     Restructuring and Other. In the fourth quarter of 2002, we began implementation of a restructuring plan intended to bring our operating expenses in line with expected revenues due to concerns with a weakening global economy and decreasing capital expenditures by retailers. Actions taken included a reduction of our workforce and a reduction in the amount of leased space.

     The restructuring plan includes workforce reductions of 265 employees across most business functions and geographic regions and all employees were notified in 2002 of benefits to be received. We recorded a charge for severance and related benefits of $2.6 million in the fourth quarter of 2002. In the second quarter of 2003 we recorded an additional charge of $0.1 million to reflect adjustments to final severance benefits paid. As of June 30, 2003, substantially all payments had been made to the severed individuals.

     We also recorded a net loss on lease abandonment of $17.0 million in the fourth quarter of 2002. This lease abandonment loss consists of the payments to be made for the remaining lease term of the abandoned space that aggregates $31.1 million, net of estimated sublease income of $14.1 million. The lease terms on the leased space to be abandoned range from five to eleven years. Management has made its best estimates of expected sublease income over the remaining term of the abandoned leases. The estimated sublease income amount is highly judgmental and includes assumptions regarding the periods of sublease and the price per square foot to be paid by the sublessors. Our plan calls for the affected space to be abandoned by us at various dates through the third quarter of 2003. As required by the applicable accounting standards, we will review these estimates each quarter and make adjustments, as necessary, to reflect management’s best estimates.

     The following table sets forth a summary of the restructuring charges, payment made against those charges and the remaining liabilities as of June 30, 2003.