INTERWOVEN INC - 10-Q Quarterly Report

x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

¨ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

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 Exchange Act Rule 12b-2). Yes x No ¨

There were 102,915,202 shares of the Registrant’s common stock, par value $0.001, outstanding on May 1, 2003.

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

The interim unaudited condensed consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly the Company’s financial position and results of operations and cash flows for the three months ended March 31, 2003 and 2002. These unaudited condensed consolidated financial statements and notes thereto should be read in conjunction with the Company’s audited financial statements and related notes included in the Company’s 2002 Annual Report on Form 10-K. The results of operations for the three months ended March 31, 2003 are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year.

Revenue consists principally of fees for licenses of the Company’s software products, maintenance, consulting and training. The Company recognizes revenue using the residual method in accordance with Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” as amended by SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions.” Under the residual method, revenue is recognized in a multiple element arrangement in which company-specific objective evidence of fair value exists for all of the undelivered elements in the arrangement, but does not exist for one or more of the delivered elements in the arrangement. Company-specific objective evidence of fair value of maintenance and other services is based on the Company’s customary pricing for such maintenance and/or services when sold separately. At the outset of the arrangement with the customer, the Company defers revenue for the fair value of its undelivered elements (e.g., maintenance, consulting and training) and recognizes revenue for the remainder of the arrangement fee attributable to the elements initially delivered in the arrangement (i.e., software product) when the basic criteria in SOP 97-2 have been met. If such evidence of fair value for each undelivered element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value does exist or until all elements of the arrangement are delivered.

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

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

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

The fee is fixed or determinable. If at the outset of the customer arrangement, the Company determines that the arrangement fee is not fixed or determinable, revenue is recognized when the arrangement fee becomes due and payable. Fees due under an arrangement are generally deemed not to be fixed or determinable if a

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

significant portion of the fee is beyond the Company’s normal payment terms, which are generally no greater than 180 days from the date of invoice.

Collectibility is probable. The Company determines whether collectibility is probable on a case-by-case basis. When assessing probability of collection, the Company considers the number of years in business, history of collection, and product acceptance for each customer within each geographic sales region. The Company typically sells to customers, for whom there is a history of successful collection. New customers are subject to a credit review process, which evaluates the customer’s financial position and ultimately their ability to pay. If the Company determines from the outset of an arrangement that collectibility is not probable based upon its review process, revenue is recognized as payments are received.

Due to the Company’s relatively limited operating history outside of the United States, the Company generally defers revenue recognition on sales outside of the United States until cash is collected or when a letter of credit is obtained. However, the Company recognizes revenue from sales occurring in Northern Europe and Australia upon the signing of the contract and shipment of the product, assuming all other revenue recognition criteria have been met because its history of collections and the development of its sales infrastructure in those regions allow it to ascertain that collection is probable. The Company expects to continually assess the appropriateness of revenue recognition on sales agreements in other geographic locations once it has developed an adequate infrastructure and collections history for customers in those regions.

The Company allocates revenue on software arrangements involving multiple elements to each element based on the relative fair value of each element. The Company’s determination of fair value of each element in multiple-element arrangements is based on vendor-specific objective evidence (“VSOE”). The Company limits its assessment of VSOE for each element to the price charged when the same element is sold separately. The Company has analyzed all of the elements included in its multiple-element arrangements and determined that it has sufficient VSOE to allocate revenue to the maintenance, support and professional services components of its perpetual license arrangements. The Company sells its professional services separately, and has established VSOE on this basis. VSOE for maintenance and support is determined based upon the customer’s annual renewal rates for these elements. Accordingly, assuming all other revenue recognition criteria are met, revenue from perpetual licenses is recognized upon delivery using the residual method in accordance with SOP 98-9, and revenue from maintenance and support services is recognized ratably over their respective terms. The Company recognizes revenue from time-based licenses ratably over the license terms as the Company does not have VSOE for the individual elements in these arrangements.

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

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

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

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

The Company has five stock-based employee compensation plans and accounts for those plans under the recognition and measurement principles of Accounting Principles Board “APB” Opinion No. 25, “Accounting for Stock Issued to Employees”, and related Interpretations. In connection with stock options granted and assumed through acquisitions, the Company recorded deferred stock-based compensation which is being amortized over the vesting periods of the applicable options. Amortization expense recognized during the three months ended March 31, 2003 and 2002 totaled $514,000 and $3.2 million, respectively. The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of Statements of Financial Accounting Standard (“SFAS”) No. 123, “Accounting for Stock-Based Compensation”, to stock-based employee compensation. The following table presents the pro forma information (in thousands, except per share amounts):

The Company calculated the fair value of each option grant on the date of grant and stock purchase right using the Black-Scholes option-pricing model as prescribed by SFAS No. 123 using the following assumptions:

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Amortization of deferred stock-based compensation is attributable to the following categories (in thousands):

For the three months ended March 31, 2003, comprehensive loss of $9.1 million consists of $15,000 net unrealized investment gain and $9.1 million net loss. For the three months ended March 31, 2002, comprehensive loss of $16.0 million consists of $332,000 net unrealized investment loss and $15.7 million net loss.

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

The Company computes net loss per share in accordance with SFAS No. 128, “Earnings per Share”. The following is a reconciliation of the numerators and denominators used in computing basic and diluted net loss per share (in thousands, except per share amounts):

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The following table sets forth potential shares of common stock that are not included in the diluted net loss per share calculation above, as their effect would have been antidilutive for the periods indicated (in thousands):

In July 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 revises the accounting for specified employee and contract terminations that are part of restructuring activities. Companies will be allowed to record a liability for a cost associated with an exit or disposal activity only when the liability is incurred and can be measured at fair value. The Company is required to adopt this statement for exit or disposal activities initiated after December 31, 2002. The Company adopted SFAS No. 146 on January 1, 2003. The adoption of SFAS No. 146 did not have a material impact on its financial position and results of operations.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure”. SFAS No. 148 amends FASB Statement No. 123, “Accounting for Stock-Based Compensation”, to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. It also requires additional disclosures about the effects on reported net income of an entity’s accounting policy with respect to stock-based employee compensation. The Company adopted the annual disclosure requirements of SFAS No. 148 during the year ended December 31, 2002. The Company adopted the interim disclosure requirements of SFAS No. 148 during the three months ended March 31, 2003.

In November 2002, the FASB issued FASB Interpretation No. 45, “Guarantors Accounting and Disclosure Requirement for Guarantors, including Indirect Guarantors of Indebtedness Others” (“FIN 45”). FIN 45 creates new disclosure and liability recognition requirements for certain guarantees, including obligations to stand ready to perform. The initial recognition and measurement requirements of FIN 45 are effective prospectively for guarantees issued or modified after December 31, 2002 and the disclosure requirements are effective for financial statement periods ending after December 15, 2002. The Company had no existing guarantees as of March 31, 2003, and the Company does not expect that the adoption of FIN 45 will have a material impact on its financial position or results of operations.

Indemnification and warranty provisions contained within the Company’s license and service agreements are generally consistent with those prevalent in its industry. The duration of the Company’s product warranties generally does not exceed 90 days following delivery of its products. The Company has not incurred significant obligations under customer indemnification or warranty provisions historically and does not expect to incur significant obligations in the future. Accordingly, the Company does not maintain accruals for potential customer indemnification or warranty-related obligations.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The following table provides information relating to the intangible and other assets contained within the Company’s unaudited condensed consolidated balance sheets as of March 31, 2003 and December 31, 2002 (in thousands):

The Company expects that annual amortization of acquired intangible assets to be $1.3 million for the remainder of 2003, $1.5 million in 2004 and $74,000 in 2005.

Due to the continuing economic slowdown, during 2002 and 2003, the Company implemented a series of restructuring and facility consolidation plans to improve its operating performance in light of the global reduction in spending on information technology initiatives. Restructuring and facilities consolidation costs consist of workforce reductions, the consolidation of excess facilities and the impairment of leasehold improvements and other equipment associated with abandoned facilities.

During the three months ended March 31, 2002, the Company implemented a restructuring plan in an effort to better align its expenses and revenues in light of the continued economic slowdown. These cost saving efforts resulted in the termination of 94 employees worldwide, throughout all functional areas. The Company recorded charges of $1.2 million associated with involuntary terminations, which included severance costs. The workforce reductions associated with this plan were substantially completed as of December 31, 2002

During the three months ended March 31, 2003, the Company implemented additional restructuring plans in an effort to better align its expenses and revenues in light of the continued economic slowdown. These cost saving efforts resulted in the termination of 18 employees worldwide, throughout all functional areas. The Company recorded charges of $1.1 million associated with involuntary terminations. The workforce reductions associated with this plan were substantially completed as of March 31, 2003, and $804,000 was accrued at March 31, 2003, associated with future severance payments for associated plans.

During 2002, as a result of reduced staffing levels, the Company performed an evaluation of its current facilities requirements and identified additional facilities that were in excess of current and estimated future needs. As a result of this analysis, the Company recorded $24.1 million in lease abandonment charges associated with excess facilities. It also evaluated operating equipment and leasehold improvements associated with these facilities to identify those assets that had suffered a reduction in their economic useful lives. Based on these

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

evaluations, the Company incurred charges of $1.2 million associated with the impairment of leasehold improvements and certain operating equipment associated with the abandoned facilities. Additionally, due to the deterioration of the commercial real estate market, the Company revised its assumptions regarding future sublease income for certain facilities previously abandoned in 2001. As a result, the Company reduced its estimates regarding sublease income and recorded an additional $4.7 million in charges to reflect this change in estimate. At March 31, 2003, $36.8 million had been accrued associated with facility consolidation plans and is payable through 2010. The facilities charges were an estimate as of March 31, 2003. The Company will reassess this liability each period based on current market conditions and revisions to the estimates of these liabilities could materially impact the Company’s operating results and financial position in future periods if anticipated events and key assumptions, such as the timing and amounts of sublease rental income change from previous estimates.

The restructuring costs and excess facility charges the Company has incurred to date have had a material impact on its results of operations and will require additional payments in future periods. The following table summarizes our estimated payments associated with these charges as of March 31, 2003 (in thousands):

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

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or group, in deciding how to allocate resources and in assessing performance.

The Company’s chief operating decision maker, the chief executive officer, reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenues by geographic region for purposes of making operating decisions and assessing financial performance. Accordingly, the Company considers itself to be in a single industry segment, specifically the license, implementation and support of its software applications.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Information regarding revenues for the three months ended March 31, 2003 and 2002, and information regarding long-lived assets in geographic areas as of March 31, 2003 and December 31, 2002, are as follows (in thousands):

On November 8, 2001, the Company and certain of its officers and directors and certain investment banking firms, were named as defendants in a purported securities class-action lawsuit filed in the United States District Court Southern District of New York. The complaint asserts that the prospectuses for the Company’s October 8, 1999 initial public offering and the Company’s January 26, 2000 follow-on public offering failed to disclose certain alleged actions by the underwriters for the offerings. The complaint alleges claims under Section 11 and 15 of the Securities Act of 1933 against the Company and certain of its officers and directors. The plaintiff seeks damages in an unspecified amount. On February 19, 2003, the District Court denied a motion to dismiss all claims brought collectively by the issuers and investment banks. The Company continues to believe this lawsuit is without merit and intends to defend itself vigorously. However, an unfavorable resolution of such suit could significantly harm the Company’s business, operating results and financial condition. The Company is participating in a mediation and certain settlement proposals are under consideration that could mitigate the risk of an unfavorable resolution in litigation. There can be no guarantee that the parties will be able to reach agreement on either a partial dismissal or a global resolution of the claims against the Company.

In addition to the matters mentioned above, the Company has been named as a defendant in various employment related lawsuits that have arisen in the ordinary course of business. In the opinion of management, the outcome of such lawsuits will not have a material effect on the financial statements of the Company.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Some of the statements contained in this report constitute forward-looking statements that involve substantial risks and uncertainties. In some cases, you can identify these statements by forward-looking words such as “may,” “will,” “should,” “expect,” “anticipate,” “believe,” “estimate” or “continue” and variations of these words or comparable words. In addition, any statements which refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. Our Management’s Discussion and Analysis of Financial Condition and Results of Operations contains many such forward-looking statements. For example, we make projections regarding future revenues, gross profit, and various operating expense items, as well as future liquidity. These forward-looking statements involve known and unknown risks, uncertainties and situations that may cause our or our industry’s actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. The risk factors contained in this report, as well as any other cautionary language in this report, provide examples of risks, uncertainties and events that may cause our actual results to differ from the expectations described or implied in our forward-looking statements. Readers are urged to review and consider carefully our various disclosures, in this report and in our Annual Report on Form 10-K, that advise of risks and uncertainties that affect our business.

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. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this report. Except as required by law, we do not undertake to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

As a result of our limited operating history and the rapidly evolving nature of the market for content management software and services, it is difficult for us to accurately forecast our revenues or earnings. It is possible that in some future periods our results of operations may not meet management’s projections, or expectations of securities analysts and investors. If this occurs, the price of our common stock is likely to decline. Factors that have caused our results to fluctuate in the past, and are likely to cause fluctuations in the future, include:

The following discussion and analysis of the financial condition and results of operations should be read in conjunction with our financial statements and notes appearing elsewhere in this report.

Interwoven was incorporated in March 1995, to provide software products and services for enterprise content management. Our software products and services help customers automate the process of developing, managing and deploying content assets used in business applications. The information technology industry refers to this process as “content management.” Our products are designed to allow all content contributors within an organization to create, manage and deploy content assets, such as documents, XML/HTML, rich media, database content and application code. In May 1997, we shipped the first version of our principal product, TeamSite. We have subsequently developed and released enhanced versions of TeamSite and have introduced related products to compliment our content management offerings. As of March 31, 2003, we had sold our products and services to over 1,100 customers. We market and sell our products primarily through a direct sales force and augment our sales efforts through relationships with systems integrators and other strategic partners. Our revenues to date have been derived primarily from accounts in North America; however, revenues from outside of North America represented 36% and 35% of our revenues during the three months ended March 31, 2003 and 2002, respectively. We are headquartered in Sunnyvale, California and maintain additional offices in the metropolitan areas of Atlanta, Boston, Chicago, Columbus, Dallas, Los Angeles, New York City, San Francisco, Seattle and Washington, D.C. In addition, we have offices in Australia, Canada, France, Germany, Hong Kong, Italy, Japan, Netherlands, Norway, Singapore, South Korea, Spain, Sweden, Taiwan and the United Kingdom. We had 585 employees as of March 31, 2003.

We have incurred substantial costs to develop our technology and products, to recruit and train personnel for our engineering, sales and marketing and services organizations, and to establish our administrative organization. As a result, we incurred net losses through December 31, 2002 and had an accumulated deficit of $335.8 million as of December 31, 2002. We have experienced declining revenues since 2001 due to the continued economic slowdown that has resulted in substantial reductions in spending on information technology initiatives, to increased competition from other enterprise software firms and to the loss of services revenues to system integrators. We expect the current economic slowdown and the competitive business environment to affect our business for the foreseeable future. We will continue to make a concerted effort to manage costs to align our revenues and our expenses. In light of the current business environment and as a result of our cost management efforts, we do not anticipate a significant increase in our expenses in the foreseeable future. However, due to our limited operating history and the weakness of the current economic environment, the prediction of future results is difficult and, accordingly, we cannot assure you that we will achieve or sustain profitability. We expect to make acquisitions in the future, thereby potentially reducing our cash and cash equivalents and incurring stock-based compensation and intangible amortization charges, which would increase our reported losses, including non-cash expenses.

In connection with our earnings releases and investor conference calls, we provide supplemental consolidated financial information that excludes from our reported earnings and earnings per share, the effects of expenses such as the amortization of deferred stock-based compensation, amortization of acquired intangibles, in-process research and development, restructuring and excess facilities charges and impairment of goodwill. This supplemental consolidated financial information is reported as pro forma net loss and pro forma net loss per share in addition to information that is reported based on generally accepted accounting principles in the United States (“GAAP”). We believe that such pro forma information provides investors with a more meaningful measure of our operations because it excludes certain non-cash expenses and other expenses that we believe are not indicative of our on-going operations. However, we urge readers to review and consider carefully the GAAP financial information contained within in our earnings releases.

We derive revenues from the license of our software products and from services that we provide to our customers.

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

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

At the outset of our customer arrangements, if we determine that the arrangement fee is not fixed or determinable, we recognize revenue when the arrangement fee becomes due and payable. We assess whether the fee is fixed or determinable based on the payment terms associated with each transaction. If a significant portion of a fee is due beyond our normal payments terms, which generally does not exceed 180 days from the invoice date, we do not consider the fee to be fixed or determinable. In these cases, we recognize revenue as the fees become due. We do not offer product return rights to resellers or end users. We determine collectibility on a case-by-case basis, following analysis of the general payment history within the geographic sales region and a customer’s years of operation, payment history and credit profile. If we determine from the outset of an arrangement that collectibility is not probable based upon our review process, we recognize revenue as payments are received. In general, for sales occurring outside of the United States, we defer recognition of revenue until cash is collected or when a letter of credit is obtained, because in most countries we do not have a sufficient operating history to determine whether collectibility is probable. However, we recognize revenue from our customers in Northern Europe and Australia upon the signing of the contract and shipment of the product, assuming all other revenue recognition criteria have been met. Our history of collections and development of sale infrastructure in those regions enables us to determine that collectibility is probable in those areas. We expect to continually assess the appropriateness of revenue recognition on sales agreements in other geographic locations as our sales infrastructure matures, and our collections history improves, in those regions.

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

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

Due to the continuing economic slowdown, we implemented a series of restructuring and facility consolidation plans to improve our operating performance in light of the global reduction in spending on information technology initiatives. Restructuring and facilities consolidation costs consist of expenses associated with workforce reductions, consolidation of excess facilities and the impairment of leasehold improvements and other equipment associated with abandoned facilities.

During the three months ended March 31, 2003, we implemented a restructuring plan that resulted in the termination of 18 employees worldwide, in all functional areas. As result of our restructuring plan, we recorded a charge of $1.1 million associated with involuntary termination benefits including severance costs. The workforce reductions associated with this plan were substantially completed as of March 31, 2003, and $804,000 was accrued at March 31, 2003, associated with future severance payments.

During the three months ended March 31, 2002, we implemented a restructuring plan in an effort to better align our expenses and revenues in light of the continued economic slowdown. These cost saving efforts resulted in the termination of 94 employees worldwide, in all functional areas. As result of this plan, we recorded a charge of $1.2 million associated with involuntary termination benefits including severance costs. The workforce reductions associated with this plan were completed as of December 31, 2002.

During 2002, as a result of our reduced staffing levels, we performed an evaluation of our current facilities requirements and identified additional facilities that were in excess of our current and estimated future needs. As a result of this analysis, we recorded $24.1 million in lease abandonment charges associated with identified excess facilities, which primarily consisted of domestic sales offices. We also evaluated operating equipment and leasehold improvements associated with these facilities to identify those assets that had suffered a reduction in their economic useful lives. Based on these evaluations, we incurred charges of $1.2 million associated with the impairment of leasehold improvements and certain operating equipment associated with the abandoned facilities. Additionally, due to the deterioration of the commercial real estate market, after receiving independent appraisals from real estate brokers to estimate such lease rates, we revised our assumptions regarding future sublease income for certain facilities previously abandoned in 2001. As a result, we reduced our estimates regarding sublease income and recorded an additional $4.7 million in charges to reflect this change in estimate. At March 31, 2003, $36.8 million had been accrued associated with facility consolidation plans and is payable through 2010. The facilities charges were an estimate as of March 31, 2003. We reassess this estimated liability each period based on current market conditions. Revisions to our estimated liabilities could materially impact our operating results and financial position in future periods if anticipated events and key assumptions, such as the timing and amounts of sublease rental income change from previous estimates, are different from expected. We expect to revise the estimated liability if necessary.

The restructuring costs and excess facilities charges we have incurred to date have had a material impact on our results of operations and will require additional payments in future periods. The following table summarizes our estimated payments associated with these charges (in thousands):

We have acquired four corporations since our inception. Under GAAP, we have accounted for these business combinations using the purchase method of accounting and recorded the market value of our common stock and options issued in connection with these acquisitions and the related amount of direct transaction costs as the cost of acquiring these entities. These costs are allocated among the individual assets acquired and liabilities assumed, including goodwill and various identifiable intangible assets such as, in-process research and development, acquired technology and covenants not to compete, based on their respective fair values. We allocated the amount by which the purchase price exceeded the fair value of the net identifiable assets to goodwill. The impact of purchase accounting on our results of operations has been significant. Amortization of intangibles assets associated with business acquisitions were $442,000 and $1.2 million during the three months ended March 31, 2003 and 2002, respectively. In September 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 142 “Goodwill and Other Intangible Assets”, which became effective for us on January 1, 2002. Under SFAS No. 142, we ceased amortizing $148.2 million of goodwill as of January 1, 2002. Additionally, during 2002, we reclassified to deferred stock-based compensation $1.2 million of goodwill recorded in connection with our acquisition of Neonyoyo, Inc. In lieu of amortization of goodwill, we performed a transitional impairment test of our goodwill on January 1, 2002, and annual impairment testing thereafter.

We assess the impairment of identifiable intangibles, long-lived assets and related goodwill from time to time as changes in circumstances indicate that the carrying value may not be recoverable. We consider key indicators of impairment to include:

We have determined that we have one reporting unit for evaluation under SFAS No. 142. When determining if the carrying value of our goodwill is impaired, we perform a two-step process. First, we will compare the estimated fair value of our reporting unit to its carrying value, including goodwill. Second, if the carrying value exceeds the fair value of the reporting unit, then the implied fair value of the reporting unit’s goodwill will be determined and compared to the carrying value of the goodwill. The implied fair value of goodwill is determined

by allocating the fair value of all of the reporting unit’s assets and liabilities as if the reporting unit had been newly acquired in a business combination as described above. If the carrying value of the reporting unit’s goodwill exceeds its implied fair value, then an impairment charge will be recognized equal to the difference of the computed and recorded amounts.

During the three months ended September 30, 2002, we completed our annual impairment testing. Using the steps mentioned above to determine the estimated fair value of goodwill, we determined that goodwill had been impaired as of the valuation date. Accordingly, we recorded a goodwill impairment charge of $76.4 million during the three months ended September 30, 2002. In performing our testing, we were required to make estimates regarding future operating trends and other variables used in the analysis. Actual future results could differ from the estimates used in the analysis.

We are also required to assess goodwill for impairment on an interim basis when indicators exist that goodwill may be impaired based on the factors mentioned above. As a result of the conditions that have affected the stock markets in 2002, our market capitalization has declined. As of March 31, 2003, our net book value exceeded our market capitalization. If a sustained decline in our stock price continues, this decline would be considered an indicator that goodwill may be impaired. A significant impairment could result in additional charges and have a material adverse impact our financial position and operating results.

We have recorded deferred compensation liabilities related to options assumed and restricted shares issued to effect business combinations, options granted below fair market value associated with our initial public offering in October 1999.

The following table reflects the prospective impact of all deferred compensation costs and the annual amortization of purchased intangibles (other than goodwill) attributable to our mergers and acquisitions that have occurred since our inception (in thousands):

The amortization expense related to the intangible assets acquired may be accelerated in the future if we reduce the estimated useful life of the intangible assets. Intangible assets may become impaired in the future if expected cash flows to be generated by these assets decline.

Accounts receivable are recorded net of allowance for doubtful accounts and sales return reserves in the amount of $1.9 million at both March 31, 2003 and December 31, 2002. We regularly review the adequacy of our allowances through identification of specific receivables where we expect that payment will not be received, and we have established a general reserve policy that is applied to all amounts that are not specifically identified. In determining specific receivables where collection may not be received, we review past due receivables and give consideration to prior collection history, changes in the customer’s overall business condition and the potential risk associated with the customer’s industry among other factors. We establish a general reserve for all receivable amounts that have not been specifically identified by applying a percentage based on historical collection experience. We establish a general reserve for sales returns by applying a historical percentage based on our license and services revenues activity. The allowances reflect our best estimate as of the reporting dates. Changes may occur in the future, which may make us reassess the collectibility of amounts and at which time we may need to provide additional allowances in excess of that currently provided.

The following table lists, for the periods indicated, our statement of operations data as a percentage of total revenues:

Revenues. Total revenues decreased 22% from $32.7 million for the three months ended March 31, 2002 to $25.6 million for the three months ended March 31, 2003. This decrease in revenues was primarily attributable to the continued worldwide economic slowdown which has resulted in a substantial reduction in overall spending on information technology initiatives, as well as increased competition from other enterprise software firms. We also experienced a decrease in our average selling prices due to general pricing pressures, a sustained shift to a greater number of smaller dollar value agreements accounting for a larger percentage of our total revenue, and the loss of service revenues to systems integrators. We expect this economic slowdown to continue to adversely affect our business for the foreseeable future.

License. License revenues decreased 39% from $14.9 million for the three months ended March 31, 2002 to $9.2 million in the three months ended March 31, 2003. License revenues represented 46% and 36% of total revenues, respectively, in those periods. The decrease in license revenues as a percentage of total revenues and in absolute dollars was primarily attributable to the effect of lengthy deferrals of purchasing decisions or increased delays in customer spending, which we believe was caused by the general slowdown in the worldwide economy.

Services. Services revenues decreased 7% from $17.7 million for the three months ended March 31, 2002 to $16.4 million for the three months ended March 31, 2003. Services revenues represented 54% and 64% of total

revenues, respectively, in those periods. The decrease in services revenues reflects a $1.6 million decrease in professional service revenues, primarily attributable to a sustained shift by our customers to using more systems integrators to perform customer implementations and a decline in selling prices of professional services as a result of general pricing pressures.

License. Cost of license revenues includes expenses incurred to manufacture, package and distribute our software products and related documentation, as well as costs of licensing third-party software sold in conjunction with our software products. Cost of license revenues decreased 26% from $948,000 for the three months ended March 31, 2002 to $702,000 for the three months ended March 31, 2003. Cost of license revenues represented 6% and 8%, respectively, of license revenues in those periods. The decrease in cost of license revenues was attributable to a decrease in costs associated with purchases of third-party software and royalties paid during the period and a decrease in license revenues.

We expect cost of license revenues as a percentage of license revenues to vary from period to period depending primarily on the fluctuations in the amount of royalties paid to third parties and purchases of third-party software incorporated into our product offerings.

Services. Cost of services revenues consist primarily of salary and related costs of our professional services, training, support personnel and subcontractor expenses. Cost of services revenues decreased 21% from $10.0 million for the three months ended March 31, 2002 to $7.9 million for the three months ended March 31, 2003. This decrease was primarily attributable to a decrease in personnel costs as a result of reduced staffing within in our internal services organization as we continue to rely on systems integrators to perform customer implementations and employ other costs savings strategies. Cost of services revenues represented 56% and 48% of services revenues, respectively, in those periods. The decrease in cost of services revenues as a percentage of services revenues is primarily attributable to an increase in maintenance revenues as a percentage of services revenues, as maintenance revenues generally have lower costs associated with them.

Since our services revenues have lower gross margins than our license revenues, our overall gross margins will typically decline if our services revenues decline slower or grow faster than our license revenues. We expect cost of services revenues as a percentage of services revenues to vary from period to period, depending in part on whether the services are performed by our in-house staff, subcontractors or third-party system integrators, and on the overall utilization rates of our in-house professional services staff. As our customers increase their use of systems integrators to perform customer implementations in the future, we expect our services revenues and cost of services revenues to decline.

Gross Profit. Gross profit decreased 22% from $21.8 million for the three months ended March 31, 2002 to $17.0 million for the three months ended March 31, 2003. Gross profit represented 66% of total revenues in both periods. The decrease in gross profit as a percentage of total revenues was a result of the decrease in license revenues, as a percentage of total revenues, resulting from a general slowdown in spending on information technology initiatives. The decrease in absolute dollar amounts reflects a decrease in both license and services revenues during those periods.

Research and Development. Research and development expenses consist primarily of personnel and related costs to support product development activities. To date, all software development costs have been expensed in the period incurred. Research and development expenses decreased 16% from $7.0 million for the three months ended March 31, 2002 to $5.9 million for the three months ended March 31, 2003, representing 21% and 23% of total revenues in those periods, respectively. This decrease in absolute dollars reflects a decrease in personnel costs as a result of reduced staffing as a result of cost saving strategies implemented to help improve our overall operational performance.

We expect that the percentage of total revenues represented by research and development expenses will remain relatively consistent as we continue to manage our expenses in line with our projected operational performance in the continued economic downturn. With evidence of a sustained recovery of the worldwide economy, we would anticipate making investments within our research and development efforts to continue to further advance and expand our product offerings.

Sales and Marketing. Sales and marketing expenses consist primarily of salaries and related costs for sales and marketing personnel, sales commissions, travel and marketing programs. Sales and marketing expenses decreased 30% from $20.7 million for the three months ended March 31, 2002 to $14.5 million for the three months ended March 31, 2003, representing 64% and 57% of total revenues in those periods, respectively. This decrease in absolute dollar amounts primarily relates to lower personnel costs associated with headcount reductions, lower commissions as a result of lower sales activity and revenue, and a reduction in our promotional efforts.

We are endeavoring to control, and reduce, our sales and marketing costs during the current economic slowdown. We anticipate that with evidence of a sustained recovery of the U.S. economy, we would review spending in sales and marketing to expand our customer base and increase brand awareness. We also anticipate that the percentage of total revenues represented by sales and marketing expenses will fluctuate from period to period depending primarily on when we hire new sales personnel, the timing of new marketing programs and the levels of revenues in each period.

General and Administrative. General and administrative expenses consist primarily of salaries and related costs for accounting, human resources, legal and other administrative functions, as well as provisions for doubtful accounts. General and administrative expenses decreased 19% from $5.1 million for the three months ended March 31, 2002 to $4.1 million for the three months ended March 31, 2003, representing 16% of total revenues in both periods. The decrease in absolute dollar amounts was primarily attributable to a decrease in bad debt expense as a result of the overall stability of our customer base and current collection patterns. General and administrative expenses also decreased, to a lesser extent, due to decreased personnel costs associated with reduced staffing within general and administrative functions.

We are endeavoring to control, and reduce, our general and administrative costs in light of the current economic slowdown. We anticipate that, with evidence of a sustained recovery of the U.S. economy, we would review investments in our general and administrative infrastructure to support our operations. We expect that the percentage of total revenues represented by general and administrative expenses will fluctuate from period to period depending primarily on when we hire new general and administrative personnel to support expanding operations as well as the size and timing of expansion projects.

Amortization of Deferred Stock-Based Compensation. We recorded deferred stock-based compensation in connection with stock options granted prior to our initial public offering and in connection with stock options granted and assumed during our business acquisitions. Amortization of deferred stock-based compensation was $3.2 million for the three months ended March 31, 2002 and $514,000 for the three months ended March 31, 2003. The decrease in absolute dollar amounts was primarily attributable to the use of the accelerated method of amortizing deferred compensation expense, as prescribed by Financial Accounting Standards Board Interpretation No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans (An Interpretation of APB Opinions No. 15 and 25)”, which has resulted in greater recognition of amortization expense in the beginning of the vesting period for such options. Amortization of deferred stock-based compensation is attributable to the following categories for the three months ended March 31, 2003 and 2002, respectively (in thousands):

We expect amortization of deferred stock-based compensation to be $1.1 million for the remainder of 2003 and $514,000 in 2004, including the projected variable accounting charge associated with our stock option exchange program (based on the assumption that our stock price in future periods will remain unchanged from March 31, 2003). The variable component of the accounting charge for the options will be reassessed and reflected in the statement of operations for each reporting period based on the then current stock price for each period.

Amortization of Acquired Intangible Assets. Effective January 1, 2002, we adopted SFAS No. 142. In connection with the adoption of SFAS No. 142, we ceased amortizing net goodwill of $148.2 million, including $1.7 million related to assembled workforce. Additionally, during 2002, we reclassified $1.2 million of goodwill recorded in connection with our acquisition of Neonyoyo, Inc., to deferred stock-based compensation. We expect amortization of acquired intangible assets to be $1.3 million for the remainder of 2003, $1.5 million in 2004 and $74,000 in 2005.

Restructuring Costs. During 2002, we implemented several restructuring plans in an effort to better align our expenses and revenues in light of the continued economic slowdown. As a result of these plans, we recorded a charge of $1.2 million associated with workforce reductions. Workforce reduction costs primarily consisted of severance benefits associated with involuntary termination.

During the three months ended March 31, 2003, we implemented additional restructuring plans in light of the continued economic slowdown and our operational performance. As a result of these additional restructuring plans, we recorded a charge of $1.1 million associated with workforce reductions. Workforce reduction costs primarily consisted of severance benefits associated with involuntary termination.

Interest Income and Other, Net. Interest income and other, net, decreased from $1.5 million for the three months ended March 31, 2002 to $899,000 for the three months ended March 31, 2003, primarily due to the decrease in interest rates earned on cash and short-term investments and lower average cash and short-term investment balances during the period.

Provision for Income Taxes. Income tax expense for the three months ended March 31, 2002 and 2003 was $454,000 and $441,000, respectively. Income tax expense was associated with state and foreign income taxes.

Net cash used in operating activities was $388,000 and $6.6 million in the three months ended March 31, 2002 and 2003, respectively. Net cash used in operating activities during the three months ended March 31, 2002 primarily reflected net losses and restructuring and excess facilities charges, as well as an increase in prepaid expenses and other assets and a decrease in deferred revenue offset in part by depreciation expense, amortization of acquired intangible assets and amortization of deferred stock-based compensation, as well as a decrease in accounts receivable and an increase in accrued liabilities. Net cash used in operating activities during the three months ended March 31, 2003 primarily reflected net losses and restructuring and excess facilities charges, as well as decreases in accrued liabilities and deferred revenue offset in part by depreciation expense and a decrease in accounts receivable.

A significant portion of our cash inflows have historically been generated by our sales. These inflows fluctuate significantly from period to period. A decrease in customer demand or decrease in the acceptance of our products would jeopardize our ability to generate positive cash flows from operations.

During the three months ended March 31, 2002 and 2003, investing activities included purchases of property and equipment, principally computer hardware and software to upgrade our current operating systems. Cash used to purchase property and equipment was $955,000 and $257,000 during the three months ended March 31, 2002 and 2003, respectively. We do not expect that capital expenditures will increase substantially over our expenditure levels in prior periods. As of March 31, 2003, we had no material capital expenditure commitments.

During the three months ended March 31, 2002 and 2003, our investing activities included purchases and maturities of short-term investments. Net purchases of investments were $2.2 million and $4.3 million during the three months ended March 31, 2002 and 2003, respectively. As of March 31, 2003, we had not invested in derivative securities. In the future, we expect that cash in excess of current requirements will continue to be invested in high credit quality, interest-bearing securities.

During the three months ended March 31, 2002 and 2003, our financing activities included proceeds from the issuance of common stock. During the three months ended March 31, 2002 and 2003, proceeds from the issuance of common stock were $950,000 and $134,000, respectively.

At March 31, 2003, our sources of liquidity consisted of $174.9 million in cash, cash equivalents and investments. At March 31, 2003, we had $139.3 million in working capital. We have a $20.0 million line of credit with Washington Mutual Business Bank, which bears interest at the Wall Street Journal’s prime rate, which was 4.75% at March 31, 2003 and is secured by cash. This line of credit agreement expires in July 2003. We also have a $7.5 million line of credit with Wells Fargo Bank, which is secured by cash and bears interest at our option of either a variable rate of 1% below the bank’s prime rate adjusted from time to time or a fixed rate of 1.5% above the LIBOR in effect on the first day of the term. This line of credit agreement expires in December 2003. We had no outstanding borrowings under these lines of credit as of March 31, 2003. There are no covenants requirements associated with these lines of credit. We intend to maintain these lines of credit in the future.

We lease our facilities under operating lease agreements that expire at various dates through 2010. The following presents our prospective future lease payments under these agreements (in thousands):

Of these total minimum lease commitments, $36.8 million had been accrued, which is net of estimated sublease income, in restructuring and excess facilities costs at March 31, 2003.

We have entered into various standby letter of credit agreements associated with our facilities operating leases, which serve as required deposits for such facilities. These letters of credit expire at various times through 2013. At March 31, 2003, we had $11.9 million outstanding under standby letters of credit, which are secured by substantially all of our assets. The following presents our outstanding commitments under these agreements at each respective balance sheet date (in thousands):

We believe that our current cash and cash equivalents, short-term investments, cash flows from operations and funds available under existing credit facilities will be sufficient to meet our working capital requirements and capital expenditures for the foreseeable future. Long-term, we may require additional funds to support our working capital requirements or for other purposes and may seek to raise additional funds through public or private equity or debt financing or from other sources. We cannot assure you that additional financing will be available on acceptable terms, or at all.

If adequate funds are not available or are not available on acceptable terms, we may be unable to develop or enhance our products, take advantage of future opportunities, or respond to competitive pressures or unanticipated requirements, which could harm our business, financial condition and operating results.

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

In addition to other information in this Form 10-Q, the following factors should be considered carefully in evaluating Interwoven and our business.

Our operating history is limited, so it will be difficult for you to evaluate our business in making an investment decision.

We have a limited operating history and are still in the early stages of our development, which makes the evaluation of our business operations and our prospects difficult. We shipped our first product in May 1997. Since that time, we have derived substantially all of our revenues from licensing our TeamSite product and related products and services. In evaluating our common stock, you should consider the risks and difficulties frequently encountered by companies in new and rapidly evolving markets, particularly those companies whose businesses depend on the Internet and corporate information technology spending. These risks and difficulties, as they apply to us in particular, include:

One or more of the foregoing factors may cause our operating expenses to be disproportionately high during any given period or may cause our net revenues and operating results to be significantly lower than expected. Based upon the preceding factors, we may experience a shortfall in revenues or earnings or otherwise fail to meet public market expectations, which could harm our business, financial condition and the market price of our common stock.

If we do not increase our license revenues significantly, we will fail to achieve and sustain operating profitability.

We have incurred net losses from operations in each quarter since our inception through the quarter ended March 31, 2003. As of March 31, 2003, we had an accumulated deficit of approximately $344.9 million. We

anticipate that we will continue to invest in order to expand our customer base and increase brand awareness. To achieve and sustain operating profitability on a quarterly and annual basis, we will need to increase our revenues significantly, particularly our license revenues. We cannot predict when we will become profitable, if at all. We are currently operating at a loss. Furthermore, we have generally made business decisions with reference to net profit metrics excluding non-cash charges, such as acquisition and stock-based compensation charges. We expect to continue to make acquisitions, which are likely to cause us to incur certain non-cash charges such as stock-based compensation and intangible amortization charges, which will increase our losses.

Reduced demand and increased competition may cause our services revenue to decline and our results to fluctuate unpredictably.

Our services revenues represent a significant component of our total revenues—54% and 64% of total revenues during the three months ended March 31, 2002 and 2003, respectively. We anticipate that services revenues will continue to represent a significant percentage of total revenues in the future, and the actual percentage that it represents will have an impact on our results of operations. To a large extent, the level of our services revenues depends upon our ability to license products that generate follow-on services revenues, such as maintenance. Services revenue also depends on demand for professional services, which is subject to fluctuation in response to economic slowdowns. The current economic slowdown has and may continue to reduce demand for our professional services. As systems integrators and other third parties, many of whom are our partners, have become proficient at installing and servicing our products, our services revenues have declined and will continue to decline. Whether we will be able to successfully manage our professional services capacity during the current economic slowdown is difficult to predict. If our professional services capacity is too low, we may not be able to capitalize on future increases in demand for our services, but if our capacity is too high, our gross margin on services revenue will be harmed.

Our operating results fluctuate widely and are difficult to predict, so we may fail to satisfy the expectations of investors or market analysts and our stock price may decline.

Our quarterly operating results have fluctuated significantly in the past, and we expect them to continue to fluctuate unpredictably in the future. However, we anticipate flat revenues, on average, for the next few quarters due to the current economic slowdown and competitive environment. The main factors affecting these fluctuations are:

It is possible that in some future periods our results of operations may not meet the forecasts periodically disclosed by management or the expectations of securities analysts and investors. If this occurs, the price of our common stock is likely to decline.

The continuing economic slowdown has reduced our sales and will cause us to experience operating losses.

The current widespread economic slowdowns in the markets we serve have harmed our sales. Capital spending on information technology in general and capital spending on web initiatives in particular have

declined. We expect this trend to continue for the foreseeable future. In addition, since many of our customers are also adversely affected by the general economic slowdown, we may find that collecting accounts receivable from existing or new customers will take longer than we expect or that some accounts receivable will become uncollectible.

We face significant competition, which could make it difficult to acquire and retain customers and inhibit any future growth.

We expect market competition to persist and intensify. Competitive pressures may seriously harm our business and results of operations if they inhibit our future growth, require us to hold down or reduce prices, or increase our operating costs. Our competitors include, but are not limited to:

We also face potential competition from our strategic partners, such as BEA Systems, IBM and Oracle, or from other companies that may in the future decide to compete in our market. Some of our existing and potential competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical and marketing resources than we do. Many of these companies can also leverage extensive customer bases and adopt aggressive pricing policies to gain market share. Potential competitors may bundle their products in a manner that discourages users from purchasing our products. For example, Microsoft has introduced a content management product and might choose to bundle it with other products in ways that would harm our competitive position. Barriers to entering the content management software market are relatively low.

Although we believe the number of our competitors is increasing, we believe there may be consolidation in the content management software industry. We expect that the general downturn of stock prices in the technology-related companies since March 2000 will result in significant acceleration of this trend, with fewer but more financially-sound competitors surviving that are better able to compete with us for our current and potential customers.

If we fail to establish and maintain strategic relationships, the market acceptance of our products, and our profitability, may decline.

To offer products and services to a larger customer base, our direct sales force depends on strategic partnerships and marketing alliances to obtain customer leads, referrals and distribution. For example, the majority of our revenues are associated with referrals from our strategic partners. If we are unable to maintain our existing strategic relationships or fail to enter into additional strategic relationships, our ability to increase our sales and reduce expenses will be harmed. We would also lose anticipated customer introductions and co-marketing benefits. Our success depends in part on the success of our strategic partners and their ability to market our products and services successfully. We also rely on our strategic partnerships to aid in the development of our products. Should our strategic partners not regard us as significant for their own businesses, they could reduce their commitment to us or terminate their respective relationships with us, pursue other partnerships or relationships, or attempt to develop or acquire products or services that compete with our products and services. Even if we succeed in establishing these relationships, they may not result in additional customers or revenues.

Because the market for our products is new, we do not know whether existing and potential customers will purchase our products in sufficient quantity for us to achieve profitability.

The market for enterprise content management software is evolving rapidly. We expect that we will continue to need to educate prospective clients about the uses and benefits of our products and services. Various

factors could inhibit the growth of the market and market acceptance of our products and services. In particular, potential customers that have invested substantial resources in other methods of conducting business over the Internet may be reluctant to adopt a new approach that may replace, limit or compete with their existing systems. We cannot be certain that the market for our products will expand or continue to deteriorate further.

We may be required to write-off all or a portion of the value of assets we acquired in our recent business combinations.

Accounting principles require companies to review the value of assets from time to time to determine whether those values have been impaired. Due to the decline of our stock price and our operational performance in 2002, we reduced the carrying value of assets from acquired companies. We are required to review the carrying value of acquired companies on our balance sheet periodically to determine if those values should be reduced as a result of significant changes in our operations.

This process includes an analysis of the carrying value of the assets acquired as compared to the fair value of such assets through the use of comparison of our market capitalization and through the use of valuation models. If, as a result of this analysis, we determine there has been an impairment of goodwill and other intangible assets, the carrying value of those assets is written down to fair value as a charge against operating results in the period that the determination is made. Any significant impairment harms our operating results for that period and our financial position, and could harm the price of our stock.

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

Since June 30, 2001, we have reduced our employee headcount by more than 40% of our employees worldwide. In connection with these restructurings, we relocated offices and abandoned facilities in the San Francisco Bay area and Austin, Texas. However, it is possible that our present facilities may exceed our estimated future needs. If this happens, and given the decline in the commercial real estate market, we could be faced with paying rent for space we are not using, or with subleasing the excess space for less than our lease rate and recognizing a financial statement charge reflecting the loss. If the commercial real estate market continues to deteriorate, or if we cannot sublease these facilities at all, we may record additional facilities charges in the future. Any charge we record would be based on assumptions and our estimates about our ability to sublease facilities or terminate leases. We cannot assure you that our estimates and assumptions about these charges will be accurate in the future, and additional charges may be required in future periods.

Our lengthy sales cycle makes it particularly difficult for us to forecast revenues, requires us to incur high costs of revenues, and increases the variability of our quarterly results.

The time between our initial contact with a potential customer and the ultimate sale, which we refer to as our sales cycle, typically ranges between three and nine months, depending largely on the customer. We believe that the continuing economic slowdown has lengthened our sales cycle as customers delay or defer decisions on implementing content management initiatives. If we do not shorten our sales cycle, it will be difficult for us to reduce sales and marketing expenses. In addition, as a result of our lengthy sales cycle, we have only a limited ability to forecast the timing and size of specific sales. This makes it more difficult to predict quarterly financial performance, or to achieve it, and any delay in completing sales in a particular quarter could harm our business and cause our operating results to vary significantly.

We rely heavily on sales of one product, so if it does not continue to achieve market acceptance we will continue to experience operating losses.

Since 1997, we have generated substantially all of our revenues from licenses of, and services related to, our TeamSite product. We believe that revenues generated from TeamSite will continue to account for a large

portion of our revenues for the foreseeable future. A decline in the price of TeamSite, or our inability to increase license sales of TeamSite, would harm our business and operating results more seriously than it would if we had several different products and services to sell. In addition, our future financial performance will depend upon successfully developing and selling enhanced versions of TeamSite. If we fail to deliver product enhancements or new products that customers want, it will be more difficult for us to succeed.

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

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

Stock-based compensation charges and amortization of acquired intangibles will reduce our reported net income.

In connection with our acquisitions, we allocated a portion of the purchase price to intangible assets such as goodwill, in-process research and development, acquired technology, acquired workforce and covenants not to compete. We have also recorded deferred compensation related to options assumed and shares issued to effect business combinations, as well as options granted below fair market value associated with our initial public offering in October 1999. The future amortization expense related to the acquisitions and deferred stock-based compensation may be accelerated as we assess the value and useful life of the intangible assets, and accelerated expense would reduce our earnings.

In addition, our stock option repricing program requires us to record a compensation charge on a quarterly basis as a result of variable plan accounting treatment, which will lower our earnings. This charge will be evaluated on a quarterly basis and additional charges will be recorded if the market price of our stock exceeds the price of the repriced options. Since the variable component of this charge is computed based on the current market price of our stock, such charges may vary significantly from period to period. For example, for every dollar in value that our stock price exceeds the adjusted exercise price of these options, we will recognize an additional $2.6 million in deferred stock compensation.

Our products might not be compatible with all major platforms, which could limit our revenues.

Our products currently operate on the Microsoft Windows NT, Microsoft Windows 2000, Linux, IBM AIX, Hewlett Packard UX and Sun Solaris operating systems. In addition, our products are required to interoperate with leading content authoring tools and application servers. We must continually modify and enhance our products to keep pace with changes in these applications and operating systems. If our products were to be incompatible with a popular new operating system or business application, our business would be harmed. In addition, uncertainties related to the timing and nature of new product announcements, introductions or modifications by vendors of operating systems, browsers, back-office applications, and other technology-related applications, could also harm our business.

Acquisitions may harm our business by being more difficult than expected to integrate, by diverting management’s attention or by subjecting us to unforeseen accounting problems.

As part of our business strategy, we may seek to acquire or invest in additional businesses, products or technologies that we feel could complement or expand our business. If we identify an appropriate acquisition opportunity, we might be unable to negotiate the terms of that acquisition successfully, finance it, develop the intellectual property acquired from it or integrate it into our existing business and operations. We may also be unable to select, manage or absorb any future acquisitions successfully. Further, the negotiation of potential acquisitions, as well as the integration of an acquired business, especially if it involved our entering a new market, would divert management time and other resources and put us at a competitive disadvantage. We may have to use a substantial portion of our available cash, including proceeds from public offerings, to consummate an acquisition. On the other hand, if we consummate acquisitions through an exchange of our securities, our stockholders could suffer significant dilution. In addition, we cannot assure you that any particular acquisition, even if successfully completed, will ultimately benefit our business.

In connection with our acquisitions, we may be required to write-off software development costs or other assets, incur severance liabilities, amortization expenses related to acquired intangible assets, or incur debt, any of which could harm our business, financial condition, cash flows and results of operations. The companies we acquire may not have audited financial statements, detailed financial information, or adequate internal controls. There can be no assurance that an audit subsequent to the completion of an acquisition will not reveal matters of significance, including with respect to revenues, expenses, contingent or other liabilities, and intellectual property. Any such write-off could harm our financial results.

We depend on our international operations for a substantial portion of our revenues.

Sales to customers located outside the North America have historically accounted for a significant percentage of our revenues and we anticipate that such sales will continue to represent a significant percentage of our revenues. As a percentage of our total revenues, sales to international customers were 35% and 36% for the three months ended March 31, 2002 and 2003, respectively. We face risks associated with our international operations, including:

Any of these risks could harm our international operations and cause lower international sales. For example, some European countries already have laws and regulations related to technologies used on the Internet that are more strict than those currently in force in North America. Any or all of these factors could cause our business to be harmed.

In addition, our operations in Asia may be adversely impacted by the recent outbreak of Severe Acute Respiratory Syndrome. This outbreak has caused customers to delay or defer purchases, and our sales force to

experience travel disruptions (including quarantines). If the number of cases continues to rise or spread to other areas and we continue to experience these problems, our international sales and operations will be harmed.

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

We depend upon our proprietary technology, and rely on a combination of patent, copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect it. We currently have three issued United States patents and one foreign patent, as well as several U.S. and foreign patents pending approval. It is possible that patents will not be issued from our currently pending patent applications or any future patent application we may file. We have also restricted customer access to our source code and required all employees to enter into confidentiality and invention assignment agreements. Despite our efforts to protect our proprietary technology, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. In addition, the laws of some foreign countries do not protect our proprietary rights as effectively as the laws of the United States, and we expect that it will become more difficult to monitor use of our products as we increase our international presence. Further, third parties may claim that our products infringe the intellectual property of their products.

Our workforce reductions plans may hurt the morale and performance of our continuing personnel, and make it more difficult to retain the services of key personnel.

We restructured our operations over the past two years, resulting in substantial workforce reductions worldwide, in all functional areas. In addition to direct economic costs, these personnel reductions may hurt morale among continuing employees, or create concerns about job security. These morale issues may lower productivity or make it more likely that some of our key employees will seek new employment and require us to hire replacements. These reductions may also make the management of our business more difficult, subject us to increased risk of litigation and make it harder for us to attract employees in the future.

Since large orders may have a significant impact on our results from time to time, our quarterly results are subject to wide fluctuations.

We expect that any relatively large orders that we may receive from time to time in the future would have a significant impact on our license revenues in the quarter in which we recognize revenues from these orders. Large orders make our net revenues and operating results more likely to vary from quarter to quarter because the number of large orders we receive is expected to vary from period to period. The loss of any particular large order in any period could be significant. As a result, our operating results could suffer if any large orders are delayed or cancelled in any future period.

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

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

Defects in our products may result in customer claims against us that could cause unanticipated losses.

Because customers rely on our products for business critical processes, defects or errors in our products or services might result in tort or warranty claims. It is possible that the limitation of liability provisions in our contracts will not be effective as a result of existing or future federal, state or local laws or ordinances or unfavorable judicial decisions. We have not experienced any product liability claims like this to date, but we could in the future. Further, although we maintain errors and omissions insurance, this insurance coverage may not be adequate to cover us. A successful product liability claim could harm our business. Even defending a product liability suit, regardless of its merits, could harm our business because it entails substantial expense and diverts the time and attention of key management personnel.

We have various mechanisms in place to discourage takeover attempts, which might tend to suppress our stock price.

Provisions of our certificate of incorporation and bylaws that may discourage, delay or prevent a change in control include:

Fluctuations in the exchange rates of foreign currency may harm our business.

We are exposed to adverse movements in foreign currency exchange rates because we translate foreign currencies into U.S. Dollars for reporting purposes. Historically, these risks were minimal for us, but as our international revenues and operations have grown and continue to grow, the adverse currency fluctuations could have a material adverse impact on our financial results. Historically, our primary exposures have related to operating expenses and sales in Australia, Asia and Europe that were not U.S. Dollar denominated. The increasing use of the Euro as a common currency for members of the European Union could affect our foreign exchange exposure.

We have been notified of the commencement of a purported class action litigation alleging violations of federal securities laws by us. While we believe the litigation is without merit, our defense of this litigation could result in substantial costs and diversion of our management’s attention and resources, which could have a material adverse effect on our operating results and financial condition in future periods.

We develop products in the United States and market our products in North America, and, to a lesser extent in Europe and the Pacific Rim. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets.

Since a majority of our revenue is currently denominated in U.S. Dollars, a strengthening of the dollar could make our products less competitive in foreign markets. Our interest income and expense is sensitive to changes in the general level of U.S. interest rates, particularly since the majority of our financial investments are in cash equivalents and investments. Due to the short-term nature of our financial investments, we believe that there is no material risk exposure.

The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including both government and corporate obligations and money market funds. We believe an immediate 10% increase or decrease in interest rates affecting our investment portfolio as of March 31, 2003 would not have a material effect on our financial position or results of operations.

We did not hold derivative financial instruments as of March 31, 2003, and have never held such instruments in the past. In addition, we had no outstanding debt as of March 31, 2003.

Currently the majority of our sales and expenses are denominated in U.S. Dollars, as a result we have experienced no significant foreign exchange gains and losses to date. While we do expect to effect some transactions in foreign currencies in 2003, we do not anticipate that foreign exchange gains or losses will be significant. We have not engaged in foreign currency hedging activities to date.

Regulations under the Securities Exchange Act of 1934 require public companies, including Interwoven, to maintain “disclosure controls and procedures,” which are defined to mean a company’s controls and other procedures that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Our chief executive officer and our chief financial officer, based upon their evaluation of our disclosure controls and procedures within 90 days before the filing date of this report, concluded that as of the date of this evaluation, our disclosure controls and procedures were effective for this purpose.

There were no significant changes in our internal controls or, to our knowledge, in other factors that could significantly affect these controls subsequent to the date of their evaluation stated above.

On April 4, 2003, we announced that John Van Siclen had resigned as our President and Chief Executive Officer and that Martin Brauns had been named as our President and Chief Executive Officer. Mr. Brauns will continue to serve as our Chairman of the Board of Directors. In addition, we further announced the resignations of Thor Culverhouse, our Senior Vice President of Worldwide Sales and Rene White, our Senior Vice President of Marketing.

On April 17, 2003, we announced that John Bara had been named as our Senior Vice President of Marketing.

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.

By:

/s/ MARTIN W. BRAUNS

Martin W. Brauns

Chairman, President and Chief Executive Officer

By:

/s/ DAVID M. ALLEN

David M. Allen

Senior Vice President and Chief Financial Officer

Delaware		77-0523543
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

803 11th Avenue, Sunnyvale, CA		94089
(Address of principal executive offices)		(Zip Code)

		Page No.
PART I FINANCIAL INFORMATION

Item 1.	Financial Statements:

	Unaudited Condensed Consolidated Balance Sheets as of March 31, 2003 and December 31, 2002	3

	Unaudited Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2003 and 2002	4

	Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2003 and 2002	5

	Notes to the Unaudited Condensed Consolidated Financial Statements	6

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	14

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	34

Item 4.	Controls and Procedures	34

PART II OTHER INFORMATION

Item 1.	Legal Proceedings	35

Item 2.	Changes in Securities and Use of Proceeds	35

Item 3.	Defaults upon Senior Securities	35

Item 4.	Submission of Matters to a Vote of Security Holders	35

Item 5.	Other Information	35

Item 6.	Exhibits and Reports on Form 8-K	35

SIGNATURE		36

CERTIFICATIONS		37

	March 31, 2003			December 31, 2002
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	47,780		$	58,855
Short-term investments		127,144			122,814
Accounts receivable, net of allowances of $1,888 and $1,926, respectively		16,695			22,151
Prepaid expenses		4,214			3,715
Other current assets		3,175			3,562

Total current assets		199,008			211,097
Property and equipment, net		10,156			11,694
Goodwill, net		70,564			70,564
Other intangible assets, net		2,866			3,308
Restricted cash		378			378
Other assets		1,616			1,616

	$	284,588		$	298,657


LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	3,790		$	3,438
Accrued liabilities		11,486			13,319
Restructuring and excess facilities costs		10,051			10,564
Deferred revenue		34,347			36,331

Total current liabilities		59,674			63,652

Other accrued liabilities, net of current portion		2,053			2,070
Restructuring and excess facilities costs, net of current portion		27,579			29,210

Total liabilities		89,306			94,932

Stockholders’ equity:
Common stock and additional paid-in capital, 500,000 shares authorized, 102,584 and 102,536 shares issued and outstanding, respectively		541,506			541,377
Deferred stock-based compensation		(1,653	)		(2,166	)
Accumulated other comprehensive income		338			323
Accumulated deficit		(344,909	)		(335,809	)

Total stockholders’ equity		195,282			203,725

	$	284,588		$	298,657

	Three Months Ended March 31,
	2003			2002
	(unaudited)
Revenues:
License	$	9,151		$	14,927
Services		16,435			17,745

Total revenues		25,586			32,672

Cost of revenues:
License		702			948
Services		7,895			9,973

Total cost of revenues		8,597			10,921

Gross profit		16,989			21,751

Operating expenses:
Research and development		5,884			6,971
Sales and marketing		14,514			20,747
General and administrative		4,127			5,083
Amortization of deferred stock-based compensation		514			3,207
Amortization of acquired intangible assets		442			1,236
Restructuring charges		1,066			1,220

Total operating expenses		26,547			38,464

Loss from operations		(9,558	)		(16,713	)
Interest income and other, net		899			1,503

Net loss before provision for income taxes		(8,659	)		(15,210	)
Provision for income taxes		441			454

Net loss	$	(9,100	)	$	(15,664	)

Basic and diluted net loss per share	$	(0.09	)	$	(0.15	)

Shares used in computing basic and diluted net loss per share		102,162			102,625

	Three Months Ended March 31,
	2003			2002
	(unaudited)
Cash flows from operating activities:
Net loss	$	(9,100	)	$	(15,664	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		1,795			2,400
Provisions for doubtful accounts and sales returns		(38	)		730
Amortization of deferred stock-based compensation		514			3,207
Amortization of acquired intangible assets		442			1,236
Restructuring and excess facilities charges		(2,144	)		(1,942	)
Changes in assets and liabilities:
Accounts receivable		5,494			11,688
Prepaid expenses and other assets		(113	)		(1,793	)
Accounts payable		352			430
Accrued liabilities		(1,850	)		924
Deferred revenue		(1,984	)		(1,604	)

Net cash used in operating activities		(6,632	)		(388	)

Cash flows from investing activities:
Purchases of property and equipment		(257	)		(955	)
Purchases of short-term investments		(32,844	)		(59,863	)
Maturities of short-term investments		28,529			57,638

Net cash used in investing activities		(4,572	)		(3,180	)

Cash flows from financing activities:
Proceeds from issuance of common stock		134			950
Repurchase of common stock		(5	)		—

Net cash provided by financing activities		129			950

Net decrease in cash and cash equivalents		(11,075	)		(2,618	)
Cash and cash equivalents at beginning of period		58,855			69,312

Cash and cash equivalents at end of period	$	47,780		$	66,694

Supplemental non-cash activity:
Deferred stock-based compensation	$	—		$	1,222

Unrealized gain (loss) on short-term investments	$	15		$	(332	)

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	Three Months Ended March 31,
	2003		2002
Risk-free interest rates	2.9	%	3.8	%
Expected lives from vest date (in years)—Options	1.0		1.0
Expected lives from vest date (in years)—ESPP	0.5		0.5
Dividend yield	0.0	%	0.0	%
Expected volatility	93.3	%	89.2	%

	March 31, 2003				December 31, 2002
	Cost		Accumulated Amortization		Cost		Accumulated Amortization
Goodwill	$	252,135	$	181,571	$	252,135	$	181,571

Acquired identifiable intangibles:
Covenants not to compete	$	6,929	$	6,929	$	6,929	$	6,929
Completed technology		5,975		3,109		5,975		2,667

	$	12,904	$	10,038	$	12,904	$	9,596

Year Ending December 31,	Work Force Reductions		Excess Facilities		Total
2003 (remaining nine months)	$	804	$	7,616	$	8,420
2004		—		6,873		6,873
2005		—		7,063		7,063
2006		—		6,726		6,726
2007		—		4,590		4,590
Thereafter		—		3,958		3,958

Total	$	804	$	36,826	$	37,630

	Work Force Reductions			Non-Cancelable Lease Commitments And Other			Write-Down of Leasehold Improvements and Operating Equipment		Total
Balance at December 31, 2002	$	1,042		$	38,732		$	—	$	39,774
Restructuring costs		1,066			—			—		1,066
Cash payments		(1,304	)		(1,906	)		—		(3,210	)

Balance at March 31, 2003	$	804		$	36,826		$	—	$	37,630

	2003		2004		2005
Intangible assets (other than goodwill)	$	1,331	$	1,460	$	74
Stock-based compensation		1,139		514		—

	$	2,470	$	1,974	$	74

	2003		2002
Cost of services revenues	$	8	$	44
Research and development		314		1,149
Sales and marketing		181		1,871
General and administrative		11		143

Total	$	514	$	3,207

Year Ended December 31,	Occupied Facilities		Abandoned Facilities		Total
2003 (remaining nine months)	$	8,674	$	6,728	$	15,402
2004		10,601		8,895		19,496
2005		10,244		9,104		19,348
2006		10,293		8,679		18,972
2007		5,225		5,873		11,098
Thereafter		414		3,565		3,979

Total minimum lease payments	$	45,451	$	42,844	$	88,295

December 31,	Standby Letters of Credit
2003	$	10,625
2004	$	8,785
2005	$	8,712
2006	$	8,712
2007	$	6,600
Thereafter	$	6,600

Exhibit No.		Description
99.1		Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*

99.2		Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*

	INTERWOVEN, INC.

Dated: May 13, 2003	By:	/s/ DAVID M. ALLEN
		David M. Allen Senior Vice President and Chief Financial Officer (Principal Financial Officer and Chief Accounting Officer)

Number		Exhibit Title
99.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*

99.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*