SEEBEYOND TECHNOLOGY CORP - 10-Q Quarterly Report

SeeBeyond Technology Corporation and Subsidiaries

Condensed Consolidated Balance Sheets

(in thousands, except share and per share amounts)

	September 30, 2004			December 31, 2003
	(unaudited)
Assets:
Current assets:
Cash and cash equivalents	$	68,106		$	70,135
Accounts receivable, net of allowances of $1,531 and $2,373 at September 30, 2004 and December 31, 2003, respectively	34,450			34,333
Prepaid expenses and other current assets	3,210			4,596
Total current assets	105,766			109,064
Property and equipment, net	13,113			15,224
Goodwill	1,391			1,391
Other assets	1,709			2,068
Total assets	$	121,979		$	127,747
Liabilities and stockholders’ equity:
Current liabilities:
Accounts payable	$	5,487		$	5,120
Accrued employee compensation and related expenses	12,538			12,675
Accrued expenses	8,050			9,263
Deferred revenues	31,985			31,221
Equipment line and advance payable	734			3,097
Capital lease payable - current portion	324			310
Total current liabilities	59,118			61,686
Capital lease payable	303			515
Total liabilities	59,421			62,201
Commitments and contingencies
Stockholders’ equity:
Common stock, $.0001 par value - 200,000,000 shares authorized; 87,269,395 shares issued and 84,716,243 shares outstanding as of September 30, 2004 and 85,548,522 shares issued and 83,826,520 shares outstanding as of December 31, 2003	8			8
Additional paid-in capital	225,773			222,539
Treasury stock	(6,286		)	(3,632		)
Deferred stock compensation	—			(47		)
Accumulated other comprehensive loss	605			616
Accumulated deficit	(157,542		)	(153,938		)
Total stockholders’ equity	62,558			65,546
Total liabilities and stockholders’ equity	$	121,979		$	127,747

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

SeeBeyond Technology Corporation and Subsidiaries

Condensed Consolidated Statements of Operations

(Unaudited)

(in thousands, except per share data)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004			2003
Revenues:
License	$	17,944		$	11,249		$	48,602		$	31,376
Services	10,090			9,440			29,710			30,495
Maintenance	13,698			11,667			39,726			35,164
Total revenues	41,732			32,356			118,038			97,035
Cost of revenues:
License	331			299			989			1,120
Services and maintenance	10,645			10,041			31,439			32,161
Total cost of revenues	10,976			10,340			32,428			33,281
Gross profit	30,756			22,016			85,610			63,754
Operating expenses:
Research and development	9,657			10,142			29,033			31,218
Sales and marketing	14,623			12,443			45,693			40,883
General and administrative	4,869			3,846			13,727			13,071
Restructuring and impairment charges	—			—			—			6,386
Amortization of sales and marketing warrants	—			48			(14		)	172
Amortization of stock-based compensation	—			41			97			213
Total operating expenses	29,149			26,520			88,536			91,943
Income (loss) from operations	1,607			(4,504		)	(2,926		)	(28,189		)
Interest and other income, net	187			123			117			741
Interest expense	(68		)	(112		)	(201		)	(367		)
Income (loss) before provision for income tax	1,726			(4,493		)	(3,010		)	(27,815		)
Provision for income tax	416			356			594			442
Net income (loss)	$	1,310		$	(4,849	)	$	(3,604	)	$	(28,257	)

Basic net income (loss) per share	$	0.02		$	(0.06	)	$	(0.04	)	$	(0.34	)
Diluted net income (loss) per share	$	0.01		$	(0.06	)	$	(0.04	)	$	(0.34	)
Number of shares used in calculating:
- basic net income (loss) per share	85,025			83,065			84,628			82,841
- diluted net income (loss) per share	87,830			83,065			84,628			82,841

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

SeeBeyond Technology Corporation and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(in thousands)

	Nine Months Ended September 30,
	2004			2003
Cash flows from operating activities:
Net loss	$	(3,604	)	$	(28,257	)
Adjustments to reconcile net loss to net provided by (used in) operating activities:
Gain on disposal of fixed assets	(34		)	(16		)
Depreciation and amortization	3,572			4,406
Provision for doubtful accounts receivable	(24		)	82
Amortization of sales and marketing warrants	(14		)	172
Amortization of stock-based compensation	97			213
Non-cash restructuring and impairment charges	—			4,274
Changes in assets and liabilities:
Accounts receivable	(93		)	5,389
Prepaid expenses and other current assets	1,386			(580		)
Accounts payable	367			(3,044		)
Accrued expenses	(1,350		)	(1,297		)
Deferred revenues	764			1,100
Net cash provided by (used in) operating activities:	1,067			(17,558		)

Cash flows from investing activities:
Purchases of property and equipment	(1,427		)	(4,416		)
Other	359			(1,294		)
Net cash used in investing activities	(1,068		)	(5,710		)

Cash flows from financing activities:
Repayments on bank lines of credit	(2,363		)	(2,363		)
Repayments of capital lease obligation	(198		)	(173		)
Proceeds from issuance of common stock pursuant to employee stock option plan	2,870			1,600
Proceeds from issuance of common stock pursuant to employee stock purchase plan	328			347
Payments for purchase of common stock	(2,654		)	(872		)
Net cash used in financing activities	(2,017		)	(1,461		)

Effect of exchange rate changes on cash and cash equivalents	(11		)	345
Net decrease in cash and cash equivalents	(2,029		)	(24,384		)
Cash and cash equivalents at beginning of the period	70,135			94,114
Cash and cash equivalents at end of the period	$	68,106		$	69,730

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

SeeBeyond Technology Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared by SeeBeyond Technology Corporation (the “Company” or “SeeBeyond”) in accordance with the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted in accordance with such rules and regulations. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position of the Company, and its results of operations and cash flows. These condensed consolidated financial statements should be read in conjunction with the annual audited consolidated financial statements and notes as of and for the year ended December 31, 2003 included in the Company’s Form 10-K filed with the Securities and Exchange Commission on March 11, 2004.

The results of operations for the three months and nine months ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004 or any other interim period, and the Company makes no representations related thereto.

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

Certain reclassifications have been made to prior year information to conform to the current period’s presentation.

Note 2. Revenue Recognition

The Company recognizes revenue when an agreement has been signed by both parties or other persuasive evidence of an arrangement exists, the software has been shipped or electronically delivered, the fees are fixed or determinable, collection of the resulting receivable is probable and no other significant obligations remain. For multiple element arrangements where vendor-specific objective evidence of fair value exists for all undelivered elements, we account for the delivered elements in accordance with the “residual method” prescribed by Statement of Position 98-9. Vendor-specific objective evidence of fair value is based on the price a customer is required to pay when the element is sold separately. The Company enters into arrangements with end users, which may include the sale of licenses of software, maintenance and services under the arrangement or various combinations of each element, including the sale of such elements separately.

For multiple element arrangements, each element of the arrangement is analyzed and the Company allocates a portion of the total fee under the arrangement to the undelivered elements, primarily services and maintenance, using vendor-specific objective evidence of fair value of the element and the remaining portion of the fee is allocated to the delivered elements (i.e. generally the software license), regardless of any separate prices stated within the contract for each element, under the residual method prescribed by SOP 98-9. Vendor-specific objective evidence of fair value is based on the price the customer is required to pay when the element is sold separately (i.e. hourly rates charged for consulting services when sold separately from a software license and the renewal rate for maintenance arrangements). Each license agreement offers additional maintenance renewal periods at a stated price. If vendor-specific objective evidence of fair value does not exist for the undelivered elements, all revenue is deferred and recognized ratably over the service period if the undelivered element is services, or over the period the maintenance is provided if the undelivered element is maintenance, or until sufficient objective evidence exists or all elements have been delivered.

License Revenues: Amounts allocated to license revenues under the residual method are recognized at the time of delivery of the software when vendor specific objective evidence of fair value exists for the undelivered elements, if any, and all the other revenue recognition criteria discussed above have been met.

Services Revenues: Revenues from services are comprised of consulting and implementation services and, to a limited extent, training. Services are generally sold on a time-and-materials or fixed fee basis and include a range of services including installation of off-the-shelf software, data conversion and building non-complex interfaces to allow the software to operate in customized environments. Services are generally separable from the other elements under the arrangement since the performance of the services is not essential to the functionality (i.e. do not involve significant production, modification or customization of the software or building

complex interfaces) of any other element of the transaction and are described in the contract such that the total price of the arrangement would be expected to vary as the result of the inclusion or exclusion of the services. Revenues for services are recognized as the services are performed. Training services are sold either on a per student basis or per class and are recognized as classes are attended.

Maintenance Revenues: Maintenance revenues consist primarily of fees for providing unspecified software upgrades on a when-and-if-available basis and technical support over a specified term, which is typically twelve months. Maintenance revenues are typically paid in advance and are recognized on a straight-line basis over the term of the contract.

Revenues on sales made by alliance partners are generally recognized upon shipment of the software to the end user, if all other revenue recognition criteria noted above are met. Under arrangements with distributors revenue is recognized upon delivery of the product to the distributor. The Company does not offer a right of return on its products.

Note 3. Operations by Reportable Segments and Geographic Area

SeeBeyond has developed a comprehensive solution for business integration, enabling the seamless flow of information across systems applications and enterprises in real-time, on a global basis. The Company operates in one industry segment, which is the development and marketing of a comprehensive solution for business integration where all key integration technologies, including application-to-application, business-to-business and business process management, are seamlessly integrated. Revenues and long-lived assets by geographic area were as follows (in thousands):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2004			2003		2004		2003
Revenues:
North America	$		23,690	$	18,305	$	61,140	$	58,182
Europe	15,698			10,898		49,290		29,123
Pacific Rim	2,344			3,153		7,608		9,730
Total revenues	$	41,732		$	32,356	$	118,038	$	97,035

	September 30, 2004		December 31, 2003
Long-lived assets:
North America	$	13,311	$	15,341
Europe	1,686		1,894
Pacific Rim	1,216		1,448
Total long-lived assets	$	16,213	$	18,683

No single customer accounted for more than 10% of the Company’s net revenues during the three months and nine months ended September 30, 2004 and 2003.

Note 4. Computation of Net Income (Loss) Per Share

Basic net income (loss) per share is computed on the basis of the weighted average number of common shares outstanding. Diluted net income (loss) per share is computed on the basis of the weighted average number of common shares outstanding plus the effect of outstanding stock warrants and outstanding employee stock options using the “treasury stock” method.

The following table sets forth the components of basic and diluted net income (loss) per share for the periods indicated (in thousands, except per share amounts):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2004		2003			2004			2003
Net income (loss)	$	1,310	$	(4,849	)	$	(3,604	)	$	(28,257	)
Weighted average outstanding shares of common stock used to compute basic net income (loss) per share	85,025		83,065			84,628			82,841
Dilutive effect of employee stock options	2,805		—			—			—
Common stock and common stock equivalents	87,830		83,065			84,628			82,841
Basic net income (loss) per share	$	0.02	$	(0.06	)	$	(0.04	)	$	(0.34	)
Diluted net income (loss) per share	$	0.01	$	(0.06	)	$	(0.04	)	$	(0.34	)

Options to purchase approximately 18,088,000 shares of common stock for the nine months ended September 30, 2004, and options to purchase approximately 20,680,000 shares of common stock for the three months and nine months ended September 30, 2003 were not included in the calculations of diluted net income (loss) per share because their effect would be antidilutive. For the three months ended September 30, 2004, options to purchase approximately 2,805,000 shares of common stock were included in the calculations of diluted net income per share. Common stock warrants to purchase 625,000 and 650,000 shares were not included in the calculations of diluted net loss per share because their effect would be antidilutive for the nine months ended September 30, 2004 and the three months and nine months ended September 30, 2003, respectively.

Note 5. Stock-Based Compensation

As permitted under SFAS No. 123 “Accounting for Stock-based Compensation”, the Company continues to apply the provisions of APB No. 25, “Accounting for Stock Issued to Employees,” for its recording of stock-based compensation arrangements. Accordingly, the Company accounts for its stock-based compensation using the intrinsic value method, which requires recognition of expense when the option exercise price is less than the fair value of the stock at the date of grant. The Company provides the required pro forma net income (loss) and pro forma earnings (loss) per share disclosures for employee stock option grants made in 1995 and future years as if the fair value based method defined in SFAS No. 123 had been applied. Under the fair value method stock options are valued and expensed based on the fair value of the options determined under an option-pricing model.

The following table sets forth pro forma net loss and pro forma loss per share (in thousands, except per share amounts):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004			2003
Net income (loss), as reported	$	1,310		$	(4,849	)	$	(3,604	)	$	(28,257	)
Stock-based employee compensation costs, included in net income (loss), as reported	—			41			97			213
Stock-based employee compensation costs if fair value based method had been applied	(3,098		)	(2,845		)	(8,049		)	(9,522		)
Pro forma net loss	$	(1,788	)	$	(7,653	)	$	(11,556	)	$	(37,566	)
Earnings (loss) per share:
Basic - as reported	$	0.02		$	(0.06	)	$	(0.04	)	$	(0.34	)
Diluted - as reported	$	0.01		$	(0.06	)	$	(0.04	)	$	(0.34	)
Basic and diluted - pro forma	$	(0.02	)	$	(0.09	)	$	(0.14	)	$	(0.45	)

Note 6. Commitments, Contingencies and Debt

Bank Lines of Credit and Equipment Line Payable

monthly). The expiration date of the Line has been extended through May 31, 2005. As of September 30, 2004, $11.5 million was available under the Line and there were no borrowings outstanding. The Company may use up to $5.0 million of the Line to issue letters of credit. As of September 30, 2004, approximately $386,000 was available for the issuance of letters of credit. The Line is secured by intellectual property rights, accounts receivable and certain other assets and is subject to certain borrowing base restrictions. The Line requires maintenance of certain financial covenants pertaining to key financial ratios and the Company is in compliance with those covenants as of September 30, 2004.

In October 2001, the Company’s $3.0 million equipment line (the “Equipment Line”) with the same lending institution providing the Line was amended, reducing the maximum amount available for borrowing under the Equipment Line to $2.0 million. The Equipment Line bears interest at an annual rate of prime plus 0.75%, or the LIBOR rate plus 2.75% (payable monthly) and expires on November 30, 2004. The rate at September 30, 2004 was 5.5%. The Company could draw against the Equipment Line through November 30, 2001. Interest is payable monthly and principal is payable in 36 monthly installments commencing in December 2001. As of September 30, 2004, there was approximately $109,000 outstanding under the Equipment Line. The Equipment Line is secured by certain assets of the Company.

In December 2002, the Company’s credit facility was amended to include an equipment advance (the “Equipment Advance”) in the amount of $5.0 million from the same lending institution. Interest on the Equipment Advance is payable monthly and principal is payable in 24 equal monthly installments, beginning January 31, 2003. The Equipment Advance bears interest at an annual rate of prime plus 0.75% or the LIBOR rate plus 3.0%. The rate at September 30, 2004 was 5.5%. As of September 30, 2004, the balance outstanding under this Equipment Advance was approximately $625,000.

Future principal payments on the Equipment Line and the Equipment Advance will aggregate approximately $734,000 in 2004.

Note 7. Restructuring

In 2002, the Company recorded restructuring and impairment charges totaling $6.6 million, consisting of $1.7 million for employee termination benefits and related costs associated with headcount reductions, $2.7 million related to future rent obligations for properties abandoned in connection with facilities consolidation and $2.2 million related to the write-down of leasehold improvements, furniture, computer equipment and software and other assets in connection with facilities consolidation and headcount reductions. The headcount reduction of 57 employees was made up of 58% sales and marketing staff, 19% professional services staff, 14% research and development staff and 9% general and administrative staff. The restructuring and impairment charges recorded in 2002 were recorded under EITF No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity.” Under EITF No. 94-3, the accrual for future rent obligations was recorded when the commitment to abandon the facilities was approved.

In 2003, the Company recorded restructuring and impairment charges totaling $7.4 million, consisting of $1.9 million for employee termination benefits and related costs associated with headcount reductions, $1.2 million related to future rent obligations for properties abandoned in connection with facilities consolidation and $4.3 million related to the write-down of leasehold improvements, furniture, computer equipment and software in connection with the facilities consolidation and headcount reductions. The 2003 headcount reduction of 56 employees was comprised of approximately 48% sales and marketing staff, 41% professional services staff and 11% general and administrative staff. The Company also recovered approximately $944,000 in restructuring expenses that had previously been reserved for. The restructuring and impairment charges recorded during 2003 were recorded under SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” Under SFAS No. 146, the accrual for future rent obligations were recorded when the facilities were abandoned.

These restructuring and impairment charges were recorded to better align the Company’s cost structure with changing market conditions. The following table sets forth the Company’s accrued restructuring costs as of September 30, 2004 (in thousands).

	Facilities Consolidation			Termination Benefits			Total

Balance at December 31, 2003	$	1,913		$	214		$	2,127
Cash utilized	(424		)	(214		)	(638		)
Balance at March 31, 2004	1,489			—			1,489
Cash utilized	(425		)	—			(425		)
Balance at June 30, 2004	1,064			—			1,064
Cash utilized	(385		)	—			(385		)
Balance at September 30, 2004	$	679		$	—		$	679

Accrued facilities consolidation costs represent future payment obligations on abandoned excess facilities, net of sublease income, and are expected to be paid over the next thirteen months.

Note 8. Legal Proceedings

Beginning on July 3, 2002, several purported class action shareholder complaints were filed in the United States District Court for the Central District of California against the Company and several of our officers and directors. The actions were subsequently consolidated and a consolidated amended complaint was filed purportedly brought on behalf of purchasers of common stock of SeeBeyond Technology Corporation between December 10, 2001 and May 7, 2002. The complaint generally alleged that defendants made false statements about SeeBeyond’s operating results and business, while concealing material information. The plaintiffs seek unspecified monetary damages. We have entered into an agreement, subject to court approval, to settle this litigation. The total amount of the settlement is $13.1 million which is to be paid by our insurers. The settlement provides for a complete dismissal of all claims against SeeBeyond and the individual defendants.

Beginning on September 5, 2002, several derivative lawsuits were filed by purported Company shareholders in the Superior Court of California for the County of Los Angeles. The complaints name certain of the Company’s present and former officers and directors as defendants and name the Company as a nominal defendant. The complaints generally allege that the defendants breached their fiduciary duties to the Company through the dissemination of allegedly misleading and inaccurate information and other allegations. The parties entered into a settlement of this litigation, which has been approved by the court, involving the implementation of certain policies and procedures by the Company and the payment of attorneys’ fees to plaintiffs’ counsel paid by our insurers.

The Company is also party to claims and suits brought against it in the ordinary course of business. In the opinion of management, such claims should not have any material adverse effect upon the results of operation, cash flows or the financial position of the Company.

Note 9. Comprehensive Income (Loss)

SFAS No. 130 “Reporting Comprehensive Income,” establishes standards for reporting comprehensive income (loss) and its components in financial statements. Comprehensive income (loss), as defined, refers to revenues, expenses, gains and losses that are not included in net income (loss) but rather are recorded directly in stockholders’ equity.

Total comprehensive income (loss) was as follows (in thousands):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2004		2003			2004			2003
Net income (loss)	$	1,310	$	(4,849	)	$	(3,604	)	$	(28,257	)
Other comprehensive income (loss):
Foreign translation adjustment	54		437			(11		)	345
Comprehensive income (loss)	$	1,364	$	(4,412	)	$	(3,615	)	$	(27,912	)

Note 10. Stockholders’ Equity

Treasury Stock

During the three months ended September 30, 2004, the Company repurchased 683,814 shares of its common stock at an average price of $2.91 per share. As of September 30, 2004, the Company held 2,553,152 shares of its common stock in treasury.

Note 11. Recent Accounting Pronouncements

In October 2004, the Financial Accounting Standards Board (“FASB”) concluded that the Proposed Statement of Financial Accounting Standards, Share-Based Payment, which would require all companies to measure compensation cost for all share-based payments (including employee stock options) at fair value, would be effective for public companies for interim or annual periods beginning after June 15, 2005. The Company is currently evaluating the effect the adoption of this proposed standard will have on its financial position and results of operations.

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

You should read the following discussion in conjunction with the consolidated financial statements and related notes of SeeBeyond Technology Corporation appearing elsewhere in this Form 10-Q. The following discussion contains forward-looking statements that involve risks and uncertainties, including statements regarding anticipated costs and expenses, mix of revenues and plans for introducing new products and services. Our actual results could differ materially from the results contemplated by these forward-looking statements as a result of a number of factors, including those discussed below, under “Risk Factors” and elsewhere in this Form 10-Q.

General Overview

In October 2003, we announced the general availability of our new suite of products, the SeeBeyond Integrated Composite Application Network version 5.0 (“ICAN 5”). ICAN 5 offers the integration industry’s first fully integrated platform for the development and deployment of composite applications. ICAN 5 helps organizations to rapidly assemble and deploy enterprise-scale end-user composite applications built on existing systems and infrastructure.

We sell our products and services on a global basis through our direct sales force, and through alliances with leading systems integrators, and in other instances, through value-added software resellers and technology vendors. Our products are typically licensed directly to customers for a perpetual term, with pricing based on the number of systems or applications the customer is integrating or connecting with our products.

Total revenue for the three months and nine months ended September 30, 2004 was $41.7 million and $118.0 million, respectively, as compared to $32.4 million and $97.0 million in the same periods of the prior year. For the three months ending September 30, 2004, respectively, total revenue was up 29% from the same period in the prior year.

License revenue for the three months ended September 30, 2004 was $17.9 million, a 60% increase over the same period of the prior year. For the three months ended September 30, 2004, license revenues represented 43% of total revenue with services revenues representing 24% and maintenance revenues representing 33%. International revenues represented 43% of total revenues for the three months ending September 30, 2004, with Europe revenues representing 38% and Asia Pacific revenues representing 5%.

We closed 75 customer license transactions for the three months ended September 30, 2004, up from 66 customer license transactions for the three months ended June 30, 2004. For the three months ended September 30, 2004 we closed customer license transactions in key verticals such as financial services, healthcare, manufacturing and retail. The following customers represent new and repeat business during the quarter: BMW Group, BNP Paribas, Borders Group, Inc., Dun and Bradstreet, EDS, Emerson, Haworth, Hertz Corporation, Nestle, United Kingdom’s National Health Service (NHS), ORIX Australia, Pegasus Solutions, Phoenix Wealth Management, Societe Generale, St. Paul Travelers, State of South Dakota, Sutter Health and US Oncology, Inc. We are continuing to drive progress in key areas such as North American sales execution, a renewed focus on strategic alliances development, customer adoption of ICAN 5, which debuted a year ago and composite application development with our existing customer base.

Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.

Our significant accounting policies are described in Note 1 to the annual consolidated financial statements as of and for the year ended December 31, 2003 in Item 8: Financial Statements and Supplementary Data of our annual report on Form 10-K for the year ended December 31, 2003. We believe our most critical accounting policies include the following:

• revenue recognition,

• estimating allowance for doubtful accounts,

• accounting for income taxes

Revenue recognition. We recognize revenue when an agreement has been signed by both parties or other persuasive evidence of an

arrangement exists, the software has been shipped or electronically delivered, the fees are fixed or determinable, collection of the resulting receivable is probable, and no other significant obligations remain. For multiple element arrangements where vendor specific objective evidence of fair value exists for all undelivered elements, we account for the delivered elements in accordance with the “residual method” prescribed by Statement of Position 98-9. Vendor-specific objective evidence of fair value is based on the price a customer is required to pay when the element is sold separately.

We assess whether the fee is fixed and determinable and collection is probable at the time of the transaction. In assessing whether the fee is fixed and determinable, we analyze the payment terms of the transaction and other factors, including the nature and class of customer, our historical experience of collecting under our payment terms without granting a concession, the possibility of the product becoming technologically obsolete before the payments become due and the likelihood of the customer asking for a refund. We do not offer a right of return on our products.

If we determine the fee is not fixed or determinable, we defer the revenue until the payments under the arrangement become due. We assess whether collection is probable based on a number of factors, including the customer’s past transaction history and credit worthiness. If we determine that collection of a fee is not probable, we defer the fee and recognize revenue at the time collection becomes probable, which is generally upon the receipt of cash.

Maintenance revenues consist primarily of fees for providing unspecified software upgrades on a when-and-if-available basis and technical support over a specified term, which is typically twelve months. Maintenance revenues are typically paid in advance and are recognized on a straight-line basis over the specified term.

The fair value of services such as consulting or training is based upon separate sales of these services. Consulting and training services are generally sold on a time-and-materials or fixed fee basis and are generally recognized as the services are performed. Consulting services primarily consist of implementation services related to the installation of our products and generally do not involve significant production, modification or customization to or development of the software.

Significant management judgments and estimates must be made when applying our revenue recognition policy. In the event the application of our revenue recognition policy is incorrect material differences in the amount and timing of revenue could result.

Allowance for doubtful accounts. We maintain allowances for doubtful accounts based on our analyses of the likelihood that our customers will not pay us all the money they owe. In circumstances where there is knowledge of a specific customer’s inability to meet its financial obligations, a specific reserve is recorded against amounts due to reduce the net recognized receivable to the amount that is reasonably believed to be collected. For all our customers we perform analyses, which include a review of their credit profiles, the terms and conditions of the contracts with our customers, and the current economic trends and payment history. We reassess these allowances each accounting period. If actual payment experience with our customers is different than our estimates, adjustments to these allowances may be necessary resulting in additional charges to our statement of operations.

Accounting for income taxes. We record a valuation allowance to reduce our deferred tax assets to the amount expected to be realized. As of September 30, 2004, a valuation allowance equal to the value of the net deferred tax assets was maintained. In the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of its net recorded amount, an adjustment to the valuation allowance would increase income in the period such determination was made.

Significant management judgment is required in determining our provision for income tax assets and liabilities and our future taxable income for purposes of assessing our ability to realize any future benefit from our deferred tax assets. In the event actual results differ from these estimates or we adjust these estimates in future periods, our operating results and financial position could be materially affected.

Results of Operations

The following table sets forth our results of operations for the three months and nine months ended September 30, 2004 and 2003, respectively, expressed as a percentage of total revenues:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2004		2003		2004		2003
Revenues:
License	43	%	35	%	41	%	33	%
Services	24		29		25		31
Maintenance	33		36		34		36
Total revenues	100		100		100		100
Cost of revenues:
License	1		1		1		1
Services and maintenance	25		31		26		33
Total cost of revenues	26		32		27		34
Gross profit	74		68		73		66
Operating expenses:
Research and development	23		31		25		32
Sales and marketing	35		39		39		42
General and administrative	12		12		12		14
Restructuring and impairment charges	—		—		—		7
Amortization of sales and marketing warrants	—		—		—		—
Amortization of stock-based compensation	—		—		—		—
Total operating expenses	70		82		76		95
Income (loss) from operations	4		(14	)	(3	)	(29	)
Interest and other income, net	—		—		—		—
Interest expense	—		—		—		—
Income (loss) before income tax provision	4		(14	)	(3	)	(29	)
Provision for income tax	—		1		—		—
Net income (loss)	4	%	(15	)%	(3	)%	(29	)%

Revenues

Total revenues (in thousands except percentages):

	Three Months Ended September 30,								Nine Months Ended September 30,
	2004		2003		Change				2004		2003		Change
Total revenues	$	41,732	$	32,356	$	9,376	29	%	$	118,038	$	97,035	$	21,003	22	%

Total revenues increased for the three months and nine months ended September 30, 2004 as compared to the same periods of the prior year primarily due to increases in license and maintenance revenues.

License revenues (in thousands except percentages):

	Three Months Ended September 30,								Nine Months Ended September 30,
	2004		2003		Change				2004		2003		Change
License revenues	$	17,944	$	11,249	$	6,695	60	%	$	48,602	$	31,376	$	17,226	55	%

License revenues increased for the three months and nine months ended September 30, 2004 as compared to the same periods in the prior year primarily due to an increase in license revenue in Europe as a result of increased sales of ICAN 5 which was made generally available in October 2003.

Services revenues (in thousands except percentages):

Revenues from services include consulting and implementation services, training and reimbursable out-of-pocket expenses. A majority of our customers use third-party systems integrators to implement our products. Customers also typically purchase additional consulting services from us to support their implementation activities. From time to time, we use third-party systems integrators in a sub-contractor capacity to supplement our own internal services employees. Our consulting services are generally sold on a time and materials or fixed fee basis, and services revenues are recognized as the services are performed. We also offer training services, which are sold on a per student basis and for which revenues are recognized as the classes are attended.

	Three Months Ended September 30,								Nine Months Ended September 30,
	2004		2003		Change				2004		2003		Change
Services revenues	$	10,090	$	9,440	$	650	7	%	$	29,710	$	30,495	$	(785	)	(3	)%

Services revenues increased for the three months ended September 30, 2004 as compared to the same period of the prior year primarily due to a higher demand for our consulting services in EMEA (Europe, Middle East and Africa) due to higher license revenues in the preceding quarterly periods. Services revenues decreased slightly for the nine months ended September 30, 2004 as compared to the same period of the prior year primarily due to a decrease in North American services revenues. This decrease primarily resulted from lower average rates earned for our consulting services due to increased competition from other service providers in the industry.

Maintenance revenues (in thousands except percentages):

Customers who license our products normally purchase maintenance contracts. These contracts provide unspecified software upgrades and technical support over a fixed term, which is typically 12 months. Maintenance contracts are usually paid in advance, and revenues from these contracts are recognized ratably over the term of the contract.

	Three Months Ended September 30,								Nine Months Ended September 30,
	2004		2003		Change				2004		2003		Change
Maintenance revenues	$	13,698	$	11,667	$	2,031	17	%	$	39,726	$	35,164	$	4,562	13	%

Maintenance revenues for the three months and nine months ended September 30, 2004 increased as compared to the same periods of the prior year primarily due to renewals of prior period maintenance contracts associated with the increase in our cumulative license revenues.

Cost of revenues (in thousands except percentages):

Cost of revenues consists primarily of compensation and related overhead costs for personnel and sub-contractors engaged in implementation services, maintenance support activities, training and out-of-pocket expenses as well as royalties for third-party products embedded or bundled with our products. Such costs include salaries, employee benefits, incentive compensation, bonuses, travel, rent and allocated facilities and professional fees.

	Three Months Ended September 30,								Nine Months Ended September 30,
	2004		2003		Change				2004		2003		Change
Total cost of revenues	$	10,976	$	10,340	$	636	6	%	$	32,428	$	33,281	$	(853	)	(3	)%

Total cost of revenues for the three months ended September 30, 2004 increased slightly as compared to the same period of the prior year with no significant year over year changes in any particular cost of revenue line item. Total cost of revenues decreased slightly for the nine months ended September 30, 2004 as compared to the same period of the prior year primarily due to a decrease in professional services related headcount as part of cost-cutting exercises that were performed during the third and fourth quarters of 2003, as well as the use of sub-contractors to supplement our own consultants.

Operating expenses

Research and development expenses (in thousands except percentages):

Research and development expenses consist primarily of personnel, third party contractors and related costs associated with the development and enhancement of our products.

	Three Months Ended September 30,									Nine Months Ended September 30,
	2004		2003		Change					2004		2003		Change
Research and development expenses	$	9,657	$	10,142	$	(485	)	(5	)%	$	29,033	$	31,218	$	(2,185	)	(7	)%

Research and development expenses decreased for the three months and nine months ended September 30, 2004 as compared to the same periods of the prior year primarily due to a slight decrease in development expenses during the post-release development period of ICAN 5. We anticipate research and development expenses to increase slightly in absolute dollars for the foreseeable future.

Sales and marketing expenses (in thousands except percentages):

Sales and marketing expenses consist primarily of personnel and related costs of our direct sales force and marketing staff and the cost of expenditures specific to the marketing group, such as public relations and advertising, trade shows and marketing collateral materials and expenditures.

	Three Months Ended September 30,								Nine Months Ended September 30,
	2004		2003		Change				2004		2003		Change
Sales and marketing expenses	$	14,623	$	12,443	$	2,180	18	%	$	45,693	$	40,883	$	4,810	12	%

Sales and marketing expenses increased for the three months and nine months ended September 30, 2004 as compared to the same periods of the prior year primarily due to an increase in sales commissions as a result of increases in license revenues, promotional and public relations activities related to the marketing of ICAN 5, and an increase in sales headcount. We anticipate sales and marketing expenses to increase slightly in absolute dollars for the foreseeable future.

General and administrative expenses (in thousands except percentages):

General and administrative expenses consist primarily of personnel and related costs for corporate, executive, human resources, legal, IT, finance and accounting functions.

	Three Months Ended September 30,								Nine Months Ended September 30,
	2004		2003		Change				2004		2003		Change
General and administrative expenses	$	4,869	$	3,846	$	1,023	27	%	$	13,727	$	13,071	$	656	5	%

General and administrative expenses for the three months and nine months ended September 30, 2004 increased as compared to the same periods of the prior year primarily due to consulting and related expenses incurred on compliance and review projects related to the requirements imposed by the Sarbanes-Oxley Act of 2002. There was no other significant period over period changes in any particular general and administrative expense item. We anticipate general and administrative expenses to increase slightly in absolute dollars for the foreseeable future.

Interest and other income, net (in thousands except percentages):

Interest and other income, net consists of interest earned on cash balances, foreign currency gains and losses, gains and losses on the disposal of fixed assets and other miscellaneous income and expense items.

	Three Months Ended September 30,								Nine Months Ended September 30,
	2004		2003		Change				2004		2003		Change
Interest and other income, net	$	187	$	123	$	64	52	%	$	117	$	741	$	(624	)	(84	)%

Interest and other income, net for the three months ended September 30, 2004 increased as compared to the same period of the prior year primarily due to decreases in foreign exchange losses in several of our international subsidiaries. Interest and other income, net for the nine months ended September 30, 2004 decreased as compared to the same period of the prior year primarily due to increases in foreign exchange losses in several of our international subsidiaries.

Interest expense (in thousands except percentages):

	Three Months Ended September 30,									Nine Months Ended September 30,
	2004		2003			Change				2004			2003			Change
Interest expense	$	(68)	$	(112	)	$	44	(39	)%	$	(201	)	$	(367	)	$	166	(45	)%

Interest expense for the three months and nine months ended September 30, 2004 decreased as compared to the same period of the prior year primarily due to the lower equipment line and equipment advance balances.

Liquidity and capital resources

As of September 30, 2004, we had cash and cash equivalents of $68.1 million, a decrease of $2.0 million from $70.1 million held as of December 31, 2003.

Operating activities:

	Nine Months Ended September 30,
	2004		2003			Change
Net cash provided by (used in) operating activities	$	1,067	$	(17,558	)	$	18,625	(106	)%

Net cash provided by operating activities for the nine months ended September 30, 2004 was $1.1 million, as compared to cash used in operating activities of $17.6 million for the same period of the prior year. The cash provided by operating activities in the 2004 period was principally related to changes in operating assets and liabilities; whereas the cash used in operating activities in the comparable period in 2003 was comprised of the $28.3 million net loss which was partially offset by $9.1 million of non-cash charges (principally depreciation and amortization of $4.4 million and restructuring and impairment charges of $4.3 million) and $1.6 million related to changes in operating assets and liabilities.

Investing activities:

	Nine Months Ended September 30,
	2004			2003			Change
Net cash used in investing activities	$	(1,068	)	$	(5,710	)	$	4,642	(81	)%

Net cash used in investing activities for the nine months ended September 30, 2004 decreased as compared to the same period of the prior year primarily due to a decrease in capital expenditures. We expect capital expenditures in the next three months to remain flat compared to the previous three months.

Financing activities:

	Nine Months Ended September 30,
	2004			2003			Change
Net cash used in financing activities	$	(2,017	)	$	(1,461	)	$	(556	)	38	%

Net cash used in financing activities for the nine months ended September 30, 2004 increased as compared to the same period of the prior year primarily due to an increase in treasury stock purchases, partially offset by an increase in proceeds from stock options

exercises.

In November 2000, the Company established a $15.0 million line of credit facility (the “Line”) with a lending institution that bears interest at an annual rate of either prime plus 0.5% or the London InterBank Offered Rate (“LIBOR”) rate plus 2.50% (payable monthly). The expiration date of the Line has been extended through May 31, 2005. As of September 30, 2004, $11.5 million was available under the Line and there were no borrowings outstanding. The Company may use up to $5.0 million of the Line to issue letters of credit. As of September 30, 2004, approximately $386,000 was available for the issuance of letters of credit. The Line is secured by intellectual property rights, accounts receivable and certain other assets and is subject to certain borrowing base restrictions. The Line requires maintenance of certain financial covenants pertaining to key financial ratios and the Company is in compliance with those covenants as of September 30, 2004.

Future principal payments on the Equipment Line and the Equipment Advance will aggregate approximately $734,000 in 2004.

We believe that our current cash and cash equivalents balance will be sufficient to meet our working capital and capital expenditure requirements for at least the next twelve months. However, we may need to raise additional funds, and we may not be able to obtain additional debt or equity financing on favorable terms, if at all. In addition, we may also utilize cash resources to fund acquisitions or investments in complementary businesses, technologies or product lines.

Risks Related to SeeBeyond

You should carefully consider the risks described below in evaluating the other statements made herein. The risks described below are not the only ones facing our company. Additional risks not presently known to us, or we currently deem immaterial, may also impair our business operations.

Our business, financial condition or results of operations could be adversely affected by any of these risks. The trading price of our common stock could decline due to any of these risks.

A continued downturn in the general economy or a continuation of the industry trend toward reducing or delaying additional information technology spending due to cost-cutting pressures could reduce demand for our products and services.

We rely significantly upon customers making large information technology purchasing decisions as a source of revenue. The general slow-down in capital spending by our customers that we experienced in recent years, if sustained again in future periods, could result in reduced sales or the postponement of sales to our customers. There can be no assurance the level of spending on information technology in general or on business integration software by our customers and potential customers in particular, will increase or remain at current levels in future periods. Lower spending on information technology could result in reduced license sales to our customers, reduced overall revenues, diminished margin levels, and could impair our operating results in future periods.

We have a large accumulated deficit, we may incur future losses and we may not achieve or maintain profitability.

We have incurred substantial losses since 1998 as we increased funding of the development of our products and technologies and expanded our sales and marketing organization. As of September 30, 2004, we had an accumulated deficit of approximately $157.5 million. We may continue to incur losses in future periods and we may not maintain profitability on a quarterly basis, or achieve and sustain profitability on an annual basis.

Our operating results fluctuate significantly, and an unanticipated decline in revenues or gross margin may disappoint securities analysts or investors and result in a decline in our stock price.

Our operating results have fluctuated significantly in the past and may vary significantly in the future. We believe period-to-period comparisons of our historical results of operations are not a good predictor of our future performance.

Our revenues and operating results depend upon the volume and timing of customer orders and payments and the date of product delivery. Historically, a substantial portion of our revenues in a given quarter has been recorded in the final month of that quarter, with a concentration of these revenues in the last two weeks of the final month. We expect this trend to continue and, therefore, any failure or delay in the closing of orders would have a material adverse effect on our quarterly operating results. Since our operating expenses are based on anticipated revenues and because a high percentage of these expenses are relatively fixed, a delay in the recognition of revenues from one or more license transactions could cause significant variations in operating results from quarter to quarter and cause a decline in our stock price. We realize substantially higher gross margins on our license revenues compared to our services and maintenance revenues. Thus, our margins for any particular quarter will be highly dependent on our revenue mix in that quarter. In our international markets, we have experienced some seasonality of revenues, with lower revenues in the summer months. Although this seasonality has not had a material impact on our operating results in the past, we cannot assure you our operating results will not fluctuate in the future as a result of these and other international trends.

We record as deferred revenue, payments from customers that do not meet our revenue recognition policy requirements. Since only a small portion of our revenues each quarter is recognized from deferred revenue, our quarterly results depend primarily upon entering into new contracts to generate revenues for that quarter. New contracts may not result in revenues in the quarter in which the contract was signed, and we may not be able to predict accurately when revenues from these contracts will be recognized. If our operating results are below the expectations of securities analysts or investors for these or other reasons, our stock price would likely decline, perhaps substantially.

We experience long and variable sales cycles, which could have a negative impact on our results of operations for any given quarter.

Our products are often used by our customers throughout their organizations to address critical business problems. Customers generally consider a wide range of issues before committing to purchase our products, including product benefits, the ability to operate with existing and future computer systems, the ability to accommodate increased transaction volumes and product reliability. Many customers are addressing these issues for the first time when they consider whether to buy our products and services. As a result, we or other parties, including systems integrators, must educate potential customers on the use and benefits of our products and services. In addition, the purchase of our products generally involves a significant commitment of capital and other resources by a customer. This commitment often requires significant technical review, assessment of competitive products and approval at a number of management levels within a customer’s organization. Our sales cycle may vary based on the industry in which the potential customer operates and is difficult to predict for any particular license transaction. The length and variability of our sales cycle makes it difficult to predict whether particular sales will be concluded in any given quarter. If one or more of our license transactions are not consummated in a given quarter, our results of operations for that quarter may be below our expectations and the expectations of analysts and investors.

Our operating results are highly dependent on license revenues from one software suite, and our business could be materially harmed by factors that adversely affect the pricing and demand for this software suite.

Substantially all of our license revenues have been, and are expected to continue to be, derived from the license of our Business Integration Suite. Accordingly, our future operating results will depend on the demand for our Business Integration Suite by future customers, including new and enhanced releases that are subsequently introduced. Our latest version of the Business Integration Suite, ICAN 5, was announced in March 2003 and made generally available to customers in October 2003. If our competitors release new products that are superior to our Business Integration Suite in performance or price, or if we fail to enhance our Business Integration Suite and introduce new products in a timely manner, demand for our products may decline, and we may have to reduce the pricing of our products. A decline in demand or pricing for our Business Integration Suite as a result of these or other factors would significantly reduce our revenues.

In the past, we have experienced delays in the commencement of commercial releases of our Business Integration Suite. In the future, we may fail to introduce or deliver new products on a timely basis. If new releases or products are delayed or do not achieve market acceptance, we could experience customer dissatisfaction or a delay or loss of revenues. For example, the introduction of new enterprise and business applications requires us to introduce new e*Way adapters to support the integration of these applications. Our failure to introduce these or other modules in a timely manner could cause our revenues and market share to decline. In addition, customers may delay purchases of our products in anticipation of future releases. If customers defer material orders in anticipation of new releases or new product introductions, our revenues may decline.

Moreover, as we release enhanced versions of our products, we may not be successful in upgrading our customers who purchased previous versions of our Business Integration Suite to the current version. We also may not be successful in selling add-on modules for our products to existing customers. Any failure to continue to upgrade existing customers’ products or sell new modules, if and when they are introduced, could negatively impact customer satisfaction and our revenues.

The loss of any significant customer could harm our business and cause our stock price to decline.

We do not have long-term sales contracts with any of our customers. There can be no assurance that any of our customers will continue to purchase our products in the future. As a result, a customer that generates substantial revenue for us in one period may not be a source of revenue in subsequent periods. The loss of any significant customer could cause our revenues to decline, harm our business and cause our stock price to decline.

Our revenues will likely decline if we do not develop and maintain successful relationships with our systems integration partners and other partners, who also have relationships with our competitors.

We have entered into agreements with a number of systems integrators for them to install and deploy our products and perform custom integration of systems and applications. These systems integrators also engage in joint marketing and sales efforts with us. If these relationships fail, we will have to devote substantially more resources to the sales and marketing and implementation and support of our products than we would otherwise, and our efforts may not be as effective as those of the systems integrators. In many cases, these parties have extensive relationships with our existing and potential customers and influence the decisions of these customers. We rely upon these firms to recommend our products during the evaluation stage of the purchasing process, as well as for implementation and customer support services.

These systems integrators are not contractually required to implement our products, and competition for these resources may preclude us from obtaining sufficient resources to provide the necessary implementation services to support our needs. If the number of installations of our products exceeds our access to the resources provided by these systems integrators, we will be required to provide these services internally, which would increase our expenses and significantly limit our ability to meet our customers’ implementation needs. A number of our competitors have stronger relationships with some of these systems integrators and, as a result, these systems integrators might be more likely to recommend competitors’ products and services instead of ours. In addition, a number of our competitors have relationships with a greater number of these systems integrators or have stronger systems integrator relationships based on specific vertical markets and, therefore, have access to a broader base of customers.

Our failure to establish or maintain systems integrator relationships would significantly harm our ability to license and successfully implement our software products. In addition, we rely on the industry expertise and customer contacts of these firms in order to market our products more effectively. Therefore, any failure of these relationships would also harm our ability to increase revenues in key commercial markets. We are currently investing, and plan to continue to invest, significant resources to develop these relationships. Our operating results could be adversely affected if these efforts do not generate license and service revenues necessary to offset this investment.

Our markets are highly competitive and, if we do not compete effectively, we may suffer price reductions, reduced gross margins and loss of market share.

The market for our products is intensely competitive, evolving and subject to rapid technological change. We expect the intensity of competition to increase in the future. As a result of increased competition, we may have to reduce the price of our products and services, and we may experience reduced gross margins and loss of market share, any one of which could significantly reduce our future revenues and operating results. Our current competitors include vendors offering business application integration and traditional electronic data interchange, or EDI, software products, as well as “in house” information technology departments of potential customers that have developed or may develop systems that provide some or all of the functionality of our Business Integration Suite. We may also encounter competition from major enterprise software developers in the future.

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

Our substantial and expanding international operations are subject to uncertainties, which could adversely affect our operating results.

Revenues from the sale of products and services outside the United States accounted for 43% for the three months ended September 30, 2004 and 2003 and 48% and 40% for the nine months ended September 30, 2004 and 2003, respectively. Revenues from the sale of products and services in the United Kingdom as a percent of our total revenues were 21% and 10% for the three months ended September 30, 2004 and 2003, respectively, and 27% and 13% for the nine months ended September 30, 2004 and 2003, respectively. We believe revenues from sales outside the United States will continue to account for a material portion of our total revenues for the foreseeable future. We are exposed to several risks inherent in conducting business internationally, such as:

• fluctuations in currency exchange rates, which could result in increased expenses;

• unexpected changes in regulatory requirements, including imposition of currency exchange controls, applicable to our business or to the Internet, which could result in increased costs of doing business overseas;

• difficulties and costs of staffing and managing international operations;

• political and economic instability, which could result in increasing governmental ownership or regulation of businesses or other instrumentalities of commerce, wage and price controls, higher interest rates and spiraling inflation; and

• reduced protection for intellectual property rights in some countries.

Any of these factors could adversely affect our international operations and, consequently, our operating results.

We could suffer losses and negative publicity if new versions or releases of our products contain errors or defects.

Our products and their interactions with customers’ software applications and IT systems are complex and, accordingly, there may be undetected errors or failures when our products are introduced or as new versions are released. In the past we have discovered software errors in our new releases and new products after their introduction, which have resulted in additional product development expenses. To date, these additional expenses have not been material. These errors have resulted in product release delays, delayed revenues and customer dissatisfaction. In the future we may discover errors, including performance limitations, in new releases or new products after the commencement of commercial shipments. Since many customers are using our products for mission-critical business operations, any of these occurrences could seriously harm our business and generate negative publicity, which could have a negative impact on future sales. Although we maintain product liability and errors and omissions insurance, we cannot assure you these policies will be sufficient to compensate for losses caused by any of these occurrences.

If our products do not operate with the many hardware and software platforms used by our customers and keep pace with technological change, our business may fail.

We currently serve a customer base with a wide variety of constantly changing hardware, software applications and platforms. If our products fail to gain broad market acceptance due to an inability to support a variety of these platforms, our operating results may suffer. Our business depends on a number of factors, including the following:

• our ability to integrate our products with multiple platforms and existing, or legacy, systems and to modify our products as new versions of software applications are introduced;

• the portability of our products, particularly the number of operating systems and databases our products can source or target;

• our ability to anticipate and support new standards, especially Internet standards;

• the integration of additional software modules under development with our existing products; and

• our management of software being developed by third parties for our customers for use with our products.

Our industry is characterized by very rapid technological change, frequent new product introductions and enhancements, changes in customer demands and evolving industry standards. We have also found the technological life cycles of our products are difficult to estimate. We believe we must continue to enhance our current products and concurrently develop and introduce new products that anticipate emerging technology standards and keep pace with competitive and technological developments. Failure to do

so will harm our ability to compete. As a result, we are required to continue to make substantial product development investments.

The market for business integration software may not grow as quickly as we anticipate which would cause our revenues to fall below expectations.

The market for business integration software is rapidly evolving. We earn substantially all of our license revenues from sales of our Business Integration Suite. We expect to earn substantially all of our revenues in the foreseeable future from sales of our Business Integration Suite and related products and services. Our future financial performance will depend on continued growth in the number of organizations demanding software and services for application integration and business integration solutions and seeking outside vendors to develop, manage and maintain this software for their critical applications. Many of our potential customers have made significant investments in internally developed systems and would incur significant costs in switching to third-party products, which may substantially inhibit the growth of the market for business integration software. If this market fails to grow, or grows more slowly than we expect, our revenues will be adversely affected.

Pending or future litigation could have a material adverse impact on our results of operation and financial condition.

From time to time, we have been subject to litigation. Several putative securities class action lawsuits are currently pending against us, our directors and officers. The plaintiffs in these suits allege we and the other defendants made false statements about our operating results and business, while concealing material information. We have reached an agreement, subject to court approval, to settle these suits. There is no assurance that the court will approve the settlement. Should the court not approve the settlement, the ultimate outcome of the litigation could harm our business, financial condition and reputation or cause our stock price to decline. In addition to the related cost and use of cash, pending or future litigation could cause the diversion of management’s attention and resources. Although we have begun to accrue amounts relating to legal costs and expenses, we have not accrued any amounts relating to potential damages associated with the putative class action lawsuits. However, because of uncertainties relating to litigation, our decision as to whether to accrue and the amount of our estimates could be wrong.

If we fail to adequately protect our proprietary rights, we may lose these rights and our business may be seriously harmed.

We depend upon our ability to develop and protect our proprietary technology and intellectual property rights to distinguish our product from our competitors’ products. The unauthorized use by others of our proprietary rights could materially harm our business. We rely on a combination of copyright, trademark and trade secret laws, as well as confidentiality agreements and licensing arrangements, to establish and protect our proprietary rights. We currently have no issued patents. Despite our efforts to protect our proprietary rights, existing laws afford only limited protection. Attempts may be made to copy or reverse engineer aspects of our products or to obtain and use information we regard as proprietary. Accordingly, we cannot be certain we will be able to protect our proprietary rights against unauthorized third party copying or use. Furthermore, policing the unauthorized use of our products is difficult, and expensive litigation may be necessary in the future to enforce our intellectual property rights.

Our products could infringe the intellectual property rights of others, causing costly litigation and the loss of significant rights.

Third parties may claim we have infringed their current or future intellectual property rights. We expect software developers in our market will increasingly be subject to infringement claims as the number of products in different software industry segments overlap. Any claims, with or without merit, could be time-consuming, result in costly litigation, prevent product shipment or cause delays, or require us to enter into royalty or licensing agreements, any of which could harm our business. Patent litigation in particular has complex technical issues and inherent uncertainties. In the event an infringement claim against us is successful and we cannot obtain a license on acceptable terms, license a substitute technology or redesign our products to avoid infringement, our business would be harmed. Furthermore, former employers of our current and future employees may assert our employees have improperly disclosed to us or are using their confidential or proprietary information.

Failure to raise additional capital or generate the significant capital necessary to expand our operations and invest in new products could reduce our ability to compete and result in lower revenues.

We currently expect our current cash resources will be sufficient to meet our working capital and capital expenditure needs for at least the next twelve months. After that, we may need to raise additional funds, and we cannot be certain we will be able to obtain additional debt or equity financing on favorable terms, or at all. If we raise additional equity financing, our stockholders may experience significant dilution of their ownership interests and the per share value of our common stock could decline. If we engage in debt financing, we may be required to accept terms that restrict our ability to incur additional indebtedness and force us to maintain specified liquidity or other ratios, any of which could harm our business. If we need additional capital and cannot raise it on acceptable terms, we may not be able to, among other things:

• develop or enhance our products and services;

• maintain or expand our sales and marketing organizations;

• acquire complementary technologies, products or businesses;

• expand operations, in the United States or internationally;

• hire, train and retain employees; or

• respond to competitive pressures or unanticipated working capital requirements.

Our failure to do any of these things could result in lower revenues and could seriously harm our business.

If we fail to attract, retain and integrate qualified personnel, our ability to compete will be harmed.

We depend on the continued service of our key technical, sales and senior management personnel, including our founder and Chief Executive Officer, James T. Demetriades. Most of these persons are not bound by an employment agreement, and we do not maintain key person life insurance on any of these persons, other than Mr. Demetriades. The loss of any of our senior management or other key product development or sales and marketing personnel could adversely affect our future operating results. Additionally, we recently experienced significant turnover in our North American sales force, including new staff and management. Our ability to effectively train and integrate this new North American sales force could pose continuing challenges to our business. If we fail to do so, our operating results, particularly in the short term, could be negatively impacted. In addition, we must attract, retain and motivate highly skilled employees, including sales personnel and software engineers. We face significant competition for individuals with the skills required to develop, market and support our products and services. We may not be able to recruit and retain sufficient numbers of these highly skilled employees. If we fail to do so, our ability to compete will be significantly harmed.

Our growth continues to place a significant strain on our management systems and resources. If we fail to manage our growth, our ability to market and sell our products and develop new products may be harmed.

We must plan and manage our growth effectively in order to offer our products and services and achieve revenue growth and profitability in a rapidly evolving market. Our growth has and will continue to place a significant strain on our management systems and resources, and we may not be able to effectively manage our growth in the future.

Furthermore, if our relationships with systems integrators succeed and we are able to penetrate additional commercial markets, we may need additional sales and marketing and professional services resources to support these customers. The growth of our customer base will require us to invest significant resources in the training and development of our employees and our systems integration partners. If these organizations fail to keep pace with the number and demands of the customers that license our products, our ability to market and sell our products and services and our ability to develop new products and services will be harmed. To manage our business, we must continue to:

• effectively manage our direct sales force;

• effectively manage our professional services organization;

• hire and retain qualified software engineers;

• improve our operational, financial and management controls;

• improve our reporting systems and procedures;

• enhance our management and information control systems; and

• effectively manage, train and motivate our workforce.

In addition, if we acquire or invest in other companies, we may experience further strain on our resources and face risks

inherent in integrating two corporate cultures, product lines, operations and businesses.

Failure to comply with all of the requirements imposed by Section 404 of the Sarbanes-Oxley Act of 2002 could severely harm our credibility and lead to a reduction in our stock price.

As required by Section 404 of the Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission adopted rules requiring public companies to include a report of management on our internal control over financial reporting in our annual reports on Form 10-K beginning with the annual report we file in 2005. This report is required to contain an assessment by management of the effectiveness of our internal controls over financial reporting. In addition, the public accounting firm auditing a public company’s financial statements must attest to and report on management’s assessment of the effectiveness of our internal controls over financial reporting. While we are expending significant resources in developing the necessary documentation and testing procedures required by Section 404, there is a significant risk that we will not be able to fully comply with all of the requirements imposed by Section 404. Further, if we fail to implement required new or improved controls, we may be unable to comply with the requirements of Section 404 in a timely manner. This could result in an adverse reaction in the financial markets due to a loss of confidence in the reliability of our financial statements and could cause the market price of our common stock to decline.

We have implemented anti-takeover provisions that could discourage or prevent a takeover, even if an acquisition would be beneficial to our stockholders.

Some provisions of Delaware law and our certificate of incorporation and bylaws could have the effect of delaying or preventing a third party from acquiring us, even if a change in control would be beneficial to our stockholders. For example, our certificate of incorporation provides for a classified board of directors whose members serve staggered three-year terms and does not provide for cumulative voting in the election of directors. Our board of directors has the authority, without further action by our stockholders, to fix the rights and preferences of and issue shares of preferred stock. In addition, our stockholders are unable to act by written consent. These and other provisions could make it more difficult for a third party to acquire us, even if doing so would benefit our stockholders.

Concentration of ownership among our existing executive officers and directors may prevent new investors from influencing significant corporate decisions.

Our Chief Executive Officer, James T. Demetriades beneficially owns approximately 32% of our outstanding common stock. Our executive officers and directors beneficially own, in the aggregate, approximately 41% of our outstanding common stock. As a result, these stockholders will be able to exercise a significant level of control over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This could have the effect of delaying or

preventing a change of control of SeeBeyond and will make some transactions difficult or impossible without the support of these stockholders.

External factors such as potential terrorist attacks could have a material adverse affect on the U.S. and global economics.

The possibility of potential terrorist attacks could have an adverse effect upon an already weakened world economy and could cause U.S. and foreign businesses to slow spending on products and services and delay sales cycles. The economic uncertainty resulting from any such future attacks and other responses associated with such attacks may continue to negatively impact short-term consumer and business confidence.

Item 3 . Quantitative and Qualitative Disclosure About Market Risk

We are exposed to a variety of risks, including changes in interest rates affecting the return on our investments and foreign currency fluctuations. We have established policies and procedures to manage our exposure to fluctuations in interest rates and foreign currency exchange rates.

Interest rate risk. We maintain our funds in money market and certificate of deposit accounts at financial institutions. Our exposure to market risk due to fluctuations in interest rates relates primarily to our interest earnings on our cash deposits. These securities are subject to interest rate risk in as much as their fair value may fall if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10% from the levels prevailing as of September 30, 2004, the fair value of the portfolio would not decline by a material amount. We do not use derivative financial instruments to mitigate risks. However, we do have an investment policy that would allow us to invest in short-term and long-term investments such as money market instruments and corporate debt securities. Our policy attempts to reduce such risks by typically limiting the maturity date of such securities, placing our investments with high credit quality issuers and limiting the amount of credit exposure with any one issuer.

Foreign currency exchange rate risk. Our exposure to market risk due to fluctuations in foreign currency exchange rates relates primarily to the intercompany balances with our subsidiaries located in Australia, Belgium, France, Germany, India, Italy, Japan, Korea, The Netherlands, New Zealand, Singapore, Spain, Sweden, Switzerland and the United Kingdom. Transaction gains or losses have not been significant in the past and we do not participate in any hedging activity on foreign currencies. We would not experience a material foreign exchange loss based on a hypothetical 10% adverse change in the price of any of the local currencies of these countries. Consequently, we do not expect that a reduction in the value of such accounts denominated in foreign currencies resulting from a sudden or significant fluctuation in foreign exchange rates would have a direct material impact on our financial position, results of operations or cash flows.

Item 4 . Controls and Procedures

Our management evaluated, with the participation of our chief executive officer and chief financial officer, the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon this evaluation, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. There was no change in our internal control over financial reporting (as defined in Rule 13a—15(f) under the Exchange Act) during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II —OTHER INFORMATION

Item 1. Legal Proceedings

The Company is party to routine claims and suits brought against it in the ordinary course of business including disputes arising over the ownership of intellectual property rights and collection matters. In the opinion of management, the outcome of such routine claims will not have a material adverse effect on the Company’s business, financial condition or results of operation.

Information with respect to this item is incorporated by reference to Note 8 (“—Legal Proceedings”) of the Notes to the Condensed Consolidated Financial Statements included in this Report on Form 10-Q.

Item 2. Changes in Securities and Use of Proceeds

(a)	Not applicable
(b)	Not applicable
(c)	Purchases of Equity Securities by the Issuer and Affiliated Purchasers

Issuer Purchases of Equity Securities

Period	(a) Total Number of Shares Purchased	(b) Average Price Paid per Share		(c) Total Number of Shares Purchased as Part of Publicly Announced Plan	(d) Maximum Dollar Amount of Shares that May Yet Be Purchased Under the Plan
7/1/04-7/31/04	70,100	$	2.97	217,436	$	7,905,803
8/1/04-8/31/04	509,714	$	2.89	727,150	$	6,432,730
9/1/04-9/30/04	104,000	$	2.87	831,150	$	6,134,250
Total	683,814	$	2.91	831,150	$	6,134,250

The repurchase plan was announced on February 25, 2003 to repurchase up to $10,000,000 worth of shares and will terminate on February 24, 2005.

Item 3. Defaults Upon Senior Securities

Not applicable

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

None

Item 5. Other Information

None

Item 6. Exhibits

Exhibit No.		Description
3.1(f)		Restated Certificate of Incorporation of the Registrant
3.2(f)		Bylaws of the Registrant
4.1(a)		Specimen common stock certificates
10.1(f)		Form of Indemnification Agreement between the Registrant and each of its directors and officers
10.2(n)(c)		Amended and Restated 1998 Stock Plan
10.3(a)(c)		2000 Employee Stock Purchase Plan and form of agreements there under
10.5(a)		Registration Rights Agreement dated May 8, 1998, as amended
10.6(a)		Lease Agreement dated June 6, 1997 between the Registrant and Boone/Fetter/Occidental I for premises in Monrovia, California
10.7(a)		Lease Agreement dated June 10, 1999 between the Registrant and Franklin Select Realty Trust for premises in Redwood Shores, California
10.8(a)		Lease Agreement dated December 30, 1991 between the Registrant and the Demetriades Family Trust (dated December 20, 1983) for premises in Arcadia, California
10.9(b)		Lease Agreement between The Employees Retirement System of The State of Hawaii and the Registrant dated July 21, 2000 for premises in Monrovia, California
10.10(b)		Lease Agreement between Grant Regent, LLC and the Registrant dated August 2, 2000 for premises in New York,

		New York
10.11(e)		Lease Agreement dated October 9, 2000 between S & F Huntington Millennium LLC and the Registrant for premises in Monrovia, California
10.12(e)		Loan and Security Agreement, dated December 4, 2000, between the Registrant and Comerica Bank-California
10.13(d)		Warrant Purchase Agreement and Warrant dated March 16, 2001 issued to General Motors Corporation
10.14(f)		Amendment to the Loan and Security Agreement dated as of June 25, 2001, between the Registrant and Comerica Bank-California
10.15(f)		Second amendment to the Loan and Security Agreement dated October 31, 2001, between the Registrant and Comerica Bank-California
10.16(f)		Lease Agreement dated as of February 24, 2001 between MWB Business Exchange Limited and the Registrant for premises in Berkshire, United Kingdom
10.17(f)		Lease Agreement as of July 1, 2001 between Trust Company of Australia Limited and the Registrant for premises in Melbourne, Australia
10.18(g)		Lease Agreement between Monrovia Technology Campus LLC and the Registrant dated November 28, 2000 for premises in Monrovia, California
10.19(g)		Sublease Agreement between the Registrant (Tenant) and The Employees Retirement System of The State Of Hawaii (Landlord) and Loopnet (Subtenant) dated April 23, 2002 for premises in Monrovia, California
10.20(g)		Third Amendment to the Loan and Security Agreement dated as of June 30, 2002 between the Registrant and Comerica Bank-California
10.21(h)		Sublease Agreement between the Registrant (Sublessor) and Fidelity National Information Services (Sublessee) and The Employees Retirement System of the State of Hawaii (Lessor) dated December 17, 2002 for premises in Monrovia, California
10.22(h)		First Amendment to the Lease Agreement between Monrovia Technology Campus LLC and the Registrant dated January 23, 2002
10.23(h)		Second Amendment to the Lease Agreement between Foothill Technology Center LLC, (Boone/Fetter/Occidental I) and the Registrant dated October 25, 2002
10.24(h)		Fourth Amendment to the Loan and Security Agreement dated December 24, 2002 between the Registrant and Comerica Bank-California
10.25(c)(h)		Change of Control Letter Agreement between Alex Demetriades and the Registrant dated March 19, 2001
10.26(c)(k)		Form of Change of Control Letter Agreement between the Registrant and certain of its executive officers.
10.27(c)(l)		Employment Letter Agreement between the Registrant and H. Carvel Moore dated July 21, 2003.
10.28(l)		Fifth Amendment to the Loan and Security Agreement dated December 24, 2002 between the Registrant and Comerica Bank-California dated March 26, 2003
10.29(l)		Sixth Amendment to the Loan and Security Agreement dated December 24, 2002 between the Registrant and Comerica Bank-California dated May 30, 2003
10.30(c)(m)		Employment Letter Agreement between the Registrant and Thor Culverhouse dated September 8, 2003.
10.31(o)		Lease Agreement between Mr. T. Devendar Reddy and STC Systems Private Limited dated April 22, 2004 for premises in Hyderabad, India
10.32(o)		Equipment Lease Agreement between Mrs. T. Jhansi Reddy and STC Systems Private Limited dated April 22, 2004 for equipment at leased premises in Hyderabad, India
10.33(o)		Seventh Amendment to the Loan and Security Agreement dated December 24, 2002 between the Registrant and Comerica Bank-California dated July 29, 2004
31.1		Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act.
32.1		Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act.

(a)		Incorporated by reference to an exhibit in the Registrant’s Registration Statement on Form S-1 File No. 333-330648.
(b)		Incorporated by reference to an exhibit in the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on November 14, 2000.
(c)		Denotes a management contract or compensatory plan arrangement.
(d)		Incorporated by reference to an exhibit in the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on May 15, 2001.
(e)		Incorporated by reference to an exhibit in the Registrant’s Annual Report on Form 10-K filed with the Commission on March 30, 2001.
(f)		Incorporated by reference to an exhibit in the Registrant’s Annual Report on Form 10-K filed with the Commission on February 8, 2002.
(g)		Incorporated by reference to an exhibit in the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on August 14, 2002.

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

For the quarterly period ended September 30, 2004

OR

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

For the transition period from to

Delaware		95-4249153
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification Number)

800 E. Royal Oaks Drive Monrovia, California 91016 (626) 471-6000
(Address, including Zip Code, of Registrant’s Principal Executive Offices and Registrant’s Telephone Number, including Area Code)

SeeBeyond Technology Corporation
/s/ BARRY J. PLAGA
Barry J. Plaga
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)

Part I - Financial Information
Item 1.	Financial Statements:
	Condensed Consolidated Balance Sheets as of September 30, 2004 (unaudited) and December 31, 2003
	Condensed Consolidated Statements of Operations (unaudited) for the three months and nine months ended September 30, 2004 and 2003
	Condensed Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2004 and 2003
	Notes to Condensed Consolidated Financial Statements (unaudited)
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosure About Market Risk
Item 4.	Controls and Procedures
Part II - Other Information
Item 1.	Legal Proceedings
Item 2.	Changes in Securities and Use of Proceeds
Item 3.	Defaults Upon Senior Securities
Item 4.	Submission of Matters to a Vote of Security Holders
Item 5.	Other Information
Item 6.	Exhibits
Signatures
Certification of the Chief Executive Officer
Certification of the Chief Financial Officer