UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended September 30, 2004

OR

Commission File Number: 000-27389

INTERWOVEN, INC.

803 11^TH Avenue
Sunnyvale, California 94089
(Address of principal executive offices)

(408) 774-2000
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:

Yes x                               No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act):

Yes x                               No o

As of October 31, 2004, there were approximately 40,765,000 shares of the registrant’s common stock outstanding.

INTERWOVEN, INC.

Table of Contents

PART I: FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

INTERWOVEN, INC.

See accompanying notes to condensed consolidated financial statements.

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INTERWOVEN, INC.

See accompanying notes to condensed consolidated financial statements.

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INTERWOVEN, INC.

See accompanying notes to condensed consolidated financial statements.

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INTERWOVEN, INC.

Note 1. Summary of Significant Accounting Policies

     Basis of Presentation

     The condensed consolidated financial statements included herein are unaudited and reflect all adjustments (consisting only of normal recurring adjustments), which are, in the opinion of management, necessary for a fair presentation of the consolidated financial position, results of operations and cash flows for the interim periods. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto, together with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Interwoven, Inc. (“Interwoven” or “Company”) Annual Report on Form 10-K for the year ended December 31, 2003. The results of operations for the three and nine months ended September 30, 2004 are not necessarily indicative of the results for the entire year or for any other period.

     The consolidated balance sheet as of December 31, 2003 has been derived from audited consolidated financial statements but does not include all disclosures required by generally accepted accounting principles. Such disclosures are contained in the Company’s Annual Report on Form 10-K.

     The preparation of condensed consolidated 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 condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

     The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated.

     Certain reclassifications have been made to the prior period financial statements to conform to the current period presentation.

     On November 18, 2003, the Company effected a one-for-four reverse stock split. All share and per share information included in these consolidated financial statements have been retroactively adjusted to reflect the reverse stock split.

     Effective January 1, 2004, the Company changed the functional currency of its foreign subsidiaries from the United States Dollar to the local currency due to the increased operations and activity of the foreign subsidiaries associated with the merger with iManage, Inc. (“iManage”). As a result of the merger, the foreign subsidiaries have increased resources locally, requiring less support from the domestic parent and will incur increased operational costs that will be paid locally, in local currency. Accordingly, all assets and liabilities are translated using current rates of exchange at the balance sheet date, while revenues and expenses are translated using weighted-average exchange rates prevailing during the period. The resulting gains or losses from translation are charged or credited to other comprehensive income (loss) and are accumulated and reported in the stockholders’ equity section of the Company’s consolidated balance sheets.

     Revenue Recognition

     Revenue consists principally of software license, support, consulting and training fees. The Company recognizes revenue using the residual method in accordance with Statement of Position (“SOP”) 97-2, Software Revenue Recognition, as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition with

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Respect to Certain Transactions. Revenue is recognized under the residual method in a multiple element arrangement in which company-specific objective evidence of fair value exists for all of the undelivered elements in the arrangement, but does not exist for one or more of the delivered elements in the arrangement. Company-specific objective evidence of fair value of support and other services is based on the Company’s customary pricing for such support and services when sold separately. At the outset of a customer arrangement, the Company defers revenue for the fair value of its undelivered elements (e.g., support, consulting and training) and recognizes revenue for the remainder of the arrangement fee attributable to the elements initially delivered in the arrangement (i.e., software product) when the basic criteria in SOP 97-2 have been met. If such evidence of fair value for each undelivered element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value does exist or until all elements of the arrangement are delivered.

     Under SOP 97-2, revenue attributable to an element in a customer arrangement is recognized when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the fee is fixed or determinable, (iv) collectibility is probable and (v) the arrangement does not require services that are essential to the functionality of the software.

     Persuasive evidence of an arrangement exists. The Company determines that persuasive evidence of an arrangement exists with respect to a customer when it has a written contract, which is signed by both the customer and the Company, or a signed purchase order from the customer and the customer has previously executed a standard license arrangement with the Company. The Company does not offer product return rights to customers.

     Delivery has occurred. The Company’s software may be either physically or electronically delivered to the customer. The Company determines that delivery has occurred upon shipment of the software pursuant to the terms of the agreement or when the software is made available to the customer through electronic delivery.

     The fee is fixed or determinable. If at the outset of the customer arrangement, the Company determines that the arrangement fee is not fixed or determinable, revenue is recognized when the arrangement fee becomes due and payable. Fees due under an arrangement are generally deemed not to be fixed or determinable if a portion of the license fee is beyond the Company’s normal payment terms, which are generally no greater than 180 days from the date of invoice.

     Collectibility is probable. The Company determines whether collectibility is probable on a case-by-case basis. When assessing probability of collection, the Company considers the number of years in business, history of collection for each customer and market acceptance of our products within each geographic sales region. The Company typically sells to customers for whom there is a history of successful collection. New customers are subject to a credit review process, which evaluates the customer’s financial position and, ultimately, their ability to pay. If the Company determines from the outset of an arrangement or based on historical experience in a specific geographic region that collectibility is not probable based upon its review process, revenue is recognized as payments are received. The Company periodically reviews collection patterns from its geographic locations to ensure that its historical collection results provide a reasonable basis for revenue recognition upon signing of an arrangement. For example, in the first quarter of 2004, the Company determined that it had sufficient evidence in Japan and Singapore to begin recognizing revenue on an accrual basis. In the third quarter of 2004, we began recognizing revenue from Spain on an accrual basis which resulted in additional revenues of $172,000 from sales in the third quarter. Previously, revenues had been recognized in those countries only when cash was received. In the remaining countries which have geographically been identified as cash basis, the Company reviews collectibility for the individual customers to determine if they have historical evidence of global purchasing and financial stability. If these requirements are met, the Company assesses that collectibility is probable from these individual customers within a cash basis country.

     The Company allocates revenue to each element in software arrangements involving multiple elements based on the relative fair value of each element. The Company’s determination of fair value of each element in multiple-element arrangements is based on vendor-specific objective evidence of fair value (“VSOE”). The Company limits its assessment of VSOE for each element to the price charged when the same element is sold separately. The Company has analyzed all of the elements included in its multiple-element arrangements and determined that it has sufficient VSOE to allocate revenue to the support and professional services components including consulting and training services of its perpetual license arrangements. The Company sells its professional services separately and has established VSOE on this basis. VSOE for support is determined based upon the customer’s annual renewal rates for this element. Accordingly, assuming all other revenue recognition criteria are met, revenue from licenses is recognized upon delivery using the residual method in accordance with SOP 98-9, and revenue from support services is recognized ratably over their respective support period. The Company recognizes revenue from time-

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based licenses ratably over the license terms as the Company does not have VSOE for the individual elements in these arrangements.

     Support and service revenues consist of professional services (consulting and training services) and support fees. The Company’s professional services, which are comprised of software installation and integration, business process consulting and training, are not essential to the functionality of the Company’s software products. These products are fully functional upon delivery and implementation and do not require any significant modification or alteration of products for customer use. Customers purchase these professional services to facilitate the adoption of the Company’s technology and dedicate personnel to participate in the services being performed, but they may also decide to use their own resources or appoint other professional service organizations to provide these services. Software products are billed separately from professional services, which are generally billed on a time-and-materials basis. The Company recognizes revenue from professional services as services are performed.

     Support contracts are typically priced based on a percentage of license fees and have a one-year term, renewable annually. Services provided to customers under support contracts include technical support and unspecified product upgrades. Deferred revenues from advanced payments for support contracts are recognized ratably over the term of the agreement, which is typically one year.

     The Company expenses all manufacturing, packaging and distribution costs associated with software license as cost of license revenues.

     Cash, Cash Equivalents and Short- and Long-Term Investments

     The Company considers all highly liquid investments with original maturities of three months or less at the date of purchase to be cash equivalents. Cash and cash equivalents include money market funds, commercial paper and various deposit accounts. Cash equivalents are recorded at fair value, which approximates cost.

     The Company’s investments are classified as “available-for-sale” and are carried at fair value based on quoted market prices. These investments consist of corporate obligations that include commercial paper, corporate bonds and notes and United States government agency securities.

     Allowance for Doubtful Accounts

     The Company makes estimates as to the overall collectibility of accounts receivable and provides an allowance for accounts receivable considered uncollectible. The Company specifically analyzes its accounts receivable and historical bad debt experience, customer concentrations, customer credit-worthiness, current economic trends and changes in its customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. At September 30, 2004 and December 31, 2003, the Company’s allowance for doubtful accounts was $1.1 million and $1.5 million, respectively.

     Allowance for Sales Returns

     The Company makes an estimate of its expected product returns and provides an allowance for sales returns. The Company analyzes its revenue transactions, customer software installation patterns, historical return pattern, current economic trends and changes in its customer payment terms when evaluating the adequacy of the allowance for sales returns. At September 30, 2004 and December 31, 2003, the Company’s allowance for sales returns was $620,000 and $745,000, respectively.

     Risks and Concentrations

     Financial instruments that subject the Company to concentrations of credit risk consist principally of cash and cash equivalents, short-term investments and accounts receivable. The Company maintains the majority of its cash and cash equivalents and short-term investments with three financial institutions domiciled in the United States and one financial institution domiciled in the United Kingdom. The Company performs ongoing evaluations of its customers’ financial condition and generally requires no collateral from its customers on accounts receivable.

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     The Company relies on software licensed from third parties, including software that is integrated with internally developed software and used to perform key functions. These software license agreements expire on various dates from 2005 to 2009 and the majority of these agreements are renewable with written consent of the parties. Either party may terminate the agreement for cause before the expiration date with written notice. If the Company cannot renew these licenses, shipments of its products could be delayed until equivalent software could be developed or licensed and integrated into its products. These types of delays could seriously harm the Company’s business. In addition, the Company would be seriously harmed if the providers from whom the Company licenses its software ceased to deliver and support reliable products, enhance their current products or respond to emerging industry standards. Moreover, the third-party software may not continue to be available to the Company on commercially reasonable terms or at all.

     Goodwill and Other Intangible Assets

     On January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets, which requires that goodwill no longer be amortized and that goodwill be tested annually for impairment or more frequently if events and circumstances warrant. This impairment testing involves a two-step process as follows:

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Step 1 — The Company compares the fair value of its reporting unit to its carrying value, including goodwill. If the reporting unit’s carrying value, including goodwill, exceeds the unit’s fair value, the Company moves on to Step 2. If the unit’s fair value exceeds the carrying value, no further work is performed and no impairment charge is necessary.

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Step 2 — The Company performs an allocation of the fair value of the reporting unit to its identifiable tangible and non-goodwill intangible assets and liabilities. This derives an implied fair value for the reporting unit’s goodwill. The Company then compares the implied fair value of the reporting unit’s goodwill with the carrying amount of the reporting unit’s goodwill. If the carrying amount of the reporting unit’s goodwill is greater than the implied fair value of its goodwill, an impairment charge would be recognized for the excess.

     The Company performed its annual impairment test in the third quarter of 2004. Based on this testing, the Company determined that the carrying value of its recorded goodwill of $185.5 million had not been impaired. Accordingly, no impairment charge was recorded as a result of this testing. The Company will continue to assess goodwill for impairment on an interim basis when indicators exist that goodwill may be impaired. Conditions that indicate that the Company’s goodwill may be impaired include a sustained decline in the Company’s market capitalization below its net book value or the Company suffering a sustained decline in its stock price.

     Impairment of Long-Lived Assets

     The Company accounts for the impairment and disposal of long-lived assets utilizing SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 requires that long-lived assets, such as property and equipment, and purchased intangible assets subject to amortization, be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The recoverability of an asset is measured by a comparison of the carrying amount of an asset to its estimated undiscounted future cash flows expected to be generated. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less estimated selling costs, and would no longer be depreciated. The assets and liabilities of a disposal group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet.

     Software Development Costs

     Costs incurred in the research and development of new software products are expensed as incurred until technological feasibility has been established at which time such costs are capitalized, subject to a net realizable value evaluation. Technological feasibility is established upon the completion of an integrated working model. Costs incurred between completion of the working model and the point at which the product is ready for general

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release have not been significant. Accordingly, the Company has charged all costs to research and development expense in the period incurred.

     Income Taxes

     The Company accounts for income taxes under the provisions of SFAS No. 109, Accounting for Income Taxes. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and carryforwards of net operating losses and tax credits. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amounts expected to be recovered.

     Stock-based Compensation

     At September 30, 2004, the Company had six stock-based compensation plans. The Company accounts for stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and has elected to adopt the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation. The resulting stock-based compensation is amortized over the estimated term of the stock option, generally four years, using an accelerated approach. This accelerated approach is consistent with the method described in Financial Accounting Standards Board Interpretation (“FIN”) No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Awards Plans. Stock-based compensation to non-employees is based on the fair value of the option estimated using the Black-Scholes model on the date of the grant and revalued at the end of each reporting period until vested.

     Pro Forma Net Loss and Net Loss per Share

     The Company has adopted the interim disclosure provisions of SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure – an amendment of FASB Statement No. 123. These disclosure provisions require disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation to be displayed prominently and in a tabular format. Had compensation cost been determined based on the fair value at the grant date, the Company’s net loss and basic and diluted net loss per common share would have been as follows (in thousands, except per share amounts):

     The fair value of each option is estimated on the date of grant using the Black-Scholes option valuation method, using the following weighted-average assumptions:

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     The fair value of each stock purchase right granted under the Employee Stock Purchase Plan (“ESPP”) is estimated using the Black-Scholes option valuation method, using the following weighted-average assumptions:

Note 2. Net Loss Per Common Share

     Basic net loss per common share is computed using the weighted average number of outstanding shares of common stock during the period, excluding shares of restricted stock subject to repurchase. Dilutive net loss per common share is computed using the weighted average number of common shares outstanding during the period and, when dilutive, potential common shares from options to purchase common stock and common stock subject to repurchase, using the treasury stock method.

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

     The following potential common shares have been excluded from the calculation of diluted net loss per share for all periods presented because the effect would have been anti-dilutive (in thousands):

Note 3. Comprehensive Loss

     Other comprehensive income (loss) refers to gains and losses that under the accounting principles generally accepted in the United States of America are recorded as an element of stockholders’ equity and are excluded from net loss.

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     Comprehensive loss consisted of the following items (in thousands):

     Accumulated other comprehensive income (loss) as of September 30, 2004 and December 31, 2003 consisted of the following (in thousands):

Note 4. Mergers and Acquisitions

     On August 12, 2004, the Company acquired certain assets and assumed certain liabilities of Software Intelligence, Inc. (“Software Intelligence”), a provider of records management systems.. The aggregate purchase price of the acquisition was $1.6 million, which included issuance of 118,042 shares of the Company’s common stock with an estimated fair value of $782,000, assumed liabilities of $693,000 and transaction costs of $156,000. The allocation of the purchase price for this acquisition included purchased technology of $1.2 million, customer list of $303,000, fair value of assumed liabilities of $84,000 and goodwill of $215,000. The purchase price may increase by up to $200,000 if specific software license revenue goals are achieved, with such purchase price increase payable in shares of common stock under the amended terms of the definitive agreement relating to the acquisition of assets of Software Intelligence. Pro forma results of operations have not been presented because the effect of the acquisition was not material to the Company.

     On November 18, 2003, the Company completed the merger with iManage. iManage was a provider of collaborative content management software that enables businesses to effectively manage and collaborate on critical business content across the enterprise and its value chain of customers, partners and suppliers. In connection with this merger, the Company paid the iManage common stockholders $1.20 in cash and 0.523575 shares of the Company’s common stock in exchange for each share of iManage common stock outstanding as of the merger date. The aggregate purchase price of the acquisition was $181.7 million, which included cash payments to former iManage stockholders of $30.6 million, issuance of 13.3 million shares of common stock with an estimated fair value of $122.2 million, assumed stock options with a fair value of $18.9 million, estimated employee severance and facilities closure costs of $5.8 million and transaction costs of $4.2 million. The results of operations of iManage and the estimated fair values of the net assets acquired and liabilities assumed and incurred have been included in the results of operations of the Company since November 18, 2003.

     On June 27, 2003, the Company acquired MediaBin, Inc. (“MediaBin”). MediaBin developed standards-based enterprise brand management solutions to help companies manage, produce, share and deliver volumes of digital assets, such as product photographs, advertisements, brochures, presentations, video clips and other marketing collateral. The aggregate purchase price of this acquisition was $12.9 million, which included cash of $4.2 million, issuance of 704,000 shares of common stock with an estimated fair value of $6.4 million, assumed stock options with a fair value of $683,000, estimated employee severance costs of $775,000 and transaction costs of $899,000. The results of operations of MediaBin and the estimated fair values of the net assets acquired and liabilities assumed and incurred have been included in the results of operations of the Company since June 27, 2003.

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Note 5. Stock-Based Compensation

     The amortization of stock-based compensation relates to the following items in the accompanying condensed consolidated statement of operations (in thousands):

     Amortization of stock-based compensation will be reduced in future periods to the extent options are terminated prior to full vesting.

Note 6. Goodwill and Intangible Assets

     The Company adopted SFAS No. 142 effective January 1, 2002 and, as a result, ceased to amortize goodwill. The carrying amount of the goodwill and intangible assets as of September 30, 2004 and December 31, 2003 is as follows (in thousands):

     The aggregate amortization expense of intangible assets was $4.0 million and $657,000 for the three months ended September 30, 2004 and 2003, respectively, and $11.5 million and $1.5 million for the nine months ended September 30, 2004 and 2003, respectively. Of the $4.0 million amortization of intangible assets recorded in the three months ended September 30, 2004, $1.2 million was recorded in operating expenses and $2.8 million was recorded as amortization of purchased technology in cost of revenues. For the nine months ended September 30, 2004, $3.6 million was recorded as operating expenses and $7.9 million was recorded as amortization of purchased technology in cost of revenues. Based on the intangible assets balance as of September 30, 2004, the Company expects amortization of intangible assets recorded as operating expenses to be $910,000 in the remaining three months of 2004, $3.2 million in 2005, $2.9 million in 2006, $2.5 million in 2007 and $47,000 in 2008, as well as the amortization of purchased technology classified as a cost of license revenues to be $2.7 million in the remaining three months in 2004, $10.8 million in 2005, $9.5 million in 2006 and $648,000 in 2007.

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     The change in the carrying amount of goodwill for the nine months ended September 30, 2004 is as follows (in thousands):

Note 7. Restructuring and Excess Facilities

     The Company implemented a series of restructuring and facility consolidation plans in each of the last three years to improve operating performance. Restructuring and facilities consolidation costs consist of workforce reductions, the consolidation of excess facilities and the impairment of leasehold improvements and other equipment associated with abandoned facilities.

     Workforce Reductions

     During the three months ended June 30, 2004, the Company implemented a restructuring plan in certain of its European locations, and within its professional services organization, to better align its expenses with future revenue potential. These actions resulted in the termination of 28 employees and, as a result, the Company recorded a charge of $1.8 million associated with these workforce reductions. The employee terminations were substantially completed by June 30, 2004 and $1.2 million remained accrued at September 30, 2004.

     Excess Facilities

     As a result of staffing reductions, the Company performed an evaluation of its facilities requirements and identified facilities that were in excess of current and estimated future needs. The Company recorded charges in each of the last three years associated with the abandonment of identified excess facilities and, due to the continued deterioration of the commercial real estate market, has revised its assumptions regarding future estimated sublease income on several occasions. In the three months ended June 30, 2004, the Company further revised its sublease assumptions associated with certain of its excess facilities, abandoned a leased facility in Germany and elected to terminate a lease in Chicago, Illinois. As a result of these actions, the Company recorded a charge of $10.0 million associated with these actions. The abandonment of these facilities was completed by June 30, 2004.

     On September 9, 2004, the Company and Ariba, Inc. (“Ariba”) entered into an amendment of the Amended and Restated Ariba Plaza Sublease dated August 6, 2001 between Ariba and Interwoven (the “Amendment”). The Amendment was subject to certain closing conditions. On November 1, 2004, all of the required closing conditions had been met and the Amendment was effective. Under the Amendment, the Company relinquished its rights to occupy approximately 89,000 square feet of currently unoccupied space and will pay Ariba approximately $12.3 million. The Company will be relieved of its obligation to pay rent and operating expenses on that abandoned space for the remaining term of the sublease, which ends July 31, 2007. In connection with entering into the Amendment, the Company expects to improve its future cash flows. As a result, the Company reversed the remaining excess facilities accrual associated with this lease of $1.1 million.

     On July 13, 2004, the Company notified the landlord of a facility in Chicago, Illinois, that the Company was exercising a termination option included in the lease agreement Exercising this option terminated the lease effective August 31, 2005 and relieved the Company of future obligations under the lease after such date in return for a one-time termination payment of $346,000. In addition, on September 30, 2004, Interwoven entered into an agreement with the landlord of the same facility, under which the lease termination date was changed to September 30, 2004 and the Company was relieved of its future obligations under its lease agreement in return for an additional one-time termination payment of $212,000. As a result, the Company reversed the remaining excess facilities accrual associated with this lease of $266,000.

     At September 30, 2004, the Company had $41.7 million accrued for excess facilities, which is payable through 2010. This accrual is net of estimated future sublease income of $3.8 million. The Company reassesses this estimated liability each quarterly period based on current real estate market conditions. Excluding the facilities that are currently subleased, the Company’s excess facilities are being marketed for sublease and all are currently unoccupied. Accordingly, the estimate of excess facilities costs could differ from actual results and such differences could result in additional charges that could materially affect the Company’s consolidated financial position and results of operations. The restructuring costs and excess facilities charges have had a material impact on the Company’s consolidated results of operations and will require additional payments in future periods.

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     The following table summarizes the estimated payments associated with these charges (in thousands):

     The following table summarizes the activity in the related restructuring and excess facilities accrual (in thousands):

     The accrual balance at September 30, 2004 of $41.7 million associated with excess facilities is net of estimated sublease income of $3.8 million.

Note 8. Borrowings

     In June 2004, the Company amended its line of credit agreement with a financial institution, which it had originally entered into in August 2001. The amended line of credit provides for borrowings up to $16.0 million. Borrowings under the line of credit agreement bear interest at the lower of 1% below the bank’s prime rate (4.75% at September 30, 2004) or 1.5% above LIBOR in effect on the first day of the term. Borrowings under the line of credit agreement are secured by cash. This line of credit expires in July 2005. At September 30, 2004, there were no borrowings under this line of credit agreement.

     In connection with the merger with iManage, the Company assumed a term loan with a bank secured by certain of the Company’s property and equipment. The term loan bears interest at the greater of prime (4.75% at September 30, 2004) plus 0.50% or 4.75%. At September 30, 2004 and December 31, 2003, amounts outstanding under the term loan were $611,000 and $1.2 million, respectively. Outstanding borrowings are payable monthly in installments of principal and interest, with the outstanding principal balance to be repaid by November 2004.

     The Company has no financial covenant requirements associated with its lines of credit and the term loan.

     Interest expense was $11,000 and $36,000 for the three and nine months ended September 30, 2004, respectively. The Company had no interest expense for the three and nine months ended September 30, 2003, as there were no outstanding borrowings. Cash paid for interest was $11,000 and $40,000 for the three and nine months ended September 30, 2004, respectively.

Note 9. Guarantees

     In November 2002, the Financial Accounting Standards Board (“FASB”) issued 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. FIN No. 45 requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation

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undertaken by issuing the guarantee. It 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 following is a summary of the agreements that the Company has determined is within the scope of FIN No. 45.

     The Company enters into standard indemnification agreements in the 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, the Company’s business partners, subsidiaries and/or customers, in connection with any United States patent or any copyright or other intellectual property infringement claim by any third-party with respect to the Company’s products or services. 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 not incurred significant costs to defend lawsuits or settle claims related to these indemnification agreements.

     The Company generally warrants that its software products will perform in all material respects in accordance with the Company’s standard published specifications in effect at the time of delivery of the licensed products to the customer. Additionally, the Company warrants that its support and services will be performed consistent with generally accepted industry standards. If necessary, the Company would provide for the estimated cost of product and service warranties based on specific warranty claims and claim history. The Company has not incurred significant expense under its product or services warranties.

     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 customers are indemnified 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 not incurred significant costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the Company believes the estimated fair value of these agreements is not significant. Accordingly, the Company has no liabilities recorded for these agreements as of September 30, 2004.

Note 10. Recent Accounting Pronouncements

     In January 2003, FASB issued FIN No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. FIN No. 46 addresses the consolidation by business enterprises of variable interest entities as defined in the interpretation. In December 2003, the FASB issued a revised Interpretation No. 46 (“FIN No. 46R”), which expands the criteria for consideration in determining whether a variable interest entity should be consolidated. Public companies must apply FIN No. 46R to entities considered to be special purpose entities no later than the end of the first reporting period that ended after December 15, 2003, and no later then the first reporting period that ends after March 15, 2004 for all other entities. The Company adopted FIN No. 46 in the first quarter of 2004. As the Company does not have any interests in variable interest entities, the adoption of FIN No. 46 did not have a material effect on the Company’s consolidated financial statements.

     In March 2004, the Emerging Issues Task Force (“EITF”) issued EITF No. 03-01, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. EITF 03-01 provides guidance with respect to determining the meaning of other-than-temporary impairment and its application to debt and equity securities within the scope of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, including investments accounted for under the cost method.

     In September 2004, the FASB delayed the accounting provisions in EITF 03-01. The Company adopted the disclosure provisions of EITF 03-01 for marketable investments as of December 31, 2003. The adoption of EITF 03-01 did not have a material effect on the Company’s consolidated financial statements.

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Note 11. Contingencies

     Beginning 2001, Interwoven and certain of its officers and directors and certain investment banking firms, were separately named as defendants in a securities class-action lawsuit filed in the United States District Court Southern District of New York, which was subsequently consolidated with more than 300 substantially identical proceedings against other companies. Similar suits were named against iManage, its directors and certain of its officers. The consolidated complaint asserts that the prospectuses for the Interwoven October 8, 1999 initial public offering and January 26, 2000 follow-on public offering, and iManage’s November 17, 1999 initial public offering, failed to disclose certain alleged actions by the underwriters for the offerings. In addition, the consolidated complaint alleges claims under Section 11 and 15 of the Securities Act of 1933 against Interwoven and iManage and certain officers and directors of Interwoven and iManage. The plaintiff seeks damages in an unspecified amount. In June 2003, following the dismissal of Interwoven’s and iManage’s respective officers and directors from the litigation without prejudice and after several months of negotiation, the plaintiffs named in the consolidated complaint and Interwoven and iManage, together with the other issuers named thereunder and their respective insurance carriers, agreed to settle the litigation and dispose of any remaining claims against the issuers named in the consolidated complaint, in each case without admitting any wrongdoing. As part of this settlement, the respective insurance carriers of Interwoven and iManage have agreed to assume Interwoven’s and iManage’s entire payment obligation under the terms of the settlement. This settlement has been presented to the District Court for approval and a decision is expected in the coming months; however, there can be no guarantee that the District Court will approve the settlement.

     On August 6, 2004, Advanced Software, Inc. filed suit against Interwoven in the United States District Court for the Northern District of California alleging that its TeamSite software infringes Advanced Software’s United States Patent No. Re. 35,861. Advanced Software seeks damages in an unspecified amount. Interwoven believes that the claim is without merit and intend to vigorously contest this matter. Although the Company cannot currently estimate whether there will be a loss, or the size of any loss, a litigation outcome unfavorable to the Company could have a material impact on Interwoven’s consolidated financial position and results of operations. In addition, intellectual property litigation is inherently uncertain and, regardless of the ultimate outcome, could be costly and time-consuming to defend, divert management’s attention or cause product delays; any of which could have a material impact on Interwoven’s consolidated financial position and results of operations.

     In addition to the matter mentioned above, the Company has been named as a defendant in various employment-related lawsuits and as a party to other threathened legal actions that have arisen in the normal course of business. In the opinion of management, the resolution of these matters is not expected to have a material adverse impact on the Company’s consolidated results of operations, cash flows or its financial position. However, depending on the amount and timing, an unfavorable resolution of a matter could materially affect the Company’s results of operations, cash flows or financial position in a particular period.

     The Company accrues for loss contingencies when available information indicates that it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated, in accordance with SFAS No. 5, Accounting for Contingencies.

Note 12. Significant Customer Information and Segment Reporting

     The Company has adopted the provisions of SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, which establishes standards for the manner in which public companies report information about operating segments in annual and interim financial statements. It also establishes standards for related disclosures about products and services, geographic areas and major customers. The method for determining the information to report is based on the way management organizes the operating segments within the Company for making operating decisions and assessing financial performance.

     The Company’s chief operating decision-maker is considered to be the Chief Executive Officer. The Chief Executive Officer reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenues by geographic region for purposes of making operating decisions and assessing financial performance. On this basis, the Company is organized and operates in a single segment: the design, development and marketing of software solutions.

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     The following table presents geographic information (in thousands):

     The Company’s revenues are derived from software licenses, consulting and training services and customer support. It is impracticable to disaggregate software license revenue by product. The Company’s disaggregated revenue information is as follows (in thousands):

     No customer accounted for more than 10% of the total revenues for the three and nine months ended September 30, 2004 and 2003. At September 30, 2004 and 2003, no single customer accounted for more than 10% of the outstanding accounts receivable.

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

     The following contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Words such as “anticipates,” “expects,” “believes,” “seeks,” “estimates” and similar expressions identify such forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those indicated in the forward-looking statements. Factors that could cause actual results to differ materially from expectations include those set forth in the following discussion, and, in particular, the risks discussed below under the subheading “Factors That May Impact Our Business” and in other documents we file with the Securities and Exchange Commission. Unless required by law, we do not undertake any obligation to update any forward-looking statements or risk factors.

Overview

     Incorporated in March 1995, Interwoven provides enterprise content management software and services that enable businesses to create, review, manage, distribute and archive critical business content, such as documents, spreadsheets, emails and presentations, Web images, graphics, content and applications code, across the enterprise and its value chain of customers, partners and suppliers. Our enterprise content management, or ECM, platform consists of six integrated software product offerings, delivering customers end-to-end content lifecycle management. Customers have deployed our products for enterprise initiatives, such as brand management, enterprise portals, global Web content management, content distribution, corporate governance, deal management, records management and online self-service. We have licensed our software products to more than 3,000 organizations worldwide. We market and license our software products and services primarily through a direct sales force and augment our sales efforts through relationships with technology vendors, professional service firms, systems integrators and other strategic partners. We had 692 employees at September 30, 2004.

     In June 2003, we completed the acquisition of MediaBin and, in November 2003, we completed a merger with iManage. In addition, in August 2004, we acquired certain assets and assumed certain liabilities of Software Intelligence, Inc. The results of operations of those acquisitions have been included prospectively from the closing dates of the respective transactions. Accordingly, our financial results for the three and nine months ended September 30, 2004 are not directly comparable to those for the comparable three and nine months ended September 30, 2003.

Results of Operations

Revenues

     The following sets forth, for the periods indicated, our revenues (in thousands, except percentages):

     Total revenues increased 54% to $40.3 million for the three months ended September 30, 2004 from $26.1 million for the three months ended September 30, 2003. We believe that the increase in revenues from the three months ended September 30, 2003 to the three months ended September 30, 2004 was attributable to revenues from our collaborative content management product, WorkSite, acquired in our merger with iManage. Our average selling prices were $180,000 and $128,000 for the three months ended September 30, 2004 and 2003, respectively, for transactions in excess of $50,000 in aggregate license revenues. Sales outside of North America represented 35% and 33% of our total revenues for the three months ended September 30, 2004 and 2003, respectively. In the three months ended September 30, 2004, we began recognizing revenue from Spain on an accrual basis which resulted in additional revenues of $172,000 from sales in the three months ended September 30, 2004. Total

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revenues increased 50% to $117.2 million for the nine months ended September 30, 2004 from $77.9 million for the nine months ended September 30, 2003. We believe that the increase in revenues in the nine months ended September 30, 2004 from the nine months ended September 30, 2003 was attributable to revenues from our WorkSite product and to revenues from sales of digital asset management products acquired in our acquisition of MediaBin. In addition, throughout 2003 and the nine months ended September 30, 2004, our sales cycles continued to lengthen due to increased organizational review of software purchases by sales prospects, regardless of transaction size.

     Over the past several years, our business has been adversely affected by an economic slowdown and, more specifically, a reduction in spending on information technology software applications. Our revenues for the three months ended September 30, 2004 continued to be affected by delays in software spending and we cannot assure you that spending on software products like ours will increase. If spending on information technology applications does increase, we may not see any impact on our business until after a sustained economic recovery is underway.

     License. License revenues increased 56% to $16.2 million for the three months ended September 30, 2004 from $10.4 million for the three months ended September 30, 2003. License revenues represented 40% of total revenues for both the three months ended September 30, 2004 and 2003, respectively. License revenues increased 66% to $49.3 million for the nine months ended September 30, 2004 from $29.7 million in the same period in 2003. License revenues represented 42% and 38% of total revenues for the nine months ended September 30, 2004 and 2003, respectively. We believe that the increase in license revenues for both the three and nine months ended September 30, 2004 was attributable to revenues from our collaborative content management and digital asset management products. The increase in license revenues as a percentage of total revenues was due to the inclusion of products acquired in our merger with iManage in our sales mix for the three and nine months ended September 30, 2004, as historically iManage’s business had a higher proportion of license revenues to service revenues, and to lower growth rates in our consulting and training services.

     Support and Service. Support and service revenues increased 54% to $24.1 million for the three months ended September 30, 2004 from $15.7 million for the three months ended September 30, 2003. The increase in support and service revenues was the result of higher customer support revenues from our larger installed base of customers and existing customer reorders ($6.8 million) and higher consulting services revenues ($1.4 million) and training services revenues ($227,000), as a result of the additions of our collaborative content management and digital asset management products. In addition, the increase was, in part, due to the renewal of support contracts that had been written down as part of the merger with iManage. Support and service revenues accounted for 60% of total revenues for both the three months ended September 30, 2004 and 2003, respectively. Support and service revenues increased 41% to $67.8 million for the nine months ended June 30, 2004 from $48.1 million for the nine months ended September 30, 2003. The increase in support and service revenues was the result of higher customer support revenues from our larger installed base of customers ($16.4 million) and higher consulting services revenues ($3.3 million), as a result of the acquisitions of iManage and MediaBin. In addition, the increase was, in part, due to the renewal of support contracts that had been written down as part of the merger with iManage. As a percentage of total revenues, support and service revenues accounted for 58% and 62% for the nine months ended September 30, 2004 and 2003, respectively.

     To the extent that our license revenues decline in the future, our support and service revenues may also decline. A decline in license revenues may result in fewer consulting engagements and fewer customer support contracts, resulting in a decline in customer support and service revenues. However, since customer support revenues are recognized over the duration of the support contract, we believe the impact will lag a decline in license revenues. We expect that our system integrator and reseller partners will continue to provide a large portion of the consulting and training services associated with our products, which will result in slower revenue growth for our consulting services when compared to customer support services or even a decline in consulting and training revenues.

Cost of Revenues

     The following sets forth, for the periods indicated, our cost of revenues (in thousands, except percentages):

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     License. Cost of license revenues includes expenses incurred to manufacture, package and distribute our software products and related documentation, amortization of purchased technology associated with the MediaBin and iManage acquisitions, as well as costs of licensing third-party software embedded in or sold in conjunction with our software products. Cost of license revenues represented 8% and 5% of license revenues for the three months ended September 30, 2004 and 2003, respectively, and 8% and 3% of license revenues for the nine months ended September 30, 2004 and 2003, respectively. The increases in cost of license revenues in absolute dollars and as a percentage of total revenues in the three and nine months ended September 30, 2004 from the same periods in 2003 were attributable to amortization of purchased technology associated with our recent business combinations ($2.8 million for the three months ended September 30, 2004 and $7.9 million for the nine months ended September 30, 2004), as well as slightly higher royalties to third parties. Cost of license revenues for the three months ended September 30, 2003 included fees paid to iManage for the resale of the WorkSite product of $687,000.

     Based on acquisitions completed through September 30, 2004, we expect the amortization of purchased technology classified as a cost of license revenues to be $2.7 million in the remaining three months in 2004, $10.8 million in 2005, $9.5 million in 2006 and $648,000 in 2007. We expect cost of license revenues as a percentage of license revenues to vary from period to period depending on the mix of the products sold, the extent to which third-party software products are bundled with our products and the amount of overall license revenues, as many of the third-party software products embedded with our software are under fixed fee arrangements.

     Support and Service. Cost of support and service revenues consists of salary and personnel-related expenses for our consulting services, training and support personnel, costs associated with delivering product updates to customers under active support contracts, subcontractor expenses, facilities, shared services and depreciation of equipment used in our services and customer support operation. Cost of support and service revenues increased 34% to $9.7 million in the three months ended September 30, 2004 from $7.3 million in the same period in 2003. The increase in cost of support and service revenues in the three months ended September 30, 2004 from the same period in 2003 was due primarily to higher subcontractor fees of $1.2 million as a result of the increased usage of outside consulting firms to supplement our current services capacity, higher personnel costs of $705,000 as a result of higher headcount and higher travel expense of $280,000 due to the increase in personnel and consulting services. Cost of support and service revenues increased 20% from $23.8 million in the nine months ended September 30, 2003 to $28.6 million in the same period in 2004. The increase in cost of support and service revenues in the nine months ended September 30, 2004 from the same period in 2003 was due primarily to higher subcontractor fees of $2.4 million as a result of the increased usage of outside consulting firms to supplement our current services capacity and higher personnel costs of $1.6 million as a result of higher headcount. Cost of support and service revenues represented 40% and 46% of support and service revenues in the three months ended September 30, 2004 and 2003, respectively, and 42% and 50% for the nine months ended September 30, 2004 and 2003 respectively. The decrease in cost of support and service revenues as a percentage of its related revenues was primarily attributable to an increase in support revenues as a percentage of total support and service revenues, as support revenues generally have higher gross margins than consulting services and training. As noted above, the increase in support revenues was due to higher customer support revenues from our larger installed base of customers and existing customer reorders. Support and service headcount was 177 and 145 at September 30, 2004 and 2003, respectively. The increase in headcount from 2003 to 2004 was due to the iManage merger.

     We expect cost of support and service revenues as a percentage of support and service revenues to vary from period to period, depending in part on whether the services are performed by our in-house staff, subcontractors or third-party system integrators. As our customers become more capable of performing services activities in-house or increase the use of third-party systems integrators and as our software products become easier to implement, we expect our support and service revenues and cost of support and service revenues realized on a per-customer basis to decline.

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Operating Expenses

     Sales and Marketing

     The following sets forth, for the periods indicated, our sales and marketing expenses (in thousands, except percentages):

     Sales and marketing expenses consist of salaries, commissions, benefits and related costs for sales and marketing personnel, travel, facilities, shared services and marketing programs, including customer conferences, promotional materials, trade shows and advertising. Sales and marketing expenses increased 31% to $17.3 million for the three months ended September 30, 2004 from $13.3 million for the three months ended September 30, 2003. The increase in sales and marketing expenses in the three months ended September 30, 2004 from the same period in 2003 was due primarily to a $1.7 million increase in personnel costs due to higher average headcount in the period as a result of the iManage merger and $2.2 million in higher commissions as a result of higher revenues. Sales and marketing expenses increased 27% to $52.6 million for the nine months ended September 30, 2004 from $41.5 million for the same period in 2003. The increase in sales and marketing expenses in the nine months ended September 30, 2004 from the same period in 2003 was due primarily to a $5.0 million increase in personnel costs due to higher average headcount in the period as a result of the iManage merger, $4.9 million in higher commissions as a result of higher revenues and a $894,000 increase in marketing program costs. Sales and marketing expenses represented 43% and 51% as a percentage of total revenues in the three months ended September 30, 2004 and 2003, respectively, and 45% and 53% of total revenues for the nine months ended September 30, 2004 and 2003, respectively. The decline in sales and marketing expenses as a percentage of total revenues is due to increased revenues, as well as the realization of cost savings associated with the iManage and MediaBin business combinations. Sales and marketing headcount was 234 and 185 at September 30, 2004 and 2003, respectively. The increase in headcount from 2003 to 2004 was due to the iManage merger.

     We anticipate that sales and marketing expenses as a percentage of total revenues will continue to decrease in 2004 from levels posted in comparable periods in 2003 due, in large part, to expected continued economies of scale associated with the iManage and MediaBin business combinations. We also anticipate that the percentage of total revenues represented by sales and marketing expenses will fluctuate from period to period due to the timing of hiring of new sales and marketing personnel, our spending on marketing programs to increase the demand for our products and the level of revenues, in particular license revenues, in each period.

     Research and Development

     The following sets forth, for the periods indicated, our research and development expenses (in thousands, except percentages):

     Research and development expenses consist of salaries and benefits, third-party contractors, facilities and related overhead costs associated with our product development and quality assurance activities. Research and development expenses increased 28% to $7.7 million in the three months ended September 30, 2004 from $6.1 million for the three months ended September 30, 2003. The increase in the three months ended September 30, 2004 from the same period in 2003 was primarily due to a $1.0 million increase in personnel costs associated with a higher average headcount in the period as a result of the iManage merger and higher third-party contractor fees of $267,000. Research and development expenses increased 28% to $23.0 million for the nine months ended September 30, 2004 from $18.1 million for the same period in 2003. The increase in the nine months ended

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September 30, 2004 from the same period in 2003 was primarily due to a $3.1 million increase in personnel costs associated with a higher average headcount in the period as a result of the iManage merger and higher third-party contractor fees of $402,000. As a percentage of total revenues, research and development expenses were 19% and 20% in the three and nine months ended September 30, 2004, respectively, and were 23% for both the three and nine months ended September 30, 2003. The decline in research and development expenses as a percentage of total revenues is due to increased revenues, as well as the realization of cost savings associated with the iManage and MediaBin business combinations. Research and development headcount was 200 and 133 at September 30, 2004 and 2003, respectively. The increase in headcount in 2004 over 2003 was due to the acquisitions of iManage and MediaBin and the opening of our Bangalore, India development facility in the fourth quarter of 2003. We expect that research and development expenses in 2004 will decline slightly as a percentage of total revenues when compared to comparable periods in 2003 as we continue to manage our expenses and realize greater expected cost efficiencies.

     General and Administrative

     The following sets forth, for the periods indicated, our general and administrative expenses (in thousands, except percentages):

     General and administrative expenses consist of salaries and related costs for general corporate functions, including finance, accounting, human resources and legal, as well as insurance, professional fees, facilities costs and provisions for doubtful accounts. General and administrative expenses increased 6% to $3.1 million for the three months ended September 30, 2004 from $2.9 million in the three months ended September 30, 2003. The increase was primarily due to a $117,000 increase in personnel costs as a result of the iManage merger. General and administrative expenses decreased 3% to $9.0 million in the nine months ended September 30, 2004 from $9.3 million in the same period in 2003. The decrease was primarily due to a $308,000 decline in travel and recruiting expenses. As a percentage of total revenues, general and administrative expenses were 8% and 11% for the three months ended September 30, 2004 and 2003 and 8% and 12% for the nine months ended September 30, 2004 and 2003, respectively. The decline in general and administrative expenses as a percentage of total revenues is due to increased revenues, as well as greater economies of scale associated with the iManage and MediaBin business combinations. General and administrative headcount was 81 and 69 at September 30, 2004 and 2003, respectively. The increase in headcount from 2003 to 2004 was due to the iManage merger. We anticipate that general and administrative expenses will decline as a percentage of total revenues in 2004 when compared to comparable periods in 2003 due to continued cost control efforts and economies of scale associated with our recent business combinations.

     Amortization of Stock-Based Compensation

     The following sets forth, for the periods indicated, our amortization of stock-based compensation (in thousands, except percentages):

     We recorded deferred stock-based compensation in connection with stock options assumed in our business combinations, granted at exercise prices below market prices on the date of grant and granted prior to our initial

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public offering. Amortization of stock-based compensation was $941,000 and $475,000 for the three months ended September 30, 2004 and 2003, respectively, and $4.4 million and $1.5 million for the nine months ended September 30, 2004 and 2003, respectively. The increase in amortization of stock-based compensation in the three and nine months ended September 30, 2004 from the same period in 2003 was primarily attributable to the amortization of stock-based compensation from stock options assumed as part of the acquisition of MediaBin in June 2003 and the merger with iManage in November 2003. Amortization expense for the three months ended September 30, 2004 was reduced by $71,000 associated with cancelled stock options for employees terminating prior to the completion of option vesting. Based on deferred stock-based compensation recorded through September 30, 2004, we expect the amortization of deferred stock-based compensation to be $667,000 in the remaining three months in 2004, $1.5 million in 2005, $494,000 in 2006 and $67,000 in 2007.

     Amortization of Intangible Assets

     The following sets forth, for the periods indicated, our amortization of intangible assets (in thousands, except percentages):

     Amortization of intangible assets consists of amortization expense related to customer lists and assembled workforce associated with our business combinations. Amortization of intangible assets was $1.2 million and $657,000 for the three months ended September 30, 2004 and 2003, respectively, and $3.6 million and $1.5 million for the nine months ended September 30, 2004 and 2003, respectively. The increase in amortization of intangible assets from the three and nine months ended September 30, 2004 from the same periods in 2003 is due to the addition of intangible assets amortization associated with the merger with iManage, the acquisition of MediaBin and the acquisition of certain assets from Software Intelligence, Inc. Based on the intangible assets balance as of September 30, 2004, we expect amortization of intangible assets to be $910,000 in the remaining three months of 2004, $3.2 million in 2005, $2.9 million in 2006, $2.5 million in 2007 and $47,000 in 2008.

     In-Process Research and Development

     The following sets forth, for the periods indicated, our in-process research and development (in thousands, except percentages):

     In conjunction with our acquisition of MediaBin on June 27, 2003, we recorded a one-time charge of $599,000 for acquired in-process research and development. The acquired in-process research and development was immediately expensed because technological feasibility had not been established for the acquired technology and no future alternative use exists. The portion of the purchase price allocated to in-process research and development was based, in part, on a third-party appraisal using established valuation techniques.

     Restructuring and Excess Facilities Charges

     The following sets forth, for the periods indicated, our restructuring and excess facilities charges (in thousands, except percentages):

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     During the three months ended September 30, 2004, we entered into an agreement with the landlord of an excess facility in Chicago, Illinois. As part of this agreement, we were relieved of future obligations under the lease agreement in return for a one-time termination payment of $212,000. As a result, we reversed the remaining excess facilities accrual associated with this lease of $266,000. In addition, we entered into an agreement with our sublandlord of our corporate headquarters. As part of this agreement, we relinquished our rights to occupy approximately 89,000 square feet of currently unoccupied space and were relieved of future obligations under the sublease agreement in return for a one-time termination payment of $12.3 million. As a result, we reversed the $1.1 million remaining excess facilities accrual associated with this lease.

     During the three months ended June 30, 2004, we revised our sublease assumptions associated with certain of our excess facilities, abandoned a leased facility in Germany and elected to terminate a lease in Chicago, Illinois. As a result of these actions, we recorded a charge of $10.0 million. Additionally, we implemented a restructuring plan in some of our European locations, and within our professional services organization, to better align our expenses with future revenue potential in those locations. These actions resulted in the termination of 28 employees and a charge of $1.8 million associated with these workforce reductions.

     For the three and nine months ended September 30, 2003, we implemented restructuring plans in an effort to better align our expenses with our revenues and improve operational performance. As a result of these plans, we recorded a charge of $13.3 million in the three months ended September 30, 2003, of which $11.7 million was related to abandoned facilities and reductions in our estimate of sublease income and $1.6 million was associated with workforce reductions. In addition to the charge recorded in the three months ended September 30, 2003, we recorded $2.4 million in charges for workforce reductions primarily related to severance benefits associated with involuntary terminations, of which $1.1 million was recorded in the three months ended March 31, 2003 and $1.3 million was recorded in the three months ended June 30, 2003.

     We have continued to review our operational performance across the company and will continue to make cost adjustments to better align our expenses with our revenues. In addition, we will continue to evaluate our facilities requirements to identify facilities that are in excess of our current and estimated future needs, as well as evaluate the assumptions related to estimated future sublease income for excess facilities. Any changes to these estimates of excess facilities costs could result in additional charges that could materially affect our consolidated financial position and results of operations.

Interest Income and Other, Net

     The following sets forth, for the periods indicated, our interest income and other (in thousands, except percentages):

     Interest income and other decreased $111,000, or 19%, to $468,000 for the three months ended September 30, 2004 from $579,000 for the three months ended September 30, 2003. The decrease was due to lower interest rates on our cash and investments, a lower average balance of cash, cash equivalents and investments during each successive period and an aggregate increase in foreign currency transaction gains of $18,000 for the three months

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ended September 30, 2004, when compared to the same period in 2003. For the nine months ended September 30, 2004, interest income and other decreased to $1.1 million, or 56%, from $2.5 million in the same period in 2003. The decrease was due to an aggregate increase in foreign currency transaction losses of $597,000 for the nine months ended September 30, 2004, when compared to the same period in 2003, as well as lower interest rates on our cash and investments, a lower average balance of cash, cash equivalents and investments during each successive period.

Provision for Income Taxes

     The following sets forth, for the periods indicated, our provision for income taxes (in thousands, except percentages):

     The provision for income taxes recorded for the three and nine months ended September 30, 2004 and 2003 related to state and international taxes. Management periodically evaluates the recoverability of the deferred tax assets and recognizes the tax benefit only as reassessment demonstrates that these assets are realizable. Currently, it is determined that it is not likely that the assets will be realized. Therefore, we have recorded a full valuation allowance against the deferred income tax assets.

Liquidity and Capital Resources

     Cash, cash equivalents and short-term investments decreased $1.8 million, or 1%, to $138.7 million as of September 30, 2004 from $140.5 million at December 31, 2003.

     Cash provided by (used in) in the nine months ended September 30, 2004 and 2003 is as follows (in thousands):

     Operating Activities. Net cash used in operating activities of $2.7 million in the nine months ended September 30, 2004 resulted from a net loss of $24.1 million, offset by depreciation of $3.3 million, amortization of stock-based compensation of $4.4 million and amortization of intangible assets and purchased technology of $11.5 million, as well as a decrease of $8.3 million in accounts receivable and an increase of $1.3 million in deferred revenues. These amounts were partially offset by a decrease of $4.5 million in accounts payable and accrued liabilities, a decrease of $2.9 million in restructuring and excess facilities accrual and a reduction of $479,000 in allowance for doubtful accounts and sales returns.

     Net cash used in operating activities of $28.2 million for the nine months ended September 30, 2003 primarily resulted from a net loss of $35.1 million, offset by depreciation of $5.0 million, amortization of stock-based compensation of $1.5 million and amortization of intangible assets of $1.5 million, as well as a decrease of $6.4 million in accounts receivable and an increase of $4.6 million in restructuring and excess facilities accrual. These amounts were offset by a decrease of $6.4 million in accounts payable and accrued liabilities and a decrease of $5.5 million in deferred revenues.

     A number of non-cash items were charged to expense and increased our net loss in the nine months ended September 30, 2004 and 2003, respectively. These items include depreciation of property and equipment and amortization of deferred stock-based compensation and intangible assets. The extent to which these non-cash items

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increase or decrease in amount and increase or decrease our future operating results will have no corresponding impact on our operating cash flows.

     Our primary source of operating cash flow is the collection of accounts receivable from our customers offset by payments to our employees, vendors and service providers. We measure the effectiveness of our collection efforts by an analysis of average accounts receivable days outstanding (“days outstanding”). Days outstanding were 58 days and 59 days on September 30, 2004 and 2003, respectively. Collections of accounts receivable and related days outstanding will fluctuate in future periods due to the timing and amount of our future revenues, payment terms on customer contracts and the effectiveness of our collection efforts.

     Our operating cash flows will also be affected in the future based on the timing of payments to our vendors. We endeavor to pay our vendors and service providers in accordance with invoice terms and conditions. The timing of cash payments in future periods will be affected by the nature of vendor arrangements and management’s assessment of our cash inflows.

     Investing Activities. Net cash provided by investing activities was $29.7 million in the nine months ended September 30, 2004. This primarily resulted from net proceeds from investment activity of $31.8 million, comprised of $39.3 million of proceeds from the maturity and sale of investments partially offset by $7.5 million to purchase investment securities, and $2.1 million to purchase property and equipment.

     Net cash provided by investing activities was $11.4 million in the nine months ended September 30, 2003. This primarily resulted from net proceeds from investment activity of $16.2 million, comprised of $94.2 million in proceeds from the maturity and sale of our investments partially offset by $78.0 million to purchase investment securities and $624,000 to purchase property and equipment. In addition, during the nine months ended September 30, 2003, our investing activities included $4.2 million in net cash paid for business acquired, attributable to the acquisition of MediaBin.

     We have classified our investment portfolio as “available for sale,” and our investments objectives are to preserve principal and provide liquidity while at the same time maximizing yields without significantly increasing risk. We generally hold investments in commercial paper, corporate bonds and United States government agency securities to maturity; however, we may sell an investment at any time if the quality rating of the investment declines, the yield on the investment is no longer attractive or we are in need of cash. Because we invest only in investment securities that are highly liquid with a ready market, we believe that the purchase, maturity or sale of our investments has no material impact on our overall liquidity. As of September 30, 2004, the average maturity for our investment portfolio was approximately 4 months.

     We anticipate that we will continue to purchase property and equipment necessary in the normal course of our business. The amount and timing of these purchases and the related cash outflows in future periods is difficult to predict and is dependent on a number of factors including the hiring of employees, the rate of change of computer hardware and software used in our business and our business outlook.

     Financing Activities. Net cash provided by financing activities of $3.2 million in the nine months ended September 30, 2004 included $3.8 million from the net proceeds from issuance of common stock under our stock option and employee stock purchase plans, partially offset by the repayment of bank borrowings of $602,000.

     Net cash provided by financing activities of $1.1 million in the nine months ended September 30, 2003 consisting of proceeds received from purchases of our common stock under our stock option and employee stock purchase plans.

     Our cash flows from financing activities are primarily the result of cash receipts from the issuance of common stock, our repurchases of common stock and treasury stock, and borrowings and payments under our lines of credit and term loan. We have used our lines of credit primarily to finance purchases of property and equipment. We receive cash from the exercise of common stock options and the sale of common stock under our Employee Stock Purchase Plan. While we expect to continue to receive these proceeds in future periods, the timing and amount of such proceeds is difficult to predict and is contingent on a number of factors including the price of our common stock, the number of employees participating in our stock option plans and our Employee Stock Purchase Plan and

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general market conditions. We may continue to use lines of credit to finance our equipment purchases to the extent that such financing is available to us on acceptable terms. From time to time, our Board of Directors has approved common stock repurchase programs allowing management to repurchase shares of our common stock in the open market.

     Bank Borrowings. We had available one line of credit and a term loan at September 30, 2004. We have a $16.0 million line of credit, which is secured by cash and bears interest at our option of either a variable rate of 1% below the bank’s prime rate adjusted from time to time or a fixed rate of 1.5% above the LIBOR in effect on the first day of the term. This line of credit agreement expires in July 2005. There were no outstanding borrowings under this line of credit as of September 30, 2004.

     In connection with the iManage merger, we assumed a term loan with a bank secured by certain of our property and equipment. The loan bears interest at the greater of prime (4.75% at September 30, 2004) plus 0.50% or 4.75%. Principal payments are due quarterly and will continue until November 2004 when the remaining outstanding balance is due in full. At September 30, 2004, we had $611,000 outstanding under the term loan.

     There are no financial covenant requirements under any of our lines of credit or the term loan.

     Facilities. We lease our facilities under operating lease agreements that expire at various dates through 2016. As of September 30, 2004, minimum cash payments due under our operating lease obligations totaled $72.0 million. The following presents our prospective future lease payments under these agreements as of December 31, excluding our estimate of potential sublease income (in thousands):

     Of these future minimum lease payments, we have accrued $41.7 million in the restructuring and excess facilities accrual at September 30, 2004. This accrual includes $5.6 million of estimated operating expenses associated with excess facilities and sublease commencement costs and is net of our estimate of sublease income of $3.8 million. In relation to our excess facilities, we may decide to negotiate and enter into lease termination agreements, if and when the circumstances are appropriate. These lease termination agreements would likely require a significant amount of future lease payments to be paid at the time of execution of the lease termination agreement, but would release us from future lease payment obligations for the abandoned facility. The timing of a lease termination agreement and the corresponding payment would affect our cash flows in the period of payment.

     On September 9, 2004, Interwoven and Ariba, Inc. (“Ariba”) entered into an amendment of the Amended and Restated Ariba Plaza Sublease dated August 6, 2001 between Ariba and Interwoven (the “Amendment”). The Amendment was subject to certain closing conditions. On November 1, 2004, all of the required closing conditions had been met and the Amendment became effective. Under the Amendment, we relinquished our rights to occupy approximately 89,000 square feet of currently unoccupied space and have paid Ariba approximately $12.3 million. We have been relieved of our obligation to pay rent and operating expenses on that abandoned space for the remaining term of the sublease, which ends July 31, 2007. The table above reflects the effects of the Amendment on our future minimum lease payments.

     We have entered into various standby letter of credit agreements associated with our facilities leases, which serve as required security deposits for such facilities. These letters of credit expire at various times through 2016. At September 30, 2004, we had $16.0 million outstanding under standby letters of credit, which are secured by substantially all of our assets.

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     We anticipate that our current cash, cash equivalents and short-term investments, together with our existing lines of credit, will be sufficient to meet our anticipated needs for working capital and capital expenditures for at least the next 12 months. However, we may be required, or could elect, to seek additional funding at any time. We cannot assure you that additional equity or debt financing, if required, will be available on acceptable terms, if at all.

Financial Risk Management

     As a global concern, we face exposure to adverse movements in foreign currency exchange rates. These exposures may change over time as business practices evolve and could have a material adverse impact on our consolidated financial results. Our primary exposures relate to non-United States Dollar-denominated revenues and operating expenses in Europe, Asia Pacific, Australia and Canada. At the present time, the exposure is not significant. We have engaged in only limited hedging activity to date and have no outstanding foreign currency forward contracts at September 30, 2004. We do not anticipate significant currency gains or losses in the near term.

     We maintain investment portfolio holdings of various issuers, types and maturities. These securities are classified as available-for-sale and, consequently, are recorded on the consolidated balance sheet at fair value with unrealized gains and losses reported in accumulated other comprehensive income (loss). These securities are not leveraged and are held for purposes other than trading.

Critical Accounting Policies

     In preparing our consolidated financial statements, we make estimates, assumptions and judgments that can have a significant impact on our revenues, loss from operations and net loss, as well as on the value of certain assets and liabilities on our consolidated balance sheet. We believe that there are several accounting policies that are critical to an understanding of our historical and future performance, as these policies affect the reported amounts of revenues, expenses and significant estimates and judgments applied by management. While there are a number of accounting policies, methods and estimates affecting our consolidated financial statements, areas that are particularly significant include:

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revenue recognition;

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estimating the allowance for doubtful accounts and sales returns;

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estimating the accrual for restructuring and excess facilities costs;

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accounting for income taxes; and

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valuation of long-lived assets, intangible assets and goodwill.

     Revenue Recognition. We derive revenues from the license of our software products and from support, consulting and training services that we provide to our customers.

     We recognize revenue using the “residual method” in accordance with Statement of Position (“SOP”) 97-2, Software Revenue Recognition, as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions. Under the residual method, for agreements that have multiple deliverables or “multiple element arrangements” (e.g., software products, services, support, etc.), revenue is recognized based on company-specific objective evidence of fair value for all of the undelivered elements. Our specific objective evidence of fair value is based on the price of the element when sold separately. Once we have established the fair value of each of the undelivered elements, the dollar value of the arrangement is allocated to the undelivered elements first and the residual of the dollar value of the arrangement is then allocated to the delivered elements. At the outset of the arrangement with the customer, we defer revenue for the fair value of its undelivered elements (e.g., support, consulting and training) and recognize revenue for the remainder of the arrangement fee attributable to the elements initially delivered in the arrangement (i.e., software product) when the basic criteria in SOP 97-2 have been met. If such evidence of fair value for each undelivered element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value does exist or until all elements of the arrangement are delivered.

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     Under SOP 97-2, revenue attributable to an element in a customer arrangement is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, collectibility is reasonably assured and the arrangement does not require services that are essential to the functionality of the software.

     At the outset of our customer arrangements, if we determine that the arrangement fee is not fixed or determinable, we recognize revenue when the arrangement fee becomes due and payable. We assess whether the fee is fixed or determinable based on the payment terms associated with each transaction. If a portion of the license fee is due beyond our normal payments terms, which generally does not exceed 180 days from the invoice date, we do not consider the fee to be fixed or determinable. In these cases, we recognize revenue as the fees become due. We do not offer product return rights to resellers or end users. We determine collectibility on a case-by-case basis, following analysis of the general payment history within the geographic sales region and a customer’s years of operation, payment history and credit profile. If we determine from the outset of an arrangement that collectibility is not probable based upon our review process, we recognize revenue as payments are received. We periodically review collection patterns from our geographic locations to ensure historical collection results provide a reasonable basis for revenue recognition upon signing of an arrangement. We determined that we had sufficient evidence in the first quarter of 2004 in Japan and Singapore to begin recognizing revenue on an accrual basis and, in the third quarter of 2004, we began recognizing revenue from Spain on an accrual basis. Previously, revenues had been recognized in those countries only when cash was received. In the remaining countries which have geographically been identified as cash basis, the Company reviews collectibility for the individual customers to determine if they have historical evidence of global purchasing and financial stability. If these requirements are met, the Company assesses that collectibility is probable from these individual customers within a cash basis country.

     Support and service revenues consist of professional services and support fees. Professional services consist of software installation and integration, training and business process consulting. Professional services are predominantly billed on a time-and-materials basis and we recognize revenues as the services are performed.

     Support contracts are typically priced as a percentage of the product license fee and generally have a one-year term, renewable annually. Services provided to customers under support contracts include technical product support and unspecified product upgrades. Deferred revenues from advanced payments for support contracts are recognized ratably over the term of the agreement, which is typically one year.

     Allowance for Doubtful Accounts. The preparation of our consolidated financial statements requires management to make estimates and assumptions that affect the reported amount of assets and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reported period. Specifically, we make estimates as to the overall collectibility of accounts receivable and provide an allowance for amounts deemed to be uncollectible. Management specifically analyzes its accounts receivable and historical bad debt experience, customer concentrations, customer credit-worthiness, current economic trends and changes in its customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. In general, our allowance for doubtful accounts would consist of specific accounts where we believe collection is not probable and our historical experience applied to accounts receivable not specifically reserved. At September 30, 2004 and December 31, 2003, our allowance for doubtful accounts balance was $1.1 million and $1.5 million, respectively. These amounts represent 4% of total accounts receivable at both September 30, 2004 and December 31, 2003. The decrease in the allowance for doubtful accounts reflects the continued improvement of our aged accounts receivable profile.

     Allowance for Sales Returns. From time to time, a customer may return to us some or all of the software purchased. While our software and reseller agreements generally do not provide for a specific right of return, we may accept product returns in certain circumstances. To date, sales returns have been infrequent and not significant in relation to our total revenues. We make an estimate of our expected returns and provide an allowance for sales returns in accordance with SFAS No. 48, Revenue Recognition When Right of Return Exists. In determining the amount of the allowance required, management specifically analyzes our revenue transactions, customer software installation patterns, historical return pattern, current economic trends and changes in its customer payment terms when evaluating the adequacy of the allowance for sales returns. At September 30, 2004 and December 31, 2003, our allowance for sales returns was $620,000 and $745,000, respectively.

     Restructuring and Excess Facilities Accrual. In order to better align our cost structure with our revenues, we implemented a series of restructuring and facility consolidation plans. Restructuring and facilities consolidation costs consist of expenses associated with workforce reductions, consolidation of excess facilities and the impairment of leasehold improvements and other equipment associated with abandoned facilities.

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     Workforce Reductions

     In connection with our restructuring plans, we accrue for severance payments and other related termination benefits provided to employees in connection with involuntary staff reductions. We generally accrue for these benefits in the period when benefits are communicated to the terminated employees. Typically, terminated employees are not required to provide continued service to receive termination benefits. If continued service is required, then the severance liability is accrued over the required service period. In general, we use a formula based on a combination of the number of years of service and the employee’s position within the Company to calculate the termination benefits to be provided to affected employees. At September 30, 2004, $1.2 million was accrued for future severance and termination benefits payments.

     Excess Facilities

     In connection with our restructuring and facility consolidation plans, we perform evaluations of our then-current facilities requirements and identify facilities that are in excess of our current and estimated future needs. When a facility is identified as excess and we have ceased use of the facility, we accrue the fair value of the lease obligations. In determining fair value of expected sublease income over the remainder of the lease term and of related exit costs if any, we receive appraisals from real estate brokers to aid in our estimate. In addition, during our evaluation of our facilities requirements, we also identify operating equipment and leasehold improvements that may have suffered a reduction in their economic useful lives. Excluding the facilities that are currently subleased, our excess facilities are being marketed for sublease and are currently unoccupied. Accordingly, our estimate of excess facilities could differ from actual results and such differences could result in additional charges that could materially affect our consolidated financial position and results of operations. At September 30, 2004, we had $41.7 million accrued for excess facilities, which is payable through 2010. This accrual is net of estimated future sublease income of $3.8 million. We reassess our excess facilities liability each period based on current real estate market conditions.

     Accounting for Income Taxes. As part of the process of preparing our consolidated financial statements, we are required to estimate our income tax liability in each of the jurisdictions in which we do business. This process involves estimating our actual current tax expense together with assessing temporary differences resulting from differing treatment of items, such as deferred revenues, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheet. We must then assess the likelihood that these deferred tax assets will be recovered from future taxable income and, to the extent we believe it is more likely than not that these amounts will not be recovered, we must establish a valuation allowance.

     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 deferred tax assets. At September 30, 2004, we have recorded a full valuation allowance against our deferred tax assets, due to uncertainties related to our ability to utilize our deferred tax assets, consisting principally of certain net operating losses carried forward. The valuation allowance is based on our estimates of taxable income by jurisdiction and the period over which our deferred tax assets will be recoverable.

     Impairment of Goodwill and Long-Lived Assets. On January 1, 2002, we adopted SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 requires that goodwill no longer be amortized and that goodwill be tested annually for impairment or more frequently if events and circumstances warrant. We are required to perform an impairment review of goodwill on at least an annual basis. This impairment review involves a two-step process as follows:

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Step 1 — We compare the fair value of our reporting unit to its carrying value, including goodwill. If the reporting unit’s carrying value, including goodwill, exceeds the unit’s fair value, we move on to Step 2. If the unit’s fair value exceeds the carrying value, no further work is performed and no impairment charge is necessary.

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Step 2 — We perform an allocation of the fair value of the reporting unit to its identifiable tangible and non-goodwill intangible assets and liabilities. This derives an implied fair value for the reporting unit’s goodwill. We then compare the implied fair value of the reporting unit’s goodwill with the carrying

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amount of the reporting unit’s goodwill. If the carrying amount of the reporting unit’s goodwill is greater than the implied fair value of its goodwill, an impairment charge would be recognized for the excess.

     We performed and completed our required annual impairment testing in the third quarter of 2004. Upon completing our reviews, we determined that the carrying value of our recorded goodwill of $185.5 million had not been impaired. Accordingly, no impairment charge was recorded as a result of our testing under SFAS No. 142. Although we determined that our recorded goodwill had not been impaired, changes in the economy, the business in which we operate and our own relative performance may result in the existence of indicators that our recorded goodwill may be impaired.

     We are also required to assess goodwill for impairment on an interim basis when indicators exist that goodwill may be impaired based on the factors mentioned above. For example, if we suffer a sustained decline in our market capitalization below our net book value or we suffer a sustained decline in our stock price, we will assess whether our goodwill has been impaired. A significant impairment could result in additional charges and have a material adverse impact on our consolidated financial position and operating results.

     We account for the impairment and disposal of long-lived assets utilizing SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 requires that long-lived assets, such as property and equipment, and purchased intangible assets subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The recoverability of an asset is measured by a comparison of the carrying amount of an asset to its estimated undiscounted future cash flows expected to be generated. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. We do not believe there were any circumstances which indicated that the carrying value of an asset may not be recoverable.

Recent Accounting Pronouncements

     For recent accounting pronouncements see Note 10. Recent Accounting Pronouncements to the Condensed Consolidated Financial Statements under Part I, Item. 1.

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Factors That May Impact Our Business

     The risks and uncertainties described below are not the only risks we face. These risks include those that we consider to be significant to your decision whether to invest in our common stock at this time. There may be risks that you, in particular, view differently than we do, and there are other risks and uncertainties that we do not presently know of or that we currently deem immaterial, but that may, in fact, harm our business in the future. If any of these events occur, our business, results of operations and financial condition could be seriously harmed, the trading price of our common stock could decline and you may lose part or all of your investment.

     You should consider carefully the following factors, in addition to other information in this Quarterly Report on Form 10-Q, in evaluating our business.

We have incurred losses throughout our operating history and may not be able to achieve consistent profitability.

     We have incurred operating losses on a quarterly and annual basis throughout our history. As of September 30, 2004, we had an accumulated deficit of $407.4 million. We must increase our license and support and service revenues to achieve and sustain profitable operations and positive cash flows. If our revenues do not grow, we will not become profitable, which could cause the price of our common stock to decline. In addition, our revenues may decline from earlier periods resulting in greater operating losses and significant negative cash flows, which could cause us to fail and the price of our common stock to decline.

Many factors can cause our revenues to fluctuate on a quarterly basis and if we fail to satisfy the expectations of investors or securities analysts, our stock price may decline.

     Our quarterly operating results have fluctuated significantly in the past and we expect unpredictable fluctuations in the future. The main factors impacting these fluctuations are likely to be:

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the discretionary nature of our customers’ purchases and their budget cycles;

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the number of new information technology initiatives launched by our customers;

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the failure of any of our product offerings to meet with customer acceptance;

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the size and complexity of our license and service transactions;

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potential delays in recognizing revenue from license transactions;

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timing of new product releases;

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changes in competitors’ product offerings;

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sales force capacity and the influence of resellers and systems integrator partners;

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our ability to integrate newly acquired products with our existing products and effectively sell newly acquired products;

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the impact of our sales commission and incentive plans; and

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seasonal variations in our operating results.

     If our results of operations do not meet our public forecasts or the expectations of securities analysts and investors, the price of our common stock is likely to decline.

Our revenues are derived from a small number of software products and vertical markets.

     For the three and nine months ended September 30, 2004, we believe that a significant portion of our total revenues was derived from licensing Interwoven TeamSite Content Server and related products and services. We expect that our TeamSite product will continue to account for a significant portion of our revenues in future periods. Any decline in the demand for our TeamSite product will have a material and adverse effect on our consolidated financial condition and results of operations.

     We also derive a significant portion of our revenues from a few vertical markets. In particular, our WorkSite product is primarily sold to legal and professional service firms. In order for us to sustain and grow our business, we

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must continue to successfully sell our software products and services into this vertical market. Our failure to successfully sell to legal and professional service firms will have a material and adverse effect on our consolidated financial condition and results of operations. In general, we believe that our customers in these markets are affected by the same conditions that affect our customers in other markets.

     Further, the future success of our collaborative content management software applications depends on our ability to sell software licenses and services to large multi-national corporations in financial services, manufacturing, telecommunications and governments. To sell to these organizations, we must devote time and resources to hire and train sales employees to work with enterprises in industries other than legal and professional services. Even if we are successful in hiring and training sales teams, customers in other industries may not need or sufficiently value our collaborative content management software applications.

Our products have a long and unpredictable sales cycle, which makes it difficult to forecast our future results and may cause our operating results to vary from period to period.

     The period between initial contact with a prospective customer and the licensing of our software applications varies and can range from three months to more than twelve months. Additionally, our sales cycle involves complexity as customers consider a number of factors before committing to purchase our application suite. Factors considered by customers when evaluating our software applications include, among other factors, product benefits, cost and time of implementation, return on investment, ability to operate with existing and future computer systems and the ability to accommodate increased transaction volume and product reliability. Customer evaluation, purchasing and budgeting processes vary significantly from company to company. As a result, we spend significant time and resources informing prospective customers about our software products, which may not result in a completed transaction and may negatively impact our operating margins. Even if a customer has chosen our software products, completion of the associated sales transaction is subject to a number of factors, which makes our quarterly revenues difficult to forecast. These factors include but are not limited to the following:

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Licensing of our software products is often an enterprise-wide decision by our customers that involves many factors. Accordingly, our ability to license our product may be affected by changes in the strategic importance of content management projects to a customer, a customer’s budgetary constraints or changes in a customer’s personnel.

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A customer’s internal approval and expenditure authorization process can be difficult and time consuming to overcome. Delays in approvals, even after vendor selection, could impact the timing and amount of revenues recognized in a quarterly period.

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Changes in our sales incentive plans may have an unpredictable impact on our sales cycle and contracting activities.

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The number, timing and significance of enhancements to our software products and the introduction of new software by our competitors and us may affect customer purchasing decisions.

     Throughout 2003 and 2004, our sales cycles continued to be affected by increased organizational review by sales prospects, regardless of transaction size. Specifically, we experienced several delayed software license orders at the end of the second quarter of 2004 at levels greater than those experienced in the first and third quarters of 2004. A continued lengthening in sales cycles and our inability to predict these trends could result in lower than expected future revenue, which would have a material impact on our consolidated operating results and, correspondingly, our stock price.

     Our sales incentive plans are primarily based on quarterly and annual quotas by sales representatives and certain sales support personnel. These sales incentive plans have accelerated commission rates in the event a representative exceeds the expected sales quota. The concentration of sales orders with any one or a few sales representatives has resulted, and in the future may result, in commission expense in excess of forecasted levels, which have caused, or would in the future cause, fluctuations in sales and marketing expenses. Any increase in sales and marketing expenses could adversely affect our consolidated results of operation.

Competition from providers of software enabling content and collaboration management is increasing, which could cause us to reduce our prices and result in reduced gross margins or loss of market share.

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     The enterprise content management market is new, highly fragmented, rapidly changing and increasingly competitive. We expect competition to continue to intensify, which could result in price reductions for our products, reduced gross margins, increased sales cycles and loss of market share, any of which would have a material adverse effect on our business and financial condition. Our current competitors include:

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companies addressing needs of the market in which we compete, including EMC Corporation, FileNet Corporation, Hummingbird Ltd., Microsoft Corporation, Open Text Corporation, Stellent, Inc., Oracle Corporation and Vignette Corporation;

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intranet and groupware companies, such as IBM, Microsoft Corporation, and Novell, Inc.; and

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in-house development efforts by our customers and partners.

     We also face potential competition from our strategic partners, such as BEA Systems, Inc. and Oracle Corporation, or from other companies that may in the future decide to compete in our market. Some of our existing and potential competitors have longer operating histories, greater name recognition, larger customer bases and greater financial, technical and marketing resources than we do. Many of these companies can also take advantage of extensive customer bases and adopt aggressive pricing policies to gain market share. Potential competitors may bundle their products in a manner that discourages users from purchasing our products. For example, Microsoft Corporation sells a content management product and might choose to bundle it with other products in ways that would harm our competitive position. Barriers to entering the content management software market are relatively low. Competitive pressures may also increase with the consolidation of competitors within our market and partners in our distribution channel, such as the acquisition of Documentum, Inc. by EMC Corporation, Presence Online Pty Ltd. by IBM, Kramer Lee & Associates by Hummingbird Ltd., Optika, Inc. by Stellent, Inc., Artesia Technologies, Inc. by Open Text Corporation and TOWER Technology Pty Ltd. and Epicentric, Inc. by Vignette Corporation.

     In recent quarters, some of our competitors have drastically reduced their price proposals in an effort to strengthen their bids and expand their customer bases. Such tactics, even if unsuccessful, could delay decisions by some customers that would otherwise purchase our software products and may reduce the ultimate selling price of our software and services and our operating results.

Our future revenues are dependent in part upon our installed customer base continuing to license additional products, renew customer support agreements and purchase additional services.

     Our installed customer base has traditionally generated additional license and support and service revenues. In addition, our plans are dependent on our ability to sell newly acquired products, such as the products acquired in the acquisitions of MediaBin, Inc. (“MediaBin”), iManage, Inc. (“iManage”) and Software Intelligence, Inc. (“Software Intelligence”) to our installed base of customers. In future periods, customers may not necessarily license additional products or contract for additional support or other services. Customer support agreements are generally renewable annually at a customer’s option, and there are no mandatory payment obligations or obligations to license additional software. If our customers decide not to renew their support agreements or license additional products or contract for additional services, or if they reduce the scope of the support agreements, our revenues could decrease and our operating results could be adversely affected.

Economic conditions and significant world events have harmed and could continue to negatively affect our revenues and results of operations.

     Our revenue growth and profitability depend on the overall demand for our enterprise content management software platforms and applications. Prolonged economic weakness in the United States and declining economic conditions worldwide have resulted in and may continue to result in lower revenues, longer sales cycles, lower average selling prices and deferred or cancelled orders. To the extent that the economy does not improve or declines, the demand for our products and services, and therefore our future revenues, will be further affected. In addition, many of our customers have also been affected adversely by these economic conditions and, as a result, we may find that collecting on accounts receivable may take longer than we expect or that some accounts receivable will become uncollectible.

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     Our consolidated financial results could also be significantly affected by geopolitical concerns and world events, such as wars and terrorist attacks. For example, we experienced delays in customer orders in the first quarter of 2003 as a result of concerns over the war in Iraq. Our revenues and financial results could be negatively affected to the extent geopolitical concerns continue and similar events occur or are anticipated to occur.

The timing of large customer orders may have a significant impact on our consolidated financial results from period to period.

     From time to time, we receive large customer orders that have a significant impact on our consolidated financial results in the period in which the order is recognized as revenue. For example, we had one customer order greater than $1 million in the three months ended September 30, 2004. Because it is difficult for us to accurately predict the timing of such large customer orders, our consolidated financial results are likely to vary materially from quarter to quarter based on the receipt of such orders and their ultimate recognition as revenue. Additionally, the loss or delay of an anticipated large order in a given quarterly period could result in a shortfall of revenues from levels anticipated by us and our stockholders. Any shortfall in revenues from levels anticipated by our stockholders and securities analysts could have a material and adverse impact on the trading price of our common stock.

Support and service revenues have represented a larger percentage of our total revenues in 2004 and 2003. Our support and service revenues are vulnerable to reduced demand and increased competition.

     Our support and service revenues represented 60% of total revenues for both the three months ended September 30, 2004 and 2003, respectively. Support and service revenues depend, in part, on our ability to license software products to new and existing customers that generate follow-on consulting, training and support revenues. Demand for these services is also affected by competition from independent service providers and systems integrators with knowledge of our software products. Since mid-2000, the economic slowdown, and the corresponding reduction in information technology spending, has increased competition for service engagements and has resulted in an overall decrease in average billing rates for our consultants and price pressure on our software support products. If these factors continue to affect our business, our support and service revenues may decline and such a decline would have a material and adverse effect on our consolidated financial condition and results of operations.

Increases in support and service revenues as a percentage of total revenues may decrease overall margins.

     We realize lower margins on support and service revenues than on license revenues. In addition, we may contract with outside consultants and system integrators to supplement the services we provide to customers, which generally yields lower gross margins than the gross margins yielded by our services business. As a result, if support and service revenues increases as a percentage of total revenues or if we increase our use of third parties to provide such services, our gross margins will be lower and our operating results may be adversely affected.

We might not be able to protect and enforce our intellectual property rights, a loss of which could harm our business.

     We depend upon our proprietary technology and rely on a combination of patent, copyright and trademark laws, trade secrets, confidentiality procedures and contractual restrictions to protect it. We currently have 30 issued United States patents and 27 foreign patents, as well as several United States and foreign patents pending approval. It is possible that patents will not be issued from our currently pending patent applications or any future patent application we may file. We also have restricted customer access to our source code and require all employees enter into confidentiality and invention assignment agreements. Despite our efforts to protect our proprietary technology, unauthorized parties may attempt to copy aspects of our products or to obtain and use information we regard as proprietary. In addition, the laws of some foreign countries do not protect our proprietary rights as effectively as the laws of the United States and we expect that it will become more difficult to monitor use of our products as we increase our international presence. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement or invalidity. Any such resulting litigation could result in substantial costs and diversion of resources that could have a material adverse effect on our business, operating results and financial condition.

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     Further, third parties may claim that our products infringe the intellectual property of their products. In fact, on August 6, 2004, Advanced Software, Inc. filed suit against us in the United States District Court for the Northern District of California alleging that our TeamSite software infringes Advanced Software’s United States Patent No. Re. 35,861. We believe the claim is without merit and intend to vigorously contest this matter. However, this claim or any other claims, with or without merit, could be costly and time-consuming to defend, divert our management’s attention or cause product delays. If our product was found to infringe a third party’s proprietary rights, we could be required to enter into royalty or licensing agreements to be able to sell our product. Royalty and licensing agreements, if required, may not be available on terms acceptable to us, if at all, which could harm our business.

We may be required to write-off all or a portion of the goodwill value of companies acquired.

     Generally accepted accounting principles in the United States require companies to review the value of acquired assets from time to time to determine whether those values have been impaired. As a result, we are required periodically to review the value reported on our balance sheet of companies we have acquired, to determine if those values should be reduced. In connection with our 2002 review, we reduced recorded goodwill by $76.4 million. We performed our required annual impairment test in the third quarter of 2004. Upon completion of our testing, we determined that the carrying value of our recorded goodwill had not been impaired. We will continue to assess goodwill for impairment on an interim basis when indicators exist that goodwill may be impaired. For example, indicators include if our market capitalization declines below our net book value or we suffer a sustained decline in our stock price. Changes in the economy, the business in which we operate and our own relative performance may result in the existence of indicators that our recorded goodwill may be impaired. We may in the future be required to write down the carrying value of goodwill assets, including goodwill associated with our merger with iManage.

     If we determine there has been an impairment of goodwill and other intangible assets, the carrying value of those assets will be written down to fair value, and a charge against operating results will be recorded in the period that the determination is made. Any impairment harms our consolidated operating results and financial position, and could harm the price of our stock.

Because a significant portion of our revenues are influenced by referrals from strategic partners and sold through resellers, our future success depends in part on those partners, but their interests differ from ours.

     Our direct sales force depends on strategic partnerships, marketing alliances and resellers to obtain customer leads, referrals and distribution. Approximately 62% of our new license orders in the third quarter of 2004 were influenced by our strategic partners and resellers. If we are unable to maintain our existing strategic relationships or fail to enter into additional strategic relationships, our ability to increase our sales and reduce expenses will be harmed, and we could also lose anticipated customer introductions and co-marketing benefits. Our success depends in part on the success of our strategic partners and their ability and willingness to market our products and services successfully. Losing the support of these third parties may limit our ability to penetrate our existing and potential markets. These third parties are under no obligation to recommend or support our software products and could recommend or give higher priority to the products and services of other companies or to their own products. Our inability to gain the support of resellers, consulting and systems integrator firms or a shift by these companies toward favoring competing products could negatively affect our software license and support and service revenues.

     Some systems integrators also engage in joint marketing and sales efforts with us. If our relationship with these systems integrators fails, we will have to devote substantially more resources to the sales and marketing of our software products. In many cases, these parties have extensive relationships with our existing and potential customers and influence the decisions of these customers. A number of our competitors have longer and more established relationships with these systems integrators than we do and, as a result, these systems integrators may be more likely to recommend competitors’ products and services.

     We may also be unable to grow our revenues if we do not successfully obtain leads and referrals from our customers. If we are unable to maintain these existing customer relationships or fail to establish additional relationships, we will be required to devote substantially more resources to the sales and marketing of our products. As a result, we are dependent on the willingness of our customers to provide us with introductions, referrals and leads. Our current customer relationships do not afford us any exclusive marketing and distribution rights. In addition, our customers may terminate their relationship with us at any time, pursue relationships with our

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competitors or develop or acquire products that compete with our products. Even if our customers act as references and provide us with leads and introductions, we may not penetrate additional markets or grow our revenues.

     We also rely on our strategic partnerships to aid in the development of our products. Should our strategic partners not regard us as significant to their own businesses, they could reduce their commitment to us or terminate their relationship with us, pursue competing relationships or attempt to develop or acquire products or services that compete with our products and services.

Contractual issues may arise during the negotiation process that may delay the anticipated closure of license transactions and our ability to recognize revenue as anticipated.

     Because our solution is mission-critical to many of our customers, the process of contractual negotiation may be protracted. The additional time needed to negotiate mutually acceptable terms that culminate in an agreement to license our products could extend the sales cycle.

     Several factors may also require us to defer recognition of license revenue for a significant period of time after entering into a license agreement, including instances in which we are required to deliver either unspecified additional products or specified product upgrades for which we do not have vendor-specific objective evidence of fair value. We have a standard software license agreement that provides for revenue recognition provided that, among other factors, delivery has taken place, collectibility from the customer is reasonably assured and no significant future obligations or customer acceptance rights exist. However, customer negotiations and revisions to these terms could have an impact on our ability to recognize revenue at the time of delivery.

     In addition, slowdowns or variances from internal expectations in our quarterly license contracting activities may impact our service offerings and may result in lower revenues from our customer training, consulting services and customer support organizations. Our ability to maintain or increase support and service revenues is highly dependent on our ability to increase the number of license agreements we enter into with customers.

If the emerging market for enterprise content management software does not develop as quickly as we expect, our business will suffer.

     The market for our enterprise content management software is rapidly evolving. We cannot be certain that a viable market for our products will emerge or be sustainable. If the enterprise content management software market fails to develop, or develops more slowly than expected, demand for our products will be less than anticipated and our business and operating results would be seriously harmed.

     Furthermore, to be successful in this emerging market, we must be able to differentiate our business from our competitors through our product and service offerings and brand name recognition. We may not be successful in differentiating our business or achieving widespread market acceptance of our products and services. In addition, enterprises that have already invested substantial resources in other methods of managing their content and collaborative process may be reluctant or slow to adopt a new approach that may replace, limit or compete with their existing systems.

Our revenues from international operations are a significant part of our overall operating results. We may not successfully develop these international markets, which could harm our business.

     We have established offices in various international locations in Europe and Asia Pacific and we derive a significant portion of our revenues from these international locations. For the three months ended September 30, 2004, revenues from these international operations constituted approximately 35% of our total revenues. For the years ended December 31, 2003, 2002 and 2001, revenues from these international operations constituted approximately 35%, 34% and 32% of our total revenues, respectively. We anticipate devoting significant resources and management attention to international opportunities, which subjects us to a number of risks including:

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changes in multiple tax and regulatory requirements;

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difficulties in staffing, retaining staff and managing foreign operations;

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the expense of foreign operations and compliance with applicable laws;

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political and economic instability;

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the expense of localizing products for sale in various international markets;

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reduced protection for intellectual property rights in some countries;

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protectionist laws and business practices that favor local competitors;

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longer sales cycles and collection periods or seasonal reductions in business activity; and

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economic downturns in international markets.

     Any of these risks could reduce revenues from international locations, or increase our cost of doing business outside of the United States.

     In addition to our international sales offices, in the fourth quarter of 2003, we opened a customer support and development operation in Bangalore, India. This operation is also subject to many of the same risks and uncertainties noted above.

Our workforce reductions may require us to incur severance costs and reduce our facilities commitments, which may cause us to incur expenses or recognize additional financial statement charges.

     Over the last several years, we have significantly reduced our worldwide employee headcount. In connection with our restructuring plans and the merger with iManage, we relocated offices and abandoned facilities in the San Francisco Bay Area; Chicago; New York City; Boston; Austin, Texas and several locations internationally. As a result, we are paying for facilities that we are not using and have no future plans to use. In the nine months ended September 30, 2004, we recorded charges for excess facilities, net of expected sublease income, of $8.6 million. We recorded similar charges in the years ended December 31, 2003, 2002 and 2001 in the amounts of $12.6 million, $30.0 million and $22.2 million, respectively. At September 30, 2004, we have an accrual for excess facilities of $41.7 million, which is net of anticipated sublease income of $3.8 million. If the commercial real estate market continues to deteriorate, or if we cannot sublease these excess facilities at all, we may be required to record additional charges for excess facilities or revise our estimate of future sublease income in the future which may be material to our consolidated financial condition and results of operations. Additionally, we have negotiated and may continue to negotiate early terminations to our excess facilities leases that may result in significant cash payments. Additionally, Interwoven and Ariba, Inc. entered into an amendment of the Amended and Restated Ariba Plaza Sublease dated August 6, 2001 between Ariba and Interwoven. On November 1, 2004, the amendment became effective. Under the amendment, we relinquished our rights to occupy approximately 89,000 square feet of currently unoccupied space and have paid Ariba approximately $12.3 million.

     We have continued to review our operational performance across the Company and will continue to make cost adjustments to better align our expenses with our revenues. In the three months ended June 30, 2004, we implemented a restructuring plan in certain of our European locations to better align our expenses with future revenue potential. These actions resulted in the termination of 28 employees and a charge of $1.8 million associated with these terminations. We may be required to make further adjustments to our business model to achieve operational efficiency and, as a result, may be required to take additional charges which could be material to our results of operations.

Our estimates of future sublease income related to our restructuring and excess facilities charges may be incorrect and may require us to incur expenses or recognize additional financial statement charges.

     In connection with our restructuring and excess facilities charges, we made certain estimates of expected future sublease income for our abandoned facilities. Although, we are in the process of actively marketing our excess facilities that have not been sublet, we may be unable to sublease them and even if we are successful in subleasing them, we may be required to accept significantly less in rent from a subtenant than our lease rate. If the commercial real estate market continues to deteriorate, or if we cannot sublease these excess facilities at all, we may be required to record additional charges to revise our estimates of future sublease income, which could result in additional expenses we would incur, as well as financial statement charges which may be material to our consolidated financial condition and results of operations.

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If our products cannot scale to meet the demands of tens of thousands of concurrent users, our targeted customers may not license our solutions, which will cause our revenues to decline.

     Our strategy is to target large organizations that require our enterprise content management software solution because of the significant amounts of information and content that they generate and use. For this strategy to succeed, our software products must be highly scalable and accommodate tens of thousands of concurrent users. If our products cannot scale to accommodate a large number of concurrent users, our target markets will not accept our products and our business and operating results will suffer.

     If our customers cannot successfully implement large-scale deployments, or if they determine that our products cannot accommodate large-scale deployments, our customers will not license our solutions, and this will materially adversely affect our consolidated financial condition and operating results.

If our products do not operate with a wide variety of hardware, software and operating systems used by our customers, our revenues would be harmed.

     We currently serve a customer base that uses a wide variety of constantly changing hardware, software applications and operating systems. For example, we have designed our products to work with databases and servers developed by Microsoft Corporation, Sun Microsystems, Inc., Oracle Corporation and IBM and software applications including Microsoft Office, WordPerfect, Lotus Notes and Novell GroupWise. We must continually modify and enhance our software products to keep pace with changes in computer hardware and software and database technology as well as emerging technical standards in the software industry. We further believe that our application suite will gain broad market acceptance only if it can support a wide variety of hardware, software applications and systems. If our products were unable to support a variety of these products, our business would be harmed. Additionally, customers could delay purchases of our application suite until they determine how our products will operate with these updated platforms or applications.

     Our products currently operate on the Microsoft Windows NT, Microsoft Windows 2000, Linux, IBM AIX, Hewlett Packard UX and Sun Solaris operating environments. If other platforms become more widely used, we could be required to convert our server application products to additional platforms. We may not succeed in these efforts, and even if we do, potential customers may not choose to license our product. In addition, our products are required to interoperate with leading content authoring tools and application servers. We must continually modify and enhance our products to keep pace with changes in these applications and operating systems. If our products were to be incompatible with a popular new operating system or business application, our business could be harmed. Also, uncertainties related to the timing and nature of new product announcements, introductions or modifications by vendors of operating systems, browsers, back-office applications and other technology-related applications, could harm our business.

Our failure to deliver defect-free software could result in losses and harmful publicity.

     Our software products are complex and have in the past and may in the future contain defects or failures that may be detected at any point in the product’s life. We have discovered software defects in the past in some of our products after their release. Although past defects have not had a material effect on our results of operations, in the future we may experience delays or lost revenues caused by new defects. Despite our testing, defects and errors may still be found in new or existing products, and may result in delayed or lost revenues, loss of market share, failure to achieve market acceptance, reduced customer satisfaction, diversion of development resources and damage to our reputation. As has occurred in the past, new releases of products or product enhancements may require us to provide additional services under our support contracts to ensure proper installation and implementation.

     Errors in our application suite may be caused by defects in third-party software incorporated into our application suite. If so, we may not be able to fix these defects without the cooperation of these software providers. Since these defects may not be as significant to our software providers as they are to us, we may not receive the rapid cooperation that we may require. We may not have the contractual right to access the source code of third-party software and, even if we access the source code, we may not be able to fix the defect.

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     As customers rely on our products for critical business applications, errors, defects or other performance problems of our products or services might result in damage to the businesses of our customers. Consequently, these customers could delay or withhold payment to us for our software and services, which could result in an increase in our provision for doubtful accounts or an increase in collection cycles for accounts receivable, both of which could disappoint investors and result in a significant decline in our stock price. In addition, these customers could seek significant compensation from us for their losses. Even if unsuccessful, a product liability claim brought against us would likely be time consuming and costly and harm our reputation, and thus our ability to license products to new customers. Even if a suit is not brought, correcting errors in our application suite could increase our expenses.

Difficulties in introducing new products and upgrades in a timely manner will make market acceptance of our products less likely.

     The market for our products is characterized by rapid technological change, frequent new product introductions and technology-related enhancements, uncertain product life cycles, changes in customer demands and evolving industry standards. We expect to add new content management functionality to our product offerings by internal development and possibly by acquisition. Content management technology is more complex than most software and new products or product enhancements can require long development and testing periods. Any delays in developing and releasing new products could harm our business. New products or upgrades may not be released according to schedule or may contain defects when released. Either situation could result in adverse publicity, loss of sales, delay in market acceptance of our products or customer claims against us, any of which could harm our business. If we do not develop, license or acquire new software products, or deliver enhancements to existing products on a timely and cost-effective basis, our business will be harmed.

Our products may lack essential functionality if we are unable to obtain and maintain licenses to third-party software and applications.

     We rely on software that we license from third parties, including software that is integrated with our internally developed software and used in our products to perform key functions. The functionality of our software products, therefore, depends on our ability to integrate these third-party technologies into our products. Furthermore, we may license additional software from third parties in the future to add functionality to our products. If our efforts to integrate this third-party software into our products are not successful, our customers may not license our products and our business will suffer.

     In addition, we would be seriously harmed if the providers from whom we license software ceased to deliver and support reliable products, enhance their current products or respond to emerging industry standards. Moreover, the third-party software may not continue to be available to us on commercially reasonable terms or at all. Each of these license agreements may be renewed only with the other party’s written consent. The loss of, or inability to maintain or obtain licensed software, could result in shipment delays or reductions. Furthermore, we may be forced to limit the features available in our current or future product offerings. Either alternative could seriously harm our business and operating results.

Fluctuations in the exchange rates of foreign currency, particularly in Euro, British Pound and Australian Dollar and the various local currencies of Asia and Europe, may harm our business.

     We are exposed to adverse movements in foreign currency exchange rates because we translate foreign currencies into United States Dollars for reporting purposes. Our primary exposures have related to operating expenses and sales in Australia, Asia and Europe that were not United States Dollar-denominated. Historically, these risks have been minimal for us, but as our international revenues and operations have grown and continue to grow, the adverse currency fluctuations could have a material adverse impact on our consolidated financial position and results of operations. The increasing use of the Euro as a common currency for members of the European Union could affect our foreign exchange exposure. We have generally not engaged in hedging activities to mitigate our foreign currency risk, although we have recently entered into limited forward contract activity.

New legislation and potential new accounting pronouncements are likely to impact our future consolidated financial position and results of operations.

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     Recently, there have been significant regulatory changes, including the Sarbanes-Oxley Act of 2002, and there may be new accounting pronouncements or regulatory rulings that will have an impact on our future consolidated financial position and results of operations. The Sarbanes-Oxley Act of 2002 and other rule changes and proposed legislative initiatives following several highly publicized corporate accounting and corporate governance failures are likely to increase general and administrative costs. These and other potential changes could materially increase the expenses we report under accounting principles generally accepted in the United States of America and adversely affect our consolidated operating results. Additionally, the impact of these changes may increase costs incurred by our customers and prospects which could result in delays or cancellations in spending on enterprise content management software and services like we provide. Such delays and cancellations could have a material adverse impact on our consolidated statement of operations and financial condition.

If we account for employee stock options using the fair value method, it could significantly increase our net loss.

     There has been ongoing public debate as to whether stock options granted to employees should be treated as compensation expense and, if so, how to properly value such stock options awards. On March 31, 2004, the Financial Accounting Standard Board (“FASB”) issued an Exposure Draft, Share-Based Payment: an amendment of FASB statements No. 123 and 95, which would require a company to recognize, as an expense, the fair value of stock options and other stock-based compensation to employees beginning after June 15, 2005 and subsequent reporting periods. If we elect or are required to record an expense for our stock-based compensation plans using the fair value method as described in the Exposure Draft, we could have significant and ongoing accounting charges.

Our stock price may be volatile, and your investment in our common stock could suffer a decline in value.

     The market prices of the securities of software companies have been extremely volatile and often unrelated to their operating performance. Broad market and industry factors may adversely affect the market price of our common stock, regardless of our actual operating performance. Factors that could cause fluctuations in the price of our stock may include, among other things:

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actual or anticipated variations in quarterly operating results;

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changes in financial estimates by us or in financial estimates or recommendations by any securities analysts who might cover our stock;

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operating performance and stock market price and volume fluctuations of other publicly traded companies and, in particular, those that are Internet-related or otherwise deemed comparable to us;

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announcements by us or our competitors of new products or services, technological innovations, significant acquisitions, strategic partnerships or divestitures;

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announcements of investigations or regulatory scrutiny of our operations or lawsuits filed against us;

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announcements of negative conclusions about our internal controls;

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capital outlays or commitments;