TARANTELLA INC - 10-Q Quarterly Report

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended December 31, 2002

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period From to

Commission File Number 0-21484

TARANTELLA, INC.

(Exact name of registrant as specified in this charter)


California		94-2549086
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

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

(831) 427-7222

(Registrant’s telephone number, including area code)

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 December 31, 2002 was 41,028,264.

TARANTELLA, INC.

FORM 10-Q

For the Quarterly Period Ended December 31, 2002

Table of Contents

				Page

*Part I. Financial Information*

	Item 1.	Financial Statements

		a)	Condensed Consolidated Statements of Operations for the three months ended December 31, 2002 and 2001	3

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

		c)	Condensed Consolidated Statements of Cash Flows for the three months ended December 31, 2002 and 2001	5

		d)	Notes to Condensed Consolidated Financial Statements	6

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		13

	Item 3.	Quantitative and Qualitative Disclosures about Market Risk		22

	Item 4.	Controls and Procedures		22

*Part II. Other Information*

	Item 1.	Legal Proceedings		23

	Item 2.	Changes in Securities and Use of Proceeds		23

	Item 3.	Defaults Upon Senior Securities		23

	Item 4.	Submission of Matters to a Vote of Security Holders		23

	Item 5.	Other Information		23

	Item 6.	Exhibits and Reports on Form 8-K		24

	*Signatures and Certifications*			26-28

Part I. Financial Information

Item 1. Financial Statements

TARANTELLA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS



	Three Months Ended December 31,
	2002			2001
(In thousands, except per share data)	(Unaudited)

Net revenues:
Licenses	$	3,054		$	2,454
Services		531			371

Total net revenues		3,585			2,825

Cost of revenues:
Licenses		69			68
Services		258			250

Total cost of revenues		327			318

Gross margin		3,258			2,507

Operating expenses:
Research and development		979			1,746
Selling, general and administrative		3,723			6,393
Restructuring charge		1,147			1,718

Total operating expenses		5,849			9,857

Operating loss		(2,591	)		(7,350	)

Other income (expense):
Loss of equity investment in Caldera		—			(4,010	)
Interest income, net		32			233
Other expense, net		(14	)		(533	)

Total other income (expense)		18			(4,310	)

Loss before income taxes		(2,573	)		(11,660	)

Income tax expense		60			—

Net loss		(2,633	)		(11,660	)

Other comprehensive income (loss):
Unrealized gain on available for sale securities		283			25
Foreign currency translation adjustment		(4	)		(26	)

Total other comprehensive income (loss)		279			(1	)

Comprehensive loss	$	(2,354	)	$	(11,661	)

Loss per share:
Basic and diluted	$	(0.06	)	$	(0.29	)
Shares used in loss per share calculation:
Basic and diluted		41,028			40,121

See accompanying notes to condensed consolidated financial statements.

TARANTELLA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS



	December 31, 2002			September 30, 2002
(In thousands)	(Unaudited)

Assets
Current assets:
Cash and cash equivalents	$	4,701		$	7,055
Available-for-sale equity securities		506			223
Trade receivables, net of allowance for doubtful accounts of $334 at December 31, 2002 and $340 at September 30, 2002		2,924			3,045
Other receivables		317			236
Prepaids and other current assets		590			823

Total current assets		9,038			11,382

Property and equipment, net		1,026			1,192
Restricted cash		500			500
Other assets		555			524

Total assets	$	11,119		$	13,598


Liabilities and shareholders’ equity
Current liabilities:
Trade accounts payable	$	259		$	448
Royalties payable		172			212
Income taxes payable		803			773
Accrued restructuring charges		1,325			871
Other payables—Caldera		—			400
Accrued expenses and other current liabilities		3,717			3,700
Deferred revenues		925			945

Total current liabilities		7,201			7,349

Long-term deferred revenues		56			33

Total long-term liabilities		56			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 41,028 shares at December 31, 2002 and September 30, 2002		120,844			120,844
Accumulated other comprehensive income		396			117
Accumulated deficit		(117,378	)		(114,745	)

Total shareholders’ equity		3,862			6,216

Total liabilities and shareholders’ equity	$	11,119		$	13,598

See accompanying notes to condensed consolidated financial statements.

TARANTELLA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS



	Three Months Ended December 31,
	2002			2001
(In thousands)	(Unaudited)

Cash flows from operating activities:
Net loss	$	(2,633	)	$	(11,660	)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization		216			237
Foreign currency exchange gain		(7	)		(6	)
Gain on sale of marketable security		—			(267	)
Loss on disposal of property and equipment		79			217
Equity losses in Caldera		—			4,010
Impairment of equity investments		—			350
Warrant and stock compensation expense		—			912
Changes in operating assets and liabilities:
Trade receivables		119			1,288
Other current assets		153			903
Other assets		(31	)		(117	)
Trade accounts payable		(189	)		(263	)
Royalties payable		(40	)		(279	)
Income taxes payable		30			(76	)
Accrued restructuring expenses		454			669
Accrued expenses and other current liabilities		(381	)		(1,140	)
Deferred revenues		3			91

Net cash used in operating activities		(2,227	)		(5,131	)

Cash flows from investing activities:
Sales of short-term investments and marketable securities		—			2,157
Purchases of property and equipment		(127	)		(5	)

Net cash provided (used) in investing activities		(127	)		2,152

Cash flows from financing activities:
Payments on capital lease obligations		(2	)		(181	)
Net proceeds from issuance of common stock		—			2

Net cash used in financing activities		(2	)		(179	)

Effects of exchange rate changes on cash and cash equivalents		2			(1	)

Decrease in cash and cash equivalents		(2,354	)		(3,159	)
Cash and cash equivalents at beginning of period		7,055			12,100

Cash and cash equivalents at end of period	$	4,701		$	8,941

Supplemental disclosure of cash flow information:
Cash paid:
Income taxes	$	31		$	71
Interest		—			8
Non-cash financing and investing activities:
Product sale exchanged for equity investment		—			375
Unrealized gain on available-for-sale equity securities		283			25

See accompanying notes to condensed consolidated financial statements.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1—Basis of Presentation

Tarantella, Inc., 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 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.

Going concern and management’s plans

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. The Company has incurred net losses of approximately $2.6 million during the first quarter of fiscal 2003 and $11.7 million during the first quarter of fiscal 2002. Net cash used for operating activities was $2.2 million in the first quarter of fiscal 2003 and $5.1 million used in the first quarter of fiscal 2002. The Company has an accumulated deficit of $117.4 million as of December 31, 2002. These conditions, among others, raise substantial doubt about the Company’s ability to continue as a going concern.

While growing Tarantella Products licenses and services revenues year over year, the Company’s management has reduced its operating expenses by 41% in the first quarter of fiscal 2003 over the first quarter of fiscal 2002. The Company is continuing to drive 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 through fiscal 2003, however additional financing may be required thereafter. Management cannot be assured that additional financing will be available when it is needed.

Note 2—Recent Accounting Pronouncements

In December 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (SFAS 148). SFAS 148 amends FASB Statement No. 123, “Accounting for Stock-Based Compensation.” 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 Statement 123 and APB Opinion No. 28, “Interim Financial Reporting,” 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 is effective for interim periods beginning after December 15, 2002. The Company will adopt this standard for its second quarter of fiscal year 2003. Unless the company elects to adopt the fair value recognition provisions of SFAS 123, adoption of SFAS 148 will only require expanded disclosure to include the effect of stock-based compensation in interim reporting Beginning with the Company’s quarter ending March 31, 2003.

In November 2002, the Financial Accounting Standards Board (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 Company is in the process of assessing the effect, if any, of FIN 45 on the Company’s financial position and results of operations.

As discussed in Note 7, as part of the agreement between the Company and Caldera, the Company was a guarantor to various building leases expiring in 2005. In the fourth quarter of fiscal 2002 the Company was released from its obligation as guarantor.

In June 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” 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).” 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 Issue No. 94-3, a liability for an exit cost, as defined in Issue No. 94-3, was recognized at the date of an entity’s commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. The Company will adopt 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 No. 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 No. 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 No. 142 addresses the recognition and measurement of goodwill and other intangible assets subsequent to their acquisition. SFAS No. 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 No. 142. SFAS No. 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.

Note 3—Earnings Per Share (EPS) Disclosures

Basic and diluted earnings per share were calculated as follows during the three months ended December 31, 2002 and 2001 (in thousands):

	Three Months Ended December 31,
(In thousands, except per share data)	2002			2001

Basic:
Weighted average shares		41,028			40,121

Net loss	$	(2,634	)	$	(11,661	)

Loss per share	$	(0.06	)	$	(0.29	)

Options and warrants outstanding, not included in computation of diluted EPS because the exercise price was greater than the average market price.		13,651			10,244
Options outstanding, not included in computation of diluted EPS because their inclusion would have an anti-dilutive effect due to net loss during the period.		3,205			4,318

Note 4—Accrued Restructuring Charge

Fiscal 2003

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. The restructuring included a reduction in staffing of 25 employees and reserve for unused facilities at two of the Company’s UK facilities.

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.

Fiscal 2003 First Quarter Restructuring Accrual

(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

Fiscal 2002

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 on the building expires on June 30, 2005. In addition, a charge was taken for expenses associated with office closures in Japan and Brazil. 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 year 2002, with the exception of sub-leasing excess space at the Company’s corporate headquarters in Santa Cruz, California and closing a subsidiary in Australia.

Fiscal 2002 First Quarter Restructuring Accrual

(In thousands)	Reduction in Force			Facilities			Disposal of Fixed Assets			Total

Restructuring charge accrued	$	856		$	736		$	44		$	1,636
Payments/utilization of the accrual		(772	)		(31	)		—			(803	)

Accrual at December 31, 2001		84			705			44			833
Payments/utilization of the accrual		(89	)		(211	)		(39	)		(339	)
Provision Adjustment		5			—			(5	)		—

Accruals at March 31, 2002		—			494			—			494
Payments/utilization of the accrual		—			(156	)		—			(156	)
Provision Adjustment		—			—			—			—

Accruals at June 30, 2002		—			338			—			338
Payments/utilization of the accrual		—			(148	)		—			(148	)
Provision Adjustment		—			560			—			560

Accruals at September 30, 2002		—			750			—			750
Payments/utilization of the accrual		—			(150	)		—			(150	)
Provision Adjustment		—			—			—			—

Accruals at December 31, 2002	$	—		$	600		$	—		$	600

Fiscal 2001

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.

Fiscal 2001 Second Quarter Restructuring Accrual

(In thousands)	Reduction in Force			Facilities			Total

Restructuring charge accrued	$	1,499		$	64		$	1,563
Payments/utilization of the accrual		(885	)		—			(885	)

Accrual at March 31, 2001		614			64			678
Payments/utilization of the accrual		(484	)		—			(484	)

Accruals at June 30, 2001		130			64			194
Payments/utilization of the accrual		(91	)		(24	)		(115	)
Provision Adjustment		(39	)		—			(39	)

Accruals at September 30, 2001		—			40			40
Payments/utilization of the accrual		—			(40	)		(40	)
Provision Adjustment		—			81			81

Accruals at December 31, 2001		—			81			81
Payments/utilization of the accrual		—			(20	)		(20	)

Accruals at March 31, 2002		—			61			61
Payments/utilization of the accrual		—			(20	)		(20	)

Accruals at June 30, 2002		—			41			41
Payments/utilization of the accrual		—			(20	)		(20	)
Provision Adjustment		—			85			85

Accruals at September 30, 2002		—			106			106
Payments/utilization of the accrual		—			(21	)		(21	)

Accruals at December 31, 2002	$	—		$	85		$	85

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 $14,000 at December 31, 2002 relates to the facility in Australia, which the Company is in the final stages of closing.

Fiscal 2001 Fourth Quarter Restructuring Accrual

(In thousands)	Reduction in Force			Facilities			Total

Restructuring charge accrued	$	402		$	102		$	504
Payments/utilization of the accrual		(200	)		—			(200	)

Accrual at September 30, 2001		202			102			304
Payments/utilization of the accrual		(202	)		(3	)		(205	)

Accrual at December 31, 2001		—			99			99
Payments/utilization of the accrual		—			(6	)		(6	)

Accrual at March 31, 2002		—			93			93
Payments/utilization of the accrual		—			—			—

Accrual at June 30, 2002		—			93			93
Payments/utilization of the accrual		—			(14	)		(14	)
Provision Adjustment		—			(64	)		(64	)

Accrual at September 30, 2002		—			15			15
Payments/utilization of the accrual		—			(1	)		(1	)

Accrual at December 31, 2002	$	—		$	14		$	14

Note 5—Industry and Geographic Segment Information

The Company operates in one reportable segment. For the three months ended December 31, 2002, one customer accounted for 15.2% of the Company’s net revenues. For the three months ended December 31, 2001, one customer accounted for 21.1% of the Company’s net revenues.

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.

	Three Months Ended December 31,
(In thousands)	2002		2001

Net revenues:
United States	$	1,370	$	1,346
Canada and Latin America		177		223
EMEIA (1)		1,419		960
Asia Pacific		602		243
Corporate adjustments		17		53

Total net revenues	$	3,585	$	2,825


(In thousands)	December 31, 2002		September 30, 2002

Long-lived assets:
United States	$	1,640	$	1,788
Canada and Latin America		—		—
EMEIA (1)		441		428
Asia Pacific		—		—

Total long-lived assets	$	2,081	$	2,216

(1)

Europe, Middle East, India and Africa

Note 6—Investments

Available for sale equity securities:

At December 31, 2002, 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 December 31, 2002 was $505,767 and cost was $170,830 for an unrealized gain of $334,937. Rainmaker’s common stock is traded on the Nasdaq under the symbol “RMKR.”

Note 7—Transaction with Caldera

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, which 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. 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. In the fourth quarter of fiscal 2002 the Company was released from its obligation as guarantor.

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 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. The Company’s shares are still subject to de-listing, however the de-listing review process was extended until approximately February 10, 2003. As of the date of this filing, the Company has not received notification from the Nasdaq regarding the status of the de-listing.

Critical Accounting Policies

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 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.

Revenue Recognition

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.

Returns and Reserves

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.

Income Taxes

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.

Results of Operations

Net Revenues

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

Net revenues for the three months ended December 31, 2002 increased 27% to $3.6 million from $2.8 million in the same period in fiscal 2002. The increase in revenue performance, broken out geographically, was a $0.5 million increase in Europe and $0.4 million increase in Asia. All other regions remained relatively flat. The increase in net revenues was mainly due to increased transactions size.

License revenues for the three months ended December 31, 2002 were $3.1 million compared to $2.5 million in the same quarter of fiscal 2002, an increase of 24% from the prior year. The increase is attributed to an increase in the average transaction size as more customers move from pilot programs to deployment.

Service revenues increased to $0.5 million for the three months ended December 31, 2002, from $0.4 million in the same period in fiscal 2002, an increase of 43%. Service revenue was 15% of the total revenue for the first fiscal quarter of 2003, compared to 13% 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.

International revenues were 61% of total revenues for the first fiscal quarter of 2003 and 50% for the same period in the prior year. For the three months ended December 31, 2002, one customer accounted for 15.2% of the Company’s net revenues. For the three months ended December 31, 2001, one customer accounted for 21.1% of the Company’s net revenues.

Costs and Expenses

Cost of license revenues for the three months ended December 31, 2002 were flat at $0.1 million compared to $0.1 million in the same period of fiscal 2002.

Cost of service revenues for the three months ended December 31, 2002 remained flat at $0.3 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 33% in the first quarter of fiscal 2002, to 51% in the first quarter of fiscal 2003. The improvement in the services gross margin is a result of higher revenue and lower costs due to headcount reductions and pay reductions of 15%.

Total cost of revenues as a percentage of net revenues decreased to 9% in the first quarter of fiscal 2003 from 11% for the same period in fiscal 2002. Cost of revenues as a percentage of net revenue was lower because of improved gross margins for service revenues.

Research and development expenses decreased 44% to $1.0 million in the first quarter of fiscal 2003 from $1.7 million in the comparable quarter of fiscal 2002, and as a percentage of net revenues were 27% and 62%, 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 a pay reduction of 15%.

Selling, general and administrative expenses decreased 42% to $3.7 million in the first quarter of fiscal 2003 from $6.4 million for the comparable quarter of the prior year. 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 were also lower due to a $0.4 million decrease in bad debt expense. Selling, general and administrative expenses as a percentage of net revenues were 104% in the first quarter of fiscal 2003 and 226% in the same period in fiscal 2002.

Restructuring charges for the three months ended December 31, 2002 were $1.1, compared to $1.7 million for the three months ended December 31, 2001. The Company has substantially completed these plans as of December 31, 2002.

Interest income, net was $32,000 for the first quarter of fiscal 2003 and $233,000 for the same period in fiscal 2002. The decrease in interest income, net reflects the lower cash balances held during the first quarter of fiscal 2003. Interest income was also lower due to a lower average interest rate for the period. In the first quarter of fiscal 2003, the interest rate was approximately 6.0%. In the first quarter of fiscal 2002, the interest rate was approximately 7.2% for cash and 10% for the Caldera Note.

Other expense, net was $14,000 in the first quarter of fiscal 2003, compared to $533,000 for the same period of fiscal 2002. The first quarter of fiscal 2002 included an investment impairment of $0.4 million, and expense for issuance of warrants of $0.3 million. These charges were partially offset by a gain of $0.3 million for the sale of marketable securities.

Income tax provision was $60,000 for the first quarter of fiscal 2003 compared to zero for the same period in fiscal year 2002. The tax provision for the first quarter of fiscal 2003 reflects foreign taxes payable.

Net loss for the first quarter of fiscal 2003 was $2.6 million compared to net loss of $11.7 million for the same quarter of fiscal 2002. The decrease in net loss is primarily due to higher revenues and lower operating expenses.

Liquidity and Capital Resources

Cash, cash equivalents and short-term investments were $4.7 million at December 31, 2002, representing 42% of total assets. The decrease in cash and short-term investments of $2.4 million from September 30, 2002 is due to operating losses. The Company’s operating activities used cash of $2.2 million in the first quarter of fiscal 2003, compared to $5.1 million used for operating activities in the first quarter of fiscal 2002. The decrease in the cash used for operating activities is due to the significant reduction in operating loss from the first quarter of fiscal 2002 as compared to the first quarter of fiscal 2003. The operating loss was $2.6 million in the first quarter of fiscal 2003 compared to a loss of $7.4 million in the first quarter of fiscal 2002. Cash used in investing activities was $0.1 million in the first quarter of fiscal 2003 compared to cash provided from investing activities of $2.2 million in the first quarter 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 $2.2 million, which were included in the results for the first quarter of fiscal 2002. There was negligible cash provided by or used for financing activities in the first quarter of fiscal 2003 or the first quarter of fiscal 2002.

The company’s days sales outstanding (DSO) at December 31, 2002 was 73, a decrease of 4 days from December 31, 2001. DSO is calculated using revenues for the quarter, and net accounts receivable at the end of the quarter. The decrease in DSO was due to improved collections. The past due accounts receivable decreased from $0.7 million down to $0.2 million.

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 Nasdaq SmallCap Market. Among other requirements, the listing maintenance standards established by the Nasdaq for its Small Cap 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. The Company’s shares are still subject to de-listing, however the de-listing review process was extended until approximately February 10, 2003. As of the date of this filing, the Company has not received notification from the Nasdaq regarding the status of the de-listing.

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

The Company has incurred net losses of approximately $2.6 million during the first quarter of fiscal 2003 and $11.7 million during the first quarter of fiscal 2002. Revenues have increased from $2.8 million in the first quarter of fiscal 2002 to $3.6 million in the first quarter of fiscal 2003. Losses from operations were $2.6 million for the first quarter of fiscal 2003, and $7.4 million for the first quarter of 2002. Net cash used for operating activities was $2.2 million in the first quarter of fiscal 2003 and $5.1 million used in the first quarter of fiscal 2002. The Company has an accumulated deficit of $117.4 million as of December 31, 2002. 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 quarter of fiscal 2003 increased 36% from the same quarter in fiscal 2002. While growing Tarantella Products licenses and services revenues year over year, the Company’s management has reduced its operating expenses by 69% in the first quarter of fiscal 2003 over the first quarter 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 through fiscal 2003. Additional financing may be required thereafter.

Factors That May Affect Future Results

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 statement in this filing.

The Company’s operating results may fluctuate in future periods.

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:

Overall technology spending

Changes in general economic conditions and specific market conditions in the Internet infrastructure industry

Rapid technological changes that can adversely affect the demand for the Company’s products

Fluctuations in demand for the Company’s products and services

The public’s perception of Tarantella and its products

The long sales and implementation cycle for the Company’s products

General industry trends and the potential effects of price and product competition in the Internet infrastructure industry

The introduction and acceptance of new technologies and products

Reductions in sales to, or loss of, any significant customers

The timing of orders, timing of shipments, and the ability to satisfy all contractual obligations in customer contracts

The impact of acquired technologies and businesses

The Company’s ability to control spending and achieve targeted cost reductions

The ability of the Company to generate cash adequate to continue operations

The potential loss of key employees

The Company’s ability to attract and retain qualified personnel

Adverse changes in the value of equity investments in third parties held by the Company

The ability of the Company’s customers and suppliers to obtain financing or to fund capital expenditures

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

The Company is exposed to general economic and market conditions.

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.

Operating results for a particular quarter are difficult to predict.

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.

It may be difficult to raise needed capital in the future.

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 operational results could be affected by price variations.

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 61%, 50% and 53% of total revenues for the first three 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 Company’s stock price is volatile.

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.

The Company’s common stock may be subject to de-listing by the Nasdaq.

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 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. The Company’s shares are still subject to de-listing, however the de-listing review process was extended until approximately February 10, 2003. As of the date of this filing, the Company has not received notification from the Nasdaq regarding the status of the de-listing.

When notification is received, the Company will determine what action to take, including but not limited to the possibility of an appeal. Possible grounds for an appeal may include the Company’s decision to seek shareholder approval for a reverse stock split. The Company will ask its shareholders to grant discretionary authority to the Company’s board of directors to effect a reverse stock split of the Company’s common stock at its annual meeting on February 27, 2003.

The Company’s shareholders may not approve the reverse stock split, or if the reverse stock split is approved and completed, it may not result in a sustained trading price for the Company’s common stock sufficient to prevent de-listing. Further, there can be no assurance that the Company will continue to meet the Nasdaq’s other listing requirements.

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.

The Company may never achieve profitability in the future.

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.

Recent Accounting Pronouncements

In December 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (SFAS 148). SFAS 148 amends FASB Statement No. 123, “Accounting for Stock-Based Compensation.” 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 Statement 123 and APB Opinion No. 28, “Interim Financial Reporting,” 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 is effective for interim periods beginning after December 15, 2002. The Company will adopt this standard for its second quarter of fiscal year 2003. Unless the company elects to adopt the fair value recognition provisions of SFAS 123, adoption of SFAS 148 will only require expanded disclosure to include the effect of stock-based compensation in interim reporting beginning with the Company’s quarter ending March 31, 2003.

In June 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“ SFAS”) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” 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).” 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 Issue No. 94-3, a liability for an exit cost, as defined in Issue No. 94-3, was recognized at the date of an entity’s commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. The Company will adopt 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.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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.

Item 4. Controls and Procedures

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.

Part II. Other Information

Item 1. Legal Proceedings

Not applicable

Item 2. Changes in Securities and Use of Proceeds

Not applicable

Item 3. Defaults Upon Senior Securities

Not applicable

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

Not applicable

Item 5. Other Information

Not applicable

Item 6. Exhibits and Reports on Form 8-K

Exhibits

Exhibit 99.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER

PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

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 December 31, 2002 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: February 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 December 31, 2002 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: February 14, 2003

Reports on Form 8-K

The Company filed one Report on Form 8-K during the quarter ended December 31, 2002. The Report on Form 8-K was filed on October 11, 2002, and it disclosed the Company’s plan for a reduction in workforce.

Signatures

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

TARANTELLA, INC.

By:		/s/ RANDALL BRESEE
		Randall Bresee Senior Vice President, Chief Financial Officer February 14, 2003

By:		/s/ JENNY TWADDLE
		Jenny Twaddle Vice President, Corporate Controller February 14, 2003

Certification

I, Douglas L. Michels, certify that:

I have reviewed this quarterly report on Form 10-Q of Tarantella, Inc.;

Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors:

all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: February 14, 2003

/s/ DOUGLAS L. MICHELS

Douglas L. Michels

President, Chief Executive Officer and Director

Certification

I, Randall Bresee, certify that:

I have reviewed this quarterly report on Form 10-Q of Tarantella, Inc.;

Based on my knowledge, this quarterly does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors:

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

Date: February 14, 2003

/s/ RANDALL BRESEE

Randall Bresee

Senior Vice President, Chief Financial Officer