ONYX SOFTWARE CORP/WA - 10-Q Quarterly Report

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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 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 0-25361

ONYX SOFTWARE CORPORATION

(Exact name of registrant as specified in its charter)

Washington		91-1629814
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

3180-139th Avenue S.E.

Suite 500

Bellevue, Washington 98005

(Address of principal executive offices) (Zip code)

(425) 451-8060

(Registrant’s telephone number)

Indicate by check whether the registrant (1) 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 ¨

The number of shares of common stock, par value $0.01 per share, outstanding on October 31, 2002 was 50,566,426.

ONYX SOFTWARE CORPORATION

CONTENTS

PART I—FINANCIAL INFORMATION		3

Item 1.	Condensed Consolidated Financial Statements (Unaudited)	3

	Condensed Consolidated Balance Sheets as of December 31, 2001 and September 30, 2002	3

	Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2001 and 2002	4

	Condensed Consolidated Statement of Shareholders’ Equity and Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2002	5

	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2001 and 2002	6

	Notes to Condensed Consolidated Financial Statements	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	50

Item 4.	Controls and Procedures	51

PART II—OTHER INFORMATION		52

Item 1.	Legal Proceedings	52

Item 5.	Other Information	52

Item 6.	Exhibits and Reports on Form 8-K	52

SIGNATURES		53

CERTIFICATIONS		54

PART I—FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

(Unaudited)

	December 31, 2001			September 30, 2002
ASSETS
Current assets:
Cash and cash equivalents	$	15,868		$	20,814
Restricted cash		—			4,670
Accounts receivable, less allowances of $2,079 in 2001 and $1,114 in 2002		20,029			12,349
Prepaid expense and other		2,596			4,057

Total current assets		38,493			41,890
Property and equipment, net		12,884			8,543
Purchased technology, net		751			337
Other intangible assets, net		3,467			1,670
Goodwill, net		7,396			8,180
Other assets		1,520			1,435

Total assets	$	64,511		$	62,055

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	2,826		$	1,517
Salary and benefits payable		1,833			2,151
Accrued liabilities		3,260			2,912
Income taxes payable		695			313
Current portion of capital-lease obligations		173			156
Current portion of restructuring-related liabilities		15,384			14,247
Deferred revenues		19,191			15,197

Total current liabilities		43,362			36,493
Capital-lease obligations, less current portion		248			123
Restructuring-related liabilities, less current portion		9,930			6,528
Deferred tax liability		1,223			568
Minority interest in joint venture		1,613			444

Shareholders’ equity:
Preferred stock, $0.01 par value:
Authorized shares—20,000,000 shares;
Designated shares—none		—			—
Common stock, $0.01 par value:
Authorized shares—80,000,000 shares;
Issued and outstanding shares—43,949,874 shares at December 31, 2001 and 50,565,290 at September 30, 2002		118,557			139,170
Deferred stock-based compensation		(809	)		(129	)
Accumulated deficit		(108,291	)		(120,403	)
Accumulated other comprehensive loss		(1,322	)		(739	)

Total shareholders’ equity		8,135			17,899

Total liabilities and shareholders’ equity	$	64,511		$	62,055

See accompanying notes to condensed consolidated financial statements.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2001			2002			2001			2002
Revenue:
License	$	6,263		$	7,265		$	31,030		$	16,828
Support and service		15,080			11,763			49,023			35,325

Total revenue		21,343			19,028			80,053			52,153
Cost of revenue:
License		169			270			1,657			667
Amortization of acquired technology		205			138			613			414
Support and service		8,444			4,922			29,320			15,181

Total cost of revenue		8,818			5,330			31,590			16,262

Gross margin		12,525			13,698			48,463			35,891
Operating expenses:
Sales and marketing		11,224			7,882			46,608			20,941
Research and development		4,902			3,530			17,975			11,506
General and administrative		3,455			2,382			12,120			7,358
Restructuring and other related charges		40,075			1,171			43,664			7,729
Amortization and impairment of goodwill and other acquisition-related intangibles		8,830			209			12,076			627
Amortization of stock-based compensation		164			51			700			203

Total operating expenses		68,650			15,225			133,143			48,364

Loss from operations		(56,125	)		(1,527	)		(84,680	)		(12,473	)
Interest and other income (expense), net		48			269			405			(73	)
Equity investment losses and impairment		(500	)		—			(2,500	)		—

Loss before income taxes		(56,577	)		(1,258	)		(86,775	)		(12,546	)
Income tax provision (benefit)		(279	)		(29	)		(381	)		383
Minority interest in loss of consolidated subsidiary		(349	)		(345	)		(1,017	)		(817	)

Net loss	$	(55,949	)	$	(884	)	$	(85,377	)	$	(12,112	)

Net loss per share:
Basic and diluted	$	(1.37	)	$	(0.02	)	$	(2.17	)	$	(0.24	)

Shares used in calculation of net loss per share:
Basic and diluted		40,987			50,564			39,351			49,709

See accompanying notes to condensed consolidated financial statements.

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY AND

COMPREHENSIVE INCOME (LOSS)

(In thousands, except share data)

(Unaudited)

	Common Stock				Deferred Stock-Based Compensation			Accumulated Deficit			Accumulated Other Comprehensive Loss			Shareholders’ Equity
	Shares	Amount			Deferred Stock-Based Compensation			Accumulated Deficit			Accumulated Other Comprehensive Loss			Shareholders’ Equity
Balance at December 31, 2001	43,949,874	$	118,557		$	(809	)	$	(108,291	)	$	(1,322	)	$	8,135
Amortization of deferred stock-based compensation	—		—			87			—			—			87
Reversal of deferred stock-based compensation associated with terminated employees	—		(332	)		332			—			—			—
Exercise of stock options	101,607		150			—			—			—			150
Proceeds from public offering, net of offering costs	6,325,000		20,531			—			—			—			20,531
Issuance of common stock to vendor for services rendered	11,622		50			—			—			—			50
Comprehensive income (loss):
Translation gain	—		—			—			—			20			20
Net loss	—		—			—			(6,558	)		—			(6,558	)
Total comprehensive loss															(6,538	)

Balance at March 31, 2002	50,388,103	$	138,956		$	(390	)	$	(114,849	)	$	(1,302	)	$	22,415
Amortization of deferred stock-based compensation	—		—			65			—			—			65
Reversal of deferred stock-based compensation associated with terminated employees	—		(145	)		145			—			—			—
Exercise of stock options	74,734		79			—			—			—			79
Issuance of common stock under ESPP	94,699		272			—			—			—			272
Comprehensive income (loss):
Translation gain	—		—			—			—			675			675
Net loss	—		—			—			(4,670	)		—			(4,670	)
Total comprehensive loss															(3,995	)

Balance at June 30, 2002	50,557,536	$	139,162		$	(180	)	$	(119,519	)	$	(627	)	$	18,836
Amortization of deferred stock-based compensation	—		—			51			—			—			51
Exercise of stock options	7,754		8			—			—			—			8
Comprehensive income (loss):
Translation loss	—		—			—			—			(112	)		(112	)
Net loss	—		—			—			(884	)		—			(884	)
Total comprehensive loss															(996	)

Balance at September 30, 2002	50,565,290	$	139,170		$	(129	)	$	(120,403	)	$	(739	)	$	17,899

See accompanying notes to condensed consolidated financial statements.

CONDE NSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Nine Months Ended September 30,
		2001			2002
Operating activities:
Net loss	$	(85,377	)	$	(12,112	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		10,431			4,915
Accretion of premium on investments		5			—
Deferred income taxes		(844	)		(268	)
Noncash stock-based compensation expense		700			203
Minority interest in loss of consolidated subsidiary		(1,016	)		(817	)
Equity investment losses and impairment		2,500			—
Impairment on intangible assets		7,207			—
Impairment on property, plant and equipment		13,335			709
Changes in operating assets and liabilities:
Accounts receivable		17,798			7,761
Other assets		(362	)		(1,376	)
Accounts payable and accrued liabilities		(5,450	)		(1,538	)
Restructuring-related liabilities		22,960			(4,539	)
Deferred revenue		(939	)		(3,994	)
Income taxes		(316	)		(382	)

Net cash used in operating activities		(19,368	)		(11,438	)
Investing activities:
Purchases of securities		(4,900	)		—
Proceeds from maturity of securities		8,017			—
Restricted cash		—			(4,670	)
Acquisition of RevenueLab in 2001, net of cash		(869	)		—
Purchases of property and equipment		(11,737	)		(416	)
Proceeds on disposal of equipment		—			174

Net cash used in investing activities		(9,489	)		(4,912	)
Financing activities:
Proceeds from exercise of stock options		727			237
Proceeds from issuance of shares under employee stock purchase plan		932			272
Payments on capital lease obligations		(207	)		(142	)
Proceeds from shareholder notes		157			—
Net proceeds from sale of common stock		31,525			20,531

Net cash provided by financing activities		33,134			20,898
Effects of exchange rate changes on cash		(389	)		398
Net increase in cash and cash equivalents		3,888			4,946
Cash and cash equivalents at beginning of period		11,492			15,868

Cash and cash equivalents at end of period	$	15,380		$	20,814

Supplemental cash flow disclosure:
Interest paid	$	174		$	12
Income taxes paid, net		778			290
Issuance of common stock and stock options in connection with acquisition		5,659			—
Payment of obligation with common stock		—			50

See accompanying notes to condensed consolidated financial statements.

ONYX SOFTWARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Description of Business and Basis of Presentation

Description of the Company

Onyx Software Corporation and subsidiaries (Company) is a leading provider of enterprise-wide customer relationship management (CRM) solutions designed to promote strategic business improvement and revenue growth by enhancing the way businesses market, sell and service their products. Using the Internet in combination with traditional forms of interaction, including phone, mail, fax and e-mail, the Company’s solution helps enterprises to more effectively acquire, manage and maintain customer, partner and other relationships. The Company markets its solution to companies that want to merge new, online business processes with traditional business processes to enhance their customer-facing operations, such as marketing, sales, customer service and technical support. The Company’s solution uses a single data model across all customer interactions, resulting in a single repository for all marketing, sales and service information. It is fully integrated across all customer-facing departments and interaction media. The Company’s solution is designed to be easy to use, widely accessible, rapidly deployable, scalable, flexible, customizable and reliable, which can result in a low total cost of ownership and rapid return on investment. The Company was incorporated in the state of Washington on February 23, 1994 and maintains its headquarters in Bellevue, Washington.

Interim Financial Information

The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed, or omitted, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). In the Company’s opinion, the statements include all adjustments necessary (which are of a normal and recurring nature) for a fair presentation for the results of the interim periods presented. These financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2001, included in the Company’s Form 10-K filed with the SEC on March 1, 2002. The Company’s results of operations for any interim period are not necessarily indicative of the results of operations for any other interim period or for a full fiscal year.

2. Summary of Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect amounts reported in the financial statements. Changes in these estimates and assumptions may have a material impact on the financial statements. The Company has used estimates in determining certain provisions, including uncollectible trade accounts receivable, useful lives for property and equipment, intangibles, tax liabilities and restructuring liabilities.

Revenue Recognition

The Company recognizes revenue in accordance with accounting standards for software companies including Statement of Position (SOP) 97-2, “Software Revenue Recognition”, as amended by SOP 98-4, SOP 98-9, and related interpretations, including Technical Practice Aids.

ONYX SOFTWARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The Company generates revenue through two sources: (a) software license revenue and (b) support and service revenue. Software license revenue is generated from licensing the rights to use the Company’s products directly to end-users and vertical service providers (VSPs) and indirectly through value-added resellers (VARs) and, to a lesser extent, through third-party products the Company distributes. Support and service revenue is generated from sales of customer support services, consulting services and training services performed for customers that license the Company’s products.

License revenue is recognized when a noncancellable license agreement is in force as evidenced by a signed contract, the product has been shipped, the license fee is fixed or determinable, and collectibility is probable.

In software arrangements that include rights to multiple software products and/or services, the Company allocates the total arrangement fee among each of the deliverables using the residual method, under which revenue is allocated to undelivered elements based on vendor-specific objective evidence of fair value of such undelivered elements and the residual amounts of revenue are allocated to delivered elements. Elements included in multiple element arrangements could consist of software products, maintenance (which includes customer support services and unspecified upgrades), or consulting services. Vendor-specific objective evidence is based on the price charged when an element is sold separately or, in the case of an element not yet sold separately, the price established by authorized management, if it is probable that the price, once established, will not change before market introduction.

Standard terms for license agreements call for payment within 90 days. Probability of collection is based upon the assessment of the customer’s financial condition through the review of its current financial statements or credit reports. For follow-on sales to existing customers, prior payment history is also used to evaluate probability of collection. Revenue from distribution agreements with VARs is typically recognized upon the earlier of receipt of cash from the VAR or identification of an end-user. In the latter case, probability of collection is evaluated based upon the credit worthiness of the VAR. The Company’s agreements with its customers, VSPs and VARs do not contain product return rights.

Revenue from maintenance arrangements is recognized ratably over the term of the contract, typically one year. Consulting revenue is primarily related to implementation services performed on a time-and-materials basis, or in certain situations on a fixed-fee basis, under separate service arrangements. Revenue from consulting and training services is recognized as services are performed. Standard terms for renewal of maintenance arrangements, consulting services and training services call for payment within 30 days.

Fees from licenses sold together with consulting services are generally recognized upon shipment of the software, provided that the above criteria are met, payment of the license fees are not dependent upon the performance of the services, and the consulting services are not essential to the functionality of the licensed software. If the services are essential to the functionality of the software, or payment of the license fees is dependent upon the performance of the services, both the software license and consulting fees are recognized under the percentage of completion method of contract accounting.

If the fee is not fixed or determinable, revenue is recognized as payments become due from the customer. If a nonstandard acceptance period is provided, revenue is recognized upon the earlier of customer acceptance or the expiration of the acceptance period.

Cash Equivalents and Restricted Cash

The Company considers all highly liquid investments with a remaining maturity of three months or less at the date of purchase to be cash equivalents. At September 30, 2002, the Company’s cash equivalents consisted of money market funds.

ONYX SOFTWARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Separately, the Company has $4.7 million in restricted cash at September 30, 2002, $4.2 million of which is security for its credit line with Silicon Valley Bank that supports its outstanding letters of credit and $500,000 of which is security for its corporate card program.

Fair Values of Financial Instruments

At September 30, 2002, the Company has the following financial instruments: cash and cash equivalents, accounts receivable, accounts payable, salaries and benefits payable, accrued liabilities and capital lease obligations. The carrying value of cash and cash equivalents, accounts receivable, accounts payable, salaries and benefits payable, and accrued liabilities approximates their fair value based on the liquidity of these financial instruments or based on their short-term nature. The carrying value of capital lease obligations approximates fair value based on the market interest rates available to the Company for debt of similar risk and maturities.

Property and Equipment

Property and equipment is stated at cost less accumulated depreciation and amortization. Depreciation and amortization is provided using the straight-line method over the estimated useful lives of the related assets (or over the lease term if it is shorter for leasehold improvements), which range from two to seven years. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life.

Intangible Assets and Goodwill

The Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 141, “Business Combinations” (SFAS 141), and SFAS No. 142, “Goodwill and Other Intangible Assets” (SFAS 142), in July 2001. SFAS 141 requires that all business combinations be accounted for using the purchase method, thereby prohibiting the pooling-of-interests method. SFAS 141 also specifies criteria for recognizing and reporting intangible assets apart from goodwill; however, assembled workforce must be recognized and reported in goodwill. SFAS 142 requires the use of a non-amortization approach to account for purchased goodwill and certain intangibles. Under a non-amortization approach, goodwill and certain intangibles are no longer amortized into results of operations, but instead are reviewed for impairment and written down and charged to results of operations only in the periods in which the recorded value of goodwill and certain intangibles is more than their fair value.

The Company adopted SFAS 142 on January 1, 2002. There was no cumulative transition adjustment required upon adoption. SFAS 141 and SFAS 142 required the Company to perform the following as of January 1, 2002: (i) review goodwill and intangible assets for possible reclasses; (ii) reassess the lives of intangible assets; and (iii) perform a transitional goodwill impairment test. The Company reclassified an assembled workforce intangible asset with an unamortized balance of $1.2 million (along with a deferred tax liability of $387,000) to goodwill on January 1, 2002. The Company has also reviewed the useful lives of its identifiable intangible assets and determined that the original estimated lives remain appropriate. The Company has completed the transitional goodwill impairment test and has determined that the Company did not have a transitional impairment loss to record.

As required by SFAS 142, the Company has ceased amortization of goodwill associated with acquisitions completed prior to July 1, 2001, effective January 1, 2002. Prior to January 1, 2002, the Company amortized goodwill associated with the pre-July 1, 2001 acquisitions over three to five years using the straight-line method. Identifiable intangibles are currently amortized over two to five years using the straight-line method.

ONYX SOFTWARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Impairment of Long-Lived Assets

On January 1, 2002, the Company adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144), which supersedes certain provisions of Accounting Principles Board (APB) Opinion No. 30, “Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,” and supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” There was no cumulative transition adjustment required upon adoption. In accordance with SFAS 144, the Company evaluates long-lived assets, including intangible assets other than goodwill, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable based on expected undiscounted cash flows attributable to that asset. The amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. The Company currently believes that the carrying value of its long-lived assets is recoverable.

Investment Losses and Impairment

During 1999 and 2000, the Company invested in a small number of private companies. One of these investments was accounted for using the equity method of accounting due to the Company’s ability to exercise significant influence, but not control, over the investee and losses were recorded to the extent of our investment. The remaining private equity investments are accounted for on a cost basis since the Company does not have the ability to exercise significant influence over the investee and the Company’s ownership interest is less than 20%. Under the cost method of accounting, investments in private companies are carried at cost and are adjusted only for other-than-temporary declines in fair value, distributions of earnings and additional investments. The Company periodically evaluates whether any declines in fair value of its investments are other-than-temporary. This evaluation consists of a review of qualitative and quantitative factors by members of senior management, including a review of the investee’s financial condition, results of operations, operating trends and other financial ratios. The Company further considers the implied value from any recent rounds of financing completed by the investee, as well as market prices of comparable public companies. The Company generally requires its private investees to deliver monthly, quarterly and annual financial statements to assist in reviewing relevant financial data and to assist in determining whether such data may indicate other-than-temporary declines in fair value below the Company’s accounting basis. The Company generally considers a decline to be other-than-temporary if the estimated value is less than its accounting basis for two consecutive quarters, absent evidence to the contrary.

Research and Development Costs

Research and development costs, which consist primarily of software development costs, are expensed as incurred. Financial accounting standards provide for the capitalization of certain software development costs after technological feasibility of the software is established. Under the Company’s current practice of developing new products and enhancements, the technological feasibility of the underlying software is not established until the development of a working model. To date, the period between achieving technological feasibility and the general availability of such software has been short; therefore, software development costs qualifying for capitalization have been immaterial.

Concentration of Credit Risk and Major Customers

Financial instruments that potentially subject the Company to a concentration of credit risk consist principally of accounts receivable. The Company’s customer base is dispersed across many different geographic areas throughout North America, Europe, Asia Pacific and Latin America and consists of companies in a variety

ONYX SOFTWARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

of industries, although the majority of the Company’s revenue is generated from customers in the high technology, financial services and healthcare industries. The Company assesses each customer’s financial condition through the review of current financial statements or credit reports. For existing customers, prior payment history is also used to evaluate probability of collection and credit worthiness.

For the three and nine months ended September 30, 2001, no single customer accounted for more than 10% of total revenue or accounts receivable. For the three months ended September 30, 2002, ntl Business Solutions accounted for approximately 15% of total revenue. For the nine months ended September 30, 2002, no single customer accounted for more than 10% of total revenue. At September 30, 2002, no single customer accounted for more than 10% of accounts receivable. The Company does not require collateral or other security to support credit sales, but provides an allowance for bad debts based on historical experience applied against its aged receivables and specifically identified risks.

Foreign Currency Translation

The functional currency of the Company’s foreign subsidiaries is the local currency in the country in which the subsidiary is located. Assets and liabilities denominated in foreign currencies are translated to U.S. dollars at the exchange rate in effect on the balance sheet date. Revenues and expenses are translated at the average monthly rates of exchange prevailing throughout the year. The translation adjustment resulting from this process is shown within accumulated other comprehensive income (loss) as a component of shareholders’ equity. Gains and losses on foreign currency transactions are included in the consolidated statement of operations as incurred. To date, gains and losses on foreign currency transactions have not been significant.

Income Taxes

The Company accounts for income taxes under the liability method. Under the liability method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amounts expected to be realized.

Stock-Based Compensation

The Company has elected to follow APB Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25), and related interpretations, in accounting for employee stock options rather than the alternative fair value accounting allowed by SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS 123). Under APB 25, compensation expense related to the Company’s employee stock options is measured based on the intrinsic value of the stock option. SFAS 123 requires companies that continue to follow APB 25 to provide pro forma disclosure of the impact of applying the fair value method of SFAS 123. The Company recognizes compensation expense for options granted to non-employees in accordance with the provisions of SFAS 123 and the Emerging Issues Task Force consensus Issue 96-18, “Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” which require using a Black-Scholes option pricing model and remeasuring such stock options to the current fair market value until the performance date has been reached.

Deferred stock-based compensation consists of amounts recorded when the exercise price of an option or the sales price of restricted stock was lower than the subsequently determined fair value for financial reporting purposes. Deferred stock-based compensation also includes the intrinsic value of unvested options assumed in

ONYX SOFTWARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

acquisitions. Deferred stock-based compensation is amortized over the vesting period of the underlying options using a graded vesting approach.

Earnings Per Share

Basic earnings per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution of securities by including other common stock equivalents, including stock options and redeemable convertible preferred stock, in the weighted average number of common shares outstanding for a period, if dilutive.

Other Comprehensive Income

SFAS No. 130, “Reporting Comprehensive Income,” establishes standards for reporting and display of comprehensive income and its components in the financial statements. The only items of other comprehensive income (loss) that the Company currently reports are foreign currency translation adjustments and unrealized gains (losses) on marketable securities.

Business Segments

SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” establishes standards for reporting information about operating segments in annual financial statements. It also establishes standards for related disclosures about products and services, geographic areas and major customers. Information related to segment disclosures is contained in Note 10.

Reclassifications

Certain prior year amounts have been reclassified to conform with the current year presentation. Such reclassifications had no impact on the results of operations or shareholders’ equity for any year presented.

On January 1, 2002, the Company adopted EITF Topic No. D-103, “Income Statement Characterization of Reimbursements Received for ‘Out-of-Pocket’ Expenses Incurred.” Topic D-103 requires that certain out-of-pocket expenses rebilled to customers be recorded as revenue versus an offset to the related expense. Prior to the adoption of Topic D-103, the Company recorded rebilled out-of-pocket expenses as an offset to the related expense. Comparative financial statements for prior periods have been conformed to the current year presentation. The impact of the reclassification was to increase service revenue and cost of service revenue by $625,000, or an increase to service revenue of 4%, and $388,000, or an increase to service revenue of 3%, in the third quarter of 2001 and 2002, respectively, and $2.1 million, or 5%, and $1.3 million, or 4%, in the nine months ended September 30, 2001 and 2002, respectively.

Recently Issued Accounting Pronouncements

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” (SFAS 146). SFAS 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 146 requires that a liability for a cost associated with an exit or disposal activity be recognized at fair value when the liability is incurred. The Company will be required to adopt SFAS 146 no later than January 1, 2003. The Company is currently assessing the impact of SFAS 146 on its results of operations and financial position.

ONYX SOFTWARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

3. Purchased Technology, Other Intangible Assets and Goodwill

Purchased technology, intangible assets and goodwill consisted of the following (in thousands):

	December 31, 2001			September 30, 2002
Purchased technology	$	2,328		$	2,328
Less: accumulated amortization		(1,577	)		(1,991	)

Purchased technology, net	$	751		$	337


Other intangible assets	$	6,517		$	4,175
Less: accumulated amortization		(3,050	)		(2,505	)

Other intangible assets, net	$	3,467		$	1,670


Goodwill	$	12,110		$	14,065
Less: accumulated amortization		(4,714	)		(5,885	)

Goodwill, net	$	7,396		$	8,180

Changes in the carrying amounts of other intangible assets and goodwill during the nine months ended September 30, 2002 relate to the reclassification of an assembled workforce intangible asset with a gross asset value of $2.3 million and an unamortized value of $1.2 million, along with an offsetting deferred tax liability of $387,000, to goodwill on January 1, 2002.

Expected future amortization expense related to identifiable intangible assets is as follows (in thousands):

October 1 to December 31, 2002	$	292
Period Ending December 31,
2003		1,088
2004		627

Total	$	2,007

Summarized below are the effects on net income and net income per share data, if the Company had followed the amortization provisions of SFAS 142 for all periods presented (in thousands, except per share data):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2001			2002			2001			2002
Net loss:
As reported	$	(55,949	)	$	(884	)	$	(85,377	)	$	(12,112	)
Add: goodwill and assembled workforce amortization, net of taxes		754			—			3,494			—

Adjusted net loss	$	(55,195	)	$	(884	)	$	(81,883	)	$	(12,112	)


Basic and diluted net loss per share:
As reported	$	(1.37	)	$	(0.02	)	$	(2.17	)	$	(0.24	)
Add: goodwill and assembled workforce amortization, net of taxes		0.02			—			0.09			—

Adjusted basic and diluted net loss per share	$	(1.35	)	$	(0.02	)	$	(2.08	)	$	(0.24	)

ONYX SOFTWARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

4. Restructuring and Other Related Charges

In April and again in September of 2001, the Company approved a restructuring plan to reduce headcount, reduce infrastructure and eliminate excess facilities. During 2001, the Company recorded approximately $51.8 million in restructuring and other related charges. Restructuring charges for the three and nine months ended September 30, 2001 totaled $40.1 million and $43.7 million, respectively. Restructuring charges for the three and nine months ended September 30, 2002 totaled $1.2 million and $7.7 million, respectively.

The components of the first quarter 2002 charges and a roll-forward of the related liability follow (in thousands):

	Balance at December 31, 2001		Charge for the three months ended March 31, 2002			Cash payments			Balance at March 31, 2002
Excess facilities	$	24,295	$	2,580		$	(3,762	)	$	23,113
Employee separation costs		250		297			(472	)		75
Other		769		(260	)		(297	)		212

Total	$	25,314	$	2,617		$	(4,531	)	$	23,400

The components of the second quarter 2002 charges and a roll-forward of the related liability follow (in thousands):

	Balance at March 31, 2002		Charge for the three months ended June 30, 2002		Cash payments & Impairments			Balance at June 30, 2002
Excess facilities	$	23,113	$	3,756	$	(3,376	)	$	23,493
Adjusted loss on asset disposals		—		125		(125	)		—
Employee separation costs		75		60		(105	)		30
Other		212		—		(132	)		80

Total	$	23,400	$	3,941	$	(3,738	)	$	23,603

The components of the third quarter 2002 charges and a roll-forward of the related liability follow (in thousands):

	Balance at June 30, 2002		Charge for the three months ended September 30, 2002		Cash payments & Impairments			Balance at September 30, 2002
Excess facilities	$	23,493	$	586	$	(3,400	)	$	20,679
Adjusted loss on asset disposals		—		465		(465	)		—
Employee separation costs		30		120		(130	)		20
Other		80		—		(4	)		76

Total	$	23,603	$	1,171	$	(3,999	)	$	20,775

The excess facility charges recorded in 2001 and the first nine months of 2002 are the result of the Company’s decision to reduce its utilization of certain facilities and to terminate usage of certain domestic and international facilities altogether. The most significant portion of the excess facility charges relates to the Company’s leases for 262,000 square feet of office space in Bellevue, Washington that expire in 2011 and 2013. These leases have annual minimum lease payments and operating costs currently totaling $10.1 million, with annual increases in these payments of $1 per square foot through the remainder of the lease term. The excess facility charges have been determined based on current comparable rates for leases in the respective markets in which the excess facilities are located or estimated fees that would be required to terminate the underlying leases.

ONYX SOFTWARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

In recent months, the Company has made progress in its efforts to mitigate excess facility commitments. Specifically, in August 2002, the Company executed a sublease agreement on its 21,000 square foot facility in the United Kingdom that reduces its obligation on seven of the remaining 14 years on the lease, and in November 2002, the Company executed a lease termination agreement on its 100,000 square foot current corporate headquarters facility in Bellevue, Washington. This lease termination will result in accelerated cash outflows of approximately $2.0 million during the fourth quarter of 2002. The Company will continue to pay its monthly lease obligation of approximately $250,000 until the Company relocates its corporate headquarters, which is expected to occur at the end of January 2003. The signing of this agreement, which requires the Company to move its corporate headquarters, will result in accelerated amortization of leasehold improvements totaling approximately $800,000 at September 30, 2002 and may result in impairment of other furniture and equipment. The Company is also pursuing a partial lease termination whereby the Company’s excess facilities in Bellevue, Washington would be reduced by approximately 200,000 square feet. The Company expects this partial termination to result in cash outflows over 19 months, the sum of which approximates the Company’s current lease obligations on the terminated square footage through the end of 2003, and the issuance of warrants to purchase approximately 800,000 shares of its common stock at exercise prices that are at a premium to market. A definitive agreement has not been reached as of the date of this filing and the estimates of excess facilities could change.

If the Company is unsuccessful in negotiating affordable termination fees on certain facilities, if facilities operating lease rental rates continue to decrease in these markets, if it takes longer than expected to find a suitable tenant to sublease these facilities, or if other estimates and assumptions change, the Company’s actual charges will exceed the current estimate. The accounting for excess facilities is complex and, as a result, any final mitigation measures will likely result in adjustments to the Company’s current restructuring charge. Future cash outlays are anticipated through July 2006 unless estimates and assumptions change or the Company is able to negotiate to exit the leases at an earlier date. The Company’s contractual lease obligations extend through 2016.

The current portion of restructuring-related liabilities totaled $14.2 million at September 30, 2002 and the long-term portion of restructuring-related liabilities totaled $6.5 million at September 30, 2002.

5. Litigation and Contingencies

The Company, several of the Company’s officers and directors and Dain Rauscher Wessels have been named as defendants in a series of related lawsuits filed in the United States District Court for the Western District of Washington on behalf of purchasers of publicly traded Company common stock during various time periods. The consolidated amended complaint in these lawsuits alleges that the Company violated the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act), and seeks certification of a class action for purchasers of Company common stock in the Company’s February 12, 2001 public offering and on the open market during the period January 30, 2001 through July 24, 2001. In addition, a shareholder to whom the Company issued shares in the first quarter of 2001 has claimed that the Company made certain misrepresentations and omissions and otherwise violated the securities laws. None of the complaints or claims specifies the amount of damages to be claimed.

The Company, one of its officers and one of its former officers have also been named as defendants in a lawsuit filed in the United States District Court for the Southern District of New York on behalf of purchasers through December 6, 2000 of Company common stock sold under the February 12, 1999 registration statement and prospectus for the Company’s initial public offering. The complaint alleges that the Company and the individual defendants violated the Securities Act by failing to disclose excessive commissions allegedly obtained

ONYX SOFTWARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

by the Company’s underwriters pursuant to a secret arrangement whereby the underwriters allocated initial public offering shares to certain investors in exchange for the excessive commissions. The complaint also asserts claims against the underwriters under the Securities Act and the Exchange Act in connection with the allegedly undisclosed commissions.

The Company’s directors and some of its officers have been named as defendants in a shareholder derivative lawsuit filed in the Superior Court of Washington in and for King County. The complaint alleges that the individual defendants breached their fiduciary duty and their duty of care to the Company by allegedly failing to supervise the Company’s public statements and public filings with the SEC. The complaint alleges that, as a result of these breaches, misinformation about the Company’s financial condition was disseminated into the marketplace and filed with the SEC. The complaint asserts that these actions have exposed the Company to harmful and costly securities litigation, which could potentially result in an award of damages against the Company.

The Company disputes the allegations of wrongdoing in these complaints and intends to vigorously defend itself and, where applicable, its officers and directors, against these lawsuits and claims, and believes it has several meritorious defenses and, in certain instances, counterclaims. Accordingly, while the Company does not believe it is probable that the outcome of these litigation matters will be unfavorable to the Company, the Company cannot provide assurance that some or all of these matters will not materially and adversely affect the Company’s business, future results of operations, financial position or cash flows in a particular period.

In October 2001, Thomas Weisel Partners LLC filed a lawsuit against the Company in the United States District Court for the Northern District of California, San Francisco division. This lawsuit arose out of the Company’s engagement of Thomas Weisel for services in connection with the signing of the Company’s equity financing arrangement with Ramius Securities and Ramius Capital. Thomas Weisel alleged in its pleadings that a payment of $1.5 million became due under the engagement letter upon the signing of the arrangement. The Company did not make the payment because the underwriting terms of its equity facility with Ramius were not approved by the NASD. The claim was settled for an immaterial amount through mediation in September 2002, which was previously accrued by the Company and subsequently paid to Thomas Weisel in October 2002.

6. Earnings (Loss) Per Share

Basic earnings (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share reflects the potential dilution of securities by including other common stock equivalents, including stock options and convertible preferred stock, in the weighted average number of common shares outstanding for a period, if dilutive.

	Three Months Ended September 30,						Nine Months Ended September 30,
	2001			2002			2001			2002
Net loss (A)	$	(55,949	)	$	(884	)	$	(85,377	)	$	(12,112	)

Weighted average number of common shares(1) (B)		40,987			50,564			39,351			49,709
Effect of dilutive securities:
Stock options		*			*			*			*

Adjusted weighted average shares (C)		40,987			50,564			39,351			49,709

Loss per share:
Basic (A)/(B)	$	(1.37	)	$	(0.02	)	$	(2.17	)	$	(0.24	)
Diluted (A)/(C)	$	(1.37	)	$	(0.02	)	$	(2.17	)	$	(0.24	)

ONYX SOFTWARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(1)

For purposes of determining the weighted average number of common shares outstanding, shares of restricted common stock issued through the July 1998 exercise of stock options in exchange for promissory notes to the Company are excluded from both basic and diluted loss per share. The outstanding promissory note was paid in full during the second quarter of 2001 and the related 1,600,000 shares of common stock were released from restriction. As a result, the shares associated with the promissory note were included in the weighted average number of common shares outstanding on a weighted basis from the date of repayment, which totaled 557,000 shares for the nine months ended September 30, 2001.

Excluded from the computation of diluted earnings per share because the effects are antidilutive. Options to purchase 12,016,538 shares of common stock with exercise prices of $0.10 to $38.09 per share were outstanding as of September 30, 2001 and options to purchase 10,485,183 shares of common stock with exercise prices of $0.10 to $38.09 per share were outstanding as of September 30, 2002. Based on the weighted average share price, the common stock equivalents added to shares outstanding would have been 1,718,091 and 2,411,609 for the three and nine months ended September 30, 2001 and 704,268 and 913,292 for the three and nine months ended September 30, 2002, respectively.

7. Stock-Based Compensation

Stock-based compensation includes stock-based charges resulting from option-related deferred compensation recorded at the Company’s initial public offering and certain compensation arrangements with third-party consultants, as well as the portion of acquisition-related consideration conditioned on the continued tenure of key employees of certain acquired businesses, which must be classified as compensation expense rather than as a component of purchase price under accounting principles generally accepted in the United States. Stock-based compensation was $164,000 and $51,000 for the three months ended September 30, 2001 and 2002, respectively and $700,000 and $203,000 for the nine months ended September 30, 2001 and 2002.

The following table shows the amounts of stock-based compensation that would have been recorded under the following income statement categories had stock-based compensation not been separately stated in the consolidated statements of operations (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2001		2002		2001		2002
Support and service cost of sales	$	3	$	29	$	169	$	114
Sales and marketing		140		10		440		42
Research and development		8		4		29		15
General and administrative		14		8		62		32

Total amortization of stock-based compensation	$	164	$	51	$	700	$	203

8. Other Comprehensive Income (Loss)

A reconciliation of comprehensive loss for the three and nine months ended September 30, 2001 and 2002 follows (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2001			2002			2001			2002
Net loss	$	(55,949	)	$	(884	)	$	(85,377	)	$	(12,112	)
Other comprehensive income (loss):
Foreign currency translation adjustments		276			(112	)		(508	)		583
Unrealized loss on marketable securities		(2	)		—			(18	)		—

Total comprehensive loss	$	(55,675	)	$	(996	)	$	(85,903	)	$	(11,529	)

ONYX SOFTWARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

At December 31, 2001 and September 30, 2002, accumulated other comprehensive loss, related solely to foreign currency translation adjustments, totaled $1.3 million and $739,000, respectively.

9. Loan and Security Agreement

On February 14, 2002, the Company entered into a new Loan and Security Agreement with Silicon Valley Bank (SVB), which superseded the previous agreement entered into in September 2001. Under the terms of the new agreement, the Company has a $15.0 million working capital revolving line of credit with SVB, which is secured by accounts receivable, property and equipment and intellectual property. This facility allows the Company to borrow up to the lesser of (a) 75% of eligible accounts receivable and (b) $15.0 million. If the borrowing base calculation falls below the outstanding standby letters of credit issued by SVB on the Company’s behalf, SVB may require the Company to cash secure the amount by which outstanding standby letters of credit exceed the borrowing base. The amount required to be restricted under the loan agreement was $4.2 million, measured as of September 30, 2002. Due to the variability in the Company’s borrowing base, the Company may be subject to restrictions on its cash at various times throughout the quarter. Any borrowings will bear interest at SVB’s prime rate, which was 4.75% as of September 30, 2002, plus 1.5%, subject to a minimum rate of 6.0%. Additionally, the facility requires the Company to maintain at least $7.0 million in unrestricted deposit accounts with SVB. The agreement requires the Company to maintain certain financial covenants based on monthly tangible net worth. The Company amended the loan documents on July 10, 2002 to revise the tangible net worth covenants beginning with the month ended June 30, 2002. The Company was in compliance with these amended covenants at September 30, 2002. The Company is also prohibited under the Loan and Security Agreement from paying dividends. The new facility expires on December 31, 2002. Based on the outstanding standby letters of credit totaling $10.1 million at September 30, 2002, no additional amounts are currently available under the new credit facility.

10. Segment and Geographic Information

The Company and its subsidiaries are principally engaged in the design, development, marketing and support of enterprise-wide CRM solutions designed to promote strategic business improvement and revenue growth by enhancing the way businesses market, sell and service their products. Substantially all revenue results from the licensing of the Company’s software products and related consulting and customer support (maintenance) services. The Company’s chief operating decision maker reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenue by geographic region for purposes of making operating decisions and assessing financial performance. Accordingly, the Company considers itself to be in a single industry segment, specifically the license, implementation and support of its software applications and to have only one operating segment. The Company does not prepare reports for, or measure the performance of, its individual software applications and, accordingly, the Company has not presented revenue or any other related financial information by individual software product.

11. Shareholders’ Equity

In February 2002, the Company completed a public offering of 6,325,000 shares of its common stock at a purchase price to the public of $3.50 per share from its $100.0 million shelf registration statement, including 600,000 shares issued pursuant to the exercise of the over-allotment option granted to Wells Fargo Securities, LLC, the sole underwriter for the offering. The proceeds to the Company totaled $20.5 million after deducting the costs of the offering.

ONYX SOFTWARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

12. Equity Investment Losses and Impairment

During 1999 and 2000, the Company invested $3.5 million in a small number of private companies. The carrying value of these investments is included in “other assets” on the accompanying consolidated balance sheets and totaled $500,000 at December 31, 2001 and September 30, 2002.

During the three and nine months ended September 30, 2001, the Company recorded impairment losses, which totaled $500,000 and $2.5 million, respectively, relating to other-than-temporary declines in three of its cost basis equity investments based upon a recent review of qualitative and quantitative factors surrounding the financial condition of the investees. These impairment losses were recorded to reflect each investment at its estimated fair value. No other than temporary impairment-related losses were recorded in the first nine months of 2002.

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

Forward-Looking Information

Our disclosure and analysis in this report contain forward-looking statements, which provide our current expectations or forecasts of future events. Forward-looking statements in this report include, without limitation:

•

information concerning possible or assumed future results of operations, trends in financial results and business plans, including those relating to earnings growth and revenue growth;

•

statements about the level of our costs and operating expenses relative to our revenues, and about the expected composition of our revenues;

•

statements about our future capital requirements and the sufficiency of our cash, cash equivalents, investments and available bank borrowings to meet these requirements;

•

information about the anticipated release dates of new products;

•

statements about the expected costs and timing of terminating our excess facility commitments;

•

other statements about our plans, objectives, expectations and intentions; and

•

other statements that are not historical facts.

Words such as “believes,” “anticipates” and “intends” may identify forward-looking statements, but the absence of these words does not necessarily mean that a statement is not forward-looking. Forward-looking statements are subject to known and unknown risks and uncertainties and are based on potentially inaccurate assumptions that could cause actual results to differ materially from those expected or implied by the forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the factors described in the section entitled “Important Factors That May Affect Our Business, Our Results of Operations and Our Stock Price” in this report. Other factors besides those described in this report could also affect actual results. You should carefully consider the factors described in the section entitled “Important Factors That May Affect Our Business, Our Results of Operations and Our Stock Price” in evaluating our forward-looking statements.

You should not unduly rely on these forward-looking statements, which speak only as of the date of this report. We undertake no obligation to publicly revise any forward-looking statement to reflect circumstances or events after the date of this report, or to reflect the occurrence of unanticipated events. You should, however, review the factors and risks we describe in the reports we file from time to time with the Securities and Exchange Commission, or SEC.

Overview

Onyx Software Corporation is a leading provider of enterprise-wide customer relationship management, or CRM, solutions designed to promote strategic business improvement and revenue growth by enhancing the way businesses market, sell and service their products. We focus on our customers’ success as the prime criterion for how we judge our own success. Using the Internet in combination with traditional forms of interaction, including phone, mail, fax and e-mail, our solution helps enterprises to more effectively acquire, manage and maintain customer, partner and other relationships. We market our solution to companies that want to merge new, online business processes with traditional business processes to enhance their customer-facing operations, such as marketing, sales, customer service and technical support. Our solution is Internet-based, which means companies can take advantage of lower costs and faster deployment associated with accessing CRM software with a simple browser. Our solution uses a single data model across all customer interactions, resulting in a single repository for all marketing, sales and service information. It is fully integrated across all customer-facing departments and interaction media. Our solution is designed to be easy to use, widely accessible, rapidly deployable, scalable, flexible, customizable and reliable, which can result in a low total cost of ownership and rapid return on investment.

Overview of the Results for the Three and Nine Months Ended September 30, 2002

Key financial data points relating to our three and nine month performance include:

•

Revenue in the current quarter of $19.0 million, up 3% from the second quarter of 2002 and down 11% from the third quarter of 2001;

•

License revenue in the current quarter of $7.3 million, up 12% from the second quarter of 2002 and up 16% from the third quarter of 2001;

•

Service revenue in the current quarter of $11.8 million, down 2% from the second quarter of 2002 and down 22% from the third quarter of 2001;

•

Service margins in the current quarter of 58%, consistent with the margins generated in the second quarter of 2002 and up significantly from 44% in the third quarter of 2001;

•

Total operating expenses in the current quarter of $15.2 million, down from $17.7 million in the second quarter of 2002 and down from $68.7 million in the third quarter of 2001. Operating expenses, excluding acquisition-related amortization, stock compensation and restructuring charges, in the current quarter of $13.8 million, up from $13.5 million in the second quarter of 2002 and down from $19.6 million in the third quarter of 2001;

•

Revenue for the first nine months of 2002 of $52.2 million, down 35% from the first nine months of 2001;

•

License revenue for the first nine months of 2002 of $16.8 million, down 46% from the first nine months of 2001;

•

Service revenue for the first nine months of 2002 of $35.3 million, down 28% from the first nine months of 2001;

•

Service margins for the first nine months of 2002 of 57%, up significantly from 40% for the first nine months of 2001;

•

Total operating expenses for the first nine months of 2002 of $48.4 million, down from $133.1 million for the first nine months of 2001. Operating expenses, excluding acquisition-related amortization, stock compensation and restructuring charges, for the first nine months of 2002 of $39.8 million, down from $76.7 million for the first nine months of 2001;

•

Restricted and unrestricted cash balances up $4.9 million from December 31, 2001, and down $3.2 million from June 30, 2002 to $20.8 million at September 30, 2002; and

•

Days sales outstanding, based on end of period receivable balances, at 59 days compared to 78 days in the first and second quarters of 2002.

Although our license revenue in the third quarter of 2002 showed incremental improvement, we believe that continued adverse economic conditions in the global economy, particularly impacting the information technology industry, will continue to challenge our ability to generate new license sales. The majority of our revenue is generated from customers in the high technology, financial services, and healthcare industries. Accordingly, our business is affected by the economic and business conditions of these industries and the demand for information technology within these industries. Macroeconomic conditions were extremely challenging during 2001 and the first nine months of 2002 and we expect them to continue to impact capital spending initiatives of our targeted new and existing customer base.

As a result of current economic uncertainties, we will be focused on the following objectives in the near-term:

•

successful integration of our new Senior Vice President of the Americas, who joined Onyx in April 2002, three new regional sales managers, who joined Onyx during the second quarter of 2002, our new Chief Marketing Officer, who joined Onyx in July 2002, and our new Vice President of Asia, who joined Onyx in October 2002;

•

aggressive pipeline management aimed at focusing our resources and efforts on the opportunities with the highest probability of success;

•

maximizing the value of our partnerships with key system integration and technology vendors;

•

maintaining cost controls that may facilitate our return to profitability when coupled with modest revenue growth;

•

aggressive marketing of our recent major product releases on the Windows NT/Microsoft BackOffice and Oracle/Unix platforms;

•

maintaining high customer satisfaction levels; and

•

aggressively working to mitigate our excess facility commitments.

We hope that, by focusing our efforts on these key objectives, we will be able to return to profitability in challenging economic times and successfully grow our business, although we can make no assurances about when, or whether, this will occur. We continue to align costs and expenses to our expected revenues and review our restructuring efforts. However, we may continue to experience losses and negative cash flows in the near term, even if sales of our products and services continue to grow.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our critical accounting policies and estimates, including those related to revenue recognition, bad debts, intangible assets, restructuring, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition

Revenue recognition rules for software companies are very complex and often subject to interpretation. We follow very specific and detailed guidelines in measuring revenue; however, certain judgments affect the application of our revenue policy. Revenue results are difficult to predict, and any shortfall in revenue or delay in recognizing revenue could cause our operating results to vary significantly from quarter to quarter and could result in future operating losses.

We recognize revenue in accordance with accounting standards for software companies including Statement of Position, or SOP, 97-2, “Software Revenue Recognition,” as amended by SOP 98-4, SOP 98-9, and related interpretations including Technical Practice Aids.

Onyx generates revenue through two sources: (a) software license revenue and (b) support and service revenue. Software license revenue is generated from licensing the rights to use our products directly to end-users and vertical service providers, or VSPs, and indirectly through value-added resellers, or VARs, and, to a lesser extent, through third-party products we distribute. Support and service revenue is generated from sales of customer support services (maintenance contracts), consulting services and training services performed for customers that license our products.

In software arrangements that include rights to multiple software products and/or services, we allocate the total arrangement fee among each of the deliverables using the residual method, under which revenue is allocated to undelivered elements based on vendor-specific objective evidence of fair value of such undelivered elements and the residual amounts of revenue are allocated to delivered elements. Elements included in multiple element arrangements could consist of software products, maintenance (which includes customer support services and unspecified upgrades), or consulting services. Vendor-specific objective evidence is based on the price charged when an element is sold separately or, in the case of an element not yet sold separately, the price established by authorized management, if it is probable that the price, once established, will not change before market introduction.

Standard terms for license agreements call for payment within 90 days. Probability of collection is based upon the assessment of the customer’s financial condition through the review of its current financial statements or credit reports. For follow-on sales to existing customers, prior payment history is also used to evaluate probability of collection. Revenue from distribution agreements with VARs is typically recognized upon the earlier of receipt of cash from the VAR or identification of an end-user. In the latter case, probability of collection is evaluated based upon the creditworthiness of the VAR. Our agreements with customers, VSPs and VARs do not contain product return rights.

Revenue from maintenance arrangements is recognized ratably over the term of the contract, typically one year. Consulting revenue is primarily related to implementation services performed on a time-and-materials basis or, in certain situations, on a fixed-fee basis, under separate service arrangements. Implementation services are periodically performed under fixed-fee arrangements, and in such cases, consulting revenue is recognized on a percentage-of-completion basis. Revenue from consulting and training services is recognized as services are performed. Standard terms for renewal of maintenance arrangements, consulting services and training services call for payment within 30 days.

Revenue consisting of fees from licenses sold together with consulting services is generally recognized upon shipment of the software, provided that the above criteria are met, payment of the license fees are not dependent upon the performance of the services, and the consulting services are not essential to the functionality of the licensed software. If the services are essential to the functionality of the software, or payment of the license fees is dependent upon the performance of the services, both the software license and consulting fees are recognized under the percentage of completion method of contract accounting.

Bad Debts

A considerable amount of judgment is required when we assess the ultimate realization of receivables, including assessing the probability of collection and the current creditworthiness of each customer. We have recorded significant charges in our bad debt reserves in previous periods due to the rapid downturn in the economy, and in the technology sector in particular, and we may record additional charges in the future.

Restructuring

During 2001 and the first nine months of 2002, we recorded significant write-offs and accruals in connection with our restructuring program under Emerging Issues Task Force, or EITF, Issue No. 94-3. These write-offs and accruals include estimates pertaining to employee separation costs and the settlements of

contractual obligations related to excess leased facilities and other contracts. Although we believe that we have made reasonable estimates of our restructuring costs in calculating these write-offs and accruals, the actual costs will differ from these estimates, particularly the costs surrounding the excess leased facilities. If we are unable to negotiate affordable termination fees, if rental rates continue to decrease in the real estate markets where these excess facilities are located, or if it takes us longer than expected to find a suitable sublease tenant, the actual costs could significantly exceed our estimates.

In June 2002, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This statement 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).” This statement requires that a liability for a cost associated with an exit or disposal activity be recognized at fair value when the liability is incurred. We will be required to adopt this statement no later than January 1, 2003. We are currently assessing the impact of this statement on our results of operations and financial position.

Impairment of Intangible Assets

We periodically evaluate acquired businesses for potential impairment indicators. Our judgments regarding the existence of impairment indicators are based on legal factors, market conditions and operational performance of our acquired businesses. Future events could cause us to conclude that impairment indicators exist and that goodwill and other intangible assets associated with our acquired businesses are impaired. Beginning in 2002, the methodology for assessing potential impairments of intangibles changed based on new accounting rules issued by the FASB and related practice implementation guidance. Any resulting future impairment losses could have a material adverse impact on our financial condition and results of operations.

Contingencies and Litigation

We are subject to proceedings, lawsuits and other claims related to class action lawsuits and other matters. We are required to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses. A determination of the amount of loss accrual required, if any, for these contingencies are made after careful analysis of each individual issue. The required accruals may change in the future due to new developments in each matter or changes in approach such as a change in defense strategy in dealing with these matters.

Onyx Japan

In September 2000, we entered into a joint venture with Softbank Investment Corporation and Prime Systems Corporation to create Onyx Software Co., Ltd., or Onyx Japan, a Japanese corporation, for the purpose of distributing our technology and product offerings in Japan. In October 2000, we made an initial contribution of $4.3 million in exchange for 58% of the common stock of Onyx Japan. Our joint venture partners invested an additional $3.1 million for the remaining 42% of the common stock of Onyx Japan. Because we have a controlling interest, Onyx Japan has been included in our consolidated financial statements. The minority shareholders’ interest in Onyx Japan’s earnings or losses is accounted for in our statement of operations.

Under the terms of the joint venture agreement, Prime Systems may at any time after September 14, 2001, sell its shares to a third party provided that they notify us 90 days prior to doing so. We have a right of first refusal to purchase any of Prime Systems’ shares that are offered for resale at the same price at which those shares are being offered to a third party. Further, either Onyx or Prime Systems may terminate the joint venture agreement at its discretion if Onyx Japan does not complete an initial public offering on or before July 31, 2003. If Prime Systems exercises its right of termination for this reason, Onyx has the right, at its election, to either (a) buy Prime Systems’ shares at the current fair market value as determined by appraisal or (b) force a liquidation of Onyx Japan.

We have entered into a distribution agreement with Onyx Japan, which was approved by the minority shareholders, that provides for a fee to us based on license and maintenance revenues in Japan. During the third quarter of 2001 and 2002, fees charged under this agreement were $290,000 and $77,000, and during the nine months ended September 30, 2001 and 2002, fees charged under this agreement were $926,000 and $328,000. All intercompany fees are eliminated in consolidation; however, we allocate 42% of the fees to the minority shareholders.

In recent periods, Onyx Japan has incurred substantial losses. The minority shareholders capital account balance as of September 30, 2002 was $444,000. Additional Onyx Japan losses above approximately $1.1 million in the aggregate will be absorbed 100% by Onyx, as compared to 58% in prior periods.

We restructured Onyx Japan’s operations during the third quarter of 2002, which we expect to significantly reduce our future operating expenses and increase our ability to be profitable and cash flow positive in Japan. Nevertheless, additional funding may be required to continue the operation of the joint venture. Our joint venture partners are not obligated to participate in any capital call and have indicated that they do not currently intend to invest additional sums in Onyx Japan. We are, however, discussing other ways our partners can assist Onyx Japan. If Onyx Japan continues to incur losses and no additional capital is invested, we may have to further restructure our operations in Japan.

Results of Operations

The following table presents certain financial data, derived from our unaudited statements of operations, as a percentage of total revenue for the periods indicated. The operating results for the three and nine months ended September 30, 2001 and 2002 are not necessarily indicative of the results that may be expected for the full year or any future period.

	Three Months Ended September 30,				Nine Months Ended September 30,
	2001		2002		2001		2002
Consolidated Statement of Operations Data:
Revenue:
License	29.3	%	38.2	%	38.8	%	32.3	%
Support and service	70.7		61.8		61.2		67.7

Total revenue	100.0		100.0		100.0		100.0

Cost of revenue:
License	0.8		1.4		2.1		1.3
Amortization of acquired technology	1.0		0.7		0.8		0.8
Support and service	39.7		25.9		36.6		29.1

Total cost of revenue	41.3		28.0		39.5		31.2

Gross margin	58.7		72.0		60.5		68.8
Operating expenses:
Sales and marketing	52.6		41.4		58.2		40.2
Research and development	23.0		18.5		22.5		22.1
General and administrative	16.2		12.5		15.1		14.1
Restructuring and other related charges	187.7		6.2		54.5		14.8
Amortization and impairment of goodwill and other acquisition-related charges	41.4		1.1		15.1		1.2
Amortization of stock-based compensation	0.8		0.3		0.9		0.4

Total operating expenses	321.7		80.0		166.3		92.8

Loss from operations	(263.0	)	(8.0	)	(105.8	)	(24.0	)
Interest and other income (expense), net	0.2		1.4		0.5		(0.1	)
Equity investment losses and impairment	(2.3	)	—		(3.1	)	—

Loss before income taxes	(265.1	)	(6.6	)	(108.4	)	(24.1	)
Income tax provision (benefit)	(1.3	)	(0.2	)	(0.5	)	0.7
Minority interest in loss of consolidated subsidiary	(1.7	)	(1.8	)	(1.3	)	(1.6	)

Net loss	(262.1	)%	(4.6	)%	(106.6	)%	(23.2	)%

Revenue

Total revenue, which consists of software license revenue and support and service revenue, decreased 11% from $21.3 million in the third quarter of 2001 to $19.0 million in the third quarter of 2002. Total revenue decreased 35% from $80.1 million in the first nine months of 2001 to $52.2 million in the first nine months of 2002. For the three and nine months ended September 30, 2001, no single customer accounted for more than 10% of total revenue. For the three months ended September 30, 2002, one customer accounted for approximately 15% of total revenue. For the nine months ended September 30, 2002, no single customer accounted for more than 10% of total revenue. At September 30, 2002, no single customer accounted for more than 10% of accounts receivable.

Our license revenue increased 16%, from $6.3 million in the third quarter of 2001 to $7.3 million in the third quarter of 2002. Our license revenues decreased 46% from $31.0 million in the first nine months of 2001 to $16.8 million in the first nine months of 2002. We believe the decrease for the nine months ended September 30, 2002 compared to the same period of the prior year was primarily due to the progressive weakening of the global economy, which has caused a delay in the capital spending initiatives of our prospective and existing customers, particularly in the middle market. Macroeconomic conditions were extremely challenging during 2001 and the first nine months of 2002, and we expect them to continue to impact capital spending initiatives of our targeted new and existing customer base.

Our support and service revenue decreased 22%, from $15.1 million in the third quarter of 2001 to $11.8 million in the third quarter of 2002. Support and service revenue represented 71% of our total revenue in the third quarter of 2001 and 62% in the third quarter of 2002. Our support and service revenues decreased 28%, from $49.0 million in the first nine months of 2001 to $35.3 million in the first nine months of 2002. Support and service revenue represented 61% of our total revenue in the first nine months of 2001 and 68% in the first nine months of 2002. The majority of the decrease for the third quarter and the nine months ended September 30, 2002 compared to the same periods of the prior year was due to decreased consulting and training services. We expect our support and service revenue to decrease in absolute dollars in 2002 compared to 2001, primarily because of our strategic decision to provide more opportunities for our partners to engage with our customers, and due to the reduction in demand for our consulting services resulting from the decrease in our license revenue in recent quarters. In addition, we may experience a decline in maintenance revenue as some customers elect not to renew annual maintenance contracts, which we believe is primarily related to specific economic circumstances facing these customers and fewer new licenses sold in 2001. We expect the proportion of support and service revenue to total revenue to fluctuate in the future, depending in part on our customers’ direct use of third-party consulting and implementation service providers, the degree to which we provide opportunities for our partners to engage with our customers and the ongoing renewals of customer support contracts, as well as our overall sales of software licenses to new and existing customers.

On January 1, 2002, we adopted EITF No. D-103, “Income Statement Characterization of Reimbursements Received for ‘Out-of-Pocket’ Expenses Incurred.” Topic D-103 requires that certain out-of-pocket expenses rebilled to customers be recorded as revenue versus an offset to the related expense. Prior to the adoption of Topic D-103, we recorded rebilled out-of-pocket expenses as an offset to the related expense. Comparative financial statements for prior periods have been conformed to the current year presentation. The impact of the reclassification was to increase service revenue by $625,000, or 4%, and $388,000, or 3%, in the third quarter of 2001 and 2002, and $2.1 million, or 5%, and $1.3 million, or 4%, in the nine months ended September 30, 2001 and 2002.

Revenue outside of North America increased 7%, from $6.7 million in the third quarter of 2001 to $7.2 million in the third quarter of 2002. Revenue outside of North America decreased 15%, from $21.1 million in the first nine months of 2001 to $17.9 million in the first nine months of 2002. The increase in international revenue in the third quarter of 2002 compared to the same period of the prior year is largely the result of an increase in European license revenues involving a significant add-on purchase by an existing customer, offset in part by a decrease in support and service revenues in Europe, Japan and Australia. The decrease in international revenue for the nine months ended September 30, 2002 compared to the same period of the prior year was due to a decrease in both license and support and service revenues in Europe, Japan, Australia and Southeast Asia, which have been impacted by the progressive weakening of the global economy and the resulting delay in capital spending initiatives.

Cost of Revenue

Cost of license revenue

Cost of license revenue consists of license fees for third-party software, amortization of acquired technology, product media, product duplication, manuals, product fulfillment and shipping costs. Cost of license

revenue increased 60%, from $169,000 in the third quarter of 2001 to $270,000 in the third quarter of 2002. Cost of license revenue as a percentage of related license revenue was 3% in the third quarter of 2001 and 4% in the third quarter of 2002. The increase in dollar amount in cost of license revenue resulted primarily from an increase in third party product royalties and an increase in license revenue. Cost of license revenue decreased 60%, from $1.7 million in the first nine months of 2001 to $667,000 in the first nine months of 2002. Cost of license revenue as a percentage of related license revenue was 5% in the first nine months of 2001 and 4% in the first nine months of 2002. The decrease in dollar amount in cost of license revenue resulted from a decrease in license revenue and from a write-down of third-party product inventory not yet sold that was recorded in the first quarter of 2001. No excess inventory write-downs were recorded in the first nine months of 2002.

Amortization of acquired technology

Amortization of acquired technology represents the amortization of capitalized technology associated with our acquisitions of EnCyc in 1998 and Versametrix and Market Solutions in 1999. Amortization of acquired technology was $205,000 in the third quarter of 2001 and $138,000 in the third quarter of 2002. Amortization of acquired technology was $613,000 in the first nine months of 2001 and $414,000 in the first nine months of 2002. The decrease in amortization of acquired technology is the result of an impairment recorded in the third quarter of 2001 relating to the carrying value of the acquired technology asset associated with Versametrix.

Cost of service revenue

Cost of service revenue consists of personnel and third-party service provider costs related to consulting services, customer support and training. Cost of service revenue decreased 42%, from $8.4 million in the third quarter of 2001 to $4.9 million in the third quarter of 2002. Cost of service revenue decreased 48%, from $29.3 million in the first nine months of 2001 to $15.2 million in the first nine months of 2002. The decrease in dollar amount resulted primarily from a reduction in consulting personnel during 2001 to more closely align with our service revenue, as well as a decrease in the use of third-party service providers, which have a higher cost structure than our internal resources. Our service employees decreased 40% from September 30, 2001 to September 30, 2002. Cost of service revenues as a percentage of related service revenues was 56% in the third quarter of 2001, compared to 42% in the third quarter of 2002. Cost of service revenues as a percentage of related service revenues was 60% in the first nine months of 2001, compared to 43% in the first nine months of 2002. The decrease in cost of service revenues as a percentage of related service revenues is due to a higher proportion of maintenance revenue, which has a lower direct cost structure and therefore contributes higher margins than our consulting and training services, coupled with a lower percentage use of third-party service providers in our consulting engagements, which contribute significantly lower margins than internal resources. The cost of services as a percentage of service revenue may vary between periods primarily for two reasons: (1) the mix of services we provide (consulting, customer support, training), which have different cost structures, and (2) the resources used to deliver these services (internal versus third parties).

Costs and Expenses

Sales and marketing

Sales and marketing expenses consist primarily of salaries, commissions and bonuses earned by sales and marketing personnel, travel and promotional expenses and facility and communication costs for direct sales offices. Sales and marketing expenses decreased 30%, from $11.2 million in the third quarter of 2001 to $7.9 million in the third quarter of 2002. Sales and marketing expenses decreased 55%, from $46.6 million in the first nine months of 2001 to $20.9 million in the first nine months of 2002. The decrease in dollar amount from 2001 to 2002 was primarily due to restructuring activities and reductions in sales and marketing headcounts. Sales and marketing employees decreased 41% from September 30, 2001 to September 30, 2002. Sales and marketing expenses represented 53% of our total revenue in the third quarter of 2001, compared to 41% in the third quarter of 2002. Sales and marketing expenses represented 58% of our total revenue in the first nine months

of 2001, compared to 40% in the first nine months of 2002. The decrease in sales and marketing expenses as a percentage of total revenue is primarily the result of a change in the mix of license and service revenue between periods.

We expect our sales and marketing expenses to decrease in absolute dollars in 2002 relative to 2001 as we gain the full benefit of our restructuring efforts and maintain resource levels that more closely align with the expected demand for our products. However, the number of personnel is expected to increase modestly from current levels between now and the end of 2002. As we gain visibility into our long-term sales growth opportunity, we believe that we may need to significantly increase our sales and marketing efforts to expand our market position and further increase acceptance of our products.

Research and development

Research and development expenses consist primarily of salaries, benefits and equipment for software developers, quality assurance personnel, program managers and technical writers and payments to outside contractors. Research and development expenses decreased 28%, from $4.9 million in the third quarter of 2001 to $3.5 million in the third quarter of 2002. Research and development expenses decreased 36%, from $18.0 million in the first nine months of 2001 to $11.5 million in the first nine months of 2002. The decrease was primarily due to a decrease in the use of outside contractors, and to a lesser extent, due to a decrease in the number of development personnel. Research and development employees decreased 17% from September 30, 2001 to September 30, 2002. Research and development costs represented 23% of our total revenue in the third quarter of 2001, compared to 19% in the third quarter of 2002. Research and development costs represented 22% of our total revenue in the first nine months of 2001 and in the first nine months of 2002.

Although research and development expenses were affected by our restructuring activities, those development projects that we believe to be most strategic to our long-term growth were not affected. We believe our research and development investments are essential to our strategic priorities. As we gain visibility into our long-term sales growth opportunity, we believe that we may need to increase our research and development investment in absolute dollars to expand our market position and continue to expand our product line.

General and administrative

General and administrative expenses consist primarily of salaries, benefits and related costs for our executive, finance, human resource and administrative personnel, professional services fees and allowances for bad debt. General and administrative expenses decreased 31%, from $3.5 million in the third quarter of 2001 to $2.4 million in the third quarter of 2002. General and administrative expenses decreased 39%, from $12.1 million in the first nine months of 2001 to $7.4 million in the first nine months of 2002. The decrease in dollar amount in the third quarter of 2002 and the first nine months of 2002 compared to the same periods of the prior year was primarily due to restructuring activities and reductions in executive, finance, human resource and administrative personnel, along with a decrease in professional fees and allowances for bad debt expense. General and administrative employees decreased 19% from September 30, 2001 to September 30, 2002. General and administrative costs represented 16% of our total revenue in the third quarter of 2001, compared to 13% in the third quarter of 2002. General and administrative costs represented 15% of our total revenue in the first nine months of 2001 and 14% of our total revenue in the first nine months of 2002.

In October 2002, Onyx eliminated the role of our President and Chief Operating Officer and we do not plan to hire a replacement for this position in the near term. The costs associated with his departure will be included in our results of operations for the fourth quarter of 2002 and are estimated to be approximately $800,000 to be paid over the next 12 months. Additionally, pursuant to Mr. Rechan’s employment agreement, he received one-year acceleration on his employee stock options, all of which must be exercised on or before January 3, 2003. As we gain visibility into our long-term sales growth opportunity, we believe our general and administrative expenses may increase as we expand our administrative staff, domestically and internationally, and incur additional professional services fees.

Restructuring and other related charges

Restructuring and other related charges represent our efforts to reduce our overall cost structure. In April and again in September of 2001, we approved a restructuring plan to reduce headcount, reduce infrastructure and eliminate excess facilities. During 2001, we recorded approximately $51.8 million in restructuring and other related charges. Restructuring charges for the three and nine months ended September 30, 2001 totaled $40.1 million and $43.7 million. Restructuring charges for the three and nine months ended September 30, 2002 totaled $1.2 million and $7.7 million.

The components of the first quarter 2002 charges and a roll-forward of the related liability follow (in thousands):

	Balance at December 31, 2001		Charge for the three months ended March 31, 2002			Cash payments			Balance at March 31, 2002
Excess facilities	$	24,295	$	2,580		$	(3,762	)	$	23,113
Employee separation costs		250		297			(472	)		75
Other		769		(260	)		(297	)		212

Total	$	25,314	$	2,617		$	(4,531	)	$	23,400

The components of the second quarter 2002 charges and a roll-forward of the related liability follow (in thousands):

	Balance at March 31, 2002		Charge for the three months ended June 30, 2002		Cash payments & Impairments			Balance at June 30, 2002
Excess facilities	$	23,113	$	3,756	$	(3,376	)	$	23,493
Adjusted loss on asset disposals		—		125		(125	)		—
Employee separation costs		75		60		(105	)		30
Other		212		—		(132	)		80

Total	$	23,400	$	3,941	$	(3,738	)	$	23,603

The components of the third quarter 2002 charges and a roll-forward of the related liability follow (in thousands):

	Balance at June 30, 2002		Charge for the three months ended September 30, 2002		Cash payments & Impairments			Balance at September 30, 2002
Excess facilities	$	23,493	$	586	$	(3,400	)	$	20,679
Adjusted loss on asset disposals		—		465		(465	)		—
Employee separation costs		30		120		(130	)		20
Other		80		—		(4	)		76

Total	$	23,603	$	1,171	$	(3,999	)	$	20,775

The excess facility charges recorded in 2001 and the first nine months of 2002 are the result of our decision to reduce our utilization of certain facilities and to terminate usage of certain domestic and international facilities altogether. The most significant portion of the excess facility charges relates to our leases for 262,000 square feet of office space in Bellevue, Washington that expire in 2011 and 2013. These leases have annual minimum lease payments and operating costs currently totaling $10.1 million, with annual increases in these payments of $1 per square foot through the remainder of the lease term. The excess facility charges have been determined based on current comparable rates for leases in the respective markets in which the excess facilities are located or estimated fees that would be required to terminate the underlying leases.

In recent months, we have made progress in our efforts to mitigate excess facility commitments. Specifically, in August 2002, we executed a sublease agreement on our 21,000 square foot facility in the United Kingdom that reduces our obligation on seven of the remaining 14 years on the lease, and in November 2002, we executed a lease termination agreement on our 100,000 square foot current corporate headquarters facility in Bellevue, Washington. This lease termination will result in accelerated cash outflows of approximately $2.0 million during the fourth quarter of 2002. We will continue to pay our monthly lease obligation of approximately $250,000 until we relocate our corporate headquarters, which is expected to occur at the end of January 2003. The signing of this agreement, which requires us to move our corporate headquarters, will result in accelerated amortization of leasehold improvements totaling approximately $800,000 at September 30, 2002 and may result in impairment of other furniture and equipment. We are also pursuing a partial lease termination whereby our excess facilities in Bellevue, Washington would be reduced by approximately 200,000 square feet. We expect this partial termination to result in cash outflows over 19 months, the sum of which approximates our current lease obligations on the terminated square footage through the end of 2003, and the issuance of warrants to purchase approximately 800,000 shares of our common stock at exercise prices that are at a premium to market. A definitive agreement has not been reached as of the date of this filing and the estimates of excess facilities could change.

If we are unsuccessful in negotiating affordable termination fees on certain facilities, if facilities operating lease rental rates continue to decrease in these markets, if it takes longer than expected to find a suitable tenant to sublease these facilities, or if other estimates and assumptions change, our actual charges will exceed the current estimate. The accounting for excess facilities is complex and, as a result, any final mitigation measures will likely result in adjustments to our current restructuring charge. Future cash outlays are anticipated through July 2006 unless estimates and assumptions change or we are able to negotiate to exit the leases at an earlier date. Our contractual lease obligations extend through 2016.

We are continuing to align our operations and review our restructuring efforts. However, we may be unable to achieve these expense reductions without adversely affecting our business and operating results. We may continue to experience losses and negative cash flows in the near term, even if sales of our products and services continue to grow.

Amortization and impairment of goodwill and other acquisition-related intangibles

Amortization and impairment of acquired intangibles consists of intangible amortization associated with our acquisitions of EnCyc in 1998, Versametrix and Market Solutions in 1999, CSN Computer Consulting in 2000 and RevenueLab in 2001. Amortization and impairment of acquired intangibles totaled $8.8 million in the third quarter of 2001 and $12.1 million for the first nine months of 2001. Due to the full impairment of the carrying value of intangibles associated with the acquisitions of Versametrix, Market Solutions and RevenueLab during the third and fourth quarters of 2001, coupled with the elimination of goodwill amortization expense in 2002 as the result of the required adoption of new accounting pronouncements effective January 1, 2002, as more fully described in Note 1 to the accompanying unaudited consolidated financial statements, amortization and impairment of acquired intangibles was reduced to $209,000 in the third quarter of 2002 and $627,000 for the first nine months of 2002.

Deferred stock-based compensation

We recorded deferred stock-based compensation as a component of shareholders’ equity of $2.2 million in 1998, representing the difference between the exercise prices of options granted to acquire shares of common stock during 1997 and 1998, prior to our initial public offering, and the deemed fair value for financial reporting purposes of our common stock on the grant dates. We recorded an additional $1.8 million in deferred

compensation in connection with the options granted to new employees in conjunction with the acquisition of RevenueLab in January 2001. Deferred compensation is amortized over the vesting periods of the options. We amortized stock-based compensation expense of $164,000 in the third quarter of 2001 and $51,000 in the third quarter of 2002. We amortized stock-based compensation expense of $700,000 in the first nine months of 2001 and $203,000 in the first nine months of 2002. Approximately $1.0 million of deferred compensation that was recorded in January 2001 in connection with options granted to employees of RevenueLab was reversed within shareholders’ equity during 2001 and the first nine months of 2002 upon the employees’ termination. Amortization of the deferred stock-based compensation balance of $129,000 at September 30, 2002 will approximate $45,000 in the remaining three months of 2002, $51,000 in 2003, $26,000 in 2004 and $7,000 in 2005.

Interest and other income or expense, net

Interest and other income or expense, net consists of earnings on our cash and cash equivalent and short-term investment balances, offset by interest expense and bank fees associated with debt obligations and credit facilities. Interest and other income, net was $48,000 in the third quarter of 2001, compared to $269,000 in the third quarter of 2002. The increase in interest and other income, net is primarily the result of a benefit recorded in the third quarter of 2002 relating to lower than previously estimated equity transaction-related expenses which were not associated with the sale of securities, originally recorded in the first quarter of 2002. Interest and other income, net was $405,000 in the first nine months of 2001 compared to an expense of $73,000 in the first nine months of 2002. The decrease in interest and other income, net is primarily the result of an increase in bank fees and equity transaction-related expenses which were not associated with the sale of securities, coupled with lower interest rates on marketable securities as compared to the same period of 2001.

Equity investment losses and impairment

During the three and nine months ended September 30, 2001, we recorded impairment losses, which totaled $500,000 and $2.5 million, relating to other-than-temporary declines in three of our cost basis equity investments based upon a recent review of qualitative and quantitative factors surrounding the financial condition of the investees. These impairment losses were recorded to reflect each investment at its estimated fair value. No other- than-temporary impairment-related losses were recorded in the first nine months of 2002. At December 31, 2001 and September 30, 2002, the remaining carrying value of private equity investments totaled $500,000 and is included in other assets in the consolidated balance sheets.

Income taxes

We recorded a benefit of $279,000 in the third quarter of 2001 and a benefit of $29,000 in the third quarter of 2002. We recorded a benefit of $381,000 in the first nine months of 2001 and an income tax provision of $383,000 in the first nine months of 2002. The significant benefit recorded in the third quarter of 2001 resulted from the reduction of the deferred tax liability associated with the intangibles of CSN Computer Consulting, which was fully impaired during the third quarter of 2001. The increase in income tax expense in the nine months ended September 30, 2002 is primarily related to withholding taxes associated with the expected settlement of royalties due to our U.S. entity by Onyx Japan, our Japanese joint venture. Although these withholding taxes generate foreign tax credits, we have recorded a valuation allowance for the entire deferred tax asset as a result of uncertainties regarding the realization of the asset balance. Our income tax provision or benefit in all periods presented is the net result of income taxes in connection with our foreign operations, offset by the deferred tax benefit recorded as we amortize the intangibles associated with our international acquisitions. We made no provision and recorded no benefit for federal or state income taxes in the first nine months of 2001 or the first nine months of 2002 due to our historical operating losses, which resulted in deferred tax assets. We have recorded a valuation allowance for the entire deferred tax asset as a result of uncertainties regarding the realization of the asset balance.

Minority interest in loss of consolidated subsidiary

Softbank Investment Corporation and Prime Systems Corporation together own 42% of Onyx Japan, our Japanese joint venture. Because we have a controlling interest, Onyx Japan has been included in our consolidated financial statements. The minority shareholders’ interest in Onyx Japan’s earnings or losses is accounted for in the statement of operations for each period. In the third quarter of 2001 and 2002, the minority shareholders’ interest in Onyx Japan’s losses totaled $349,000 and $345,000. In the first nine months of 2001 and 2002, the minority shareholders’ interest in Onyx Japan’s losses totaled $1.0 million and $817,000. At September 30, 2002, the minority shareholders’ remaining interest in the joint venture, net of their share of cumulative translation losses, totaled $444,000. Any future losses of Onyx Japan will be shared by the minority shareholders to the extent of their interest in the joint venture. As a result, additional Onyx Japan losses above approximately $1.1 million in the aggregate will be absorbed 100% by Onyx, as compared to 58% in prior periods.

In recent periods, Onyx Japan has incurred substantial losses. We restructured Onyx Japan’s operations during the third quarter of 2002, which we expect to significantly reduce our future operating expenses and increase our ability to be profitable and cash flow positive in Japan. Nevertheless, additional funding may be required to continue the operation of the joint venture. Our joint venture partners are not obligated to participate in any capital call and have indicated that they do not currently intend to invest additional sums in Onyx Japan. We are, however, discussing other ways our partners can assist Onyx Japan. If Onyx Japan continues to incur losses and no additional capital is invested, we may have to further restructure our operations in Japan.

Liquidity and Capital Resources

As of September 30, 2002, we had unrestricted cash and cash equivalents of $20.8 million, an increase of $4.9 million from cash and cash equivalents held as of December 31, 2001. As of September 30, 2002, we also had restricted cash balances totaling $4.7 million. We invest our cash in excess of current operating requirements in a portfolio of investment-grade securities. We did not hold any short-term marketable securities as of December 31, 2001 or September 30, 2002.

As of September 30, 2002, our principal obligations consisted of restructuring-related liabilities totaling $20.8 million, of which $14.2 million is expected to be paid within the next 12 months, accrued liabilities of $2.9 million, salaries and benefits payable of $2.2 million and trade payables of $1.5 million. The majority of the restructuring-related liabilities relate to excess facilities in domestic and international markets. The most significant of these commitments are our leases for 262,000 square feet of office space in Bellevue, Washington that expire in 2011 and 2013. These leases have annual minimum lease payments and operating costs currently totaling $10.1 million, with annual increases in these payments of $1 per square foot through the remainder of the lease term. The majority of our accounts payable, salaries and benefits payable and accrued liabilities at September 30, 2002 will be settled during the next three months and will result in a corresponding decline in the amount of cash and cash equivalents, offset by liabilities associated with activity in the fourth quarter of 2002. Off-balance sheet commitments as of September 30, 2002 primarily consisted of operating leases associated with facilities in Bellevue, Washington and our domestic and international field office facilities.

On February 14, 2002, we entered into a new Loan and Security Agreement with Silicon Valley Bank, or SVB, which superseded the previous agreement entered into in September 2001. Under the terms of the new Agreement, we have a $15.0 million working capital revolving line of credit with SVB, which is secured by accounts receivable, property and equipment and intellectual property. This facility allows us to borrow up to the lesser of (a) 75% of eligible accounts receivable and (b) $15.0 million. If the borrowing base calculation falls below the outstanding standby letters of credit issued by SVB on our behalf, SVB may require us to cash secure the amount by which outstanding standby letters of credit exceed the borrowing base. The amount required to be restricted under the loan agreement was $4.2 million, measured as of September 30, 2002. Due to the variability in our borrowing base, we may be subject to restrictions on our cash at various times throughout the quarter. Any borrowings will bear interest at SVB’s prime rate, which was 4.75% as of September 30, 2002, plus 1.5%,

subject to a minimum rate of 6.0%. Additionally, the facility requires us to maintain at least $7.0 million in unrestricted deposit accounts with SVB. The agreement requires us to maintain certain financial covenants based on monthly tangible net worth. We amended the loan documents on July 10, 2002 to revise the tangible net worth covenants beginning with the month ended June 30, 2002. We were in compliance with the covenants, as amended, at September 30, 2002. We are also prohibited under the Loan and Security Agreement from paying dividends. The new facility expires on December 31, 2002. Based on the outstanding standby letters of credit totaling $10.1 million at September 30, 2002, no additional amounts are currently available under the new credit facility.

Our operating activities resulted in net cash outflows of $19.4 million in the first nine months of 2001 and $11.4 million in the first nine months of 2002. The operating cash outflows in each of these periods were primarily the result of our operating losses adjusted for non-cash amortization and impairment charges, decreases in accounts payable and accrued liabilities, decreases in deferred revenues and increases in prepaid expenses and other assets, offset in part by cash provided by collections on accounts receivable. The net cash outflow of $11.4 million in the first nine months of 2002 includes $11.9 million in cash paid for restructured items.

Investing activities used cash of $9.5 million in the first nine months of 2001, primarily for funding leasehold improvements and purchasing capital equipment associated with our new Bellevue, Washington facility, coupled with cash used to acquire RevenueLab, offset in part by the net proceeds from the maturity of short-term marketable securities. Investing activities used cash of $4.9 million in the first nine months of 2002, primarily due to the restriction of cash used to secure our outstanding letters of credit and corporate card program.

Financing activities provided cash of $33.1 million in the first nine months of 2001 primarily due to the proceeds from our public offering of common stock in February 2001 and proceeds from the exercise of stock options and shares issued under our employee stock purchase plan, offset in part by payments on our long-term obligations. Financing activities provided cash of $20.9 million in the first nine months of 2002 primarily due to the proceeds from our public offering of common stock in February 2002 and proceeds from the exercise of stock options and shares issued under our employee stock purchase plan, offset in part by payments on our long-term obligations.

Our near-term restructuring costs and mitigation of our excess facilities liabilities, along with our ongoing operations, will consume a material amount of our cash resources. The termination of our 100,000 square foot lease for our current corporate headquarters facility in Bellevue, Washington will result in accelerated cash outflows of approximately $2.0 million during the fourth quarter of 2002. We will continue to pay our monthly lease obligation of approximately $250,000 until we relocate our corporate headquarters, which is expected to occur at the end of January 2003. The signing of this agreement, which requires us to move our corporate headquarters, will result in accelerated amortization of leasehold improvements totaling approximately $800,000 at September 30, 2002 and may result in impairment of other furniture and equipment. We are also pursuing a partial lease termination whereby our excess facilities in Bellevue, Washington would be reduced by approximately 200,000 square feet. We expect this partial termination to result in cash outflows over 19 months, the sum of which approximates our current lease obligations on the terminated square footage through the end of 2003, and the issuance of warrants to purchase approximately 800,000 shares of our common stock at exercise prices that are at a premium to market. A definitive agreement has not been reached as of the date of this filing and the estimates of excess facilities could change. We may also use a portion of our cash resources to provide further capital to Onyx Japan. Our Japanese joint venture partners are not obligated to participate in any capital call and have currently indicated that they do not intend to invest additional sums in Onyx Japan. We are, however, discussing other ways our partners can assist Onyx Japan. If Onyx Japan continues to incur losses and no additional capital is invested, we may have to further restructure our operations in Japan. Finally, it is also possible that we will use a portion of our cash resources to acquire or invest in complementary business, products or technologies; however, we currently have no commitments or agreements with respect to any transactions of this nature.

Assuming our future financial performance is comparable to the most recent periods reported, we believe that our existing cash and cash equivalents will be sufficient to meet our capital requirements for at least the next twelve months. However, due to the potential impact lower cash balances could have on our sales we will likely need to seek additional funds through public or private equity financing or from other sources to fund our operations and pursue our growth strategy. We have no commitment for additional financing, and we may experience difficulty in obtaining additional financing on favorable terms, if at all. Any financing we obtain may contain covenants that restrict our freedom to operate our business or may have rights, preferences or privileges senior to our common stock and may dilute our current shareholders’ ownership interest in Onyx.

Recently Issued Accounting Pronouncements

During the nine months ended September 30, 2002, we adopted new accounting standards related to the accounting for: business combinations; intangible assets and goodwill; impairment of long lived assets; discontinued operations; and presentation of rebilled out-of-pocket expenses. There was no cumulative transition adjustment recorded upon the adoption of any of these accounting standards and the adoption of these accounting standards did not have a material impact on our consolidated financial position, results of operations or cash flows other than the discontinuance of goodwill amortization discussed below, which had no impact on cash flows, but effectively improved our operating results. The following is a brief summary of the accounting standards adopted during the nine months ended September 30, 2002:

Business Combinations. On July 1, 2001, we adopted certain provisions of SFAS 141, although no business combinations have been consummated since June 30, 2001. We adopted the remaining provisions of SFAS 141 effective January 1, 2002. SFAS 141 requires that all business combinations be accounted for using the purchase method, thereby prohibiting the pooling-of-interests method. SFAS 141 also specifies criteria for recognizing and reporting intangible assets apart from goodwill; however, assembled workforce must be recognized and reported in goodwill.

Goodwill and Intangible Assets. We adopted the provisions of SFAS 142 on January 1, 2002. SFAS 142 requires that intangible assets with an indefinite life should not be amortized until their life is determined to be finite and all other intangible assets must be amortized over their useful life. SFAS 142 also requires that goodwill not be amortized but instead tested for impairment at the reporting unit level at least annually and more frequently upon the occurrence of certain events. We have completed the first step of the transitional goodwill impairment test and have determined that there was no transitional impairment upon full adoption in the first quarter of 2002. If the non-amortization provisions of SFAS 142 had been effective in 2001, net loss and basic and diluted net loss per share for the three months and nine months ended September 30, 2001, would have been a loss of $55.2 million and $1.35 per share and a loss of $81.9 million and $2.08 per share.

Impairment of Long-Lived Assets and Discontinued Operations. On January 1, 2002, we adopted SFAS 144. SFAS 144 supersedes certain provisions of APB Opinion No. 30, “Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” and supersedes SFAS No. 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” There was no cumulative transition adjustment required upon adoption.

Presentation of Rebilled Expenses. On January 1, 2002, we adopted EITF Topic No. D-103. Topic D-103 requires that certain out-of-pocket expenses rebilled to customers be recorded as revenue versus an offset to the related expense. Prior to the adoption of Topic D-103, we recorded rebilled out-of-pocket expenses as an offset to the related expense. Comparative financial statements for prior periods have been conformed to the current year presentation. This change had no effect on operating income or net income for any period presented.

Accounting for Costs Associated with Exit or Disposal Activities. In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This statement 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).” This statement requires that a liability for a cost associated with an exit or disposal activity be recognized at fair value when the liability is incurred. We will be required to adopt this statement no later than January 1, 2003. We are currently assessing the impact of this statement on our results of operations and financial position.

IMPORTANT FACTORS THAT MAY AFFECT OUR BUSINESS, OUR RESULTS OF OPERATIONS AND OUR STOCK PRICE

Our operating results fluctuate and could fall below expectations of securities analysts and investors, resulting in a decrease in our stock price.

Our operating results have varied widely in the past, and we expect that they will continue to fluctuate in the future. If our operating results fall below the expectations of securities analysts and investors, it could result in a decrease in our stock price. Some of the factors that could affect the amount and timing of our revenue and related expenses and cause our operating results to fluctuate include:

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general economic conditions, which may affect our customers’ capital investment levels in management information systems and the timing of their purchases;

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rate of market acceptance of our CRM solution;

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budget and spending decisions by our customers;

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customers’ decisions to defer orders or implementations, particularly large orders or implementations, from one quarter to the next, or to proceed with smaller-than-forecasted orders or implementations;

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level of purchases by our existing customers, including additional license and maintenance revenues;

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the cost and timing of any terminations of our excess facilities liabilities;

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our ability to enable our products to operate on multiple platforms;

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our ability to compete in the highly competitive CRM market;

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the loss of any key technical, sales, customer support or management personnel and the timing of any new hires;

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our ability to develop, introduce and market new products and product versions on a timely basis;

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variability in the mix of our license versus service revenue, the mix of our direct versus indirect license revenue and the mix of services that we perform versus those performed by third-party service providers;

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our ability to successfully expand our operations, and the amount and timing of expenditures related to this expansion; and

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the cost and financial accounting effects of any acquisitions of companies or complementary technologies that we may complete.

As a result of all of these factors, we cannot predict our revenue with any significant degree of certainty, and future product revenue may differ from historical patterns. It is particularly difficult to predict the timing or amount of our license revenue because:

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our sales cycles are lengthy and variable, typically ranging between three and twelve months from our initial contact with a potential customer to the signing of a license agreement, although the sales cycle varies substantially from customer to customer and occasionally sales require substantially more time;

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a substantial portion of our sales are completed at the end of the quarter and, as a result, a substantial portion of our license revenue is recognized in the last month of a quarter, and often in the last weeks or days of a quarter;

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the amount of unfulfilled orders for our products at the beginning of a quarter is small because our products are typically shipped shortly after orders are received; and

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delay of new product releases can result in a customer’s decision to delay execution of a contract or, for contracts that include the new release as an element of the contract, will result in deferral of revenue recognition until such release.

Even though our revenue is difficult to predict, we base our decisions regarding our operating expenses on anticipated revenue trends. Many of our expenses are relatively fixed, and we cannot quickly reduce spending if our revenue is lower than expected. As a result, revenue shortfalls could result in significantly lower income or greater loss than anticipated for any given period, which could result in a decrease in our stock price.

Economic conditions could adversely affect our revenue growth and ability to forecast revenue.

Our revenue growth and potential for profitability depend on the overall demand for CRM software and services. Because our sales are primarily to corporate customers, we are also impacted by general economic and business conditions. A softening of demand for computer software caused by the weakened economy, both domestic and international, has affected our sales and may continue to result in decreased revenue and growth rates. As a result of the economic downturn, we have also experienced and may continue to experience difficulties in collecting outstanding receivables from our customers. In addition, the terrorist attacks on the United States on September 11, 2001, and the armed conflict that followed, have added or exacerbated economic, political and other uncertainties, which could adversely affect our sales and thus our revenue growth.

Our management team uses our proprietary software to identify, track and forecast future revenue, backlog and trends in our business. Our sales force monitors the status of all proposals, such as the date when they estimate that a transaction will close and the potential dollar amount of such sale. We aggregate these estimates regularly in order to generate a sales pipeline and then evaluate the pipeline at various times to look for trends in our business. While this pipeline analysis provides us with visibility about our potential customers and the associated revenue for budgeting and planning purposes, these pipeline estimates may not consistently correlate to revenue in a particular quarter or over a longer period of time. The slowdown in the domestic and international economies, as well as the effects of terrorist activity and armed conflict, may continue to cause customer purchasing decisions to be delayed, reduced in amount or cancelled, which could reduce the rate of conversion of the pipeline into contracts during a particular period of time. In particular, as a result of the economic slowdown, we believe that a number of our potential customers may delay or cancel their purchase of our software, consulting services or customer support services or may elect to develop their own CRM solution or solutions. A variation in the pipeline or in the conversion of the pipeline into contracts could adversely affect our business and operating results. In addition, because a substantial portion of our sales are completed at the end of the quarter, and often in the last weeks or days of a quarter, we may be unable to adjust our cost structure in response to a variation in the conversion of the pipeline into contracts in a timely manner, which could adversely affect our business and operating results. We have also recently experienced a trend of smaller initial orders by new purchasers of our software. Some customers are reluctant to make large purchases before they have had the opportunity to observe how our software performs in their organization, and have opted instead to make their planned purchase in stages. Additional purchases only occur if the software performs as expected. We believe that this is a symptom of poor economic conditions. To the extent that this trend continues, it will impact the pace of our revenue flow, and could also result in a reduction of the total amount of revenue over time.

If we do not retain our key employees and management team, and integrate our new senior management personnel, our ability to execute our business strategy will be limited.

Our future performance will depend largely on the efforts and abilities of our key technical, sales, customer support and managerial personnel and on our ability to attract and retain them. In addition, our ability to execute our business strategy will depend on our ability to recruit additional experienced management personnel and to retain our existing executive officers. The competition for qualified personnel in the computer software and technology markets is particularly intense. We have in the past experienced difficulty in hiring qualified technical, sales, customer support and managerial personnel, and we may be unable to attract and retain such personnel in the future. In addition, due to the intense competition for qualified employees, we may be required to increase the level of compensation paid to existing and new employees, which could materially increase our operating expenses. Our key employees are not obligated to continue their employment with us and could leave at any time.

The market price of our common stock has fluctuated substantially since our initial public offering in February 1999. Consequently, potential employees may perceive our equity incentives such as stock options as less attractive, and current employees whose options are no longer priced below market value may choose not to remain employed by us. In that case, our ability to attract or retain employees will be adversely affected.

In October 2002, we eliminated the role of our President and Chief Operating Officer and we do not plan to hire a replacement for this position in the near term. In addition, we hired a new Senior Vice President of the Americas in April 2002, three new regional sales managers during the second quarter of 2002 and a new Vice President of Asia in October 2002. The restructuring of the management of our sales organization following the departure of our President and Chief Operating Officer and integration of these new sales officers and key employees may result in some disruption in our sales activities.

In addition, we hired a new Chief Marketing Officer in July 2002. To be fully integrated in our company, this new senior officer must spend a significant amount of time learning our business model and management system, in addition to performing his regular duties. Accordingly, until our Chief Marketing Officer has become familiar with our business model and systems, his integration may result in some disruption in marketing activities in particular and our ongoing operations in general.

Fluctuations in support and service revenue could decrease our total revenue or decrease our gross margins, which could cause a decrease in our stock price.

During 2001 and the first nine months of 2002, our support and service revenue represented a higher percentage of our total revenue than in past periods, which negatively impacted our gross margins. To the extent that this trend continues, our gross margins will continue to suffer. Support and service revenue represented 37% of our total revenue in 1999 and 38% of our total revenue in 2000. Due largely to the decrease in license revenue in 2001, support and service revenue represented 61% of our total revenue in 2001. Support and service revenue represented 68% of our total revenue in the first nine months of 2002. We anticipate that support and service revenue will continue to represent a significant percentage of total revenue. Because support and service revenue has lower gross margins than license revenue, a continued increase in the percentage of total revenue represented by support and service revenue or a further decrease in license revenue, as we experienced in 2001 and the first nine months of 2002, could have a detrimental effect on our overall gross margins and thus on our operating results. Our support and service revenue is subject to a number of risks. First, we subcontract some of our consulting, customer support and training services to third-party service providers. Third-party contract revenue generally carries even lower gross margins than our service business overall. As a result, our support and service revenue and related margins may vary from period to period, depending on the mix of these third-party contract revenues. In addition, support and service revenue depends in part on ongoing renewals of support contracts by our customers, some of which may not renew their support contracts. We believe that the renewal rates of our support contracts declined during 2001 and the first nine months of 2002 at least in part as a result of the economic downturn, and we cannot offer any assurance that these rates will increase or that they will not

continue to decline. Finally, support and service revenue as a percentage of total revenue could decline further if customers select third-party service providers to install and service our products more frequently than they have in the past. If support and service revenue is lower than anticipated, our operating results could fall below the expectations of securities analysts or investors, which could result in a decrease in our stock price.

Our excess facilities costs may consume a material amount of our cash resources, which could limit our liquidity position and harm our business, financial condition and operating results.

Expenses associated with our near-term excess facilities, including payments associated with terminating leases for these excess facilities, will consume a material amount of our cash resources. In August 2002, we executed a sublease agreement on our 21,000 square foot facility in the United Kingdom that reduces our obligation on seven of the remaining 14 years on the lease, and in November 2002, we executed a lease termination agreement on our 100,000 square foot current corporate headquarters facility in Bellevue, Washington. This lease termination will result in accelerated cash outflows of approximately $2.0 million during the fourth quarter of 2002. We will continue to pay our monthly lease obligation of approximately $250,000 until we relocate our corporate headquarters, which is expected to occur at the end of January 2003 and could disrupt our business. The signing of this agreement, which requires us to move our corporate headquarters, will result in accelerated amortization of leasehold improvements totaling approximately $800,000 at September 30, 2002 and may result in impairment of other furniture and equipment. We are also pursuing a partial lease termination whereby our excess facilities in Bellevue, Washington would be reduced by approximately 200,000 square feet. We expect this partial termination to result in cash outflows over 19 months, the sum of which approximates our current lease obligations on the terminated square footage through the end of 2003, and the issuance of warrants to purchase approximately 800,000 shares of our common stock at exercise prices that are at a premium to market. A definitive agreement has not been reached as of the date of this filing and the estimates of excess facilities could change.

If we are unable to successfully sublease our excess facilities or negotiate affordable lease terminations, particularly in Bellevue, Washington, we will incur continued substantial facilities costs for which we will receive no economic benefit. Further, if facilities operating lease rental rates continue to decrease in these markets, if it takes longer than expected to find a suitable tenant to sublease these facilities, if we are unable to negotiate affordable lease terminations, or if other estimates and assumptions change adversely, the actual loss on our excess facilities will exceed the estimate recorded to date. As a result, our liquidity position may be further limited and our business, financial condition and operating results could be harmed.

Our operating results may fluctuate seasonally, and these fluctuations may cause our stock price to decrease.

Our stock price may decrease due to seasonal fluctuations in our revenue. We have experienced and expect in the future to experience significant seasonality in the amount of our software license revenue. In fiscal years before 2001, we recognized more license revenue in our fourth quarter than in each of the first three quarters of the fiscal year and experienced lower license revenue in the first quarter than in the preceding fourth quarter. We believe that these fluctuations are caused in part by customer buying patterns and the efforts of our direct sales force to meet or exceed fiscal year-end quotas. Our fourth quarter 2001 revenue was, however, lower than the revenue we achieved in the first and second quarters, and was only slightly higher than the revenue we achieved in the third quarter. We believe that this deviation from our historical experience reflects recessionary economic conditions, and that in the current economic environment the approval process for capital spending will be lengthy. This may result in a delay in the customer procurement process throughout 2002, which could cause our seasonal sales to continue to vary from the historical pattern. We expect to experience again in future periods the seasonal patterns described above, starting in 2003.

We have a limited operating history and are subject to the risks of new enterprises.

We commenced operations in February 1994 and commercially released the first version of our flagship product in December 1994. Accordingly, we have a limited operating history, and we face all of the risks and uncertainties encountered by early-stage companies. These risks and uncertainties include:

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no history of sustained profitability;

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uncertain growth in the market for, and uncertain market acceptance of, our solution;

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reliance on one product family;

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the risk that competition, technological change or evolving customer preferences, such as preferences for different computing platforms, could harm sales of our solution;

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the need to implement our sales, marketing and after-sales service initiatives, both domestically and internationally;

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the need to execute our product development activities;

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dependence on a limited number of key technical, customer support, sales and managerial personnel; and

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the risk that our management will be unable to effectively manage growth or any acquisition we may undertake.

The evolving nature of the CRM market increases these risks and uncertainties. Our limited operating history makes it difficult to predict how our business will develop.

We have incurred losses in recent periods, and may not again achieve profitability, which could cause a decrease in our stock price.

If we do not return to profitability in future quarters, our stock price could decrease. We incurred net losses in each quarter from Onyx’s inception through the third quarter of 1994, from the first quarter of 1997 through the second quarter of 1999, and from the first quarter of 2000 through the third quarter of 2002. As of September 30, 2002, we had an accumulated deficit of $120.4 million. Our accumulated deficit and financial condition have caused some of our potential customers to question our viability, which we believe has in turn hampered our ability to sell some of our products.

In the near-term, we believe our costs and operating expenses, excluding restructuring-related charges, will continue to decrease to a level that is closer to our expected revenue while allowing us to continue to invest in accordance with our strategic priorities. We may not, however, realize cost savings from these restructuring initiatives in future periods. In addition, we may be unable to achieve cost savings without adversely affecting our business and operating results. We may continue to experience losses and negative cash flows in the near term, even if sales of our products and services continue to grow.

If we are unable to successfully sublease our excess facilities or negotiate affordable lease terminations, particularly in Bellevue, Washington, we will incur continued substantial facilities costs for which we will receive no economic benefit. Further, if facilities operating lease rental rates continue to decrease in these markets, if it takes longer than expected to find a suitable tenant to sublease these facilities, if we are unable to negotiate affordable lease terminations, or if other estimates and assumptions change adversely, the actual loss on our excess facilities will exceed the estimate recorded to date, which would adversely affect our operating results.

In recent periods, Onyx Japan has incurred substantial losses. The minority shareholders capital account balance in Onyx Japan as of September 30, 2002 was $444,000. Additional Onyx Japan losses above approximately $1.1 million in the aggregate will be absorbed 100% by Onyx, as compared to 58% in prior periods, which could impact our ability to achieve profitability in future periods.

Finally, we may need to significantly increase our sales and marketing, product development and professional services efforts to expand our market position and further increase acceptance of our products. We may not be able to increase our revenues sufficiently to keep pace with these growing expenditures, if at all, and, as a result, may be unable to achieve or maintain profitability in the future.

Our workforce reduction and financial performance may place additional strain on our resources and may harm the morale and performance of our personnel and our ability to hire new personnel.

In connection with our effort to streamline our operations, reduce costs and bring our staffing and structure in line with our revenue base, in 2001 we restructured our organization and reduced our workforce by more than 300 employees. There have been and may continue to be substantial costs associated with the workforce reduction related to severance and other employee-related costs, as well as material charges for reduction of excess facilities, and our restructuring plan may yield unanticipated consequences, such as attrition beyond our planned reduction in workforce. This workforce reduction has placed significant strain on our administrative, operational and financial resources and has resulted in increasing responsibilities for each of our management personnel. As a result, our ability to respond to unexpected challenges may be impaired and we may be unable to take advantage of new opportunities. In addition, many of the employees who were terminated possessed specific knowledge or expertise, and that knowledge or expertise may prove to have been important to our operations. In that case, their absence may create significant difficulties. Further, the reduction in workforce may reduce employee morale and may create concern among potential and existing employees about job security at Onyx, which may lead to difficulty in hiring and increased turnover in our current workforce, and divert management’s attention. In addition, this headcount reduction may subject us to the risk of litigation, which could result in substantial costs to Onyx and could divert management’s time and attention away from business operations.

If we are unable to compete successfully in the highly competitive CRM market, our business will fail.

Our solution targets the CRM market. This market is intensely competitive, fragmented, rapidly changing and significantly affected by new product introductions. We face competition in the CRM market primarily from front-office software application vendors, large enterprise software vendors and our potential customers’ information technology departments, which may seek to develop proprietary CRM systems. The dominant competitor in our industry is Siebel Systems, Inc., which holds a significantly greater percentage of the CRM market than we do. Other companies with which we compete include, but are not limited to, Amdocs Limited, BroadVision, Inc., E.piphany, Inc., Kana Communications, Inc., Oracle Corporation, PeopleSoft, Inc., Pivotal Corporation and SAP AG.

In addition, as we develop new products, including new product versions operating on new platforms, we may begin competing with companies with whom we have not previously competed. It is also possible that new competitors will enter the market. An increase in competitive pressures in our market or our failure to compete effectively may result in pricing reductions, reduced gross margins and loss of market share. Many of our competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical, marketing and other resources than we do. Furthermore, a number of our competitors have recently been acquired by other large technology companies, which enhances their resources. We believe that there will be further consolidation among our competitors. As a result, they may be able to adapt more quickly to new technologies and customer needs, devote greater resources to promoting or selling their products and services, initiate and withstand substantial price competition, take advantage of acquisition or other strategic opportunities more readily or develop and expand their product and service offerings more quickly than we can. In addition, our competitors may form strategic relationships with each other and with other companies in attempts to compete more successfully against us. These relationships may take the form of strategic investments, joint marketing agreements, licenses or other contractual arrangements, any of which may increase our competitors’ ability, relative to ours, to address customer needs with their software and service offerings and that may enable them to rapidly increase their market share.

We may be unable to obtain the funding necessary to support the expansion of our business, and any funding we do obtain could dilute our shareholders’ ownership interest in Onyx.

Our future revenue may be insufficient to support the expenses of our operations, liabilities for excess facilities, capital needs of Onyx Japan and the expansion of our business. We may therefore need additional equity or debt capital to finance our operations. If we are unable to generate sufficient cash flow from operations or to obtain funds through additional financing, we may have to reduce some or all of our development and sales and marketing efforts and limit the expansion of our business.

We currently have a loan and security agreement with SVB which allows us to borrow up to the lesser of (a) 75% of our eligible accounts receivable based on a borrowing base calculation and (b) $15.0 million. At the time of this filing, however, no additional amounts are available under the line of credit based on the level of our borrowing base and our outstanding letters of credit. Although we were in compliance with the financial covenants of this facility as of September 30, 2002, if we are unable to maintain compliance in the future, or if SVB decides to restrict our cash deposits, our liquidity will be further limited and our business, financial condition and operating results could be harmed.

Assuming our future financial performance is comparable to the most recent periods reported, we believe that our existing cash and cash equivalents will be sufficient to meet our capital requirements for at least the next twelve months. However, our near-term restructuring costs and mitigation of our excess facilities liabilities, along with our ongoing operations and possible additional funding of Onyx Japan, will consume a material amount of our cash resources. As a result of these factors along with the impact lower cash balances could have on our sales, we will likely need to seek additional funds through public or private equity financing or from other sources to fund our operations and pursue our growth strategy. We have no commitment for additional financing, and we may experience difficulty in obtaining funding on favorable terms, if at all. Any financing we obtain may contain covenants that restrict our freedom to operate our business or may require us to issue securities that have rights, preferences or privileges senior to our common stock and may dilute your ownership interest in Onyx.

We have been named as a defendant in securities class actions and other litigation, and have received other claims, that could result in substantial costs and divert management’s attention and resources.

We, several of our officers and directors and Dain Rauscher Wessels have been named as defendants in a series of related lawsuits filed in the United States District Court for the Western District of Washington on behalf of purchasers of publicly traded Onyx common stock during various time periods. The consolidated amended complaint in these lawsuits alleges that we violated the Securities Act of 1933, or Securities Act, and the Securities Exchange Act of 1934, or Exchange Act, and seeks certification of a class action for purchasers of Onyx common stock in Onyx’s February 12, 2001 public offering and on the open market during the period January 23, 2001 through July 24, 2001. In addition, a shareholder to which we issued shares in the first quarter of 2001 has claimed that we made certain misrepresentations and omissions and otherwise violated the securities laws. None of the complaints or claims specifies the amount of damages to be claimed.

Onyx, one of its officers and one of its former officers have also been named as defendants in a lawsuit filed in the United States District Court for the Southern District of New York on behalf of purchasers through December 6, 2000 of Onyx common stock sold under the February 12, 1999 registration statement and prospectus for our initial public offering. The complaint alleges that Onyx and the individual defendants violated the Securities Act by failing to disclose excessive commissions allegedly obtained by our underwriters pursuant to a secret arrangement whereby the underwriters allocated initial public offering shares to certain investors in exchange for the excessive commissions. The complaint also asserts claims against the underwriters under the Securities Act and the Exchange Act in connection with the allegedly undisclosed commissions.

Onyx’s directors and some of its officers have been named as defendants in a shareholder derivative lawsuit filed in the Superior Court of Washington in and for King County. The complaint alleges that the individual

defendants breached their fiduciary duty and their duty of care to Onyx by allegedly failing to supervise Onyx’s public statements and public filings with the SEC. The complaint alleges that, as a result of these breaches, misinformation about Onyx’s financial condition was disseminated into the marketplace and filed with the SEC. The complaint asserts that these actions have exposed Onyx to harmful and costly securities litigation which could potentially result in an award of damages against Onyx.

Onyx intends to vigorously defend itself and, where applicable, its officers and directors against these lawsuits and claims, and believes it has several meritorious defenses and, in certain instances, counterclaims. If we are not successful in our defense of these claims, however, we could be forced to make significant payments to the plaintiffs and their lawyers and such payments, if not covered by our insurance carriers, could harm our financial condition, operating results and cash flows. Even if these claims are not successful, the litigation could result in substantial costs to Onyx and could divert management’s time and attention away from business operations. The uncertainty associated with substantial unresolved litigation may also impair our relationships with existing customers and our ability to obtain new customers.

Because many potential customers are unaware of the benefits of CRM systems, our solution may not achieve significant market acceptance.

The market for CRM systems is still emerging, and continued growth in demand for and acceptance of CRM systems remains uncertain. Even if the market for CRM systems grows, businesses may purchase our competitors’ solutions or develop their own. We believe that many of our potential customers are not fully aware of the benefits of CRM systems and that, as a result, CRM systems may never achieve significant market acceptance. We have spent, and will continue to spend, considerable resources educating potential customers not only about our solution but also about CRM systems in general. Even with these educational efforts, however, market acceptance of our solution may not increase. We will not succeed unless we can educate our target market about the benefits of CRM systems and the cost-effectiveness, ease of use and other benefits of our solution.

If potential customers do not accept the Onyx product family, our business will fail.

We rely on one product family for the success of our business. License revenue from the Onyx product family have historically accounted for nearly all of our license revenue. We expect product license revenue from the Onyx product family to continue to account for a substantial majority of our future revenue. As a result, factors adversely affecting the pricing of or demand for the Onyx product family, such as competition or technological change, could dramatically affect our operating results. If we are unable to successfully deploy current versions of the Onyx product family and to develop, introduce and establish customer acceptance of new and enhanced versions of the Onyx product family, our business will fail.

In June 2002, we released version 4.0 of Onyx Employee Portal, the next generation of our flagship product on the Windows NT/Microsoft BackOffice platform and our first release on the Unix/Oracle platform. In the event that prospects or customers do not embrace this new product version or are unable to successfully deploy this product, our business will fail.

If we are unsuccessful in our attempt to enable our products to operate on multiple platforms, our revenue growth could be limited.

We originally designed our products to operate exclusively on the Windows NT and Microsoft BackOffice platforms. As a result, our primary market has historically been to customers that have developed or are willing to develop their enterprise computing systems around these platforms, which limits our potential sales. In December 2000, we announced the platform release of a new product version designed to operate on the Oracle/Unix platform. Due to the complexity of the development of this new product version, we delayed the general availability of this product and subsequently launched the product in June 2002. We cannot predict the degree to which it will achieve market acceptance or the extent to which it will perform as our customers expect. If our

new product version contains defects or errors, or otherwise does not run as expected, its market acceptance may be delayed or limited, and our reputation may be damaged. Further, if our new product version does not achieve general market acceptance, our revenue growth will be limited. We believe that our ability to effectively expand our business into large enterprises depends on the successful release and market acceptance of our new product version. If we are unable to expand into large enterprises, the growth of our business and our revenue will be limited. Moreover, enabling our products to run on multiple platforms could lengthen the development cycle, thus delaying the release date of future product versions or new products, which could further restrict our revenue growth.

If we are unable to compete effectively in the Internet-based solutions market, demand for our solution may be limited.

Our products communicate through public and private networks over the Internet. The success of our solution may depend, in part, on our ability to develop products that compete effectively in the Internet-based market. We are uncertain of the extent to which businesses will use the Internet as a means of communication and commerce and whether a significant market will develop for Internet-based CRM systems. The use of the Internet is evolving rapidly, and many companies are developing products that use the Internet. The increased commercial use of the Internet could require substantial modification of our products and the introduction of new products. We do not know what forms of products may emerge as alternatives to our existing ones, or to any future Internet-based or electronic commerce products and product features we may introduce.

In addition, critical issues concerning the commercial use of the Internet, including security, demand, reliability, cost, ease of use, accessibility, quality of service and potential tax or other government regulation, remain unresolved and may affect the use of the Internet as a medium to support the functionality and distribution of our products. If these critical issues are not favorably resolved, our Internet-related solution may not achieve market acceptance.

Privacy and security concerns, particularly related to the use of our software on the Internet, may limit the effectiveness of and reduce the demand for our solution.

The effectiveness of our solution relies on the storage and use of customer data collected from various sources, including information derived from customer registrations, billings, purchase transactions and surveys. The collection and use of such data by our customers for customer profiling may raise privacy and security concerns. Our customers generally have implemented security measures to protect customer data from disclosure or interception by third parties. However, the security measures may not be effective against all potential security threats. If a well-publicized breach of customer data security were to occur, our solution may be perceived as less desirable, which could limit our revenue growth.

In addition, due to privacy concerns, some Internet commentators, consumer advocates and governmental or legislative bodies have suggested legislation to limit the use of customer profiling technologies. The European Union and some European countries have already adopted some restrictions on the use of customer profiling data. If major countries or regions adopt legislation or other restrictions on the use of customer profiling data, our solution would be less useful to customers, and our sales could decrease.

We may be unable to efficiently restructure or expand our sales organization, which could harm our ability to expand our business.

To date, we have sold our solution primarily through our direct sales force. As a result, our future revenue growth will depend in large part on recruiting, training and retaining direct sales personnel and expanding our indirect distribution channels. These indirect channels include VARs, VSPs, original equipment manufacturer, or OEM, partners and system integrators and consultants. We have experienced and continue to experience difficulty in recruiting qualified direct sales personnel and in establishing third-party relationships with VARs,

VSPs, OEM partners and systems integrators and consultants. Moreover, during 2001 we reduced and restructured our sales organization in an attempt to reduce expenses and increase efficiency relative to the market demand. In October 2002, we eliminated the role of our President and Chief Operating Officer and we do not plan to hire a replacement for this position in the near term. In addition, we hired a new Senior Vice President of the Americas in April 2002, three new regional sales managers during the second quarter of 2002 and a new Vice President of Asia in October 2002.We may face difficulty integrating these sales officers and key employees into our company, and are subject to the risk that this integration might not be successful. Our sales force restructuring efforts and future efforts to expand our sales force may not prove successful. If one or more of these initiatives is unsuccessful, our ability to retain top sales personnel may be affected, which could reduce our sales or limit our sales growth.

If our customers cannot successfully implement our products in a timely manner, demand for our solution will be limited.

The implementation of our products involves a significant commitment of resources by prospective customers. Our customers frequently deploy our products to large numbers of sales, marketing and customer service personnel. The end-users may not accept our products. Our products are also used with a number of third- party software applications and programming tools. This use may present significant technical challenges, particularly as large numbers of personnel attempt to use our product concurrently. If an implementation is not successful, we may be required to deliver additional consulting services free of charge in order to remedy the problem. If our customers have difficulty deploying our software or for any other reason are not satisfied with our software, our operating results and financial condition may be harmed.

Rapid changes in technology could render our products obsolete or unmarketable, and we may be unable to introduce new products and services successfully and in a timely manner.

The CRM market is characterized by rapid change due to changing customer needs, rapid technological developments and advances introduced by competitors. Existing products can become obsolete and unmarketable when products using new technologies are introduced and new industry standards emerge. New technologies, including the rapid growth of the Internet, could change the way CRM systems are sold or delivered. We may also need to modify our products when third parties change software that we integrate into our products. As a result, the life cycles of our products are difficult to estimate.

To be successful, we must continue to enhance our current product line and develop new products that successfully respond to changing customer needs, technological developments and competitive product offerings. We may not be able to successfully develop or license the applications necessary to respond to these changes, or to integrate new applications with our existing products. We have delayed enhancements or new product release dates several times in the past, including in 2001 the Oracle/Unix version of our product, and may be unable to introduce enhancements or new products successfully or in a timely manner in the future. If we delay release of our products and product enhancements, or if they fail to achieve market acceptance when released, it could harm our reputation and our ability to attract and retain customers, and our revenues may decline. In addition, customers may defer or forego purchases of our products if we, our competitors or major technology vendors introduce or announce new products or product enhancements.

If we do not expand our international operations and successfully overcome the risks inherent in international business activities, the growth of our business will be limited.

To be successful, we must continue to expand our international operations and enter new international markets. This expansion may be delayed as a result of our recent operating expense reduction measures and general economic conditions. If we do expand internationally, it will require significant management attention and financial resources to successfully translate and localize our software products to various languages and to develop direct and indirect international sales and support channels. Even if we successfully translate our

software and develop new channels, we may not be able to maintain or increase international market demand for our solution. We, or our VARs or VSPs, may be unable to sustain or increase international revenues from licenses or from consulting and customer support. In addition, our international sales are subject to the risks inherent in international business activities, including

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costs of customizing products for foreign countries;

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export and import restrictions, tariffs and other trade barriers;

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the need to comply with multiple, conflicting and changing laws and regulations;

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reduced protection of intellectual property rights and increased liability exposure; and

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regional economic, cultural and political conditions, including the direct and indirect effects of terrorist activity and armed conflict in countries in which we do business.

As noted above, Onyx Japan has incurred substantial losses in recent period. The minority shareholders capital account balance as of September 30, 2002 was $444,000. Additional Onyx Japan losses above approximately $1.1 million in the aggregate will be absorbed 100% by Onyx, as compared to 58% in prior periods. Although we restructured Onyx Japan’s operations during the third quarter of 2002, which we expect to significantly reduce our future operating expenses and increase our ability to be profitable and cash flow positive in Japan, additional funding may be required to continue the operation of the joint venture. Our joint venture partners are not obligated to participate in any capital call and have indicated that they do not currently intend to invest additional sums in Onyx Japan. We are, however, discussing other ways our partners can assist Onyx Japan. If Onyx Japan continues to incur losses and no additional capital is invested, we may have to further restructure our operations in Japan.

Our foreign subsidiaries operate primarily in local currencies, and their results are translated into U.S. dollars. We do not currently engage in currency hedging activities, but we may do so in the future. Changes in the value of the U.S. dollar relative to foreign currencies have not materially affected our operating results in the past. Our operating results could, however, be materially harmed if we enter into license or other contractual agreements involving significant amounts of foreign currencies with extended payment terms if the values of those currencies fall in relation to the U.S. dollar over the payment period.

If we are unable to develop and maintain effective long-term relationships with our key partners, or if our key partners fail to perform, our ability to sell our solution will be limited.

We rely on our existing relationships with a number of key partners, including consulting firms, system integrators, VARs, VSPs and third-party technology vendors, that are important to worldwide sales and marketing of our solution. We expect an increasing percentage of our revenues to be derived from sales that arise out of our relationships with these key partners. In addition, to be successful and to more effectively sell our products to larger customers, we must develop successful new relationships with prestigious key partners. Key partners often provide consulting, implementation and customer support services, and endorse our solution during the competitive evaluation stage of the sales cycle. Although we seek to maintain relationships with our key partners, and to develop relationships with new partners, many of these existing and potential key partners have similar, and often more established, relationships with our competitors. These existing and potential partners, many of which have significantly greater resources than we have, may in the future market software products that compete with our solution or reduce or discontinue their relationships with us or their support of our solution. In addition, our sales will be limited if

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we are unable to develop and maintain effective, long-term relationships with existing and potential key partners;

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our existing and potential key partners endorse a product or technology other than our solution;

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we are unable to adequately train a sufficient number of key partners; or

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our existing and potential key partners do not have or do not devote the resources necessary to implement our solution.

If our relationships with vertical service providers are unsuccessful, our ability to market and sell our solution will be limited.

We expect a substantial percentage of our revenues to be derived from our relationships with domestic and international VSPs that market and sell our CRM systems. If these VSPs do not successfully market our products, our operating results will be materially harmed. Because our relationships with VSPs are relatively new, we cannot predict the degree to which the VSPs will succeed in marketing and selling our solution. In addition, because the VSP model for selling software is relatively new and unproven in the CRM industry, we cannot predict the degree to which our potential customers will accept this delivery model. If the VSPs fail to deliver and support our solution, end-users could decide not to subscribe, or cease subscribing, for our solution. The VSPs typically offer our solution in combination with other products and services, some of which may compete with our solution.

Our sales cycle is long, and sales delays could cause our operating results to fluctuate, which could cause a decline in our stock price.

An enterprise’s decision to purchase a CRM system is discretionary, involves a significant commitment of its resources and is influenced by its budget cycles. To successfully sell our solution, we generally must educate our potential customers regarding the use and benefit of our solution, which can require significant time and resources. Consequently, the period between initial contact and the purchase of our solution is often long and subject to delays associated with the lengthy budgeting, approval and competitive evaluation processes that typically accompany significant capital expenditures. Our sales cycles are lengthy and variable, typically ranging between three and twelve months from our initial contact with a potential customer to the signing of a license agreement, although the amount of time varies substantially from customer to customer and occasionally sales require substantially more time. When economic conditions weaken, sales cycles for software products tend to lengthen, and as a result, we experienced longer sales cycles in 2001 and the first nine months of 2002. We expect to continue to experience longer sales cycles than usual for the rest of 2002. Sales delays could cause our operating results to fall below the expectations of securities analysts or investors, which could result in a decrease in our stock price.

Delivery of our solution may be delayed if we cannot continue to license third-party technology that is important to the functionality of our solution.

We incorporate into our products software that is licensed to us by third-party software developers, including Cognos, Inso, Scribe Software and Sybase. We depend on these third parties’ abilities to deliver and support reliable products, enhance their current products, develop new products on a timely and cost-effective basis, and respond to emerging industry standards and other technological changes. The third-party software currently offered in conjunction with our solution may become obsolete or incompatible with future versions of our products. We believe there are other sources for the functionality we derive from this licensed software and that we could identify and incorporate alternative software within a relatively short period of time, approximately four to six months. However, a significant interruption in the supply of this technology could delay our sales until we can find, license and integrate equivalent technology.

We may be unable to adequately protect our proprietary rights, which may limit our ability to compete effectively.

Our success depends in part on our ability to protect our proprietary rights. To protect our proprietary rights, we rely primarily on a combination of copyright, trade secret and trademark laws, confidentiality agreements with employees and third parties, and protective contractual provisions such as those contained in license

agreements with consultants, vendors and customers, although we have not signed these agreements in every case. Despite our efforts to protect our proprietary rights, unauthorized parties may copy aspects of our products and obtain and use information that we regard as proprietary. Other parties may breach confidentiality agreements and other protective contracts we have entered into, and we may not become aware of, or have adequate remedies in the event of, a breach. We face additional risk when conducting business in countries that have poorly developed or inadequately enforced intellectual property laws. While we are unable to determine the extent to which piracy of our software products exists, we expect piracy to be a continuing concern, particularly in international markets and as a result of the growing use of the Internet. In any event, competitors may independently develop similar or superior technologies or duplicate the technologies we have developed, which could substantially limit the value of our intellectual property.

Intellectual property claims and litigation could subject us to significant liability for damages and result in invalidation of our proprietary rights.

In the future, we may have to resort to litigation to protect our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Any litigation, regardless of its success, would probably be costly and require significant time and attention of our key management and technical personnel. Although we have not been sued for intellectual property infringement, we may face infringement claims from third parties in the future. The software industry has seen frequent litigation over intellectual property rights, and we expect that participants in the industry will be increasingly subject to infringement claims as the number of products, services and competitors grows and the functionality of products and services overlaps. Infringement litigation could also force us to

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stop or delay selling, incorporating or using products that incorporate the challenged intellectual property;

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pay damages;

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enter into licensing or royalty agreements, which may be unavailable on acceptable terms; or

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redesign products or services that incorporate infringing technology, which we might not be able to do at an acceptable price, in a timely fashion or at all.

Our products may suffer from defects or errors, which could result in loss of revenues, delayed or limited market acceptance of our products, increased costs and reputational damage.

Software products as complex as ours frequently contain errors or defects, especially when first introduced or when new versions are released. Our customers are particularly sensitive to such defects and errors because of the importance of our solution to the day-to-day operation of their businesses. We have had to delay commercial release of past versions of our products until software problems were corrected, and in some cases have provided product updates to correct errors in released products. Our new products or releases, including any new or limited Oracle/Unix version of our product that may be generally released, may not be free from errors after commercial shipments have begun. Any errors that are discovered after commercial release could result in loss of revenues or delay in market acceptance, diversion of development resources, damage to our reputation, increased service and warranty costs or claims against us.

In addition, the operation of our products could be compromised as a result of errors in the third-party software we incorporate into our software. It may be difficult for us to correct errors in third-party software because that software is not in our control.

Integration of recent past or future acquisitions may be difficult and disruptive.

We have completed several corporate acquisitions in the last few years. In the future, we may acquire additional complementary companies or technologies. Managing these acquisitions has entailed, and may in the future entail, numerous operational and financial risks and strains, including

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difficulty and cost in combining the operations and personnel of acquired businesses with our operations and personnel;

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disruption of our ongoing business and diversion of management’s time and attention to integrating or completing the development or commercialization of any acquired technologies;

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impairment of relationships with key customers of acquired businesses due to changes in management and ownership of the acquired businesses; and

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inability to retain key employees of any acquired businesses.

If we do not successfully integrate any acquisition, our business will suffer.

You may be unable to resell your shares at or above the price at which you purchased them, and our stock price may be volatile.

Since our initial public offering in February 1999, the price of our common stock has been volatile, particularly in the last year. Our common stock reached a high of $44.00 per share on March 6, 2000 and traded as low as $1.45 per share on October 4, 2002. As a result of fluctuations in the price of our common stock, you may be unable to sell your shares at or above the price at which you purchased them. The trading price of our common stock could be subject to fluctuations for a number of reasons, including

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future announcements concerning us or our competitors;

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actual or anticipated quarterly variations in operating results;

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changes in analysts’ earnings projections or recommendations;

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announcements of technological innovations;

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the introduction of new products;

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changes in product pricing policies by us or our competitors;

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proprietary rights litigation or other litigation; or

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changes in accounting standards that adversely affect our revenues and earnings.

In addition, future sales of substantial numbers of shares of our common stock in the public market, or the perception that these sales could occur, could adversely affect the market price of our common stock. On October 1, 2001, we issued 2,234,483 shares of common stock to the former shareholders of Market Solutions Limited in connection with our 1999 acquisition of Market Solutions. These shares, which have been restricted from resale under the securities laws, became eligible for resale pursuant to Rule 144 under the Securities Act beginning October 1, 2002.

Stock prices for many technology companies fluctuate widely for reasons that may be unrelated to operating results of these companies. These fluctuations, as well as general economic, market and political conditions, such as national or international currency and stock market volatility, recessions or military conflicts, may materially and adversely affect the market price of our common stock, regardless of our operating performance and may expose us to class action securities litigation which, even if unsuccessful, would be costly to defend and distracting to management.

Our articles of incorporation and bylaws and Washington law contain provisions that could discourage a takeover.

Certain provisions of our restated articles of incorporation and bylaws, our shareholder rights plan and Washington law would make it more difficult for a third party to acquire us, even if doing so would be beneficial for our shareholders. This could limit the price that certain investors might be willing to pay in the future for shares of our common stock. For example, certain provisions of our articles of incorporation or bylaws

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stagger the election of our board members so that only one-third of our board is up for reelection at each annual meeting;

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allow our board to issue preferred stock without any vote or further action by the shareholders;

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eliminate the right of shareholders to act by written consent without a meeting, unless the vote to take the action is unanimous;

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eliminate cumulative voting in the election of directors;

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specify a minimum threshold for shareholders to call a special meeting;

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specify that directors may be removed only with cause; and

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specify a supermajority requirement for shareholders to change those portions of our articles that contain the provisions described above.

In October 1999, we adopted a shareholder rights plan, which is triggered upon commencement or announcement of a hostile tender offer or when any one person or group acquires 15% or more of our common stock. Once triggered, the rights plan would result in the issuance of preferred stock to the holders of our common stock other than the acquirer. The holders of this preferred stock would be entitled to ten votes per share on corporate matters. In addition, these shareholders receive rights under the rights plan to purchase our common stock, and the stock of the entity acquiring us, at reduced prices.

We are also subject to certain provisions of Washington law that could delay or make more difficult a merger, tender offer or proxy contest involving us. In particular, Chapter 23B.19 of the Washington Business Corporation Act prohibits corporations based in Washington from engaging in certain business combinations with any interested shareholder for a period of five years unless specific conditions are met.

These provisions of our articles of incorporation, bylaws and rights plan and Washington law could have the effect of delaying, deferring or preventing a change in control of Onyx, including, without limitation, discouraging a proxy contest or making more difficult the acquisition of a substantial block of our common stock. The provisions could also limit the price that investors might be willing to pay in the future for shares of our common stock.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

We are exposed to financial market risks, including changes in interest rates and foreign currencies.

Interest Rate Risk

We typically do not attempt to reduce or eliminate our market exposures on our investment securities because the majority of our investments are short-term. We do not have any derivative instruments. The fair value of our investment portfolio or related income would not be significantly impacted by either a 100 basis point increase or decrease in interest rates primarily due to the short-term nature of the major portion of our investment portfolio. All of the potential changes noted above are based on sensitivity analysis performed on our balances as of September 30, 2002.

Foreign Currency Risk

In 2001, international revenue accounted for 30% of consolidated revenue. In the first nine months of 2002, international revenue accounted for 34% of consolidated revenue. International revenue, as well as most of the related expenses incurred, is denominated in the functional currencies of the corresponding country. Results of operations from our foreign subsidiaries are exposed to foreign currency exchange rate fluctuations as the financial results of these subsidiaries are translated into U.S. dollars upon consolidation. As exchange rates vary, revenues and other operating results, when translated, may differ materially from expectations. The effect of foreign exchange transaction gains and losses were not material to Onyx during the first nine months of 2002 or in the prior three fiscal years.

At September 30, 2002, we were also exposed to foreign currency risk related to the current assets and current liabilities of our foreign subsidiaries, in particular, our consolidated joint venture denominated in Yen. Cumulative unrealized translation losses related to the consolidation of Onyx Japan amounted to $485,000, or approximately 66% of total unrealized translation losses included in shareholders’ equity at September 30, 2002.

Although we have not engaged in foreign currency hedging to date, we may do so in the future.

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures

The term “disclosure controls and procedures” is defined in Rules 13a-14(c) and 15d-14(c) of the Exchange Act. These rules refer to the controls and other procedures of a company that are designed to ensure that the information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our Exchange Act reports is accumulated and communicated to management, including our principal executive officer and our chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

Our chief executive officer and our chief financial officer have evaluated the effectiveness of our disclosure controls and procedures as of the Evaluation Date, which is a date within 90 days before the filing of this quarterly report, and they have concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective.

Changes in internal controls

There were no significant changes in Onyx’s internal controls or, to Onyx’s knowledge, in other factors that could significantly affect Onyx’s disclosure controls and procedures subsequent to the Evaluation Date.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings

In October 2001, Thomas Weisel Partners LLC filed a lawsuit against us in the United States District Court for the Northern District of California, San Francisco division. This lawsuit arose out of our engagement of Thomas Weisel for services in connection with the signing of an equity financing arrangement with Ramius Securities and Ramius Capital. Thomas Weisel alleged in its pleadings that a payment of $1.5 million became due under the engagement letter upon the signing of the arrangement. We did not make the payment because the underwriting terms of our equity facility with Ramius were not approved by the NASD. The claim was settled for an immaterial amount through mediation in September 2002, which was previously accrued by Onyx and subsequently paid o Thomas Weisel in October 2002.

Item 5. Other Information

In November 2002, we executed a lease termination agreement on our 100,000 square foot current corporate headquarters facility in Bellevue, Washington. This lease termination will result in accelerated cash outflows of approximately $2.0 million during the fourth quarter of 2002. We will continue to pay our monthly lease obligation of approximately $250,000 until we relocate our corporate headquarters, which is expected to occur at the end of January 2003. The signing of this agreement, which requires us to move our corporate headquarters, will result in accelerated amortization of leasehold improvements totaling approximately $800,000 at September 30, 2002 and may result in impairment of other furniture and equipment.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

Number		Description
3.1		Restated Articles of Incorporation of the registrant (exhibit 3.1)(a)

3.2		Amended and Restated Bylaws of the registrant (exhibit 3.2)(b)

4.1		Rights Agreement dated October 25, 1999 between the registrant and ChaseMellon Shareholder Services, L.L.C. (exhibit 2.1)(c)

10.1		Amendment to Loan Documents dated July 10, 2002 by and between the registrant and Silicon Valley Bank (d)

10.2		Lease Termination Agreement dated as of November 7, 2002 by and between the registrant and EOP-Sunset North Bellevue, L.L.C. *

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

Filed herewith.

(a)

Incorporated by reference to the designated exhibit to the registrant’s Quarterly Report on Form 10-Q (No. 0-25361) for the quarter ended September 30, 2001.

(b)

Incorporated by reference to the designated exhibit to the registrant’s Quarterly Report on Form 10-Q (No. 0-25361) for the quarter ended March 31, 2001.

(c)

Incorporated by reference to the designated exhibit to the registrant’s registration statement on Form 8-A (No. 0-25361) filed October 28, 1999.

(d)

Incorporated by reference to the designated exhibit to the registrant’s Quarterly Report on Form 10-Q (No. 0-25361) for the quarter ended June 30, 2002.

(b) Current Reports on Form 8-K

No current reports on Form 8-K were filed during the quarter ended September 30, 2002

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.

	ONYX SOFTWARE CORPORATION (Registrant)

Date: November 13, 2002	By:	/s/ BRENT R. FREI
		Brent R. Frei Chief Executive Officer and Chairman of the Board (Principal Executive Officer)

Date: November 13, 2002	By:	/s/ BRIAN C. HENRY
	Brian C. Henry Executive Vice President and Chief Financial Officer (Principal Financial Officer)

Date: November 13, 2002	By:	/s/ AMY E. KELLERAN
		Amy E. Kelleran Vice President Finance, Corporate Controller and Assistant Secretary (Principal Accounting Officer)

CERTIFICATIONS

I, Brent R. Frei, certify that:

I have reviewed this quarterly report on Form 10-Q of Onyx Software Corporation (Onyx);

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 Onyx as of, and for, the periods presented in this quarterly report;

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

designed such disclosure controls and procedures to ensure that material information relating to Onyx, 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 Onyx’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;

Onyx’s other certifying officer and I have disclosed, based on our most recent evaluation, to Onyx’s auditors and the audit committee of Onyx’s board of directors (or persons performing the equivalent function):

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

Onyx’s other certifying officer 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: November 13, 2002

/s/ BRENT R. FREI

Brent R. Frei

Chief Executive Officer and Chairman of the Board

(Principal Executive Officer)

I, Brian C. Henry, certify that:

I have reviewed this quarterly report on Form 10-Q of Onyx Software Corporation (Onyx);

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

evaluated the effectiveness of Onyx’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;

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

Date: November 13, 2002

/s/ BRIAN C. HENRY

Brian C. Henry

Executive Vice President and Chief Financial Officer

(Principal Financial Officer)