TARANTELLA INC - 10-Q Quarterly Report

Indicate by check mark whether the registrant (1) has filed all reports 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 ¨

The number of shares outstanding of the registrant’s common stock as of March 31, 2003 was 41,280,211.

Tarantella, Inc. (the “Company”), is a leading provider of Internet infrastructure software that enables web-based access to enterprise applications from virtually any client device. Headquartered in Santa Cruz, California, Tarantella has development sites in the U.S. and UK and sales representatives in the U.S., UK, Germany, Australia, Mexico, Canada, France, Spain and Italy. Tarantella products are sold through an integrated worldwide channel of Tarantella account executives, enterprise class distributors, value-added resellers, systems integrators and computer manufacturers. The Company has exclusive distribution relationships in Japan and China.

The Company’s flagship product, Tarantella Enterprise 3, has been installed in corporations and agencies worldwide, including customers such as the U.S. Department of Defense, Oracle, Bell South, Air China, Bank of America, Verizon, Publicis, Sun Microsystems, ABN-AMRO and NASA. Tarantella Enterprise 3 software was introduced to the marketplace in 2001. Earlier client integration products, which are part of the Vision2K Suite, have been selling since the late 1990s and are still available.

In the opinion of management, the accompanying unaudited condensed consolidated statements of operations, balance sheets and statements of cash flows include all material adjustments (consisting of normal recurring adjustments) which the Company considers necessary for a fair presentation of its financial condition and results of operations as of and for the interim periods presented. The financial statements include the accounts of the Company and its wholly owned subsidiaries after all material intercompany balances and transactions have been eliminated. These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in the Company’s 2002 Annual Report on Form 10-K. The consolidated interim results presented are not necessarily indicative of results to be expected for a full year. The September 30, 2002 balance sheet was derived from audited financial statements, and is included for comparative purposes. Certain reclassifications have been made for consistent presentation.

The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X.

The condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. Losses from operations were $0.7 million for the second quarter of fiscal 2003, and $2.1 million for the second quarter of fiscal 2002. The Company has incurred net losses of approximately $3.3 million during the first six months of fiscal 2003 and $15.3 million during the first six months of fiscal 2002. Net cash used for operating activities was $5.3 million in the first six months of fiscal 2003 and $9.0 million used in the first six months of fiscal 2002. The Company has an accumulated deficit of $118.1 million as of March 31, 2003 compared to $114.7 million as of September 30, 2002. These conditions, among others, raise substantial doubt about the Company’s ability to continue as a going concern. The condensed consolidated financial statements do not reflect any adjustments that might be required as a result of this uncertainty.

While growing Tarantella Products licenses and services revenues year over year, the Company’s management has reduced its operating expenses by 33% in the first six months of fiscal 2003 over the first six months of fiscal 2002. The Company has driven down expenses through its restructuring plans as described in Note 4. The Company’s management believes that, based on its current plans, its existing cash and cash equivalents, short-term investments, and funds generated from operations will be sufficient to meet the Company’s operating requirements for the next twelve months. Although the Company’s current business plan does not foresee the need for further financing activities to fund the Company’s operations for the foreseeable future, due to risks and uncertainties in the market place, the Company may need to raise additional capital. Management cannot be assured that additional financing will be available when it is needed.

In December 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (“SFAS 148”). SFAS 148 amends FASB Statement No. 123, “Accounting for Stock-Based Compensation (“SFAS 123”).” Although it does not require use of fair value method of accounting for stock-based employee compensation, it does provide alternative methods of transition. It also amends the disclosure provisions of SFAS 123 Accounting Principles Board (“APB”) Opinion No. 28, “Interim Financial Reporting (“APB 28”),” to require disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. SFAS 148’s amendment of the transition and annual disclosure requirements is effective for fiscal years ending after December 15, 2002. The amendment of disclosure requirements of Opinion No. 28 became effective for interim periods beginning after December 15, 2002. Management does not intend to adopt the fair value accounting provisions of SFAS 123 and currently believes that the adoption of SFAS 148 will not have a material impact on the Company’s financial position or results of operations. The Company adopted this standard for its second quarter of fiscal 2003. Adoption of SFAS 148 required expanded disclosure to include the effect of stock-based compensation in interim reporting beginning with the Company’s quarter ending March 31, 2003.

We account for of stock-based compensation arrangements under the provisions of Accounting Principles Board (“APB”) Opinion No. 25 “Accounting for Stock Issued to Employees” for our fixed stock option plan and employee stock purchase plan and accordingly, have not recognized compensation cost in the accompanying consolidated statement of operations for options issued at fair value. SFAS 123, permits the use of either a fair value based method or the intrinsic value method to measure the expense associated with stock-based compensation arrangements.

In accordance with the interim disclosure provisions of SFAS 148, the pro forma effect on our net loss had compensation expense been recorded for the three and six months ended March 31, 2003 and 2002, respectively, as determined under the fair value method, is shown below (in thousands, except per share amounts):

The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model. The principal determinants of option pricing are: fair market value of our common stock at the date of grant, expected volatility, risk-free interest rate, expected option lives and dividend yields. Weighted average assumptions employed by us were: expected volatility of 94% for the three and six months ended March 31, 2003 and 2002, respectively, and a risk-free interest rate of 2.75% and 3.73% for the three and six months ended

March 31, 2003 and 2002, respectively. In addition, we assumed an expected option life of 4 years for non-executive employees and 5 years for executive employees and assumed no dividend yield for both periods.

In November 2002, FASB issued Interpretation 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN45). The Interpretation elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value, or market value, of the obligations it assumes under the guarantee and must disclose that information in its interim and annual financial statements. The provisions related to recognizing a liability at inception of the guarantee for the fair value of the guarantor’s obligations do not apply to product warranties or to guarantees accounted for as derivatives. The initial recognition and initial measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002. The adoption of this statement did not have a material impact on the Company’s financial position or results of operations.

The Company licenses its software and services pursuant to a software license agreement, in which the Company agrees to indemnify, hold harmless and defend the customer against damages arising out of claims filed by third parties that the Company’s products infringe any copyright or other intellectual property right. The term of the indemnification is generally perpetual, limited by applicable statutes of limitations. The license agreement generally limits the scope of the remedies for such indemnification obligation, including but not limited to certain product usage limitations and the right to replace an infringing product or modify it to make it non-infringing. If the Company cannot address the infringement by replacing or repairing the product, the Company is allowed to cancel the license and return the fees paid by the customer. The Company has never incurred expense under such indemnification provisions. The Company believes the estimated fair value of these indemnification agreements is minimal.

Further the Company generally warrants for a period of 90 days that its software products will perform substantially in accordance with its published specifications and that the reproduction of the software on the media material provided by the Company is correct and that the documentation is correctly printed. In the event of any non-conformance, the Company agrees to repair, replace or accept return of the non-conforming product and refund any fees paid by the customer for said non-conforming product. The Company has never incurred significant expense under its product warranties. The Company believes the estimated fair value of these indemnification agreements is minimal.

As permitted under California law, the Company has agreements whereby it indemnifies its officers and directors for certain events while the officer or director is, or was serving at the Company’s request in such capacity. The maximum potential amount of future payments the Company could be required to make under these indemnification agreement s is unlimited; however, the Company has a Director’s and Officer’s insurance policy that limits the Company’s exposure and enables it to recover at lease a portion of any future amounts paid. As a result of its insurance policy coverage, the Company believes the estimated fair value of these indemnification agreements is minimal.

As discussed in Note 7, as part of the agreement between the Company and Caldera, various building leases were assigned to Caldera International, however, the Company was a guarantor under such leases which expire in 2005. In the fourth quarter of fiscal 2002 the Company was released from its obligation as guarantor. There were also buildings related to the agreement between the Company and Caldera, where the lease was assigned to the Company and Caldera was a guarantor, for which the Company has in escrow $0.5 million of restricted cash.

In June 2002, the FASB issued “SFAS” No. 146, “Accounting for Costs Associated with Exit or Disposal Activities (“SFAS 146”)”, which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (“EITF”) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring) (“EITF 94-3”).” SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost, as defined in EITF 94-3, was recognized at the date of an entity’s commitment to an exit plan. SFAS 146 also establishes that the liability should initially be measured and recorded at fair value. The Company adopted the provisions of SFAS 146 for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS 146 may affect the timing of recognizing future restructuring costs as well as the amounts recognized.

In October 2001, the FASB issued SFAS No. 144, “Accounting for Impairment of Long-Lived Assets (SFAS 144”)”. SFAS 144 supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,” and addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement is effective for fiscal years beginning after December 15, 2001. The Company adopted SFAS 144 on October 1, 2002. The adoption of this statement did not have a material impact on the Company’s financial position or results of operations.

In June 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets (“SFAS 142”).” SFAS No. 142 addresses the recognition and measurement of goodwill and other intangible assets subsequent to their acquisition. SFAS 142 also addresses the initial recognition and measurement of intangible assets acquired outside of a business combination whether acquired individually or with a group of other assets. Goodwill and intangible assets previously recorded on the Company’s consolidated financial statements are affected by the provisions of SFAS 142. SFAS 142 became effective for the Company’s current fiscal year. As the Company does not currently have any goodwill or intangible assets, this statement did not impact the Company’s financial position or results of operations.

Basic and diluted earnings per share were calculated as follows for the three months and six months ended March 31, 2003 and 2002 (in thousands, except per share data):

During the first quarter of fiscal 2003, the Company announced a restructuring plan, which resulted in a charge of $1.1 million. The Company reduced its spending levels to align its operating expenses with the Company’s continued lower than expected revenues.

A severance charge of $0.8 million included the elimination of 10 positions in the United States, 13 positions in the United Kingdom, and 2 positions in Italy. The reductions in work force affected the product development, sales, marketing and general and administrative functions of the Company. As of December 31, 2002, all 25 positions had been eliminated.

A facilities charge of $0.3 million was related to space the Company vacated at two locations in the UK. This included a non-cash charge of $89,000 related to the write-off of leasehold improvements at the two vacated facilities.

The Company completed all of the cost reduction actions initiated in the first quarter of fiscal year 2003 during the quarter. Liabilities remain for lease obligation on the two facilities in the UK and for outstanding severance payments to two employees.

During the first quarter of fiscal 2002, the Company announced a restructuring plan, which resulted in a charge of $1.6 million. The Company reduced its spending levels to align its operating expenses with the Company’s lower than expected revenues. The restructuring included a reduction in staffing of 52 employees, a reserve for unused facilities at the Company’s corporate headquarters, and costs associated with closing several foreign offices.

A severance charge of $0.9 million included the elimination of 19 positions in the United States, 23 positions in the United Kingdom, and 10 positions in Japan. The reductions in force affected the product development, support, sales, marketing and general and administrative functions of the Company. As of March 31, 2002, all 52 positions had been eliminated.

A facilities charge of $0.7 million was related to space the Company vacated. The Company had anticipated that it would sub-lease the space by December 31, 2002. As of September 30, 2002, the Company had not secured a sub-lease tenant, so a provision adjustment of $0.6 million was made to reserve for the cost of this space through December 31, 2003. The lease for this building expires on June 30, 2005. In addition, a charge was taken for expenses associated with office closures in Japan and Brazil. There was a non-cash charge of $39,000 related to fixed asset disposals at the Japan subsidiary.

The Company completed the cost reduction actions initiated in fiscal 2002, with the exception of sub-leasing excess space at the Company’s corporate headquarters in Santa Cruz, California and finalizing the closure of a subsidiary in Australia.

During the second quarter of fiscal 2001, the Company announced a restructuring plan which resulted in a charge of $1.6 million, which when taken with an adjustment to a previously established restructuring reserve, resulted in the net charge of $1.1 million. The restructuring charge included a reduction in personnel of 28 employees and a reserve for unused facilities. Total cash expenditures were $1.6 million (see table below).

The $1.6 million restructuring charge included a severance charge of $1.5 million for the elimination of 16 positions in the United States, 4 positions in the United Kingdom, and 8 positions in various other geographies. The reduction in force affected the sales, marketing and general and administrative functions of the Company. As of September 30, 2001, all 28 positions had been eliminated. The Company vacated additional space within its Santa Cruz, California office in the first quarter of fiscal 2002, and an additional charge of $81,000 was recorded for estimated payments on the lease for an additional 12 months. In the fourth quarter of fiscal 2002, an additional charge of $85,000 was recorded because the facility is not yet sub-leased. The restructuring reserve now covers rents through December 31, 2003. The Company believes it will be able to sub-lease the space by that date. The lease for this building expires on June 30, 2005.

During the fourth quarter of fiscal 2001, the Company announced a restructuring plan, which resulted in a charge of $0.5 million. The restructuring charge included a reduction in personnel of 10 employees and a planned elimination of offices in Singapore and Australia. Total cash expenditures were $0.4 million.

The severance charge of $0.4 million included the elimination of 4 positions in the United States and 6 positions in the United Kingdom. The reductions in force affected the sales, marketing and general and administrative

functions of the Company. At September 30, 2001, all 10 positions had been eliminated. A provision adjustment of $64,000 was made to release excess restructure reserve, which resulted from the fact that the Company had not anticipated the Australian office would be sub-leased. The remaining reserve of $5,000 at March 31, 2003 relates to the facility in Australia, which the Company is in the final stages of closing.

The following table presents information on revenue and long-lived assets by geography. Revenue is allocated based on the location from which the sale is satisfied and long-lived asset information is based on the physical location of the asset.

At March 31, 2003, the Company held 505,767 shares of Rainmaker stock. The Company accounts for this investment as available-for-sale, and accordingly, records it at fair market value based on quoted market prices. Any unrealized gains or losses are included as part of accumulated other comprehensive income. The fair market value at March 31, 2003 was $328,749 and cost was $170,830 for an unrealized gain of $157,919. Rainmaker’s common stock is traded on the Nasdaq under the symbol “RMKR”.

On May 4, 2001, the Company consummated the sale of its Server Software and Professional Services divisions to Caldera Systems, Inc. Under the terms of the transaction, Caldera Systems, Inc. acquired the assets of the Server and Professional Services groups. A new company, Caldera International, Inc., was formed which combined the assets acquired from the Company with the assets of Caldera Systems. Upon the completion of the sale, the Company is continuing to operate its Tarantella business, and accordingly, changed its corporate name to Tarantella, Inc. and Nasdaq trading symbol to TTLA to reflect the new corporate name.

As consideration for the transaction, the Company received 16 million common stock shares of Caldera International (representing approximately 28.2% of Caldera International), $23 million in cash (of which $7 million was received on January 26, 2001) and a non-interest bearing promissory note in the amount of $8 million that was originally to be received in quarterly installments of $2 million beginning in August 2002.

As part of the original transaction, if the OpenServer line of business of the Server and Professional Services groups generated revenues in excess of specified thresholds during the three-year period following the completion of the combination, the Company had earn-out rights entitling it to receive 45% of these excess revenues. The transaction was treated as a disposal of Server and Professional Services groups and a gain of $53,267,000 was recorded upon completion of the transaction.

For the fourth fiscal quarter of 2001, the Company’s operating results included 28.2% of the operating results of Caldera International, adjusted for amortization of 5 months of negative goodwill of approximately $0.7 million. The net amount of the losses included was $4.6 million. In the fourth fiscal quarter of 2001, the Company also recorded an impairment of the investment, net of the remaining negative goodwill of $7.8 million, in the amount of $22.5 million. The impairment was recorded as the share price of Caldera International was significantly below the fair market value of Tarantella’s and was deemed to be other than temporarily impaired.

During the first fiscal quarter of 2002, the Company’s net loss included equity losses of $4.0 million for its share of Caldera International losses. After recording this loss, the carrying value of the shares of Caldera International stock was reduced to zero, in accordance with APB opinion No. 18.

During the second quarter of fiscal 2002, the Company signed an agreement with Caldera International to redeem the $8 million note receivable held by the Company for $5 million. The note was originally payable in four quarterly installments of $2 million each, beginning in August 2002. A loss of $3,038,000 was recorded against the gain on Caldera transaction for the redemption of the note receivable.

Additionally, Caldera International agreed to the buyout of certain licenses for products bundled in older releases of The Santa Cruz Operation, Inc.’s software, and the buyback of 500,000 post split shares of Caldera International stock held by the Company for $555,000. On March 7, 2002, Caldera International executed a 1 for 4 reverse stock split. Accordingly, the shares held by the Company were adjusted to reflect the stock split.

During the third quarter of fiscal 2002, Tarantella announced an agreement with Caldera International for Caldera to repurchase the remaining 3,289,401 shares of Caldera common stock held by Tarantella. Tarantella recorded other income of $3,059,250 from this transaction in the third fiscal quarter and subsequently received the cash in July 2002. For the fiscal year ended September 30, 2002, the Company sold 4,010,417 post split shares of Caldera International stock for total proceeds of $4,360,938. As of September 30, 2002, the Company no longer owns any securities in Caldera International. During the third quarter of fiscal 2002, Caldera also bought out the remaining term of the OpenServer revenue sharing plan that was part of the original transaction, for $100,000, which was recorded as a gain on Caldera transaction. In addition, royalty reserves of $345,000 related to the original transaction were written off and recorded as a gain on Caldera transaction.

As part of the agreement between the Company and Caldera, various building leases were assigned to Caldera International, however, the Company was a guarantor under such leases which expire in 2005. In the fourth quarter of fiscal 2002 the Company was released from its obligation as guarantor. There were also buildings related to the agreement between the Company and Caldera, where the lease was assigned to the Company and Caldera was a guarantor, for which the Company has in escrow $0.5 million of restricted cash.

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

This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our condensed consolidated financial statements and notes thereto included elsewhere in the Quarterly Report on Form 10-Q, as well as the Management’s Discussion and Analysis of Financial Condition and Result of Operations included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2002. In addition to historical information contained herein, this Discussion and Analysis contains forward-looking statements. These statements involve risks and uncertainties and can be identified by the use of forward-looking terminology such as “estimates,” “projects,” “anticipates,” “plans,” “future,” “may,” “will,” “should,” “predicts,” “potential,” “continue,” “expects,” “intends,” “believes,” and similar expressions. Examples of forward-looking statements include those relating to financial risk management activities and the adequacy of financial resources for operations. These and other forward-looking statements are only estimates and predictions. While the Company believes that the expectations reflected in the forward-looking statements are reasonable, the Company’s actual results could differ materially. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s expectations only as of the date hereof.

On February 14, 2002, the Company received a letter from Nasdaq notifying it that for 30 consecutive trading days the price of the Company’s common stock had closed below the minimum bid requirement of $1 per share and that the Company had 90 calendar days to regain compliance with Nasdaq rules. If, by May 15, 2002, the bid price of the Company’s common stock did not close at $1 per share or more for a minimum of 10 consecutive trading days, the Company would be subject to de-listing from Nasdaq. On April 23, 2002 the Company applied to move to the Nasdaq SmallCap Market. The Company’s application for the Nasdaq SmallCap Market was accepted on June 4, 2002 and the Company’s common stock is currently listed on the Nasdaq SmallCap Market. Among other requirements, the listing maintenance standards established by the Nasdaq for its Small Cap Market require that a company’s common stock have a minimum bid price of at least $1.00 per share. On August 14, 2002, the Company received a letter from the NASDAQ giving the Company 180 days to comply with the $1.00 minimum bid rule, or face de-listing. On March 18, 2003 the Company received a letter from Nasdaq stating that the Company would be de-listed. On March 25, 2003 the Company sent a response to Nasdaq stating that the de-listing would be appealed. The appeal letter to Nasdaq was sent on April 8, 2003. The Company appeared before the Nasdaq Listing Qualifications Panel on May 1, 2003, and is awaiting the panel’s determination.

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make judgments, assumptions and estimates that affect the amounts reported in our consolidated financial statements and the accompanying notes. Note 3 to the consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended September 30, 2002 describes the significant accounting policies and methods used in the preparation of the consolidated financial statements for the three fiscal years in the period ended September 30, 2002. The amounts of assets and liabilities reported on our balance sheets and the amounts of revenues and expenses reported for each of our fiscal periods are affected by estimates and assumptions which are used for, but not limited to, the accounting for revenue, bad debts, product returns, certain accrued expenses, restructuring and liabilities and a valuation allowance for deferred tax assets. Actual results could differ from these estimates. The following critical accounting policies are significantly affected by judgments, assumptions and estimates used in the preparation of the condensed consolidated financial statements.

The Company’s net revenues are derived from software licenses and fees for services, which include custom engineering, support and training. In accordance with Statement of Position 97-2 “Software Revenue Recognition” we recognize revenue when the price is fixed and determinable, upon persuasive evidence of an agreement, when fulfillment of our obligations under any such agreement is complete and when there is a determination that collection is probable. Our payment arrangements with customers primarily provide 30-day terms and, to a limited extent with certain customers, 45, 60 or 90 day terms. In certain transactions, the Company does not have a reliable basis to estimate returns and allowances for certain customers or is unable to determine that collection of receivables is probable. In such circumstances, the Company defers revenues at the time of sale and recognizes revenues when collection of the related receivable becomes probable or cash is collected and any potential returns can be reasonably estimated.

The Company records a provision for product returns for related sales in the same period as the related revenues are recorded. These estimates are based on historical sales returns, analysis of credit memo data and other known factors. If the historical data the Company uses to calculate these estimates do not properly reflect future returns, revenue could be affected.

Tarantella has operations in many countries other than the United States. Transfer prices for services provided between the United States and these countries have been documented as reasonable, however, tax authorities could challenge these transfer prices and assess additional taxes on prior period transactions. Any such assessment could require the Company to record an additional tax provision in its statement of operations.

Income tax assets and liabilities are determined by taxable jurisdiction. The Company evaluates net deferred tax assets in each tax jurisdiction by estimating the likelihood of the Company generating future profits to realize these assets. The Company has assumed that it will not generate sufficient future taxable income to realize these assets and has created valuation reserves to reduce the net deferred tax asset values to zero.

Certain prior period amounts have been reclassified to conform to current period presentation. These reclassifications had no significant impact on the financial statements for the periods presented.

The Company’s net revenues are derived from software licenses and fees for services.

Net revenues for the three months ended March 31, 2003 increased by 1% to $4.4 million from $4.3 million in the same period in fiscal 2002. Net revenues for the six months ended March 31, 2003 increased by 12% to $8.0 million from $7.2 million in the same period of fiscal 2002. The increase in revenue performance year to date, broken out geographically, was a $0.7 million increase in Europe and $0.3 million increase in Asia. Revenues in the United States decreased $0.2 million. The increase in net revenues was mainly due to larger average transaction size sales to large enterprise and government customers.

License revenues for the three months ended March 31, 2003 were $3.7 million compared to $3.8 million in the same quarter of fiscal 2002, a decrease of 3% from the prior year. License revenues for the six months ended March 31, 2003 were $6.8 million compared to $6.3 million for the same period of fiscal 2002, an increase of 7% from the prior year. The increase in year to date revenues is attributed to an increase in the average transaction size due to increased sales to large enterprise and government customers.

Service revenues increased to $0.7 million for the three months ended March 31, 2003, from $0.5 million in the same period in fiscal 2002, an increase of 39%. Service revenue was 16% of the total revenue for the first fiscal quarter of 2003, compared to 12% for the same period in the prior year. Service revenues increased to $1.2 million for the six months ended March 31, 2003, from $0.9 million in the same period in fiscal 2002, an increase of 41%. Service revenue was 15% of the total revenue for the first six months of 2003, compared to 12% for the same period in the prior year. The increase in service revenues is the result of an increased percentage of customers purchasing service contracts with new product purchases, as well as an increase in the renewal rate.

International revenues were 44% of total revenues for the second quarter of fiscal 2003 and 39% for the same period in the prior year. For the six months ended March 31, 2003, international revenues were 52%, compared to 44% for the same period in the prior year.

Cost of license revenues for the three months ended March 31, 2003 decreased by 47% to $0.1 million from to $0.2 million in the same period of fiscal 2002. For the six months ended March 31, 2003, cost of license revenues decreased by 33% from $0.1 million to $0.2 million in the same period of fiscal 2002. Cost of license revenues decreased because of lower overhead, which is attributable to lower headcount, due to planned reductions in force. There were also lower royalty costs due to favorable product mixes.

Cost of service revenues for the three months ended March 31, 2003 remained flat at $0.3 million compared to the same period in fiscal 2002. Cost of service revenues for the six months ended March 31, 2003 also remained relatively flat at $0.5 million compared to the same period in fiscal 2002. Although actual cost of service revenues remained flat, they declined as a percentage of service revenue, increasing gross margin from 50% in the second quarter of fiscal 2002, to 59% in the second quarter of fiscal 2003. Service gross margin also increased to 56% for the six months ended March 31, 2003, from 42% for the same period of fiscal 2002. The improvement in the services gross margin is a result of higher revenue and lower costs due to headcount reductions and employee pay reductions of 15%.

Total cost of revenues as a percentage of net revenues decreased to 9% in the second quarter of fiscal 2003 from 10% for the same period in fiscal 2002. For the six months ended March 31, 2003, cost of revenues as a percentage of net revenues decreased to 9% from 10% for the same period in fiscal 2002. Cost of revenues as a percentage of net revenue was lower mainly due to improved gross margins for service revenues.

Research and development expenses decreased 31% to $0.9 million in the second quarter of fiscal 2003 from $1.3 million in the comparable quarter of fiscal 2002, and as a percentage of net revenues were 21% and 30%, respectively. For the six months ended March 31, 2003 research and development expenses decreased 38% to $1.9 from $3.1 million in the comparable period of fiscal 2002, and as a percentage of net revenues were 24% and 43%, respectively. The decrease in research and development expenses can be attributed to lower labor costs driven by lower headcount as a result of planned reductions in force. In addition, labor costs were lower because of employee pay reductions of 15%.

Selling, general and administrative expenses decreased 19% to $3.8 million in the second quarter of fiscal 2003 from $4.7 million for the comparable quarter of the prior year. For the six months ended March 31, 2003, selling, general and administrative expenses decreased 32% to $7.5 from $11.1 million in the comparable period of fiscal 2002. The significant decrease in expenses is due mainly to lower labor costs that were driven by lower headcount as a result of a planned reduction in force. In addition, labor costs were lower because of a pay reductions of 15% for employees in Marketing and General and Administrative departments and 7.5% for employees in Sales. Selling, general and administrative expenses as a percentage of net revenues were 87% in the second quarter of fiscal 2003 and 108% in the same period in fiscal 2002. For the six months ended March 31, 2003, selling, general and administrative expenses were 94% of net revenues compared to 155% in the same period of fiscal 2002.

There were no restructuring charges in the second quarter of fiscal 2003 or in the second quarter of fiscal 2002. For the six months ended March 31, 2003, restructuring charges were $1.1 million for a restructuring plan that was initiated in the first quarter of fiscal 2003. For the six months ended March 31, 2002, restructuring charges were $1.7 million for a restructuring plan that was initiated in the first quarter of fiscal 2002. The Company plans to substantially complete these plans by September 30, 2003. The Company cannot assure that its current estimates of costs associated with these restructuring actions will not change during the implementation period.

Interest income, net was $14,000 for the second quarter of fiscal 2003 and $208,000 for the same period in fiscal 2002. For the six months ended March 31, 2003, interest income, net was $46,000 compared to $441,000 for the same period in fiscal 2002. The decrease in interest income, net reflects the lower cash balances held for the quarter and the six month period ended March 31, 2003, as well as the collection of the Caldera note receivable. Interest income was also lower due to a lower average interest rate for the period. In the second quarter of fiscal 2003, the interest rate was approximately 1.2%. In the second quarter of fiscal 2002, the interest rate was approximately 1.65% for cash and 10% for the Caldera Note.

Other income, net was $63,000 in the second quarter of fiscal 2003, compared to $545,000 for the same period of fiscal 2002. For the six months ended March 31, 2003, other income was $49,000 compared to $12,000 for the same period in fiscal 2002.

Loss on Caldera transaction was $3.0 million for the three and six months ended March 31, 2002. This loss related to the early redemption of a note payable from Caldera International.

Loss of equity investment in Caldera was $4.0 million for the six months ended March 31, 2002. This loss reflected the Company’s portion of Caldera International’s losses.

Income tax provision was $0.1 million for the second quarter of fiscal 2003 compared to a benefit of $0.8 million for the same period in fiscal year 2002. For the six months ended March 31, 2003 there was an income tax provision of $0.2 million compared to an income tax benefit of $0.8 million for the same period of fiscal 2002. The tax provision for the three and six months ended March 31, 2003, reflects foreign taxes payable. The tax benefit for the six months ended March 31, 2002 reflects a benefit due to a change in U.S. tax law enacted in March 2002 as well as benefit for the reduction of foreign audit issues.

Net loss for the second quarter of fiscal 2003 was $0.7 million compared to net loss of $3.6 million for the same quarter of fiscal 2002. For the six months ended March 31, 2003, net loss was $3.3 million compared to $15.3 million for the same period of fiscal 2002. The decrease in net loss is primarily due to higher revenues and lower operating expenses, and the absence of losses for the investment in Caldera. The losses for the investment in Caldera were $3.0 million for the three months ended March 31, 2002 and $7.0 million for the six months ended March 31, 2002.

Cash, cash equivalents and short-term investments were $1.7 million at March 31, 2003, representing 17% of total assets. The decrease in cash and cash equivalents of $5.4 million from September 30, 2002 is mainly due to operating losses of $3.3 million, a prepayment of royalties of $0.3 million, an increase in accounts receivable of $1.7 million, and a decrease in other payables – Caldera of $0.4 million. The Company’s operating activities used cash of $5.3 million in the first six months of fiscal 2003, compared to $9.0 million used for operating activities in the first six months of fiscal 2002. The decrease in the cash used for operating activities is due to the significant reduction in operating loss from the first six months of fiscal 2002 as compared to the first six months of fiscal 2003. The operating loss was $3.3 million in the first six months of fiscal 2003 compared to a loss of $15.2 million in the first six months of fiscal 2002. Cash used in investing activities was $0.1 million in the first six months of fiscal 2003 compared to cash provided from investing activities of $2.8 million in the first six months of fiscal 2002. The decrease in cash provided by investing activities was due primarily to the proceeds received from the sale of Caldera common stock of $2.9 million, which were included in the results for the first six months of fiscal 2002. Negligible cash was provided by financing activities in the first six months of fiscal 2003 compared to $0.3 million used for financing activities in the first six months of fiscal 2002.

The Company’s days sales outstanding (“DSO”) at March 31, 2003 was 98, an increase of 24 days from March 31, 2002. DSO is calculated using revenues for the quarter, and net accounts receivable at the end of the quarter. The increase in DSO was due to an increase in past due receivables. The unreserved past due accounts receivable increased from $0.2 million at March 31, 2002 to $0.7 million at March 31, 2003.

On February 14, 2002, the Company received a letter from Nasdaq notifying it that for 30 consecutive trading days the price of the Company’s common stock had closed below the minimum bid requirement of $1 per share and that the Company had 90 calendar days to regain compliance with Nasdaq rules. If, by May 15, 2002, the bid price of the Company’s common stock did not close at $1 per share or more for a minimum of 10 consecutive trading days, the Company would be subject to de-listing from Nasdaq. On April 23, 2002 the Company applied to move to the Nasdaq SmallCap Market. The Company’s application for the Nasdaq SmallCap Market was accepted on June 4, 2002 and the Company’s common stock is currently listed on the Nasdaq SmallCap Market. Among other requirements, the listing maintenance standards established by the Nasdaq for its SmallCap Market require that a company’s common stock have a minimum bid price of at least $1.00 per share. On August 14, 2002, the Company received a letter from the NASDAQ giving the Company 180 days to comply with the $1.00 minimum bid rule, or face de-listing. On March 18, 2003 the Company received a letter from Nasdaq stating that the Company would be de-listed. On March 25, 2003 the Company sent a response to Nasdaq stating that the de-listing would be appealed. The appeal letter to Nasdaq was sent on April 8, 2003. The Company appeared before the Nasdaq Listing Qualifications Panel on May 1, 2003, and is awaiting the panel’s determination.

The Company has operating lease commitments of $1.9 million in fiscal 2003. See Note 10 of the Company’s Form 10K for the fiscal year ended September 30, 2002 for operating lease commitments beyond fiscal 2003.

Revenues have increased from $7.2 million in the first six months of fiscal 2002 to $8.0 million in the first six months of fiscal 2003. Losses from operations were $3.3 million for the first six months of fiscal 2003, and $9.4

million for the first six months of 2002. The Company has incurred net losses of approximately $3.3 million during the first six months of fiscal 2003 and $15.3 million during the first six months of fiscal 2002. Net cash used for operating activities was $5.3 million in the first six months of fiscal 2003 and $9.0 million used in the first six months of fiscal 2002. The Company has an accumulated deficit of $118.1 million as of March 31, 2003. These conditions, among others, raise substantial doubt about the Company’s ability to continue as a going concern.

Since its release in fiscal 1997, annual Tarantella Products revenues have generated positive year-over-year growth. Excluding Server Software, CID and related services, Tarantella Products license and service revenues for the first six months of fiscal 2003 increased 12% from the same period in fiscal 2002. While growing Tarantella Products licenses and services revenues year over year, the Company’s management has reduced its operating expenses by 33% in the first six months of fiscal 2003 over the first six months of fiscal 2002. The Company is continuing to drive down expenses through its restructuring plans as described in Note 4 to the accompanying condensed consolidated financial statements.

The Company’s management believes that, based on the Company’s current plans, its existing cash and cash equivalents, short-term investments, and funds generated from operations will be sufficient to meet its operating requirements for the next twelve months. Although the Company’s current business plan does not foresee the need for further financing activities to fund the Company’s operations for the foreseeable future, due to risks and uncertainties in the market place, the Company may need to raise additional capital. Management cannot be assured that additional financing will be available when it is needed.

Set forth below and elsewhere in this filing and in other documents the Company files with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements in this filing.

The results of operations for any quarter or fiscal year are not necessarily indicative of the results to be expected in future periods. The Company’s operating results have in the past been, and will continue to be, subject to quarterly and annual fluctuations as a result of a number of factors, including but not limited to:

As a consequence, operating results for a particular future period are difficult to predict.

Any significant downturn in the Company’s customers’ markets, or domestic and global conditions, which result in a decline in demand for their software and services could harm our business. The state of the economy has had a negative impact on the software industry. This could result in customers continuing to delay or cancel orders

for software. Any of these occurrences could have a significant impact on the Company’s operating results, revenues and costs and may cause the market price of our common stock to decline or become more volatile.

The Company’s future operating results may be affected by various uncertain trends and factors that are beyond the Company’s control. These include adverse changes in general economic conditions and rapid or unexpected changes in the technologies affecting the Company’s products. The process of developing new high technology products is complex and uncertain and requires accurate anticipation of customer needs and technological trends.

The Company depends on the development and acceptance of new products in a rapidly changing market.

The market for the Company’s products is characterized by rapidly changing technology, evolution of new industry standards, and frequent introductions of new products and product enhancements. The Company’s success will depend upon its continued ability to enhance its existing products, to introduce new products on a timely and cost-effective basis to meet evolving customer requirements, to achieve market acceptance for new product offerings, and to respond to emerging industry standards and other technological changes. There can be no assurance that the Company will be successful in developing new products or enhancing its existing products or that such new or enhanced products will receive market acceptance. The Company’s success also depends upon its ability to license from third parties and to incorporate into its products new technologies that become industry standards. There can be no assurance that the Company will continue to obtain such licenses on favorable terms or that it will successfully incorporate such third-party technologies into its own products.

The Company anticipates new releases of products in the fiscal year ending September 30, 2003. There can be no assurance that such new releases will not be affected by technical problems or “bugs”, as is common in the software industry. Furthermore, there can be no assurance that these or other future product introductions will not be delayed. Delays in the availability, or a lack of market acceptance, of new or enhanced products could have an adverse effect on the Company’s business. There can be no assurance that product introductions in the future will not disrupt product revenues and adversely affect operating results.

The Company competes in the highly competitive Internet infrastructure market.

The industry has become increasingly competitive and, accordingly, the Company’s results may also be adversely affected by the actions of existing or future competitors, including the development of new technologies, the introduction of new products, and the reduction of prices by such competitors to gain or retain market share. The Company’s results of operations could be adversely affected if it were required to lower its prices significantly.

The Company participates in a highly dynamic industry and future results could be subject to significant volatility, particularly on a quarterly basis. The Company’s revenues and operating results may be unpredictable due to the Company’s shipment patterns. The Company operates with little backlog of orders because its products are generally shipped as orders are received. In general, a substantial portion of the Company’s revenues have been booked and shipped in the third month of the quarter, with a concentration of these revenues in the latter half of that third month. In addition, the timing of closing of large license contracts and the release of new products and product upgrades increase the risk of quarter to quarter fluctuations and the uncertainty of quarterly operating results. The Company’s staffing and operating expense levels are based on an operating plan and are relatively fixed throughout the quarter. As a result, if revenues are not realized in the quarter as expected, the Company’s expected operating results and cash balances could be adversely affected, and such effect could be substantial and could result in an operating loss and depletion of the Company’s cash balances.

The Company may require substantial additional capital to finance future growth and fund ongoing operations through the remainder of fiscal 2003 and beyond. Although the Company’s current business plan does not foresee the need for further financing activities to fund the Company’s operations for the foreseeable future, due to risks and uncertainties in the market place, the Company may need to raise additional capital. If the Company issues additional stock to raise capital, particularly at its current, low price per share, the Company’s stockholders’ percentage ownership in the Company would be diluted. Raising such additional financing may not be available when needed and, if such financing is available, it may not be available on terms that are favorable to the Company.

The Company’s revenues may be affected by the seasonality of revenues in the European and government markets.

The Company experiences seasonality of revenues for both the European and the U.S. federal government markets. European revenues during the quarter ending June 30 are historically lower or relatively flat compared to the prior quarter. This reflects a reduction of customer purchases in anticipation of reduced selling activity during the summer months. Sales to the U.S. federal government generally increase during the quarter ending September 30. This seasonal increase is primarily attributable to increased purchasing activity by the U.S. federal government prior to the close of its fiscal year. Additionally, net revenues for the first quarter of the fiscal year are typically lower or relatively flat compared to net revenues of the prior quarter.

Cost of revenues may be affected by changes in the mix of products and services.

The overall cost of revenues may be affected by changes in the mix of net revenue contribution between licenses and services, geographical regions and channels of distribution, as the costs associated with these revenues may have substantially different characteristics. The Company may also experience a change in margin as net revenues increase or decrease since technology costs and services costs are fixed within certain volume ranges.

The Company’s results of operations could be adversely affected if it were to lower its prices significantly. In the event the Company reduced its prices, the Company’s standard terms for selected distributors would be to provide credit for inventory ordered in the previous 180 days, such credits to be applied against future purchases. The Company, as a matter of policy, does not allow product returns for a refund. Product returns are generally allowances for stock balancing and are accompanied by compensating and offsetting orders. Revenues are net of a provision for estimated future stock balancing and excess quantities above levels the Company believes are appropriate in its distribution channels. The Company monitors the quantity and mix of its product sales.

The Company is dependent upon information received from third parties in order to determine reserves for product returns.

The Company depends on information received from external sources in evaluating the inventory levels at distribution partners in the determination of reserves for the return of materials not sold, stock rotation and price protection. Significant effort has gone into developing systems and procedures for determining the appropriate reserve level. In the event information is not received timely or accurately, our ability to monitor the inventory levels will be affected and may negatively impact our business.

The Company’s business depends upon its proprietary rights and there is a risk that such rights will be infringed.

The Company attempts to protect its software with a combination of patent, copyright, trademark, and trade secret laws, employee and third party nondisclosure agreements, license agreements, and other methods of protection. Despite these precautions, it may be possible for unauthorized third parties to copy certain portions of the Company’s products or reverse engineer or obtain and use information the Company regards as proprietary. While the Company’s competitive position may be affected by its ability to protect its intellectual property rights, the Company believes that trademark and copyright protections are less significant to the Company’s success than other factors, such as the knowledge, ability, and experience of the Company’s personnel, name recognition, and ongoing product development and support. Further, certain provisions of the Company’s licenses, including provisions protecting against unauthorized use, copying, transfer, and disclosure of the licensed product, may be unenforceable under the laws of certain jurisdictions. In addition, the laws of some foreign countries do not protect the Company’s intellectual property rights to the same extent as do the laws of the U.S.

Risks of claims from third parties for intellectual property infringement could adversely affect the business.

As the number of software products in the industry increases and the functionality of these products further overlaps, the Company believes that software products will increasingly become subject to infringement claims. There can be no assurance that third parties will not assert infringement claims against the Company and/or against the Company’s suppliers of technology. In general, the Company’s suppliers have agreed to indemnify the Company in the event any such claim involves supplier-provided software or technology, but any such claim,

whether or not involving a supplier, could require the Company to enter into royalty arrangements or result in costly litigation.

The Company’s results of operations may be affected by fluctuations in foreign currency exchange rates.

Although the Company’s revenues are predominantly in U.S. dollars, substantial portions of the Company’s revenues are derived from sales to customers outside the United States. Trade sales to international customers represented 52%, 44% and 52% of total revenues for the first six months of fiscal 2003, 2002 and 2001 respectively. The Company’s revenues can be affected by general economic conditions in the United States, Europe and other international markets. Also, portions of the Company’s operating expenses are transacted in foreign currencies. The Company’s operating strategy and pricing take into account changes in exchange rates over time. However, the Company’s results of operations may be significantly affected in the short term by fluctuations in foreign currency exchange rates.

The Company’s results of operations may be affected by the assessment of additional taxes.

The Company’s success largely depends upon its ability to retain and recruit key personnel.

The Company’s continued success depends to a significant extent on senior management and other key employees. None of these individuals is subject to a long-term employment contract or a non-competition agreement. Competition for qualified people in the software industry is intense. The loss of one or more key employees or the Company’s inability to attract and retain other key employees could have a material adverse effect on the Company.

The Company has undergone significant restructurings, which may have a material adverse effect on operating results.

Following the Company’s divestiture of its server software and professional services divisions in May 2001, the Company undertook several restructurings of its worldwide operations. Each of the restructuring plans involved reductions in the Company’s worldwide workforce. The restructuring plans may not achieve the desired results, and may not improve the Company’s future operating results. Completion of the restructuring plans may disrupt the Company’s operations and may have a material adverse effect on its business, financial condition and results of operations. The Company may also be required to implement additional restructuring plans in the future.

The stock market in general, and the market for shares of technology companies in particular, has experienced extreme price fluctuations, which have often been unrelated to the operating performance of the affected companies. Strategic factors such as new product introductions, acquisitions or restructurings by the Company or its competitors may have a significant impact on the market price of the Company’s common stock. Furthermore, quarter-to-quarter fluctuations in the Company’s operating results may have a significant impact on the market price of the Company’s stock. These conditions, as well as factors which generally affect the market for stocks of high technology companies, could cause the price of the Company’s stock to fluctuate substantially over short periods.

require that a company’s common stock have a minimum bid price of at least $1.00 per share. On August 14, 2002, the Company received a letter from the NASDAQ giving the Company 180 days to comply with the $1.00 minimum bid rule, or face de-listing. On March 18, 2003 the Company received a letter from Nasdaq stating that the Company would be de-listed. On March 25, 2003 the Company sent a response to Nasdaq stating that the de-listing would be appealed. The appeal letter to Nasdaq was sent on April 8, 2003. The Company appeared before the Nasdaq Listing Qualifications Panel on May 1, 2003, and is awaiting the panel’s determination.

If the Company’s stock is de-listed by the Nasdaq, it will be traded on the Over-the-Counter (OTC) market. If this should happen, trading the Company’s stock may become more difficult due to the limited trading activity on the OTC market. This could cause a further decline in the Company’s stock price. De-listing of the Company’s stock from the Nasdaq or further declines in the market price of the Company’s stock could greatly impair the Company’s ability to raise capital through equity or debt financing.

Following the Company’s divestiture of its server software and professional services divisions in May 2001, the Company has not achieved profitability, and may never generate sufficient revenues to achieve profitability.

Reference is made to part II, Item 7A, Quantitative and Qualitative Disclosures about Market Risk, in our Annual Report on Form 10-K for the year ended September 30, 2002.

Under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Exchange Act Rule 13a-14(c) within 90 days of the filing date of this quarterly report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective. There were no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to the date of their evaluation.

The Company held a meeting of shareholders on February 27, 2003. Proxies representing 38,038,929 shares of Common Stock or 93% of the total outstanding shares were tabulated. The following matters were voted on by the shareholders and the results are indicated:

Proposal IV (To renew the Option Plan, the 1993 Director Option Plan (the “Director Option Plan”) and the Purchase Plan for additional ten (10) year terms and to approve the material terms of the Option Plan.)

Proposal V (To approve the grant of discretionary authority to the Company’s Board of Directors to amend the Company’s amended and restated certificate of incorporation to effect a reverse stock split of the Company’s Common Stock in one of the following ratios: one-for-five, one-for-eight, one-for-twelve or one-for-fifteen, with the exact ratio to be set by the Board of Directors in its sole discretion at such a time as it may elect to effectuate a reverse stock split).

Proposal VI (To ratify the appointment of Deloitte & Touche LLP as independent public accountants of the Company for the fiscal year ending September 30, 2003).

The following matters were not approved by the shareholders by the votes indicated:

Proposal II (To amend the 1994 Incentive Stock Option Plan (the “Option Plan”) to increase the number of shares of Common Stock reserved for issuance thereunder by one million (1,000,000) shares for a total reserved for issuance under the Option Plan of twenty-two million, five hundred and thirteen thousand, six hundred and sixty-five (22,513,665) shares.

Proposal III (To amend the Employee Stock Purchase Plan (the “Purchase Plan”) to increase the number of shares of Common Stock reserved for issuance thereunder by five hundred (500,000) shares for a total reserved for issuance under the Purchase Plan of five million, seven hundred and fifty thousand (5,750,000) shares.

On the record date December 31, 2002 there were 41,028,264 shares of the Company’s Common Stock issued and outstanding entitled to be voted at the Annual Meeting if represented.

* Broker non-votes are shares held by brokers that are present but not voted because the brokers were prohibited from exercising discretionary authority. Broker non-votes are counted for purposes of determining the presence or absence of a quorum, but were not counted for purposes of determining the number of votes cast with respect to the proposal.

I, Douglas L. Michels, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of Tarantella, Inc. on Form 10-Q for the fiscal quarter ended March 31, 2003 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Quarterly Report on Form 10-Q fairly presents in all material respects the financial condition and results of operations of Tarantella, Inc.


By:		/s/ DOUGLAS L. MICHELS
Name:		Douglas L. Michels
Title:		Chief Executive Officer
Date:		May 14, 2003

I, Randall Bresee, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of Tarantella, Inc. on Form 10-Q for the fiscal quarter ended March 31, 2003 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Quarterly Report on Form 10-Q fairly presents in all material respects the financial condition and results of operations of Tarantella, Inc.


By:		/s/ RANDALL BRESEE
Name:		Randall Bresee
Title:		Chief Financial Officer
Date:		May 14, 2003

The Company filed no Report on Form 8-K’s during the quarter ended March 31, 2003.

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.

Tarantella, Inc.

By:		/s/ Randall Bresee
		Randall Bresee
		Senior Vice President, Chief Financial Officer
		May 14, 2003

By:		/s/ Jenny Twaddle
		Jenny Twaddle
		Vice President, Corporate Controller
		May 14, 2003

/s/ Douglas L. Michels
Douglas L. Michels
President, Chief Executive Officer and Director

/s/ Randall Bresee
Randall Bresee
Senior Vice President, Chief Financial Officer

425 Encinal Street, Santa Cruz, California				95060
(Address of principal executive office)				(Zip Code)

				Page
*Part I*	*Financial Information*

	Item 1.	Financial Statements

		a)	Condensed Consolidated Statements of Operations for the three and six months ended March 31, 2003 and 2002	3

		b)	Condensed Consolidated Balance Sheets, as of March 31, 2003 and September 30, 2002	4

		c)	Condensed Consolidated Statements of Cash Flows for the six months ended March 31, 2003 and 2002	5

		d)	Notes to Condensed Consolidated Financial Statements	7

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		16

	Item 3.	Quantitative and Qualitative Disclosures about Market Risk		27

	Item 4.	Controls and Procedures		27

*Part II.*	*Other Information*

	Item 1.	Legal Proceedings		28

	Item 2.	Changes in Securities and Use of Proceeds		28

	Item 3.	Defaults Upon Senior Securities		28

	Item 4.	Submission of Matters to a Vote of Security Holders		28

	Item 5.	Other Information		29

	Item 6.	Exhibits and Reports on Form 8-K		30

	*Signatures and certifications*			32

	Three Months Ended March 31,						Six Months Ended March 31,
	2003			2002			2003			2002
(In thousands, except per share data)	(Unaudited)						(Unaudited)
Net revenues:
Licenses	$	3,697		$	3,830		$	6,751		$	6,284
Services		707			509			1,238			880

Total net revenues		4,404			4,339			7,989			7,164

Cost of revenues:
Licenses		85			161			154			229
Services		291			257			549			507

Total cost of revenues		376			418			703			736

Gross margin		4,028			3,921			7,286			6,428

Operating expenses:
Research and development		906			1,307			1,885			3,053
Selling, general and administrative		3,811			4,698			7,534			11,091
Restructuring charge		—			—			1,147			1,718

Total operating expenses		4,717			6,005			10,566			15,862

Operating loss		(689	)		(2,084	)		(3,280	)		(9,434	)

Other income (expense):
Interest income, net		14			208			46			441
Other income, net		63			545			49			12
Loss on Caldera transaction		—			(3,038	)		—			(3,038	)
Loss of equity investment in Caldera		—			—			—			(4,010	)

Total other income (expense)		77			(2,285	)		95			(6,595	)

Loss before income taxes		(612	)		(4,369	)		(3,185	)		(16,029	)

Income tax expense (benefit)		98			(760	)		158			(760	)

Net loss		(710	)		(3,609	)		(3,343	)		(15,269	)

Other comprehensive income (loss):
Unrealized gain (loss) on available for sale securities		(177	)		40			106			65
Foreign currency translation adjustment		(18	)		42			(22	)		16

Total other comprehensive income (loss)		(195	)		82			84			81

Comprehensive loss	$	(905	)	$	(3,527	)	$	(3,259	)	$	(15,188	)

Net loss per share:
Basic and diluted	$	(0.02	)	$	(0.09	)	$	(0.08	)	$	(0.38	)
Shares used in net loss per share calculation:
Basic and diluted		41,199			40,348			41,113			40,233

	March 31, 2003			September 30, 2002
(In thousands)	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	1,665		$	7,055
Available-for-sale equity securities		329			223
Trade receivables, net of allowance for doubtful accounts of $410 at March 31, 2003 and $340 at September 30, 2002		4,781			3,045
Other receivables		347			236
Prepaids and other current assets		476			823

Total current assets		7,598			11,382

Property and equipment, net		866			1,192
Restricted cash		500			500
Other assets		795			524

Total assets	$	9,759		$	13,598

Liabilities and shareholders’ equity
Current liabilities:
Trade payables	$	474		$	448
Royalties payable		172			212
Income taxes payable		617			581
Accrued restructuring charges		850			871
Other payables—Caldera		—			400
Accrued expenses and other current liabilities		3,468			3,892
Deferred revenues		1,118			945

Total current liabilities		6,699			7,349

Long-term deferred revenues		69			33

Total long-term liabilities		69			33

Shareholders’ equity:
Preferred stock, authorized 20,000 shares; no shares issued and outstanding		—			—
Common stock, no par value, authorized 100,000 shares; issued and outstanding 41,280 shares at March 31, 2003 and 41,028 shares at September 30, 2002		120,878			120,844
Accumulated other comprehensive income		201			117
Accumulated deficit		(118,088	)		(114,745	)

Total shareholders’ equity		2,991			6,216

Total liabilities and shareholders’ equity	$	9,759		$	13,598

	Six Months Ended March 31,
	2003			2002
(In thousands)	(Unaudited)
Cash flows from operating activities:
Net loss	$	(3,343	)	$	(15,269	)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization		388			472
Foreign currency exchange loss (gain)		(32	)		47
Gain on sale of marketable security		—			(1,350	)
Loss on disposal of property and equipment		82			281
Loss on Caldera transaction					3,038
Equity losses in Caldera		—			4,010
Impairment of equity investments		—			796
Stock compensation expense		—			595
Changes in operating assets and liabilities:
Trade receivables		(1,735	)		151
Other receivables		(111	)		666
Prepaids and other current assets		347			420
Other assets		(271	)		(907	)
Trade payables		26			(96	)
Royalties payable		(40	)		(238	)
Income taxes payable		36			100
Accrued restructuring expenses		(21	)		304
Accrued expenses and other current liabilities		(422	)		(1,613	)
Other payables—Caldera		(400	)		124
Deferred revenues		209			259
Other long-term liabilities		—			(749	)

Net cash used in operating activities		(5,287	)		(8,959	)

Cash flows from investing activities:
Sales of short-term investments and marketable securities		—			2,856
Purchases of property and equipment		(134	)		(15	)

Net cash provided (used) in investing activities		(134	)		2,841

Cash flows from financing activities:
Payments on capital lease obligations		(2	)		(365	)
Net proceeds from issuance of common stock		34			92

Net cash provided (used) in financing activities		32			(273	)

Effects of exchange rate changes on cash and cash equivalents		(1	)		(7	)

Decrease in cash and cash equivalents		(5,390	)		(6,398	)
Cash and cash equivalents at beginning of period		7,055			12,100

Cash and cash equivalents at end of period	$	1,665		$	5,702

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Table of Contents

Table of Contents

Table of Contents

Table of Contents

(In Thousands)	Reduction in Force			Facilities			Disposal of Fixed Assets			Total
Restructuring charge accrued	$	820		$	238		$	89		$	1,147
Payments/utilization of the accrual		(408	)		(24	)		(89	)		(521	)

Accrual at December 31, 2002		412			214			—			626
Payments/utilization of the accrual		(240	)		(74	)		—			(314	)
Provision Adjustment		—			—			—			—

Accruals at March 31, 2003	$	172		$	140		$	—		$	312

*Nominees:*	FOR	AGAINST
Ninian Eadie	35,097,306 (92%)	2,941,623 (8%)
Ronald Lachman	34,487,344 (91%)	3,551,585 (9%)
Robert M. McClure	34,908,369 (92%)	3,130,560 (8%)
Douglas L. Michels	34,212,512 (90%)	3,826,417 (10%)
Alok Mohan	34,464,984 (91%)	3,573,945 (9%)
R. Duff Thompson	35,090,183 (92%)	2,948,746 (8%)
Gilbert P. Williamson	34,853,548 (92%)	3,185,381 (8%)

FOR		AGAINST		ABSTAIN		BROKER NON-VOTE *
14,784,732		3,947,829		1,757,274		17,549,094

FOR		AGAINST		ABSTAIN
34,988,912		1,478,444		1,571,573

FOR		AGAINST		ABSTAIN
36,159,868		231,351		1,647,710