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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

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

For the quarterly period ended June 30, 2003

OR

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

For the transition period from ___________ to _______

Commission file number: 0-27358

DOCUMENTUM, INC.

(Registrant’s telephone number, including area code): (925) 600-6800

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:
Nasdaq National Market
Common Stock, $0.001 par value
(Title of Class)

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

Yes  [X]  No  [  ].

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

Yes  [X]   No [  ]

     The number of outstanding shares of the registrant’s Common Stock, par value $0.001 per share, was 49,875,330 on July 31, 2003.

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FORM 10-Q

Index

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PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

DOCUMENTUM, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(in thousands; unaudited)

See accompanying notes to condensed consolidated financial statements.

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DOCUMENTUM, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except per share data; unaudited)

See accompanying notes to condensed consolidated financial statements.

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DOCUMENTUM, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOW
(in thousands; unaudited)

See accompanying notes to condensed consolidated financial statements.

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DOCUMENTUM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1. Basis of Presentation

     The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions in Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments, consisting only of normal recurring adjustments except as described in Notes 4 and 5, have been recorded as necessary to present fairly our consolidated financial position, results of operations and cash flows for the periods presented. These financial statements should be read in conjunction with our audited consolidated financial statements included in our 2002 Annual Report on Form 10-K. The consolidated results of operations for the three and six months ended June 30, 2003 and 2002 are not necessarily indicative of the results that may be expected for any future period.

Note 2. Summary of Significant Accounting Policies

Operations

     Documentum, Inc. was incorporated in the state of Delaware in January 1990. We provide enterprise content management (ECM) solutions that enable organizations to unite teams, content and associated business processes. Our integrated set of content, compliance and collaboration solutions support the way people work, from initial discussion and planning through design, production, marketing, sales, service and corporate administration. This business-critical content includes everything from documents and discussions to email, Web pages, records and rich media. The Documentum platform makes it possible for companies to distribute all of this content across internal and external systems, applications and user communities.

Principles of Consolidation

     The Condensed Consolidated Financial Statements include those of Documentum and our wholly-owned subsidiaries after elimination of intercompany accounts and transactions.

Use of Estimates

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

Cash and Cash Equivalents and Marketable Securities

     We consider all highly liquid investments purchased with original maturities of 90 days or less to be cash equivalents. The following table details our cash and cash equivalents at June 30, 2003 and December 31, 2002 (in thousands):

     In accordance with Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities, our marketable securities are classified as “available-for-sale” and are

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stated at fair value based on quoted market prices, with the unrealized gains and losses, net of related tax effects, reported as a component of stockholders’ equity. We intend to maintain a liquid portfolio and have the ability to redeem our marketable securities at their carrying amounts. Therefore, all marketable securities at June 30, 2003 have been classified as current.

Foreign Currency and Derivative Instruments

     Assets and liabilities of our foreign subsidiaries for which the local currency is the functional currency are translated into U.S. dollars at exchange rates in effect at the balance sheet date. Income and expense items are translated at the actual current exchange rates prevailing at the time of each transaction. Gains and losses from the translation are included in accumulated other comprehensive income (loss). Gains and losses resulting from remeasuring monetary asset and liability accounts of foreign subsidiaries for which the functional currency is the U.S. dollar are included in other expense, net. We recorded foreign currency remeasurement losses of approximately $0.2 million in the three months ended June 30, 2003 and incurred immaterial losses in the three months ended June 30, 2002. We recorded foreign currency remeasurement losses of approximately $0.3 million and $0.1 million in the six months ended June 30, 2003 and 2002, respectively.

     We enter into foreign currency forward exchange contracts with financial institutions to protect against currency exchange risks associated with existing assets and liabilities denominated in a foreign currency. These contracts require us to exchange currencies at rates agreed upon at the contract’s inception. The principal foreign currencies hedged were the British Pound, Japanese Yen and Euro. A foreign currency forward exchange contract acts as an economic hedge as the gains and losses on these contracts typically offset or partially offset gains and losses on the assets, liabilities, and transactions being hedged. We do not designate foreign exchange forward contracts as accounting hedges and do not hold or issue financial instruments for speculative or trading purposes. Foreign exchange forward contracts are accounted for on a mark-to-market basis, with unrealized gains or losses recognized in the current period. Unrealized gains and losses were insignificant for both the three and six months ended June 30, 2003 and 2002.

Property and Equipment

     Property and equipment are recorded at cost. Depreciation and amortization of leasehold improvements is computed using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the estimated useful life or the life of the lease, whichever is shorter.

Software Development Costs

     SFAS No. 86 requires the capitalization of certain software development costs once technological feasibility is established. To date, the period between achieving technological feasibility, which we have defined as the establishment of a working model, and the general availability of such software has been short and, accordingly, software development costs are expensed as incurred and are included in research and development costs.

     In accordance with the provisions of Statement of Position (SOP) No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, certain costs of computer software developed or obtained for internal use have been capitalized. The estimated useful life of the software costs capitalized is evaluated for each specific project and ranges from one to five years. We have capitalized costs in the amount of approximately $0.3 million and $0.2 million for the three months ended June 30, 2003 and 2002, respectively, and approximately $0.7 million and $0.5 million for the six months ended June 30, 2003 and 2002, respectively.

Goodwill and Identifiable Purchased Intangibles

     Goodwill is stated at cost and purchased intangible assets are stated at cost less accumulated amortization. All of our goodwill at June 30, 2003 is associated with acquisitions completed after June 30, 2001. We have not amortized any goodwill, including workforce intangibles that were subsumed into goodwill, arising from acquisitions that were completed after June 30, 2001.

     Purchased intangible assets with definite lives are amortized on a straight-line basis over the remaining estimated economic life of the underlying products and technologies (original lives assigned are one to five years).

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Long-lived Assets, Excluding Goodwill

     Our long-lived assets, excluding goodwill, consist of property and equipment and other purchased intangibles. We periodically review our long-lived assets for impairment in accordance with SFAS No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets. For assets to be held and used, we initiate this review whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset group may not be recoverable. Recoverability of an asset group is measured by comparison of its carrying amount to the expected future undiscounted net cash flows (without interest charges) that the asset group is expected to generate. If it is determined that an asset group is not recoverable, an impairment loss is recorded in the amount by which the carrying amount of the asset group exceeds its fair value.

     We concluded that there were no events or changes in circumstances during the three and six months ended June 30, 2003 that would indicate that the carrying amounts of our long-lived assets were impaired.

     Assets to be disposed of and for which we have committed to a plan of disposal of such assets, whether through sale or abandonment, are reported at the lower of their carrying amount or their fair value less cost to sell.

Warranty Reserve

     We generally offer a 90-day warranty from shipment of the software. We estimate the costs that we expect to incur under our warranty obligations and record a liability in the amount of such costs at the time of the transaction. Factors that affect our warranty liability include the number of installed seats, historical and anticipated rates of warranty claims and cost per claim, as well as the introduction of new products or versions of existing products. We regularly assess the adequacy of our recorded warranty liabilities and adjust the amounts as necessary.

     The following table summarizes changes in our warranty reserve during the six months ended June 30, 2003 (in thousands):

Deferred Revenue

     Deferred revenue primarily relates to maintenance and support agreements that have been paid for by customers prior to the performance of those services. Generally, the services will be provided within twelve months from the transaction date. Payments received in advance of revenue recognition for license fees are recorded as deferred revenue.

Stock-based Compensation Plans

     We apply Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, in accounting for our stock-based compensation plans. Accordingly, no compensation cost has been recognized for our stock option plans and our stock purchase plan.

     We have also included the disclosures prescribed by SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure — an amendment to FASB Statement No. 123, Accounting for Stock- Based Compensation.

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     The following table illustrates the effect on net loss and loss per share if we had applied the fair value recognition provisions of SFAS No. 123 (in thousands, except per share data):

Net Income (Loss) Per Share and Pro Forma Net Loss Per Share

     Basic net income (loss) per share and basic pro forma net loss per share, as if we had applied the fair value recognition provisions of SFAS No. 123, are computed using the weighted average number of shares of common stock outstanding. Diluted net income (loss) per share and diluted pro forma net loss per share are computed using the weighted average number of shares of common stock and, when dilutive, potential shares from options to purchase common stock using the treasury stock method. Diluted net income (loss) per share and diluted pro forma net loss per share also give effect, when dilutive, to the conversion of our convertible debt, using the if-converted method.

     The following is a reconciliation of the number of shares used in both the basic and diluted income (loss) per share calculation and the proforma diluted income (loss) per share computations (in thousands):

     Weighted average options to purchase 7,335,516 and 9,687,120 shares of common stock at prices ranging from $0.57 to $46.75 and $0.56 to $59.38 were outstanding during the three months ended June 30, 2003 and 2002, respectively, and 9,754,457 and 7,195,145 shares of common stock at prices ranging from $0.57 to $46.75 and $0.56 to $59.38 were outstanding during the six months ended June 30, 2003 and 2002, respectively, but were excluded from the computation of diluted net loss per share if either the option’s exercise price was greater than the average market price of the common stock or inclusion of such options would have been anti-dilutive. Weighted average shares issuable upon conversion of convertible debt have been excluded for all periods presented because the inclusion of such shares would have been anti-dilutive.

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Deferred Stock-based Compensation

     The Company recorded deferred stock-based compensation totaling approximately $7.3 million related to the acquisition of eRoom Technology, Inc. This amount is amortized in accordance with Financial Accounting Standards Board Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans over the vesting period of the individual options.

Revenue Recognition

     Our revenue is derived from the sale of perpetual licenses for our enterprise content management solutions and related services, which include maintenance and support, consulting and education services. We recognize revenue in accordance with SOP 97-2, Software Revenue Recognition, as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions and related accounting literature. Revenue from license arrangements is recognized upon contract execution, provided all shipment obligations have been met, fees are fixed or determinable, and collection is determined as being probable. If an undelivered element of the arrangement exists under the license arrangement, a portion of revenue is deferred based on vendor-specific objective evidence of the fair value (VSOE) of the undelivered element until delivery occurs. If VSOE does not exist for all undelivered elements, all revenue is deferred until sufficient evidence exists or all elements have been delivered. We consider fees on transactions with payment terms of up to 270 days from the contract execution date to be fixed or determinable. In the event payment terms exceed 270 days, we recognize revenue when it becomes due and payable as we do not consider the fees to be fixed or determinable. We have a history of successfully collecting under the original payment terms for transactions with similar types of customers and similar economics, without providing concessions in arrangements with payment terms up to 270 days. License revenue from resellers or distributors is recognized, net of fees, when there is evidence of an arrangement with the end-user or we have executed a contract directly with the reseller or distributor which identifies the end-user, and all other revenue recognition criteria are met. Revenue from annual maintenance and support agreements are deferred and recognized on a straight-line basis over the term of the contract. Revenue from consulting and training services are recognized as the services are performed and are typically on a time and materials basis. Such services primarily consist of implementation services related to the installation of our products and do not include significant customization, modification, or development of the underlying software code.

     Our customers include several of our vendors and, on occasion, we have purchased goods or services for our operations from these vendors at or about the same time we have licensed our software to these same organizations (a “concurrent transaction”). Concurrent transactions are separately negotiated, settled in cash, and recorded at terms we consider to be arm’s length. We recognized no such transactions during the three and six months ended June 30, 2003. We recognized approximately $1.1 million and $2.1 million of software license revenues from concurrent transactions in the three and six months ended June 30, 2002, respectively.

Concentrations of Credit Risk

     Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash, marketable securities and accounts receivable. We deposit substantially all of our cash with four financial institutions.

     We generally do not require collateral for our accounts receivable and maintain reserves for potential credit losses. At June 30, 2003 and 2002, no one customer comprised 10% or more of accounts receivable.

     Our investment policy limits investments to low-risk instruments. All financial instruments are executed with financial institutions that have strong credit ratings, which minimizes risk of loss due to nonpayment.

Income Taxes

     We use the asset and liability method to account for income taxes. We are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating actual current tax liability together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are measured using

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enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period in which the enactment date occurred. We then assess the likelihood that deferred tax assets will be recovered from future taxable income, and to the extent we believe that recovery is not likely, we must establish a valuation allowance.

Fair Value of Financial Instruments

     The fair value of our cash and cash equivalents, marketable securities, receivables, accounts payable and accrued liabilities approximate their carrying value due to the short-term nature of these instruments. The fair values of our capital lease obligations approximate their carrying values based upon current market rates of interest. The fair value of our convertible debt was approximately $133.8 million at June 26, 2003 based on the most recent quoted market price of the convertible debt prior to June 30, 2003.

Advertising

     We expense the costs of advertising as such costs are incurred. Advertising costs of approximately $0.1 million for each of the three and six months ended June 30, 2003 and 2002, respectively, were included in sales and marketing expense in the accompanying Condensed Consolidated Statement of Operations.

Reclassifications

     Certain prior period amounts have been reclassified on the Condensed Consolidated Balance Sheet, Condensed Consolidated Statement of Operations and Condensed Consolidated Statement of Cash Flow to conform to the current period presentation.

Recent Accounting Pronouncements

     In May 2003, the FASB issued SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS 150 requires that certain financial instruments, which under previous guidance were accounted for as equity, must now be accounted for as liabilities. The financial instruments affected include mandatory redeemable stock, certain financial instruments that require or may require the issuer to buy back some of its shares in exchange for cash or other assets and certain obligations that can be settled with shares of stock. SFAS 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We do not expect the adoption of SFAS 150 to have a material impact on our consolidated financial position, results of operations or cash flows.

Note 3. Goodwill and Identifiable Purchased Intangible Assets

Goodwill

     The following table presents the changes in goodwill for our one reporting unit during the six months ended June 30, 2003 (in thousands):

     Adjustments to goodwill in the amount of approximately $0.1 million primarily related to purchase price adjustments that were made in connection with the acquisitions that were consummated during the fourth quarter of fiscal 2002.

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Identifiable Purchased Intangible Assets

     Amortization of identifiable purchased intangible assets with finite lives was approximately $3.2 million and $0.2 million for the three months ended June 30, 2003 and 2002, respectively, and approximately $6.6 million and $0.4 million for the six months ended June 30, 2003 and 2002, respectively. Of the approximately $6.6 million and $0.4 million of amortization expense recognized in the six months ended June 30, 2003 and 2002, respectively, approximately $5.4 million and $0.2 million, respectively, related to the amortization of technology related identifiable purchased intangible assets and was included as cost of license revenue in the respective periods. The remaining amortization of approximately $1.2 million and $0.2 million, respectively, related to the amortization of non-technology related identifiable purchased intangible assets and was recognized as operating expense in the six months ended June 30, 2003 and 2002, respectively.

Note 4. Convertible Debt

     On April 5, 2002, we sold $125.0 million (the “face value”) in senior convertible notes that mature on April 1, 2007 (the “Notes”). The Notes bear interest at a rate of 4.5% per annum. We received proceeds of $121.3 million, net of underwriter debt issuance costs of $3.7 million. We also incurred debt issuance costs totaling $0.4 million comprised of legal, accounting, and various other fees relating to the offering. Debt issuance costs are being amortized using the effective interest rate method through April 5, 2007. Holders of the Notes are entitled to convert the Notes, at any time after April 5, 2002, and before the close of business on April 1, 2007, subject to prior redemption or repurchase of the Notes, into shares of common stock at a conversion price of $30.02 per share. We may redeem the Notes on or after April 5, 2005. The Notes will effectively rank behind all other secured debt to the extent of the value of the assets securing those debts. The Notes do not contain any restrictive financial covenants.

Note 5. Restructuring Charges

     In January 2003, we adopted SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which provides guidance on the recognition and measurement of liabilities associated with exit or disposal activities and requires that such liabilities be recognized when incurred and establishes that fair value is the means for initial measurement of the liabilities. During the first quarter of 2003, we recognized approximately $11.0 million in estimated costs, net of sublease income, in the United States and Europe as a result of abandoning certain facilities. Approximately $10.1 million of the estimated costs are related to one large facility in Europe that management has determined would not be utilized going forward. We worked with external real estate experts in each of the markets where the properties are located to determine the best estimate of sublease income. We did not estimate any sublease income in connection with our exit of the facility in Europe that resulted in a $10.1 million restructuring charge. This determination was based on the various restrictions that are included in the existing lease agreement that limit our ability to sublease the facility. This determination was also impacted by current and forecasted commercial real estate rates in the area.

     In addition to these facilities exit costs, we also incurred approximately $1.3 million of severance and benefits-related restructuring costs in the first quarter of 2003 for the involuntary termination of 39 legacy Documentum employees, of which 36 were based in the United States and the remainder were located internationally. These charges were incurred as a result of management determining that certain synergies resulted from combining workforces that were assumed during our recent acquisition activity in fiscal 2002. Severance and benefit related costs associated with terminated employees of the acquired enterprise during the fourth quarter of fiscal 2002 were included in the cost of the respective acquisition.

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     The following table summarizes the components of the above restructuring charge, the cash payments, non-cash activities, and the remaining accrual as of and for the six months ended June 30, 2003 (in thousands):

     The remaining reserve balance of $9.8 million relating to the restructuring charge recognized during the six months ended June 30, 2003 consists of $2.6 million of current liabilities to be paid out during fiscal 2003 and in the first quarter of fiscal 2004 and $7.2 million of long-term liabilities related to the fair value of remaining lease obligations on excess facilities, net of sublease income, to be paid out through fiscal 2007.

     The remaining restructuring accrual relating to our restructuring activity in fiscal 2001 and 2002 of approximately $0.2 million relates to remaining severance and benefits and facility costs net of sublease income. We expect that the remaining severance and benefits will be paid in fiscal 2003 and the remaining facility obligations are expected to be paid in fiscal 2005.

Note 6. Comprehensive Income (Loss)

     Comprehensive income (loss) is comprised of net income (loss) and other non-owner changes in stockholders’ equity, including foreign currency translation gains or losses and unrealized gains or losses on available-for-sale marketable securities. Our total comprehensive income (loss) was as follows (in thousands):

Note 7. Segment Reporting

     We are principally engaged in the design, development, marketing and support of ECM solutions. Substantially all of our revenue results from the sale of our software products and related services. Our chief operating decision-making group reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenue by geographic region for purposes of making operating decisions and assessing financial performance. Accordingly, we consider ourselves to be in a single reporting segment, specifically the licensing, implementation and support of our software. We do not prepare reports for, or measure the performance of, our individual software applications and, accordingly, we have not presented revenue or any other related financial information by individual software product.

     We evaluate the performance of our geographic regions based on revenue and gross margin only. We do not assess the performance of our geographic regions on other measures of income or expense, such as depreciation and amortization, operating income or net income. Therefore, geographic information is presented for revenue, gross margin, and long-lived assets.

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     Revenue is generally attributable to geographic areas based on the country in which the customer is domiciled. For the three and six months ended June 30, 2003 and 2002, no one customer accounted for more than 10% of total revenues.

     Long-lived assets are attributable to geographic areas based on where the assets are located. The following table presents a breakdown of total revenue and long-lived assets by geographic region as of and for the three and six months ended June 30, 2003 and 2002 (in thousands):

Note 8. Subsequent Event

     On July 1, 2003 we renegotiated a third-party contract with an existing vendor which resulted in the release of $1.2 million of obligations that were accrued in previous periods and included in accrued liabilities. We recognized the benefit from this renegotiation in cost of service revenue during the three months ended June 30, 2003.

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

Forward-Looking Statements

The following discussion contains forward-looking statements regarding our business, prospects and results of operations that are subject to certain risks and uncertainties posed by many factors and events that could cause the our actual business, prospects and results of operations to differ materially from those that may be anticipated by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed herein as well as those discussed under the caption “Risk Factors”. When used in this report, the words “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “targets,” “estimates,” “looks for,” “looks to,” and similar expressions, as well as statements regarding our focus for the future, are generally intended to identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. We undertake no obligation to revise any forward-looking statements in order to reflect events or circumstances that may subsequently arise. Readers are urged to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks and factors that may affect our business.

Overview

     With a single platform, Documentum enables people to collaboratively create, manage, deliver, and archive unstructured content that drives critical business operations.

     We provide enterprise content management (ECM) solutions that enable organizations to unite teams, content and associated business processes. Our integrated set of content, compliance and collaboration solutions support the way people work, from initial discussion and planning through design, production, marketing, sales, service and corporate administration. This business-critical content includes everything from documents and discussions to email, Web pages, records and rich media. The Documentum platform makes it possible for companies to distribute all of this content across internal and external systems, applications and user communities. As a result, our customers are able to harness corporate knowledge, accelerate their time to market, increase customer satisfaction, enhance supply chain efficiencies and reduce operating costs, thereby improving their overall competitive advantage.

     From our inception in 1990 through December 1992, our activities consisted primarily of developing products, establishing infrastructure and conducting market research. We shipped the first commercial version of our Documentum Server product in late 1992, and since that time substantially all of our revenue has been from licenses of our family of ECM system products and related services, which include maintenance and support, education and consulting services.

     Since 1993, we have delivered products that enable management of business-critical content and knowledge sharing within an enterprise. These solutions have been largely applied toward accelerating business processes that reduce new product time to market and time to revenue as well as ensure compliance in highly regulated industries. We are leveraging our substantial experience in managing dynamic content for business-critical documents and extending it to facilitate e-business connections.

     In fiscal 1999, we evolved from focusing on enterprise document management to focusing on content management to power e-business. As the Internet evolved, we helped existing and new customers alike leverage the Web to conduct business by extending our platform to enable Web content management. Since that time, we have focused mainly on providing a complete content management solution — the ability to manage all of the information that exists inside a company, whether through enterprise document management or Web content management, and the use of that information to drive e-business initiatives aimed at customers, partners and employees. Increasingly, our ECM solutions are being used to accelerate and extend companies’ online presence by delivering active and trusted content to multiple channels. Today, these solutions enable more than 2,500 organizations worldwide to apply trusted content within and between organizations, driving e-business applications that connect employees, customers and business partners. To facilitate this evolution, we introduced Documentum 4i, an open, standards-based ECM platform, in 1999. Because it is an open, standards-based platform, developers outside Documentum are able to easily integrate with the product using the standard set of tools, resulting in a larger number of developers

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working to build applications on top of our platform. This platform allows for the creation, management and delivery of content to a wide variety of information devices, including the Web, cellular phone, pager, fax machine, printer, CD or PDA device.

     In 2000 and 2001, we introduced four packaged solutions (formerly called “Editions” by us) based on our 4i platform. These solutions — Web Content Management, Portal Content Management, B2B Content Management, and Compliance Content Management — offer a tailored mix of core technology from Documentum 4i that can manage volumes of content. Early in 2002, a fifth solution — Digital Asset Management— was released, and later in the year we introduced Documentum 5, the next version of our ECM platform, which enables collaboration, communication, compliance and knowledge-sharing on a global scale. Incorporated within the newly released Documentum 5 platform are two of our newest products — Documentum eRoom Enterprise and Documentum Records Manager. Documentum eRoom Enterprise is the foundation of the now available Collaboration solution, which brings together people, processes, and content with a digital, collaborative workplace. Enterprise Records Management solution was also introduced, featuring Documentum Records Manager as an integrated records management solution that equips organizations to create, safeguard, and access necessary records, relate them to relevant business content, and archive or destroy records according to system-enforced administrative, regulatory, or legal rules. We continue to invest in research and development in order to update our family of products and expand our market focus to deliver products to provide an ECM solution for customers, partners, and employees.

     We will continue to license and support the Documentum 4i platform, however, we expect that license and service revenue from Documentum 5 and newer product offerings will account for substantially all of our revenue for the foreseeable future.

Strategic Acquisitions

     On November 26, 2002, we acquired privately-held TrueArc Corporation in exchange for consideration totaling approximately $3.8 million, which was comprised of cash consideration of $3.6 million and approximately $0.2 million in acquisition costs. TrueArc was a provider of records management and digital preservation software allowing companies to manage physical and electronic records. Since the time of the acquisition, we have integrated the records management technology acquired in this transaction and the product (currently called Documentum Records Manager) is now part of our comprehensive suite of enterprise content management solutions.

     On December 10, 2002, we acquired privately-held eRoom Technology, Inc. in exchange for consideration totaling approximately $118.4 million, which was comprised of 7,772,708 shares of common stock valued at $90.8 million (share value was calculated using an average five-day stock price extending two days before and two days after the terms of the acquisition were publicly announced), cash of $12.6 million, issuance of options to purchase 1,605,108 shares of Documentum common stock valued at approximately $8.1 million, and direct acquisition costs of approximately $6.9 million. eRoom was a provider of business collaboration software products enabling organizations and their employees, customers, suppliers, and other partners to manage their business relationships over the Internet. Since the time of the acquisition, we have integrated the collaboration technology acquired in this transaction and the product (currently called Documentum eRoom Enterprise) is now part of our comprehensive suite of enterprise content management solutions. During the six months ended June 30, 2003, we made acquisition-related payments of approximately $12.1 million which are included in cash used in investing activity in the Condensed Consolidated Statement of Cash Flow.

Critical Accounting Policies and Estimates

     Our significant accounting policies are more fully described in Note 2 of Notes to Consolidated Financial Statements included in our 2002 Annual Report on Form 10-K. However, certain of our accounting policies are particularly important to obtaining an understanding of our financial position and results of operations. Application of many of these policies requires our management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses related disclosures. In general, these estimates or judgments are based on historical experience of our management, prevailing industry trends, information provided by our customers, and information available from other outside sources, each as appropriate. Actual results may differ from these estimates under different conditions. We consider our most critical accounting policies to be those policies that are both most important to the portrayal of our financial condition and results of operations, and those that require our management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about matters that are inherently uncertain at the time of estimation. We believe the following critical accounting policies

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affect our more significant judgments and estimates used in the preparation of our Unaudited Condensed Consolidated Financial Statements.

Revenue Recognition

     Our revenue is derived from the sale of perpetual licenses for our enterprise content management solutions and related services, which include maintenance and support, consulting and education services. We recognize revenue in accordance with SOP 97-2, Software Revenue Recognition, as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions and related accounting literature. Revenue from license arrangements is recognized upon contract execution, provided all shipment obligations have been met, fees are fixed or determinable, and collection is determined as being probable. If an undelivered element of the arrangement exists under the license arrangement, a portion of revenue is deferred based on vendor-specific objective evidence of the fair value (VSOE) of the undelivered element until delivery occurs. If VSOE does not exist for all undelivered elements, all revenue is deferred until sufficient evidence exists or all elements have been delivered. We consider fees on transactions with payment terms of up to 270 days from the contract execution date to be fixed or determinable. In the event payment terms exceed 270 days, we recognize revenue when it becomes due and payable as we do not consider the fees to be fixed or determinable. We have a history of successfully collecting under the original payment terms for transactions with similar types of customers and similar economics, without providing concessions in arrangements with payment terms up to 270 days. License revenue from resellers or distributors is recognized, net of fees, when there is evidence of an arrangement with the end-user or we have executed a contract directly with the reseller or distributor which identifies the end-user, and all other revenue recognition criteria are met. Revenue from annual maintenance and support agreements are deferred and recognized on a straight-line basis over the term of the contract. Revenue from consulting and training services are recognized as the services are performed and are typically on a time and materials basis. Such services primarily consist of implementation services related to the installation of our products and do not include significant customization, modification, or development of the underlying software code.

Allowances

     We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We analyze accounts receivable and historical bad debts, customer concentrations, customer creditworthiness, current economic trends and changes in customer payment terms and practices when evaluating the adequacy of the allowance for doubtful accounts. If the financial condition of our customers was to improve or deteriorate, revision to the allowance may be required. To date, actual experience has been consistent with our estimates.

Accounting for Income Taxes

     We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of the net recorded amount, an adjustment to the deferred tax asset would increase net income in the period such determination was made if the adjustment was related to normal operating expenses. If a future adjustment to the valuation allowance were to relate to a deferred tax item resulting from stock-based compensation, the adjustment to the deferred tax asset would increase additional paid-in capital. Similarly, if a future adjustment to the valuation allowance were attributable to one or more of the acquired companies, the adjustment to the deferred tax asset would result in an increase to goodwill. Likewise, should we determine that we would not be able to realize all or part of our net deferred tax asset in the future related to normal operating expenses, an adjustment to the deferred tax asset would be charged to income in the period such determination was made.

Goodwill and Purchased Intangibles

     Goodwill and purchased intangible assets are stated at cost less accumulated amortization. Goodwill represents the excess of costs over fair value of assets of businesses acquired. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead are

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tested annually for impairment and more frequently if events and circumstances indicate that the assets might be impaired in accordance with the provisions of SFAS No. 142. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. We expect to complete our annual impairment review during the third quarter of 2003.

     Purchased intangible assets with definite lives are amortized on a straight-line basis over the remaining estimated economic life of the underlying products and technologies (original lives assigned are one to five years) and reviewed for impairment in accordance with SFAS No. 144, Accounting for Impairment or Disposal of Long-Lived Assets.

Long-lived Assets, Excluding Goodwill

     Our long-lived assets consist of property and equipment and other acquired intangibles, excluding goodwill. We periodically review our long-lived assets for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. For assets to be held and used, we initiate our review whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. Recoverability of an asset group is measured by comparison of its carrying amount to the expected future undiscounted net cash flows (without interest charges) that the asset group is expected to generate. If it is determined that an asset group is not recoverable, an impairment loss is recorded in the amount by which the carrying amount of the asset group exceeds its fair value.

     Assets to be disposed of and for which we have committed to a plan to dispose of the assets, whether through sale or abandonment, are reported at the lower of their carrying amount or fair value less cost to sell.

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Results of Operations

The following table sets forth the condensed consolidated statement of operations expressed as a percentage of total revenue for the periods indicated: