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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(303) 473-9118
(Registrant’s telephone number, including area code)

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

Indicate the number of shares outstanding of each of the registrant’s classes of Common Stock, as of the latest practicable date.

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PART I - FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

ROGUE WAVE SOFTWARE, INC.
AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

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

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ROGUE WAVE SOFTWARE, INC.
AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER
COMPREHENSIVE LOSS

(in thousands, except per share data, unaudited)

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

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ROGUE WAVE SOFTWARE, INC.
AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands, unaudited)

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

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ROGUE WAVE SOFTWARE, INC.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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              In October 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” and replaces the accounting and reporting provisions for segments of a business to be disposed of under Accounting Principles Board (“APB”) Opinion No. 30, “Reporting Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.” SFAS No. 144 maintains the requirement that an impairment loss be recognized for a long-lived asset to be held and used if its carrying value is not expected to be recoverable from its undiscounted cash flows. SFAS No. 144 requires that long-lived assets to be disposed of, other than by sales, be considered held and used until actually disposed of and requires that depreciable lives be revised in accordance with APB Opinion No. 20, “Accounting Changes.” SFAS No. 144 also requires that long-lived assets to be disposed of by sale be measured at the lower of carrying amount or fair value less selling costs, but retains the requirement to report discontinued operations separately from continuing operations and extends that reporting to a component of an entity that has either been disposed of or is classified as held for sale. The provisions of SFAS No. 144 are effective for the Company for the fiscal year beginning October 1, 2002. Management does not believe adoption of this statement will have a material impact on the Company’s financial position, results of operations or cash flows.

              In July 2002, the FASB issued SFAS No. 146, “Accounting for Exit or Disposal Activities.” SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies 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).” SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred instead of the date of an entity’s commitment to an exit plan. This Statement also establishes that fair value is the objective for initial measurement of the liability. Severance pay under Statement 146, in many cases, would be recognized over time rather than upfront for employees who render future services beyond a minimum retention period. The minimum retention period would be based on the legal notification period, or if there is no such requirement, 60 days. The provisions of SFAS No. 146 are effective for the Company for disposal activities initiated after December 31, 2002. Management does not believe adoption of this statement will have a material impact on the Company’s financial position, results of operations or cash flows.

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

              Except for the historical information contained herein, the following discussion contains forward-looking statements that involve risks and uncertainties. The Company’s actual results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this section, as well as in the section “Risk Factors” and “Business” in the Company’s Annual Report on Form 10-K for the year ended September 30, 2001. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date hereof. The Company undertakes no obligation to publicly release the results of any revision to these forward-looking statements, which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. The following discussions should be read in conjunction with our condensed consolidated financial statements and the notes thereto.

Overview

              Rogue Wave was founded in 1989, and is a leading provider of object-oriented software technology. Customers around the world rely on Rogue Wave products to build comprehensive application solutions. Rogue Wave believes that application development efforts are most effective when businesses are able to concentrate on the domain specific application capabilities that enable them to differentiate themselves from their competitors. Rogue Wave offers proven software components and frameworks that enhance developer productivity for implementing common application functionality. The Company’s software also handles the complex architectural issues that are key to successful application implementation, but which most often fall outside a company’s in-house development expertise. Rogue Wave is committed to providing products and services that reduce the effort, time to market, and overall project risk associated with the development of comprehensive application solutions.

              The Company’s products are marketed to information technology development managers, independent software vendors, value added resellers, original equipment manufacturers and professional programmers in all industry and geography segments. The Company’s products are designed to enable customers to construct robust applications faster, with higher quality and lower risk, resulting in significant cost savings. These products provide customers with greater independence from hardware platforms, operating systems and other vendor-specific dependencies.

The Rogue Wave Strategy and Business Model

              Rogue Wave’s strategic objective is to provide technology and services that allow customers to optimize productivity when building software solutions to address their business requirements. Simply, the Company strives to create products that efficiently and effectively align underlying information technology with a customer’s application of that technology.

Core Technology – SourcePro C++

              The Company’s history is rich in object oriented C++, the language of choice for large scale, business critical applications. During fiscal 2001, Rogue Wave announced the launch of the SourcePro C++ product line, reflecting a substantive alteration to the Company’s core products and business model. The SourcePro C++ products, which integrate the majority of formerly offered Rogue Wave C++ component technology as well as features not previously available, are designed to provide more comprehensive solutions while optimizing the use of the Company’s core C++ products. SourcePro C++

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is comprised of four products: SourcePro Core, SourcePro DB, SourcePro Net and SourcePro Analysis. Pricing of the SourcePro C++ products is based on a customer value model, which considers scope of deployment, including operating systems, in contrast to the historically employed “license per developer” approach. Overall, the model allows customers greater flexibility in their utilization of the Company’s products. Additionally, the Company has made significant investment in Java and XML initiatives. Most recently, Rogue Wave has initiated the pursuit of two new technologies, the first addressing the Web integration needs of the C++ developer and the second involving an Internet shared memory space for transparent collaborative applications, providing an area on the Internet where XML documents can be written or read, subject to appropriate security constraints. These core products represent the foundation of the Company’s technological sophistication and capabilities.

              Evolution of the market place has created the need for higher order solutions. We believe that customers are less interested in atomic software components and more interested in technology suites and frameworks that address a higher percentage of their needs. We believe that customer purchasing practices have migrated away from the individual developer, with a greater focus on project, division or enterprise requirements. Further, to better position itself in the market, the Company is also aggressively pursuing partnership opportunities with leading technology companies. We believe that Rogue Wave’s technological history is deep and highly regarded by its clients and the technological community. By better aligning the Company’s current products, and more importantly its product development efforts, with the world’s leading companies, Rogue Wave expects to have greater success building solutions that solve real world business problems that meets our customers’ needs.

              The Company’s international revenue is generated primarily by the Company’s European subsidiaries. The Company has entered into forward foreign exchange contracts to reduce certain risks associated with currency fluctuations. Although exposure to currency fluctuations to date has been insignificant, to the extent international revenue is denominated in local currencies, foreign currency translations may contribute to significant fluctuations in, and could have a material adverse effect upon, the Company’s business, financial condition and results of operations. See “Factors That May Affect Future Results.”

Strategic Realignment – Globalization

              During the second quarter of fiscal year 2002, the Company announced a realignment of its corporate strategy to include an aggressive focus on expansion in Europe, Asia Pacific and Latin America. In conjunction with this action and to better align its cost structure with its new international business focus, on March 29, 2002, the Company announced plans to restructure certain areas of its global operations, which resulted in severance related charges of $352,000 and $128,000 in the second and third fiscal quarter of 2002, respectively. The cost reductions, which resulted in a workforce reduction of approximately 47 employees or 16%, are expected to reduce future operating expenses by approximately $2 million quarterly, or 15% of total expenses.  All severance expenses were paid in the third fiscal quarter of 2002.

              Additionally, as part of this restructuring plan and to better meet the needs of our customers, the Company has established three separate regional operations, the Americas, EMEA ( “Europe”) and Asia Pacific in an effort to drive autonomy and greater accountability. During the second fiscal quarter, the Company opened an office in Australia and increased its resources in Europe and other areas of the Asia Pacific region. In the third quarter, the Company began the process of establishing several new distributor arrangements. As a part of the strategy to move into new international markets, the Company is creating a streamlined license and packaging process to run through these new distributor channels. The Company anticipates further expansion in foreign countries, including within the Asian markets, and

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expects that international license and service and maintenance revenue will account for an increasing portion of its total revenue in the future. There can be no assurance, however, that the Company will be able to maintain or increase international market demand for its products. See “Factors that May Affect Future Results” for additional risk factors associated with the Company’s global expansion.

Large Scale Object Solutions

              Large Scale Object Solutions (“LSOS”) is a set of technologies targeted at customers with specific needs related to running very high throughput systems deployed against a relational database. LSOS offers services such as a hierarchical object model, object history, object reconciliation, and a method for storing objects on relational databases in order to maximize performance.

              The Company’s first implementation of this technology is an application that the Company developed, in partnership with JP Morgan Chase, known as Global Market Reference Data. This product has been renamed and will be marketed as CornerstoneST to the worldwide financial institutions industry, which are facing T+1 compliance issues. Our objective is to expand into additional financial application projects and then branch out into other industries.

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Results of Operations

              The following table sets forth for the periods indicated the percentage of net revenue represented by certain line items in the Company’s Condensed Consolidated Statements of Operations.

Revenue

              Total revenue for the three and nine months ended June 30, 2002 was $10.1 million and $34.0 million, respectively, versus $14.6 million and $44.0 million for the three and nine months ended June 30, 2001, representing a decrease of 31% and 23%, respectively. License revenue for the three and nine months ended June 30, 2002 was $5.4 million and $18.2 million, respectively, versus $8.0 million and $22.5 million for the three and nine months ended June 30, 2001, representing a decrease of 33% and 19%, respectively. The decrease is due to a decrease in the number of licenses sold to existing and new customers, primarily as a result of restrained corporate technology spending. In general, the slowing economy has had the effect of lengthening the sales cycle and, in some cases, outright cancellation of technology spending. Rogue Wave has adopted a new corporate strategy that significantly focuses on the development of its international operations, which is designed to increase future revenue.

              Service and maintenance revenue for the three and nine months ended June 30, 2002 was $4.7 million and $15.8 million, respectively, versus $6.6 million and $21.5 million, respectively, for the three and nine months ended June 30, 2001, representing a decrease of 29% and 27%, respectively. The decrease in service and maintenance revenue was primarily attributable to the decrease in revenue received from two significant customized consulting contracts signed in the first quarter of fiscal 2001.

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Although the initial projects were comprised entirely of consulting revenue, the Company expects future sales of the resulting finished application to increase license revenue. In addition, maintenance revenue has also been negatively impacted as a result of restrained technology spending from the depressed economy.

Cost of Revenue

              Cost of license revenue consists primarily of amortization of purchased software, materials, packaging and freight expense. Cost of license revenue for the three and nine months ended June 30, 2002 was $231,000 and $523,000, respectively, versus $234,000 and $713,000 for the three and nine months ended June 30, 2001, respectively, representing a decrease of 1% and 27%. The decreases are primarily the result of a decrease in purchased software costs as well as a continued decrease in the number of manuals produced due to an increase in product offerings delivered through the Internet versus physically shipped.

              Cost of service and maintenance revenue consists primarily of personnel related and facilities costs incurred in providing customer support and training services as well as third party costs incurred in providing training and consulting services. Cost of service and maintenance revenue for the three and nine months ended June 30, 2002 was $1.3 million and $5.2 million, respectively, versus $3.0 million and $9.5 million for the three and nine months ended June 30, 2001, respectively, representing a decrease of 57% and 45%, respectively. The decreases were due primarily to staffing efficiencies gained from fiscal year 2002 restructuring actions and a decrease in the utilization of third-party consulting services for the additional costs associated with the two significant customized software consulting contracts entered into in the first quarter of fiscal 2001.

Operating Expenses

              Product development expense for the three and nine months ended June 30, 2002 was $2.9 million and $9.5 million, respectively, versus $3.3 million and $10.8 million for the three and nine months ended June 30, 2001, respectively, representing a decrease of 12% in each period. As a percent of revenue, product development expense for the three and nine months ended June 30, 2002 was 29% and 28%, respectively, versus 22% and 25% for the three and nine months ended June 30, 2001, respectively. The decrease in the three and nine months ended June 30, 2002 product development expense was due to staffing reductions achieved during the last half of fiscal year 2001 and in the third fiscal quarter of 2002. The Company does not expect that product development expense will grow or will increase materially as a percentage of total revenue for fiscal 2002. All costs incurred in the research and development of software products and enhancements to existing products have been expensed as incurred.

              Sales and marketing expenses for the three and nine months ended June 30, 2002 were $5.6 million and $17.0 million, respectively, versus $6.4 million and $19.0 million for the three and nine months ended June 30, 2001, respectively, representing a decrease of 13% and 11%, respectively. As a percentage of total revenue, sales and marketing expenses were 55% and 50% for the three and nine months ended June 30, 2002, respectively, versus 44% and 43% for the three and nine months ended June 30, 2001, respectively. The decrease in sales and marketing expense is due to the decrease in sales and marketing personnel and related costs associated with the implementation of cost containment programs. The Company does not expect that sales and marketing expenses will grow or that expenses will increase significantly as a percentage of total revenue for fiscal 2002.

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              General and administrative expenses for the three and nine months ended June 30, 2002 was $1.2 million and $4.4 million, respectively, versus $1.7 million and $4.5 million, respectively, representing a decrease of 29% and 2%, respectively. The decrease is primarily due to cost containment programs implemented during the last half of fiscal year 2001 and the aggressive focus on expense reduction in fiscal year 2002. The variability between the percent decrease in expenses from the three and nine month period to period comparison is due to approximately $600,000 reduction in expense accruals for certain employment and product distribution contract issues that occurred in the first quarter of 2001. The Company believes that its general and administrative expenses will remain flat for fiscal 2002.

              Restructuring, severance and goodwill expenses totaling approximately $270,000 and $1.3 million were recognized during the three and nine months ended June 30, 2002, respectively. The Company incurred severance of $617,000 for the termination of certain senior managers and $142,000 for the finalization of lease closure costs for the Stingray facility and related asset impairment charge. In addition, $76,000 of goodwill amortization was recognized in the first half of fiscal year 2002.

              During the second quarter of fiscal year 2002, the Company announced a realignment of its corporate strategy to include an aggressive focus on expansion in Europe, Asia Pacific and Latin America. In conjunction with this action and to better align its cost structure with its new international business focus, on March 29, 2002, the Company announced plans to restructure certain areas of its global operations, which resulted in severance related charges of $352,000 and $128,000 in the second and third fiscal quarters of 2002, respectively. The Company expects that the restructuring, which included a workforce reduction of approximately 47 employees or 16%, will reduce future operating expenses by approximately $2 million quarterly, or 15% of total expenses. All severance expenses were paid in the third fiscal quarter of 2002.

Other Income, Net

              Other income for the three and nine months ended June 30, 2002 and 2001 primarily consists of interest income on the Company’s cash, cash equivalents and short-term investments as well as foreign currency translation adjustments. The decrease in other income of $468,000 and $809,000 for the three and nine months ended June 30, 2002, respectively, compared to the three and nine months ended June 30, 2001, is primarily due to an erosion in value of the U.S. dollar world wide, which resulted in foreign currency losses, as well as a decrease in investments and interest rates during the current fiscal period as compared to the same fiscal periods last year.

Income Tax Benefit

              In general, income taxes for the three and nine month period ended June 30, 2002 are provided during interim periods based on the expected effective tax rate for the year. The provision for income taxes benefit for the three and nine month periods ended June 30, 2002, is based on an estimated annual effective tax rate of approximately 35% plus adjustments, which is applied to the loss before income taxes and includes federal, state and foreign income taxes.

              The Company has recorded a deferred tax asset of $4.1 million reflecting the benefit of $1.5 million loss carryforwards, $975,000 of research credits and various other tax credits and temporary differences, which expire in varying amounts between 2003 and 2021. Realization is dependent on generating sufficient taxable income prior to expiration of the loss carryforwards. Although realization is not assured, management believes it is more likely than not that all of the deferred tax asset will be realized.

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Liquidity and Capital Resources

              The Company’s working capital was $26.8 million at June 30, 2002 compared to $30.6 million at June 30, 2001 and $28.5 million at March 31, 2002. The decrease in working capital is primarily due to a decline in sales.

              Net cash used in operating activities was $4.0 million during the nine months ended June 30, 2002, compared to $2.1 million in the comparable 2001 period. The decrease in cash flows from operations was primarily due to the net loss and a decrease in deferred revenue. The decrease in deferred revenue is primarily due to the timing of the completion of contracts with a decrease in new maintenance, support and service revenue signed in the nine months of fiscal 2002, compared to the same period in fiscal 2001.

              The Company’s investing activities consist primarily of the purchase and sale of short-term investments and purchases of equipment. During the nine months ended June 30, 2002, net cash used in investing activities was $1.3 million, which included the purchase of short-term investments of $362,000 and the purchase of equipment of $943,000, compared to $7.8 million in the comparable 2001 period.

              Net cash used in or derived from financing activities was $1.4 million for the nine months ended June 30, 2002, compared with net cash provided by financing activities of $411,000 for the comparable 2001 period. In September 2001, the Board of Directors authorized the Company to repurchase up to an aggregate of $5.0 million or 2.5 million shares of its Common Stock. At June 30, 2002, the Company had repurchased 529,000 shares for approximately $1.7 million, at prices ranging from $2.50 – $3.65 per share.

              The Company believes that expected cash flows from operations combined with existing cash and cash equivalents and short-term investments will be sufficient to meet its cash requirements for the foreseeable future. See “Factors That May Affect Future Results.”

Critical Accounting Policies

              The preparation of the condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the condensed consolidated financial statements and accompanying notes. The Securities and Exchange Commission has defined a company’s most critical accounting policies as those that are most important to the portrayal of the company’s financial condition and results of operations, and which require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, the Company has identified the critical accounting policies and judgments described below. Additionally, Rogue Wave also has other key accounting policies, which involve the use of estimates, judgments and assumptions and which are detailed in Note 1 “Description of Business and Summary of Significant Accounting Policies” in Item 14 of Part IV, “Exhibits, Consolidated Financial Statements, Schedules and Reports on Form 8-K,” of our Annual Report on Form 10-K for the year ended September 30, 2001. Although the Company believes that its estimates and assumptions are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates under different assumptions or conditions.

Revenue Recognition

              The Company’s revenue is derived from licenses of its software products and related maintenance, training and consulting services. License, maintenance and most services are recognized in accordance with

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Statement of Position 97-2, “Software Revenue Recognition” (SOP 97-2), as amended by SOP 98-9, which permits revenue recognition when (1) persuasive evidence of an arrangement exists, (2) delivery of the product has occurred, (3) the fee is fixed or determinable, and (4) collectibility is probable. The Company defines each of the four criteria above as follows:

              Persuasive evidence of an arrangement exists. Rogue Wave’s customary practice is to execute a written contract, signed by both the customer and the Company, or a purchase order from those customers that have previously negotiated a license agreement.

              Delivery.  The Company’s software may be either physically or electronically delivered to the customer. Delivery is deemed to have occurred upon the shipment of the product or delivery of the authorization code. If undelivered products or services exist in an arrangement that are essential to the functionality of the delivered product, delivery is not considered to have occurred until these products or services are delivered.

              The fee is fixed or determinable.  Rogue Wave negotiates the fee for its products at the outset of an arrangement. In these arrangements, the majority of the development licenses are perpetual and nonrefundable. The fees are generally due within one to twelve months depending on the length of the contract. The Company considers fees relating to arrangements with payment terms extending beyond twelve months not to be fixed or determinable. If the fee is not fixed or determinable, revenue is recognized as payments become due from the customer.

              Collectibility is probable.  Collectibility is evaluated on a customer-by-customer basis. New and existing customers are subject to a credit review process, which evaluates the customers’ financial position (e.g. cash position and credit rating) and their ability to pay. If collectibility is not considered probable at the outset of an arrangement in accordance with the Company’s credit review process, revenue is recognized when the fee is collected.

              SOP 97-2, as amended, generally requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of the elements. The determination of fair value of each element in multiple-element arrangements is based on vendor-specific objective evidence (“VSOE”). The VSOE for license, consulting and training fees is established when the same element is sold separately. VSOE for maintenance and support is determined based upon the customer’s annual renewal rates.

              Assuming all other revenue recognition criteria are met, revenue from licenses is recognized upon delivery. Maintenance and support revenue is deferred and recognized on a straight-line basis over the contractual service period, which are typically one to three years. Consulting services, which include training, are not considered essential to the functionality of the other elements of the arrangement. The revenue allocable to the consulting services is generally recognized as the services are performed. In instances where the Company enters into customized software consulting contracts, the fees are recognized using the percentage of completion method of contract accounting in accordance with SOP No. 81-1, “Accounting for Performance of Construction-Type and Certain Product-Type Contracts”.

Sales Returns and Allowance for Doubtful Accounts

              The Company’s management must make estimates of potential future product returns related to current period product revenue. Management analyzes historical returns, current economic trends, and changes in customer demand and acceptance of the products when evaluating the adequacy of the sales

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returns. Significant management judgments must be made and used in connection with establishing the estimated sales returns in any accounting period.

              The Company’s allowance for doubtful accounts is intended to reduce the value of customer accounts receivable to amounts expected to be collected. In determining the required allowance, the Company considers factors such as customer credit history, overall and industry economic conditions and the customer’s current financial performance. Rogue Wave performs ongoing credit evaluations of its customers and adjusts credit limits based upon payment history and the customer’s current credit worthiness, as determined by the review of their current credit information. The Company continuously monitors collections and payments from the customers. While such credit losses have historically been within expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past.

Accounting for Income Taxes

              As part of the process of preparing the Company’s condensed consolidated financial statements, Rogue Wave is required to estimate income taxes in each of the jurisdictions in which it operates. This process involves estimates of the actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets, which are included within our consolidated balance sheet. Rogue Wave records a valuation allowance to reduce its deferred tax assets to the amount that it believes is more likely than not to be realized. In assessing the need for a valuation allowance, the Company estimates future taxable income, considering the feasibility of ongoing tax planning strategies and the realizability of tax changes to tax laws, changes to statutory tax rates and future taxable income levels. In the event the Company were to determine that it would not be able to realize all or a portion of its deferred tax assets in the future, the Company would reduce such amounts through a charge to income in the period that such determination is made. Conversely, if the Company were to determine that it would be able to realize its deferred tax assets in the future in excess of the net carrying amounts, the Company would decrease the recorded valuation allowance through an increase to income in the period that such determination is made.

Factors That May Affect Future Results

              In evaluating the Company’s business, investors should carefully consider the following factors in addition to the other information presented in this report.

Our future operating results are difficult to predict and actual financial results may vary from our expectations, which could have an adverse effect on our stock price.

              Our future operating results are difficult to predict due to a variety of factors, many of which are outside of our control. These factors include:

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              One or more of the foregoing factors may cause our operating results to fluctuate significantly. Based on the preceding factors, we may experience a shortfall in revenue or earnings or otherwise fail to meet public market expectations, which could materially adversely affect our business, financial condition and the market price of our Common Stock.

Our sales volume is subject to fluctuations and unpredictable timing and may cause our operating results to fluctuate significantly.

              We generally ship orders as received, which means that quarterly revenue and operating results depend substantially on the volume and timing of orders we receive during the quarter. Sales volume is difficult to forecast due to a number of reasons, many of which are outside our control. These reasons include:

              We base operating expenses on anticipated revenue trends. A high percentage of these expenses are relatively fixed. As a result, a delay in the recognition of revenue from a limited number of transactions could cause significant variations in operating results from quarter to quarter and could lead to significant losses. Accordingly, operating results and growth rates for any particular quarter or other fiscal period may not be indicative of future operating results. Furthermore, fluctuations in our quarterly operating results may result in volatility in the price of our Common Stock in the future.

Our failure to manage planned growth could adversely affect our ability to increase revenue.

              Our business has evolved significantly in recent years, placing a strain on our management systems and resources. To manage future growth, we must continue to improve our financial and management controls, reporting systems and procedures on a timely basis and expand, train and manage our employee work force. If we fail to manage our growth effectively, our business, financial condition and results of operations could be materially and adversely affected.

Failure to attract and retain key employees will adversely affect our business.

              Our future performance depends significantly upon the continued service of our key technical, sales and senior management personnel, none of whom is bound by an employment agreement. We believe that the technological and creative skills of our personnel are essential to establishing and maintaining a leadership position, particularly in light of the fact that our intellectual property, once sold

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to the public market, is easily replicated. The loss of the services of one or more of our executive officers or key technical personnel may have a material adverse effect on our business.

              Our future success also depends on our continuing ability to attract and retain highly qualified technical, sales and managerial personnel. In the past, we have experienced some difficulty in attracting key personnel. Competition for such personnel is intense and there can be no assurance that we can retain key employees or that we can attract, assimilate or retain other highly qualified personnel in the future.

Variability of our sales cycles makes it difficult to forecast quarterly revenue and operating results, making it likely that period-to-period comparisons are not necessarily meaningful as an indicator of future results.

              We distribute our products primarily through two different direct sales channels, a telesales force and a field sales force, each of which is subject to a variable sales cycle. Products sold by our telesales force may be sold after a single phone call or may require several weeks of education and negotiation before a sale is made. As such, the sales cycle associated with telesales typically ranges from a few days to two months. On the other hand, the purchase of products from our field sales force is often an enterprise-wide decision and may require the sales person to provide a significant level of education to prospective customers regarding the use and benefits of our products. For these and other reasons, the sales cycle associated with the sale of our products through our field sales force typically ranges from two to six months and is subject to a number of significant delays over which we have little or no control. As a result, quarterly revenue and operating results are variable and are difficult to forecast, and we believe that period-to-period comparisons of quarterly revenue are not necessarily meaningful and should not be relied upon as an indicator of future revenue.

We face risks involving future business acquisitions.

              We frequently evaluate strategic opportunities available to us and may in the future pursue additional acquisitions of complementary technologies, products or businesses. Future acquisitions of complementary technologies, products or businesses will result in the diversion of management’s attention from the day-to-day operations of our business and may include numerous other risks, including difficulties in the integration of the operations, products and personnel of the acquired companies. Future acquisitions may also result in a dilutive issuance of equity securities, the incurrence of debt, and amortization expenses related to intangible assets. Our failure to successfully manage future acquisitions may have a material adverse effect on our business and financial results.

Doing business outside the United States involves numerous factors that could negatively affect our financial results.

              A significant portion of our revenue is derived from international sources. To service the needs of these customers, we must provide worldwide product support services. We have expanded, and intend to continue expanding, our international operations and plan to enter additional international markets. This will require significant management attention and financial resources that could adversely affect our operating margins and earnings. We may not be able to maintain or increase international market demand for our products. If we do not, our international sales will be limited, and our business, operating results and financial condition could be materially and adversely affected.

              Our international operations are subject to a variety of risks, including (1) foreign currency fluctuations, (2) economic or political instability, (3) shipping delays and (4) various trade restrictions.

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Any of these risks could have a significant impact on our ability to deliver products on a competitive and timely basis. Significant increases in the level of customs duties, export quotas or other trade restrictions could also have an adverse effect on our business, financial condition and results of operations. In situations where direct sales are denominated in a foreign currency, any fluctuation in foreign currency or the exchange rate may adversely affect our business, financial condition and results of operations.

We may not be able to adequately protect our intellectual property or operate our business without infringing on the intellectual property rights of others.

              We rely primarily on a combination of copyright, trademark and trade secret laws, confidentiality procedures and contractual provisions to protect our proprietary rights. We also believe that factors such as the technological and creative skills of our personnel, new product developments, frequent product enhancements, name recognition and reliable product maintenance are essential to establishing and maintaining a technological leadership position. We seek to protect our software, documentation and other written materials under trade secret and copyright laws, which afford only limited protection. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. The nature of many of our products requires the release of the source code to customers. As such, policing unauthorized use of our products is difficult, and while we are unable to determine the extent to which piracy of our products exists, software piracy can be expected to be a persistent problem. In addition, the laws of some foreign countries do not protect our proprietary rights as fully as do the laws of the United States. There can be no assurance that our means of protecting our proprietary rights in the United States or abroad will be adequate or that competition will not independently develop similar technology.

              Although we do not believe that we are infringing any proprietary rights of others, third parties may claim that we have infringed their intellectual property rights. Furthermore, former employers of our former, current or future employees may assert claims that such employees have improperly disclosed to us the confidential or proprietary information of such former employers. Any such claims, with or without merit, could (1) be time consuming to defend, (2) result in costly litigation, (3) divert management’s attention and resources, (4) cause product shipment delays or (5) require us to pay money damages or enter into royalty or licensing agreements. A successful claim of intellectual property infringement against us and our failure or inability to license or create a workaround for such infringed or similar technology may materially and adversely affect our business, operating results and financial condition.

              Our license agreements with our customers typically contain provisions designed to limit our exposure to potential product liability claims. It is possible, however, that the limitation of liability provisions contained in our license agreements may not be effective under the laws of certain jurisdictions. A successful product liability claim brought against us could have a material adverse effect upon our business, operating results and financial condition.

Our business will suffer if our products contain defects or do not function as intended, which would cause our revenue to decline.

              Software products frequently contain errors or failures, especially when first introduced or when new versions are released. Also, new products or enhancements may contain undetected errors, or “bugs,” or performance problems that, despite testing, are discovered only after a product has been installed and used by customers. Errors or performance problems could cause delays in product introduction and shipments or require design modifications, either of which could lead to a loss in revenue. Our products are typically intended for use in applications that may be critical to a customer’s

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business. As a result, we expect that our customers and potential customers have a greater sensitivity to product defects than the market for software products generally. Despite extensive testing by us and by current and potential customers, errors may be found in new products or releases after commencement of commercial shipments, resulting in loss of revenue or delay in market acceptance, diversion of development resources, the payment of monetary damages, damage to our reputation, or increased service and warranty costs, any of which could have a material adverse effect on our business and results of operations.

We cannot predict whether the market acceptance for C++ and Visual C++/MFC will continue to grow.

              Our product lines are designed for use in object-oriented software application development. To date, a substantial majority of our revenue has been attributable to sales of products and related maintenance and consulting services associated with C++ programming and development. We believe that, while the market for object-oriented technology is maturing, optimization of the C++ solutions through realignment of products and services coupled with the pursuit of unsaturated markets in Asia Pacific, Europe and Latin America, will serve to enhance future revenue. However, object-oriented programming languages are very complex and the number of software developers using them is relatively small compared to the number of developers using other software development technology. Our financial performance will depend in part upon continued growth in object-oriented technology and markets and the development of standards that our products address. There can be no assurance that the market will continue to grow or that we will be able to respond effectively to the evolving requirements of the market.

Our market is highly competitive, and if we are unable to compete successfully our ability to grow our business or maintain revenue and earnings at current levels will be impaired.

              Our products target the markets for Visual C++/MFC and Visual Basic/ActiveX software parts and programming tools. Direct competitors in the C++ market include Microsoft (with its MFC), ILOG and several privately held companies. Microsoft is a particularly strong competitor due to its large installed base and the fact that it bundles its MFC library with its own and other C++ compilers. Microsoft may decide in the future to devote more resources to or broaden the functions of MFC in order to address and more effectively compete with the functionality of our products.

              Software applications can also be developed using software parts and programming tools in environments other than C++. Indirect competitors with such offerings include Microsoft, Borland, Oracle and Powersoft. Many of these competitors have significantly greater resources, name recognition and larger installed bases of customers than we do. These potential competitors also have well-established relationships with current and potential customers and have the resources to enable them to more easily offer a single vendor solution. As a result, these potential competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the development, promotion and sale of their products than we can.

              We also face competition from systems integrators and our customers’ internal information technology departments. Many systems integrators possess industry specific expertise that may enable them to offer a single vendor solution more easily, and already have a reputation among potential customers for offering enterprise-wide solutions to software programming needs. Systems integrators may market competitive software products in the future.

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              There are many factors that may increase competition in the market for object-oriented software parts and programming tools, including (1) entry of new competitors, (2) alliances among existing competitors and (3) consolidation in the software industry. Increased competition may result in price reductions, reduced gross margins or loss of market share, any of which could materially adversely affect our business, operating results and financial condition. If we cannot compete successfully against current and future competitors or overcome competitive pressures, our business, operating results and financial condition may be adversely affected.

We operate in an industry with rapidly changing technology and, if we do not successfully modify our products to incorporate new technologies, they may become obsolete and sales will suffer.

              The software market in which we compete is characterized by (1) rapid technological change, (2) frequent introductions of new products, (3) changing customer needs and (4) evolving industry standards. To keep pace with technological developments, evolving industry standards and changing customer needs, we must support existing products and develop new products. We may not be successful in developing, marketing and releasing new products or new versions of our products that respond to technological developments, evolving industry standards or changing customer requirements. We may also experience difficulties that could delay or prevent the successful development, introduction and sale of these enhancements. In addition, these enhancements may not adequately meet the requirements of the marketplace and may not achieve any significant degree of market acceptance. If release dates of any future products or enhancements are delayed, or if these products or enhancements fail to achieve market acceptance when released, our business, operating results and financial condition could be materially adversely affected. In addition, new products or enhancements by our competitors may cause customers to defer or forgo purchases of our products, which could have a material adverse effect on our business, financial condition and results of operations.

ITEM 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

              The Company’s market risk exposure is the potential loss arising from changes in interest rates and its impact on short-term investments and foreign currency exchange rate fluctuations.

              As of June 30, 2002, the Company had short-term investments of $17.5 million, which are classified as held to maturity. All investments had maturities of less than 360 days when acquired. Short-term investments consist primarily of highly rated credit and highly liquid corporate notes and commercial paper. A reasonable reduction in overall interest rates would not have a material effect on the fair value of the investments or the financial position of the Company.

              Exposure to variability in foreign currency exchange rates is managed primarily through the use of natural hedges, whereby funding obligations and assets are both managed in the local currency. In addition, the Company will from time to time enter into foreign currency exchange agreements to manage its exposure arising from fluctuating exchange rates, primarily in the Euro. The Company does not enter into any derivative transactions for speculative purposes. The sensitivity of earnings and cash flows to variability in exchange rates is assessed by a appropriate range of potential rate fluctuations that the Company believes to be appropriate to the Company’s assets, obligations and projected results of operations denominated in foreign currencies. Based on the Company’s overall foreign currency rate exposure at June 30, 2002, movements in foreign currency rates would not materially affect the financial position of the Company. At June 30, 2002, the Company had outstanding short-term forward exchange contracts to exchange Euros for U.S. dollars in the amount of $909,000. See Note 8 of Notes to Condensed Consolidated Financial Statements.

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PART II – OTHER INFORMATION

ITEM 6. – EXHIBITS AND REPORTS ON FORM 8-K

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