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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

For the Fiscal Year Ended September 30, 2003

Commission File Number 0-21484

TARANTELLA, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code (831) 427-7222

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Preferred Share Purchase Rights Common Stock, no par value

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   ¨    No  x

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment.    ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    

Yes  ¨    No  x

The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing sale price of the Common Stock on December 31, 2003 was approximately $18,089,805. Shares of Common Stock held by each executive officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

As of December 31, 2003, registrant had 15,279,271 shares of Common Stock outstanding.

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TARANTELLA, INC.

Form 10-K

For the Fiscal Year Ended September 30, 2003

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PART I

Item 1.    Business

Forward-Looking Statements

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The forward-looking statements include, but are not limited to, statements concerning future liquidity and financing requirements, potential price erosion, plans to make acquisitions, dispositions or strategic investments, expectations of sales volume to customers, and plans to improve and enhance existing products and develop new products.

Certain information and statements contained in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other sections of this report, including statements containing words such as “could”, “expects”, “may”, “anticipates”, “believes”, “estimates”, “plans”, and similar expressions, are forward-looking statements. The forward-looking statements of Tarantella, Inc. (also referred to as “Tarantella” or “The Company”) are subject to risks and uncertainties. Some of the factors that could cause future results to materially differ from the recent results or those projected in the forward-looking statements include, but are not limited to, significant increases or decreases in demand for the Company’s products, increased competition, lower prices and margins, changes in customer buying patterns, failure to successfully develop and market new products and technologies, competitor introductions of superior products, continued industry consolidation, instability and currency fluctuations in international markets, product defects, failure to secure intellectual property rights, results of litigation, failure to retain and recruit key employees, adverse economic conditions, acts of war or global terrorism, and unexpected natural disasters.

Actual results could differ materially from those projected in the forward-looking report and those described in other reports under the Securities Exchange Act of 1934. Readers are referred to the “Sales and Distribution,” “Customer Support and Service”, “Product Development,” “Competition,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and sections contained in this Annual Report on Form 10-K, which identify some of the important factors or events that could cause actual results of performances to differ materially from those contained in the forward-looking statements.

The Company undertakes no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this Form 10-K.

Available Information

The Company’s website is http://www.tarantella.com. Through a link on the Investor Relations section of the website, the Company makes available the following filings as such reports become available on the Securities and Exchange Commission website: the Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Section 16 filings (Form 4) and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. The public may read and copy any materials filed with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C., 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. The address of that site http://www.sec.gov. Information contained on the Company’s website is not part of this report.

Company Background

Tarantella is a leading provider of Internet infrastructure software that enables web-based access to enterprise applications from virtually any client device. Headquartered in Santa Cruz, California, Tarantella operates development centers in the United States, the United Kingdom and India with sales representatives in

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the U.S., U.K., Germany, Mexico, Canada, France, Spain and Italy. Tarantella products are sold through an integrated worldwide channel of Tarantella account executives, distributors, value-added resellers, systems integrators and computer and software manufacturers. Tarantella maintains exclusive distribution relationships in Japan as well as distribution and agent relationships in China, Northern and Southeast Asia. In total, Tarantella products are available through resellers in more than 30 countries.

The Company was incorporated in 1979 as a California Corporation under the name The Santa Cruz Operation (“SCO”), Inc. On May 4, 2001, SCO completed the sale of its Server Software and Professional Services Divisions to Caldera Systems, Inc., retaining the Tarantella Division. A new company, Caldera International, was formed which combined the assets acquired from SCO with the assets of Caldera Systems. Upon the completion of the sale, SCO changed its corporate name to Tarantella, Inc.

The company’s flagship product, Tarantella Enterprise 3, a UNIX/Linux-based application access suite, is installed in corporations and governmental agencies around the world. Tarantella Enterprise 3 was introduced to the marketplace in 2001. Earlier client integration products, which are part of the Vision2K Suite, were introduced in the late 1990s and are currently still available. In June 2003, Tarantella acquired New Moon Systems Inc, and added New Moon Canaveral^™ iQ from Tarantella^® to its product offering. Canaveral iQ is a Windows-based application access suite, intended for small to mid-sized business customers and departmental deployments with Windows-only infrastructure. In aggregate, Tarantella boasts over 12,000 customer sites including several of the most respected brands in the Forbes Magazine Global 2000.

Subsequent to the issuance of the Company’s consolidated financial statements for the fiscal year ended September 30, 2002, the three months ended December 31, 2002 and the three and six months ended March 31, 2003, the Company’s management determined that the accounting treatment initially afforded to certain transactions was not correct. As a result, the accompanying consolidated financial statements for the fiscal year ended September 30, 2002 have been restated.

The effects of the restatement are presented in note 2 of the Notes to the Consolidated Financial Statements.

Tarantella Mission and Vision: Managed, Secure, Adaptive Application Access

Tarantella’s vision is that application access will play an increasingly prominent role in a ubiquitously wired world. The Company believes server-based application hosting will be the most practical way of delivering applications to businesses, homes and mobile users regardless of time or location. Tarantella’s mission is to become the world’s leading provider of managed, secure and adaptive application access software for Global 2000 companies and government agencies.

Corporate Strategy

Tarantella’s strategy is to focus on the application access needs of Forbes Magazine Global 2000 firms and mobile service providers, and deliver purpose-built, non-invasive, non-disruptive infrastructure software solutions to meet the needs of new classes of users and applications, including new wireless applications, home information service providers and web services applications. From a sales perspective, Tarantella approaches its target market through its worldwide, integrated sales process, including direct sales, channel partners and strategic alliances.

Importance of Web-Based Application Access

Organizations today need secure, managed access to business-critical systems for employees, customers and partners. Mobile and remote worker numbers continue to grow and more companies are consolidating, often requiring diverse computer systems to work together immediately. Workers are dispersed, needing access to data from remote locations. Home workers and extended day workers require efficient, secure access to corporate data

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outside the office. The Internet offers a cost-effective and reliable way for businesses to gain access to their data. This method, however, brings with it an urgent need for high-level security and manageability.

Data Center disaster contingency plans must also allow for alternative user access modes when offices are no longer available. Valuable corporate information kept on desktops is at risk and companies need a centralized, managed business approach that is more cost-effective and secure.

Tarantella’s product offerings address global enterprises’ needs for remote and mobile access, flexible business continuance plans and provide ways to cut the high costs and risks of managing distributed desktop computers. Tarantella’s software suite is a powerful solution regardless of company size or platform environment.

Key Customer Benefits: Application Access and Server-Centric Computing

Target Markets

Tarantella software products provide horizontal network infrastructure solutions, which are used across all types and sizes of companies. However, several target markets have emerged in which the Tarantella value proposition is particularly compelling, including large financial institutions, government agencies (federal, local, defense departments), utilities and telecommunications.

These enterprises generally employ heterogeneous or mixed information systems architectures, are often geographically dispersed with remote access requirements and are under operational pressures to reduce costs while optimizing a return on assets. Large companies with diverse application platforms and a widely distributed user base are an excellent fit for a Tarantella solution. The scalability and flexibility features of Tarantella’s software differentiate it from competitors who cannot scale to meet the demanding heterogeneous architectures of the largest enterprises.

Products Overview

Tarantella offers a comprehensive, server-centric computing product line serving a broad cross-section of customers. This is accomplished by market bifurcation and by addressing distinct customer segments with purpose-built software solutions: Tarantella Enterprise 3 and Canaveral iQ. As a result, Tarantella’s software solutions deliver the benefits of application access and server-centric computing to organizations with the simplest computing and network environments as well as to those with the largest and most complex.

Product Offerings

Tarantella’s product offerings include the flagship Tarantella Enterprise 3 software products, Canaveral iQ from Tarantella, as well as the established Vision2K Suite, as described below:

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Tarantella Enterprise 3

Tarantella Enterprise 3 is focused on organizations with large, heterogeneous and complex IT environments with overriding requirements for flexibility, scalability and application and data security. Tarantella Enterprise 3 customers generally have well-developed UNIX support infrastructure and capabilities. Tarantella’s patented technology was designed for the Internet and enterprise intranets. Tarantella’s Adaptive Internet Protocol (AIP) is designed to optimize the tradeoffs between bandwidth and application performance to give users the best possible experience over any speed connection.

The Tarantella architecture is based on a three-layer approach, whereby the Tarantella server sits in between the application layer (server) and the client layer (user). The non-intrusive nature of Tarantella Enterprise 3 allows installation in the network infrastructure without impacting existing applications or clients.

Tarantella Enterprise 3 software provides universal access to corporate applications, whether modern or legacy, including those that run on Microsoft^® Windows^®, UNIX^®, Linux^®, mainframe or midrange servers. With Tarantella Enterprise 3 software, users access applications remotely from a client device (anything from a thin client to a top-of-the-range PC). Users need only a web browser (such as a current version of Microsoft Internet Explorer or Netscape Navigator), with Java technology enabled. A native client version is also available to operate without a web browser. The centralized management capabilities of Tarantella Enterprise 3 scales to accommodate rapid corporate change, technological advancement and expanding remote access needs. The product can span global multi-site IT architectures, unifying and simplifying IT complexity and diversity, providing an enhanced level of business continuity via increased application availability.

Tarantella Enterprise 3’s elegant, three-tier “drop-in” architecture means there is no need to modify clients, networks, applications or the servers on which they run, making the software ideal for heterogeneous platform environments and large-scale deployment scenarios. Users access all applications through a single, unified and familiar web-based interface. Global resources are opened up without increasing vulnerability, change is managed rapidly and complex IT infrastructures can be simplified without major disruption, expensive development or costly administration.

Tarantella Enterprise 3 software enables users to access business applications over the network, without jeopardizing corporate security, affecting the end user, disrupting the existing infrastructure or requiring costly alternatives, such as a VPN. Tarantella Enterprise 3 software offers SSL security, encryption technology and firewall and proxy server traversal.

New Moon Canaveral^™ iQ from Tarantella^®

Canaveral iQ provides server-based computing for small to mid-sized companies and departments of larger companies that primarily use Microsoft Windows operating systems and platforms in their IT infrastructure. Canaveral iQ’s design focus is on simple installation and deployment, ease of administration and seamless integration with a Microsoft infrastructure. Canaveral iQ is a simple, intelligent and cost-effective application access solution for Microsoft based IT shops.

Canaveral iQ helps organizations fully leverage their investment in Microsoft infrastructure by extending the Windows Terminal Services capabilities available within Microsoft Windows Server 2000 and 2003. The software enhances Windows Terminal Services’ client experience by adding features like seamless windows, enhanced printing and file saving functionality, as well as application access through web-based browsers, Windows desktops or the Windows Start Menu. At the network level, Canaveral iQ enables Windows Terminal Services to more effectively scale to multiple servers and higher user counts by providing:

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Canaveral iQ’s two-tier architecture easily integrates into existing Microsoft environments, providing an affordable solution to centralize the hosting of applications, both over a LAN or to remote users.

Vision2K UNIX Integration Products

Integrating the Windows and UNIX worlds, Tarantella’s established Vision2K software suite extends the power and dependability of UNIX servers to the Windows desktop environment and provides character-based and GUI access to UNIX applications.

The Vision2K Suite consists of:

Competition

The Tarantella Enterprise 3 and Canaveral iQ software solutions face strong competition from a range of point products from companies that include Citrix Systems, Inc., Hummingbird Ltd., and Attachmate Corporation. For example, Citrix is the market leader in providing remote access to Windows applications, while Hummingbird and Attachmate are market leaders for UNIX and mainframes, respectively.

While each of these competitors is formidable in its own space, Tarantella offers an integrated approach, designed to meet enterprise requirements across the board. Tarantella software solutions address the various needs of specific customer segments, regardless of company size or IT sophistication. Additionally, Tarantella products often work alongside those of its competition as well.

The scalability and flexibility of the solution in heterogeneous and demanding architectures differentiates Tarantella Enterprise 3 from its competitors. Tarantella Enterprise 3 installs on all major UNIX and Linux platforms and delivers Windows, UNIX, Linux, Mainframe and web-based applications. Tarantella products can also be used in place of, or to augment, VPN or extranet products.

Canaveral iQ was designed expressly to satisfy the needs of small and medium-sized enterprises and departments of larger enterprises seeking a simple and cost-effective alternative to such products as Citrix’s Metaframe XP. Canaveral iQ seamlessly installs in an organization’s existing Microsoft infrastructure to host Windows-based client software on centralized Microsoft Windows servers.

Strategic Relationships

Strong industry partners augment the Tarantella enterprise value proposition. Sun Microsystems, Inc. and Microsoft Corporation are two of Tarantella’s most valued industry partners.

Tarantella Enterprise 3 software is Sun Tone Certified. Tarantella is a featured technology/development partner for Sun Ray, Java Desktop System, SPARC Solaris and the Java Enterprise Server. Sun Professional Services has a worldwide contract to resell Enterprise 3. Tarantella has a worldwide joint marketing agreement with Sun and has signed distribution agreements with some of the largest Sun distributors in the world including GE Access in the USA, Clarity in the UK and ICOS in Italy.

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Tarantella is a Microsoft Gold Certified ISV Partner and licensee of the RDP specification. Canaveral iQ from Tarantella is viewed as an important complement to Microsoft Windows Terminal Services. Canaveral iQ completes the Terminal Services experience for end users. Tarantella’s relationships with Microsoft span development and executive relationships in Redmond, Washington, to field sales and marketing relationships around the world.

Tarantella also has built strategic relationships with IBM, Oracle and Computer Associates. Additionally, Tarantella partners with a variety of thin client vendors as well as software and hardware vendors. The Technology Alliance Group, or TAG program, enforces the Company’s dedication to forging strong alliances with these vendors and a TAG certification ensures compatibility with either Enterprise 3 or Canaveral iQ. Members of the Tarantella TAG Program include: Aventail, Sun Microsystems, Neoware, Wyse, Fujitsu Siemens, CodeWeavers and Hewlett Packard. These strategic relationships, both new and ongoing, provide Tarantella additional credibility and leverage in selling to the enterprise market.

Sales and Distribution

Tarantella’s target customers comprise the Global 2000 and government agencies worldwide. With more than 12,000 current customers, Tarantella has developed an integrated, two-pronged sales and distribution strategy. Utilizing an extremely focused direct sales force, as well as enterprise distribution channels, its sales force effectively leverages value-added distributors and resellers, systems integrators, Original Equipment Manufacturers (OEMs) and independent software vendors (ISVs). Tarantella selects channel partners based on expertise, experience and access to the target markets. In most large opportunities, channel partners and Tarantella sales representatives work together on identifying, selling and closing these targeted accounts.

In addition to its enterprise sales process, Tarantella sells to small to medium businesses through the PartnerConnect program, with registered and associate partners primarily managed by value-added distributors. Tarantella’s sales network includes the support of over 500 resellers and channel partners globally.

Customer Support and Services

Tarantella’s products are used in business-critical environments that require customer support and services to be essential to the full product offering. Tarantella’s services are designed to support customers ranging from small businesses to large enterprises, both at the end user and reseller levels. The Company offers a variety of support programs and services through its worldwide customer support and services staff as well as its authorized third-party education staff, support and channel partners:

Technical Support—Online support through the web and varying levels of telephone support for corporate accounts;

Educational Services—Courseware and instruction guides provided to the worldwide Tarantella Learning Centers, which train and provide materials for both end users and resellers;

Developer Services—Technical advisory and support services, as well as access to early product releases, for application developers.

The Company sells support services to end users on an annual contract basis. Options are available for customers to tailor support solutions to meet their specific needs. Electronic access to support services is available via the Internet. Software updates, enhancements and bug fixes are also available electronically. Tarantella also supports end users via Authorized Tarantella Service Providers. In addition, the Company provides support services to distributors, Value Added Resellers, OEMs and integrators.

Product Development

Tarantella product development is comprised of one integrated organization with three sites located in Santa Cruz, California, Leeds, United Kingdom, and Pune, India. Tarantella has developed or acquired skills in complex Internet infrastructure areas including web-based technologies, communications, security, Java^™

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technology, virtual user interfaces, networking, adaptive protocols, as well as deep expertise in Microsoft platforms such as Windows Terminal Services, Active Directory, and Microsoft Windows Server 2000 and 2003, Microsoft SQL, COM, and DCOM. The combined product team has developed strong links with application server vendors, including Microsoft, IBM, Sun and Oracle, as well as with client vendors manufacturing a range of products from traditional desktop and complex workstation clients to thin clients and wireless handheld devices.

Tarantella holds five patents entitled “Method of Displaying an Application on a Variety of Client Devices in a Client/Server Network”, “Universal Application Server for Providing Applications on a Variety of Client Devices in a Client/Server Network”, “Network Traffic by Instruction Packet Size Reduction”, “Detection of Peripheral Input Activity and Dynamic System Response”, “System and Method for Virtualizing and Controlling I/O of Applications”. Tarantella also has a number of patent applications pending, including “Color Quality and Packet Shaping Features for Displaying an Application on a Variety of Client Devices”, “System and Method for Dynamic Allocation of Computing Tasks”, “System and Method for Dynamic Content Allocation”, “Improved Client Server Technique for Distributed Computing”, and “System and Method for Managing Access of Distributed Resources”.

Tarantella devotes resources to ongoing product testing and quality assurance to support product reliability. The Company believes its ability to integrate product technologies, to incorporate a wide variety of standards into its products and to continue to offer enhancements to its existing products is essential to maintaining a competitive advantage in the marketplace.

Employees

As of September 30, 2003, Tarantella had 90 full time equivalent employees, including 24 in product development, 35 in sales and marketing, 8 in customer support services and 23 in distribution services and administration. In addition, Tarantella employs 18 product development contractors in Pune, India.

Brief Company History

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Geographic Information

Information about the geographies in which we operate can be found in Part II, Item 8 of this Form 10-K in the Notes to Consolidated Financial Statements at Note 19, “Segment Information and Geographic Data.”

Item 2.    Properties

The Company occupies leased office space in the United States, the United Kingdom, Germany, Spain and Italy, consisting of an aggregate of approximately 32,000 square feet. The Company believes that these facilities are adequate for its needs in the foreseeable future.

Item 3.    Legal Proceedings

On August 28, 2003, a former Tarantella sales representative, filed an action against Tarantella, Inc. and Tarantella International, Inc., a wholly owned subsidiary of Tarantella, (collectively, “Tarantella”) in the California Superior Court in Santa Clara County, California. The complaint purports to state claims for breach of contract, negligent and intentional misrepresentation, fraud, and deceit. The complaint alleges that the plaintiff is owed commissions on certain sales of Tarantella products, and seeks an unspecified amount of damages, correction of the purported contract, prejudgment interest, punitive damages and costs. On September 25, 2003, Tarantella filed a response denying the claims and asserting affirmative defenses. The case is presently in the discovery stage.

Tarantella believes the allegations contained in the complaint are without merit and intends to defend the action vigorously. Should the plaintiff’s claims succeed, however, Tarantella could be required to pay monetary damages, which could have a material adverse effect on Tarantella’s business, financial position and results.

No other material legal proceedings are pending to which the Company is a party.

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

Not applicable.

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PART II

Item 5.    Market for Registrant’s Common Stock and Related Stockholder Matters

The following required information is filed as a part of the report:

The Company’s common stock is quoted on the Over-the-Counter (“OTC”) Pink Sheets, under the symbol “TTLA.PK”. The following table sets forth the range of high and low closing sale prices for the Common Stock for the periods indicated:

On January 22, 2004, there were approximately 12,800 holders of record of the Company’s common stock, and 15,279,271 shares issued and outstanding.

The information required by this Item regarding equity compensation is incorporated by reference to the information set forth in Item 12 of this Annual Report on Form 10-K.

Dividend Policy

The Company has never declared or paid cash dividends on its capital stock. The Company currently expects to retain future earnings, if any, for use in the operation and expansion of its business and does not anticipate paying any cash dividends in the foreseeable future.

Recent Sales of Unregistered Securities

On September 30, 2003, the Company completed a private placement of common stock and warrants to Special Situations Technology Funds and Vertical Ventures resulting in gross proceeds to the Company of approximately $2,250,000 for which the Company will pay placement fees of $118,345. The Company issued 1,950,000 shares of common stock at a price of $1.156 and warrants to purchase 1,950,000 shares of common stock at $1.395 per share. Such shares of common stock and warrants were issued pursuant to an exemption from registration under Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933, as amended. See Note 11 to the Company’s Consolidated Financial Statements. See Note 23 for details on private placements completed after September 30, 2003.

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Item 6.    Selected Financial Data

TARANTELLA, INC.

SELECTED FIVE YEAR FINANCIAL INFORMATION

The significant change in the above selected financial data in fiscal 2001 is due to the sale of the Server and Professional Services divisions to Caldera International in May 2001. See note 13 of Notes to Consolidated Financial Statements.

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Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Company’s consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K, as well as the Management’s Discussion and Analysis of Financial Condition and Result of Operations included in this Annual Report on Form 10-K for the fiscal year ended September 30, 2003. In addition to historical information contained herein, this Discussion and Analysis contains forward-looking statements. These statements involve risks and uncertainties and can be identified by the use of forward-looking terminology such as “estimates,” “projects,” “anticipates,” “plans,” “future,” “may,” “will,” “should,” “predicts,” “potential,” “continue,” “expects,” “intends,” “believes,” and similar expressions. Examples of forward-looking statements include those relating to financial risk management activities and the adequacy of financial resources for operations. These and other forward-looking statements are only estimates and predictions. While the Company (also referred to as “Tarantella”) believes that the expectations reflected in the forward-looking statements are reasonable, the Company’s actual results could differ materially. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s expectations only as of the date hereof.

Overview

Tarantella is a leading provider of Internet infrastructure software that enables web-based access to enterprise applications.

Tarantella products provide managed and secure web access to enterprise mainframe, Windows, AS/400, Linux, and UNIX applications. It leverages existing IT assets to provide cost savings, improved productivity, and the flexibility to accommodate the rapid changes in today’s organizations.

Restatement

Subsequent to the issuance of the Company’s consolidated financial statements for the fiscal year ended September 30, 2002, the three months ended December 31, 2002 and the three and six months ended March 31, 2003, the Company’s management determined that the accounting treatment initially afforded to certain transactions was not correct. As a result, the accompanying consolidated financial statements for the year ended September 30, 2002 have been restated.

The effects of the restatement are presented in note 2 of the Notes to the Consolidated Financial Statements and have been reflected in management’s discussion and analysis of financial condition and results of operations.

Critical Accounting Policies

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make judgments, assumptions and estimates that affect the amounts reported in the Company’s consolidated financial statements and the accompanying notes. Note 3 to the consolidated financial statements for the fiscal year ended September 30, 2003 describes the significant accounting policies and methods used in the preparation of the consolidated financial statements for the three fiscal years in the period ended September 30, 2003. The amounts of assets and liabilities reported on the balance sheets and the amounts of revenues and expenses reported for each of the fiscal periods are affected by estimates and assumptions which are used for, but not limited to, the accounting for revenue, product returns and a valuation allowance for deferred tax assets. Actual results could differ from these estimates. The following critical accounting policies are significantly affected by judgments, assumptions and estimates used in the preparation of the consolidated financial statements.

Revenue Recognition:    The Company’s net revenues are derived from software licenses and fees for services, which include custom engineering, maintenance, support and training. In accordance with Statement of Position 97-2 “Software Revenue Recognition”, revenue is recognized when the price is fixed and determinable,

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upon persuasive evidence of an arrangement, when fulfillment of the Company’s obligations under any such agreement is complete and when there is a determination that collection is probable. Payment arrangements with customers provide primarily 30-day terms and to a limited extent with certain customers 45, 60 or 90 day terms. In certain transactions, the Company does not have a reliable basis to estimate returns and allowances for certain customers or is unable to determine that collection of receivables is probable. In such circumstances, the Company defers revenues at the time of sale and recognizes revenues when collection of the related receivable becomes probable, which is generally upon receipt of cash, and when any potential returns can be reasonably estimated.

For multiple element contracts involving the sale of the Tarantella product the Company uses the residual value method to allocate revenue to each component. The fair value of services and post contract support is determined based upon separate sales and renewal rates set forth in the contract, respectively.

The Company recognizes revenue from maintenance fees for ongoing customer support and product updates ratably over the period of the maintenance contract. Payments for maintenance fees are generally made in advance and are non-refundable. For revenue allocated to education and consulting services or derived from the separate sale of such services, the Company recognizes revenue as the related services are performed.

The Company performs ongoing credit evaluations of its customers’ financial condition and does not require collateral. The Company maintains allowances for potential credit losses and such losses have been within management’s expectations.

Returns and Reserves:    The Company records a provision for product returns for related sales in the same period as the related revenues are recorded. These estimates are based on historical sales returns, analysis of credit memo data and other known factors. If the historical data the Company uses to calculate these estimates does not properly reflect future returns, revenue could be affected.

Allowance for doubtful accounts:    Payments from customers are continuously monitored and allowances are maintained for doubtful accounts for estimated losses resulting from the inability of customers to make required payments. When evaluating the adequacy of allowances for doubtful accounts, various factors are taken into account, including accounts receivable aging, customer credit-worthiness, historical bad debts, and geographic and political risk. If the financial condition of customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. As of September 30, 2003, the Company’s net accounts receivable balance was $3.0 million.

Restructuring charges:    Over the last several years the Company has undertaken significant broad restructuring initiatives. These initiatives have required the recording of estimated provisions for severance and outplacement costs, lease cancellations, long-term asset write downs, and other restructuring costs. Given the significance and the timing of the execution of such activities, this process is complex and involves periodic reassessments of estimates made at the time the original decisions were made. The accounting for restructuring costs and asset impairments requires the recording of provisions and charges when actions are taken and/or appropriate approval for taking action is obtained, and when a liability is incurred. Company policies require continual evaluation of the adequacy of the remaining liabilities under restructuring initiatives. As management continues to evaluate the business, there may be additional charges for new restructuring activities as well as changes in estimates of amounts previously recorded.

Income Taxes:    Tarantella has operations in many countries other than the United States. Transfer prices for services provided between the United States and these countries has been documented by management based on consultation with appropriate outside service providers as reasonable, however, tax authorities could challenge these transfer prices and assess additional taxes on prior period transactions. Any such assessment could require the Company to record an additional tax provision in its statement of operations.

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Income tax assets and liabilities are determined by taxable jurisdiction. The Company evaluates net deferred tax assets in each tax jurisdiction by estimating the likelihood of the Company generating future profits to realize these assets. When necessary, a valuation allowance is recorded to reduce tax assets to an amount for which realization is more likely than not. The provision for income taxes represents taxes payable for the current period, plus the net change in deferred tax amounts.

Goodwill and intangible assets:    The Company reviews the value of long-lived assets, including goodwill, in accordance with the applicable accounting literature for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives of these assets are no longer appropriate. As of September 30, 2003, the Company had $1.3 million of net intangible assets and $2.4 million of goodwill remaining on the balance sheet. The Company believes that the net intangible assets will be realizable based on the estimated future cash flows of the associated products and technology. At September 30, 2003, the Company does not believe that the goodwill is impaired. However, it is possible that the estimates and assumptions used, such as future sales and expense levels, in assessing the carrying value of these assets may need to be reevaluated in the case of continued market deterioration, which could result in impairment of these assets.

De-Listing Status

On October 20, 2003, the Company announced that it had received notification from the Nasdaq Listing Qualifications Panel that the Company’s stock would discontinue trading on the Nasdaq SmallCap Market effective with the open of business on Tuesday, October 21, 2003.

This action followed Tarantella’s appeal to Nasdaq for a listing extension after not meeting the stated time requirements to file SEC Form 10-Q for the Company’s third fiscal quarter. The Nasdaq Panel determination to delist the Company’s stock was based on the Company’s filing delinquency, public interest concerns, and the nature of the ongoing internal revenue investigation. On December 8, 2003, the Company filed an appeal to reverse that portion of the Nasdaq Panel’s decision relating to its public interest concerns. On February 27, 2004, the Nasdaq advised the Company that its appeal had been denied.

Tarantella’s common stock is not currently eligible to trade on the OTC Bulletin Board but is eligible for quotation on the OTC Pink Sheets. The Company’s trading symbol has changed to TTLA.PK.

Regaining SEC compliance may allow the Company’s shares to be eligible for trading on the OTC Bulletin Board. If the Company resumes compliance with the periodic reporting requirements of the 1934 Exchange Act, it will attempt to meet the listing requirements for the Nasdaq SmallCap Market, however some requirements such as minimum bid price and market capitalization are outside of the Company’s control.

Management Change

On December 11, 2003, the Company announced that its Board of Directors had appointed Francis E. Wilde as Chief Executive Officer (CEO), President and a Director of the Company. Mr. Wilde succeeds Douglas Michels, who became a strategic advisor to the Company, focusing initially on merger and acquisition opportunities. Mr. Michels will also continue as a Director of Tarantella.

The Board has also approved the request by several senior executives including Messrs. Wilde, Michels and Alok Mohan, the Company’s Chairman, to receive a substantial portion of their calendar year 2004 compensation in the form of restricted stock in lieu of cash.

On January 6, 2004, the Company announced the appointment of John M. Greeley as Chief Financial Officer (CFO), reporting directly to Mr. Wilde. Mr. Greeley assumed the CFO responsibilities from Mr. Mohan, who had been serving as acting CFO since September 8, 2003.

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Results of Operations

Net Revenues

The Company’s net revenues are derived from software licenses and fees for services, which include engineering services, consulting, custom engineering, support and training.

Net revenues were $14.0 million in fiscal 2003, a decrease of 2% from $14.2 million in fiscal 2002. In fiscal 2002, net revenues decreased by 79% from $66.7 million in fiscal 2001. Revenue declined slightly in fiscal 2003 due to a decrease in prepaid royalty transactions to OEM’s and ISV’s. In fiscal 2002, the Company had $3.2 million in revenue for prepaid royalties. In fiscal 2003, this number decreased to $1.7 million. The decrease of 47% in prepaid royalty transactions in fiscal 2003 was due to customers still consuming prepaid royalties purchased in fiscal 2002. The decline in revenue performance in fiscal 2002 was worldwide across all geographies and is attributable to the sale of a significant portion of the company’s business during fiscal 2001. The Company’s revenues were also impacted by the general reduction in information technology (“IT”) spending by companies for application server software and service initiatives. For the fiscal year ended September 30, 2003, Northrop Grumman Computing accounted for 13.7% of the Company’s net revenues and for the fiscal year ended September 30, 2002, Netilla Networks, Inc. accounted for 10.3% of the Company’s net revenues. For the fiscal years ended September 30, 2001, no single customer accounted for more than 10% of the Company’s net revenues.

International revenues continue to be a significant portion of net revenues, comprising 53% of the revenues for fiscal 2003 and 44% and 52% for 2002 and 2001, respectively.

License Revenues.    License revenues were $11.0 million in fiscal 2003 as compared to $11.4 million in fiscal 2002 and $55.8 million in fiscal 2001, representing a decrease of 3% in fiscal 2003 over 2002 and a decrease of 80% in fiscal 2002 over 2001. License revenues were 78% of total net revenues for fiscal 2003 and 80% and 84% of total net revenues for fiscal 2002 and 2001, respectively. The decline in license revenues in fiscal 2003 is due to a decrease in prepaid royalty transactions to OEMs and ISVs. In fiscal 2002, the Company had $3.2 million in revenue for prepaid royalties. In fiscal 2003, this number decreased to $1.7 million. The decrease of 47% in prepaid royalty transactions in fiscal 2003 was due to the fact that customers were still consuming prepaid royalties purchased in fiscal 2002. The decline in license revenues in fiscal 2002 is attributed to the sale of the server business to Caldera Systems, Inc. (“Caldera”).

Services Revenues. Services revenues were $3.0 million in fiscal 2003, an increase of 6% over the $2.9 million in fiscal 2002. Services revenues were $2.9 million in fiscal 2002, a decrease of 74% from the $10.8 million in fiscal 2001. Services revenues were 22% of the total revenue for fiscal 2003, compared to 20% in the prior year. The increase in services revenues in fiscal 2003 was primarily due to an increased percentage of customers purchasing service contracts. The decline in services revenues in fiscal 2002 was primarily in the Professional Services area and is the result of the sale of the Professional Services business to Caldera.

Cost of Revenues

The Company’s overall cost of revenues as a percentage of net revenues can be affected by changes in net revenue contribution between product families, geographic regions and channels of distribution, since both price and cost characteristics associated with these revenue streams can vary greatly. The Company can also experience fluctuations in gross margin as net revenues increase or decrease since certain costs of revenues including technology, services, and distribution act as fixed costs within certain volume ranges.

Cost of License Revenues.    Cost of license revenues includes royalties paid to certain software vendors, amortization of acquired technologies, product packaging, documentation and all costs associated with the acquisition of components and shipping. Cost of license revenues as a percentage of license revenues remained flat with fiscal 2002 at 3%. In fiscal 2001, cost of license revenues as a percentage of license revenues, was 15%.

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The 12% decrease from 2001 to 2002 was primarily due to the fact that fiscal 2001 cost of license revenues included server products, which had significantly higher royalty and technology rates than Tarantella products. The decrease to 3% in fiscal 2003 and fiscal 2002 is also due to the fact that technology related to the Company’s Vision Family products became fully amortized during fiscal 2001. Additionally, material costs continue to decline as a result of the increasing number of Internet orders. Also certain fixed costs such as technology and overhead declined.

Cost of Services Revenues.    Cost of services revenues includes documentation, consulting and personnel related expenses associated with providing such services. Costs of services revenues as a percentage of services revenues decreased to 40% in fiscal 2003 from 41% in fiscal 2002. In fiscal 2001, costs of services revenues as a percentage of services revenues was 83%. The cost of services improved dramatically in fiscal 2003 and fiscal 2002 primarily as a result of the sale of the Professional Services division to Caldera. The Professional Services division that was sold performed services primarily for server products. Services for server products had negative gross margins, unlike services for Tarantella products (non-server and non-Vision Family), which had positive gross margins. The improvement in cost of services revenues in fiscal 2003 and fiscal 2002 is also a result of reduced staffing levels in the support organization due to realignment of this organization.

Research and Development

The Company invests in research and development both for new products and to provide continuing enhancements to current products. Research and development expenses decreased 24% to $4.3 million in fiscal 2003 from $5.6 million in fiscal 2002, which was a decrease of 69% from fiscal 2001 spending of $18.4 million. Research and development expenses represented 31% of net revenues for fiscal 2003, 40% of net revenues for fiscal 2002, and 28% of net revenues for fiscal 2001. The decrease in research and development expenses in fiscal 2003 is due to lower labor costs, which decreased $0.5 million from fiscal 2002 to fiscal 2003. The lower labor costs were driven by lower headcount, which decreased by 41% as a result of several planned reductions in force. Labor costs were also lower because there was a 15% pay reduction for all employees in research and development. In addition to lower labor costs, there was a reduction of allocations for facilities and IT costs. Expenses allocated to research and development decreased by $0.6 million in fiscal 2003. The reason for the decrease in allocations is that there was lower headcount in the allocated departments and there was an elimination of redundant facilities. The decrease in research and development in fiscal 2002 was due to lower labor costs as a result of lower headcount and also the favorable impact of the sale of the Server Software and Professional Services divisions to Caldera. Research and development expense as a percentage of revenue increased in fiscal 2003 and fiscal 2002 over fiscal 2001 because fiscal 2001 costs included research and development for the Server business which were lower as a percentage of revenue since the products were more mature.

Selling, General and Administrative

Selling, general and administrative expenses decreased 22% to $15.2 million in fiscal 2003, compared with $19.6 million in fiscal 2002 and $64.3 million in fiscal 2001. Selling, general and administrative expenses represented 108% of net revenues in fiscal 2003, 138% in fiscal 2002 and 96% in fiscal 2001. The decrease in selling, general and administrative expenses in fiscal 2003 was mainly due to lower labor costs, which decreased by $2.1 million. The lower labor costs were driven by lower headcount, which decreased by 39% as a result of several planned reductions in force. Labor costs were also lower because there was a 15% pay reduction for all employees in marketing and general and administrative and a 7.5% pay reduction for all employees in sales. In addition to lower labor costs, there was a reduction of allocations for facilities and IT costs. Expenses allocated to selling, general and administrative decreased by $0.9 million in fiscal 2003. The reason for the decrease in allocations is that there was lower headcount in the allocated departments and there was an elimination of redundant facilities. The decrease in labor and allocation costs in selling, general and administrative expenses was partially offset by increased legal and audit fees, which resulted from the restatement audit. The Company incurred expenses of $0.7 million during fiscal 2003 for the internal revenue investigation and the related

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restatement audit. The decrease in selling, general and administrative expenses in fiscal 2002 was due to lower labor costs as a result of lower headcount and also the favorable impact of the sale of the Server Software and Professional Services divisions to Caldera. Selling, general and administrative expenses also decreased in fiscal 2002 because fiscal 2001 included executive retention bonuses of $2.1 million associated with the sale of a significant division to Caldera. Selling, general and administrative expense as a percentage of revenue increased in fiscal 2003 and fiscal 2002 over fiscal 2001 because fiscal 2001 costs included selling, general and administrative expenses for the Server business, which were lower as a percentage of revenue since the products were more mature. The significant increase in selling, general and administrative expense as a percentage of revenue in fiscal 2003 and fiscal 2002 is due to fixed costs spread over much lower revenue.

Allowance for doubtful accounts at the end of September 30, 2003 was $0.5 million, or 15% of gross accounts receivable. At the end of September 30, 2002, allowance for doubtful accounts was $0.3 million, or 11% of gross accounts receivable. The increase in allowance for doubtful accounts was due to an increase in bad debt reserves of $0.1 million due to reserves acquired from the New Moon acquisition. There was also a $0.1 million increase in reserves for returns authorized but not yet returned.

Restructuring Charges

Restructuring charges of $2.2 million were incurred in fiscal year 2003. This included $1.7 million relating to worldwide restructurings undertaken in the first, third and fourth quarters of fiscal 2003 and provision adjustments of $0.5 million made in the fourth quarter of fiscal 2003. The restructurings included a reduction in staffing of 62 employees, expenses associated with the closing of several foreign offices and the write-off of fixed assets. As of September 30, 2003, 61 employees had been terminated. These reductions were made to align spending with lower than expected Company revenues. The Company also made provision adjustments to prior restructurings because it has been unable to sublet space in the Santa Cruz, California office. The Company has now reserved for this space through the end of fiscal 2004, as it believes it will sublease the space within the next twelve months.

Restructuring charges of $2.3 million were incurred in fiscal year 2002 relating to a worldwide restructuring undertaken in the first quarter of fiscal 2002 and provision adjustments made in the fourth quarter of fiscal 2002. The restructuring included a reduction in staffing of 52 employees, a reserve for unused facilities at the Company’s corporate headquarters, and costs associated with closing several foreign offices. As of September 30, 2002, all 52 positions were eliminated, all severance was paid out and all of the foreign office closures included in this reserve were completed. Of the $2.3 million, all but $39,000 related to cash expenditures. These reductions were made to align spending with lower than expected Company revenues. The Company also made provision adjustments to prior restructurings because it has been unable to sublet space in the Santa Cruz, California office.

Restructuring charges of $1.0 million were incurred in fiscal year 2001 that related to worldwide restructurings undertaken in the second and fourth quarters of fiscal 2001. The restructurings included a reduction in personnel of approximately 38 employees and elimination of non-essential facilities. As of September 30, 2001, all 38 positions were eliminated, and all cash payments had been made. The entire $1.0 million charge related to cash expenditures. These reductions were made to align spending with lower than expected company revenues.

Other Income (Expense)

Other income and expense consists of interest income net of interest expense, foreign exchange gains and losses, and realized gains and losses on investments, as well as other miscellaneous income and expense items. Net interest income was $46,000 in fiscal 2003 compared to net interest income of $0.5 million in fiscal 2002 and $1.1 million in fiscal 2001. Net interest income decreased in fiscal 2003 due to the decrease in cash from $7.0 million at the end of fiscal 2002 to $3.2 million at the end of fiscal 2003. In order to keep cash balances

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needed for operations, the Company discontinued investing cash in short-term investments. In fiscal 2003 the Company had other expense of $0.2 million compared to other expense of $1.0 million in fiscal 2002 and other income of $0.3 million in fiscal 2001. The $0.2 million of other expense in fiscal 2003 was for charges related to the impairment of certain investments. The $1.0 million of other expense in fiscal 2002 was due mainly to the impairment of certain investments of $0.9 million. The other income in fiscal 2001 was due to funds received from a securities class action recovery.

In January 2001, the Company sold 3.2 million shares of its Rainmaker Systems (RMKR) stock for $1.00 per share, and received cash proceeds of $3.2 million. The cost basis of the sale was $1.1 million, and the Company realized a gain of $2.1 million from this sale.

In fiscal 2002, the Company’s other income/(expense) included equity losses of $4.0 million for its share of Caldera International losses; also a loss of $2.4 million was recorded against the gain on the sale of divisions to Caldera. This loss included expense of $3.0 million for the early redemption of a note receivable for Caldera. In fiscal 2001 there was a $53.3 million gain included in other income for the sale of the Server and Professional Services divisions to Caldera. This gain was partially offset by losses of $27.1 million for a partial impairment of the Caldera investment and equity losses from the investment. The charge taken for the impairment of the Caldera investment was $22.5 million. The loss from the equity investment in Caldera was $4.6 million.

Income Taxes

In fiscal 2003, 2002 and 2001, the Company’s effective income tax rates were (3%), 7%, and 16%. The fiscal 2003 tax of $0.3 million reflects foreign income taxes of $0.5 million less the resolution of foreign audit issues of $0.2 million. The fiscal 2002 tax benefit of $1.1 million reflects benefits of $0.3 million due to a change in US law and $1.3 million due to the resolution of foreign audit issues, less foreign income taxes of $0.5 million. The fiscal 2001 tax benefit reflects a benefit of $1.1 million due to the resolution of foreign audit issues and foreign income taxes of $0.5 million.

Net Income (Loss)

The Company reported a net loss of $9.7 million in fiscal 2003 compared to a net loss of $16.2 million in fiscal 2002, and a net loss of $5.7 million in fiscal 2001. Net losses were lower in fiscal 2003 than in fiscal 2002 because the Company implemented several cost reduction measures to reduce the Company’s breakeven point. Although net losses were higher in fiscal 2002 than fiscal 2001, operating losses in fiscal 2002 were lower than in fiscal 2001 because of the cost reduction measures. Net losses were higher in fiscal 2002 because fiscal 2002 included $6.5 million in losses from the sale of divisions to Caldera and fiscal 2001 included a net $26.2 million gain from the sale of divisions to Caldera.

Liquidity and Capital Resources

The Company has financed its operations through cash flow from operations, private offerings of the Company’s common stock and bank borrowings. As of September 30, 2003, the Company’s principal source of liquidity included cash and cash equivalents of $3.2 million, representing 25% of total assets and an available bank line of credit under which the Company had $0.3 million of outstanding borrowings. The credit agreement provides that the Company may borrow up to $1.5 million at 2.5% per month based on 75% of eligible accounts receivable. The line of credit has no financial covenants and is secured by the assets of the Company. See Note 8 of Notes to Consolidated Financial Statements. The decrease in cash and short-term investments of $3.9 million in 2003 is due to operating losses of $9.3 million, partially offset by $3.3 million of cash received in the acquisition of New Moon Systems and $2.1 million in proceeds from a private placement.

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The Company’s operating activities used cash of $9.3 million during fiscal 2003, compared to $17.2 million used for operating activities for fiscal 2002. The decrease in the cash used for operating activities is due to a $5.5 million decrease in operating loss from fiscal 2002 to fiscal 2003. The operating loss was $9.3 million in fiscal 2003 compared to a loss of $14.8 million in fiscal 2002. Cash provided by investing activities was $3.0 million in fiscal 2003 compared to cash provided from investing activities of $12.4 million in fiscal 2002. The decrease in cash provided by investing activities was attributable primarily to the proceeds received from the early redemption of a note receivable related to the sale of divisions to Caldera, which were included in the fiscal 2002 results. Cash provided by financing activities was $2.4 million for fiscal 2003 compared with cash used in financing activities of $0.3 million for fiscal 2002.

The Company’s days sales outstanding (DSO) at the end of fiscal 2003 was 87, an increase of 16 days from 71 days at the end of fiscal 2002. DSO is calculated using revenues for the fourth quarter of each fiscal year, and net accounts receivable at September 30. There was an increase in DSO at the end of fiscal 2003 because there was one transaction totaling $0.6 million, for a large Italian customer, which was paid late. DSO is impacted about 1.4 days for every $50,000 that is uncollected, so this transaction added 15 days to the Company’s DSO.

On September 30, 2003, the Company completed a private placement of common stock and warrants to Special Situations Technology Funds and Vertical Ventures resulting in gross proceeds to the Company of approximately $2,254,200 for which the Company paid fees of $155,345. The Company issued 1,950,000 shares of common stock at a price of $1.156 and warrants to purchase 1,950,000 shares of common stock at $1.395 per share. The warrants have a value of $895,592, based on the relative fair value using a Black-Scholes calculation, using a volatility of 100%, an annual dividend of zero and a discount rate of 2.63%. The Company can require the warrant holders to exercise one-third of the warrants provided the shares issuable thereunder are registered with the SEC and the share price equals or exceeds $1.674 for a period of twenty consecutive trading days. In addition, the Company can redeem up to two-thirds of the warrants or all of the warrants for $0.01 per share should the closing bid price of the shares reach the target prices of $2.232 and $2.790, respectively. The warrant holders may exercise the warrants prior to redemption. The warrants expire on September 30, 2008. If the warrants are fully exercised, the Company would receive additional gross proceeds of approximately $2,700,000. The Company also has agreed to register the shares of common stock issued to the investors as well as the shares issuable upon exercise of the warrants for resale once the Company has complied with its reporting obligations under the Securities Exchange Act of 1934, as amended. If the shares and warrants are not registered in a timely manner, the Company will be obligated to pay damages for the delay, in an amount equal to one-percent per month of the aggregate amount invested, until registered.

On December 26, 2003, the Company completed a private placement of common stock and warrants to the following investors: Special Situations Technology Funds (who are expanding on their previous investment), Starlight Digital Technologies, LLC, an investment group in which Mr. Wilde acts as Managing Director, and an additional private investor, resulting in gross proceeds to the Company of approximately $2,750,000. In connection with the financing, the Company paid placement fees in the amount of $232,303.

On February 23, 2004, the Company announced the completion of a private placement of common stock and warrants to various investors. In the private placement, the investors purchased 11,678,580 shares of Tarantella common stock at a price of $1.40 per share. The investors also acquired warrants to purchase up to an additional 2,335,714 shares at an exercise price of $1.70 per share for gross proceeds of $16,350,000. The warrants are exercisable for five years. If the warrants are fully exercised, the Company would receive additional gross proceeds of approximately $3,970,714. The Company also has agreed to register the shares of common stock issued to the investors as well as the shares issuable upon exercise of the warrants for resale once the Company has complied with its reporting obligations under the Securities Exchange Act of 1934, as amended. In connection with the financing, the Company will pay fees in the amount of $1,074,000.

In the first quarter of fiscal 2004, the Company implemented a restructuring which reduced the existing workforce by two employees. The Company expects to record a charge of $0.2 million for this restructuring in the first quarter of fiscal 2004. All charges related to this restructuring will be cash charges.

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The Company has capital lease commitments of $32,000 in fiscal 2004. There are no capital lease commitments beyond fiscal 2004. The Company has operating lease commitments of $1.3 million in fiscal 2004. The Company’s various operating lease commitments extend to 2020. See note 10 of the consolidated financial statements for more information.

The following summarizes Tarantella’s contractual lease obligations at September 30, 2003, and the effects such obligations are expected to have on liquidity and cash flow in future periods:

The Company has an obligation to pay New Moon shareholders a minimum cash earnout of approximately $1.7 million over a period from January 1, 2004 to December 31, 2006 based on a royalty of 30% of New Moon product revenues, net of direct costs. After the shareholders have been paid the minimum earnout, they are entitled to an additional royalty of 15% of New Moon product revenues, net of direct costs, during this period. In the event the minimum earnout is not achieved by the conclusion of the quarter ending December 31, 2006, Tarantella shall pay along with the final earnout payment an amount equal to the minimum earnout less all aggregate earnouts paid to date, less any off-sets and any escrow claim deficiencies.

The Company has incurred net losses from operations of approximately $9.3 million during fiscal 2003 and $14.8 million during fiscal 2002 and revenues have declined from $14.2 million in fiscal 2002 to $14.0 million in fiscal 2003. The Company has an accumulated deficit of $124.8 million as of September 30, 2003.

The Company’s management believes that, based on the Company’s current plans, its existing cash and cash equivalents, short-term investments, and funds generated from operations will be sufficient to meet its operating requirements through fiscal 2004. The Company’s financial plan assumes revenue growth and decreased spending. If the Company does not achieve the revenue growth it anticipates or if expenses do not decline as planned, the Company will need additional financing. Management cannot be assured that additional financing will be available when it is needed.

Factors that may affect future results

Set forth below and elsewhere in this filing and in other documents the Company files with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements in this filing.

THE COMPANY’S OPERATING RESULTS MAY FLUCTUATE IN FUTURE PERIODS.

The results of operations for any quarter or fiscal year are not necessarily indicative of the results to be expected in future periods. The Company’s operating results have in the past been, and will continue to be, subject to quarterly and annual fluctuations as a result of a number of factors, including but not limited to:

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As a consequence, operating results for a particular future period are difficult to predict.

THE COMPANY IS EXPOSED TO GENERAL ECONOMIC AND MARKET CONDITIONS.

Any significant downturn in the Company’s customers’ markets, or domestic and global conditions, which result in a decline in demand for their software and services could harm the Company’s business. The state of the economy has had a negative impact on the software industry. This could result in customers continuing to delay or cancel orders for software. Any of these occurrences could have a significant impact on the Company’s operating results, revenues and costs and may cause the market price of the Company’s common stock to decline or become more volatile.

The Company’s future operating results may be affected by various uncertain trends and factors that are beyond the Company’s control. These include adverse changes in general economic conditions and rapid or unexpected changes in the technologies affecting the Company’s products. The process of developing new high technology products is complex and uncertain and requires accurate anticipation of customer needs and technological trends.

THE COMPANY DEPENDS ON THE DEVELOPMENT AND ACCEPTANCE OF NEW PRODUCTS IN A RAPIDLY CHANGING MARKET.

The market for the Company’s products is characterized by rapidly changing technology, evolution of new industry standards, and frequent introductions of new products and product enhancements. The Company’s success will depend upon its continued ability to enhance its existing products, to introduce new products on a timely and cost-effective basis to meet evolving customer requirements, to achieve market acceptance for new product offerings, and to respond to emerging industry standards and other technological changes. There can be no assurance that the Company will be successful in developing new products or enhancing its existing products or that such new or enhanced products will receive market acceptance. The Company’s success also depends

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upon its ability to license from third parties and to incorporate into its products new technologies that become industry standards. There can be no assurance that the Company will continue to obtain such licenses on favorable terms or that it will successfully incorporate such third-party technologies into its own products.

The Company anticipates new releases of products in the fiscal year ending September 30, 2004. There can be no assurance that such new releases will not be affected by technical problems or “bugs”, as is common in the software industry. Furthermore, there can be no assurance that these or other future product introductions will not be delayed. Delays in the availability, or a lack of market acceptance, of new or enhanced products could have an adverse effect on the Company’s business. There can be no assurance that product introductions in the future will not disrupt product revenues and adversely affect operating results.

THE COMPANY COMPETES IN THE HIGHLY COMPETITIVE INTERNET INFRASTRUCTURE MARKET.

The industry has become increasingly competitive and, accordingly, the Company’s results may also be adversely affected by the actions of existing or future competitors, including the development of new technologies, the introduction of new products, and the reduction of prices by such competitors to gain or retain market share. The Company’s results of operations could be adversely affected if it were required to lower its prices significantly.

OPERATING RESULTS FOR A PARTICULAR QUARTER ARE DIFFICULT TO PREDICT.

The Company participates in a highly dynamic industry and future results could be subject to significant volatility, particularly on a quarterly basis. The Company’s revenues and operating results may be unpredictable due to the Company’s shipment patterns. The Company operates with little backlog of orders because its products are generally shipped as orders are received. In general, a substantial portion of the Company’s revenues have been booked and shipped in the third month of the quarter, with a concentration of these revenues in the latter half of that third month. In addition, the timing of closing of large license contracts and the release of new products and product upgrades increase the risk of quarter to quarter fluctuations and the uncertainty of quarterly operating results. The Company’s staffing and operating expense levels are based on an operating plan and are relatively fixed throughout the quarter. As a result, if revenues are not realized in the quarter as expected, the Company’s expected operating results and cash balances could be adversely affected, and such effect could be substantial and could result in an operating loss and depletion of the Company’s cash balances.

IT MAY BE DIFFICULT TO RAISE NEEDED CAPITAL IN THE FUTURE.

The Company may require substantial additional capital to finance future growth and fund ongoing operations through the remainder of fiscal 2004 and beyond. Although the Company’s current business plan does not foresee the need for further financing activities to fund the Company’s operations for the foreseeable future, due to risks and uncertainties in the market place, the Company may need to raise additional capital. The Company may raise additional funds through public or private financing, strategic relationships or other arrangements. The Company cannot be certain that the funding, if needed, will be available on attractive terms, or at all. Furthermore, any additional equity financing may be dilutive to shareholders, and debt financing, if available, may involve restrictive covenants. Strategic arrangements, if necessary to raise additional funds, may require the Company to relinquish its rights to certain of its technologies or products. If the Company fails to raise capital when needed, the business will be negatively affected, which could cause the stock price to decline.

THE COMPANY’S REVENUES MAY BE AFFECTED BY THE SEASONALITY OF REVENUES IN THE EUROPEAN AND GOVERNMENT MARKETS.

The Company experiences seasonality of revenues for both the European and the U.S. federal government markets. European revenues during the quarter ending June 30 are historically lower or relatively flat compared to the prior quarter. This reflects a reduction of customer purchases in anticipation of reduced selling activity

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during the summer months. Sales to the U.S. federal government generally increase during the quarter ending September 30. This seasonal increase is primarily attributable to increased purchasing activity by the U.S. federal government prior to the close of its fiscal year. Additionally, net revenues for the first quarter of the fiscal year are typically lower or relatively flat compared to net revenues of the prior quarter.

COST OF REVENUES MAY BE AFFECTED BY CHANGES IN THE MIX OF PRODUCTS AND SERVICES.

The overall cost of revenues may be affected by changes in the mix of net revenue contribution between licenses and services, geographical regions and channels of distribution, as the costs associated with these revenues may have substantially different characteristics. The Company may also experience a change in margin as net revenues increase or decrease since technology costs and services costs are fixed within certain volume ranges.

THE COMPANY’S OPERATIONAL RESULTS COULD BE AFFECTED BY PRICE VARIATIONS.

The Company’s results of operations could be adversely affected if it were to lower its prices significantly. In the event the Company reduced its prices, the Company’s standard terms for selected distributors would be to provide credit for inventory ordered in the previous 180 days, such credits to be applied against future purchases. The Company, as a matter of policy, does not allow product returns for a refund. Product returns are generally allowances for stock balancing and are accompanied by compensating and offsetting orders. Revenues are net of a provision for estimated future stock balancing and excess quantities above levels the Company believes are appropriate in its distribution channels. The Company monitors the quantity and mix of its product sales.

THE COMPANY IS DEPENDENT UPON INFORMATION RECEIVED FROM THIRD PARTIES IN ORDER TO DETERMINE RESERVES FOR PRODUCT RETURNS.

The Company depends on information received from external sources in evaluating the inventory levels at distribution partners in the determination of reserves for the return of materials not sold, stock rotation and price protection. Significant effort has gone into developing systems and procedures for determining the appropriate reserve level. In the event information is not received timely or accurately, the Company’s ability to monitor the inventory levels will be affected and may negatively impact the Company’s business.

THE COMPANY’S BUSINESS DEPENDS UPON ITS PROPRIETARY RIGHTS AND THERE IS A RISK THAT SUCH RIGHTS WILL BE INFRINGED.

The Company attempts to protect its software with a combination of patent, copyright, trademark, and trade secret laws, employee and third party nondisclosure agreements, license agreements, and other methods of protection. Despite these precautions, it may be possible for unauthorized third parties to copy certain portions of the Company’s products or reverse engineer or obtain and use information the Company regards as proprietary. While the Company’s competitive position may be affected by its ability to protect its intellectual property rights, the Company believes that trademark and copyright protections are less significant to the Company’s success than other factors, such as the knowledge, ability, and experience of the Company’s personnel, name recognition, and ongoing product development and support. Further, certain provisions of the Company’s licenses, including provisions protecting against unauthorized use, copying, transfer, and disclosure of the licensed product, may be unenforceable under the laws of certain jurisdictions. In addition, the laws of some foreign countries do not protect the Company’s intellectual property rights to the same extent as do the laws of the U.S.

RISKS OF CLAIMS FROM THIRD PARTIES FOR INTELLECTUAL PROPERTY INFRINGEMENT COULD ADVERSELY AFFECT THE BUSINESS.

As the number of software products in the industry increases and the functionality of these products further overlaps, the Company believes that software products will increasingly become subject to infringement claims. There can be no assurance that third parties will not assert infringement claims against the Company and/or

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against the Company’s suppliers of technology. In general, the Company’s suppliers have agreed to indemnify the Company in the event any such claim involves supplier-provided software or technology, but any such claim, whether or not involving a supplier, could require the Company to enter into royalty arrangements or result in costly litigation.

THE COMPANY’S BUSINESS MAY BE ADVERSELY AFFECTED BY EVENTS OUTSIDE THE COMPANY’S CONTROL.

While the Company has not been the target of software viruses specifically designed to impede the performance of the Company’s products, such viruses could be created and deployed against the Company’s products in the future. Similarly, experienced computer programmers or hackers could attempt to penetrate the Company’s network security or the security of the Company’s web sites. A hacker who penetrates the Company’s network or web sites could misappropriate proprietary information or cause interruptions of services. The Company might be required to expend significant capital and resources to protect against, or to alleviate, problems caused by virus creators and/or hackers. In addition, war, power shortage, natural disasters, acts of terror, and regional and global health risks could impact the Company’s ability to conduct business in certain regions. Any of these events could have an adverse effect on the Company’s business, results of operations, and financial condition.

THE COMPANY’S RESULTS OF OPERATIONS MAY BE AFFECTED BY FLUCTUATIONS IN FOREIGN CURRENCY EXCHANGE RATES.

Although the Company’s revenues are predominantly in U.S. dollars, substantial portions of the Company’s revenues are derived from sales to customers outside the United States. Trade sales to international customers represented 53%, 44% and 52% of total revenues for fiscal 2003, 2002 and 2001 respectively. The Company’s revenues can be affected by general economic conditions in the United States, Europe and other international markets. Also, portions of the Company’s operating expenses are transacted in foreign currencies. The Company’s operating strategy and pricing take into account changes in exchange rates over time. However, the Company’s results of operations may be significantly affected in the short term by fluctuations in foreign currency exchange rates.

THE COMPANY’S RESULTS OF OPERATIONS MAY BE AFFECTED BY THE ASSESSMENT OF ADDITIONAL TAXES.

Tarantella has operations in many countries other than the United States. Transfer prices for services provided between the United States and these countries have been documented as reasonable, however, tax authorities could challenge these transfer prices and assess additional taxes on prior period transactions. Any such assessment could require the Company to record an additional tax provision in its statement of operations.

THE COMPANY’S SUCCESS LARGELY DEPENDS UPON ITS ABILITY TO RETAIN AND RECRUIT KEY PERSONNEL.

The Company’s continued success depends to a significant extent on senior management and other key employees. None of these individuals is subject to a long-term employment contract or a non-competition agreement. The loss of one or more key employees or the Company’s inability to attract and retain other key employees could have a material adverse effect on the Company.

THE COMPANY MAY NEVER ACHIEVE PROFITABILITY IN THE FUTURE.

Following the Company’s divestiture of its server software and professional services divisions in May 2001, the Company has not achieved profitability, and may never generate sufficient revenues to achieve profitability.

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THE OUTCOME OF SEC INQUIRY IS UNCERTAIN.

The Company is in contact with the Securities and Exchange Commission in connection with an informal inquiry related to the events leading up to the Company’s restatement. The Company cannot predict the outcome of this inquiry.

IF THE COMPANY IS UNABLE TO EFFECTIVELY INTEGRATE AND DEVELOP THE OPERATIONS OF NEW MOON SYSTEMS, INC. (“NEW MOON”), THE BUSINESS MAY SUFFER.

The Company acquired New Moon in June 2003. The Company intends to integrate the operations, certain employees, products and technology of New Moon into its own, and faces various risks as a result of this acquisition including, but not limited to:

If the Company is not able to successfully integrate and develop New Moon’s business, the Company’s business may be negatively affected in future periods, which may cause the stock price to decline. In addition, if the value of intangible assets and goodwill acquired becomes impaired, the Company will be required to write down the value of the assets, which would negatively affect financial results. The Company may incur liabilities from New Moon including liabilities for IP infringement or indemnification of New Moon’s customers for similar claims, which could materially and adversely affect the business.

THE COMPANY MAY MAKE FUTURE ACQUISITIONS THAT MAY RESULT IN ADDITIONAL RISKS.

The Company may continue to make investments in complementary companies, products or technologies. If the Company buys a company or a division of a company, they may experience difficulty integrating that company or division’s personnel and operations, which could negatively affect operating results. In addition:

In connection with future acquisitions, the Company may be required to assume the liabilities of the acquired companies. By assuming the liabilities, the Company may incur liabilities, including liabilities for IP infringement or indemnification of customers of acquired businesses for similar claims, which could materially and adversely affect the business. The Company may have to incur debt or issue equity securities to pay for any future acquisition, the issuance of which may involve restrictive covenants or be dilutive to existing shareholders.

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THE COMPANY’S STOCK IS SUBJECT TO SUBSTANTIAL PRICE AND VOLUME FLUCTUATIONS DUE TO A NUMBER OF FACTORS, MANY OF WHICH ARE BEYOND ITS CONTROL, AND THOSE FLUCTUATIONS MAY PREVENT SHAREHOLDERS FROM RESELLING THEIR COMMON STOCK AT A PROFIT.

The stock market in general, and the market for shares of technology companies in particular, has experienced extreme price and volume fluctuations, which have often been unrelated to the operating performance of the affected companies. Strategic factors such as new product introductions, acquisitions or restructurings by the Company or its competitors may have a significant impact on the market price of the Company’s common stock. Furthermore, quarter-to-quarter fluctuations in operating results may have a significant impact on the market price of the stock. These conditions, as well as factors that generally affect the market for stocks of high technology companies, could cause the price of the Company’s stock to fluctuate substantially over short periods.

THE COMPANY’S COMMON STOCK MAY BE DIFFICULT TO TRADE.

The Company’s stock was de-listed by the Nasdaq on October 21, 2003, and is now quoted on the Over-the-Counter (“OTC”) Pink Sheets. Trading the Company’s stock may be more difficult due to the limited trading activity on the OTC market. This could cause a further decline in the Company’s stock price. Declines in the market price of the Company’s stock could greatly impair the Company’s ability to raise capital through equity or debt financing.

FORMER NEW MOON SHAREHOLDERS WILL HAVE THE ABILITY TO SELL A LARGE NUMBER OF SHARES OF TARANTELLA COMMON STOCK, WHICH MAY CAUSE THE TRADING PRICE OF THE COMPANY’S COMMON STOCK TO DECLINE.

In connection with the acquisition of New Moon, the Company issued approximately 1,592,000 shares (calculated after the 1-for-5 reverse stock split which was implemented on June 6, 2003) of the Company’s common stock to former New Moon shareholders. During the one year period following the closing of the acquisition, the aggregate number of shares of common stock sold in any calendar quarter by each of the former New Moon shareholders shall not exceed 25% of the aggregate number of shares of common stock issued to such former New Moon shareholders pursuant to the acquisition; provided, however, that the percentage tradable in any calendar quarter shall be increased by an amount proportionate to the amount by which the trading volume of common stock exceeds 15,000,000 shares in the prior quarter. Furthermore, if the Company grants registration rights or issues shares of capital stock as part of a subsequent acquisition of the stock or assets of another company, and the sale of such stock is not subject to volume restrictions, then the 25% limitation described in the previous sentence will no longer be in effect. With the exception of the limitations set forth in this paragraph, the Company does not have any control over the timing of any sales by the former New Moon shareholders. As a result, the market price of the Company’s common stock may fall if a large portion of those shares is sold in the public market.

Recent Accounting Pronouncements

In June 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”), which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (“EITF”) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)” (“EITF 94-3”). SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost, as defined in EITF 94-3, was recognized at the date of an entity’s commitment to an exit plan. SFAS 146 also establishes that the liability should initially be measured and recorded at fair value. The Company adopted the provisions of SFAS 146 for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS 146 may affect the timing of recognizing future restructuring costs as well as the amounts recognized.

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In November 2002, FASB issued FASB Interpretation 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”. The Interpretation elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value, or market value, of the obligations it assumes under the guarantee and must disclose that information in its interim and annual financial statements. The provisions related to recognizing a liability at inception of the guarantee for the fair value of the guarantor’s obligations do not apply to product warranties or to guarantees accounted for as derivatives. The initial recognition and initial measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002. The adoption of this statement did not have a material impact on the Company’s financial position or results of operations. The Company provides disclosures required by FIN 45 in Note 17.

In May 2003, the EITF reached a consensus on EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables”. This Issue addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. This Issue addresses when and how an arrangement involving multiple deliverables should be divided into separate units of accounting. The guidance in this Issue is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of these provisions did not have a material effect on the Company’s financial position or results of operations.

In January 2003 the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities” and a revised interpretation of FIN No. 46 (FIN No. 46-R”) in December 2003. FIN No. 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. Should the Company form a variable interest entity, FIN No. 46-R will be effective at that time, but not later than the quarter ending March 31, 2004.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise became effective for the Company July 1, 2003. The adoption of SFAS No. 150 did not have a material effect on the Company’s financial position or results of operations.

Item 7A.    Quantitative and Qualitative Disclosures about Market Risk

Market-Rate Sensitive Instruments and Risk Management

The Company is exposed to market risk related to changes in interest rates, foreign currency exchange rates, and equity security prices. It does not use derivative financial instruments for speculative or trading purposes.

Interest-Rate Risk

As of September 30, 2003 the Company had cash of $3.2 million, consisting of cash and highly liquid money market instruments with maturities of less than 90 days. Because of the short maturities of these instruments, a sudden change in market interest rates would not have a material impact on the fair value of the portfolio. The Company would not expect operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest on its portfolio.

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Foreign Exchange Risks

Currently, the Company denominates sales to some European customers in Euro dollars and also incurs expenses related to its European operations in UK pounds and Euro dollars. Through May 2001, the Company used forward foreign exchange contracts to manage foreign exchange exposures associated with underlying assets, liabilities and anticipated transactions. Since the completion of the transaction in which the Company sold the Server Software and Professional Services divisions to Caldera International, the Company does not believe the foreign exchange risk is great enough to warrant the purchase of forward foreign exchange contracts.

Equity Security Price Risk

As of September 30, 2003 the Company has investments in Rainmaker Systems (Nasdaq: RMKR) and Netilla Networks (a privately-held company). The Company also has investments in other privately held companies, the carrying value of which is now zero. The Rainmaker investment is accounted for pursuant to FAS 115 in which equity gains and losses are recorded to a separate section of shareholders’ equity. The investment in Netilla has been impaired several times to the per share price of subsequent offerings. The Company does not hedge its investments in equity securities.

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Item 8.    Financial Statements and Supplementary Data

TARANTELLA, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes to consolidated financial statements.

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TARANTELLA, INC.

CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.

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TARANTELLA, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY