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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2003

OR

For the transition period from              to             

Commission file number: 000-49793

ALTIRIS, INC.

(Exact name of registrant as specified in its charter)

588 West 400 South

Lindon, Utah 84042

(Address, including zip code, of

Registrant’s principal executive offices)

Registrant’s telephone number, including area code: (801) 805-2400

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

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨  No  x

There were 21,609,283 shares of the Registrant’s common stock, par value $0.0001, outstanding on July 28, 2003.

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ALTIRIS, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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ALTIRIS, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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ALTIRIS, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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ALTIRIS, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(1) Organization and description of business

Altiris, Inc. (the “Company”) was incorporated in Utah in August 1998 and reincorporated in Delaware in February 2002. The Company develops and markets software products and services that enable organizations to better manage and utilize their Corporate Information Technology (“IT”) resources. The Company sells and markets its IT lifecycle management products and services primarily through value-added resellers (“VARs”), software distributors, original equipment manufacturers (“OEMs”), systems integrators, online sales and the Company’s direct sales force.

(2) Significant accounting policies

Basis of presentation

The accompanying unaudited condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the “Commission”) on the same basis as the Company’s audited annual financial statements, and, in the opinion of management, reflect all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the financial information set forth therein. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the following disclosures, when read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002 are adequate to make the information presented not misleading.

The condensed consolidated financial statements reflect all adjustments that, in the opinion of management, are necessary to present fairly the financial position and results of operations of the Company as of the balance sheet dates and for the periods presented. The results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for any future interim periods or for the entire fiscal year ending December 31, 2003.

Principles of consolidation

The consolidated financial statements include the financial statements of Altiris, Inc. and its wholly-owned subsidiaries, Altiris Australia Pty Ltd., Altiris Computing Edge, Inc., Altiris GmbH (Germany), Altiris Services GmbH, Altiris Ltd., Altiris S.A.R.L., Altiris B.V., Altiris AB, Altiris Estonia OÜ, Altiris GmbH (Switzerland) and Altiris Singapore Pte Ltd. (collectively, the “Company”). All intercompany balances and transactions have been eliminated in consolidation.

Use of estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from these estimates.

Key estimates in the accompanying consolidated financial statements include, among others, revenue recognition, allowances for doubtful accounts receivable and product returns, impairment of long-lived assets, and valuation allowances against deferred income tax assets.

Cash and cash equivalents

Cash equivalents consist of investments with original maturities of three months or less. Cash equivalents consisted primarily of investments in commercial paper, U.S. government and agency securities, taxable auction rate notes and money market funds and are recorded at cost, which approximates fair value.

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ALTIRIS, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

Available-For-Sale Investment Securities

Available-for-sale securities consist primarily of investment grade securities that either mature within the next 12 months or have other characteristics of short-term investments. These include corporate debt, which have contractual maturities ranging from one to two years.

All marketable debt securities classified as available-for-sale are available for working capital purposes, as necessary. Available-for-sale securities are recorded at fair market value. The unrealized gains and losses related to these securities are included in Other Comprehensive Income (Loss). Fair market values are based on quoted market prices. When securities are sold, their cost is determined based on the specific identification method. Available-for-sale securities consist of cost of $24,164,000, gross unrealized gains of $281,000 and fair market value of $24,445,000 as of June 30, 2003.

Revenue recognition

In October 1997, the Accounting Standards Executive Committee issued Statement of Position (“SOP”) 97-02, Software Revenue Recognition, which has been amended by SOP 98-09. SOP 97-02, as amended, generally requires revenue earned on software arrangements involving multiple elements such as software products, annual upgrade protection (“AUP”), technical support, installation and training to be allocated to each element based on the relative fair values of the elements. The fair value of an element must be based on vendor-specific objective evidence (“VSOE”). If VSOE of all undelivered elements exists but VSOE does not exist for one or more delivered elements, then revenue is recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the license fee is recognized as revenue.

The Company licenses its IT lifecycle management software products primarily under perpetual licenses. The Company recognizes revenue from licensing of software products to an end-user when persuasive evidence of an arrangement exists and the software product has been delivered to the customer, provided there are no uncertainties surrounding product acceptance, fees are fixed or determinable, and collectibility is probable. For licenses where VSOE for AUP and any other undelivered elements exist, license revenue is recognized upon delivery using the residual method. As a result, license revenue is recognized in the period in which persuasive evidence of an arrangement is obtained assuming all other revenue recognition criteria are met. For licensing of the Company’s software to OEMs, revenue is not recognized until the software is sold by the OEM to an end-user customer. For licensing of the Company’s software through indirect sales channels, revenue is recognized when the software is sold by the reseller, value added reseller or distributor to an end-user. Discounts given to resellers and distributors are classified as a reduction of revenue in the accompanying statements of operations. The Company considers all arrangements with payment terms longer than the Company’s normal business practice, which do not extend beyond 12 months, not to be fixed or determinable and revenue is recognized when the fee becomes due. If collectibility is not considered probable for reasons other than extended payment terms, revenue is recognized when the fee is collected. Service arrangements are evaluated to determine whether the services are essential to the functionality of the software. Revenue is recognized using contract accounting for arrangements involving customization or modification of the software or where software services are considered essential to the functionality of the software. Revenue from these software arrangements is recognized using the percentage-of-completion method with progress-to-complete measured using labor cost inputs.

The Company derives services revenue primarily from AUP, technical support arrangements, consulting and training and user training conferences. AUP and technical support revenue is recognized using the straight-line method over the period that the AUP or support is provided. Revenue from training arrangements or seminars and from consulting services is recognized as the services are performed or the seminars are held. During the three months ended March 31, 2003, the Company recognized $1.0 million in services revenue from the annual Microsoft Management Summit (MMS) user conference, of which $500,000 was barter revenue for promotional and support services related to the conference. The fair value of the barter revenue and support services was determined based on comparable cash transactions. The 2002 MMS user conference was held during the second quarter of 2002 and generated $3.9 million of service revenue and included $300,000 of barter revenue during the three months ended June 30, 2002.

The Company generally provides a 30-day return right in connection with its software licenses. The Company estimates its product returns based on historical experience and maintains an allowance for estimated returns, which has been reflected as a reduction to accounts receivable. Historically, revenue generated from operations in geographical locations for which the Company does not have sufficient historical return experience is not recognized until the return right lapses. Effective January 1, 2003, management concluded that the Company has sufficient historical return experience for certain geographical locations where the Company had historically not recognized revenue until the 30-day return right lapsed. Accordingly, during the six months ended June 30, 2003, the Company has recognized revenue in these locations upon delivery and has provided an allowance for estimated returns.

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ALTIRIS, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

The net impact on license revenue from this change in accounting estimate was $918,000 for the six months ended June 30, 2003.

Intangible assets

Intangible assets represent acquired intellectual property, customer lists, and assembled workforce. The intangible assets are being amortized using the straight-line method over estimated useful lives of 18 months. Amortization of acquired intellectual property is classified as a cost of revenue in the accompanying statements of operations.

Impairment of long-lived assets

SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, provides a single accounting model for long-lived assets to be disposed of. SFAS No. 144 also changes the criteria for classifying an asset as held for sale, broadens the scope of businesses to be disposed of that qualify for reporting as discontinued operations and changes the timing of recognizing losses on such operations. The Company adopted SFAS No. 144 on January 1, 2002. The adoption of SFAS No. 144 did not affect the Company’s financial position or results of operations.

In accordance with SFAS No. 144, long-lived assets, such as property, plant and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. Assets and liabilities held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet. Goodwill and intangible assets not subject to amortization are tested at least annually for impairment or more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value.

Prior to the adoption of SFAS No. 144, the Company accounted for long-lived assets in accordance with SFAS No. 121, Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.

As of December 31, 2002 and June 30, 2003, management did not consider any of the Company’s long-lived assets to be impaired.

Translation of foreign currencies

The assets and liabilities of foreign subsidiaries have been recorded in their local currencies and translated to U.S. dollars using period-end exchange rates. Income and expense items have been translated at the average rate of exchange prevailing during the period. Any adjustment resulting from translating the financial statements of the foreign subsidiaries is reflected as other comprehensive income (loss), which is a component of stockholders’ equity. Foreign currency transaction gains or losses are reported in the accompanying condensed consolidated statements of operations.

Income taxes

The Company recognizes a liability or asset for the expected future tax consequences of events and transactions that have been recognized in the Company’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. Deferred tax assets are recognized, net of any valuation allowance, for deductible temporary differences and operating loss and tax credit carryforwards. A valuation allowance is provided when it is considered more likely than not that some or all of the deferred tax assets may not be realized.

Stock-based compensation

The Company accounts for its stock-based compensation issued to directors, officers, and employees under Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Under APB No. 25, compensation expense is recognized if an option’s exercise price on the measurement date is below the fair market value of the Company’s common stock. The compensation, if any, is amortized to expense over the vesting period.

SFAS No. 123, Accounting for Stock-Based Compensation, requires pro forma information regarding net income (loss) as if the Company had accounted for its Stock options granted under the fair value method prescribed by SFAS No. 123. The fair value of the stock options is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions for grants during the three months ended June 30, 2003 and 2002 and for the six months ended June 30, 2003 and 2002: average risk-free interest rates of 2.93, 4.65, 2.97 and 4.33 percent, respectively; weighted average volatility of 166, 0, 165 and 0 percent, respectively; expected dividend yield of 0 percent; and an expected life of six years. For purposes of the pro forma disclosures, the estimated fair value of the stock options is amortized over the vesting periods of the respective stock options. The following is the pro forma disclosure and the related impact on net income (loss) attributable to common stockholders and net income (loss) per common share for the three months ended June 30, 2003 and 2002 and for the six months ended June 30, 2003 and 2002:

Reclassifications

Certain amounts in prior period financial statements have been reclassified to conform with the current period’s presentation.

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ALTIRIS, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

(3) Net income (loss) per common share

Basic net income (loss) per common share is computed by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding. Diluted net income (loss) per common share (“Diluted EPS”) is computed by dividing net income (loss) attributable to common stockholders by the sum of the weighted average number of common shares outstanding and the weighted average dilutive common share equivalents then outstanding. The computation of Diluted EPS does not assume exercise or conversion of securities that would have an anti-dilutive effect.

Common share equivalents consist of shares issuable upon the exercise of stock options and warrants, the conversion of amounts outstanding under a related party convertible note payable and shares issuable upon conversion of preferred stock. During the three and six months ended June 30, 2002, there were 4,013,308 and 3,818,883 outstanding common share equivalents, respectively, that were not included in the computation of Diluted EPS as their effect would have been anti-dilutive, thereby decreasing the net loss per common share. During the three and six months ended June 30, 2003, there were no outstanding common share equivalents that were not included in the computation of Diluted EPS.

(4) Commitments and contingencies

Indemnifications

Certain of the Company’s negotiated license agreements include a limited indemnification provision for claims from third-parties relating to the Company’s intellectual property. Such indemnification provisions are accounted for in accordance with SFAS No. 5, Accounting for Contingencies. At June 30, 2003, the Company is not aware of any material liabilities arising from these indemnifications.

Legal matters

On December 23, 1999, the Company commenced a patent infringement suit against Symantec Corporation, or Symantec, in the United States District Court for the District of Utah, or District Court, requesting compensatory damages and injunctive relief. In its response to the Company’s complaint, Symantec denied the Company’s claim of infringement and brought a counterclaim against the Company asserting that the Company’s patent is invalid and that the Company is infringing and diluting Symantec’s trademarks.

In July 2001, the District Court conducted a hearing for the purpose of construing or interpreting the claims comprising the Company’s patent, and in August 2001, the District Court issued an order that narrowly construed these claims. In an effort to facilitate the Company’s appeal from the order, the Company entered into a stipulation with Symantec that, based on the order, Symantec’s products do not infringe the Company’s patent. The stipulation also provided that Symantec’s counterclaims of trademark infringement and dilution would be dismissed and the remainder of the lawsuit would be stayed. Symantec’s only remaining counterclaim requests a judgment that the Company’s patent is invalid.

In November 2001, the District Court entered a final judgment based on the Company’s stipulation, ruling that Symantec did not infringe our patent and dismissing Symantec’s counterclaims for trademark infringement and dilution. The Company and Symantec each appealed the District Court’s ruling to the United States Court of Appeals for the Federal Circuit, or Court of Appeals, and on February 12, 2003, the Court of Appeals ruled that the District Court erred in its construction of the claims comprising the Company’s patent and instructed the District Court to reconsider the question of infringement by Symantec based upon the Court of Appeal’s interpretation of the patent. Although management believes that this patent is an important intellectual property asset, management does not believe that it is material to the Company’s business as a whole. Accordingly, management does not believe that an adverse ruling would have a material adverse effect on the Company’s results of operations or financial position.

The Company is involved in other claims and legal matters arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company’s financial position, results of operations or liquidity.

Concentration of credit risk and significant customers

The Company offers credit terms on the sale of its software products to certain customers. The Company generally performs ongoing credit evaluations of its customers’ financial condition and requires no collateral from its customers. The Company maintains an allowance for doubtful accounts receivable based upon the expected collectibility of all accounts receivable. For the three and six months ended June 30, 2003 and 2002 and as of June 30, 2003 and December 31, 2002, customers that accounted for more than 10% of total revenue and/or accounts receivable balances are as follows:

(5) Segment, geographic and customer information

In accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, the Company operates as one segment, the development and marketing of IT lifecycle management software products and services.

Revenue from customers located outside the United States accounted for 27% and 14% of total revenue for the three months ended June 30, 2003 and 2002, respectively, and 33% and 19% for the six months ended June 30, 2003 and 2002, respectively. The majority of international sales have been made in Europe and Canada. There were no significant long-lived assets held outside the United States as of June 30, 2003.

The following table presents revenue by geographic areas:

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(6) Subsequent event

On July 28, 2003, the Company filed a Registration Statement on Form S-3 with the Securities and Exchange Commission relating to a proposed follow-on public offering of 5,000,000 shares of the Company’s common stock, of which 3,000,000 newly issued shares will be offered by the Company and 2,000,000 shares will be offered by a selling stockholder, The Canopy Group, Inc. In addition, the Company has granted the underwriters an option to purchase an additional 450,000 shares of common stock to cover over-allotments.

Cautionary Statement Regarding Forward-Looking Statements

This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the accompanying Condensed Consolidated Financial Statements and related notes included elsewhere in this report. In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements relate to our, and in some cases our customers’ or partners’, future plans, objectives, expectations, intentions and financial performance and the assumptions that underlie these statements. These forward-looking statements include, but are not limited to, statements regarding the following:

These statements involve known and unknown risks, uncertainties and other factors that may cause industry trends or our actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. These factors include those set forth in the following discussion and under the caption “Factors That May Affect Future Results” of this Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this Quarterly Report on Form 10-Q.

Although we believe that expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We will not update any of the forward-looking statements after the date of this Quarterly Report on Form 10-Q to conform these statements to actual results or changes in our expectations, except as required by law. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report on Form 10-Q. You should carefully review the risk factors described in other documents that we file from time to time with the Securities and Exchange Commission.

Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to all such reports are available, free of charge, on our Internet website under “Company—Investor Relations—SEC Filings,” as soon as reasonably practicable after we file electronically such material with, or furnish it to, the United States Securities and Exchange Commission, or SEC. Out Internet website address is http://www.altiris.com. Information on our website does not constitute a part of this Quarterly Report on Form 10-Q.

Overview

Altiris is a leading provider of software products and services that enable organizations to manage IT assets throughout their lifecycles. Our comprehensive client management, server provisioning and asset management suites are designed to address the challenges that IT professionals face in deploying, migrating, backing up and restoring software settings on multiple hardware devices; provisioning and managing servers; tracking performance and diagnostic metrics for hardware and software; taking inventory of existing IT assets; and facilitating problem resolution for hardware or software failures. We have grown our revenue from $28.8 million in the first six months of 2002 to $43.7 million in the first six months of 2003.

History and background

We began operations in 1996 as the software division of KeyLabs, a privately held independent software quality and e-commerce testing company. In August 1998, Altiris, Inc. was spun out as a separate corporation and the stockholders and option holders of KeyLabs were issued shares of our common stock and options to purchase our common stock in proportion to their ownership interest in KeyLabs. As part of this transaction, we purchased certain assets and assumed certain liabilities of the KeyLabs software division in exchange for $377,000 promissory note. This transaction was accounted for as a reorganization of entities under common control with the assets and liabilities recorded at carry-over basis.

From inception through 2001, our operations were primarily funded through borrowings and equity investments from The Canopy Group, Inc., or Canopy, a principal stockholder. Through February 2002, we had a revolving credit facility with Canopy. In February 2002, we completed a private placement of preferred stock for net proceeds of $21.2 million. Additionally, in February 2002 Canopy exercised a warrant to purchase shares of our common stock for proceeds of $1.5 million. In May 2002, we completed a private placement of 258,064 shares of our Series C non-voting preferred stock for net proceeds of $1.8 million. The Series C non-voting preferred stock subsequently converted into Class B non-voting common stock at the completion of our initial public offering. In May of 2002, we completed our initial public offering of 5,000,000 shares of common stock at a price per share of $10.00, with net proceeds, after underwriting discounts and commissions and direct offering costs, of approximately $43.8 million. The Class B non-voting common stock automatically converted into voting common stock in May 2003.

Our initial product development was focused on deployment and imaging. In 1999, we released our first migration product. In September 2000, we acquired substantially all of the assets of Computing Edge for total consideration of $3.8 million, which added key components to our software and operations management, and inventory and asset management products. In February 2001, we acquired substantially all of the assets of Tekworks for total consideration of $0.8 million, which included key components of our helpdesk and problem resolution products that we had previously licensed from Tekworks. In March 2001, we acquired Compaq’s Carbon Copy technology for total consideration of $3.6 million, which added remote control capability to our products. In September 2002, we acquired substantially all of the technology assets of Previo, for total consideration of $1.1 million, which added system back-up and recovery technology to our product offerings.

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Sources of revenue

We derive the large majority of our revenue from sales of software licenses. We sell our products through online sales and our direct sales force, as well as through indirect channels, such as, VARs, OEMs, systems integrators and distributors. We also derive revenue from sales of annual upgrade protection, or AUP, technical support arrangements, consulting and training services. Generally, we include the first year of AUP with the initial license of our products. After the initial AUP term, the customer can renew AUP on an annual basis.

The majority of our revenue has been generated in the United States. Revenue from customers outside of the United States accounted for 33% of our total revenue for the six months ended June 30, 2003, 20% of our total revenue in 2002, 16% of our total revenue in 2001 and 14% of our total revenue in 2000. As of June 30, 2003, we had sales people located internationally in Australia, Belgium, France, Germany, Japan, the Netherlands, Singapore, Sweden, and the United Kingdom.

Revenue recognition

We recognize revenue in accordance with Statement of Position 97-2, or SOP 97-2, as modified by SOP 98-9. SOP 97-2, as modified, generally requires revenue earned on software arrangements involving multiple elements such as software products, AUP, technical support, installation and training to be allocated to each element based on the relative fair values of the elements. The fair value of an element must be based on vendor-specific objective evidence, or VSOE. We establish VSOE based on the price charged when the same element is sold separately. If VSOE of all undelivered elements exists but VSOE does not exist for one or more delivered elements, then revenue is recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the license fee is recognized as revenue.

License revenue

We license our IT lifecycle management products primarily under perpetual licenses. We recognize revenue from licensing of software products to an end user when persuasive evidence of an arrangement exists and the software product has been delivered to the customer, provided there are no uncertainties surrounding product acceptance, fees are fixed or determinable, and collectibility is probable. For licenses where VSOE for AUP and any other undelivered elements exists, license revenue is recognized upon delivery using the residual method. For licensing of our software to OEMs, revenue is not recognized until the software is sold by the OEM to an end user customer. For licensing of our software through indirect sales channels, revenue is recognized when the software is sold by the reseller, VAR or distributor to an end user customer. We consider all arrangements with payment terms longer than our normal business practice, which do not extend beyond 12 months, not to be fixed or determinable and revenue is recognized when the fee becomes due. If collectibility is not considered probable for reasons other than extended payment terms, revenue is recognized when the fee is collected. Service arrangements are evaluated to determine whether the services are essential to the functionality of the software. Revenue is recognized using contract accounting for arrangements involving customization or modification of the software or where software services are considered essential to the functionality of the software. Revenue from these software arrangements is recognized using the percentage-of-completion method with progress-to-complete measured using labor cost inputs. As of June 30, 2003, we had $18.3 million of deferred revenue.

Services revenue

We derive services revenue primarily from AUP, technical support arrangements, consulting, training and user training conferences. AUP and technical support revenue is recognized using the straight-line method over the period that the AUP or support is provided. Revenue from training arrangements or seminars and from consulting services is recognized as the services are performed or seminars are held.

Critical accounting policies

Our critical accounting policies include the following:

As described above, we recognize revenue in accordance with SOP 97-2, as amended. Revenue recognition in accordance with SOP 97-2 can be complex due to the nature and variability of our sales transactions. To continue recognizing software license revenue in the period in which we obtain persuasive evidence of an arrangement and deliver the software, we must have VSOE for each undelivered element. If we do not continue to maintain VSOE for undelivered elements, we would be required to defer recognizing the software license revenue until the other elements are delivered, which could have a significant negative impact on our revenue. We recognize a portion of our services revenue using the percentage of completion method. Completion is measured based on hours incurred to total estimated hours to complete the project. Also, we are required to estimate the total costs to complete the project. These estimates could change and the impact could be significant. As of June 30, 2003, we had deferred $0.5 million of contract revenue that will be recognized under the percentage of completion method as we complete the work under the contract. Further implementation guidelines relating to SOP 97-2 and related modifications may result in unanticipated changes in our revenue recognition practices and such changes could significantly affect our future revenues and results of operations.

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We offer credit terms on the sale of our products to a significant majority of our customers and require no collateral from these customers. We generally also provide a 30-day return right. We generally perform ongoing credit evaluations of our customers’ financial condition and maintain an allowance for doubtful accounts receivable based upon our historical collection experience and expected collectibility of all accounts receivable. We also maintain an allowance for estimated returns based on our historical experience. As of June 30, 2003, we recorded allowances for doubtful accounts receivable and returns of $1.4 million. Our actual bad debts and returns may differ from our estimates and the difference could be significant.

Stock-based compensation expense consists of the amortization of deferred stock-based compensation resulting from the grant of stock options to employees at exercise prices less than the estimated fair value of the underlying common stock on the grant date. Historically, we determined the estimated fair value of our common stock based on several factors including issuances of our preferred stock and our operating performance. We recorded stock based compensation expense of $0.3 million and $0.8 million in the three months ended June 30, 2003 and 2002, respectively. We recorded stock based compensation expense of $0.7 million and $1.3 million in the six months ended June 30, 2003 and 2002, respectively. We expect to record amortization of deferred stock based compensation of approximately $0.7 million, $0.7 million and $0.2 million for the remaining six months of 2003 and the years ended 2004 and 2005, respectively. Had different assumptions or criteria been used to determine the stock-based compensation related to stock options, materially different amounts of stock-based compensation could have been reported.

In connection with the acquisitions of the assets of Computing Edge, Tekworks, and Previo, and the Carbon Copy technology, we recorded $9.0 million of intangible assets consisting of intellectual property, customer lists and assembled workforce. The intangible assets are amortized over the estimated useful lives of 18 months. Amortization of intangible assets was $0.2 million and $0.3 million for the three months ended June 30, 2003 and 2002, respectively. Amortization of intangible assets was $0.3 million and $1.4 million for the six months ended June 30, 2003 and 2002, respectively. We evaluate our intangible assets, property and equipment and other long-lived assets for impairment and assess their recoverability when changes in circumstances lead us to believe that any of our long-lived assets may be impaired. We assess recoverability by comparing the estimated future undiscounted cash flows associated with the asset to the asset’s carrying amount. If an impairment is indicated, the write-down is measured as the difference between the carrying amount and the estimated discounted cash flow value.

We have provided a valuation allowance against our entire net deferred tax assets as of June 30, 2003 and December 31, 2002, respectively. The valuation allowance was recorded given the historical losses we have incurred and the uncertainties regarding our future operating profitability and taxable income. The valuation allowance amounted to approximately $11.5 million as of December 31, 2002.

Losses since inception and limited operating history

We have incurred significant costs to develop our technology and products, to recruit and train personnel for our engineering, sales, marketing, professional services and administration departments, and to build and promote our brand. As a result, we have incurred significant losses since our inception and had an accumulated deficit of $17.7 million as of June 30, 2003.

Our limited operating history makes the prediction of future operating results difficult. We believe that period-to-period comparisons of operating results should not be relied upon to predict future performance. Our prospects must be considered in light of the risks, expenses and difficulties encountered by companies at an early stage of development, particularly companies in rapidly evolving markets. We are subject to the risks of uncertainty of market acceptance and demand for our products and services, competition from larger, more established companies, short product life cycles, our ability to develop and bring to market new products on a timely basis, dependence on key employees, the ability to attract and retain additional qualified personnel and the ability to obtain adequate financing to support our growth. In addition, we have been dependent on a limited number of customers for a significant portion of our revenue. We may not be successful in addressing these risks and difficulties.

Dividends related to convertible preferred stock

During the year ended December 31, 2002, we recorded preferred stock dividends in the amount of $13.8 million representing the beneficial conversion feature related to the issuance of 2,933,333 shares of Series B preferred stock and 258,064 shares of Series C non-voting preferred stock. The amount of the beneficial conversion feature for the Series B preferred stock was established at the date of issuance based on the difference between the sale or conversion price of $7.50 per share and the estimated fair value of common shares on the date of issuance of $12.00 per share. The amount of the beneficial conversion feature for the Series C non-voting preferred stock was established at the date of issuance based on the difference between the sale or conversion price of $7.75 per share and the estimated fair value of common shares on the date of issuance of $10.00 per share.

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Results of Operations

The following table sets forth our historical results of operations expressed as a percentage of total revenue for the three and six months ended June 30, 2003 and 2002:

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Revenue

Our total revenue increased from $17.2 million for the three months ended June 30, 2002 to $22.8 million for the three months ended June 30, 2003, representing growth of 33% and from $28.8 million for the six months ended June 30, 2002 to $43.7 million for the six months ended June 30, 2002, representing growth of 52%. Revenue from customers outside of the United States increased from $2.5 million for the three months ended June 30, 2002 to $6.1 million for the three months ended June 30, 2003, representing growth of 149% and from $5.5 million for the six months ended June 30, 2002 to $14.2 million for the six months ended June 30, 2003, representing growth of 160%. Sales to HP, Dell and Ingram Micro accounted for 32%, 0% and 11% of our total revenue for the three months ended June 30, 2002, respectively, and 26%, 10% and 5% of our total revenue for the three months ended June 30, 2003, respectively. Sales to HP, Dell and Ingram Micro accounted for 32%, 0% and 11% of our total revenue for the six months ended June 30, 2002, respectively, and 27%, 9% and 5% of our total revenue for the six months ended June 30, 2003, respectively.We expect sales to HP, Dell and Ingram Micro will likely continue to represent a significant portion of our total revenue in the future.

Software. Our software revenue increased from $8.5 million for the three months ended June 30, 2002 to $15.1 million for the three months ended June 30, 2003, representing growth of 78%. The increase in the three months ended June 30, 2003 as compared to the comparable fiscal 2002 period was primarily due to the expansion of our product offerings and an increase in purchases of integrated suites of products as compared to lower priced purchases of individual product modules and, to a lesser extent, expansion of our relationships and indirect sales channel and expansion of our direct sales forces.

Our software revenue increased from $15.7 million for the six months ended June 30, 2002 to $27.9 million for the six months ended June 30, 2003, representing growth of 77%. The increase during the six months ended June 30, 2003 as compared to the comparable fiscal 2002 period was primarily due to the expansion of our product offerings and an increase in purchases of integrated suites of products as compared to lower priced purchases of individual product modules and, to a lesser extent, expansion of our relationships and indirect sales channel and expansion of our direct sales forces. Historically, revenue generated from product sales in geographical locations for which we did not have sufficient historical return experience was not recognized until the return right lapsed. Effective January 1, 2003, we concluded that we have sufficient historical return experience for certain geographical locations where we had historically not recognized revenue until the 30-day return right lapsed. Accordingly, during the six months ended June 30, 2003, we have recognized revenue in these locations upon delivery to the end user customer and have provided an allowance for estimated returns. The net increase on license revenue from this change in accounting estimate was $918,000 for the six months ended June 30, 2003.

Services. Services revenue decreased from $8.8 million for the three months ended June 30, 2002 to $7.8 million for the three months ended June 30, 2003, representing a decrease of 11%. A significant portion of the decrease in services revenue is due to the timing and success of the annual Microsoft Management Summit, or MMS user conference. The 2002 MMS user conference, which generated $3.9 million of revenue and included $300,000 of barter revenue, was held during the second quarter of 2002. The 2003 MMS user conference, which genereated $1.0 million of revenue and included $500,000 of barter revenue for promotional and support services related to the conference, was held during the first quarter of 2003. In 2002, we hosted the conference and assumed all administrative and hoteling functions. In 2003, we co-sponsored the conference only, resulting in the decrease in MMS revenue from 2002 to 2003. The remaining change in services revenue in the three months ended June 30, 2003 as compared to the comparable period of 2002 was due to an increase of $2.0 million of new and renewed AUP associated with the increase in software license revenue and to an increase of $0.9 million in consulting and training revenue.

Services revenue increased from $13.0 million for the six months ended June 30, 2002 to $15.8 million for the six months ended June 30, 2003, representing an increase of 21%. The $2.8 million increase was primarily due to $4.1 million of new and renewed AUP associated with the increase in software license revenue and to an increase of $1.6 million in consulting and training revenue, offset by the $2.9 million decrease in revenue from the MMS user conference described above.

Cost of revenue

Software. Cost of software license revenue consists primarily of our amortization of acquired intellectual property, operations and order fulfillment personnel, royalties, duplication charges and packaging supplies. Our cost of software license revenue decreased from $0.6 million for the three months ended June 30, 2002 to $0.3 million for the three months ended June 30, 2003, representing a decrease of 51%. The decrease was primarily due to a $138,000 decrease in amortization of acquired intellectual property. Cost of software revenue, excluding amortization, was $0.3 million for the three months ended June 30, 2002 and $0.2 million for the three months ended June 30, 2003. Excluding amortization of acquired intellectual property, cost of software revenue represented 2% of software revenue for the three months ended June 30, 2002 and 1% for the three months ended June 30, 2003.

Our cost of software license revenue decreased from $1.9 million for the six months ended June 30, 2002 to $0.6 million for the six months ended June 30, 2003, representing a decrease of 65%. Cost of software revenue, excluding amortization, was $0.5 million for the six months ended June 30, 2002 and $0.4 million for the six months ended June 30, 2003, and amortization of acquired intellectual property was $1.4 million and $0.3 million, respectively. The decrease in amortization of acquired intellectual property is due to the Computing Edge acquired intellectual property being fully amortized during the first quarter of 2002. Excluding amortization of acquired intellectual property, cost of software revenue represented 3% of software revenue for the six months ended June 30, 2002 and 1% of software revenue for the six months ended June 30, 2003. Cost of revenue, excluding amortization of acquired intellectual property, as a percentage of software revenue is expected to remain relatively consistent.

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Services. Cost of services revenue consists primarily of salaries and related costs for technical support personnel, engineers associated with consulting services, training personnel and the cost of the MMS user conference. Our cost of services revenue decreased from $3.6 million for the three months ended June 30, 2002 to $1.8 million for the three months ended June 30, 2003. The decrease in our cost of services revenue was primarily due to $2.5 million in costs associated with the 2002 MMS user conference and due to an increase of $0.7 million in professional service costs associated with the increase in related consulting and training revenue. Cost of services revenue represented 41% of services revenue for the three months ended June 30, 2002 and 23% of services revenue for the three months ended June 30, 2003.

Our cost of services revenue decreased from $4.4 million for the six months ended June 30, 2002 to $4.3 million for the six months ended June 30, 2003. The decrease in our cost of services revenue was primarily due to a decrease of $1.6 million in costs associated with the 2003 MMS user conference as compared to the 2002 MMS user conference, offset by an increase of $1.5 million in professional service costs associated with the increase in related consulting and training revenue. Cost of services revenue represented 34% of services revenue for the six months ended June 30, 2002 and 27% of services revenue for the six months ended June 30, 2003. Cost of services revenue as a percentage of services revenue is expected to remain relatively consistent.

Operating expenses

Sales and marketing. Sales and marketing expense consists primarily of salaries, sales commissions, bonuses, benefits and related costs of sales and marketing personnel, tradeshow and other marketing activities. Sales and marketing expense increased from $6.7 million for the three months ended June 30, 2002 to $9.6 million for the three months ended June 30, 2003, an increase of 44%, and from $12.3 million for the six months ended June 30, 2002 to $17.9 million for the six months ended June 30, 2003, an increase of 46%. The increases in both fiscal 2003 as compared to the comparable 2002 fiscal periods were primarily due to increases in salaries and benefits, including commissions, from an increase in our worldwide sales and marketing personnel, including customer services and support, which increased from 171 employees at June 30, 2002 to 226 employees at June 30, 2003. In addition, we had increased expenses related to travel and advertising and expansion of our sales infrastructure and the establishment of additional third-party channel partners. Sales and marketing expense represented 39% of total revenue for the three months ended June 30, 2002 and 42% of total revenue for the three months ended June 30, 2003 and represented 43% of total revenue for the six months ended June 30, 2002 and 41% of total revenue for the six months ended June 30, 2003. The decrease primarily was due to economies of scale resulting from increases in the number and size of sales transactions as well as the allocation of marketing expenses over a substantially larger revenue base. We plan to continue expanding our sales, marketing, and support functions and increasing our relationships with key customers. We expect sales and marketing expenses to continue to increase in absolute dollars during 2003 as we expand our sales and marketing efforts.

Research and development. Research and development expense consists primarily of salaries, bonuses, benefits and related costs of engineering, product strategy and quality assurance personnel. Research and development expense increased from $3.7 million for the three months ended June 30, 2002 to $5.9 million for the three months ended June 30, 2003, an increase of 58%, and from $7.3 million for the six months ended June 30, 2002 to $11.3 million for the six months ended June 30, 2003, and increase of 55%. The increases in both fiscal 2003 periods as compared to the comparable fiscal 2002 periods were primarily due to increases in expenses associated with the hiring of additional engineering and technical writing personnel, which resulted in an increase from 135 employees at June 30, 2002 to 196 employees at June 30, 2003. Research and development expense represented 22% of total revenue for the three months ended June 30, 2002 and 26% of total revenue for the three months ended June 30, 2003. Research and development expense represented 25% of total revenue for both the six months ended June 30, 2002 and 2003. We expect that research and development expense will continue to increase in absolute dollars as we invest in additional software products in 2003.

General and administrative. General and administrative expense consists of salaries, bonuses, benefits and related costs of finance and administrative personnel and outside service expense, including legal and accounting expenses. General and administrative expense increased from $1.8 million for the three months ended June 30, 2002 to $2.0 million for the three months ended June 30, 2003, an increase of 15%, and from $3.2 million for the six months ended June 30, 2002 to $3.8 million for the six months ended June 30, 2003, and increase of 20%. The increases in both fiscal 2003 periods as compared to the comparable fiscal 2002 periods were primarily due to additional expenses related to increased staffing necessary to manage and support our growth. General and administrative personnel increased from 34 employees at June 30, 2002 to 51 employees at June 30, 2003. General and administrative expense represented 10% of total revenue for the three months ended June 30, 2002 and 9% of total revenue for the three months ended June 30, 2003. General and administrative expense represented 11% of total revenue for the six months ended June 30, 2002 and 9% of total revenue for the six months ended June 30, 2003. We expect that general and administrative expense will continue to increase to support our growth and due to costs associated with being a public company through the remainder of 2003.

Stock-based compensation. Stock-based compensation consists of expense recorded when an option’s exercise price is below the fair market value of the common stock granted on the measurement date. We recorded deferred stock-based compensation relating to stock option grants to employees of $2.6 million during the year ended December 31, 2002. No deferred stock-based compensation was recorded during the six months ended June 30, 2003. We recognized stock-based compensation expense of $0.8 million for the three months ended June 30, 2002 and $0.3 million for the three months ended June 30, 2003. We recognized stock-based compensation expense of $1.3 million for the six months ended June 30, 2002 and $0.7 million for the six months ended June 30, 2003.

Amortization of intangible assets. Amortization of intangible assets relates to the intangible assets acquired in the Computing Edge and Previo acquisitions, excluding intellectual property. The remaining portion of intangible assets related to Computing Edge was fully amortized during the three months ended March 31, 2002. Amortization of intangible assets was $25,000 for the six months ended June 30, 2002 and $41,000 for the six months ended June 30, 2003. We expect amortization of intangible assets to be approximately $20,000 of amortization for each of the next three quarters.

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Other income (expense), net. During the three and six months ended June 30, 2003, we had net other income of $0.9 million and $1.2 million, respectively, which consists primarily of interest income and a gain from the termination of the Vision license agreement with MasterSolution, Inc. offset by interest expense. The termination of the Vision license resulted in a gain of $0.7 million, consisting primarily of $0.4 million for the termination of the license agreement, $0.1 million for the license of the customer list, and $0.2 million for MasterSolution’s assumption of obligations to current Vision customers under annual upgrade protection agreements for which we had deferred revenue. During the three and six months ended June 30, 2002, we had net other income of $0.7 million and $0.5 million, which consists primarily of interest income and foreign currency translation gains offset by interest expense.

Provision for income taxes. During the three and six months ended June 30, 2003, we recorded a provision for income taxes of $0.3 million and $0.4 million for state income taxes where we do not have net operating loss carryforwards and for foreign jurisdictions in which we generated taxable income. During the three and six months ended June 30, 2002, we recorded a provision for income taxes of $0.2 million for state income taxes and foreign jurisdictions.

Dividends related to convertible preferred stock. During the three months ended March 31, 2002, we recorded a deemed preferred stock dividend of $13.2 million representing the beneficial conversion feature related to the issuance of 2,933,333 shares of Series B preferred stock. The amount of the beneficial conversion feature was established at the date of issuance based on the difference between the sales or conversion price of $7.50 per share and the estimated fair value of common shares on the date of issuance of $12.00 per share.

In connection with the issuance of 258,064 shares of Series C non-voting preferred stock, we recorded an additional deemed preferred stock dividend of $0.6 million in the three months ended June 30, 2002 representing the beneficial conversion feature. The amount of the dividend was based on the difference between the sales price of $7.75 per share and the estimated fair value of common shares on the date of issuance of $10.00 per share.

Liquidity and Capital Resources

Since inception, we have funded our operations primarily through borrowings and equity investments. In May 2000, Canopy converted $9.0 million of debt into shares of preferred stock. In May 2000, we also sold shares of preferred stock for $0.5 million. In February 2002, we sold 2,933,333 shares of our Series B preferred stock through a private offering for net proceeds of $21.2 million and we issued 272,728 shares of our common stock to Canopy upon the exercise of an outstanding warrant resulting in proceeds of $1.5 million. In May 2002, we completed a private placement of 258,064 shares of our Series C non-voting preferred stock for net proceeds of $1.8 million. In May 2002, we completed the initial public offering of our common stock and realized net proceeds from the offering of approximately $43.8 million. Upon the closing of our initial public offering, our Series A and Series B preferred shares converted into common shares and the Series C non-voting preferred stock was converted into Class B non-voting common stock. The non-voting common stock automatically converted into voting common stock in May 2003.

Our operating activities provided $0.4 million of cash during the six months ended June 30, 2003 and $4.7 million during the six months ended June 30, 2002. Cash provided by operating activities in the first six months of 2003 consisted primarily of net income of $5.8 million, adjusted for $1.3 million of depreciation and amortization, $0.6 million of stock-based compensation and a $0.6 million provision for doubtful accounts and other allowances. Changes in operating assets and liabilities used $7.9 million of cash during the first six months of 2003 consisting primarily of a $10.5 million increase in accounts receivable. Net cash provided by operating activities in 2002 consisted primarily of the net loss of $86,000, adjusted for $3.2 million of depreciation and amortization, $2.6 million of stock-based compensation and a $1.5 million provision for doubtful accounts and other allowances. Changes in operating assets and liabilities provided $2.4 million of cash during the six months ended June 30, 2002.

Accounts receivable increased from $11.9 million as of December 31, 2002 to $22.3 million as of June 30, 2003. Accounts receivable increased at a higher rate than revenue as of June 30, 2003 primarily due to large sales during the last month of the period with payment not then due. Deferred revenue increased from $14.0 million as of December 31, 2002 to $18.3 million as of June 30, 2003.

Investing activities provided $1.4 million of cash during the six months ended June 30, 2003 as compared to $0.4 million of cash used by investing activities during the six months ended June 30, 2002. Cash provided by investing activities during the six months ended June 30, 2003 consisted of $3.8 million in dispositions of available-for-sale securities, offset by $1.9 million in purchases of available-for-sale securities and $0.5 million for purchases of property and equipment. Cash used in investing activities during the six months ended June 30, 2002 primarily consisted of $0.4 million of purchases of property and equipment.

Financing activities provided $1.5 million of cash during the six months ended June 30, 2003 and $64.6 million of cash during the six months ended June 30, 2002. During the six months ended June 30, 2003, we received $2.1 million of cash from the issuance of common shares of stock upon the exercise of stock options offset by $0.6 million of payments on notes payable and capital lease obligations. The cash provided by financing activities during the six months ended June 30, 2002 consisted primarily of $68.4 million of cash from the issuance of common and preferred shares of stock, net of issuance costs, offset by $3.8 million of payments on notes payable and capital lease obligations.

As of June 30, 2003, we had stockholders’ equity of $74.7 million and working capital of $75.6 million. Included in working capital is deferred revenue of $14.2 million, which will not require dollar for dollar of cash to settle but will be recognized as revenue in the future. We believe that our current working capital, together with cash anticipated to be provided by operations, will be sufficient to satisfy our anticipated cash requirements and capital expenditures for the next 12 months.

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Contractual Obligations and Commitments

The following table summarizes our contractual obligations as of June 30, 2003 (in thousands):

As of June 30, 2003, we did not have any other commercial commitments, such as letters of credit, guarantees or repurchase obligations.

Recent Events

On July 28, 2003, we filed a Registration Statement on Form S-3 with the Securities and Exchange Commission relating to a proposed follow-on public offering of 5,000,000 shares of our common stock, of which 3,000,000 newly issued shares will be offered by Altiris and 2,000,000 shares will be offered by a selling stockholder, The Canopy Group, Inc. In addition, we have granted the underwriters an option to purchase an additional 450,000 shares of our common stock to cover over-allotments.

Factors That May Affect Future Results

Set forth below and elsewhere in this Quarterly Report on Form 10-Q, and in other documents we file with the Securities and Exchange Commission, are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Quarterly Report on Form 10-Q. Because of the following factors, as well as other variables affecting our operating results, past financial performance should not be considered a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods.

We have limited operating experience, have only recently become profitable and may not be able to maintain or increase our profitability. If we cannot maintain or increase profitability, our stock price could decline.

We were incorporated in August 1998 and have a limited operating history, which makes it difficult to forecast our future operating results. You should consider and evaluate our prospects in light of the risks and uncertainty frequently encountered by early stage companies in rapidly evolving markets. Although quarterly revenues have continued to increase in recent quarters, it was not until the fourth quarter of 2002 that we were profitable under accounting principles generally accepted in the United States of America, or GAAP, and we may not realize sufficient revenue to maintain or increase profitability in future periods. As of June 30, 2003, we had an accumulated deficit of $17.7 million. We anticipate that our operating expenses will increase substantially in the foreseeable future as we continue to develop our technology, products and services, expand our distribution channels, increase our sales and marketing activities, and expand our United States and international operations. These efforts may prove more expensive than we currently anticipate and we may not succeed in increasing our revenue sufficiently to offset these higher expenses. Any failure to increase our revenue as we implement initiatives to grow our business could prevent us from maintaining or increasing profitability and, as a result, our stock price could decline. We cannot be certain that we will be able to maintain or increase profitability on a quarterly or annual basis.

Our quarterly operating results are difficult to predict, and if we do not meet quarterly financial expectations of securities analysts or investors, our stock price is likely to decline.

Our quarterly revenue and operating results are difficult to predict and may fluctuate from quarter to quarter. It is possible that our operating results in some quarters will be below market expectations. If this happens, the market price of our common stock is likely to decline. As a result, we believe that quarter-to-quarter comparisons of our financial results are not necessarily meaningful, and you should not rely on them as an indication of our future performance. Fluctuations in our future quarterly operating results may be caused by many factors, including:

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A significant portion of our software revenue in any quarter depends on orders booked and shipped in the last month, weeks or days of that quarter. Many of our customers are large businesses, and if an order from one of these large customers does not occur or is deferred, our revenue in that quarter could be substantially reduced, and we may be unable to proportionately reduce our operating expenses during a quarter in which this occurs.

Our operating expenses are based on our expectations of future revenue and are relatively fixed in the short term. We plan to increase our operating expenses. If our revenue does not increase commensurate with those expenses, net income in a given quarter could be less than expected.

If Microsoft successfully expands its systems management software offerings that compete with our products or if the Microsoft technologies upon which our products are dependent become incompatible with our products or lose market share, the demand for our Microsoft-based products would suffer.

Microsoft has announced its intention to expand its offerings in the systems management software market that compete with our products. Microsoft has substantially greater financial, technical and marketing resources, a larger customer base, a longer operating history, greater name recognition and more established relationships in the industry than we do. If Microsoft gains significant market share in the systems management market with competing products, our ability to achieve sufficient market penetration to grow our business may be impaired and the demand for our products would suffer. In addition, the possible perception among our customers and potential customers that Microsoft is going to be successful in marketing expanded systems management software offerings that compete with our products may delay their buying decisions and limit our ability to increase market penetration and grow our business.

In addition, many of our products are designed specifically for the Windows platform and designed to use current Microsoft technologies and standards, protocols and application programming interfaces. Although some of our products work on other platforms, such as UNIX, Linux, Macintosh and Palm, we believe that the integration between our products and Microsoft’s products is one of our key competitive advantages. If Microsoft promotes technologies and standards, protocols and application programming interfaces that are incompatible with our technology, or promotes and supports existing or future products launched by our competitors that compete with our products, the demand for our products would suffer. In addition, our business would be harmed if Microsoft loses market share for its Windows products. We expect many of our products to be dependent on the Windows market for the foreseeable future. If the market for Windows systems declines or develops more slowly than we anticipate, our ability to increase revenue could be limited. Although the market for Windows systems has grown rapidly, this growth may not continue at the same rate, or at all.

We believe that some of our success has depended, and will continue to depend for the foreseeable future, on our ability to continue as a complementary software provider for Microsoft’s systems management server, or SMS, and operations manager products. In the past, we have hosted or co-hosted an SMS user conference in which we provided training on and promoted the integration between Microsoft’s SMS products and our products. Because we do not have any long-term arrangements with Microsoft, we cannot be certain that our relationship with Microsoft will continue or expand. Any deterioration of our relationship with Microsoft could materially harm our business and affect our ability to develop, market and sell our products.

Any deterioration of our relationships with HP could adversely affect our ability to develop, market and sell our products and impair or eliminate a substantial revenue source.

We have generated a substantial portion of our revenue as a result of our relationships with Hewlett-Packard Company, or HP. An important part of our operating results depends on our relationships with HP. The loss of significant revenue from HP would negatively impact our results of operations. HP accounted for approximately 30% of our revenue in 2002 and approximately 27% of our revenue for the six months ended June 30, 2003. We have a license and distribution agreement with HP under which HP distributes our products to customers directly or through HP’s distributors and resellers. We also have an agreement with HP to develop and market an integrated product combining our server deployment and provisioning technology with HP servers. If either of these agreements were terminated, our business would be harmed. Any deterioration in our relationships with HP would harm our business and adversely affect our ability to develop, market and sell our products, grow our revenue or sustain profitability. We expect that we will continue to be dependent on HP for a significant portion of our revenue in future periods.

If we do not continue to execute on our relationship with Dell, our ability to market and sell our products through Dell will be limited and a substantial revenue source will be impaired or eliminated.

An important part of our future operating results will depend on our relationship with Dell, Inc., or Dell. The loss of significant revenue opportunities with Dell could negatively impact our results of operations. Dell accounted for approximately 8% of our revenue in 2002 and 9% of our revenue for the six months ended June 30, 2003. In May 2002, we entered into a software licensing agreement under which Dell was granted a nonexclusive license to distribute certain of our software products and services to third parties. Any deterioration in our relationship with Dell could adversely affect our ability to grow our business and impair a substantial revenue source.

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If the market for IT lifecycle management software does not continue to develop as we anticipate, the demand for our products might be adversely affected.

We believe that historically many companies have addressed their IT lifecycle management needs for systems and applications internally and have only recently become aware of the benefits of third-party software products such as ours as these needs have become more complex. Our future financial performance will depend in large part on the continued growth in the number of businesses adopting third-party IT lifecycle management software products and their deployment of these products on an enterprise-wide basis.

We face strong competitors that have greater market share than we do and pre-existing relationships with our potential customers, and if we are unable to compete effectively, we might not be able to achieve sufficient market penetration to sustain profitability.

The market for IT lifecycle management products and services is rapidly evolving and highly competitive, and we expect competition in this market to persist and intensify. We may not have the resources or expertise to compete successfully in the future. Many of our competitors have substantially greater financial, customer support, technical and marketing resources, larger customer bases, longer operating histories, greater name recognition and more established relationships in the industry than we do. If our competitors maintain significant market share, we might not be able to achieve sufficient market penetration to grow our business, and our operating results could be harmed.

We believe that there is likely to be consolidation in our markets, which could lead to increased price competition and other forms of competition. Established companies may not only develop their own systems management software, but may also acquire or establish cooperative relationships with our current competitors. In addition, we may face competition in the future from large established companies, as well as from emerging companies that have not previously entered the market for IT lifecycle management software or that currently do not have products that directly compete with our products. It is also possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. We may not be able to compete successfully against current or future competitors, and this would impact our revenue adversely and cause our business to suffer.

In addition, existing and potential competitors could elect to bundle their products with, or incorporate systems management software into, products developed by themselves or others. Developers of software products with which our products must be compatible to operate could change their products so that they will no longer be compatible with our products. If our competitors were to bundle their products in this manner or make their products incompatible with ours, this could harm our ability to sell our products and could lead to price reductions for our products, which would likely reduce our profit margins.

If we do not expand our indirect distribution channels, we will have to rely more heavily on our direct sales force to develop our business, which could limit our ability to increase revenue and grow our business.

Our ability to sell our products into new markets and to increase our penetration into existing markets will be impaired if we fail to expand our distribution channels and sales force. Our indirect sales channels generated approximately 73% of our revenue in 2002 and approximately 82% of our revenue for the six months ended June 30, 2003. Our sales strategy requires that we establish multiple indirect marketing channels in the United States and internationally through computer manufacturers, original equipment manufacturers, or OEMs, VARs, systems integrators and distributors, and that we increase the number of customers licensing our products through these channels. Our ability to establish relationships with additional computer manufacturers will be adversely affected to the extent that computer manufacturers decide not to enter into relationships with us because of our existing relationships with computer manufacturers with which they compete. In addition, the establishment or expansion of our relationships with computer manufacturers may cause other computer manufacturers with which we have relationships to reduce the level of business they conduct with us or even terminate their relationships with us, either of which would adversely affect our revenue and our ability to grow our business. Moreover, our channel partners must market our products effectively and be qualified to provide timely and costeffective customer support and service, which requires us to provide proper training and technical support. If our channel partners do not effectively market, sell and support our products or choose to place greater emphasis on products offered by our competitors, our ability to grow our business and sell our products will be negatively affected.

We plan to continue to expand our sales efforts worldwide and invest substantial resources toward this expansion. Despite these efforts, we may experience difficulty in recruiting and retaining qualified sales personnel. Because we rely heavily on our sales organizations, any failure to expand these organizations could limit our ability to sell our products. In addition, new sales personnel can require up to several months to begin to generate revenue from the sale of our products. As a result, our operating results may be adversely affected to the extent we incur significant expenses on hiring and retaining new sales personnel who do not begin to generate revenue within several months or at all.

If our existing customers do not purchase additional licenses or renew annual upgrade protection, our sources of revenue might be limited to new customers and our ability to grow our business might be impaired.

Historically, we have derived, and plan to continue to derive, a significant portion of our total revenue from existing customers who purchase additional products and renew annual upgrade protection, or AUP. Sales to existing customers represented 56% of our revenue in 2002 and 62% of our revenue for the six months ended June 30, 2003. If our customers do not purchase additional products or renew AUP, our ability to increase or maintain revenue levels could be limited. Most of our current customers initially license a limited number of our products for use in a division of their enterprises. We actively market to these customers to have them license additional products from us and increase their use of our products on an enterprise-wide basis. Our customers may not license additional products and may not expand their use of our products throughout their enterprises. In addition, as we deploy new versions of our products or introduce new products, our current customers may not require or desire the functionality of our new products and may not ultimately license these products.

We also depend on our installed customer base for future revenue from AUP renewal fees. The terms of our standard license arrangements provide for a one-time license fee and a prepayment for one year of AUP. AUP is renewable annually at the option of our customers and there are no minimum payment obligations or obligations to license additional software.

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Our product sales cycles for large enterprise-wide sales often last in excess of three months and are unpredictable and our product sales cycles for sales to large businesses are typically longer than the sales cycles to small businesses, both of which make it difficult to forecast our revenues and results of operations for any given period.

We have traditionally focused our sales efforts on the workgroups and divisions of our customers, resulting in a sales cycle ranging between 30 and 90 days or even longer. We are continually increasing our efforts to generate enterprise-wide sales, which often have sales cycles that extend beyond that experienced with sales to workgroups or divisions. In addition, our sales to larger enterprises have increased in recent periods. If we do not correctly forecast the timing of our sales in a given period, the amount of revenue we recognize in that period could be negatively impacted, which could negatively affect our operating results. In addition, the failure to complete sales, especially large, enterprise-wide sales, in a particular period could significantly reduce revenue in that period, as well as in subsequent periods over which revenue for the sale would likely be recognized. The sales cycle associated with the purchase of our products is subject to a number of significant risks over which we have little or no control, including:

We may engage in future acquisitions or investments that could require significant management attention and prove difficult to integrate with our business, which could make planning and forecasting our future growth rates and operating results more difficult.