UNITED STATES
SECURITIES AND EXCHANGE
COMMISSION

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004

OR

FOR THE TRANSITION PERIOD

FROM                    TO                    .

COMMISSION FILE NUMBER 0-28121

RETEK INC.

(Exact Name of Registrant as Specified in its Charter)

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

     Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [   ]

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

     As of October 29, 2004, the number of shares of the Registrant’s common stock outstanding was 56,003,352.

TABLE OF CONTENTS

RETEK INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2004

INDEX

SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION

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

     Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of these statements. We are under no duty to update any of the forward-looking statements after the date of this Quarterly Report on Form 10-Q to conform these statements to actual future results.

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PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Retek Inc.

See accompanying notes to the consolidated financial statements.

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Retek Inc.

See accompanying notes to the consolidated financial statements.

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Retek Inc.

See accompanying notes to the consolidated financial statements.

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RETEK INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – The Company and its Significant Accounting Policies

The Company

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

Basis of Presentation

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

     We believe the accompanying unaudited financial information for interim periods presented reflects all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation. These consolidated financial statements and notes thereto should be read in conjunction with our audited financial statements and notes thereto presented in our Annual Report on Form 10-K for the year ended December 31, 2003. The interim financial information contained in this Quarterly Report on Form 10-Q is not necessarily indicative of the results to be expected for any other interim period or for an entire year.

Financial Statement Preparation

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

Note 2 — Stock-Based Compensation

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

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

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Note 3 – Per Share Data

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

     For the three and nine months ended September 30, 2004, the calculation of diluted earnings per share excludes the impact of the potential exercise of 7,681,266 stock options and 750,000 warrants for the purchase of common stock outstanding, because their effect would be anti-dilutive.

     For the three and nine months ended September 30, 2003, the calculation of diluted earnings per share excludes the impact of the potential exercise of 11,694,547 stock options and 750,000 warrants for the purchase of common stock outstanding because their effect would be anti-dilutive.

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Note 4 – Contingencies

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

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

     On February 14, 2002, the parties signed and filed a stipulation dismissing the consolidated action without prejudice against us and the Individual Defendants, which the Court approved and entered as an order on March 1, 2002. On April 20, 2002, the plaintiffs filed an amended complaint in which they elected to proceed with their claims against us and the Individual Defendants only under Sections 10(b) and 20(a) of the Exchange Act. The amended complaint alleges that the prospectus filed in connection with the IPO was false or misleading in that it failed to disclose: (i) that the underwriters allegedly were paid excessive commissions by certain of the underwriters’ customers in return for receiving shares in the IPO and (ii) that certain of the underwriters’ customers allegedly agreed to purchase additional shares of our common stock in the aftermarket in return for an allocation of shares in the IPO. The complaint further alleges that the underwriters offered to provide positive market analyst coverage for the Company after the IPO, which had the effect of manipulating the market for our stock. Plaintiffs contend that, as a result of the omissions from the prospectus and alleged market manipulation through the use of analysts, the price of our common stock was artificially inflated between November 18, 1999 and December 6, 2000, and that the defendants are liable for unspecified damages to those persons who purchased our common stock during that period.

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

     On June 30, 2003, a Special Litigation Committee of the Board of Directors of the Company approved a Memorandum of Understanding (the “MOU”) reflecting a tentative settlement in which the plaintiffs agreed to dismiss the case against the Company with prejudice in return for the assignment by the Company of certain claims that we might have against our underwriters. The same offer of settlement was made to all issuer defendants involved in the litigation. No payment to the plaintiffs by the Company was required under the MOU. After further negotiations, the essential terms of the MOU were formalized in a Stipulation and Agreement of Settlement (“Settlement”), which has been executed on our behalf and on behalf of the Individual Defendants. The settling parties presented the proposed Settlement to the Court on June 15, 2004 and filed formal motions seeking preliminary approval on June 25, 2004. The underwriter defendants, who are not parties to the proposed Settlement, filed a brief objecting to the Settlement’s terms on July 14, 2004. The Court is reviewing the matter and has had continued discussions with all of the parties on various matters relating to the proposed Settlement. The Court has not yet reached a decision regarding preliminary approval. There can be no assurance that it will approve the proposed Settlement.

     We believe that the Company and the individual Defendants have meritorious defenses to the claims made in the complaint and, if the Settlement is not approved by the Court, we intend to contest the lawsuit vigorously. Securities class action litigation can result in substantial costs and divert our management’s attention and resources, which may have a material adverse effect on our business and results of operations.

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

     Between October 30, 2002 and December 8, 2002, several purported shareholder class action suits were filed in federal district court in Minnesota. The Court has not yet certified any class. The federal court in Minnesota appointed a lead plaintiff and lead plaintiff’s counsel on February 14, 2003 and consolidated the suits into one action. The consolidated complaint (the “Consolidated Complaint”) alleged, among other things, violations of Sections 10(b) and 20(a) of the Exchange Act against us and certain of our current and former officers and directors. Specifically, the Consolidated Complaint alleged that, among other things, between July 19, 2001 and July 8, 2002 (the “Class Period”), defendants made false and misleading statements and/or concealed material adverse facts from the market in press releases, presentations and SEC disclosures. The Consolidated Complaint alleged that our Company and the individual defendants misled the market with respect to, among other things our alliance with IBM, our ability to develop certain

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software, and our expectations regarding certain customer sales. Plaintiffs further alleged that defendants manipulated financial statements and failed to disclose problems with existing and potential customer deals, which led to the Company’s stock price being artificially inflated during the Class Period. The plaintiffs sought compensatory damages and other unspecified relief.

     On May 30, 2003, the Company and the individual defendants served a motion to dismiss the Consolidated Complaint. On March 30, 2004, the Court dismissed the Consolidated Complaint, granting the plaintiffs leave to amend. On May 21, 2004, plaintiffs filed an Amended Consolidated Complaint, which attempts to cure several of the deficiencies of the Consolidated Complaint. On July 21, 2004, the Company and the individual defendants served a motion to dismiss the Amended Consolidated Complaint, and the Company is currently awaiting a ruling from the Court on this motion.

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

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

     In addition to the above federal litigation, in December 2002 two shareholder derivative lawsuits were filed in state court in Hennepin County, Minnesota, against certain of our current and former officers and directors, naming us as a nominal defendant. Plaintiffs in both derivative cases have agreed to consolidate their respective actions, although the derivative plaintiffs have not yet filed a consolidated derivative complaint. The derivative suits claim that certain of our officers and directors breached their fiduciary duties to us and our stockholders by: (i) selling shares of our common stock while in possession of material adverse non-public information regarding our business and prospects, and (ii) disseminating inaccurate information regarding our business and prospects to the market and/or failing to correct such inaccurate information. The derivative complaints seek compensatory and other damages, restitution, disgorgement, and other legal and equitable relief. As stated above, the complaints are brought derivatively on our behalf, and consequently do not seek relief from us. We however, have entered into indemnification agreements in the ordinary course of business with certain of the officer and director defendants and may be obligated throughout the pendency of this action to advance payment of legal fees and costs incurred by those defendants pursuant to our obligations under the indemnification agreements and/or applicable Delaware law.

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

Legal Proceedings that Arise in the Ordinary Course of Business

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

Note 5 – Restructuring and Other

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

     The restructuring plan included workforce reductions of 265 employees across most business functions and geographic regions and all employees were notified in 2002 of benefits to be received. We recorded a charge for severance and related benefits of $2.6 million in the fourth quarter of 2002. We recorded an additional charge of $0.3 million in 2003 to reflect adjustments to final severance benefits paid. All payments have been made to terminated individuals.

     We also recorded a net loss on lease abandonment of $17.0 million in the fourth quarter of 2002. In the third quarter of 2003 we

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recorded a $0.1 million reduction to the estimated lease abandonment charges. The lease abandonment loss recorded in the fourth quarter of 2002 consisted of the payments to be made for the remaining lease term of the abandoned space aggregating $31.1 million, net of estimated sublease income of $14.1 million. Lease terms of the leased space abandoned range from five to eleven years. Management has made its best estimates of expected sublease income over the remaining term of the abandoned leases. The estimated sublease income amount is highly judgmental and includes assumptions regarding the periods of sublease and the price per square foot to be paid by the sublessors. We review these estimates each quarter and make adjustments, as necessary, to reflect management’s best estimates. As of September 30, 2004, the remaining accrual for lease obligations and terminations is $12.4 million.

     The following table sets forth a summary of the restructuring charges, adjustments to the provision, payment made against those charges and the remaining liabilities as of September 30, 2004.

     Related to the lease abandonment charge, we recorded $0.2 million and $1.9 million of accelerated depreciation on fixed assets abandoned in the three and nine-month periods ended September 30, 2003, which is recorded as general and administrative expense.

Note 6 – Comprehensive Income (Loss)

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

Note 7 – Segment Information

     We operate in one reportable segment. Our operations are primarily conducted in the United States, our country of domicile. Geographic data, determined by the location of our customers for the three and nine months ended September 30, 2004 and 2003 are as follows:

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

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

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

Overview

     We completed our initial public offering on November 23, 1999. Prior to the completion of our initial public offering, we were a wholly owned subsidiary of HNC Software Inc., a business-to-business software company that developed and marketed predictive software solutions. On October 2, 2000, HNC announced it had completed its separation of Retek from HNC through a pro rata distribution to HNC’s stockholders of HNC’s entire holding of 40 million shares of our common stock. After the close of the Nasdaq National Market on September 29, 2000, HNC stockholders who were stockholders of record as of September 15, 2000 were distributed 1.243 shares of our common stock for each share of HNC stock held as of the record date.

     We generate revenue from the sale of software licenses, maintenance and support contracts, professional consulting and contract development services. Until the fourth quarter of 1999, we generally licensed products to customers on a perpetual basis and recognized revenue upon delivery of the products. We revised the terms of our software licensing agreements for a substantial portion of our license revenues. Under these revised terms, we provide technical advisory services after the delivery of our products to help customers exploit the full value and functionality of our products. Revenue from the sale of software licenses under these agreements is recognized over the period the technical advisory services are performed if all other criteria for recognition of revenue are met (i.e. if there is evidence of an arrangement, fees are fixed or determinable and collection is probable). These periods of technical advisory services generally range from 12 to 24 months, as determined by each customer’s objectives. Deferred revenue consists principally of the unrecognized portion of amounts received under license and maintenance service agreements. Deferred license revenue is recognized ratably over the technical advisory period (if applicable), on a percentage of completion basis, or is recognized when all criteria for recognition of revenue are met based on the contract terms. Deferred maintenance revenue is recognized ratably over the term of the service agreement.

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

Critical Accounting Policies and Estimates

     For discussion on critical accounting policies and estimates, see our 2003 Annual Report on Form 10-K.

Results of Operations

Understanding Our Major Revenues and Expenses

Revenues

     We record revenues for the sale of software licenses, maintenance, and services. License revenues are recognized by one of four methods based on the elements of the arrangement and contract terms:

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1.

On a percentage of completion basis where revenue is recognized over the technical advisory period,

2.

Revenue is recognized over the term of the license,

3.

On a percentage of completion basis where revenue is recognized as consulting services are performed, or

4.

Upon delivery if all other criteria are met.

     Software licenses are generally sold with technical advisory services and revenues are recognized over the period during which the technical advisory services are provided. For example, a $7.5 million license contract to be completed ratably over the technical advisory services period of fifteen months would be recognized at a rate of $0.5 million per month over the period of the technical advisory services. A $7.5 million license contract recognized over the term of the license would be recognized at a rate of $0.5 million per month over the license term. If that same $7.5 million license contract was recognized using the percentage of completion method on other than a ratable basis, the amount of revenue would be based on how much of the work was completed in the applicable reporting period. Thus, if 20% of the total estimated work was completed during the reporting period, $1.5 million would be recognized as revenue. If the contract were recognized upon delivery, $7.5 million would all be recognized during the reporting period.

     Fluctuations in license revenues between periods whether increasing or decreasing are influenced by the following factors:

1.		The length of the technical advisory periods. Technical advisory periods generally run from twelve to twenty-four months depending on the goals of the customer. If a license contract has a shorter advisory period, the amount of revenue recognized will be higher on a monthly basis, whereas if the technical advisory period is longer, the amount of license revenue recognized on a monthly basis will be less.
2.		Increases or decreases in license revenue may be dependent upon the number of license contracts being recognized. Because we recognize revenue in monthly amounts over a period of time there are “layers” of revenue being recognized. Thus, an increase or decrease in revenues is not only dependent upon the size of the contracts but the number of contracts being concurrently recognized. Fluctuations in our revenues may result from the rate at which we add more contracts, or “layers” of revenue, as others are taken away because they are fully recognized.
3.		Timing of contract consummation. Depending on when a contract is consummated, it may not have an impact on the reported period’s results. Many of our contracts are consummated in the last month of the quarter, thus, major contracts may not impact the period in which they are consummated.
4.		The mix of license revenues recognized upon shipment or percent complete may impact our revenues. If proportionately more contracts are consummated without technical advisory services, this may materially affect our revenue recognition during the quarter. In the case of recognition based on shipment, this may materially increase the period revenues. An increase in percent complete license revenues would cause revenues to fluctuate depending on the amount of work that could be completed on those projects. If there is a shift in license contracts that adds proportionately more or less percent complete arrangements or more or less software revenues that are recognized upon shipment, revenue streams may be materially affected both in the current period and in the outlook of the future periods.

     Maintenance revenues are recognized ratably over the maintenance contract term. Services revenue is typically recognized on a time and materials basis as services are performed.

Expenses

     Employee and related costs represent our largest expense and software engineers represent the largest segment of our employees. We manage our software engineers as a resource pool to be applied against the demands of our business. Software engineers have many differing skills and expertise that create sub-sets within this resource pool. Software engineers work in many different capacities within our organization and therefore associated costs are included in several operating expense categories in our Statement of Operations including:

1.		Cost of License and Maintenance,
2.		Cost of Services and Other,
3.		Research and Development, and

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4.

Sales and marketing.

     We assign software engineers in our resource pool to projects across the organization based on demand. As a result, the number of software engineers working on a license and maintenance project may quickly change to a research and development project based on the individual project needs. We may have a reduction in the total number of software engineers during a period, but personnel and related expenses for a certain operating expense category may increase because the remaining software engineers work on projects based on need and demand. Projects are assigned to a Statement of Operations operating expense category based on the type of project involved.

     Another significant expense is third party consultant costs. Generally, third party consultants are software engineers utilized to supplement, or in place of, our employee software engineers. Third party consultants are used on an as-needed basis depending on the availability and skills of internal resources and our ability to leverage our relationships with third party integrators. Third party consultants offer flexibility to meet our programming needs without increasing fixed costs.

Key Performance Indicators

     Our management reviews and analyzes several key performance indicators to manage our business and assess our success in the marketplace. These key indicators include:

•		Revenues, which is an overall indicator of business growth.
•		Gross profit, which is an indicator of a mix of license, maintenance, services and other revenues, competitive pressures and efficiency of our sales delivery.
•		Operating cash flow, which is an indicator of our ability to generate cash to fund future operations.
•		Deferred revenue, which is an indicator of our ability to collect cash on revenue streams to be recognized in future periods.
•		Accounts receivable ratio of quarterly days sales outstanding, which indicates our ability to collect cash from our customers.
•		Non-GAAP operational income and Non-GAAP operational income per share, which indicates the growth of our business excluding certain non-cash charges.

•

Operational income has been adjusted to exclude the effects of non-cash expenses for stock-based compensation, amortization of intangibles, accelerated depreciation, and non-operational accrual adjustments. We believe operational income per share provides useful information to investors regarding certain additional financial and business trends relating to our financial condition and results of operations.

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

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Three and Nine Months Ended September 30, 2004 and 2003

Revenue

     Total revenue. Total revenue decreased 6% to $41.3 million for the three months ended September 30, 2004 from $43.8 million in the corresponding prior year period and increased 8% to $134.5 million for the nine months ended September 30, 2004, from $124.2 million in the corresponding prior year period. The decrease in total revenue for the three months ended September 30, 2004 is primarily due to a decrease in services and other revenues. The increase in total revenues for the nine months ended September 30, 2004 is primarily due to increased license and maintenance revenue.

     License and maintenance revenue. License and maintenance revenue increased 2% and 16% to $24.3 and $75.9 million for the three and nine months ended September 30, 2004, respectively, from $23.7 and $65.6 million for the corresponding prior year periods. For the three months ended September 30, 2004 the increase in license and maintenance revenue was primarily due to a $2.7 million increase in maintenance revenue, which was partially offset by a $2.1 million decrease in license revenues. License revenue decreased primarily due to a decrease in funded research and development projects during the period. For the nine months ended September 30, 2004, the increase in license and maintenance revenue was due to a $4.8 million increase in license revenue and a $5.5 million increase in maintenance revenue. License revenues increased during the nine months ended September 30, 2004 primarily due to revenues from larger contracts signed in previous quarters that are now being recognized over the technical advisory period associated with those contracts. For the three and nine months ended September 30, 2004 maintenance revenues increased primarily due to the addition of three new large maintenance customers. In addition, as we sell additional products into our existing customer base, we receive incrementally more maintenance revenues from our existing customers to support the additional products purchased.

     Services and other revenue. Services and other revenue decreased 15% to $17.1 million for the three months ended September 30, 2004 from $20.1 million for the corresponding prior year period. The decrease was due to a $1.8 million decrease in consulting services projects and a $1.4 million decrease in custom modification projects. Services and other revenue decreased $0.1 million to $58.6 million for the nine months ended September 30, 2004 from $58.7 million in the prior year. A $6.1 million decrease in custom modifications projects and a $1.0 million decrease in other revenues for the nine months ended September 30, 2004 were partially offset by a $6.7 million increase in revenue from consulting services projects. The decrease in consulting services projects for the three months ended September 30, 2004 was due to our completing several projects in the first and second quarter of 2004 and a decrease in consulting and custom modification business due to the release of our new product, Retek Xi. The decrease in consulting services projects in the third quarter only partially offset the increase in projects completed in the first and second quarter 2004, causing overall consulting services revenues to increase for the nine months ended September 30, 2004. Custom modifications decreased during the three and nine-month periods ended September 30, 2004 due to several projects being completed during the first quarter of 2004 and due to the release of our new product, Retek Xi. Generally, the levels of custom modifications decrease prior to and shortly after the release of a new product, and, as a result, we anticipate lower custom modification revenues for the remainder of 2004. This decrease in custom modification work may generally be due to customers waiting to see the final specifications of the new product, prior to initiating any custom modifications.

     We have relationships with third party integrators and consultants that contract either with us or directly with our customers for services and other integration needs. Our customer’s proportionate use of our services offerings or other third party integrators and consultants may cause our services revenue to vary independently of changes in license and maintenance revenue.

     Cost of Revenue

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

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support organization, and an allocation of our facilities and depreciation expense. Cost of license and maintenance revenue decreased $0.1 million to $7.9 million for the three months ended September 30, 2004, from $8.0 million for the corresponding prior year period. This decrease is due to a $0.5 million decrease in employee and related expenses, which was partially offset by a $0.4 million increase in third party consulting costs. We primarily used third party consultant resources to complete our funded license projects. The decrease is also due to less funded research and development revenues recognized during the quarter, which is indicative of less funded research and development activity. Cost of license and maintenance revenue increased 16% to $25.9 million for the nine months ended September 30, 2004, from $22.3 million in the corresponding prior year period. The increase for the nine-months ended September 30, 2004 was due to a $6.8 million increase in third party consultant costs, which was partially offset by $1.9 million decrease in employee and related expenses and a $0.7 million decrease in non-cash purchased software amortization expenses. For the nine months ended September 30, 2004, funded license revenues increased, primarily due to higher levels of activity in the first and second quarter of 2004. To complete these funded research and development projects we primarily used third party consultants. We anticipate that we will continue the use of third party consultant resources to complete pending funded development contracts.

     Cost of services and other revenue. Cost of services and other revenue includes salaries and related expenses of our consulting organization, cost of third parties contracted to provide consulting services to our customers, and an allocation of facilities and depreciation expense. Cost of services and other revenue decreased 18% and 6% to $11.8 million and $41.2 million for the three and nine months ended September 30, 2004 from $14.4 and $43.7 million for the corresponding prior year periods. The decrease for the three months ended September 30, 2004 was due to a $1.7 million decrease in third party consultant costs and a $0.9 million decrease in employee and related expenses. The decrease for the nine months ended September 30, 2004 was due to a $1.5 million decrease in third party consultant costs and a $1.3 million decrease in employee and related costs. The decrease in third party consultant costs and employee and related costs for the three and nine months ended September 30, 2004 is due to decreased levels of consulting and custom modification revenues. Additionally, third party consultants are used on an as needed basis depending on the availability and skills of internal resources and our ability to leverage our relationships with third party integrators. As a percentage of services and other revenue, cost of services and other revenue decreased to 69% and 70% for the three and nine-month period ended September 30, 2004 from 72% and 75%, respectively, in the corresponding prior year periods. Margins have improved in the current periods due to higher billing rates, when compared to the corresponding prior year periods and a larger proportion of the work is being completed by our employees, rather than with third party consultants. Average third party contractor costs are typically higher than internal employee costs.

     Operating Expenses

     Research and development. Research and development expenses, which are expensed as incurred, are required to be expensed until the point that technological feasibility of the software is established. Technological feasibility is determined after a working model has been completed. Our software research and development costs primarily relate to software development during the period prior to technological feasibility and are charged to operations as incurred. Research and development expenses consist primarily of salaries and related costs of our engineering organization, fees paid to third party consultants and an allocation of facilities and depreciation expenses. Research and development expenses decreased 29% and 20% to $8.2 and $27.1 million for the three and nine months ended September 30, 2004, respectively, from $11.5 and $33.8 million for the corresponding prior year periods. The decrease was primarily due to a $3.2 and $5.8 million decrease in third party consultant costs for the three and nine months ended September 30, 2004 and a $0.5 million decrease in employee and related expenses for the nine months ended September 30, 2004. The decrease in third party consultants was due to the completion of significant research and development projects during the second quarter of 2004. Additionally, most of the work related to Retek Xi, our new product offering released in September 2004, was completed by internal resources, rather than third party consultants. We anticipate research and development expenses to decrease in absolute dollars in future periods. If our internal resources are not sufficient to complete necessary development activities, we anticipate leveraging third party consultants to assist in development.

     Sales and marketing. Sales and marketing expenses consist primarily of salaries and related costs of the sales and marketing organization, sales commissions, costs of marketing programs, including public relations, advertising, trade shows and sales collateral and an allocation of facilities and depreciation expenses. Sales and marketing expenses decreased 11% and 9% to $7.1 and $24.4 million for the three and nine months ended September 30, 2004, respectively, from $8.0 and $26.7 million for the corresponding prior year periods. The decrease for the three months ended September 30, 2004, was due to a $0.4 million decrease in employee and related costs and a $0.3 million decrease in corporate marketing expenses. The decrease in employee and related expenses was primarily due to lower salary expense and a decrease in corporate marketing was due to fewer expenses for trade shows and conferences. The decrease for the nine months ended September 30, 2004 was due to a $2.0 million decrease in pre-sales consulting expenses, a $0.8 million decrease in employee and related expenses, partially offset by a $0.7 million increase in corporate marketing expenses. Pre-sales consulting decreased due to higher pre-sales costs incurred in prior years to demonstrate the benefits derived from

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implementing our products to our potential customers. The decrease in employee and related expense was due to lower salary and commission expenses. The increase in corporate marketing expense was primarily due to costs incurred to update marketing materials and advertising to reflect our change to a solutions unit marketing strategy as well as an increase in costs due to a change in our lead generation methods. We anticipate that sales and marketing expenses will increase in absolute dollars as we expand our sales and marketing organization in future periods.

     General and administrative. General and administrative expenses consist primarily of costs from our finance and human resources organizations, legal and other professional service fees and an allocation of facilities costs and depreciation expenses. General and administrative expenses decreased 17% and 33% to $2.8 and $7.9 million for the three and nine months ended September 30, 2004, from $3.3 and $11.7 million for the corresponding prior year periods. The decrease for the three months ended September 30, 2004 was due to a $0.2 million decrease in overhead and other allocations and a $0.2 million decrease in accelerated depreciation related to assets abandoned in connection with our restructuring efforts of 2002, which was partially offset by a $0.2 million increase in professional service fees. The decrease for the nine months ended September 30, 2004 was due to $1.9 million decrease in accelerated depreciation related to assets abandoned in connection with our restructuring efforts of 2002, a $1.3 million decrease in overhead and other allocations and a $1.2 million decrease in personnel and related costs, which was partially offset by a $1.2 million increase in professional service fees. Personnel and related costs decreased for the nine months ended September 30, 2004 due to the $0.7 million of CEO severance costs that were incurred during 2003, but not during 2004. We anticipate general and administrative expense levels will remain consistent with current levels in future quarters.

     Acquisition-related amortization of intangibles. Acquisition-related amortization of intangibles remained consistent for the three months ended September 30, 2004 at $1.6 million and decreased 6% to $4.7 million for the nine months ended September 30, 2004, from $5.0 million for the corresponding prior year period. The decrease was because certain intangible assets were fully amortized in 2003.

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

     The restructuring plan included workforce reductions of 265 employees across most business functions and geographic regions and all employees were notified in 2002 of benefits to be received. We recorded a charge for severance and related benefits of $2.6 million in the fourth quarter of 2002. We recorded an additional charge of $0.3 million in 2003 to reflect adjustments to final severance benefits paid. All payments have been made to terminated individuals.

     We also recorded a net loss on lease abandonment of $17.0 million in the fourth quarter of 2002. In the third quarter of 2003 we recorded a $0.1 million reduction to the estimated lease abandonment charges. The lease abandonment loss recorded in the fourth quarter of 2002 consisted of the payments to be made for the remaining lease term of the abandoned space aggregating $31.1 million, net of estimated sublease income of $14.1 million. Lease terms of the leased space abandoned range from five to eleven years. Management has made its best estimates of expected sublease income over the remaining term of the abandoned leases. The estimated sublease income amount is highly judgmental and includes assumptions regarding the periods of sublease and the price per square foot to be paid by the sublessors. We review these estimates each quarter and make adjustments, as necessary, to reflect management’s best estimates. As of September 30, 2004, the remaining accrual for lease obligations and terminations is $12.4 million.

     The following table sets forth a summary of the restructuring charges, adjustments to the provision, payment made against those charges and the remaining liabilities as of September 30, 2004.

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     Related to the lease abandonment charge, we recorded $0.2 million and $1.9 million of accelerated depreciation on fixed assets abandoned in the three and nine-month periods ended September 30, 2003, which is recorded as general and administrative expense.

     Other income, net. Other income, net increased to $1.0 million for the three-month period ended September 30, 2004, from $0.3 million for the corresponding prior year period and remained consistent at approximately $1.1 million for the nine-month period ended September 30, 2004 and 2003. The increase for the three months ended September 30, 2004 was primarily due to a $0.5 million increase in foreign currency gains from a payment from a customer in UK Pounds.

     Income tax provision. The income tax provision for the three and nine-month periods ended September 30, 2004 and September 30, 2003 consist of income taxes payable in foreign jurisdictions as well as state income tax obligations.

     During the third quarter of 2002, we determined that it was appropriate to record a full valuation allowance for our U.S. deferred tax assets. The establishment of a full deferred tax valuation allowance was determined to be appropriate in light of the magnitude of our revenue decrease, our operating losses, our expectation of significant losses for the full year 2002 and the added uncertainty of the market in which we operate. Despite the full valuation allowance, the income tax benefits related to these deferred tax assets will remain available to offset future taxable income assuming we generate such income before the expiration or reversal of such benefits. We expect to record a full valuation allowance on future tax benefits until we can sustain an appropriate level of profitability and until such time, we would not expect to recognize any significant tax benefits in our future results of operations.

Liquidity and Capital Resources

     At September 30, 2004, our balance of cash, cash equivalents and investments available for sale was $88.9 million, or a $5.3 million decrease from December 31, 2003. This decrease is due to a $11.0 million usage of cash from operations and $1.5 million of cash used for the purchase of fixed assets, which was partially offset by $5.1 million of cash provided by the issuance of common stock through the employee stock purchase plan and employee stock option exercises and $2.0 million received from a third party as part of a settlement relating to intellectual property previously licensed from that third party. Our cash requirements for servicing debt will be less than $0.1 million for the remainder of fiscal year 2004. Cash from operations is primarily the difference between cash payments from customers to us and payments we make to vendors and for internal expenses, primarily personnel and the related costs of our employees.

     Net cash used by operating activities was $11.0 million for the nine-month period ended September 30, 2004, compared to $2.7 million cash provided operating activities for the corresponding prior year period. Sources of cash for the nine-month period ended September 30, 2004 include, net income and operating cash flow adjustments for non-cash depreciation and amortization expense. Uses of cash for the nine-month period ended September 30, 2004 were due to increases in accounts receivable and decreases in accounts payable, accrued liabilities, accrued restructuring and deferred revenue. Accounts receivable increased $4.8 million primarily due to accounts receivable balances for several larger services projects, which typically have slower collection cycles than license revenue related receivables. Accounts payable decreased $5.6 million primarily due to payments to one large vendor. Accrued liabilities decreased $2.4 million due to lower deferred rent balances related to various lease obligations, lower foreign taxes payable due to timing of payments made, lower commissions payable and lower employee stock purchase plan withholdings. Accrued restructuring decreased $2.0 million due to cash payments made for various lease obligations. Deferred revenue balances decreased $10.1 million due to fewer revenue bookings made during the quarter and less cash collected on existing revenue bookings. Sources of cash for the nine-month period ended September 30, 2003 include, operating cash flow adjustments for depreciation and amortization expense, amortization of stock based compensation and bad debt provisions, as well as increases in accounts payable and decreases of accounts receivable and other assets. Uses of cash for the nine-month period ended September 30, 2003, were due to net losses and a decrease in accrued liabilities, accrued restructuring and deferred revenue. Accounts payable increased $4.1 million, primarily due to an increase in payables balances with two vendors. Accounts receivable decreased $9.1 million due to improved collection efforts. Other assets decreased $1.2 million primarily due to decreases in prepaid insurance and prepaid third party expenses, which was partially offset by an increase in prepaid expenses for conferences and an increase in foreign tax receivable balances. Accrued liabilities decreased $2.4 million due to lower deferred rent balances related to various lease obligations and a decrease in accrued losses on certain contracts, which was partially offset by an increase in accrued employee withholdings for the Employee Stock Purchase Plan. Accrued restructuring decreased $3.5 million primarily due to payments made to terminated employees, and for various lease obligations. Deferred revenue decreased $4.8 million due to fewer revenue bookings made during the period and less cash collected on existing revenue bookings.

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     Net cash used by investing activities was $18.6 million for the nine-month period ended September 30, 2004 compared to $7.6 million provided by investing activities for the corresponding prior year period. Uses of cash for the nine months ended September 30, 2004 included purchases of available for sale investments and purchases of fixed assets. Sources of cash include a cash payment received from a third party as part of a settlement relating to intellectual property previously licensed from that third party. We purchase investments designed to protect our capital investment, primarily short-term investments that have a low risk of capital loss, such as U.S. government securities, major corporation commercial paper, money market securities and tax-exempt municipal securities. Our current investment mix has included more short-term instruments because we believe the difference between short term and long-term interest rates is not large enough to justify long term holding periods. The $7.6 million of cash provided by investing activities in the nine-month period ended September 30, 2003 resulted from our sale of $8.6 million of available for sale investments and the purchase of $0.9 million of property and equipment.

     Net cash provided by financing activities was $5.0 million for the nine-month period ended September 30, 2004, compared to $2.2 million provided by financing activities for the corresponding prior year period. Sources of cash were proceeds from the issuance of common stock for our employee stock purchase plan and employee stock option exercises.

     We believe that our current cash, cash equivalents and investments will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months. Operating cash flows would be negatively impacted if we were unable to consummate new customer contracts or if a significant number of customers were unable to pay for our solutions and services. Consumer spending, consumer confidence and other economic measures in the U.S. economy impact our customer base in the retail industry and negative trends in these measures may impact the amount and type of capital expenditures made by them.

     Management intends to invest our cash in excess of current operating requirements in short-term, interest-bearing, high credit quality financial institutions, commercial companies and government agencies in order to limit the amount of credit exposure.

     A portion of our cash could also be used to acquire or invest in complementary businesses or products or otherwise to obtain the right to use complementary technologies or data. We regularly evaluate, in the ordinary course of business, potential acquisitions of such businesses, products, technologies or data.

     A table of our contractual obligations was provided in Item 7 in our Annual Report on Form 10-K for the fiscal year ended December 31, 2003. There were no significant changes to our contractual obligations during the three or nine months ended September 30, 2004.

Factors That May Impact Future Results of Operations

     An investment in our common stock involves a high degree of risk. Investors evaluating us and our business should carefully consider the factors described below and all other information contained in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K before purchasing our common stock. Any of the following factors could materially harm our business, operating results and financial condition. Additional factors and uncertainties not currently known to us or that we currently consider immaterial could also harm our business, operating results and financial condition. Investors could lose all or part of their investment as a result of these factors. The matters discussed in this Quarterly Report on Form 10-Q regarding future events are forward looking statements as defined in the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, that are subject to risks and uncertainties. The following factors, among others, could cause actual results to differ materially from those described by such statements.

FLUCTUATIONS IN OUR QUARTERLY OPERATING RESULTS COULD CAUSE OUR STOCK PRICE TO DECLINE.

     Our quarterly operating results have fluctuated in the past and are expected to continue to fluctuate in the future. If our quarterly operating results fail to meet expectations, the trading price of our common stock could decline. In addition, significant fluctuations in our quarterly operating results may harm our business operations by making it difficult to implement our budget and business plan. Factors, many of which are outside of our control, which could cause our operating results to fluctuate include:

•		the size and timing of customer orders, which can be affected by customer budgeting and purchasing cycles;
•		the demand for and market acceptance of our software solutions;

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•		pricing pressures within the software industry;
•		competitors’ announcements or introductions of new software solutions, alliance agreements, services or technological innovations;
•		our ability to develop, introduce and market new products on a timely basis;
•		customer deferral of material orders in anticipation of new releases or new product introductions;
•		our success in expanding our sales and marketing programs;
•		technological changes or problems in computer systems;
•		general economic conditions which may affect our customers’ capital investment levels; and
•		our ability to reduce expense levels if our revenues decline.

     We currently derive a significant portion of our license revenue in each quarter from a small number of relatively large orders and we generally recognize revenue from our licenses over the related technical advisory services period. If we are unable to recognize revenue from one or more substantial license sales for a particular fiscal quarter, our operating results for that quarter would be seriously harmed and the amount of revenue deferred into future quarters would be reduced. In addition, the licensing of our products typically involves a substantial commitment of resources by our customers or their consultants over an extended period of time. The time required to complete an implementation may vary from customer to customer and may be protracted due to unforeseen circumstances. Because our revenues from implementation, maintenance and training services are largely correlated with our license revenue, a decline in license revenue may also cause a decline in our services revenue in the same quarter and in subsequent quarters. Because our sales cycle is long, we may have difficulty predicting when we will recognize revenue. If our quarterly revenue or operating results fall below expectations, the price of our common stock could fall substantially and we could become subject to additional securities class action litigation. Litigation, if instituted, could result in substantial costs and a diversion of management’s attention and resources, which could materially adversely affect our business, financial condition and results of operations.

     Additionally, our quarterly and annual operating results would be impacted if our customers did not purchase technical advisory support with our software solutions. With technical advisory support, revenues are recognized ratably over the advisory period, if all other revenue recognition criteria are met. Without the advisory services, revenues would be recognized when we execute the license agreement or contract, deliver the software, determine that collections of the proceeds is probable and that vendor specific objective evidence of fair value exists to allocate revenue to undelivered elements of the arrangement. As a result, failure of our customers to purchase advisory services could materially impact the period over period results in our consolidated financial statements.

     We have incurred, and will continue to incur, compensation expense in connection with our grants of options under our 1999 Equity Incentive Plan, our HighTouch Technologies, Inc. 1999 Stock Option Plan and our 1999 Directors Stock Option Plan. This expense will be amortized over the vesting period of these granted options, which is generally four years, resulting in lower quarterly income.

     Our quarterly expense levels are relatively fixed and are based, in part, on our expectations of future revenue. As a result, if revenue levels fall below our expectations, net income will decrease because only a small portion of our expenses varies with our revenue.

IF OUR CUSTOMERS DO NOT CONTINUE TO ACCEPT OUR CURRENT PRODUCTS OR WE DO NOT RESPOND ADEQUATELY TO OUR INDUSTRY’S RAPID PACE OF CHANGE, SALES OF OUR PRODUCTS MAY DECLINE.

     Our business depends on the successful customer acceptance of our products and we expect to continue to depend on revenue from existing, new and enhanced versions of our products. Our business will be harmed if our target customers do not adopt and/or expand their use of our products. In addition, potential customers are evaluating solutions more deliberately, which has resulted in the extension of our sales cycles. The life cycles of our products are difficult to predict because the market for our products is characterized by rapid technological change and changing customer needs. The introduction of products employing new technologies could render our existing products or services obsolete and unmarketable.

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     In developing new products and services or enhancements to our existing products and services, we may:

•		fail to respond to technological changes in a timely or cost-effective manner;
•		encounter products, capabilities or technologies developed by others that render our products and services obsolete or noncompetitive or that shorten the life cycles of our existing products and services;
•		experience difficulties that could delay or prevent the successful development, introduction and marketing of these new products and services; or
•		fail to achieve market acceptance of our products and services.

     The occurrence of any of these factors could seriously harm our business and operating results.

IF WE FAIL TO ESTABLISH, MAINTAIN AND EXPAND OUR RELATIONSHIPS WITH THIRD PARTIES WHO IMPLEMENT OUR PRODUCTS, OUR ABILITY TO MEET OUR CUSTOMERS’ NEEDS COULD BE HARMED.

     Implementation of our software solutions can also be a lengthy process as our software products perform or directly affect mission-critical functions across many different functional and geographic areas of the enterprise. We rely, and expect to continue to rely on a number of third parties to implement our software solutions at certain customer sites. If we are unable to establish and maintain effective, long-term relationships with these implementation providers or if these providers do not meet the needs or expectations of our customers, our revenue will be reduced and our customer relationships will be harmed. Our current implementation partners are not contractually required to continue to help implement our software solutions.

     We may be unable to establish or maintain relationships with third parties having sufficient qualified personnel resources to provide the necessary implementation services to support our needs. If third-party services are unavailable, we will be required to provide these services internally, which would significantly limit our ability to meet customers’ implementation needs and would increase our operating expenses and could reduce our gross margins. A number of our competitors have significantly more established relationships with these third parties and, as a result, these third parties may be more likely to recommend competitors’ products and services rather than our own. In addition, we cannot control the level and quality of service provided by our current and future implementation partners. Significant issues arising in implementation of our solutions could result in client dissatisfaction and could therefore cause delays or prevent us from collecting fees from our customers and could damage our ability to attract new customers.

COMPETITIVE PRESSURES COULD REDUCE OUR MARKET SHARE OR REQUIRE US TO REDUCE OUR PRICES, WHICH WOULD REDUCE OUR REVENUE AND/OR OPERATING MARGINS.

     The market for our software solutions is highly competitive and subject to rapidly changing technology and marketing strategies. Competition could seriously impede our ability to sell products and services on terms favorable to us. Competitive pressures could reduce our market share or require us to reduce prices, which would reduce our revenues and/or operating margins. Many of our competitors have substantially greater financial, marketing, development or other resources and greater name recognition than us. In addition, these companies may adopt aggressive pricing policies that could compel us to reduce the prices of our products and services in response or require us to bid fixed price service contracts. Our competitors may also be able to respond more quickly than us to new or emerging technologies and changes in customer requirements. Our current and potential competitors may:

•		develop and market new technologies that render our existing or future products obsolete, unmarketable or less competitive;
•		make strategic acquisitions or establish cooperative relationships among themselves or with other solution providers, which would increase the ability of their products to address the needs of our customers; and
•		establish or strengthen cooperative relationships with our current or future strategic partners, which would limit our ability to sell products through these channels.

     As a result, we may not be able to maintain or improve our competitive position against current or future competitors.

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IF WE LOSE KEY PERSONNEL OR ARE UNABLE TO ATTRACT AND RETAIN ADDITIONAL PERSONNEL, OUR ABILITY TO GROW OUR BUSINESS COULD BE HARMED.

     We believe that our future success will depend significantly upon our ability to attract, integrate, motivate and retain skilled sales, research and development, marketing and management personnel. Competition for skilled personnel is intense and the software industry is characterized by a high level of employee mobility and aggressive recruiting of skilled personnel. There can be no assurance that we will be successful in attracting, retaining and motivating the personnel required to grow and operate profitably. Failure to attract, retain and motivate qualified personnel would adversely affect our business.

     The recent trading levels of our stock have decreased the value of our stock options granted to employees under our stock option plans. As a result of these factors, our remaining personnel may seek alternate employment, such as with larger, more established companies or companies that they perceive as having less volatile stock prices. A new accounting standard proposed by the Financial Accounting Standards Board (“FASB”) would require us to expense the fair value of all stock options. If the FASB adopts this new standard, its application may adversely affect our ability to grant stock options to employees as an incentive due to the increased compensation expense. Continuity of personnel can be a very important factor in sales and implementation of our software and completion of our product development efforts. Attrition beyond any planned reduction in workforce could have a material adverse effect on our business, operating results, financial condition and cash flows.

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

     Our products are complex and, accordingly, may contain undetected errors or failures when we first introduce them or as we release new versions. This may result in loss of, or delay in, market acceptance of our products and could cause us to incur significant costs to correct errors or failures or to pay damages suffered by customers as a result of such errors or failures. In the past, we have discovered software errors in new releases and new products after their introduction. We have incurred costs during the period required to correct these errors, although to date such costs, including costs incurred on specific contracts, have not been material. We may in the future discover errors in new releases or new products after the commencement of commercial shipments.

SUBSTANTIALLY ALL OF OUR REVENUE IS DERIVED FROM THE RETAIL INDUSTRY.

     We have in the past derived substantially all of our revenues from the license of our software products and the delivery of related services to retail customers. Our future growth and profitability is dependent upon increased sales to retailers. Recent world wide economic conditions and competitive pressures in the retail industry have negatively impacted demand for our products and services. Such competitive pressures and an unsustained economic recovery could continue to cause retail customers and potential customers to delay, cancel or reduce their information technology budgets and their spending on our software products and services.

WE HAVE BEEN NAMED A DEFENDANT IN SECURITIES CLASS ACTION LITIGATION AND DERIVATIVE ACTIONS AND WE MAY IN THE FUTURE BE NAMED IN ADDITIONAL LITIGATION, WHICH MAY RESULT IN SUBSTANTIAL COSTS AND DIVERT MANAGEMENT’S ATTENTION AND RESOURCES.

     As described in Part II — Item 1: Legal Proceedings, a number of shareholder class action suits have been filed naming us and/or certain of our current and former officers and directors as co-defendants. Two additional related derivative action suits have been filed on our behalf naming certain of our officers and directors. We believe these claims are subject to a variety of meritorious defenses, which we intend to vigorously pursue. However, it is possible that the litigation could be resolved adversely to us, could result in substantial costs and could divert management’s attention and resources, which could seriously harm our business. More generally, securities class action litigation has often been brought against a company following declines in the market price of its securities. This risk is greater for technology companies, which have experienced greater-than-average stock price declines in recent years and, as a result, have been subject to, on average, a greater number of securities class action claims than companies in other industries.

     In addition to securities class action litigation, we face legal risks in our business, including claims from disputes with our employees and our former employees and claims associated with implementations involving client projects. Risks associated with legal liability often are difficult to assess or quantify and their existence and magnitude can remain unknown for significant periods of time. While we maintain director and officer insurance, the amount of insurance coverage may not be sufficient for any such claim and the continued availability of such insurance cannot be assured. We may in the future be the target of this kind of litigation and such litigation could also result in substantial costs and divert management’s attention and resources.

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IF WE FAIL TO OBTAIN ACCESS TO THE INTELLECTUAL PROPERTY OF THIRD PARTIES, OUR BUSINESS AND OPERATING RESULTS COULD BE HARMED.

     We must now, and may in the future need to, license or otherwise obtain access to the intellectual property of third parties, including MicroStrategy, Wavelink, SeeBeyond, Lucent, Sun, IBM, Accenture and Oracle. Our business would be seriously harmed if the providers from whom we license such software cease to deliver and support reliable products or enhance their current products. In addition, the third-party software may not continue to be available to us on commercially reasonable terms or prices or at all. Our inability to maintain or obtain this software could result in shipment delays or reduced sales of our products. Furthermore, we might be forced to limit the features available in our current or future product offerings. Either alternative could seriously harm our business and operating results.

IF OUR INTELLECTUAL PROPERTY IS NOT ADEQUATELY PROTECTED, OUR COMPETITORS MAY GAIN ACCESS TO OUR TECHNOLOGY AND WE MAY LOSE CUSTOMERS.

     We depend on our ability to develop and maintain the proprietary aspects of our technology. To protect proprietary technology, we rely primarily on a combination of contractual provisions, confidentiality procedures, trade secrets, and copyright and trademark laws. We seek to protect our software, documentation and other written materials under trade secret and copyright laws, which afford only limited protection.

     Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or obtain and use information that we regard as proprietary. Policing unauthorized use of our products is difficult and expensive, and while we are unable to determine the extent to which piracy of our software products exists, software piracy may be a problem. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States. We intend to vigorously protect intellectual property rights through litigation and other means. However, such litigation can be costly to pursue and we cannot be certain that we will be able to enforce our rights or prevent other parties from developing similar technology, duplicating our products or designing around our intellectual property.

IF, IN THE FUTURE, THIRD PARTIES CLAIM THAT OUR PRODUCTS INFRINGE ON THEIR INTELLECTUAL PROPERTY, WE MAY INCUR SIGNIFICANT COSTS.

     There has been a substantial amount of litigation in the software industry and the Internet industry regarding intellectual property rights. It is possible that in the future third parties may claim that our current or potential future products infringe their intellectual property. We expect that software product developers and providers of electronic commerce solutions will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grow and the functionality of products in different industry segments overlap. Any claims, with or without merit, could be time-consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. Royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all, which could seriously harm our business and expose us to claims by our customers.

OUR BUSINESS IS SUBJECT TO ECONOMIC, POLITICAL AND OTHER RISKS ASSOCIATED WITH INTERNATIONAL SALES.

     Since we sell products worldwide, our business is subject to risks associated with doing business internationally. To the extent that our sales are denominated in foreign currencies, the revenue we receive could be subject to fluctuations in currency exchange rates. If the effective price of the products we sell to our customers were to increase due to fluctuations in foreign currency exchange rates, demand for our technology could fall, which would, in turn, reduce our revenue. We have not historically attempted to mitigate the effect that currency fluctuations may have on our revenue through the use of hedging instruments, and we do not currently intend to do so in the future.

     We anticipate that revenue from our international operations will continue to represent a substantial portion of our total revenue. Accordingly, our future results could be harmed by a variety of factors, including:

•		changes in foreign currency exchange rates;
•		greater risk of uncollectable accounts and longer accounts receivable payment cycles;

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•		changes in a specific country’s or region’s political, legal or economic conditions, particularly in emerging markets;
•		trade protection measures and import or export licensing requirements;
•		potentially negative consequences from changes in tax laws or other localization legal requirements;
•		cost of and difficulty in staffing and managing widespread operations and foreign language skill limitations;
•		international variations in technology standards;
•		differing levels of protection of intellectual property; and
•		unexpected changes in regulatory requirements.

TERRORIST ATTACKS OR GLOBAL UNREST COULD LEAD TO FURTHER ECONOMIC INSTABILITY WHICH COULD HARM OUR BUSINESS.

     Terrorist attacks, such as the attacks that occurred in New York, Pennsylvania and Washington, D.C., on September 11, 2001, and current and future global unrest may adversely affect our business, results of operations, financial condition or future growth. Terrorist attacks and global unrest may lead to additional armed hostilities or to further acts of terrorism and civil disturbance in the United States or elsewhere, which may further contribute to economic instability and could adversely affect economic conditions, particularly in the retail industry.

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     The following discusses our exposure to market risk related to changes in interest rates, foreign currency exchange rates and equity prices.

Interest Rate Risk

     The fair value of our cash, cash equivalents and investments available for sale at September 30, 2004 was $88.9 million. The objectives of our investment policy are safety and preservation of invested funds and liquidity of investments that is sufficient to meet cash flow requirements. Our policy is to place our cash, cash equivalents and investments available for sale with high credit quality financial institutions, commercial companies and government agencies in order to limit the amount of credit exposure. It is also our policy to maintain certain concentration limits and to invest only in certain “allowable securities” as determined by our management. Our investment policy also provides that our investment portfolio must not have an average portfolio maturity of beyond one year. Investments are prohibited in certain industries and speculative activities. Investments must be denominated in U.S. dollars.

     Due to our small debt balance as of September 30, 2004 and because this debt has a fixed interest rate, a change in market interest rates would not materially affect our financial results.

Foreign Currency Exchange Rate Risk

     We develop products in the United States and sell in North America, Australia, Asia and Europe. As a result, our financial results could be affected by various factors, including changes in foreign currency exchange rates or weak economic conditions in foreign markets. Our foreign currency risks are mitigated principally by contracting primarily in U.S. dollars and maintaining only minimal foreign currency cash balances. Working funds necessary to facilitate the short-term operations of our subsidiaries are kept in local currencies in which they do business, with excess funds transferred to our offices in the United States. Approximately 21% and 28%

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of our sales were denominated in currencies other than the U.S. dollar for the three and nine-month periods ended September 30, 2004, compared to 24% and 23% for the corresponding prior year periods, respectively.

Equity Price Risk

     We own several investments in the common stock of certain companies that we have entered into for strategic business purposes. As of September 30, 2004, we had substantially written off all of the value associated with our equity investments.

ITEM 4: CONTROLS AND PROCEDURES

     An evaluation was carried out under the supervision and with the participation of Retek’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of Retek’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this quarterly report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that Retek’s disclosure controls and procedures are effective to ensure that information required to be disclosed by Retek in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

     No change in Retek’s internal control over financial reporting was identified in connection with the evaluation required by Rule 13a-15(d) of the Exchange Act that occurred during the period covered by this quarterly report and that has materially affected, or is reasonably likely to materially affect, Retek’s internal control over financial reporting.

PART II — OTHER INFORMATION

ITEM 1: LEGAL PROCEEDINGS

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

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

     On February 14, 2002, the parties signed and filed a stipulation dismissing the consolidated action without prejudice against us and the Individual Defendants, which the Court approved and entered as an order on March 1, 2002. On April 20, 2002, the plaintiffs filed an amended complaint in which they elected to proceed with their claims against us and the Individual Defendants only under Sections 10(b) and 20(a) of the Exchange Act. The amended complaint alleges that the prospectus filed in connection with the IPO was false or misleading in that it failed to disclose: (i) that the underwriters allegedly were paid excessive commissions by certain of the underwriters’ customers in return for receiving shares in the IPO and (ii) that certain of the underwriters’ customers allegedly agreed to purchase additional shares of our common stock in the aftermarket in return for an allocation of shares in the IPO. The complaint further alleges that the underwriters offered to provide positive market analyst coverage for the Company after the IPO, which had the effect of manipulating the market for our stock. Plaintiffs contend that, as a result of the omissions from the prospectus and alleged market manipulation through the use of analysts, the price of our common stock was artificially inflated between November 18, 1999 and December 6, 2000, and that the defendants are liable for unspecified damages to those persons who purchased our common stock during that period.

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

     On June 30, 2003, a Special Litigation Committee of the Board of Directors of the Company approved a Memorandum of Understanding (the “MOU”) reflecting a tentative settlement in which the plaintiffs agreed to dismiss the case against the Company with prejudice in return for the assignment by the Company of certain claims that we might have against our underwriters. The same

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offer of settlement was made to all issuer defendants involved in the litigation. No payment to the plaintiffs by the Company was required under the MOU. After further negotiations, the essential terms of the MOU were formalized in a Stipulation and Agreement of Settlement (“Settlement”), which has been executed on our behalf and on behalf of the Individual Defendants. The settling parties presented the proposed Settlement to the Court on June 15, 2004 and filed formal motions seeking preliminary approval on June 25, 2004. The underwriter defendants, who are not parties to the proposed Settlement, filed a brief objecting to the Settlement’s terms on July 14, 2004. The Court is reviewing the matter and has had continued discussions with all of the parties on various matters relating to the proposed Settlement. The Court has not yet reached a decision regarding preliminary approval. There can be no assurance that it will approve the proposed Settlement.

     We believe that the Company and the individual Defendants have meritorious defenses to the claims made in the complaint and, if the Settlement is not approved by the Court, we intend to contest the lawsuit vigorously. Securities class action litigation can result in substantial costs and divert our management’s attention and resources, which may have a material adverse effect on our business and results of operations.

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

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

     On May 30, 2003, the Company and the individual defendants served a motion to dismiss the Consolidated Complaint. On March 30, 2004, the Court dismissed the Consolidated Complaint, granting the plaintiffs leave to amend. On May 21, 2004, plaintiffs filed an Amended Consolidated Complaint, which attempts to cure several of the deficiencies of the Consolidated Complaint. On July 21, 2004, the Company and the individual defendants served a motion to dismiss the Amended Consolidated Complaint, and the Company is currently awaiting a ruling from the Court on this motion.

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

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

     In addition to the above federal litigation, in December 2002 two shareholder derivative lawsuits were filed in state court in Hennepin County, Minnesota, against certain of our current and former officers and directors, naming us as a nominal defendant. Plaintiffs in both derivative cases have agreed to consolidate their respective actions, although the derivative plaintiffs have not yet filed a consolidated derivative complaint. The derivative suits claim that certain of our officers and directors breached their fiduciary duties to us and our stockholders by: (i) selling shares of our common stock while in possession of material adverse non-public information regarding our business and prospects, and (ii) disseminating inaccurate information regarding our business and prospects to the market and/or failing to correct such inaccurate information. The derivative complaints seek compensatory and other damages, restitution, disgorgement, and other legal and equitable relief. As stated above, the complaints are brought derivatively on our behalf, and consequently do not seek relief from us. We however, have entered into indemnification agreements in the ordinary course of business with certain of the officer and director defendants and may be obligated throughout the pendency of this action to advance payment of legal fees and costs incurred by those defendants pursuant to our obligations under the indemnification agreements and/or

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applicable Delaware law.

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

Legal Proceedings that Arise in the Ordinary Course of Business

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

ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

     Not applicable.

ITEM 3: DEFAULTS UPON SENIOR SECURITIES

     Not applicable.

ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     None

ITEM 5: OTHER INFORMATION

     None.

ITEM 6: EXHIBITS

     The exhibits filed in response to Item 601 of Regulation S-K are listed in the Index to Exhibits on page 27.

SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	Retek Inc.
	By: /s/ Gregory A. Effertz
	Gregory A. Effertz
	Senior Vice President, Finance and Administration, Chief Financial Officer, Treasurer and Secretary (Duly Authorized Officer and Principal Financial and Accounting Officer)

Date: November 8, 2004

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Index to Exhibits

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