SERENA SOFTWARE INC - 10-Q Quarterly Report

SERENA SOFTWARE, INC.
(Exact name of registrant as specified in its charter)

DELAWARE
(State or other jurisdiction of
incorporation or organization)

94-2669809
(I.R.S. Employer Identification No.)

2755 CAMPUS DRIVE, 3^rd FLOOR, SAN MATEO, CALIFORNIA 94403-2538
(Address of principal executive offices, including zip code)

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

The number of shares of the registrant's Common Stock, par value $0.001, outstanding as of November 30, 2002 was 40,636,408.

SERENA SOFTWARE, INC.
Condensed Consolidated Balance Sheets
(In thousands, except share data)
(Unaudited)

SERENA SOFTWARE, INC.
Condensed Consolidated Statements of Income and Comprehensive Income
For the Three Months and Nine Months Ended October 31, 2002 and 2001
(In thousands, except per share data)
(Unaudited)

SERENA SOFTWARE, INC.
Condensed Consolidated Statements of Cash Flows
For the Nine Months Ended October 31, 2002 and 2001
(In thousands)
(Unaudited)

SERENA Software, Inc. ("SERENA" or the "Company") is an industry-leading provider of software infrastructure products and consulting best practices that automate enterprise software and Web content changes. Its principal markets are North America, and to a lesser extent, Europe.

The accompanying unaudited condensed consolidated financial statements have been prepared on substantially the same basis as the audited consolidated financial statements, and in the opinion of management include all adjustments, consisting only of normal recurring adjustments, except as otherwise noted, necessary for their fair presentation. These unaudited condensed consolidated financial statements and the notes thereto have been prepared in accordance with the Instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all disclosures required by accounting principles generally accepted in the United States of America and Regulation S-X for annual financial statements. For these additional disclosures, readers should refer to the Company's annual report on Form 10-K for the fiscal year ended January 31, 2002. The interim results presented are not necessarily indicative of results for any subsequent quarter or for the fiscal year ending January 31, 2003.

Basic net income per share is computed using the weighted-average number of shares of common stock outstanding. Diluted net income per share is computed using the weighted-average number of shares of common stock outstanding and, when dilutive, potentially dilutive common shares from restricted stock and options to purchase common stock using the treasury stock method.

The following is a reconciliation of the shares used in the computation of basic and diluted net income per share (in thousands):

Options to purchase shares of common stock at a share price which is greater than the closing market price of the shares at the balance sheet date are not included in the computation of diluted earnings per share because the effect of their inclusion would be anti-dilutive. For each of the periods ended October 31, 2002 and 2001, 3,141,666 and 2,507,041, respectively, of options to purchase shares of common stock at an average share price of $20.86 and $22.77, respectively, were excluded from the computation of diluted EPS.

In August 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 requires an enterprise to record the fair value of an asset retirement obligation as a liability in the period in which it incurs a legal obligation associated with the retirement of a tangible long-lived

asset. SFAS No. 143 also requires an enterprise to record the contra to the initial obligation as an increase in the carrying amount of the related long-lived asset (i.e., the associated asset retirement costs) and to depreciate that cost over the remaining useful life of the asset. The amount of the asset retirement obligation is revised at the end of each period to reflect the passage of time (i.e., accretion expense) and changes in the estimated future cash flows underlying the initial fair value measurement. The Company is required to adopt SFAS No. 143 as of February 1, 2003. The Company does not expect SFAS No. 143 to have a material impact on its financial position or results of operations.

In April 2002, the FASB issued SFAS No. 145, "Recission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." Among other provisions, SFAS 145 rescinds SFAS 4, "Reporting Gains and Losses from Extinguishment of Debt." Accordingly, gains or losses from extinguishment of debt that do not meet the criteria of APB No. 30 should be reclassified to income from continuing operations in all prior periods presented. SFAS 145 is effective for fiscal years beginning after May 15, 2002. The Company plans to adopt SFAS 145 beginning in its fiscal year 2004. The effect of adopting SFAS 145 is not expected to have a material effect on the Company's consolidated financial position or results of operations.

In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 eliminates Emerging Issues Task Force, or EITF, Issue No. 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)." Under SFAS No. 146, liabilities for costs associated with an exit or disposal activity are recognized when the liabilities are incurred, as opposed to being recognized at the date of entity's commitment to an exit plan under EITF No. 94-3. Furthermore, SFAS No. 146 establishes that fair value is the objective for initial measurement of the liabilities. This Statement will be effective for exit or disposal activities that are initiated after December 31, 2002. The effect of adopting SFAS 146 is not expected to have a material effect on the Company's consolidated financial position or results of operations.

On August 6, 2001, in response to the general weakening of the worldwide economy and resulting IT spending slowdown, the Company announced and began to execute its plan to reduce workforce by approximately 12% or 45 positions affecting all parts of the organization and incur costs associated with the closure of facilities. The Company has realized and expects to continue to realize cost savings going forward as a result of this reduction and other cost savings initiatives implemented. The Company's reduction in work force and closure of facilities are substantially complete, and in connection with these actions, the Company recorded a restructuring charge in the third quarter of fiscal 2002 consisting principally of severance, payroll taxes and other employee benefits totaling $1.5 million and

facilities closures totaling $1.0 million. The nature of the restructuring charges and the amounts paid through and accrued as of October 31, 2002 are summarized as follows (in thousands):

	Total		Paid		Accrued as of October 31, 2002
Severance, payroll taxes and other employee benefits	$	1,483	$	1,135	$	348
Facilities closures		875		532		343
Legal and other miscellaneous		70		65		5

Total restructuring accrual		2,428	$	1,732	$	696

Fixed asset impairment		101

Total restructuring charges	$	2,529

In July 2001, the FASB approved the issuance of SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 provides guidance on how to account for goodwill and certain intangible assets after an acquisition is completed. The most substantive change is that goodwill and other indefinite life intangible assets can no longer be amortized but instead should be periodically tested for impairment. This statement applies to existing goodwill and intangible assets beginning with fiscal years starting after December 15, 2001. In the fiscal quarter ended April 30, 2002, the Company reevaluated its intangible asset lives and no adjustment to any of the useful lives was determined to be necessary. In the fiscal quarter ended July 31, 2002 and in accordance with Statement No. 142, the Company completed its initial transitional goodwill impairment test and concluded that there was no impairment of goodwill as of February 1, 2002. The annual impairment test required by SFAS No. 142 will be performed in the fourth fiscal quarter. No reclassification of intangible assets apart from goodwill was necessary as a result of the adoption of Statement No. 142. We have also stopped the amortization of approximately $29.2 million of goodwill beginning February 1, 2002. This reduction in amortization effective February 1, 2002 may affect the comparability of current period results of operations with prior periods.

The following table discloses what reported net income and basic and diluted earnings per share would have been in all periods presented exclusive of amortization expense (including tax related effects, reported in thousands, except for per share amounts):

In the second fiscal quarter ended July 31, 2002, the Company settled a dispute with the former principals of UltiMIS Corporation and as a result paid $710,000 of the $2.6 million earn-out consideration previously accrued. The Company also reversed $1.9 million of the earn-out in the second fiscal quarter ended July 31, 2002. The following table details the change in goodwill and work-force-in-place (in thousands):

Balance as of January 31, 2002	$	29,165
Contingent consideration accrued (reversed) for the UltiMIS acquisition, net		(290	)

Balance as of October 31, 2002	$	28,875

Intangible assets subject to amortization, net, consisted of the following (in thousands):

	Useful Life	As of October 31, 2002		As of January 31, 2002
Acquired technology	5 to 7 years	$	27,626	$	27,626
Non-compete agreements	1 year or less		944		944

			28,570		28,570
Less: accumulated amortization			11,005		7,600

		$	17,565	$	20,970

In August 2002, our Board of Directors authorized the repurchase of up to 1.0 million shares of our Common Stock from time to time in the open market or in privately negotiated block transactions. The Company will utilize any reacquired shares under this program for reissuance in connection with employee stock programs and general corporate purposes. In September 2002, the Company repurchased 71,000 shares of its common stock for cash at an average price of $11.68 per share. The timing and size of any future stock repurchases are subject to market conditions, stock prices, our cash position and other cash requirements going forward.

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

This report contains forward-looking statements under the Private Securities Reform Act of 1995. Certain statements under the captions "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this report are "forward-looking statements." These forward-looking statements include, but are not limited to, statements about our plans, objectives, expectations and intentions and other statements contained in this report that are not historical facts. When used in this report, the words "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates" and similar expressions are generally intended to identify forward-looking statements. Because these forward-looking statements involve risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements, including our plans, objectives, expectations and intentions and other factors discussed under "Factors That May Affect Future Results" under "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in, or incorporated by reference into, this report. Factors that could cause or contribute to such differences include but are not limited to, our reliance on our mainframe products for revenue; the percentage of license revenue typically closed at the end of each quarter making estimation of operating results prior to the end of the quarter extremely uncertain; weak economic conditions worldwide which may continue to affect the overall demand for software and services, which could result in decreased revenues or lower revenue growth rates; changes in revenue mix and seasonality; our ability to deliver our products on the distributed systems platform; dependence on revenues from our installed base; continued demand for additional mainframe MIPS capacity; expansion of our professional services and international organizations; and our ability to manage our growth. We assume no obligation to update the forward-looking information contained in this report. It is important that the discussion below be read together with the attached condensed consolidated financial statements and notes thereto, with the discussion of such risks and uncertainties and with the audited financial statements and notes thereto, and the "Management's Discussion and Analysis of Financial Condition and Results of Operations," contained in the Company's Form 10-K for fiscal 2002.

SERENA Software, Inc. is an industry leading provider of software infrastructure products and consulting best practices that automate enterprise software and Web content changes. SERENA's Enterprise Change Management ("ECM") strategy manages the Software Change Management ("SCM") process throughout the entire application development lifecycle across multiple platforms—from the mainframe to the Web.

In the most recent completed fiscal year ended January 31, 2002 and the first nine months of fiscal 2003 ending October 31, 2002, SERENA experienced a decrease in total revenue as total annual revenues were $98.6 million in fiscal 2002, versus $103.6 million in fiscal 2001 and $69.7 million in the first nine months of fiscal 2003 versus $74.2 million in the first nine months of fiscal 2002. The overall demand for the Company's software depends in large part on general and economic business conditions. The recent general weakening of the worldwide economy and resulting slowdown in IT spending contributed to the overall decrease in total revenues.

Prior to fiscal 2002, SERENA had grown rapidly as total revenue increased incrementally from $32.1 million in fiscal 1998 to $103.6 million in fiscal 2001. The growth in total revenue has been primarily attributable to increased demand for our mainframe products, and to a lesser extent beginning in the second half of fiscal 2000, the introduction of our distributed systems products, primarily ChangeMan DS, into the marketplace. In general, demand had been increasing as a result of greater awareness of and need for automated third party ECM solutions. We derive our revenue from software licenses, maintenance and professional services.

Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgements that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an ongoing basis, management evaluates its estimates and judgments, including those related to revenue recognition, trade accounts receivable and allowance for doubtful accounts, and accounting for income taxes.

Revenue Recognition. SERENA recognizes revenues in accordance with SOP 97-2, Software Revenue Recognition, as amended by SOP 98-9, and generally recognizes revenues when all of the following criteria are met as set forth in paragraph 8 of SOP 97-2: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred, (3) the fee is fixed or determinable and (4) collectibility is probable. SERENA defines each of these four criteria as follows:

Persuasive evidence of an arrangement exists. It is SERENA's customary practice to have a written contract, which is signed by both the customer and SERENA, or a purchase order from those customers who have previously negotiated a standard license arrangement with SERENA.

Delivery has occurred. SERENA's software is physically delivered to the customer. If an arrangement includes undelivered products or services that are essential to the functionality of the delivered product, delivery is not considered to have occurred until these products or services are delivered.

The fee is fixed or determinable. SERENA's policy is to not provide customers the right to a refund of any portion of their license fees paid. SERENA may agree to payment terms with a foreign customer based on local customs. Generally, at least 80% of the arrangement fees are due within one year or less. Arrangements with payment terms extending beyond these customary payment terms are considered not to be fixed or determinable, and revenues from such arrangements are recognized as payments become due and payable.

Collectibility is probable. Collectibility is assessed on a customer-by-customer basis. SERENA typically sells to customers for whom there is a history of successful collection. If it is determined from the outset of an arrangement that collectibility is not probable, revenues are recognized as cash is collected.

For contracts with multiple elements (e.g., license and maintenance), revenue is allocated to each component of the contract based on vendor specific objective evidence ("VSOE") of its fair value, which is the price charged when the elements are sold separately. Since VSOE has not been established for license transactions, the residual method is used to allocate revenue to the license portion of multiple-element transactions.

The Company sells its products to its end users and distributors under license agreements. Each new mainframe license includes maintenance, which includes the right to receive telephone support, "bug fixes" and unspecified upgrades and enhancements, for a specified duration of time, usually one year. The fee associated with such agreements is allocated between software license revenue and maintenance revenue based on their respective fair values as determined based on list price. Software license revenue from these agreements is recognized upon receipt and acceptance of a signed contract and delivery of the software, provided the related fee is fixed and determinable, collectibility of the revenue is probable and the arrangement does not involve significant customization of the software. If an acceptance period is required, revenue is recognized upon the earlier of customer acceptance or the expiration of the acceptance period, as defined in the applicable software license agreement.

The Company recognizes maintenance revenue ratably over the life of the related maintenance contract. Maintenance contracts on perpetual licenses generally renew annually. The Company typically invoices and collects maintenance fees on an annual basis at the anniversary date of the license. Service and other revenue includes fees derived from the delivery of training, installation, and consulting services. Revenue from training, installation, and consulting services is recognized on a time and materials basis as the related services are performed. These services do not involve significant production, modification or customization of the software and the services are not essential to the functionality of the software. Deferred revenue represents amounts received by the Company in advance of performance of the maintenance obligation.

Trade Accounts Receivable and Allowance for Doubtful Accounts. Trade accounts receivable are recorded net of allowance for doubtful accounts. We regularly review the adequacy of our allowance for doubtful accounts through identification of specific receivables where we expect that payment will likely not be received, and we have established a general reserve policy that is applied to all amounts that are not specifically identified. In determining specific receivables where collection may not be received, we review past due receivables and give consideration to prior collection history, changes in the customer's overall business condition, the potential risk associated with the customer's industry or political and economic environment among other factors. We establish a general reserve for all receivable amounts that have not been specifically identified, by applying a graduated percentage to each invoice's relative aging category. The allowance for doubtful accounts reflects our best estimate as of the reporting dates. Changes may occur in the future, which may make us reassess the collectibility of amounts and at which time we may need to provide additional allowances in excess of that currently provided.

Accounting for Income Taxes. Income taxes are recorded using the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

References to the dollar and percentage increases or decreases set forth below in this discussion and analysis of SERENA's results of operations are derived from comparisons between SERENA's condensed consolidated statements of income and comprehensive income for the three and nine month periods ended October 31, 2002 to the condensed consolidated statements of income and comprehensive income for the three and nine month periods ended October 31, 2001.

The following table sets forth our results of operations expressed as a percentage of total revenue. These operating results for the periods presented are not necessarily indicative of the results for the full fiscal year or any other period.

		Percentage of Revenue Three Months Ended October 31,		Percentage of Revenue Nine Months Ended October 31,
		2002		2001		2002		2001
Revenue:
	Software licenses		47	%	48	%	45	%	50	%
	Maintenance		45	%	45	%	47	%	42	%
	Professional services		8	%	7	%	8	%	8	%

		Total revenue		100	%	100	%	100	%	100	%

Cost of revenue:
	Software licenses		1	%	1	%	1	%	1	%
	Maintenance		6	%	6	%	6	%	6	%
	Professional services		7	%	6	%	7	%	7	%

		Total cost of revenue		14	%	13	%	14	%	14	%

		Gross profit		86	%	87	%	86	%	86	%

Operating expenses:
	Sales and marketing		27	%	29	%	28	%	31	%
	Research and development		12	%	14	%	13	%	14	%
	General and administrative		7	%	7	%	7	%	7	%
	Stock-based compensation		—		—		—		—
	Amortization of intangible assets, including goodwill in 2001		5	%	9	%	5	%	8	%
	Restructuring charges		—		11	%	—		3	%

		Total operating expenses		51	%	70	%	53	%	63	%

Operating income		35	%	17	%	33	%	23	%
Interest and other income, net		5	%	7	%	5	%	6	%

	Income before income taxes		40	%	24	%	38	%	29	%
Income taxes		15	%	10	%	14	%	12	%

	Net income		25	%	14	%	24	%	17	%

We derive revenue from software licenses, maintenance and professional services. Our total revenue increased $1.4 million or 6% to $24.6 million in the current fiscal quarter ended October 31, 2002 from $23.2 million in the same quarter a year ago. For the nine months ended October 31, 2002, total revenue decreased $4.5 million or 6% to $69.7 million from $74.2 million in the same nine month period a year ago. International sales represented approximately 36% and 30% of our total revenue in the current fiscal quarter and fiscal nine months ended October 31, 2002, respectively, as compared to 15% and 20% in the same quarter and nine months a year ago. International sales as a percentage of total revenues were greater in the current fiscal quarter and fiscal nine months, when compared to the same periods a year ago, in part due to several large transactions with one international customer in fiscal 2003. This single customer accounted for 16% of total revenue in the first nine months of fiscal 2003. No single customer accounted for 10% or more of total revenue in the same nine months a year ago.

Software Licenses. Software licenses revenue as a percentage of total revenue was 47% and 45% in the current fiscal quarter and fiscal nine months ended October 31, 2002, respectively, as compared to 48% and 50% in the same quarter and nine months a year ago. Software licenses revenue increased $0.4 million or 4% to $11.5 million in the current fiscal quarter from $11.1 million in the same quarter a year ago. For the nine month period ended October 31, 2002, software licenses revenue decreased $5.7 million or 15% to $31.5 million from $37.2 million in the same nine months a year ago. For the current fiscal quarter, when compared to the same quarter a year ago, the dollar increase is predominantly due to higher sales of our distributed systems products which grew 81% quarter over quarter, all partially offset by a decrease in sales from our mainframe ChangeMan products as a result of the continued slowdown in IT spending. For the current fiscal nine months ended October 31, 2002, when compared to the same nine months a year ago, the dollar decrease is generally attributable to a slowdown in IT spending as a result of the weak economic conditions in the U.S. and abroad and, to a lesser extent, sales execution delays and customers negotiating more aggressively on price and terms. For the current fiscal nine months, when compared to the same nine months a year ago, the slowdown in IT spending manifested itself in lower sales of our Comparex, StarTool FDM and ChangeMan ZMF products, all partially offset by increases in our ChangeMan ALM, ChangeMan DS, StarTool DA and StarTool APM products. In particular, sales of our ChangeMan ZMF, ChangeMan DS and Comparex products continue to make up a significant portion of our total software licenses revenue. These products accounted for $7.7 million or 67% and $20.3 million or 64% of total software licenses revenue in the current fiscal quarter and fiscal nine months ended October 31, 2002, respectively, as compared to $8.6 million or 77% and $26.7 million or 72% in the same quarter and nine months a year ago. The Company expects that its distributed systems revenues as a percentage of software licenses revenue will increase over time, and that ChangeMan ZMF, ChangeMan DS and Comparex will continue to account for a substantial portion of software licenses revenue in the future. We may experience a decrease or little growth in license revenue in the near term.

Maintenance. Maintenance revenue as a percentage of total revenue was 45% and 47% in the current fiscal quarter and fiscal nine months ended October 31, 2002, respectively, as compared to 45% and 42% in the same quarter and nine months a year ago. Maintenance revenue increased $0.7 million or 7% to $11.2 million in the current fiscal quarter from $10.5 million in the same quarter a year ago. For the nine months ended October 31, 2002, maintenance revenue increased $1.8 million or 6% to $33.0 million from $31.2 million in the same nine months a year ago. For both the quarter and nine months, the dollar increase reflects growth in installed software licenses base, as new licenses generally include one year of maintenance, renewals of maintenance agreements by existing customers and, to a lesser extent, maintenance price increases; all partially offset by some cancellations in Comparex maintenance contracts when the general weakening of the economy in the U.S. and abroad caused some customers to reevaluate and restrict IT spending. For the current fiscal nine months ended October 31, 2002, when compared to the same nine months a year ago, maintenance revenue as a percentage of total revenue increased as a result of reduced license revenues resulting from the general weakening of the economy and slowdown in IT spending which began predominantly in the second quarter of fiscal 2002.

Professional Services. Professional services revenue as a percentage of total revenue was 8% in both the current fiscal quarter and fiscal nine months ended October 31, 2002, as compared to 7% and 8% in the same quarter and nine months, respectively, a year ago. Professional services revenue increased $0.2 million or 12% to $2.0 million in the current fiscal quarter from $1.8 million in the same quarter a year ago. For the nine months ended October 31, 2002, professional services revenue decreased $0.6 million or 10% to $5.3 million from $5.9 million in the same nine months a year ago. For the current fiscal quarter ended October 31, 2002, when compared to the same quarter a year ago, the dollar increase is generally attributable to greater consulting opportunities resulting from our larger installed customer base and our expanded consulting service capabilities, all partially offset by the continued weak U.S. economy. For the fiscal nine months ended October 31, 2002, when compared to

the same nine months a year ago, the dollar decrease is predominantly the result of a weak U.S. economy which generated declining license revenues and therefore fewer consulting opportunities and the deferral of existing consulting projects, all of which began predominantly in the second quarter of fiscal 2002.

Cost of revenue, which consists of cost of software licenses, cost of maintenance and cost of professional services, was 14% in both the current fiscal quarter and fiscal nine months ended October 31, 2002, as compared to 13% and 14% in the same quarter and nine months, respectively, a year ago. Cost of revenue increased $0.4 million or 14% to $3.6 million in the current fiscal quarter from $3.2 million in the same quarter a year ago. For the nine months ended October 31, 2002, cost of revenue decreased $0.2 million or 2% to $9.9 million from $10.1 million in the same nine months a year ago. In absolute dollar terms, the increase in the current fiscal quarter and the decrease in the current fiscal nine months, when compared to the same quarter and nine months a year ago, is consistent with the increase quarter over quarter and decrease nine months over nine months in total revenues. As a percentage of total revenue, cost of revenue has remained constant for the current fiscal quarter and fiscal nine months and the same periods a year ago as margins in software licenses, maintenance and professional services have remained constant over these same periods.

Software Licenses. Cost of software licenses consists principally of fees associated with our StarTool FDM products and, to a lesser extent, salaries, bonuses and other costs associated with our product release organization, and fees associated with integrating third party technology into our ChangeMan DS, ChangeMan ALM and ChangeMan ECP distributed systems products. Cost of software licenses as a percentage of total software licenses revenue was 3% in both the current fiscal quarter and fiscal nine months ended October 31, 2002 as compared to 3% and 2% in the same quarter and nine months, respectively, a year ago. Cost of software licenses increased $0.1 million or 10% to $0.4 million in the current fiscal quarter from $0.3 million in the same quarter a year ago. For the nine months ended October 31, 2002, cost of software licenses increased $0.3 million or 48% to $0.9 million from $0.6 million in the same nine months a year ago. In both percentage and absolute dollar terms, the increase is primarily due to increases in fees associated with our StarTool FDM products and, to a lesser extent, fees associated with integrating third party technology into our distributed systems products.

Maintenance. Cost of maintenance consists primarily of salaries, bonuses and other costs associated with our customer support organizations. Cost of maintenance as a percentage of total maintenance revenue was 13% in both the current fiscal quarter and fiscal nine months ended October 31, 2002 as compared to 12% and 13% in the same quarter and nine months, respectively, a year ago. Cost of maintenance increased $0.1 million or 10% to $1.4 million in the current fiscal quarter from $1.3 million in the same quarter a year ago. For the nine months ended October 31, 2002, cost of maintenance increased $0.1 million or 1% to $4.2 million from $4.1 million in the same nine months a year ago. For both the current fiscal quarter and fiscal nine months, when compared to the same quarter and nine months a year ago, the absolute dollar increase in cost of maintenance is primarily attributable to increases in expenses associated with our customer support organizations as a result of the growth in maintenance revenue, all partially offset by cost savings initiatives put in place as part of the Company's restructuring plans announced early in the third fiscal quarter of 2002. For both the current fiscal quarter and fiscal nine months ended October 31, 2002, when compared to the same quarter and nine months a year ago, cost of maintenance as a percentage of total maintenance revenue remained constant for all periods presented.

Professional Services. Cost of professional services consists of salaries, bonuses and other costs associated with supporting our professional services organization. Cost of professional services as a

percentage of total professional services revenue was 91% and 90% in the current fiscal quarter and fiscal nine months ended October 31, 2002, respectively, as compared to 86% and 89% in the same quarter and nine months a year ago. Cost of professional services increased $0.3 million or 19% to $1.8 million in the current fiscal quarter from $1.5 million in the same quarter a year ago. For the nine months ended October 31, 2002, cost of professional services decreased $0.5 million or 10% to $4.7 million from $5.2 million in the same nine months a year ago. For the current fiscal quarter, when compared to the same quarter a year ago, the dollar increase is attributable to increases in third party contractor costs associated with supporting the increase in professional services revenues. For the fiscal nine months ended October 31, 2002, when compared to the same nine months a year ago, the dollar decrease is attributable to a decrease in professional services revenues and cost savings initiatives put in place as part of the Company's restructuring plans announced early in the third fiscal quarter of fiscal 2002.

Sales and Marketing. Sales and marketing expenses consist primarily of salaries, commissions and bonuses, payroll taxes, and employee benefits as well as travel, entertainment and marketing expenses. Sales and marketing expenses as a percentage of total revenue were 27% and 28% in the current fiscal quarter and fiscal nine months ended October 31, 2002, respectively, as compared to 29% and 31% in the same quarter and nine months a year ago. Sales and marketing expenses decreased $0.3 million or 4% to $6.5 million in the current fiscal quarter from $6.8 million in the same quarter a year ago. For the nine months ended October 31, 2002, sales and marketing expenses decreased $3.4 million or 15% to $19.5 million from $22.9 million in the same nine months a year ago. For both the current fiscal quarter and fiscal nine months, when compared to the same quarter and nine months a year ago, the decreases in sales and marketing expenses as a percentage of total revenue and in absolute dollar terms are attributable to cost savings initiatives put in place as part of the Company's restructuring plans announced early in the third fiscal quarter of 2002. In absolute dollar terms, we expect sales and marketing expenses to increase as we continue to hire additional sales and marketing personnel, market our distributed systems products and undertake additional marketing programs.

Research and Development. Research and development expenses consist primarily of salaries, bonuses, payroll taxes, and employee benefits and costs attributable to research and development activities. Research and development expenses as a percentage of total revenue were 12% and 13% in the current fiscal quarter and fiscal nine months ended October 31, 2002, respectively, as compared to 14% in both the same quarter and nine months a year ago. Research and development expenses decreased $0.1 million or 5% to $3.0 million in the current fiscal quarter from $3.1 million in the same quarter a year ago. For the nine months ended October 31, 2002, research and development expenses decreased $1.6 million or 15% to $8.9 million from $10.5 million in the same nine months a year ago. For both the current fiscal quarter and fiscal nine months, when compared to the same quarter and nine months a year ago, the decreases in research and development expenses as a percentage of total revenue and in absolute dollar terms are primarily attributable to cost savings initiatives put in place as part of the Company's restructuring plans announced early in the third fiscal quarter of 2002, partially offset by the continued expansion of our research and development efforts to enhance existing products and develop our distributed systems products. We expect research and development expenses to increase, both in absolute dollar terms and as a percentage of total revenue, as we continue to hire additional research and development personnel primarily to develop our distributed systems product suite.

General and Administrative. General and administrative expenses consist primarily of salaries, bonuses, payroll taxes, and benefits and certain non-allocable administrative costs, including legal and accounting fees and bad debts. General and administrative expenses as a percentage of total revenue were 7% for the current fiscal quarter and fiscal nine months ended October 31, 2002 as well as for the same quarter and nine months a year ago. General and administrative expenses increased $0.2 million or 12% to $1.8 million in the current fiscal quarter from $1.6 million in the same quarter a year ago. For the nine months ended October 31, 2002, general and administrative expenses increased $0.3 million or 5% to $5.2 million from $4.9 million in the same nine months a year ago. General and administrative expenses were unchanged as a percentage of total revenue for all periods presented, and in absolute dollars increased only slightly for all periods presented predominantly due to increases in infrastructure and insurance costs, all partially offset by efficiency gains and cost controls put in place as part of the Company's restructuring plans announced early in the third fiscal quarter of 2002. We expect general and administrative expenses to increase in absolute dollar terms as we expand our infrastructure and our operations in the future.

Amortization of Goodwill and Other Intangible Assets. In July 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangibles, which the Company has adopted effective February 1, 2002. Accordingly, with the commencement of fiscal 2003, the Company no longer amortizes goodwill but instead reviews goodwill for impairment annually. On a prospective basis, we expect amortization expense for our intangible assets with finite lives to be approximately $1.1 million per quarter through fiscal 2004. These intangible assets will be fully amortized by the end of fiscal 2008. Of the total intangible assets, $1.1 million and $3.4 million was amortized in the current fiscal quarter and fiscal nine months ended October 31, 2002, respectively, as compared to $2.1 million and $6.3 million in the same quarter and nine months a year ago. The year ago periods include amortization of goodwill and identifiable assets with indefinite lives that is now not being amortized under SFAS 142. (See Note 4 of Notes to Condensed Consolidated Financial Statements for additional information related to SFAS 142 and intangibles amortization.)

Restructuring Charges. Early in the year ago third fiscal quarter ended October 31, 2001, in response to the general weakening of the worldwide economy and resulting IT spending slowdown, the Company announced and began to execute its plan to reduce workforce by approximately 12% or 45 positions affecting all parts of the organization and incur costs associated with the closure of facilities. The Company has realized and expects to continue to realize cost savings going forward as a result of this reduction and other cost savings initiatives implemented. The Company's reduction in work force and closure of facilities are substantially complete, and in connection with these actions, the Company recorded a restructuring charge in the year ago third fiscal quarter ended October 31, 2001 consisting principally of severance, payroll taxes and other employee benefits totaling $1.5 million and facilities closures totaling $1.0 million. (See Note 3 of Notes to Condensed Consolidated Financial Statements for additional information related to the restructuring charge taken in the year ago third fiscal quarter.)

Interest and Other Income, net. Interest and other income, net decreased $0.3 million or 21% to $1.2 million and decreased $1.2 million or 24% to $3.6 million in the current fiscal quarter and fiscal nine months ended October 31, 2002, respectively, from $1.5 million and $4.8 million in the same quarter and nine months a year ago. The dollar decreases in interest and other income, net is generally due to reduced market interest rates, partially offset by increases in balances on interest-bearing accounts, such as cash and cash equivalents, and both short and long-term investments, resulting from accumulation of earnings.

Income Taxes. Income taxes in absolute dollars were $3.8 million and $10.1 million in the current fiscal quarter and fiscal nine months ended October 31, 2002, respectively, and were based on a fiscal 2003 effective tax rate of 38%. This compares with income taxes of $2.3 million and $8.9 million in the same quarter and nine months, respectively, a year ago, and were based on a fiscal 2002 effective tax rate of 41%. The decrease in the effective tax rate from fiscal 2002 to fiscal 2003 is primarily due to a decrease in nondeductible charges resulting from the elimination of goodwill amortization which became effective upon the Company's adoption of SFAS No. 142 on February 1, 2002. For both the current fiscal quarter and fiscal nine months ended October 31, 2002, when compared to the same quarter and nine months a year ago, the increase in income taxes in absolute dollars is due to an increase in taxable income from the year ago quarter and nine months, partially offset by the decrease in the effective tax rate from the year ago quarter and nine months. SERENA's effective income tax rate has historically benefited from the United States research and experimentation tax credit and tax benefits generated from export sales made from the United States.

Since SERENA's inception, we have financed our operations and met our capital requirements through cash flows from operations. As of October 31, 2002, SERENA had $99.2 million in cash and cash equivalents and an additional $27.4 million and $49.1 million in short and long-term investments, respectively, consisting principally of high grade commercial paper, certificates of deposit, and short and long-term bonds. Cash flows provided by operating activities were $18.2 million and $25.9 million in the current fiscal nine months ended October 31, 2002 and the same nine months a year ago, respectively. In the current fiscal nine months, SERENA's cash flows provided by operating activities exceeded net income principally due to a decrease in trade accounts receivable, the inclusion of non-cash expenses in net income, and cash collections in advance of revenue recognition for maintenance contracts; all partially offset by a decrease in income taxes payable. In the same nine months a year ago, SERENA's cash flows provided by operating activities exceeded net income principally due to the inclusion of non-cash expenses in net income and an increase in income taxes payable; all partially offset by an increase in trade accounts receivable and a decrease in accrued expenses. In both the current fiscal nine months and the same nine months a year ago, cash used in investing activities were primarily related to the net purchase of short and long-term investments totaling $5.0 million and $22.2 million, respectively, and to a lesser extent, purchases of computer equipment and office furniture and equipment totaling $1.3 million in both periods. In the current fiscal nine months only, cash used in investing activities also included cash paid for the UltiMIS Corporation earn-out totaling $0.7 million. In both the current fiscal nine months and the same nine months a year ago, cash flows from financing activities were related to the exercise of stock options under the employee stock option plan totaling $1.3 million and $2.7 million, respectively, the sale of common stock under the employee stock purchase plan totaling $0.8 million and $1.0 million, respectively, and the payment of principal on notes receivable from stockholders totaling $0.6 million and $1.4 million, respectively; all partially offset by the repurchase of common stock under the stock repurchase plan totaling $0.8 million in both periods.

At October 31, 2002, the Company did not have any material commitments for capital expenditures and had no revolving credit agreements or other term loan agreements with any banks or other financial institutions.

At October 31, 2002, the Company had working capital of $113.2 million, trade accounts receivable, net of allowances, of $17.6 million and total deferred revenues of $30.8 million.

The Company has noncancelable operating lease agreements for office space that expire between calendar 2002 and 2008. Minimum lease payments are as follows (in thousands):

Fiscal Year Ending January 31,
2003 (Fourth fiscal quarter only)	$	398
2004		1,426
2005		1,338
2006		1,186
2007		807
Thereafter		842

	$	5,997

We believe that current cash and short-term investments, and cash flows from operations will satisfy our working capital and capital expenditure requirements for at least the next twelve months.

In August 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 requires an enterprise to record the fair value of an asset retirement obligation as a liability in the period in which it incurs a legal obligation associated with the retirement of a tangible long-lived asset. SFAS No. 143 also requires an enterprise to record the contra to the initial obligation as an increase in the carrying amount of the related long-lived asset (i.e., the associated asset retirement costs) and to depreciate that cost over the remaining useful life of the asset. The amount of the asset retirement obligation is revised at the end of each period to reflect the passage of time (i.e., accretion expense) and changes in the estimated future cash flows underlying the initial fair value measurement. The Company is required to adopt SFAS No. 143 as of February 1, 2003. The Company does not expect SFAS No. 143 to have a material impact on its financial position or results of operations.

In April 2002, the FASB issued SFAS No. 145, "Recission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." Among other provisions, SFAS 145 rescinds SFAS 4, "Reporting Gains and Losses from Extinguishment of Debt." Accordingly, gains or losses from extinguishment of debt that do not meet the criteria of APB No. 30 should be reclassified to income from continuing operations in all prior periods presented. SFAS 145 is effective for fiscal years beginning after May 15, 2002. The Company plans to adopt SFAS 145 beginning in its fiscal year 2004. The effect of adopting SFAS 145 is not expected to have a material effect on the Company's consolidated financial position or results of operations.

In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 eliminates Emerging Issues Task Force, or EITF, Issue No. 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)." Under SFAS No. 146, liabilities for costs associated with an exit or disposal activity are recognized when the liabilities are incurred, as opposed to being recognized at the date of entity's commitment to an exit plan under EITF No. 94-3. Furthermore, SFAS No. 146 establishes that fair value is the objective for initial measurement of the liabilities. This Statement will be effective for exit or disposal activities that are initiated after December 31, 2002.

This report, including this Management's Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements under the Private Securities Reform Act of 1995 and other prospective information relating to future events. These forward-looking statements and other

prospective information are subject to certain risks and uncertainties that could cause results to differ materially from historical results or anticipated results, including but are not limited to, our reliance on our mainframe products for revenue; the percentage of license revenue typically closed at the end of each quarter making estimation of operating results prior to the end of the quarter extremely uncertain; weak economic conditions worldwide which may continue to affect the overall demand for software and services, which could result in decreased revenues or lower revenue growth rates; changes in revenue mix and seasonality; our ability to deliver our products on the distributed systems platform; dependence on revenues from our installed base; continued demand for additional mainframe MIPS capacity; expansion of our professional services and international organizations; our ability to manage our growth; and the following:

There Are Many Factors, Including Some Beyond Our Control, That May Cause Fluctuations in Our Quarterly Operating Results

Our quarterly operating results have varied greatly in the past and may vary greatly in the future depending upon a number of factors described below and elsewhere in this "Factors That May Affect Future Results" section of this report, including many that are beyond our control. As a result, we believe that quarter-to-quarter comparisons of our financial results are not necessarily meaningful, and you should not rely on them as an indication of our future performance.

Our software license revenue in any quarter depends on orders booked and shipped in the last month, weeks or days of that quarter. At the end of each quarter, we typically have either minimal or no backlog of orders for the subsequent quarter. If a large number of orders or several large orders do not occur or are deferred, our revenue in that quarter could be substantially reduced. This would materially adversely affect our operating results and could impair our business in future periods.

Because we do not know when, or if, our potential customers will place orders and finalize contracts, we cannot accurately predict our revenue and operating results for future quarters. In addition, as a result of the economic slowdown worldwide, a number of customers have delayed discretionary spending for software and hardware which has reduced our revenue. Additionally, sales cycles beginning in fiscal 2002 lengthened as customers delayed decisions to purchase our products and increase capacity on mainframe computers. Historically, a majority of our revenue has been attributable to the licenses of our mainframe software products. Changes in the mix of software products and services sold by us, including the mix between higher margin software products and lower margin maintenance and services, could materially affect our operating results for future quarters.

Economic Conditions Could Adversely Affect Our Revenue Growth and Ability to Forecast Revenue

The revenue growth and profitability of our business depends on the overall demand for application software and services. Because our sales are primarily to major corporate customers, our business also depends on general economic and business conditions. The general weakening of the worldwide economy has caused the Company to experience a decrease in revenues and revenue growth rates of its software licenses. A softening of demand for computer software caused by a continued weakening of the economy, domestically or internationally, may result in a continued decrease in revenues and revenue growth rates.

Management personnel identify, track and forecast future revenues, backlog and trends in our business. Our sales personnel monitor the status of all proposals, such as the estimated date when they estimate that a transaction will close and the potential dollar amount of such sale. We aggregate these estimates periodically in order to generate a sales pipeline and then evaluate the pipeline at various times to look for trends in our business. While this pipeline analysis provides visibility to our potential customers and the associated revenues for budgeting and planning purposes, these pipeline estimates may not consistently correlate to revenues in a particular quarter or ever. A slowdown in the economy, domestically or internationally, has caused and may continue to cause customer purchasing decisions to

be delayed, reduced in amount or cancelled, all of which have reduced and could continue to reduce the rate of conversion of the pipeline into contracts. A variation in the pipeline or in the conversion of the pipeline into contracts could cause us to plan or budget improperly and thereby could adversely affect our business or results of operations. In addition, primarily due to a substantial portion of our software licenses revenue contracts closing in the latter part of a quarter, management may not be able to adjust the Company's cost structure in response to a variation in the conversion of the pipeline into contracts in a timely manner, and thereby adversely affect our business or results of operations.

Our Future Revenue Is Substantially Dependent Upon Our Installed Customers Renewing Maintenance Agreements for Our Products and Licensing or Upgrading Additional SERENA ECM Products; Our Future Professional Service and Maintenance Revenue Is Dependent on Future Sales of Our Software Products

We depend on our installed customer base for future revenues from maintenance renewal fees and licenses or upgrades of additional ECM products. If our customers do not purchase additional products, upgrade existing products or cancel or fail to renew their maintenance agreements, this could materially adversely affect our business and future quarterly and annual operating results. The terms of our standard license arrangements provide for a one-time license fee and a prepayment of one year of software maintenance and support fees. The maintenance agreements are renewable annually at the option of the customers and there are no minimum payment obligations or obligations to license additional software. Therefore, our current customers may not necessarily generate significant maintenance revenue in future periods. In addition, our customers may not necessarily purchase additional products, upgrades or professional services. Our professional service revenue and maintenance revenue are also dependent upon the continued use of these services by our installed customer base. Any downturn in our software license revenue would have a negative impact on the growth of our professional service revenue and maintenance revenue in future quarters.

We Have Relied and Expect to Continue to Rely on Sales of Our Mainframe Products for Our Revenue

Historically, the majority of our software license revenue has resulted from the sale of our mainframe products. Any factors adversely affecting the pricing of, demand for or market acceptance of our mainframe products, such as competition or technological change, could materially adversely affect our business and quarterly and annual operating results. In particular, ChangeMan ZMF and Comparex, two of our mainframe products, have been responsible for a substantial majority of our revenue. In the current fiscal quarter ended October 31, 2002 and the same quarter a year ago, sales of ChangeMan ZMF and Comparex together accounted for approximately 54% and 68% of our total software licenses revenue, respectively. We expect that these products will continue to account for a large portion of our software licenses revenue for the foreseeable future. Our future operating results depend on the continued market acceptance of our mainframe products, including future enhancements.

We Expect That Our Operating Expenses Will Increase in the Future and These Increased Expenses May Adversely Affect Our Future Operating Results and Financial Condition

Although SERENA has been profitable in recent years, we may not remain profitable on a quarterly or annual basis in the future. We anticipate that our expenses will increase in the foreseeable future as we:

With these additional expenses, in order to maintain our current levels of profitability, we will be required to increase our revenue correspondingly. Any failure to increase our revenue as we implement our product, service and distribution strategies would materially adversely affect our business, quarterly and annual operating results and financial condition. Our revenue has fluctuated in recent years and we may not experience any revenue growth in the future and our revenue could in fact decline. Our efforts to expand our software product suites, sales and marketing activities, direct and indirect distribution channels and professional service offerings and to pursue strategic relationships or acquisitions may not succeed or may prove more expensive than we currently anticipate. As a result, we cannot predict our future operating results with any degree of certainty.

Our Business Is Dependent on the Continued Market for IBM and IBM-Compatible Mainframes

We are substantially dependent upon the continued use and acceptance of IBM and IBM-compatible mainframes and the growth of this market. If the role of the mainframe does not increase as we anticipate, or if it in any way decreases, this would materially adversely affect our business, future quarterly and annual operating results and financial condition. Additionally, if there is a wide acceptance of other platforms or if new platforms emerge that provide enhanced enterprise server capabilities, our business and future operating results may be materially adversely affected. The majority of our software license revenue to date has been attributable to sales of our mainframe products. We expect that, for the foreseeable future, the majority of our software license revenue will continue to come from sales of our mainframe products. As a result, future sales of our existing products and associated maintenance revenue and professional service revenue will depend on continued use of mainframes.

Our Introduction of SERENA ECM Products for Distributed Systems May Not Be Successful

We introduced our ChangeMan DS product in fiscal 2000, our ChangeMan ALM and ChangeMan ECP products in fiscal 2001, our ChangeMan WCM product in the first quarter of fiscal 2002 and our ChangeMan ZDD product in the first quarter of fiscal 2003. We are currently developing new products and enhancing our product suite to support additional distributed systems platforms. If we do not successfully develop, market, sell and support our distributed systems products, this would materially adversely affect our business and our future quarterly and annual operating results. Historically, the majority of our products have been designed for the mainframe platform, and the majority of our software license revenue, maintenance revenue and professional services revenue to date have been attributable to licenses for these mainframe products. We have limited experience developing, marketing, selling or supporting distributed systems products. Developing, marketing and selling our distributed systems products will require significant resources that we may not have. Our sales and marketing organizations have historically focused exclusively on sales of our products for the mainframe and have limited experience marketing and selling distributed systems products. Additionally, we have limited experience in providing support services for distributed systems products. Competition for experienced software engineers, sales personnel and support staff is intense and if we fail to attract qualified personnel this would impair our ability to support our distributed systems products. Many of our competitors have substantially greater experience providing distributed systems compatible software products than we do, and many also have significantly greater financial and organizational resources.

If the SCM Market Does Not Evolve as We Anticipate, Our Business Will Be Adversely Affected

If we fail to properly assess and address the SCM market or if our products and services fail to achieve market acceptance for any reason, our business and quarterly and annual operating results

would be materially adversely affected. The SCM market is in an early stage of development. IT organizations have traditionally addressed SCM needs internally and have only recently become aware of the benefits of third-party SCM solutions as their SCM requirements have become more complex. Since the market for our products is still evolving, it is difficult to assess the competitive environment or the size of the market that may develop. Our future financial performance will depend in large part on the continued growth in the number of businesses adopting third-party SCM products and the expansion of their use on a company-wide basis. The SCM market for third-party products may grow more slowly than we anticipate. In addition, technologies, customer requirements and industry standards may change rapidly. If we cannot improve or augment our products as rapidly as existing technologies, customer requirements and industry standards evolve, our products or services could become obsolete. The introduction of new or technologically superior products by competitors could also make our products less competitive or obsolete. As a result of any of these factors, our position in existing markets or potential markets could be eroded.

Any Delays in Our Normally Lengthy Sales Cycles Could Result in Significant Fluctuations in Our Quarterly Operating Results

Our sales cycle typically takes six to 18 months to complete and varies from product to product. Any delay in the sales cycle of a large license or a number of smaller licenses could result in significant fluctuations in our quarterly operating results. The length of the sales cycle may vary depending on a number of factors over which we may have little or no control, including the size and complexity of a potential transaction and the level of competition that we encounter in our selling activities. Beginning in fiscal 2002, we have experienced an overall lengthening of sales cycles as customers delayed purchases or customers reduced budgets as a result of economic conditions. Additionally, the emerging market for ECM products and services contributes to the lengthy sales process in that during the sales cycle we often have to teach potential customers about the use and benefits of our products. In certain circumstances, we license our software to customers on a trial basis to assist the customers in their evaluation of our products. Our sales cycle can be further extended for product sales made through third party distributors.

Seasonal Trends in Sales of Our Software Products May Affect Our Quarterly Operating Results

We have experienced and expect to continue to experience seasonality in sales of our software products. These seasonal trends materially affect our quarter-to-quarter operating results. Revenue and operating results in our quarter ending January 31 are typically higher relative to our other quarters, because many customers make purchase decisions based on their calendar year-end budgeting requirements. In addition, our January quarter tends to reflect the effect of the incentive compensation structure for our sales organization, which is based on satisfaction of fiscal year-end quotas. As a result, we have historically experienced a substantial decline in revenue in the first quarter of each fiscal year relative to the preceding quarter. We expect our quarter ending October 31 to reflect the effects of summer slowing of international business activity and spending activity generally associated with that time of year.

We May Experience Delays in Developing Our Products Which Could Adversely Affect Our Business

If we are unable, for technological or other reasons, to develop and introduce new and improved products in a timely manner, this could materially adversely affect our business and future quarterly and annual operating results. We have experienced product development delays in new version and update releases in the past and may experience similar or more significant product delays in the future. To date, none of these delays has materially affected our business. Difficulties in product development could delay or prevent the successful introduction or marketing of new or improved products or the

delivery of new versions of our products to our customers. Any delay in releasing our new distributed systems products, for whatever reason, would impair our revenue growth.

We Intend to Expand Our International Operations and May Encounter a Number of Problems in Doing So; There Are Also a Number of Factors Associated With International Operations that Could Adversely Affect Our Business

Expansion of International Operations. We intend to expand the scope of our international operations, although more slowly than in prior years, and currently have sales subsidiaries in the United Kingdom, Germany, France and Belgium. If we are unable to expand our international operations successfully and in a timely manner, or if these operations experienced declining revenue growth, this could materially adversely affect our business and quarterly and annual operating results. We have only limited experience in marketing, selling and supporting our products internationally. Additionally, we do not have any experience in developing foreign language versions of our products. Such development may be more difficult or take longer than we anticipate. We may not be able to successfully market, sell, deliver and support our products internationally.

Risks of International Operations. International sales represented approximately 36% and 15% of our total revenue in the current fiscal quarter ended October 31, 2002 and the same quarter a year ago, respectively. Our international revenue is attributable principally to our European operations. Our international operations are, and any expanded international operations will be, subject to a variety of risks associated with conducting business internationally that could materially adversely affect our business and future quarterly and annual operating results, including the following:

Fluctuations in the Value of Foreign Currencies Could Result in Currency Transaction Losses for SERENA

A majority of our international business is conducted in foreign currencies, principally the British pound and euro. Fluctuations in the value of foreign currencies relative to the U.S. dollar will continue to cause currency transaction gains and losses. We cannot predict the effect of exchange rate fluctuations upon future quarterly and annual operating results. We may experience currency losses in the future. To date, we have not adopted a hedging program to protect SERENA from risks associated with foreign currency fluctuations.

SERENA is Subject to Intense Competition in the SCM Industry and We Expect to Face Increased Competition in the Future, Including Competition in the SCM Distributed Systems Market

We may not be able to compete successfully against current or future competitors and such inability would materially adversely affect our business, quarterly and annual operating results and financial condition. The market for our products is highly competitive and diverse. Moreover, the

technology for SCM products may change rapidly. New products are frequently introduced, and existing products are continually enhanced. Competition may also result in changes in pricing policies by SERENA or our competitors which could materially adversely affect our business and future quarterly and annual operating results. Competitors vary in size and in the scope and breadth of the products and services that they offer. Many of our current and potential competitors have greater financial, technical, marketing and other resources than we do. As a result, they may be able to respond more quickly to new or emerging technologies and changes in customer requirements. They may also be able to devote greater resources to the development, promotion and sale of their products than we can.

Mainframe Competition. We currently face competition from a number of sources, including:

Competition in the Distributed Systems SCM Market. We also face significant competition as we develop, market and sell our distributed systems products, including ChangeMan DS, ChangeMan ALM, ChangeMan ECP and ChangeMan WCM. If we are unable to successfully penetrate the distributed systems SCM market, our business and future quarterly and annual operating results will be materially adversely affected. Penetrating the existing distributed systems SCM market will be difficult. Competitors in the distributed systems market include Rational Software, Computer Associates, MERANT, Microsoft, Interwoven, Documentum and other smaller private companies.

Future Competition. We may face competition in the future from established companies who have not previously entered the mainframe SCM market, from emerging software companies, or from other web content management software companies. Barriers to entry in the software market are relatively low. Increased competition may materially adversely affect our business and future quarterly and annual operating results due to price reductions, reduced gross margins and reduction in market share. Established companies may not only develop their own mainframe or distributed systems SCM solutions, but they may also acquire or establish cooperative relationships with our current competitors, including cooperative relationships between large, established companies and smaller private companies. Because larger companies have significant financial and organizational resources available, they may be able to quickly penetrate the mainframe or distributed systems SCM market through acquisitions or strategic relationships and may be able to leverage the technology and expertise of smaller companies and develop successful SCM products for the mainframe. We expect that the software industry, in general, and providers of SCM solutions, in particular, will continue to consolidate. It is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share.

Bundling or Compatibility Risks. Our ability to sell our products also depends, in part, on the compatibility of our products with other third party products, particularly those provided by IBM. Developers of these third party products may change their products so that they will no longer be compatible with our products. These third party developers may also decide to bundle their products with other SCM products for promotional purposes. If that were to happen, our business and future quarterly and annual operating results may be materially adversely affected as we may be priced out of the market or no longer be able to offer commercially viable products.

We May Be Unable to Successfully Complete Strategic Relationships or Acquisitions

We may be unable to successfully complete strategic relationships or acquisitions in pursuit of our growth strategy. One component of our growth strategy, entering into strategic relationships or the strategic acquisition of businesses, involves certain risks, including, among others, the following:

In addition, any such acquisition could materially adversely affect our financial results due to dilutive issuances of equity securities, the incurrence of additional debt and the amortization of expenses or impairment of value related to goodwill and other intangible assets, if any.

Our Executive Officers and Certain Key Personnel Are Critical to Our Business and Such Officers and Key Personnel May Not Remain with SERENA in the Future

Our success will depend to a significant extent on the continued service of our senior executives and certain other key employees, including certain sales, consulting, technical and marketing personnel. If we lost the services of one or more of our executives or key employees, including if one or more of our executives or key employees decided to join a competitor or otherwise compete directly or indirectly with SERENA, this could materially adversely affect our business. In particular, we have historically relied on the experience and dedication of our product authors. With the exception of Douglas D. Troxel, SERENA's founder, Chief Technology Officer and chairman of SERENA's board of directors, the employment of all of our senior and key employees, including key product authors, is at will. Mr. Troxel's employment is on a year-to-year basis. In addition, we do not maintain key man life insurance on our employees and have no plans to do so.

Our Industry Changes Rapidly Due to Evolving Technology Standards and Our Future Success Will Depend on Our Ability to Continue to Meet the Sophisticated Needs of Our Customers

Our future success will depend on our ability to address the increasingly sophisticated needs of our customers by supporting existing and emerging hardware, software, database and networking platforms particularly for our distributed systems products. We will have to develop and introduce enhancements to our existing products and new products on a timely basis to keep pace with technological developments, evolving industry standards and changing customer requirements. We expect that we will have to respond quickly to rapid technological change, changing customer needs, frequent new product introductions and evolving industry standards that may render existing products and services obsolete. As a result, our position in existing markets or potential markets could be eroded rapidly by product advances. The life cycles of our products are difficult to estimate. Our growth and future financial performance will depend in part upon our ability to enhance existing applications, develop and introduce new applications that keep pace with technological advances, meet changing customer requirements and respond to competitive products. We expect that our product development efforts will continue to require substantial investments. We may not have sufficient resources to make the necessary investments. Any of these events could have a material adverse effect on our business, quarterly and annual operating results and financial condition.

The market price of our common shares has fluctuated significantly in recent months, and we expect that the market price of our common shares may fluctuate substantially as a result of variations in our quarterly operating results and market conditions. These fluctuations may be exaggerated if the trading volume of our common shares is low. In addition, the market price of our common shares may fluctuate dramatically in response to a variety of factors, including:

Because of this volatility, we may fail to meet the expectations of our stockholders or of securities analysts at some time in the future and the trading prices of our securities could decline as a result.

In addition, equity securities of many technology companies have recently experienced significant price and volume fluctuations. These price and volume fluctuations are sometimes unrelated to the operating performance of the affected companies. Volatility in the market price of our common shares could result in securities class action litigation. This type of litigation, regardless of the outcome, could result in substantial costs to us and a diversion of our management's attention and resources.

Third Parties in the Future Could Assert That Our Products Infringe Their Intellectual Property Rights, Which Could Adversely Affect Our Business

Third parties may claim that our current or future products infringe their proprietary rights. Any claims of this type could affect our relationships with existing customers and may prevent future customers from licensing our products. Because we are dependent upon a limited number of products, any such claims, with or without merit, could be time consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. Royalty or license agreements may not be available on acceptable terms or at all. We expect that software product developers will increasingly be subject to infringement claims as the number of products and competitors in the software industry segment grows and the functionality of products in different

industry segments overlaps. As a result of these factors, infringement claims could materially adversely affect our business.

Our future success will likely depend in large part on our ability to attract and retain experienced sales, technical, marketing and management personnel. In addition, we will need to attract and retain sufficient numbers of qualified software engineers, as well as sales and marketing and support personnel, to successfully develop, market and support our distributed systems product suite. Competition for such personnel in the computer software industry is intense, and in the past we have experienced difficulty in recruiting qualified personnel, especially developers and sales personnel. We expect competition for qualified personnel to remain intense, and we may not succeed in attracting or retaining such personnel. If we do not, this could materially adversely affect our business and future quarterly and annual operating results. In addition, new employees generally require substantial training in the use of our products. This training will require substantial resources and management attention.

Errors in Our Products or the Failure of Our Products to Conform to Specifications Could Result in Our Customers Demanding Refunds from Us or Asserting Claims for Damages Against Us

Because our software products are complex, they often contain errors or "bugs" that can be detected at any point in a product's life cycle. While we continually test our products for errors and work with customers through our customer support services to identify and correct bugs in our software, we expect that errors in our products will continue to be found in the future. Although many of these errors may prove to be immaterial, certain of these errors could be significant. Detection of any significant errors may result in, among other things, loss of, or delay in, market acceptance and sales of our products, diversion of development resources, injury to our reputation, or increased service and warranty costs. These problems could materially adversely affect our business and future quarterly and annual operating results. In the past we have discovered errors in certain of our products and have experienced delays in the shipment of our products during the period required to correct these errors. These delays have principally related to new version and product update releases. To date none of these delays have materially affected our business. However, product errors or delays in the future, including any product errors or delays associated with the introduction of our distributed systems products, could be material. In addition, in certain cases we have warranted that our products will operate in accordance with specified customer requirements. If our products fail to conform to such specifications, customers could demand a refund for the software license fee paid to us or assert claims for damages.

Product Liability Claims Asserted Against Us in the Future Could Adversely Affect Our Business

We may be subject to claims for damages related to product errors in the future. A material product liability claim could materially adversely affect our business. Our license agreements with our customers typically contain provisions designed to limit exposure to potential product liability claims. SERENA's standard software licenses provide that if our products fail to perform, we will correct or replace such products. If these corrective measures fail, we may be required to refund the license fee for such non-performing product. However, our standard license agreement limits our liability for non-performing products to the amount of license fee paid, if the license has been in effect for less than one year, or to the amount of the licensee's current annual maintenance fee, if the license is more than one year old. Our standard license also provides that SERENA shall not be liable for indirect or consequential damages caused by the failure of our products. Such limitation of liability provisions may, however, not be effective under the laws of certain jurisdictions to the extent local laws treat certain warranty exclusions as unenforceable. Although we have not experienced any product liability claims to date, the sale and support of our products entail the risk of such claims.

The Company does not have derivative financial instruments in its investment portfolio and has no foreign exchange contracts. Its financial instruments consist of cash and cash equivalents, short and long-term investments, trade accounts receivable and accounts payable. The Company considers investments in highly liquid instruments purchased with a remaining maturity of 90 days or less to be cash equivalents. All of the Company's cash equivalents and short and long-term investments principally consist of commercial paper and debt securities, and are classified as available-for-sale as of October 31, 2002. The Company's exposure to market risk for changes in interest rates relates primarily to its short and long-term investments and short-term obligations, thus, a hypothetical 10% fluctuation in interest rates would not have a material impact on the fair value of these securities.

Sales to foreign countries accounted for approximately 36% and 30% of the total revenue during the quarter and nine months, respectively, ended October 31, 2002. Because the Company invoices certain of its foreign sales in currencies other than the United States dollar, predominantly the British pound and euro, and does not hedge these transactions, fluctuations in exchange rates could adversely affect the translated results of operations of the Company's foreign subsidiaries. Therefore, foreign exchange fluctuation could create a risk of significant balance sheet gains or losses on the Company's consolidated financial statements. However, given the Company's foreign subsidiaries' net book values as of October 31, 2002 and net cash flows for the most recent fiscal quarter and nine months then ended and fiscal year ended January 31, 2002, the Company does not believe that a hypothetical 10% fluctuation in foreign currency exchange rates would have a material impact on its financial position or results of operations.

Intangible Asset Risk. We have a substantial amount of intangible assets. Although at October 31, 2002 we believe our intangible assets are recoverable, changes in the economy, the business in which we operate and our own relative performance could change the assumptions used to evaluate intangible asset recoverability. We continue to monitor those assumptions and their consequent effect on the estimated recoverability of our intangible assets.

Based on their evaluation of the Company's disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934) as of a date within 90 days of the filing date of this Quarterly Report on Form 10-Q, the Company's principal executive officer and principal financial officer have concluded that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.

There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation by the Company's principal executive officer and principal financial officer, including any corrective actions with regard to significant deficiencies and material weaknesses.

Section 10A(i)(2) of the Securities Exchange Act of 1934, as added in Section 202 of the Sarbanes-Oxley Act of 2002, requires us to disclose the approval by our Audit Committee of any non-audit services to be performed by our auditor. The Audit Committee of the Board of Directors of SERENA has approved the performance of certain tax-related services by our auditor, KPMG LLP.

Exhibit Number		Exhibit Title
99.1(a	)	Certification of Chief Executive Officer and Chief Financial Officer

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

		Page
	PART I FINANCIAL INFORMATION
Item 1	Financial Statements:
	Condensed Consolidated Balance Sheets as of October 31, 2002 and January 31, 2002	3
	Condensed Consolidated Statements of Income and Comprehensive Income for the Three Months and Nine Months Ended October 31, 2002 and 2001	4
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended October 31, 2002 and 2001	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2	Management's Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3	Quantitative and Qualitative Disclosures About Market Risk	30
Item 4	Controls and Procedures	30
	PART II OTHER INFORMATION
Item 1	Legal Proceedings	31
Item 2	Change in Securities and Use of Proceeds	31
Item 4	Submission of Matters to a Vote of Security Holders	31
Item 5	Other Information	31
Item 6	Exhibits and Reports on Form 8-K	31
SIGNATURES		32
CERTIFICATIONS		33

			October 31, 2002			January 31, 2002
ASSETS
Current assets:
	Cash and cash equivalents		$	99,169		$	85,954
	Short-term investments			27,360			46,640
	Accounts receivable, net of allowance of $815 and $846 at October 31 and January 31, 2002, respectively			17,588			14,111
	Deferred taxes			5,834			5,834
	Prepaid expenses and other current assets			976			838

		Total current assets		150,927			153,377
	Long-term investments			49,080			24,321
	Property and equipment, net			3,378			3,036
	Goodwill and other intangible assets, net			46,441			50,135
	Other assets			282			201

		TOTAL ASSETS	$	250,108		$	231,070

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Accounts payable		$	336		$	710
	Income taxes payable			5,545			1,650
	Accrued expenses			8,716			11,762
	Deferred revenue			23,151			21,877

	Total current liabilities			37,748			35,999
Deferred revenue, net of current portion				7,628			8,886
Deferred taxes				1,409			1,409

	Total liabilities			46,785			46,294

Commitments and contingencies
Stockholders' equity:
	Preferred stock, $0.001 par value; 5,000,000 shares authorized; no shares issued and outstanding			—			—
	Common stock, $0.001 par value; 90,000,000 shares authorized; 40,519,890 and 40,274,214 shares issued and outstanding at October 31 and January 31, 2002, respectively			41			40
	Additional paid-in capital			124,823			123,517
	Deferred stock-based compensation			(1	)		(23	)
	Notes receivable from stockholders			(10,126	)		(10,350	)
	Accumulated other comprehensive income			604			21
	Retained earnings			87,982			71,571

		Total stockholders' equity		203,323			184,776

		TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	250,108		$	231,070

			Three Months Ended October 31,				Nine Months Ended October 31,
			2002		2001		2002		2001
Revenue:
	Software licenses		$	11,502	$	11,063	$	31,458	$	37,192
	Maintenance			11,165		10,431		32,957		31,143
	Professional services			1,966		1,754		5,262		5,854

		Total revenue		24,633		23,248		69,677		74,189

Cost of revenue:
	Software licenses			363		331		946		640
	Maintenance			1,405		1,280		4,192		4,156
	Professional services			1,794		1,505		4,715		5,231

		Total cost of revenue		3,562		3,116		9,853		10,027

		Gross profit		21,071		20,132		59,824		64,162

Operating expenses:
	Sales and marketing			6,487		6,785		19,487		22,845
	Research and development			2,981		3,130		8,873		10,455
	General and administrative			1,811		1,623		5,200		4,946
	Stock-based compensation			5		19		22		121
	Amortization of intangible assets, including goodwill in 2001			1,113		2,080		3,405		6,256
	Restructuring charges			—		2,529		—		2,529

		Total operating expenses		12,397		16,166		36,987		47,152

Operating income				8,674		3,966		22,837		17,010
Interest and other income, net				1,237		1,564		3,633		4,797

	Income before income taxes			9,911		5,530		26,470		21,807
Income taxes				3,766		2,267		10,059		8,941

	Net income		$	6,145	$	3,263	$	16,411	$	12,866

Comprehensive income:
	Net income		$	6,145	$	3,263	$	16,411	$	12,866
	Other comprehensive income:
		Foreign currency translation adjustment		71		5		113		119
		Unrealized gain on marketable securities		225		290		470		255

	Other comprehensive income			296		295		583		374

		Total comprehensive income	$	6,441	$	3,558	$	16,994	$	13,240

Net income per share:
	Basic		$	0.15	$	0.08	$	0.41	$	0.32

	Diluted		$	0.15	$	0.08	$	0.40	$	0.32

Weighted average shares used in per share calculations:
	Basic			40,420		39,942		40,292		39,676

	Diluted			41,000		40,629		40,772		40,606

				Nine Months Ended October 31,
				2002			2001
Cash flows from operating activities:
	Net income			$	16,411		$	12,866
	Adjustments to reconcile net income to net cash provided by operating activities:
		Depreciation			1,026			1,169
		Provision (release) in allowance for bad debts			775			(238	)
		(Gain) loss on disposal of property and equipment			(30	)		11
		Accrued interest on notes receivable from stockholders, net of cash received			(399	)		(270	)
		Amortization of deferred stock-based compensation			22			121
		Amortization of intangible assets, including goodwill in 2001			3,405			6,256
		Issuance of stock warrant in exchange for operating services provided			—			129
		Changes in operating assets and liabilities:
			Accounts receivable		(3,925	)		8,251
			Prepaid expenses and other assets		(305	)		748
			Accounts payable		(394	)		(101	)
			Income taxes payable		3,865			(5,338	)
			Accrued expenses		(1,718	)		(691	)
			Deferred revenue		(504	)		2,992

			Net cash provided by operating activities		18,229			25,905

Cash flows used in investing activities:
	Purchases of property and equipment				(1,336	)		(1,253	)
	Purchases of short-term and long-term investments				(5,010	)		(22,153	)
	Cash paid for UltiMIS Corporation earn-out				(710	)		—

			Net cash used in investing activities		(7,056	)		(23,406	)

Cash flows from financing activities:
	Exercise of stock options under the employee stock option plan				1,321			2,659
	Sale of common stock under the employee stock purchase plan				813			1,026
	Common stock repurchased under the stock repurchase plan				(829	)		(794	)
	Payment of principal on notes receivable from stockholders				624			1,415

			Net cash provided by financing activities		1,929			4,306

Effect of exchange rate changes on cash					113			119

Net increase in cash and cash equivalents					13,215			6,924
Cash and cash equivalents at beginning of period					85,954			85,179

Cash and cash equivalents at end of period				$	99,169		$	92,103

Supplemental disclosures of cash flow information:
	Income taxes paid			$	6,395		$	14,156

Non-cash investing and financing activity:
	Unrealized gain on marketable securities			$	470		$	255

	Contingent consideration (reversed from) accrued for the UltiMIS acquisition, net			$	(290	)	$	1,000

	Additional paid-in capital from issuance of stock warrant			$	—		$	(129	)

	Three Months Ended October 31,		Nine Months Ended October 31,
	2002	2001	2002	2001
Basic net income per share—weighted average number of common shares outstanding	40,420	39,942	40,292	39,676
Effect of potentially dilutive securities outstanding—unvested restricted stock and options	580	687	480	930

Shares used in diluted net income per share computation	41,000	40,629	40,772	40,606

		SERENA SOFTWARE, INC.
		By:		/s/ ROBERT I. PENDER, JR. Robert I. Pender, Jr. Vice President, Finance And Administration, Chief Financial Officer (Principal Financial And Accounting Officer) And Director