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


FORM 10-Q


 

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

for the quarterly period ended March 31, 2004

OR

[  ] 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 000-29357

Chordiant Software, Inc.  

(Exact name of Registrant as specified in its Charter)

Delaware

93-105328

  (State or Other Jurisdiction of Incorporation or Organization) 

(I.R.S. Employer Identification Number)

20400 Stevens Creek Boulevard, Suite 400
Cupertino, CA    95014

(Address of Principal Executive Offices including Zip Code)

(408) 517-6100
(Registrant's Telephone Number, Including Area Code)

(Former name, former address and former fiscal year if changed since last report)

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

The number of shares of the Registrant's common stock outstanding as of May 6, 2004 was 71,677,158.


CHORDIANT SOFTWARE, INC.
QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD ENDED MARCH 31, 2004
TABLE OF CONTENTS

 

 

PART I. FINANCIAL INFORMATION (unaudited)

Page No.

Item 1. Financial Statements

 

  Condensed Consolidated Balance Sheets - March 31, 2004 and December 31, 2003 3
  Condensed Consolidated Statements of Operations and Comprehensive Loss - Three Months Ended March 31, 2004 and 2003 4
  Condensed Consolidated Statements of Cash Flows - Three Months Ended March 31, 2004 and 2003 5
  Notes to Condensed Consolidated Financial Statements  6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures about Market Risk 28
Item 4. Controls and Procedures 29
     
PART II. OTHER INFORMATION 29
Item 1. Legal Proceedings 29
Item 6. Exhibits and Reports on Form 8-K 29
 
SIGNATURES   30

 

 

 

 

 

 

 

 


Table of Contents

PART I -- FINANCIAL INFORMATION

Item 1. Financial Statements.

 CHORDIANT SOFTWARE,  INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)

 
 
March 31, 2004
  December 31, 2003  
 
 
 
 
ASSETS              
Current assets:
 

 

 

 

 

 

 
  Cash and cash equivalents   $ 63,784   $ 36,218  
Short-term investments and restricted cash     581     581  
  Accounts receivable, net     11,101     11,974  
  Prepaid expenses and other current assets     3,031     2,675  
   
 
 
    Total current assets     78,497     51,448  
Restricted cash     1,500     1,500  
Property and equipment, net     2,884     3,071  
Goodwill     24,874     24,874  
Intangible assets, net 634 1,414
Other assets     1,398     1,504  
   
 
 
    Total assets   $ 109,787   $ 83,811  
   
 
 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 
Accounts payable   $ 4,141   $ 3,931  
  Accrued expenses     13,041     13,038  
Deferred revenue     13,321     14,548  
   
 
 
    Total current liabilities     30,503     31,517  
Deferred revenue, long-term

2,998

3,848
   
 
 
    Total liabilities     33,501     35,365  
   
 
 
Stockholders' equity:              
  Common stock     72     65  
Additional paid-in capital     263,064

  235,911  
  Deferred stock-based compensation     (658 )   (1,665 )
  Accumulated deficit     (189,210 )   (188,906
  Accumulated other comprehensive income     3,018     3,041  
   
 
 
    Total stockholders' equity     76,286     48,446  
   
 
 
  Total liabilities and stockholders' equity   $ 109,787   $ 83,811  
   
 
 

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

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Table of Contents

 CHORDIANT SOFTWARE,  INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(In thousands, except per share data)
(Unaudited)

Three Months Ended

       
 

March 31, 2004

March 31, 2003

Revenues:



License

$

9,286

$

4,138

Service

10,932 9,677
     
   
 

Total revenues

20,218 13,815
   

Cost of revenues:

   

License

392 261

Service

6,293 5,926

Stock-based compensation

209 464

Amortization of intangible assets

686 792
     
   
 

Total cost of revenues

7,580 7,443
     
   
 

Gross profit

12,638

6,372

     
   
 

Operating expenses:

Sales and marketing

5,940 6,016

Research and development

4,442 4,070

General and administrative

1,851 1,378

Stock-based compensation

500 1,375
  Amortization of intangible assets   94     98  
     
   
 

Total operating expenses

12,827 12,937
     
   
 

Loss from operations

(189

) (6,565 )
 

Interest income, net

210   135  

Foreign exchange and other expenses, net

(174 ) (334 )
     
   
 

Net loss before income taxes

(153 ) (6,764 )

Provision for income taxes

151   182  
     
   
 

Net loss

$

(304

)

$

(6,946

)
     
   
 

Other comprehensive income (loss):

Foreign currency translation gain (loss)

 

(23

)

 

220

 
     
   
 

Comprehensive loss

$ (327 ) $ (6,726 )
     
   
 

Net loss per share:

Basic and diluted

$

(0.00

)

$

(0.12

)
     
   
 

Weighted average shares used in computing net loss per share - basic and diluted

 67,655

 57,210

     
   
 

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

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CHORDIANT SOFTWARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

 
  Three Months Ended  
 
 
 
 
  March 31, 2004   March 31, 2003  
 
 
 
 
Cash flows from operating activities:              
  Net loss   $ (304 ) $ (6,946 )
  Adjustments to reconcile net loss to net cash provided by (used in) operating activities:              
    Depreciation and amortization     414     778  
    Amortization of intangibles     780     890  
    Non-cash stock-based compensation expense     508     1,839  
    Warrants issued to customers     26     --  
    Loss on disposal of assets     --     2  
    Other non-cash charges     157     --  
    Changes in assets and liabilities:              
      Accounts receivable     941     (3,129 )
      Prepaid expenses and other current assets     (328 )   (404 )
      Other assets     105     405  
      Accounts payable     152     (933 )
      Accrued expenses     38     (3,082 )
      Deferred revenue     (2,327 )   331  
   
 
 
Net cash provided by (used in) operating activities     162     (10,249
   
 
 
Cash flows from investing activities:              
  Property and equipment purchases     (194 )   (20 )
  Proceeds from disposal of property and equipment     --     15  
  Purchases of short-term investments     --     (576 )
  Proceeds from maturities of short-term investments     --     6,082  
   
 
 
Net cash provided by (used in) investing activities (194 ) 5,501
   
 
 
Cash flows from financing activities:              
  Proceeds from issuance of common stock, net     24,844     --  
  Proceeds from exercise of stock options     1,640     36  
  Proceeds from issuance of common stock for Employee Stock Purchase Plan     1,072     674  
  Proceeds from borrowings     --     3,491  
  Repayment of notes receivable     --     496  
  Repayment of borrowings     --     (668 )
   
 
 
Net cash provided by financing activities     27,556     4,029  
   
 
 
Effect of exchange rate fluctuations on cash and cash equivalents     42 220  
   
 
 
Net increase (decrease) in cash and cash equivalents     27,566     (499 )
   
 
 
Cash and cash equivalents at beginning of period     36,218 30,731
   
 
 
Cash and cash equivalents at end of period   $ 63,784   $ 30,232  
   
 
 

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

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CHORDIANT SOFTWARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 1 -- BASIS OF PRESENTATION:

The accompanying unaudited condensed consolidated financial statements reflect all adjustments, consisting of only normal recurring items, which in the opinion of management, are necessary to present fairly the financial position, results of operations and cash flows for the interim periods presented. The results of operations for interim periods are not necessarily indicative of the results expected for the full fiscal year or for any future period. These financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2003.

We believe that the effects of our strategic actions implemented to improve revenue as well as control costs will be adequate to generate sufficient cash resources to fund our operations.  Failure to generate sufficient revenues or control spending could adversely affect our ability to achieve our business objectives.

NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Reclassifications

Certain reclassifications have been made to prior year balances to conform to current year presentation. 

Principles of consolidation

The accompanying condensed consolidated financial statements include our accounts and those of our wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.

Use of estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods.

On an on-going basis, we evaluate the estimates, including those related to our allowance for doubtful accounts, valuation of goodwill and intangible assets, valuation of deferred tax assets, restructuring costs, contingencies and the estimates associated with the percentage-of-completion method of accounting for certain of our revenue contracts. We base our estimates on historical experience and on various other assumptions that are believed 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.

Revenue recognition

We derive revenues from licenses of our software and related services, which include assistance in implementation, customization and integration, post-contract customer support, training and consulting. The amount and timing of our revenue is 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 operating losses.

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Table of Contents

At the time of entering into a transaction, we assess whether any services included within the arrangement require us to perform significant implementation or customization essential to the functionality of our products. For contracts involving significant implementation or customization essential to the functionality of our products, we recognize the license and professional consulting services revenues using the percentage-of-completion method using labor hours incurred as the measure of progress towards completion as prescribed by Statement of Position ("SOP") No. 81-1, "Accounting for Performance of Construction-Type and Certain Product-Type Contracts." The progress toward completion is measured based on the "go-live" date. We define the "go-live" date as the date the essential product functionality has been delivered or the application enters into a production environment or the point at which no significant additional Chordiant supplied professional services resources are required. Estimates are subject to revisions as the contract progresses to completion. We account for the change in estimate in the period the change was identified. Provisions for estimated contract losses are recognized in the period in which the loss becomes probable and can be reasonably estimated. When we sell additional licenses related to the original licensing agreement, revenue is recognized either upon delivery if the project has reached the go-live date, or if the project has not reached the go-live date, revenue is recognized under the percentage-of-completion method. We classify revenues from these arrangements as license and service revenues based upon the estimated fair value of each element.

 

On contracts for products not involving significant implementation or customization essential to the product functionality, we recognize license revenues when there is persuasive evidence of an arrangement, the fee is fixed or determinable, collection of the fee is probable and delivery has occurred as prescribed by SOP No. 97-2, "Software Revenue Recognition."

 

We assess collection based on a number of factors, including past transaction history with the customer and the credit-worthiness of the customer. We generally do not request collateral from our customers. If we determine that collection of a fee is not probable, we defer the fee and recognize revenue at the time collection becomes probable, which is generally upon receipt of cash.

 

For arrangements with multiple elements, we recognize revenue for services and post-contract customer support based upon vendor specific objective evidence ("VSOE") of fair value of the respective elements. VSOE of fair value for the services element is based upon the standard hourly rates we charge for the services when such services are sold separately. VSOE of fair value for annual post-contract customer support is established with the optional substantive stated future renewal rates included in the contracts. When contracts contain multiple elements, and VSOE of fair value exists for all undelivered elements, we account for the delivered elements, principally the license portion, based upon the "residual method" as prescribed by SOP No. 98-9, "Modification of SOP No. 97-2 with Respect to Certain Transactions."

 

In situations in which we are obligated to provide unspecified additional software products in the future, we recognize revenue as a subscription ratably over the term of the commitment period.

 

For all sales we use either a signed license agreement or a binding purchase order as evidence of an arrangement. Sales through our third party systems integrators are evidenced by a master agreement governing the relationship together with binding purchase orders on a transaction-by-transaction basis. Revenues from reseller arrangements are recognized on the "sell-through" method, when the reseller reports to us the sale of our software products to end-users. Our agreements with customers and resellers do not contain product return rights.

 

We recognize revenue for post-contract customer support ratably over the support period which ranges from one to three years. Our training and consulting services revenues are recognized as such services are performed.

Restricted cash

At March 31, 2004 and December 31, 2003, we had a balance of $1.5 million in the form of short-term investments that meet the qualification to be considered cash equivalents, which were restricted from withdrawal. This balance serves as a security deposit in a long-term, post-contract customer support revenue transaction. At March 31, 2004 and December 31, 2003, we also had an interest bearing certificate of deposit classified as short-term investments and restricted cash which serves as collateral for a $0.4 million letter of credit security deposit for a leased facility.

Stock-based compensation

We account for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and to nonemployees using the fair value method in accordance with Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation."  In addition, we apply applicable provisions of Financial Accounting Standards Board ("FASB") Interpretation No. ("FIN") 44, "Accounting for Certain Transactions Involving Stock Compensation," an interpretation of APB No. 25.  No employee stock-based compensation cost is reflected in our net loss related to options granted under those plans for which the exercise price was equal to the market value of the underlying common stock on the date of grant.

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Table of Contents

The following table illustrates the effect on our net loss and net loss per share as if we had applied the fair value recognition provisions of SFAS No. 123 to stock-based compensation for the three months ended March 31, 2004 and 2003, respectively (in thousands, except per share amounts):

 

 

Three Months Ended
 

 


   

March 31, 2004

   

March 31, 2003

   
   
Net loss -- as reported   $ (304 ) $ (6,946 )
Add: Stock-based compensation expense included in reported net loss     134

 

  279

 

Less: Stock-based compensation expense determined under fair value method     (1,128

)

  (1,039 )
     
   
 
Net loss -- proforma   $ (1,298

)

$ (7,706

)

     
   
 
Basic and diluted net loss per share -- as reported   $ (0.00 ) $ (0.12 )
     
   
 
Basic and diluted net loss per share -- proforma   $ (0.02 ) $ (0.13 )
     
   
 

 

 

The related functional breakdown of total stock-based compensation is outlined below (in thousands):

 

  Three Months Ended
 
 

March 31, 2004

   

March 31, 2003

 
   
Stock-based compensation expense:            
     Cost of service revenues $ 209   $ 464  
     Sales and marketing   271     414  
     Research and development   338

 

  495

 

     General and administrative   (109

)

  466  
   
   
 
     Total stock-based compensation expense $ 709   $ 1,839  
   
   
 

 

Concentrations of credit risk

Financial instruments that potentially subject us to concentrations of credit risk consist of cash, cash equivalents, short-term investments and accounts receivable. To date, we have invested excess funds in money market accounts, commercial paper, municipal bonds and term notes. We have cash equivalents and investments with various high quality institutions and limit the amount of credit exposure to any one institution. Our accounts receivable are derived from revenues earned from customers located in North America, Europe, and elsewhere in the world. We perform ongoing credit evaluations of our customers' financial condition and, generally, require no collateral from our customers. We maintain reserves for potential credit losses on customer accounts when deemed necessary.

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Table of Contents

The following table summarizes the revenues from customers that accounted for 10% or more of total revenues:

  Three Months Ended
 

  March 31, 2004   March 31, 2003
 

 

Barclays 29%   22%
The Royal Bank of Scotland 16%   *
Canadian Imperial Bank of Commerce 12%   *

* Represents less than 10% of total revenues.

At March 31, 2004, Canadian Imperial Bank of Commerce, Covad Communications and Sky Services, Ltd. accounted for approximately 17%, 14% and 12% of accounts receivable, respectively.  At December 31, 2003, Canadian Imperial Bank of Commerce and Sky Services, Ltd. accounted for approximately 14% and 10% of our accounts receivable, respectively. 

NOTE 3 -- BALANCE SHEET COMPONENTS (UNAUDITED):

The main components of accounts receivable, net are as follows (in thousands):

    March 31, 2004   December 31, 2003
   
 
Accounts receivable, net:                
     Accounts receivable   $ 11,216     $ 12,107  
     Less: allowance for doubtful accounts     (115 )     (133 )
     
     
 
    $ 11,101     $ 11,974  
     
     
 

The main components of accrued expenses are as follows (in thousands):

 

  March 31, 2004   December 31, 2003
   
 
Accrued expenses:                
     Accrued payroll and related expenses       $ 6,295     $ 6,656  
     Accrued restructuring expenses     3,811       4,265  
     Other accrued liabilities         2,935

 

    2,117

 

     
     
 
    $ 13,041     $ 13,038  
     
     
 

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Table of Contents

The components of intangible assets, excluding goodwill, are as follows (in thousands):

    

March 31, 2004

  

December 31, 2003

   
 
    

Gross Carrying Amount


  

Accumulated Amortization


   

Net Carrying Amount


  

Gross Carrying Amount


  

Accumulated Amortization


   

Net Carrying Amount


Intangible assets:

                                       

Developed technologies

  

$

2,374

  

$

(1,950

)

 

$

424

  

$

2,374

  

$

(1,843

)

 

$

531

Purchased technologies

  

 

7,162

  

 

(7,015

)

147

  

 

7,162

  

 

(6,436

)

726

Customer list

  

 

190

  

 

(127

)

   

63

  

 

190

  

 

(111

)

   

79

Tradenames

  

 

982

  

 

(982

)

--

  

 

982

  

 

(904

)

78

    

  


 

  

  


 

    

$

10,708

  

$

(10,074

)

$

634

  

$

10,708

  

$

(9,294

)

$

1,414

    

  


 

  

  


 

 

 

 

 

 

 

 

All of our acquired intangible assets, excluding goodwill, are subject to amortization and are carried at cost less accumulated amortization. Amortization is computed over the estimated useful lives which are as follows: developed technologies-one and one half to three years; purchased technologies-three years; tradenames-three years; customer list-three years. Aggregate amortization expense for intangible assets totaled $0.8 million and $0.9 million for the three months ended March 31, 2004 and 2003, respectively. We expect amortization expense on purchased intangible assets to be $0.5 million for the remaining nine months in fiscal 2004 and $0.1 million in fiscal 2005, at which time existing purchased intangible assets will be fully amortized.

NOTE 4 -- RESTRUCTURING:

Restructuring Costs

During fiscal years 2003 and 2002, based upon our continued evaluation of economic conditions in the information technology industry and our expectations regarding revenue levels, we restructured several areas of the Company to reduce expenses and improve our revenue per employee. This restructuring program included a worldwide workforce reduction and consolidation of excess facilities and certain business functions. We believe that these reductions and realignments have resulted and will continue to result in a more responsive management structure.

As part of the fiscal year 2003 restructuring, we entered into an agreement with an independent contracting company with global technical resources and an operations center in Bangalore, India. The agreement provides for the independent contractor, at our direction, to attract, train, assimilate and retain sufficient highly qualified personnel to perform technical support and certain sustaining engineering functions. We expect to benefit from outsourcing these functions by being able to offer increased levels of technical support services to our customers, maintain a larger number of customer technology platforms within sustaining engineering and perform more extensive quality assurance testing, all without material increases in cost.  In the event our relationship with this independent contracting company was terminated, we would either find an alternate contracting company to perform these services or we would provide these services which will increase our costs.  In fiscal year 2004, we plan to significantly increase the size of this organization and expand its scope as employee reductions occur throughout the year. Severance costs associated with the fourth quarter of fiscal year 2003 employee reductions were accounted for in accordance with SFAS No. 112, "Employers' Accounting for Post-Employment Benefits." Other one-time benefit arrangements are accounted for in accordance with SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities."

Workforce reduction

 

The restructuring program resulted in the reduction of 74 regular employees and 108 regular employees during the years ended December 31, 2003 and 2002, respectively. All areas of the Company were affected by this restructuring. We recorded a total workforce reduction expense relating to severance and benefits of approximately $2.0 million and $3.8 million for the years ended December 31, 2003 and 2002, respectively. 

 

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Table of Contents

Consolidation of excess facilities

 

We accrued for lease costs of $0.2 million and $2.8 million during the years ended December 31, 2003 and 2002, respectively, pertaining to the estimated future obligations for non-cancelable lease payments for the consolidation of excess facilities relating to lease terminations and non-cancelable lease costs. This expense included estimated sub-lease income based on current comparable rates for leases in the respective markets. If facilities rental rates continue to decrease in these markets or if it takes longer than expected to sublease these facilities, the maximum amount by which the actual loss could exceed the original estimate is approximately $1.3 million.

 

A summary of the restructuring expense and other special charges is outlined as follows (in thousands):

 

    Facilities   Severance and Benefits   Total
   
 
 
Reserve balance at December 31, 2003  $ 3,099 $ 1,166 $ 4,265
     Total charge   --   30   30
     Non-cash   (2)   (59)   (61)
     Cash paid   (119)   (304)   (423)
   
 
 
Reserve balance at March 31, 2004 $ 2,978 $ 833 $ 3,811
   
 
 

Amounts related to net lease expenses due to the consolidation of facilities will be paid over the lease terms through fiscal 2011.  As of March 31, 2004, $3.8 million related to the restructuring reserve remains outstanding and is included in the accrued expenses line item on the balance sheet.  The remaining accrual primarily relates to the termination and/or sublease of our excess facilities and to severance and other benefits for impacted employees.  During the three months ended March 31, 2004, there was a charge of less than $0.1 million relating to earned portions of severed employee retention bonus packages included in the cost of services line item in the consolidated statement of operations.

NOTE 5 -- BORROWINGS:

Revolving line of credit

 

Our two-year line of credit with Comerica Bank, effective from March 28, 2003, is comprised of an accounts receivable line and an equipment line. The terms of the line of credit require us to maintain a minimum quick ratio of 2.00 to 1.00, a tangible net worth of at least $15.0 million plus 60% of the proceeds of any equity offerings and subordinated debt issuances subsequent to the effective date of the line of credit agreement, and certain other covenants.

 

Under the terms and conditions of the accounts receivable line, the total amount of the line of credit is $5.0 million. The accounts receivable line of credit contains a provision for a sub-limit of up to $2.0 million for issuances of standby commercial letters of credit.  As of March 31, 2004, we had utilized $1.1 million of the $2.0 million standby commercial letter of credit limit.  The accounts receivable line of credit also contains a provision for a sub-limit of up to $2.0 million for issuance of foreign exchange forward contracts.  As of March 31, 2004, we had not entered into any foreign exchange forward contracts. 

 

Borrowings under the accounts receivable line of credit will bear interest at the lending bank's prime rate plus 0.5%. Advances are available on a non-formula basis up to $2.0 million (non-formula portion); however, if advances exceed $2.0 million, then subsequent advances cannot exceed 80% of eligible accounts receivable balances, and the bank would hold a security interest in those accounts receivable.

 

Borrowings under the $2.5 million equipment line bear interest at the lending bank's prime rate plus 1.0%, and the bank would hold a security interest in the equipment. In March 2003, we borrowed $2.5 million against the equipment line of credit. We paid off the outstanding line of credit balance in December 2003. As of March 31, 2004, we were in compliance with the respective debt covenants and there was no outstanding balance on our equipment line of credit.

 

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NOTE 6 -- LITIGATION:

Beginning in July 2001, we and certain of our officers and directors were named as defendants in a series of class action shareholder complaints filed in the United States District Court for the Southern District of New York, now consolidated under the caption, In re Chordiant Software, Inc. Initial Public Offering Securities Litigation, Case No. 01-CV-6222. In the amended complaint, the plaintiffs allege that Chordiant, certain of our officers and directors and the underwriters of our initial public offering ("IPO") violated Section 11 of the Securities Act of 1933 based on allegations that Chordiant's registration statement and prospectus failed to disclose material facts regarding the compensation to be received by, and the stock allocation practices of, the IPO underwriters. The complaint also contains a claim for violation of Section 10(b) of the Securities Exchange Act of 1934 based on allegations that this omission constituted a deceit on investors. The plaintiffs seek unspecified monetary damages and other relief. Similar complaints were filed in the same court against hundreds of other public companies ("Issuers") that conducted IPOs of their common stock in the late 1990s (collectively, the "IPO Lawsuits").

In October 2002, the parties agreed to toll the statute of limitations with respect to Chordiant's officers and directors until September 30, 2003, and on the basis of this agreement, our officers and directors were dismissed from the IPO Lawsuits without prejudice. In February 2003, the court issued a decision denying the motion to dismiss the Section 11 claims against Chordiant and almost all of the other Issuers and denying the motion to dismiss the Section 10(b) claims against Chordiant and many of the Issuers. In June 2003, Issuers and plaintiffs reached a tentative settlement agreement that would, among other things, result in the dismissal with prejudice of all claims against the Issuers and their officers and directors in the IPO Lawsuits, and the assignment to plaintiffs of certain potential claims that the Issuers may have against the underwriters. The tentative settlement also provides that, in the event that plaintiffs ultimately recover less than a guaranteed sum of $1 billion from the IPO underwriters, plaintiffs would be entitled to payment by each participating Issuer's insurer of a pro rata share of any shortfall in the plaintiffs' guaranteed recovery. Although Chordiant has approved this settlement proposal in principle, it remains subject to a number of procedural conditions, as well as formal approval by the Court. In September 2003, in connection with the possible settlement, those officers and directors who had entered tolling agreements with plaintiffs (described above) agreed to extend those agreements so that they would not expire prior to any settlement being finalized.

 

We are also subject to various other claims and legal actions arising in the ordinary course of business. The ultimate disposition of these various other claims and legal actions is not expected to have a material effect on our business, financial condition, results of operations or cash flows.

NOTE 7 -- COMMITMENTS AND CONTINGENCIES:

Future payments due under debt and lease obligations as of March 31, 2004 are as follows (in thousands):

    Operating Leases   Sublease Income     Total
   
 
   
Remaining portion of Fiscal 2004 $ 2,398 $ (295 ) $ 2,103
Fiscal 2005   3,266   (143 )   3,123
Fiscal 2006   3,490   --     3,490
Fiscal 2007   3,430   --     3,430
Fiscal 2008   2,893   --     2,893
Thereafter   3,065   --     3,065
   
 
   
Total $ 18,542 $ (438 ) $ 18,104
   
 
   

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NOTE 8 -- NET LOSS PER SHARE:

Basic and diluted net loss per share is computed by dividing the net loss for the period by the weighted average number of shares of common stock outstanding during the period. The calculation of diluted net loss per share includes potential shares of common stock unless their effect is anti-dilutive. Potential shares of common stock consists of common shares issuable upon the exercise of stock options (using the treasury stock method) and common shares subject to repurchase by us.

The following table sets forth the computation of basic and diluted net loss per share for the three months ended March 31, 2004 and 2003 (in thousands, except per share data):

  Three Months Ended
 
 

March 31, 2004

   

March 31, 2003

 
   
Net loss available to common stockholders $ (304 ) $ (6,946 )
   
   
 
Weighted average common stock outstanding   69,488     62,670  
Common stock subject to repurchase   (1,833

)

  (5,460

)

   
   
 
Denominator for basic and diluted calculation   67,655     57,210  
   
   
 
Net loss per share -- basic and diluted $ (0.00 ) $ (0.12 )
   
   
 

The following table sets forth the potential common shares that are excluded from the calculation of diluted net loss per share as their effect is anti-dilutive (in thousands):  

    Three Months Ended
   

    March 31, 2004   March 31, 2003
   

 

Warrants outstanding   1,662   1,850
Employee stock options   8,171   2,687
Common stock subject to repurchase   1,833   5,460
   
 
    11,666   9,997
   
 

NOTE 9 -- SEGMENT INFORMATION:

Our chief operating decision maker reviews financial information presented on a consolidated basis, accompanied by desegregated information about revenues by geographic regions for purposes of making operating decisions and assessing financial performance. Accordingly, we have concluded that we have one reportable segment.

License revenues for enterprise solutions amounted to $9.0 million and $2.1 million for the three months ended March 31, 2004 and 2003, respectively.  License revenues for marketing solutions were approximately $0.3 million and $2.0 million for the three months ended March 31, 2004 and 2003, respectively.

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Services revenues consist of consulting assistance and implementation, customization and integration and post-contract customer support, training and certain reimbursable out-of-pocket expenses.  Service revenues for enterprise solutions were approximately $7.9 million and $7.2 million for the three months ended March 31, 2004 and 2003, respectively.  Service revenues for marketing solutions were approximately $3.0 million and $2.5 million for the three months ended March 31, 2004 and 2003, respectively. 

 

Foreign revenues are based on the country in which the customer is located. The following is a summary of total revenues by geographic area (in thousands):

 

  Three Months Ended
 
 

March 31, 2004

   

March 31, 2003

 
   
North America $ 3,255   $ 2,071  
Europe   16,908     11,695  
Rest of World   55     49  
   
   
 
  $ 20,218   $ 13,815  
   
   
 

Property and equipment information is based on the physical location of the assets. The following is a summary of property and equipment, net by geographic area (in thousands):

  March 31, 2004   December 31, 2003
 
 
North America $ 1,403     $ 1,475  
Europe   1,481       1,596  
   
     
 
  $ 2,884     $ 3,071  
   
     
 

NOTE 10 -- COMMON STOCK PLACEMENT:

In January 2004, we sold 4,854,368 shares of our common stock to Acqua Wellington Opportunity I Limited for an aggregate purchase price of approximately $25.0 million which will be used for working capital and other general corporate purposes.

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

This discussion and analysis should be read in conjunction with our financial statements and accompanying notes included in this report and the 2003 audited financial statements and notes thereto included in our Annual Report on Form 10-K/A for the year ended December 31, 2003 filed with the Securities and Exchange Commission ("SEC") on April 28, 2004. Operating results are not necessarily indicative of results that may occur in future periods.

The following discussion and analysis contains forward-looking statements. These statements are based on our current expectations, assumptions, estimates and projections about our business and our industry, and involve known and unknown risks, uncertainties and other factors that may cause our or our industry's results, levels of activity, performance or achievement to be materially different from any future results, levels of activity, performance or achievements expressed or implied in or contemplated by the forward-looking statements. Words such as "believe," "anticipate," "expect," "intend," "plan," "will," "may," "should," "estimate," "predict," "guidance," "potential," "continue" or the negative of such terms or other similar expressions, identify forward-looking statements. Our actual results and the timing of events may differ significantly from those discussed in the forward-looking statements as a result of various factors, including but not limited to, those discussed under the subheading "Risk Factors" and those discussed elsewhere in this report, in our other SEC filings and under the headings "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Form 10-K/A . Chordiant undertakes no obligation to update any forward-looking statement to reflect events after the date of this report.

Overview

As an enterprise software vendor, we (Chordiant Software, Inc.) generate substantially all of our revenues from the financial services and telecommunications industries. Our customers typically fund purchases of our software and services out of their lines of business and information technology budgets. As a result, our revenues are heavily influenced by our customers' long-term business outlook and willingness to invest in new enterprise information systems and business applications.

Beginning in late calendar 2000, the financial services and telecommunications industries entered into a steep and long economic downturn, with industry sales dropping from late 2000 through the first part of 2003. Over the past three years, our customers have focused on controlling costs and reducing risk, including constraining information technology and lines of business expenditures and requiring more favorable pricing terms from their suppliers and pursuing consolidation within their own industries. As a result of this downturn, our license fee revenues have declined 18%-19% in each of the last two fiscal years.

Beginning in the latter part of 2003, economic conditions began to show signs of improvements which were reflected in increases in various economic indicators such as productivity, labor statistics and consumer confidence.  This trend has continued into the first quarter of 2004 and appears to have a favorable impact, specifically in information technology spending.  In a recent survey of 75 United States and 25 European Chief Information Officers published by Merrill Lynch, information technology budgets have increased this year and during this quarter these companies spent more than in prior years.  The quarter ended March 31, 2004 was the second consecutive quarter that we were able to grow license fee revenues and total revenues on a year over year basis since the economic downturn started.

Financial Trends

Management focuses on license and service gross margin in evaluating our financial condition and operating performance. Gross margin on license revenues was 96% and 94% for the three months ended March 31, 2004 and 2003, respectively. We expect license gross margin to range from 94% to 96% in the foreseeable future. Gross margin on service revenues was 42% and 39% for the three months ended March 31, 2004 and 2003, respectively. 

 

Service revenues as a percentage of total revenues were 54% and 70% for the three months ended March 31, 2004 and 2003, respectively.  We expect that service revenues will continue to represent over 50% of our total revenues in the foreseeable future. 

 

For the three months ended March 31, 2004 and 2003, revenues were principally derived from customer accounts in the North America and Europe. For the three months ended March 31, 2004 and 2003, international revenues were $17.0 million and $11.7 million, or approximately 84% and 85% of our total revenues, respectively.  We believe international revenues will continue to represent a significant portion of our total revenues in future periods. Our international revenue growth rate has continued to outpace our United States revenue growth rate. We believe this has occurred because the U.S. economy has been weak compared to areas where we have an international presence and our leadership and market presence have been very strong internationally, particularly in the United Kingdom.

We believe that period-to-period comparisons of our operating results should not be relied upon as indicative of future performance. Our prospects must be considered given the risks, expenses and difficulties frequently encountered by companies in early stages of development, particularly companies in new and rapidly evolving businesses. There can be no assurance we will be successful in addressing these risks and difficulties. Moreover, we may not achieve or maintain profitability in the future.

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Results of Operations

The following table sets forth, as a percentage of total revenues, consolidated statements of operations data for the periods indicated:

Three Months Ended

       
 

March 31, 2004

March 31, 2003

 Revenues:



License

 

46 %

 

30

%

Service

54   70
     
   
 

Total revenues

100 100

Cost of revenues:

License

2 2

Service

31 43

Stock-based compensation

1 3

Amortization of intangible assets

3 6
     
   
 
Total cost of revenues 37 54
     
   
 

Gross profit

63

46
     
   
 

Operating expenses:

Sales and marketing

29 44

Research and development

22 29

General and administrative

9 10

Stock-based compensation

3 10
  Amortization of intangible assets   1     1  
     
   
 
Total operating expenses 64 94
     
   
 

Loss from operations

(1 )

(48

)
   

Interest income, net

1   1

Foreign exchange and other expenses, net

(1 ) (2 )
     
   
 

Net loss before income taxes

 

(1

)

 

(49

)

Provision for income taxes

1   1
     
   
 

Net loss

(2 )% (50

)%

     
   
 

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Comparison of the Three Months Ended March 31, 2004 and 2003

Revenues

License. Total license revenues increased to $9.3 million for the three months ended March 31, 2004 from $4.1million, or approximately 125%, for the three months ended March 31, 2003. License revenues for enterprise solutions increased to $9.0 million for the three months ended March 31, 2004 from $2.1 million, or approximately 327%, for the three months ended March 31, 2003. This increase was due to revenue being recognized on three significant enterprise license contracts in the three months ended March 31, 2004 compared to one significant enterprise license contract in the three months ended March 31, 2003, as economic conditions in our target markets improved.  License revenues for marketing solutions decreased to $0.3 million for the three months ended March 31, 2004 from $2.0 million, or approximately 86%, for the three months ended March 31, 2003.  We expect marketing solutions license revenues will increase in future quarters in 2004 and represent between 15% to 25% of total license revenues for fiscal year 2004, which is consistent with the past two years.

Service. Total service revenues, which include reimbursement of out-of-pocket expenses, increased to $10.9 million for the three months ended March 31, 2004 from $9.7 million, or approximately 13%, for the three months ended March 31, 2003.  Service revenues for enterprise solutions increased to $7.9 million for the three months ended March 31, 2004 from $7.2 million, or approximately 11%, for the three months ended March 31, 2003.  This increase was due to a continuation in large customer implementations as well as maintenance, support and consulting revenues associated with license agreements entered into in prior periods.  Service revenues for marketing solutions increased to $3.0 million for the three months ended March 31, 2004 from $2.5 million, or approximately 20%, for the three months ended March 31, 2003.  This increase was due to the continuation of maintenance and support revenues associated with marketing solutions license agreements which were entered into in prior periods along with new marketing solutions agreements entered into during fiscal year 2003.  

Reimbursement of out-of-pocket expenses (which is included in total service revenues) remained flat at $0.5 million for both the three months ended March 31, 2004 and 2003.

Cost of revenues

License. Cost of license revenues increased to $0.4 million for the three months ended March 31, 2004 from $0.3 million, or approximately 50%, for the three months ended March 31, 2003. These costs resulted in license gross margins of approximately 96% and 94% for the three months ended March 31, 2004 and 2003, respectively.  The aggregate cost of license revenues is in line with the increase of our license revenues.  We expect cost of license revenues to remain in the four to six percent range of license revenues.

Service. Cost of service revenues increased to $6.3 million for the three months ended March 31, 2004 from $5.9 million, or approximately 6%, for the three months ended March 31, 2003. These costs resulted in service gross margins of 42% and 39% for the three months ended March 31, 2004 and 2003, respectively.  Service gross margins improved mainly as the result of combined effects of restructuring actions implemented, increased efficiencies, reduced spending relative to service revenues and lower stock-based compensation and amortization of intangible assets expenses. 

Stock-based compensation.  Stock-based compensation decreased to $0.2 million for the three months ended March 31, 2004 from $0.5 million, or approximately 55%, for the three months ended March 31, 2003. The decrease in stock-based compensation is mainly due to the decrease in the Company's stock price during first three months of fiscal year 2004 which affects the variable accounting calculation to which restricted stock and some outstanding stock options are subject.

Amortization of intangibles. Amortization of intangible assets was $0.7 million for the three months ended March 31, 2004 compared to $0.8 million for the three months ended March 31, 2003.  The amortization expense in the three months ended March 31, 2004 included $0.1 million attributable to the acquisition of OnDemand in April 2002, $0.4 million attributable to the acquisition of Prime Response in March 2001 and $0.2 million attributable to the acquisitions certain assets from ActionPoint and ASP Outfitter in May 2001.  We expect amortization expense on purchased intangible assets to be $0.5 million for the remaining nine months in fiscal 2004 and $0.1 million in fiscal 2005, at which time existing purchased intangible assets will be fully amortized.

Operating Expenses

Sales and marketing. Sales and marketing expenses decreased to $5.9 million for the three months ended March 31, 2004 from $6.0 million, or approximately 1%, for the three months ended March 31, 2003. The decrease in these expenses was mainly attributable to a decrease of $0.1 million in marketing programs and trade shows and a decrease of approximately $0.6 million in communication, facilities, depreciation and other allocated expenses.  These decrease were partially offset by an increase of $0.5 million in increased commission expenses and bonus expenses due to higher license revenues.

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Research and development. Research and development expenses increased to $4.4 million for the three months ended March 31, 2004 from $4.1 million, or approximately 9%, for the three months ended March 31, 2003. The increase in these expenses was mainly attributable to an increase of $0.4 million in personnel related expenses and $0.1 million in travel and equipment rental expenses related to our outsourcing of technical support and certain sustaining engineering functions.  These increases were partially offset by a decrease of $0.2 million in depreciation related expenses.

General and administrative. General and administrative expenses increased to $1.9 million for the three months ended March 31, 2004 from $1.4 million, or approximately 34%, for the three months ended March 31, 2003.  The increase in these expenses was mainly attributable to an increase of $0.4 million in personnel related expenses due to increased salary and bonus expenses and an increase of $0.4 million in allocated expenses due to lower headcounts in other operating functions of the Company as a result of restructuring actions implemented.  These increases were partially offset by a decrease of $0.3 million in office, facilities and depreciation related expenses due to restructuring actions implemented and a renegotiated lease agreement.

Stock-based compensation. We recorded amortization of stock-based compensation expense of $0.1 million for the three months ended March 31, 2004 compared to $0.2 million for the three months ended March 31, 2003 relating to options granted prior to our initial public offering with an exercise price lower than the deemed fair market value of the underlying common stock at the date of issuance.  At March 31, 2004, approximately $0.1 million of unearned stock-based compensation remained to be amortized. 

On August 23, 2002, we implemented a stock option exchange program (the "Program"). Under the Program, holders of outstanding options with an exercise price of $3.00 or greater per share (the "Eligible Options") were given the choice of retaining these options or canceling the options in exchange for (i) restricted shares of common stock ("Restricted Stock") to be issued as soon as possible after the expiration of the Program period and/or (ii) replacement options issuable six (6) months and one (1) day following the cancellation of the Program ("Replacement Options") at the closing market price on that date. The Program, as amended, also provided our Chief Executive Officer and Chief Financial Officer of the Company, if they participated in the Program, with a Separate Restricted Stock Agreement (the "CEO and CFO Agreement"), which includes specific vesting provisions based on achieving certain financial performance goals. There were 11,668,875 options subject to the Program, which closed on October 9, 2002.

Employees tendered 8,109,640 stock options and received 2,780,967 shares of Restricted Stock pursuant to the Program. In addition, employees tendered 672,948 stock options, which were cancelled and to the extent an employee was still with the Company were replaced six (6) months and one (1) day following the expiration of the Program. The tendered stock options represented approximately 59% of our total outstanding stock options as of the expiration date of the Program. In addition, in October 2002, we issued 3,706,745 shares of Restricted Stock to our employees residing in the United Kingdom, including to our Chief Executive Officer. The Restricted Stock issued to our Chief Executive Officer is subject to the CEO and CFO Agreement. In November 2003, our then acting Chief Financial Officer left our employ and, as a result, the Company is no longer subject to stock-based compensation expense related to the vesting of his restricted stock. In connection with the termination, we accelerated the vesting of 154,723 shares of restricted stock resulting in a compensation expense of $0.6 million during the fourth quarter of fiscal year 2003.

The Program has been accounted for under the guidance of Emerging Issues Task Force Issue No. 00-23, "Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25," and Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation-an Interpretation of APB Opinion No. 25." Because we offered to cancel existing fixed stock options in exchange for a grant of restricted stock within six months of the cancellation date of the existing options, the Eligible Options became subject to variable accounting treatment at the commencement date of the Program. Variable accounting ceased upon cancellation of the tendered options. A total of 2,886,287 Eligible Options that were not tendered will remain subject to variable accounting. The remaining unearned stock-based compensation expense amounted to approximately $0.6 million at March 31, 2004. For the three months ended March 31, 2004, $0.6 million was recorded as stock-based compensation expense. The compensation expense on variable options will be re-measured at the end of each operating period until the options are exercised, forfeited or have expired. Depending upon the change in the market value of our common stock, this accounting treatment may result in significant additional stock-based compensation charges in future periods.

 

As part of the Program implemented in 2002, we issued 499,068 replacement options at the current market value of $0.88 per share on April 11, 2003 to employees.

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The related functional breakdown of total stock-based compensation is outlined below (in thousands): 

 

  Three Months Ended
 
 

March 31, 2004

   

March 31, 2003

 
   
Stock-based compensation expense:            
     Cost of service revenues $ 209   $ 464  
     Sales and marketing   271     414  
     Research and development   338

 

  495

 

     General and administrative   (109

)

  466  
   
   
 
     Total stock-based compensation expense $ 709   $ 1,839  
   
   
 

 

In September 2001, we issued warrants to Accenture plc to purchase up to 600,000 shares of our common stock subject to performance-based vesting. No warrants have vested through March 31, 2004.

Amortization of intangibles. Amortization of intangible assets was $0.1 million for both the three months ended March 31, 2004 and 2003, respectively.  The $0.1 million amortization expense for both the three months ended March 31, 2004 and 2003 is mainly attributable to the acquisition of Prime Response in March 2001.  We expect amortization expense on purchased intangible assets included in operating expenses to less than $0.1 million for the remaining nine months in fiscal year 2004 and less than $0.1 million in fiscal year 2005, at which time existing purchased intangible assets will be fully amortized.

Interest Income, net

Interest income, net consist primarily of interest income generated from our cash, cash equivalents and short-term investments and interest expense incurred in connection with outstanding borrowings.  Interest income, net increased to $0.2 million for the three months ended March 31, 2004 from $0.1 million for the three months ended March 31, 2003.  This increase is due to interest being earned on a larger cash and cash equivalent balances during the quarter and no interest expense offsetting the interest income due to no outstanding borrowings during the quarter.

Foreign exchange and other expenses, net

Realized foreign currency gains and losses and other non-operating income and expenses were $0.2 million and $0.3 million for the three months ended March 31, 2004 and 2003, respectively.  The $0.2 million expense for the three months ended March 31, 2004 is mainly due to realized net foreign currency exchange losses. The $0.3 million expense for the three months ended March 31, 2003 is mainly due to the write-off of a long outstanding acquisition-related balance.

Provision for Income Taxes

Our provisions for income taxes were $0.2 million and $0.3 million for the three months ended March 31, 2004 and 2003, respectively.  The provisions were attributable to taxes on earnings from our foreign subsidiaries and certain state income taxes.

Our deferred tax assets primarily consist of net operating loss carryforwards, nondeductible allowances and research and development tax credits. We have recorded a valuation allowance for the full amount of our net deferred tax assets, as the future realization of the tax benefit is not considered by management to be more-likely-than-not.

Liquidity and Capital Resources

Our cash, cash equivalents, and short-term investments and restricted cash and long-term restricted cash consist principally of money market funds, a certificate of deposit and marketable equity securities and totaled $35.5 million, $38.3 million and $65.9 million at March 31, 2003, December 31, 2003 and March 31, 2004, respectively.   Cash and cash equivalents increased during the three months ended March 31, 2004 compared to prior periods as a result of our sale of 4,854,368 shares of our common stock for an aggregate purchase price of approximately $25.0 million during the three months ended March 31, 2004.  All of our short-term investments are classified as available-for-sale under the provisions of SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities." The securities are carried at fair market value. Gains and losses on investments are recognized when realized on the consolidated statements of income.

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Cash provided by operating activities was $0.2 million during the three months ended March 31, 2004.  Cash provided by operating activities during the three months ended March 31, 2004 consisted primarily of our net loss of $0.3 million adjusted for non-cash items (primarily depreciation, amortization, non-cash stock-based compensation expense and other non-cash charges) of approximately $1.9 million and the net cash outflow effect from changes in assets and liabilities of approximately $1.4 million.  During the three months ended March 31, 2004, the following occurred which contributed to the net cash outflow effect from changes in assets and liabilities: (i) deferred revenues decreased as long-term support and maintenance revenues were recognized for which cash was received in prior years; (ii) prepaid royalty and commission expenses increased due to the signing of two large percentage-of-completion method customer contracts in the last month of the quarter; and (iii) accounts receivable decreased due to increased customer collections during the quarter as evidenced by our days sales outstanding decreasing from 55 days to 49 days for the three months ended December 31, 2003 and March 31, 2004, respectively.

 

Cash used in operating activities was $10.2 million during the three months ended March 31, 2003. Cash used in operating activities during the three months ended March 31, 2003 consisted primarily of our net loss of $6.9 million adjusted for non-cash items (primarily depreciation, amortization, and non-cash stock-based compensation expense) of approximately $3.5 million and the net cash outflow effect from changes in assets and liabilities of approximately $6.8 million. During the three months ended March 31, 2003, the following occurred which contributed to the net cash outflow effect from changes in assets and liabilities: (i) accounts receivable increased due to revenue recognition beginning on a large percentage-of-completion method customer contract during the quarter for which payment was not received until the second quarter of 2003; (ii) accounts payable decreased as a result of timing differences when trade payables were paid; (iii) accrued expenses decreased as a result of payments for restructuring-related accruals, commissions and bonuses which were only partially offset by current quarter accruals; and (iv) deferred revenue increased due to revenue recognition on a large percentage-of-completion method customer contract carrying into the second quarter of 2003 and partially offset by long-term support and maintenance revenues being recognized for which cash was received in prior years.

 

We entered into several multi-year support and maintenance agreements in 2000 and, to a lesser extent, in 2001 and 2002.  Because we recognize support and maintenance revenue over the life of these agreements, our cash flows from operations are negatively impacted in the years after we enter into these agreements.  Since we expect to continue our recent focus on annual (instead of multi-year) agreements, we expect that this negative impact on our cash flow from operations to decrease significantly after fiscal year 2004.

 

Cash used in investing activities during the three months ended March 31, 2004 was $0.2 million and related to capital expenditures made during the quarter. Cash provided by investing activities was $5.5 million during the three months ended March 31, 2003 and related mainly to the maturities of short-term investments, net of additional purchases, which were reinvested into cash and cash equivalent investments to be available to fund operating activities.

 

Cash provided by financing activities was $27.6 million and $4.0 million during the three months ended March 31, 2004 and 2003, respectively.  During the three months ended March 31, 2004, the following occurred: (i) obtained net proceeds of $24.8 million from the sale of 4,854,368 shares of our common stock to Acqua Wellington Opportunity I Limited; (ii) received proceeds of $1.1 million from the issuance of common stock as part of the employee stock purchase plan; and (iii) received proceeds of approximately $1.7 million from the exercise of employee stock options. During the three months ended March 31, 2003, the following occurred: (i) received proceeds of $0.7 million from the issuance of common stock as part of the employee stock purchase plan; (ii) received proceeds of $2.8 million from additional borrowings entered into during the quarter net of $0.7 million of borrowings repayments; and (iii) received proceeds of $0.5 million from the collection of notes receivables.

At March 31, 2004 and December 31, 2003, we had a balance of $1.5 million in the form of short-term investments that meet the qualification to be considered cash equivalents, which were restricted from withdrawal. This balance serves as a security deposit in a long-term, post-contract customer support revenue transaction. At March 31, 2004 and December 31, 2003, we also had an interest bearing certificate of deposit classified as short-term investments and restricted cash which serves as collateral for a $0.4 million letter of credit security deposit for a leased facility.

Revolving line of credit

 

Our two-year line of credit with Comerica Bank, effective from March 28, 2003, is comprised of an accounts receivable line and an equipment line. The terms of the line of credit require us to maintain a minimum quick ratio of 2.00 to 1.00, a tangible net worth of at least $15.0 million plus 60% of the proceeds of any equity offerings and subordinated debt issuances subsequent to the effective date of the line of credit agreement, and certain other covenants.

 

Under the terms and conditions of the accounts receivable line, the total amount of the line of credit is $5.0 million. The accounts receivable line of credit contains a provision for a sub-limit of up to $2.0 million for issuances of standby commercial letters of credit.  As of March 31, 2004, we had utilized $1.1 million of the $2.0 million standby commercial letter of credit limit.  The accounts receivable line of credit also contains a provision for a sub-limit of up to $2.0 million for issuance of foreign exchange forward contracts.  As of March 31, 2004, we had not entered into any foreign exchange forward contracts. 

 

Borrowings under the accounts receivable line of credit will bear interest at the lending bank's prime rate plus 0.5%. Advances are available on a non-formula basis up to $2.0 million (non-formula portion); however, if advances exceed $2.0 million, then subsequent advances cannot exceed 80% of eligible accounts receivable balances, and the bank would hold a security interest in those accounts receivable.

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Borrowings under the $2.5 million equipment line bear interest at the lending bank's prime rate plus 1.0%, and the bank would hold a security interest in the equipment. In March 2003, we borrowed $2.5 million against the equipment line of credit. We paid off the outstanding line of credit balance in December 2003. As of March 31, 2004, we were in compliance with the respective debt covenants and there was no outstanding balance on our equipment line of credit.

Future Commitments

Future payments due under debt and lease obligations as of March 31, 2004 are as follows (in thousands):

    Operating Leases   Sublease Income     Total
   
 
   
Remaining portion of Fiscal 2004 $ 2,398 $ (295 ) $ 2,103
Fiscal 2005   3,266   (143 )   3,123
Fiscal 2006   3,490   --     3,490
Fiscal 2007   3,430   --     3,430
Fiscal 2008   2,893   --     2,893
Thereafter   3,065   --     3,065
   
 
   
Total $ 18,542 $ (438 ) $ 18,104
   
 
   

Critical Accounting Policies

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. 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 on-going basis, we evaluate our estimates, including those related to estimates of percentage of completion on our service contracts, uncollectible receivables, valuation allowances, intangible assets, income taxes, restructuring costs and contingencies. We base our estimates on historical experience and on various other assumptions that are believed 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 our more significant judgments and estimates used in the preparation of our consolidated financial statements:

 

  *   Revenue recognition, including estimating the total estimated days to complete sales arrangements involving significant implementation or customization essential to the functionality of our product;

 

  *   Estimating valuation of the allowance for doubtful accounts;

 

 

  *   Restructuring costs; and
  *   Determining functional currencies for the purposes of consolidating our international operations.

 

 

We have reviewed our critical accounting policies, critical accounting estimates, and the related disclosures with our Disclosure and Audit Committees. Additional information about our critical accounting policies may by found in the Company's Annual Report on Form 10-K/A for the year ended December 31, 2003 filed on April 28, 2004, in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," under the heading "Application of Critical Accounting Policies and Use of Estimates."  We have not changed those policies since such date.  Investors should therefore read this Item 2 in conjunction with such description.

 

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RISK FACTORS

Weakness in technology spending in our target markets combined with geopolitical concerns could make the closing of license transactions to new and existing customers difficult.

 

Our revenues fell in fiscal year 2003 compared to revenues in fiscal year 2002. Our revenues will continue to decrease in 2004 if we are unable to enter into new large-scale license transactions with new and existing customers. The current state of world affairs and geopolitical concerns have left many customers reluctant to enter into new large value license transactions without some assurance that the economy both in the customer's home country and worldwide will have some economic and political stability. Continued or further weakness in technology spending and geopolitical instability will continue to make closing large license transactions difficult. In addition, we cannot predict what effect the U.S. military presence overseas or potential or actual political or military conflict have had or are continuing to have on our existing and prospective customers' decision-making process with respect to licensing or implementing enterprise-level products such as ours. Our ability to enter into new large license transactions also directly affects our ability to create additional consulting services and maintenance revenues, on which we also depend.

 

Historically, we have not been profitable and we may continue to incur losses, which may raise vendor viability concerns thereby making it more difficult to close license transactions with new and existing customers.

 

We incurred losses of $0.3 million and $6.9 million for the three months ended March 31, 2004 and 2003, respectively, and a loss of $16.4 million for the year ended December 31, 2003. As of March 31, 2004, we had an accumulated deficit of $189.2 million. We may continue to incur losses and cannot be certain that we can achieve or generate sufficient revenues to achieve profitability. Continued losses may leave many customers reluctant to enter into new large value license transactions without some assurance that we will operate profitably. If we fail to enter into new large value license transactions due to lack of vendor profitability and or viability concerns, our revenues will decline, which would further adversely affect our operating results.

 

Because a small number of customers account for a substantial portion of our revenues, the loss of a significant customer could cause a substantial decline in our revenues.

 

We derive a significant portion of our software license revenues in each quarter from a limited number of customers. The loss of a major customer in a particular quarter could cause a decrease in revenues and net income. For the three months ended March 31, 2004, Barclays, the Royal Bank of Scotland and Canadian Imperial Bank of Commerce accounted for 29%, 16% and 12% of our total revenues, respectively.  For the three months ended March 31, 2003, Barclays accounted for 22% of our total revenues.  While our customer concentration has fluctuated, we expect that a limited number of customers will continue to account for a substantial portion of our revenues. As a result, if we lose a major customer, or if a contract is delayed or cancelled or we do not contract with new major customers, our revenues and net loss would be adversely affected. In addition, customers that have accounted for significant revenues in the past may not generate revenues in any future period, causing our failure to obtain new significant customers or additional orders from existing customers to materially affect our operating results.

 

If we fail to adequately address the difficulties of managing our international operations, our revenues and operating expenses will be adversely affected.

 

For the three months ended March 31, 2004, international revenues were $17.0 million or approximately 84% of our total revenues. For the three months ended March 31, 2003, international revenues were $11.7 million or approximately 85% of our total revenues. While we expect North American revenues to increase as a percentage of our overall revenues, international revenues will continue to represent a significant portion of our total revenues in future periods. We have faced, and will continue to face, difficulties in managing international operations which include:

 

  *   Difficulties in hiring qualified local personnel;
  *   Seasonal fluctuations in customer orders;
  *   Longer accounts receivable collection cycles;
  *   Expenses associated with licensing products and servicing customers in foreign markets; and
  *   Economic downturns and political uncertainty in international economies.

 

Any of these factors could have a significant impact on our ability to license products on a competitive and timely basis and could adversely affect our operating expenses and net income.

 

Increases in the value of the U.S. dollar relative to foreign currencies could make our products less competitive in international markets and could negatively affect our operating results and cash flows.

 

A significant portion of our sales and operating expenses result from transactions outside of the United States, often in foreign currencies. Our international sales comprised 84% and 85% of our total sales for the three months ended March 31, 2004 and 2003, respectively. In fiscal year 2003, our operating results were positively affected by changes in foreign currency rates. Our future operating results will continue to be subject to fluctuations in foreign currency rates, especially if international sales continue to grow as a percentage of our total sales, and we may be negatively impacted by fluctuations in foreign currency rates in the future.

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Competition in our markets is intense and could reduce our sales and prevent us from achieving profitability.

 

Increased competition in our markets could result in price reductions for our products and services, reduced gross margins and loss of market share, any one of which could reduce our future revenues. The market for our products is intensely competitive, evolving and subject to rapid technological change. We consider our primary competition to be from internal development, custom systems integration projects and application software competitors. In particular, we compete with:

 

  *   Internal information technology departments: in-house information technology departments of potential customers have developed or may develop systems that provide some or all of the functionality of our products. We expect that internally developed application integration and process automation efforts will continue to be a significant source of competition.

 

  *   Point application vendors: we compete with providers of stand-alone point solutions for web-based customer relationship management and traditional client/server-based, call-center service customer and sales-force automation solution providers.

 

Many of our competitors have greater resources and broader customer relationships than we do. In addition, many of these competitors have extensive knowledge of our industry. Current and potential competitors have established, or may establish, cooperative relationships among themselves or with third parties to offer a single solution and to increase the ability of their products to address customer needs.

 

We may experience a shortfall in revenue, earnings, cash flow or otherwise fail to meet public market expectations, which could materially and adversely affect our business and the market price of our common stock.

 

Our revenues and operating results may fluctuate significantly because of a number of factors, many of which are outside of our control. Some of these factors include:

 

  *   Size and timing of individual license transactions;
  *   Delay or deferral of customer implementations of our products;
  *   Lengthening of our sales cycle;
  *   Further deterioration and changes in domestic and foreign markets and economies;
  *   Success in expanding our global services organization, direct sales force and indirect distribution channels;
  *   Timing of new product introductions and product enhancements;
  *   Appropriate mix of products licensed and services sold;
  *   Levels of international transactions;
  *   Activities of and acquisitions by competitors;
  *   Product and price competition; and
  *   Our ability to develop and market new products and control costs.

 

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

 

Our operating results fluctuate significantly and delays in implementation of our products may cause unanticipated declines in revenues or cash flow, which could disappoint investors and result in a decline in our stock price.

 

Our quarterly revenues depend primarily upon product implementation by our customers. We have historically recognized most of our license and services revenue through the percentage-of-completion method, using labor hours incurred as the measure of progress towards completion of implementation of our products and we expect this practice to continue. Thus, delays in implementation by our customers and systems integration partners would reduce our quarterly revenue. Historically, a significant portion of new customer orders have been booked in the third month of the calendar quarter, with many of these bookings occurring in the last two weeks of the third month. We expect this trend to continue and, therefore, any failure or delay in bookings would decrease our quarterly revenue. If our revenues or operating margins are below the expectations of the investment community, our stock price is likely to decline.

 

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If we fail to maintain and expand our relationships with systems integrators and other business partners, our ability to develop, market, sell, and support our products may be adversely affected.

 

Our development, marketing and distribution strategies increasingly rely on our ability to form and maintain long-term strategic relationships with system integrators, in particular, our existing business alliance partners, IBM and Accenture. These business relationships often consist of joint marketing programs, technology partnerships and resale and distribution arrangements. Although most aspects of these relationships are contractual in nature, many important aspects of these relationships depend on the continued cooperation between the parties. Divergence in strategy, change in focus, competitive product offerings or potential contract defaults may interfere with our ability to develop, market, sell, or support our products, which in turn could harm our business. If either IBM or Accenture were to terminate their agreements with us or our relationship were to deteriorate, it could have a material adverse effect on our business, financial condition and results of operations. In many cases, these parties have extensive relationships with our existing and potential customers and influence the decisions of these customers. A number of our competitors have stronger relationships with IBM and Accenture and, as a result, these parties may be more likely to recommend competitors' products and services.

 

Failure to successfully customize or implement our products for a customer could prevent recognition of revenues, collection of amounts due or cause legal claims by the customer.

 

If a customer is not able to customize or deploy our products successfully, the customer may not complete expected product deployment, which could prevent or delay recognition of revenues and collection of amounts due, and could result in claims against us. We have, in the past, had disputes with customers concerning product performance.

 

Our primary products have a long sales and implementation cycle, which makes it difficult to predict our quarterly results and may cause our operating results to vary significantly.

 

The period between initial contact with a prospective customer and the implementation of our products is unpredictable and often lengthy, ranging to date from three to twenty-four months. Thus, revenue and cash receipt could vary significantly from quarter to quarter. Any delays in the implementation of our products could cause reductions in our revenues. The licensing of our products is often an enterprise-wide decision that generally requires us to provide a significant level of education to prospective customers about the use and benefits of our products. The implementation of our products involves significant commitment of technical and financial resources and is commonly associated with substantial implementation efforts that may be performed by us, by the customer or by third-party systems integrators. Customers generally consider a wide range of issues before committing to purchase our products, including product benefits, ability to operate with existing and future computer systems, vendor financial stability and longevity, ability to accommodate increased transaction volume and product reliability.

 

If we are not able to successfully manage our partner operations in India, our operations and financial results may be adversely affected.

 

In fiscal year 2003 we entered into an agreement with an independent contracting company with global technical resources and an operations center in Bangalore, India. The agreement provides for the independent contractor, at our direction, to attract, train, assimilate and retain sufficient highly qualified personnel to perform technical support and certain sustaining engineering functions.  In the event our relationship with this independent contracting company was terminated, we would either find an alternate contracting company to perform these services or we would provide these services which will increase our costs. In fiscal year 2004 we  plan to significantly increase the size of this organization and expand its scope. The expansion of this organization is an important component of our strategy to address the business needs of our customers and manage our expenses. The success of this operation will depend on our ability and our independent contractor's ability to attract, train, assimilate and retain highly qualified personnel in the required periods. A disruption of our relationship with the independent contractor could adversely affect our operations and financial results. Failure to effectively manage the organization and operations will harm our business and financial results.

 

Our stock price is subject to significant fluctuations, which may adversely affect the value of your investment in our common stock.

 

Since our initial public offering in February 2000, the price of our common stock has fluctuated widely. During the twelve-month period ended March 31, 2004, the closing price of our common stock on the NASDAQ National Market ranged from a low of $0.81 to a high of $5.85 per share.  We believe that factors such as the risks described herein or other factors could cause the price of our common stock to continue to fluctuate, perhaps substantially. In addition, recently, the stock market in general, and the market for high technology stocks in particular, has experienced extreme price fluctuations, which have often been unrelated to the operating performance of the affected companies. Such fluctuations could adversely affect the market price of our common stock.

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We may incur in future periods significant stock-based compensation charges related to certain stock options and stock awards, which may adversely affect our reported financial results.

 

Based on accounting standards involving stock compensation, we may incur variable accounting costs related to the issuance of restricted stock and certain stock options, including those associated with our stock option cancellation/re-grant program. Accounting standards require us to re-measure compensation cost for such options each reporting period based on changes in the market value of the underlying common stock. Depending upon movements in the market value of our common stock, the variable accounting treatment of those stock options may result in significant additional stock-based compensation costs in future periods.

 

We are the target of a securities class action complaint and are at risk of securities class action litigation, which may result in substantial costs and divert management attention and resources.

 

Beginning in July 2001, Chordiant and certain of our officers and directors were named as defendants in several class action shareholder complaints filed in the United States District Court for the Southern District of New York, now consolidated under the caption, In re Chordiant Software, Inc. Initial Public Offering Securities Litigation, Case No. 01-CV-6222. In the amended complaint, the plaintiffs allege that Chordiant, certain of our officers and directors and the underwriters of our initial public offering ("IPO") violated Section 11 of the Securities Act of 1933 based on allegations that Chordiant's registration statement and prospectus failed to disclose material facts regarding the compensation to be received by, and the stock allocation practices of, the IPO underwriters. The complaint also contains a claim for violation of Section 10(b) of the Securities Exchange Act of 1934 based on allegations that this omission constituted a deceit on investors. The plaintiffs seek unspecified monetary damages and other relief. Similar complaints were filed in the same court against hundreds of other public companies that conducted IPOs of their common stock in the late 1990s. Although Chordiant and almost all of the other issuers have approved in principle a tentative settlement with the plaintiffs, it remains subject to a number of procedural conditions, as well as formal approval by the Court. This action may divert the efforts and attention of our management and, if determined adversely to us, could have a material impact on our business.

 

If our products do not operate effectively in a company-wide environment, we may lose sales and suffer decreased revenues.

 

If existing customers have difficulty deploying our products or choose not to fully deploy our products, it could damage our reputation and reduce revenues. Our success requires that our products be highly scalable, and able to accommodate substantial increases in the number of users. Our products are expected to be deployed on a variety of computer hardware platforms and to be used in connection with a number of third-party software applications by personnel who may not have previously used application software systems or our products. These deployments present very significant technical challenges, which are difficult or impossible to predict. If these deployments do not succeed, we may lose future sales opportunities and suffer decreased revenues.

 

Defects in our products could diminish demand for our products and result in decreased revenues, decreased market acceptance and injury to our reputation.

 

Errors may be found from time-to-time in our new, acquired or enhanced products. Any significant software errors in our products may result in decreased revenues, decreased sales, injury to our reputation and/or increased warranty and repair costs. Although we conduct extensive product testing during product development, we have in the past discovered software errors in our products as well as in third-party products, and as a result have experienced delays in the shipment of our new products. The latest major release of our primary product suite was introduced in December 2003.

 

To date, our sales have been concentrated in the financial services and telecommunications markets, and if we are unable to continue sales in these markets or successfully penetrate new markets, our revenues may decline.

 

Sales of our products and services in two large markets-financial services and telecommunications-accounted for approximately 82% and 80% of our total revenues for the three months ended March 31, 2004 and 2003, respectively.  We expect that revenues from these two markets will continue to account for a substantial portion of our total revenues in 2004. If we are unable to successfully increase penetration of our existing markets or achieve sales in additional markets, or if the overall economic climate of our target markets deteriorates, our revenues may decline.

 

Low gross margin in services revenues could adversely impact our overall gross margin and income.

 

Our services revenues have had lower gross margins than our license revenues. Service revenues comprised 54% and 70% of our total revenues for the three months ended March 31, 2004 and 2003, respectively. Gross margin on services revenues was 42% and 39% for the three months ended March 31, 2004 and 2003, respectively.  Gross margin on license revenues was 96% and 94% for the three months ended March 31, 2004 and 2003, respectively.  As a result, an increase in the percentage of total revenues represented by services revenues, or an unexpected decrease in license revenues, could have a detrimental impact on our overall gross margins. To increase services revenues, we must expand our services organization, successfully recruit and train a sufficient number of qualified services personnel and obtain renewals of current maintenance contracts by our customers. This expansion could further reduce gross margins in our services revenues.

 

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Because we have reduced the size of our workforce, we may not have the workforce necessary to support our platform of products if demand for our products substantially increased, and, if we need to rebuild our workforce in the future, we may not be able to recruit personnel in a timely manner, which could negatively impact the development and sales of our products.

 

In 2002 and 2003, we reduced the size of our workforce and may carry out further reductions in the future. Our recent reductions were intended to align our operating expenses with our revenue expectations. In the event that demand for our products increases as a result of a positive turn in the economy, we may need to rebuild our workforce or increase outsourced functions to companies based in foreign jurisdictions and we may be unable to hire, train or retain qualified personnel in a timely manner, which may weaken our ability to market our products in a timely manner, negatively impacting our operations. Our success depends largely on ensuring that we have adequate personnel to support our platform of products as well as the continued contributions of our key management, engineering, sales and marketing and professional services personnel.

 

If we fail to introduce new versions and releases of functional and scalable products in a timely manner, customers may license competing products and our revenues may decline.

 

If we are unable to ship or implement enhancements to our products when planned, or fail to achieve timely market acceptance of these enhancements, we may suffer lost sales and could fail to achieve anticipated revenues. We have in the past, and expect in the future, to derive a significant portion of our total revenues from the license of our primary product suite. Our future operating results will depend on the demand for the product suite by future customers, including new and enhanced releases that are subsequently introduced. If our competitors release new products that are superior to our products in performance or price, or if we fail to enhance our products or introduce new features and functionality in a timely manner, demand for our products may decline. We have in the past experienced delays in the planned release dates of new versions of our software products and upgrades. New versions of our products may not be released on schedule or may contain defects when released.

 

We depend on technology licensed to us by third parties, and the loss or inability to maintain these licenses could prevent or delay sales of our products.

 

We license from several software providers technologies that are incorporated into our products. We anticipate that we will continue to license technology from third parties in the future. This software may not continue to be available on commercially reasonable terms, if at all. While currently we are not materially dependent on any single third party for such licenses, the loss of the technology licenses could result in delays in the license of our products until equivalent technology is developed or identified, licensed and integrated into our products. Even if substitute technologies are available, there can be no guarantee that we will be able to license these technologies on commercially reasonable terms, if at all.

 

Defects in third party products associated with our products could impair our products' functionality and injure our reputation.

 

The effective implementation of our products depends upon the successful operation of third-party products in conjunction with our products. Any undetected errors in these third-party products could prevent the implementation or impair the functionality of our products, delay new product introductions or injure our reputation. In the past, while our business has not been materially harmed, product releases have been delayed as a result of errors in third-party software and we have incurred significant expenses fixing and investigating the cause of these errors.

 

Our customers and system integration partners may have the ability to alter our source code and resulting inappropriate alterations could adversely affect the performance of our products, cause injury to our reputation and increase operating expenses.

 

Customers and system integration partners may have access to the computer source code for certain elements of our products and may alter the source code. Alteration of our source code may lead to implementation, operation, technical support and upgrade problems for our customers. This could adversely affect the market acceptance of our products, and any necessary investigative work and repairs could cause us to incur significant expenses and delays in implementation.

 

If our products do not operate with the hardware and software platforms used by our customers, our customers may license competing products and our revenues will decline.

 

If our products fail to satisfy advancing technological requirements of our customers and potential customers, the market acceptance of these products could be reduced. We currently serve a customer base with a wide variety of constantly changing hardware, software applications and networking platforms. Customer acceptance of our products depends on many factors such as:

 

 

*

  Our ability to integrate our products with multiple platforms and existing or legacy systems;

 

 

*

  Our ability to anticipate and support new standards, especially Internet and enterprise Java standards; and

 

 

*

  The integration of additional software modules and third party software applications with our existing products.

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Our failure to successfully integrate with future acquired or merged companies and technologies could prevent us from operating efficiently.

 

Our business strategy includes pursuing opportunities to grow our business, both through internal growth and through merger, acquisition and technology and other asset transactions. To implement this strategy, we may be involved in merger and acquisition activity, additional technology and asset purchase transactions. Merger and acquisition transactions are motivated by many factors, including, among others, our desire to grow our business, acquire skilled personnel, obtain new technologies and expand and enhance our product offerings. Growth through mergers and acquisitions has several identifiable risks, including difficulties associated with successfully integrating distinct businesses into new organizations, the substantial management time devoted to integrating personnel, technology and entire companies, the possibility that we might not be successful in retaining the employees, undisclosed liabilities, the failure to realize anticipated benefits (such as cost savings and synergies) and issues related to integrating acquired technology, merged/acquired companies or content into our products (such as unanticipated expenses). Realization of any of these risks in connection with any technology transaction or asset purchase we have entered into, or may enter into, could have a material adverse effect on our business, operating results and financial condition.

 

If we become subject to intellectual property infringement claims, these claims could be costly and time-consuming to defend, divert management's attention, cause product delays and have an adverse effect on our revenues and net income.

 

We expect that software product developers and providers of software in markets similar to our target markets will increasingly be subject to infringement claims as the number of products and competitors in our industry grows and the functionality of products overlap. Any claims, with or without merit, could be costly and time-consuming to defend, divert our management's attention or cause product delays. If any of our products were found to infringe a third party's proprietary rights, we could be required to enter into royalty or licensing agreements to be able to sell our products. Royalty and licensing agreements, if required, may not be available on terms acceptable to us or at all.

 

 

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Item 3. Quantitative and Qualitative Disclosures about Market Risk.

We are exposed to the impact of interest rate changes, foreign currency fluctuations and change in the market values of our investments. The following table presents the amounts of short-term investments and restricted cash that are subject to interest rate risk by year of expected maturity and average interest rates as of March 31, 2004 (in thousands):

 

 
  2004
  Fair Value
 
Short-term investments and restricted cash    $

581

   $

581

 
Average interest rates
 

 
1.60

 


 

Interest Rate Risk.    Our exposure to market rate risk for changes in interest rates relates primarily to our investment portfolio. We have not used derivative financial instruments to hedge our investment portfolio. We invest excess cash in debt instruments of the U.S. Government and its agencies, and in high-quality corporate issuers and, by policy, limit the amount of credit exposure to any one issuer. We protect and preserve invested funds by limiting default, market and reinvestment risk. Investments in both fixed rate and floating rate interest earning instruments carries a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities, which have declined in market value due to changes in interest rates.

Foreign Currency Risk.    International revenues from our foreign subsidiaries accounted for approximately 84% and 85% of total revenues for the three months ended March 31, 2004 and 2003, respectively. International sales are made mostly from our foreign sales subsidiaries in their respective countries and are typically denominated in the local currency of each country. These subsidiaries also incur most of their expenses in the local currency. Accordingly, all foreign subsidiaries use the local currency as their functional currency.

 

Additionally, one of our foreign subsidiaries holds cash equivalent investments in currencies other than its respective local currency. Such holdings increase our exposure to foreign exchange rate fluctuations. As exchange rates vary, the holdings may magnify foreign currency exchange rate fluctuations or upon translation or adversely impact overall expected profitability through foreign currency losses incurred upon the sale or maturity of the investments. Foreign currency losses, net for the three months ended March 31, 2004 were $0.2 million.   Foreign currency gains, net for the three months ended March 31, 2003 were $0.1 million.  

 

Our international business is subject to risks, including, but not limited to changing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility when compared to the United States. Accordingly, our future results could be materially adversely impacted by changes in these or other factors.

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Item 4. Controls and Procedures.

(a) Evaluation of disclosure controls and procedures

 We carried out an evaluation, as of March 31, 2004, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-14(c) under the Exchange Act). Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that material information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms.

 (b) Changes in internal controls

Such evaluation did not identify any significant changes in our internal controls over financial reporting that occurred during the quarter ended March 31, 2004 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

 (c) Limitations on the Effectiveness of Controls.

 The Company's management, including the Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error, mistake or circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. We believe, however, our disclosure controls and procedures are designed to provide a reasonable level of assurance of achieving our disclosure control objectives and that our disclosure controls and procedures are effective in achieving that level of reasonable assurance.

PART II - OTHER INFORMATION.

Item 1.  Legal Proceedings

Information with respect to this Item may be found in Note 6 of Notes to Condensed Consolidated Financial Statements in this Form 10-Q, which information is incorporated into this Item 1 by reference.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

The exhibits listed on the accompanying index to exhibits are filed or incorporated by reference (as stated therein) as part of this Quarterly Report on Form 10-Q.

(b) Reports on Form 8-K

On January 29, 2004, the Company furnished a Current Report on Form 8-K which announced the Company's financial results for the quarter and year ended December 31, 2003 and certain other information. 

On January 26, 2004, the Company filed a Current Report on Form 8-K which announced the Company's $25 million private placement transaction.

On January 20, 2004, the Company filed a Current Report on Form 8-K announcing the appointment of Steven R. Springsteel as a Class II Director and the resignation of George Reyes as a Class II Director effective after the Company files its Annual Report on Form 10-K. 

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Chordiant Software, Inc.


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.

Dated: May 10, 2004

 

Chordiant Software, Inc.

  (Registrant)

  /s/ Michael J. Shannahan
 
  Michael J. Shannahan
  Senior Vice President of Finance and Chief Financial Officer
  (Principal Financial and Accounting Officer)

                                                                                                                                                            

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EXHIBIT INDEX

 

     
Exhibit
Number

 
    
2.1    Stock Purchase Agreement, dated July 19, 2000, between Chordiant Software, Inc., White Spider Software, Inc. and the Sellers of capital stock of White Spider Software, Inc. (filed as Exhibit 99.1 with Chordiant's Current Report on Form 8-K (No. 000-29357) filed on August 3, 2000 and incorporated herein by reference).
2.2    Agreement and Plan of Merger and Reorganization, dated as of January 8, 2001, by and among Chordiant Software, Inc., Puccini Acquisition Corp. and Prime Response, Inc. (included as Annex A to the joint proxy statement/prospectus filed with Amendment No. 1 to Chordiant's Registration Statement on Form S-4 (No. 333-54856) filed on February 26, 2001 and incorporated herein by reference).
2.3    Agreement and Plan of Merger and Reorganization, dated as of March 28, 2002, by and among Chordiant Software, Inc., OnDemand Acquisition Corp. and OnDemand, Inc. (filed as Exhibit 2.1 to Chordiant's Current Report on Form 8-K filed on April 12, 2002 and incorporated herein by reference).
3.1    Amended and Restated Certificate of Incorporation of Chordiant Software, Inc. (filed as Exhibit 3.1 with Chordiant's Registration Statement on Form S-1 (No. 333-92187) filed on December 6, 1999 and incorporated herein by reference).
3.2    Amended and Restated Bylaws of Chordiant Software, Inc. (filed as Exhibit 3.2 with Chordiant's Registration Statement on Form S-1 (No. 333-92187) filed on December 6, 1999 and incorporated herein by reference).
4.1    Specimen Common Stock Certificate (filed as Exhibit 4.2 with Amendment No. 2 to Chordiant's Registration Statement on Form S-1 (No. 333-92187) filed on February 7, 2000 and incorporated herein by reference).
4.2    Warrant agreement, dated August 12, 2002, by and between Chordiant Software, Inc. and International Business Machines Corporation ("IBM") (filed as Exhibit 4.5 to Chordiant's Quarterly Report on Form 10-Q filed on May 15, 2003 and incorporated herein by reference).
4.3    Registration Rights Agreement, dated January 22, 2004, by and between Chordiant Software, Inc., and Acqua Wellington Opportunity I Limited (filed as Exhibit 4.5 to Chordiant's Current Report on Form 8-K filed on January 26, 2004 and incorporated herein by reference)
4.4    Warrant, dated February 28, 1999, issued to GAP Coinvestment Partners II, L.P. (filed as Exhibit 10.19 with Prime Response's Registration Statement on Form S-1 (No. 333-92461) filed on December 10, 1999 and incorporated herein by reference).
4.5    Warrant, dated December 9, 1999, issued to General Atlantic Partners 52, L.P. (filed as Exhibit 10.20 with Prime Response's Registration Statement on Form S-1 (No. 333-92461) filed on December 10, 1999 and incorporated herein by reference).
4.6    Warrant, dated December 9, 1999, issued to Accenture (Formerly known as Andersen Consulting), L.P. (filed as Exhibit 10.25 with Prime Response's Registration Statement on Form S-1 (No. 333-92461) filed on December 10, 1999 and incorporated herein by reference).
4.7    Warrant, dated December 9, 1999, issued to Accenture (Formerly known as Andersen Consulting), L.P. (filed as Exhibit 10.26 with Prime Response's Registration Statement on Form S-1 (No. 333-92461) filed on December 10, 1999 and incorporated herein by reference).
4.8    Warrant, dated December 9, 1999, issued to Accenture (Formerly known as Andersen Consulting), L.P. (filed as Exhibit 10.27 with Prime Response's Registration Statement on Form S-1 (No. 333-92461) filed on December 10, 1999 and incorporated herein by reference).
10.3   1999 Non-Employee Directors' Plan as amended and restated.
10.25   Purchase Agreement by and between Chordiant and Acqua Wellington Opportunity I Limited, dated January 22, 2004 (filed as exhibit 99.1 to Amendment No. 1 to  Chordiant's Registration Statement on Form S-3 (File No. 333-112698) filed on March 30, 2004).
23.1    Consent of Independent Accountants.
24.1    Power of Attorney (filed as Exhibit 24.1 to Chordiant's Annual Report on Form 10-K filed on March 8, 2004 and incorporated herein by reference).
31.1    Certification required by Rule 13a-14(a) or Rule15d-14(a).
31.2    Certification required by Rule 13a-14(a) or Rule15d-14(a).
32.1    Certification required by Rule 13a-14(a) or Rule15d-14(a) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350).
     

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