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U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10–K

(Mark One)

OR

Commission File Number: 000–27861

Centra Software, Inc.

(Exact name of registrant as specified in its charter)

430 Bedford Street, Lexington, MA 02420

(Address of Principal Executive Offices)

(781) 861–7000

(Issuer’s Telephone Number, Including Area Code)

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

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.001 par value

Indicate by check mark whether the registrant (1) 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 þ        No ¨

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 the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of the Form 10-K.    ¨

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

The aggregate market value of voting stock held by non-affiliates of the registrant was approximately $58,424,000 as of June 30, 2003 based on the last sale price of the Common Stock as reported on the NASDAQ National Market for that date ($3.15 per share.) There were 27,214,960 shares of the registrant’s Common Stock issued and outstanding on March 1, 2004.

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the registrants definitive Proxy Statement for its Annual Meeting of Stockholders for the year ended December 31, 2003 which will be filed with the Securities and Exchange Commission within 120 days after the end of the registrant’s fiscal year, are incorporated by reference into Part III hereof.

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SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION

Certain statements contained in this Annual Report on Form 10-K, including information with respect to our future business plans, objectives, expectations and intentions constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believe,” “plan,” “expect,” “anticipate,” “intend,” “seek,” “estimate,” “may,” “will,” and “continue,” or similar words are intended to identify forward-looking statements. You should read statements that contain these words carefully. They discuss our future expectations, contain projections of our future results of operations or our financial condition or state other forward-looking information, and may involve known and unknown risks over which we have no control. You should not place undue reliance on forward-looking statements. We cannot guarantee any future results, levels of activity, performance or achievements. Moreover, we assume no obligation to update forward-looking statements or update the reasons actual results could differ materially from those anticipated in forward-looking statements, except as required by law. The factors discussed in the sections captioned “Business” in Item 1 and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of this report, including the sub-section captioned “Factors That Could Affect Future Results,” identify important factors that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements.

AVAILABLE INFORMATION

Our Internet address is www.centra.com. We make available free of charge through our Web site our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such materials with the Securities and Exchange Commission.

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PART I

ITEM 1.    BUSINESS

Centra Software, Inc., formed as a Delaware corporation in 1995, and its wholly-owned subsidiaries, are referred to throughout this report as “Centra,” “Company,” “we,” and “us” or through similar expressions. For financial information about our business, see our consolidated financial statements and the related notes thereto found in Item 8 of this report. Centra^®, CentraOne^™, Centra 7^™, Centra Symposium^™, Centra Conference^™, Centra eMeeting^™, Centra Knowledge Center^™, Centra Knowledge Catalog^™, Centra Knowledge Composer^™, Centra Speed Scheduler^™ and MindLever^™ are trademarks or registered trademarks of Centra Software, Inc. All other brand or product names referred to throughout this report may be trademarks or registered trademarks of their respective owners.

Company Overview

We are a leading provider of application software, services and solutions for online business communications and collaboration. Our products and services augment operational business processes to enable real-time, group-oriented human interaction over corporate networks and the Internet. These real-time, “live” group sessions can range from ad hoc, one-on-one online meetings to highly interactive, structured, collaborative learning sessions to prescheduled Web seminars for larger audiences and are key elements to business processes that include collaborative learning, Web marketing, online selling and other interactive activities. We integrate these real-time, “live” group sessions with: (1) workflow tools we have developed such as desktop integration software; (2) professional services capabilities that we or others provide such as content development and (3) leading third-party enterprise software suites such as customer relationship management systems. Furthermore, our products and services support content and user management around the online session to integrate more tightly with these strategic processes across the extended enterprise. Our customers use Centra’s products and solutions to accelerate product introductions, deliver hands-on deployment of software applications, effect change-management initiatives, expand training and certification to employees and external channel partners, facilitate customer interaction and online selling and support project management activities. In addition, we offer consulting, education and support services that enable our customers to successfully implement, deploy and support our products and solutions throughout their organizations.

Our products are available as packaged software applications, hosted services, and on a subscription or per-use basis through our application service provider, or ASP, offerings. Based on a common collaboration framework, our products and services support a wide range of convenient business interactions online, including real-time virtual learning, large scale Web conferences and live, interactive Web meetings. Each real-time collaboration interface includes capabilities for Voice-Over-Internet-Protocol, or VoIP, audio, Web-based video, software application sharing, real-time data exchange, and facilities for session recording and playback. These products and services allow organizations to increase the productivity of their members and enhance the effectiveness of knowledge transfer while reducing travel, facilities and telecommunications costs.

In April 2001, we completed the acquisition of MindLever.com, Inc., or MindLever, a privately-held provider of management systems for learning content with standards-based solutions for creating, storing, and delivering live and self-paced learning content in the form of personalized eLearning programs. As a result of this acquisition and through continuing integration efforts, Centra’s products and services for live collaboration have been expanded to include capabilities and tools for rapid content authoring and for the management of proprietary content, session recordings, and other third-party, standards-compliant content in a centralized, online content repository, providing richer workflow support for business processes.

In June 2003, we released Centra 7. We consider this product to be the first application software to address corporate requirements for enterprise-wide adoption of real-time collaboration solutions. Deployed as both an on-site (installed on customer premises) and ASP solution, Centra 7 enhancements included advanced integration

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with the user desktop, solution sets that address an entire business process—before, during, and after a “live” group collaboration session, and advanced systems architecture to support large-scale global enterprise deployments.

As of December 31, 2003, we have sold Centra products to more than 1,300 customer organizations. Our customer base spans multiple industry segments, including financial services, pharmaceutical, government, manufacturing, higher education and telecommunications.

Industry Background

We believe that our customer base is made up of a variety of organizations, from small service companies to the largest 5,000 corporations, “Global 5000”, as well as government agencies and higher education organizations, all of which are operating in a climate characterized by the need for productivity improvements, the ability to address rapid changes in the global marketplace and a need for stronger focus on top-line results and bottom-line cost cutting. Companies and organizations are utilizing the ubiquity and capabilities of the Internet to accelerate critical business processes, improve productivity, create revenue-generating opportunities, leverage employee knowledge and expertise, and lower operating costs. To achieve these goals, organizations are evaluating and implementing collaborative technologies that can enable them to share and exchange business-critical information with geographically distributed customers, partners, prospects and employees and acquire the skills they need to reach their business goals faster. To be truly effective, however, these technologies must be capable of streamlining entire business processes in departments—such as sales, marketing and training—by facilitating the workflow that occurs before, during, and after online meetings, events or classes. These technologies must support the numerous ways in which people collaborate, learn and manage the intellectual capital or knowledge assets of an organization, including:

Many commonly known Internet-based communication tools, such as chat rooms, instant messaging, Web meetings, Web conferences and screen sharing, address only ad-hoc and discrete collaboration tasks, are not integrated with a common user interface, back-end management system, or existing operating databases or enterprise applications and, therefore, are difficult to adopt as a permanent collaboration solution for repeatable business applications. In addition, these products do not support the broad range of user and content management required by businesses for truly effective real-time collaboration workflow.

To maximize return on their software infrastructure investments for collaboration, companies require a solution that can integrate voice communication, video, content sharing and group interaction with existing business tools and software applications. In addition, a complete solution must support a broad range of live, self-service, and recorded group interactions in a variety of business contexts, supported by a common collaboration framework. The solution must allow customers, partners and employees to interact from any location, regardless of whether they are on a corporate network or on a low bandwidth dial-up connection, use VoIP or a standard teleconferencing bridge and provide anytime, anywhere access to knowledge and information by blending live online interaction with self-paced content and recordings. A complete solution for online Web event marketing must also support processes for registration and recruitment, lead source tracking, recorded event management, and attendance follow up. Finally, underneath these important process-oriented features and functionality, a complete online business communications and collaboration solution must have a reliable, scalable and

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interoperable user management system environment that can grow to support and integrate with e-commerce systems, enterprise computer systems, enterprise operating platforms, other enterprise software applications, and emerging Web technologies.

The Centra Solution

Our secure, scalable, standards-based application software for online business communications and collaboration is designed to enable effective, Web-based interaction and knowledge sharing among customers, partners and employees in a variety of business contexts. Our collaboration application software enables groups of people to quickly assemble, converse, interact, share content and work together in real-time over intranets, extranets and the Internet. In 2003, we built upon our industry-leading application software, CentraOne 6.0, to develop Centra 7. CentraOne 6.0 was the first integrated real-time enterprise multimedia collaboration and knowledge delivery application software capable of meeting the full range of Web conferencing and knowledge transfer needs of any organization, from Web meetings and broadcasts to training and content creation and management. To further extend the capabilities of CentraOne 6.0, Centra 7 provides enhancements including advanced integration with the user desktop, solution sets that address an entire business process–before, during, and after a “live” group collaboration session, and advanced systems architecture to support large-scale global enterprise deployments.

Strategy

Our objective is to become the leading provider of open and extensible application software, services and solutions for online business communications and collaboration. We intend to focus our sales and marketing efforts on selling to Global 5000 companies, government agencies and higher education institutions. We believe that the potential size of these markets for our products and services is estimated at $4.6 billion. We intend to grow our leadership position in the collaborative learning market segment of application software, services and solutions for online business communications and collaboration, and leverage that leadership to increase our penetration of other collaboration market segments and to broaden our usage throughout the enterprise. To achieve this objective, we are pursuing the following strategies (although we can give no assurance that these strategies will be successful or that we will be able to achieve profitability—see “Factors That Could Affect Future Results,” in Item 7):

We intend to continue to support and expand the integration of our products so that our customers can use our products with major enterprise applications and with their desktop email, messaging, and calendaring tools. In addition, we plan to continue our internal development of functionality and professional services that facilitate workflows around the “live” session, enabling easy customization by vertical application, and to invest in our architecture to improve scalability, security, performance, quality of service, and user management and reporting. We intend to continue to leverage existing and emerging technologies from major platform vendors, taking advantage of advances in underlying infrastructure. Finally, we plan to expand our ability to market our products as either packaged software, installed either on the customer’s premises or on our hosted servers, or as a service delivered via our ASP. We believe these product development initiatives are in line with the evolving requirements of organizations looking to find solutions that enable distributed groups of people to work more efficiently and effectively through the automation of important business processes using online technologies.

We intend to further establish Centra as a leader in the online business communications and collaboration market by: 1) leveraging our existing brand recognition in the collaborative learning segment of this

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marketplace, 2) actively promoting our products and services to new customers and 3) working with industry analysts to define the opportunity and leadership criteria for the online business communications and collaboration solutions market. We believe that the online business communications and collaboration solutions market is, as yet, comparatively unrecognized by industry analysts and business media but that it is starting to attract increasing attention. Through our efforts to define and provide solutions for this market, we believe we can sustain recognition as a leader in this market.

We intend to increase our sales organization and our lead generation programs, including advertising and other marketing activities to penetrate new and existing accounts at the department level of the Global 5000, government agencies and higher education organizations. Simultaneously, we intend to focus the efforts of our field sales organization at the executive level of these corporations and institutions and to support those efforts by targeted messaging, print advertising, public relations efforts and lead generation marketing programs. We believe that enterprise purchase decisions for online business communications and collaboration software will increasingly involve senior information technology management and other corporate executives, and that a sales and marketing approach that targets both executive-level and departmental opportunities will help us increase the number of large enterprise accounts who select Centra to be the standard or one of the standards for their online business communications and collaboration needs across the organization. To support these sales and marketing initiatives, we plan to spend an additional $8 million in 2004 over our 2003 expenditure rate for sales and marketing.

We intend to grow our ecosystem of partners and leverage their relationships and presence in our markets by: 1) increasing the number of identified sales opportunities from highly qualified strategic partner referrals, 2) penetrating companies through regional, national and vertical value-added resellers, 3) maintaining and expanding existing technology and marketing partnerships with learning management systems vendors and systems integrators in the collaborative learning market segment to fuel our ongoing leadership in this market, and 4) adding new partnerships with conferencing services, document management, portal systems and enterprise application vendors to help penetrate new application areas for online business communications and collaboration, specifically in the areas of online marketing, team collaboration and knowledge management. We believe that our partnership strategy is significantly enhanced over other competitors by the availability of our products as packaged software, facilitating tighter integration with partner applications. Furthermore, we believe that these relationships will enable us to increase penetration into our markets and accelerate global customer adoption of our products and services.

We believe that a company’s decision to purchase our products is based, in part, on our ability to provide a high level of customer service, integration and implementation assistance and technical support. As the worldwide demand for our products grows, we plan to continue to invest in and enhance our customer service capabilities, including state-of-the-art training and education for our products and packaged consulting services, around the best practice methodologies for enterprise deployment and integration.

We plan to continue to evaluate strategic opportunities and potential acquisitions that complement our strategy. These opportunities may include companies or technologies that broaden our market opportunity and enable us to expand into adjacent areas or companies that leverage our current solutions to extend our position in our current markets.

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Products

Our products provide multiple functions, including ad hoc and self-service interactive online meetings, virtual classes and large-scale Web seminars, and include a robust content management component. They provide access to users through firewalls and proxy servers, and deliver both half and full-duplex VoIP audio, live multi-point video, fully interactive application sharing and record and playback capabilities. They are designed to function over low-bandwidth network connections through a standard browser interface that is consistent for all products and easy to use through a small, downloadable client. Based upon a technological foundation employing Internet standards and Microsoft platform technologies, our products can be deployed on a single Microsoft Windows 2000 or 2003 server and are designed to operate without any special hardware or network technologies. Our enterprise-class software products are designed to scale, as a customer’s usage requires, by adding additional servers or Internet protocol (IP) multicasting capabilities. Centra offers flexible deployment options including on-premises software deployed behind a company firewall, a secure full-service ASP, an outsourced server hosting service, and the option to start with our ASP service and migrate to deploying the software on-premises, behind-the-firewall as needs change.

Centra 7, our enterprise-class application software, addresses a wide range of requirements for enterprise adoption of real-time collaboration solutions and is available in 13 languages (traditional Chinese, simplified Chinese, Danish, English, French, German, Greek, Italian, Iberian Portuguese, Japanese, Korean, Spanish and Arabic (for our Centra Knowledge Center product only)). Centra 7 includes integration with desktop applications for increased ease of use and enhanced integration with departmental business processes and a system architecture that supports information technology (IT) requirements for enterprise-wide deployment.

Centra 7 consists of the following products:

Centra 7 for Virtual Classes. Centra 7 for Virtual Classes is designed for virtual classrooms and highly interactive teamwork. Its real-time collaboration features include full-duplex VoIP audio, integrated Web-based video, application sharing, breakout rooms, whiteboards, slide mark-up, Web touring, text chat, real-time feedback, quizzes, surveys, graded assessments, and record and playback capabilities.

Centra 7 for Web Seminars. Centra 7 for Web Seminars is designed for large-scale Web events, such as online seminars and corporate communications. Integrated capabilities for both VoIP and traditional teleconferencing audio provide customers with the choice that best suits their audience, infrastructure, and budget. Additional in-session features include streaming video, application sharing, record and playback, and system administration capabilities optimized for managing large groups of attendees. Pre- and post-event management functionality, including lead source tracking, online registration and reminders, and post-event follow up, support overall automation and efficiency of the Web event process.

Centra 7 for Self-service Meetings. Centra 7 for Self-service Meetings provides an easy-to-use virtual meeting facility where users can schedule, organize and run their own Web meetings with co-workers, customers, suppliers, partners, and prospects. Using Centra for self-service meetings, individuals can hold online business meetings with others inside or outside their corporate network, using a personal meeting room for spontaneous meetings, or using Centra’s Speed Scheduler feature to organize a meeting for a later date and time. In-session features include VoIP audio, Web based video, application sharing, real-time data exchange and record and playback capabilities.

Centra Knowledge Center. Centra Knowledge Center is designed to provide on-demand access to a wide variety of learning resources and activities stored in a centralized, online content repository. Its capabilities include content management, personalized learning tracks, and competency management.

Centra Knowledge Composers. Centra Knowledge Composer tools are designed to enable users to create interactive content, such as Microsoft PowerPoint presentations, simulations, and other collaborative learning content. These easy-to- use tools enable business professionals to create “knowledge objects” in industry standard formats and then store them in the Centra Knowledge Center content repository.

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Services and Support

Professional Services

Our global professional services organization provides comprehensive customer assistance programs, including consulting, education and training, content services, Web event services and maintenance and support services to aid our customers in optimizing the use and experience of our products.

Consulting. We offer a wide range of consulting services to our customers to facilitate the efficient and cost-effective use of our products and services, including an Implementation Resource Kit that includes customer-tested resources and best practices. Centra’s proven deployment methodology provides a roadmap to help customers become productive quickly. Based on the unique needs of an organization, Centra offers custom development projects including business process analysis, customized system configuration, content migration, best practice audits and ongoing change management. Our consulting organization is also responsible for assisting customers with the installation and deployment of our products and offers extended services such as on-site training.

Education and Training. We provide education programs and courses to assist presenters, content developers, event managers, systems administrators, help-desk support professionals, implementation specialists and other professionals in the use of our products and services. Online and on-site courses and workshops led by expert instructors provide knowledge and skills to successfully deploy, use and maintain our products and services. These courses focus on the technical aspects of our products, as well as business issues and processes related to collaborative learning, content creation and management, Web marketing and online business collaboration. Additional offerings include Professional Certification programs.

Content Services. Centra offers a range of content creation services where our instructional designers and content specialists design and develop presentations, courseware and proprietary content based on new or existing slides. In addition, Centra can offer feedback and best practices on how to design and deliver content to increase the effectiveness of online sessions.

Web Event Services. Centra offers complete Web event services for the start-to-finish management of Web seminars including presenter training, practice sessions, custom Web registration pages, email management, in-session event moderators, event recordings and attendance reporting.

Maintenance and Support. Our standard maintenance and support agreement gives customers access to error corrections or bug fixes and rights to unspecified upgrades and enhancements on a when-and-if available basis, as well as related technical support. Our technical support organization helps resolve technical inquiries, is available by telephone, email and fax or, if necessary, on-site at a customer’s premises and provides various levels of technical support and documentation for our customers.

Hosting and ASP Services

Centra offers its entire product line accessible through a variety of secure, outsourced application services and hosting options. These options are designed to accommodate the needs of buyers who may require the flexibility of an outsourced service or who lack the information technology infrastructure and resources to deploy real-time collaboration solutions on-site. We use a third party Internet Service Provider, or ISP, to provide the telecommunications, data center and ongoing monitoring of our ASP services, and we offer our ASP services on a global basis. All options are backed by our world-class Professional Services team to ensure successful implementation.

Sales and Marketing

Distribution

We sell our products and services through a direct sales force and through indirect channel partners, including value-added resellers and integrated technology solution vendors. As of December 31, 2003, our sales and marketing organization consisted of 81 sales and marketing professionals located in 6 domestic and 5

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international locations. Our direct sales force primarily focuses on selling our enterprise products and solutions to Global 5000 companies, universities and colleges, government agencies, and other large organizations. We utilize direct sales teams consisting of both sales and technical professionals who work directly with potential customers to provide proposals, demonstrations and presentations designed to meet the specific needs of each customer. Our inside organization operates under a teaming model with our direct sales representatives, focusing on smaller opportunities within the Global 5000. Our telesales organization sells our ASP service to small- and medium-sized companies.

Augmenting the efforts of our direct sales force, Centra products and services are sold indirectly through relationships with value-added resellers. As of December 31, 2003, we had relationships with resellers throughout North and Central America, Europe, the Middle East, Africa, Asia, and Brazil, making our products and services available worldwide. Our reseller partners focus on selling packaged software and ASP services and target department-level purchasers in both the enterprise and the small- and medium-sized business markets. We intend to increase our direct sales force and to authorize additional resellers to sell Centra products and services both domestically and in select international markets.

Revenues from sales outside of the United States were $10,045,000, $6,888,000 and $8,361,000, or 26%, 21% and 19% of total revenues, for 2001, 2002 and 2003, respectively. Since 1999, we have invested in the infrastructure necessary to expand our global operations, including the formation and staffing of our European, Asian and Australian operations. We expect to continue to invest in our international operations as we expand our international indirect channels and our ASP service operations abroad to increase worldwide market share. While weak global economic conditions for enterprise software negatively affected our international revenues in 2002 and 2003, we anticipate that, because of our continued investments in this area, revenues derived from outside the United States will increase both in terms of percentage of revenues and absolute dollars in the future.

To complement our solutions, extend our reach within the online business communications and collaboration market and facilitate rapid integration with third-party products and services for online business communications and collaboration, we have identified and recruited and actively support a strategic “ecosystem” of business relationships. In the collaborative learning market segment, we have partnered with leading content developers, professional service firms, learning technology providers and online training companies. These relationships, including partners such as Saba, Docent, New Horizons, Deloitte Consulting, and Accenture, are aimed at increasing market awareness of our products and helping us generate sales leads. For example, in our relationship with Accenture, Centra products are used, if selected by the customer, to deliver live interactive training, support, implementation and consulting services to their customers in connection with their deployment of enterprise applications such as Oracle, PeopleSoft, SAP and Siebel. These arrangements are intended to provide additional marketing resources, awareness and account access. We can give no assurance, however, that these relationships will continue or that they will produce the expected results. See “Factors That Could Affect Future Results,” in item 7.

In addition to activities aimed at advancing awareness and reach of our Centra brand, we entered into agreements with SiteScape and ClearOne, technology solution providers of asynchronous team collaboration, in which they have embedded our products as part of their own product solutions. The agreements were entered into during the fourth quarter of 2002 and third quarter of 2003, respectively, and to date have not resulted in any significant revenues. We may, in the future, pursue other embedded arrangements with other technology solution providers in complementary application areas such as portals, document management and customer relationship management. We can give no assurance, however, that this will prove successful or help us increase revenues. See “Factors That Could Affect Future Results,” in item 7.

Pricing

Our products and services are divided into four major categories for pricing purposes:

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We license our software under a variety of pricing models to support the business needs of different types of customers, including perpetual named-user licenses, perpetual concurrent-user licenses and time-limited or subscription-based licenses. Customers who license our enterprise application software typically purchase renewable maintenance and support contracts that provide telephone support, error corrections or bug fixes and rights to unspecified upgrades and enhancements on a when-and-if available basis over a stated term, usually a 12-month period. Maintenance is priced as a percentage of the license fees. We also offer consulting, training and education services to our customers, primarily on a time-and-materials basis, but also, for education, on a course subscription or per-course basis. In addition, we offer hosting services for customers under hosting agreements, with terms typically ranging from 6-12 months, to outsource the administration and infrastructure necessary to operate our enterprise application software. The hosting fees include a monthly service fee in addition to license fees for the software. We offer many of our licensed products as an ASP service as well, with a variety of terms, including annual, semi-annual, quarterly or monthly or on a per event or actual usage basis to facilitate a low-entry price point for easy adoption. Prices for a complete system vary based upon the number of system users and servers, and the level of use.

Marketing

We focus our marketing efforts on creating general awareness of the capabilities of our products and services in the online business communications and collaboration market. We also focus on generating specific interest among business executives considering enterprise-level online business communications and collaboration solutions, as well as individual and departmental users we consider suitable for the Centra ASP service. We engage in a broad range of marketing activities, including advertising, sponsoring seminars for prospective customers, exhibiting at targeted conferences for the technology and investment communities, and deploying paper and email-based awareness and lead generation activities. We maintain an active public relations program through which we issue press releases that highlight major customer additions, strategic partnerships and new product releases. We develop relationships with industry analysts and promote coverage of the Company in the trade and business press. We devote resources to our Web site to provide product and company information, as well as customer profiles. We continue to enhance our Web site with features, including online presentations, seminar content and customer application success stories. Our product marketing programs are aimed at informing customers of the capabilities and benefits of our products and increasing the demand for such products across major industry segments. We plan to continue to devote significant resources to marketing our products and the Centra brand. Our marketing organization works closely with our customers and direct sales organization to manage the lead process and to capture, organize and prioritize customer feedback to help guide our product development efforts.

Customers

As of December 31, 2003, we have sold Centra products to more than 1,300 distinct customer organizations worldwide, across many industry sectors, which in the aggregate represents millions of end-users both inside and outside of their respective organzations. New customers added in 2003 include Weyerhauser, Epiphany, Tennessee Farmers Insurance, Kingdee International Software Group, Banca Italia, Roche Diagnostics, Royal Caribbean International Cruise Lines, Ascential Software, Xilinx, Eastern Bank, Boehringer Ingleheim, North Carolina State University, GreenPoint Mortgage, Spherion, Zurich American Insurance, Time Warner, and Blue Cross Blue Shield of New Jersey.

We operate within a single business segment. Our total revenues from customers in the years ended December 31, 2001, 2002 and 2003 were $39.1 million, $33.4 million and $43.0 million, respectively. No single customer, including direct end-users or resellers, accounted for more than 10% of our total revenues during the years ended December 31, 2001, 2002 or 2003.

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Competition

The market for real-time enterprise conferencing and collaboration is in its early stages, but is competitive, evolving and subject to rapid change because of market consolidation. We expect that the intensity of our competition will increase in the future. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any of which could seriously harm our business. We believe that our ability to compete depends on many factors both within and beyond our control, including: 1) our domain expertise and focus on delivering high-value, specialized applications that streamline critical business processes such as enterprise application deployments, sales and channel productivity and training and certification; 2) the performance, reliability, ease of use and features of our products as compared to those of our competitors; 3) our ability to secure and maintain key strategic relationships with large software vendors, system integrators and value-added resellers; 4) our ability to expand our sales operations and partner channels around the world; 5) increased awareness of the Centra brand through comprehensive advertising and public outreach programs and 6) the timing and market acceptance of new products and enhancements to existing products developed by us and our competitors.

Competitors vary in size and in the scope and breadth of the products and services offered. These include suppliers addressing sub-segments of our overall target market with products and services for virtual classrooms, Web conferences, Web meetings, content management and creation, and related offerings. Our primary competitors include WebEx, Microsoft (which recently purchased PlaceWare), and the Lotus division of IBM. We believe that we have a stronger product offering for the following reasons: 1) we are the only vendor that focuses on high value specialized applications that automate mission critical business processes, which provides greater functionality than generic Web-conferencing tools and 2) our products can be delivered in many ways, either deployed at a customer’s premises or on its network as a packaged software application, or delivered by Centra as an ASP or hosted service utilizing our network. Also, our products are extensible, with an open application program interface, so that they can be integrated with various software applications, operating platforms and software tools.

Centra sells complete solutions that address business challenges in an organization. Unlike competitors that sell Web conferencing tools, Centra focuses on specific business problems, enabling organizations to more effectively and cost-efficiently roll out new IT enterprise applications, prepare their sales force to be more productive, and assist and repurpose corporate training programs. The solutions include core software, workflow capabilities that automate business processes, professional services based on domain expertise, and third-party integrations. Also, we do not believe that our competitors typically offer a variety of deployment options (on premises for highest security, ASP, or hosted services) or the breadth of integration with other software assets (desktops, enterprise applications, Learning Management Systems, databases, user directories, etc.) that we offer. Finally, our competitors do not provide an integrated knowledge portal for delivery of corporate content and blended learning programs, accelerating knowledge transfer and building skills. In addition to the companies named above, there are a number of other real-time collaboration software and service companies that compete with parts of or all of our real-time enterprise offerings, such as Raindance, Latitude Communications (recently purchased by Cisco), HorizonLive, Genesys and Interwise. We believe that we are able to compete favorably against these companies because they provide products or services that are less complete than ours.

Some of our competitors have longer operating histories, and greater financial, technical, marketing and other resources than we do. In addition, many of our competitors have well-established relationships with our current and potential customers. In the past, we have lost potential customers to competitors for various reasons, including lower prices and other incentives not matched by us. In addition, current and potential competitors have established or may in the future establish cooperative selling relationships among themselves or with third parties, or expand their offerings through the acquisition of and/or merger with other current or potential competitors, to increase the distribution of their products to the marketplace and to increase the ability of their products to address customer needs. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share.

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We believe that our principal competitive advantages in the market for online business communications and collaboration include:

Although we believe that our solution competes favorably with respect to these factors, our market is relatively new and is developing rapidly. We may not be able to maintain our competitive position against current and potential competitors, especially those with significantly greater financial, marketing, service, technical and other resources. See “Factors That Could Affect Future Results—We face significant competition from other technology companies and we may not be able to compete effectively,” in Item 7.

Product Development

The market for online business communications and collaboration products is characterized by rapid technological change, evolving customer requirements, frequent new product introductions and enhancements, and emerging industry standards. We devote significant time and resources to analyzing and responding to changes in the industry, such as changes in operating systems, application software, security standards, and networking software, that have an impact on evolving customer requirements.

Our online business communications and collaboration products and services must compete on the basis of reliability, scalability, interoperability, security, ease of use and ease and flexibility of administration. We have made, and expect to continue to make, a substantial investment in research and development to enhance our products, and solutions based thereon, stay abreast of advances in collaboration technology, network infrastructure and user administration, and respond to evolving customer needs. In the years ended December 31, 2001, 2002, and 2003 we spent approximately $14.7 million (which included approximately $2.2 million of non-recurring acquired in-process research and development in connection with the acquisition of MindLever in April 2001), $12.0 million, and $11.5 million, respectively, on product development or 38%, (32% excluding the acquired MindLever in-process research and development) 36%, and 27%, respectively, of total revenues.

We believe the future success of the Company depends largely on our ability to enhance and broaden our existing product lines to meet the evolving needs of the market. There can be no assurance that we will be able to respond effectively to technological changes or new industry standards or developments. Our operating results and business could be adversely affected if we were to incur significant delays or be unsuccessful in developing new products or enhancing our existing products, or if any such enhancements or new products do not gain market acceptance. In addition, a number of factors may cause variations in our future operating results, including the timing of our product introductions and enhancements or those of our competitors, market

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acceptance of new products, or the delay of customer orders for existing products because of anticipation of the availability of new products. We believe that our ability to attract, as needed, and to retain a technically skilled development team is also critical to our future success.

Proprietary Rights

Our success and ability to compete are dependent, to a significant degree, on our ability to develop and maintain the proprietary aspects of our technology and operate without infringing the proprietary rights of others. We regard certain aspects of our products and documentation as proprietary and we rely on a combination of patent, trademark, trade secret and copyright laws and licenses and contractual restrictions to protect our proprietary rights. These legal protections afford only limited protection for our technology. We seek to protect our source code for our software, documentation and other written materials under trade secret and copyright laws. We license our software pursuant to license agreements that restrict use of the software by our customers. Finally, we seek to limit disclosure of our intellectual property by requiring employees, consultants and customers with access to our proprietary information to execute confidentiality agreements with us and by restricting access to our source code. We believe, however, that in the market for online business communications and collaboration products and services, factors such as the technological and creative skills of our personnel and our ability to develop new products and enhancements to existing products are more important than the various legal protections of our technology to establishing and maintaining a technology leadership position.

We have filed a patent application with the United States Patent and Trademark Office for two inventions embodied in the software products that we have developed and that may be useful in the field of real-time enterprise collaboration. There can be no assurance, though, that this application will result in an issued patent.

Our products are generally licensed to end-users on a “right-to-use” basis pursuant to a license that restricts the use of the products for the customer’s internal business purposes. We also rely on “click wrap” licenses, which include a notice informing the end-user that, by downloading the product, the end-user agrees to be bound by the license agreement displayed on the customer’s computer screen. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. Policing unauthorized use of our products is difficult and, while we are unable to determine the extent to which piracy of our software exists, it can be expected to be a persistent problem. In addition, the laws of many countries do not protect our proprietary rights to as great an extent as do the laws of the United States. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement or invalidity. Any such litigation could be costly and divert resources and could have a material adverse effect on our business, operating results and financial condition; even if we prevailed in such litigation. We can give no assurance that our means of protecting our proprietary rights will be adequate, or that our competitors will not independently develop similar technology. Any failure by us to protect our intellectual property could have a material adverse effect on our business, operating results and financial condition.

There can be no assurance that other parties will not claim that our current or future products infringes their rights in the intellectual property. We expect that developers of enterprise applications will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and as the functionality of products in different segments of the software industry increasingly overlaps. Any such claims, with or without merit, could be time consuming to defend, result in costly litigation, divert management’s attention and resources, cause product shipment delays or require us to enter into terms marginally acceptable to us. A successful infringement claim against us, and our failure or inability to license the infringed rights or develop license technology with comparable functionality, could have a material adverse effect on our business, financial condition and operating results. In August 2003, we were sued in federal court in the District of Colorado on a claim that we infringed the plaintiff’s patent rights. The Company has filed an answer to the complaint denying all of the allegations. See Item 3, “Legal Proceedings.”

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We integrate third-party software into our products. This third-party software may not continue to be available on commercially reasonable terms. We believe, however, there are alternative sources for such technology. If we are unable to maintain licenses to the third-party software included in our products, distribution of our products could be delayed until equivalent software could be developed or licensed and integrated into our products. This delay could materially adversely affect our business, operating results and financial condition.

Employees

As of December 31, 2003, we employed a total of 258 full-time employees, including 87 in product development, 81 in sales and marketing, 59 in services and support and 31 in general and administration. As of December 31, 2003, a total of 234 employees were located in the United States and 24 were located outside of the United States. None of our employees are represented by a collective bargaining agreement, nor have we experienced any work stoppages. We consider our relations with our employees to be good. Our future success will depend in part on our ability to attract, retain, and motivate highly qualified technical and management personnel for whom competition is intense.

ITEM 2.    PROPERTIES

The Company’s current headquarters consist of a leased office suite located at 430 Bedford Street in Lexington, Massachusetts. We occupy approximately 49,000 square feet of space at that location under a lease that expires in June 2005. In addition, we lease approximately 30,000 square feet of space in Morrisville, North Carolina, primarily as a product development facility, under a lease that expires in May 2005. We occupy approximately 9,000 square feet of the Morrisville property. We also lease approximately 5,000 square feet of space in Duluth, Georgia as a technical support facility under a lease that expires in January 2007 and approximately 3,600 square feet in Maidenhead, England as headquarters for our Europe, Middle East and Africa field operations under a lease that expires in November 2008. These facilities are expected to meet our needs through at least December 31, 2004.

To support our field sales and consulting staff, we also lease office space domestically in the metropolitan areas of Atlanta, Los Angeles, Philadelphia and San Francisco, and, internationally, in Sydney, Australia; Toronto, Canada; Tokyo, Japan and Singapore. Each of these offices, generally, is leased under an agreement with a remaining term of 12 months or less.

ITEM 3.    LEGAL PROCEEDINGS

From time to time, we have been, and expect to continue to be, subject to legal proceedings and claims in the ordinary course of our business. Such claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources. Except for the lawsuits identified below in this section, we are not presently a party to any legal proceedings, the adverse outcome of which, in management’s opinion, would have a material adverse effect on our results of operations or financial position.

Securities Class Action Lawsuit

Centra, certain of its officers and directors and the managing underwriters of Centra’s initial public offering were named as defendants in an action filed in the United States District Court for the Southern District of New York. The plaintiffs filed an initial complaint on December 6, 2001 and purported to serve the Centra defendants on or about March 18, 2002. The original complaint has been superseded by an amended complaint (complaint) filed in April 2002. The action, captioned in re Centra Software, Inc. Initial Public Offering Securities Litigation, No. 01 CV 10988, which is being coordinated with an action captioned in re Initial Public Offering Securities Litigation, No. 21 MC 92, is purportedly brought on behalf of the class of persons who purchased Centra’s common stock between February 3, 2000 and December 6, 2000. The complaint asserts claims under Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The

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complaint alleges that, in connection with Centra’s initial public offering in February 2000, the underwriters received undisclosed commissions from certain investors in exchange for allocating shares to them and also agreed to allocate shares to certain customers in exchange for the agreement of those customers to purchase additional shares in the after-market at pre-determined prices. The complaint asserts that Centra’s registration statement and prospectus for the offering were materially false and misleading due to their failure to disclose these alleged arrangements. The complaint seeks damages in an unspecified amount against Centra and the named individuals. The underwriter defendants and the Centra defendants joined in motions to dismiss the above-reference action on July 3 and July 15, 2002, respectively. On October 9, 2002, the plaintiffs dismissed, without prejudice, the claims against the named Centra officers and directors in the above-referenced action. On February 19, 2003, the court issued an order denying the motion to dismiss as to Centra and other defendants. On June 7, 2003, the plaintiffs announced a proposed settlement with all issuers, including Centra. Centra plans to participate in this settlement, which will be funded by Centra’s insurers. The settlement is subject to finalization and court approval. No amount has been accrued related to this matter and legal costs incurred in the defense of the matter are being expensed as incurred.

Bankruptcy Claim

The Company has been named as a defendant in an adversary proceeding arising out of the Winstar Communications, Inc. bankruptcy pending in bankruptcy court in the State of Delaware, which converted to a case under Chapter 7 on January 24, 2002. The claim alleges that Centra received a preferential transfer from the Debtor in the amount of $128,650, which amount was payment in full for a software license and maintenance support beginning September 2000. The bankruptcy trustee filed suit against Centra, along with numerous other entities, on April 8, 2003. Centra has reached an agreement in principle to settle this claim for $15,000.

Patent Infringement Lawsuit

On August 19, 2003, a complaint was filed against the Company and two other defendants by EdiSync Systems, LLC, in the United States District Court for the District of Colorado (No. 03-D-1587 (OES)). The complaint alleges infringement of two patents for a remote multiple user editing system and method and seeks permanent injunctive relief against continuing infringement, compensatory damages in an unspecified amount, and interest, costs and expenses associated with the litigation. The Company has filed an answer to the complaint denying all of the allegations. The Company believes it has meritorious defenses and intends to vigorously defend this action. No amount has been accrued related to this matter and legal costs incurred in the defense of the matter are being expensed as incurred.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matter was submitted to a vote of security holders during the quarter ended December 31, 2003.

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PART II

Our common stock is traded on the NASDAQ National Market under the symbol “CTRA.” The following table sets forth, for the periods indicated, the range of high and low prices per share of our common stock as reported on the NASDAQ National Market during each of the quarters indicated.

As of February 28, 2004, there were approximately 204 holders of record of our common stock. This number does not include stockholders for whom shares are held in a nominee or “street” name of which we believe there are a substantial number.

We have never declared or paid cash dividends on our common stock. We currently intend to retain earnings, if any, for use in our business and do not anticipate paying any cash dividends in the foreseeable future.

In February 2000, we completed the initial public offering of our common stock. The shares of common stock sold in the offering were registered under the Securities Act of 1933, as amended, on a Registration Statement on Form S-1 (the “Registration Statement”) (File No. 333-89817) that was declared effective by the Securities and Exchange Commission on February 3, 2000. Our net proceeds from the offering were approximately $73.2 million. From the effective date through December 31, 2003, we used approximately $6.5 million for payments of dividends to preferred shareholders, $29.7 million to fund operations, $1.9 million for capital expenditures, $5.0 million for the acquisition of MindLever and satisfaction of related debt and $4.7 million to pay amounts outstanding under term loans. As of December 31, 2003, we had approximately $25.4 million of net proceeds remaining, and pending use of these proceeds, we intend to invest such proceeds in high-quality investments, consisting primarily of obligations of the U.S. Treasury and U.S. government-backed agencies.

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ITEM 6.    SELECTED CONSOLIDATED FINANCIAL DATA

The selected consolidated financial data set forth below should be read in conjunction with our consolidated financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 in this report. The historical results are not necessarily indicative of the operating results to be expected in the future.

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The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected Consolidated Financial Data” appearing in Item 6 of this report and our consolidated financial statements and notes thereto appearing under Item 8 of this report. This discussion and analysis contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements, as described under “Special Note Regarding Forward-Looking Information” above Item 1 of this report and in the discussion under the heading “Factors That Could Affect Future Results” in this Item 7.

Overview

Centra is a leading provider of application software, services and solutions for online business communications and collaboration. Our products and services augment operational business processes to enable real-time, group-oriented human interaction over corporate networks and the Internet. Our customers use Centra to accelerate product introductions, deliver hands-on deployment of software applications, effect change-management initiatives, expand training and certification to employees and external channel partners, facilitate customer interaction and online selling and support project management activities. In addition, we offer consulting, education and support services that enable our customers to successfully implement our products and solutions throughout their organizations.

An overview of our products and services, our geographical markets, our strategic intent as well as the challenges inherent in achieving our operational and financial goals, are outlined as follows:

Product portfolio. Our products are available as either packaged software applications, with optional hosted services, or on a subscription or per-use basis through our ASP offerings. Based on a common collaboration framework, our products and services support a wide range of convenient business interactions online, including real-time virtual learning, large scale Web conferences and live, interactive Web meetings. Each real-time collaboration interface includes capabilities for VoIP audio, Web-based video, software application sharing, real-time data exchange, and facilities for session recording and playback. These products and services allow organizations to increase the productivity of their members and enhance the effectiveness of knowledge transfer while reducing travel, facilities and telecommunications costs.

Geographic presence. We sell our products and services primarily through a direct sales force and through relationships with indirect channel partners, including value-added resellers and technology solution providers. We have established direct sales and service operations for North America, with offices throughout the United States and in Canada, for Europe, with headquarters in Maidenhead, England and for Australia, based in Sydney. In addition, we have value-added resellers throughout North America, Europe, the Middle East, Africa, Asia, Brazil, and Central America. Revenues from sales outside of the United

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States were $10,045,000, $6,888,000 and $8,361,000, or 26%, 21% and 19% of total revenues, respectively for 2001, 2002 and 2003, respectively. Since 1999, we have invested in the infrastructure necessary to expand our global operations, including the formation and staffing of our European, Asian and Australian operations. We expect to continue to invest in our international operations as we expand our international indirect channels and our ASP service operations abroad to increase worldwide market share. While weak global economic conditions for enterprise software negatively affected our international revenues in 2002 and 2003, we anticipate that, because of our continued investments in this area, revenues derived from outside the United States will increase both in terms of percentage of revenues and absolute dollars in the future.

Strategic intent. Our strategy is to become the leading provider of open and extensible application software, services and solutions for online business communications and collaboration. In our effort to achieve this market position, we have undertaken several key business and operational initiatives with the intent of generating profitable revenue growth through the deliverance of exceptional products, solutions and services. We intend to invest in the areas of sales and marketing by:

During 2004, we expect to increase spending in sales and marketing by $8 million over 2003 levels, aimed at enhancing brand recognition and increasing revenues. In all other areas of the business, including product development, general and administrative, and customer support, we expect to maintain or increase slightly our level of expenditures in 2004 to execute our business plan, to expand our ecosystem of alliance and channel partners and to further develop and improve upon our products and services to address the real-time enterprise conferencing and collaboration market. See “Liquidity and Capital Resources” and “Factors That May Affect Future Results—We may not successfully execute our strategic plan despite our significant planned investments.”

Challenges in the marketplace. The market for real-time enterprise conferencing and collaboration is both evolving and subject to rapid technological change. Additionally, the purchasing behavior of our customers is influenced, in large part, by the macroeconomic environment as well as their corporate financial condition. These two factors combined or in isolation present formidable challenges in the marketplace as we cannot predict the timing or magnitude of such external situations. As we proceed through the next few quarters, we do expect to see positive results from an increase in our direct sales force, the re-alignment of our inside sales team, and from our incremental investments in lead generation programs. However, while we have done extensive market research, we cannot be entirely assured of the resulting success of these investments. Our goals of achieving revenue growth and establishing a market leading position are dependent upon various factors including: 1) macroeconomic conditions, 2) corporate IT needs and spending capacity, 3) successful packaging and presentation of our products, 4) efficient and effective execution of our sales strategy and 5) competitive entrants and marketplace actions. (For a more comprehensive analysis of risk factors, see “Factors That Could Affect Future Results” below).

On April 30, 2001, we acquired MindLever.com, Inc., a North Carolina corporation and a provider of management systems for learning content, for $2.9 million in cash and 509,745 shares of common stock valued

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at approximately $3.8 million, plus acquisition costs of approximately $512,000, for a total purchase price of approximately $7.2 million. As a result of the acquisition, MindLever became a wholly-owned subsidiary of the Company. The acquisition was accounted for using the purchase method of accounting. Accordingly, the results of operations of MindLever have been included in our results of operations from the date of acquisition. When we acquired MindLever, we recorded a goodwill asset on our balance sheet in the amount of $5.9 million. During the quarter ended December 31, 2002, however, we recorded an impairment charge of $5.9 million to write down the remaining goodwill to its implied fair value of zero.

Our revenues are classified into three main categories: license, software services and maintenance and professional services. License revenue is generated from the sale of packaged software applications on either a perpetual license or time-based license basis. Software services revenue is comprised of revenues from our ASP service sold on a subscription or per-use basis and from hosted services. Maintenance and professional services revenue includes revenue from maintenance and support contracts and from consulting and education services.

Our cost of license revenues includes royalties due to third parties for technology included in our products, as well as the cost of product documentation, media used to deliver our products, and fulfillment. Amortization of acquired developed technology represents the amortization, over a three-year period, of the valuation of the developed technology and know-how acquired in connection with our April 2001 acquisition of MindLever. Our cost of software service revenues includes (1) salaries and related expenses for our hosted and ASP services organizations, (2) an overhead allocation consisting primarily of that portion of our facilities, communications and depreciation expenses that is attributable to providing our services, and (3) direct costs related to our hosted and ASP service offerings. Our cost of professional services and maintenance revenues includes (1) salaries and related expenses for our consulting, education and technical support services organizations and (2) an overhead allocation consisting primarily of that portion of our facilities, communications and depreciation expenses that is attributable to providing our services.

Our operating expenses are classified into seven general categories: sales and marketing, product development, general and administrative, compensation charge for issuance of stock options, impairment of goodwill, merger transaction costs and restructuring and severance charges.

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In the development of new products and enhancements of existing products, the technological feasibility of the software is not established until substantially all product development is complete. Historically, our software development costs eligible for capitalization have been insignificant and all costs related to internal product development have been expensed as incurred.

We have experienced substantial losses in each fiscal period since our inception. As of December 31, 2003, we had an accumulated deficit of $88.1 million. These losses and our accumulated deficit have resulted from the significant costs incurred in the development, marketing, sale and delivery of our products and services, including the establishment of our hosted and ASP services infrastructure, which have been only partially offset by our revenues to date. Although we have experienced significant revenue growth in 2003 and we have achieved a substantial decrease in our net loss for 2003 over 2002, we may not be able to continue to increase our revenues or attain profitability and, if we do achieve profitability, we may not be able to sustain profitability for any future periods. We plan to spend an additional $8 million for sales and marketing in 2004 over our 2003 expenditure rate and as a result we expect to incur additional losses during 2004. However, we plan for our operations to become profitable by the end of 2004. To accomplish this goal we will need to generate a significant increase in revenues in 2004 over 2003. We believe that period-to-period comparisons of our historical operating results may not be meaningful, and you should not rely upon them as an indication of our future financial performance. See “Factors That Could Affect Future Results,” in Item 7.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of our financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management evaluates its estimates and judgments, including those related to revenue recognition, accounts receivable valuation and reserves, the valuation of intangible assets and goodwill and accounting for income taxes. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Note 1 to the consolidated financial statements included in this Report contains a discussion of our significant accounting policies. Management believes that the following critical accounting policies most significantly affect the portrayal of our financial condition and require management’s most difficult and subjective judgments:

Revenue Recognition

The recognition of revenue is a key component of our results of operations and the time at which revenue is recognized determines the timing of certain costs and expenses, such as royalties and referral fees. In measuring revenues, we follow the specific guidelines of the American Institute of Certified Public Accountants Statement of Position (SOP) 97-2 Software Revenue Recognition, and SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions, and related authoritative literature.

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We derive our revenues from the sale of software licenses, application service provider or ASP and hosting services, maintenance (post-contract support) and professional services. Maintenance includes telephone support, error correction or bug fixes and rights to upgrades and enhancements on a when-and-if available basis. We execute contracts that govern the terms and conditions of each software license, each ASP and hosting agreement and each maintenance and support and other professional services arrangements. These contracts may be elements in a multiple-element arrangement. Revenue under multiple-element arrangements, which may include several different software products and services sold together, is allocated to each element based on the residual method in accordance with SOP 98-9. As described below, significant management judgments and estimates must be made and used in connection with the revenue recognized in any accounting period. Management analyzes various factors, including a review of the terms of specific transactions, vendor specific objective evidence of undelivered elements, historical experience, creditworthiness of customers and current market and economic conditions. Changes in judgments based upon these factors could impact the timing and amount of revenue and cost recognized and thus affects our results of operations and financial condition. Our specific guidelines and procedures for recognizing revenue are discussed in detail in Note 1, paragraph c to our consolidated financial statements included in this Report.

Under the applicable provisions of SOP 97-2, as amended by SOP 98-9, we recognize revenue from the sale of software licenses upon the occurrence of all required conditions, including 1) persuasive evidence that an arrangement exists, 2) the product has been delivered, 3) the fees are fixed or determinable and 4) collection of the resulting receivable is reasonably assured. Each of these factors, particularly the collection of the resulting receivable, requires estimation and judgment by management.

Revenues associated with license sales to distributors or to value-added resellers are recognized when an end-user customer has been identified and all other revenue recognition criteria above have been met. Revenue associated with license sales to U.S. government agencies through a teaming arrangement with a third-party partner are recognized when a signed order from our partner and evidence of a purchase order from the government agency to the partner is received and all other revenue recognition criteria above have been met. Thus, these types of transactions require management to make judgments as to these additional factors.

For arrangements with multiple elements (for example, the sale of a product license along with the sale of maintenance and support, and training and consulting to be delivered later), we allocate revenue to each component of the arrangement using the residual value method based on the fair value of the undelivered elements. We defer revenue from the arrangement equivalent to the fair value of the undelivered elements and recognize the remaining amount at the time of shipment or when all other revenue recognition criteria have been met. Fair values for the ongoing maintenance and support obligations are based upon separate sales of renewals of maintenance contracts. Fair value of services, such as training or consulting, is based upon separate sales of these services to other customers. Thus, these types of arrangements require us to make judgments about the fair value of undelivered arrangements.

At the time of the transaction, we assess whether the fee associated with the transaction is fixed or determinable based on the payment terms associated with the transaction. Billings to customers are generally due within 30 to 90 days. However, in certain circumstances, we have offered extended payment terms greater than 90 days but equal to or less than 180 days to certain customers, for which license revenue is recognized upon shipment. These customers are well capitalized and typically have entered into larger scale license arrangements with us. We believe that we have sufficient history of collecting all amounts within the stated terms under these types of arrangements to conclude that the fee is fixed or determinable at the time license revenue is recognized. In addition, in assessing whether collection is probable or not for a given transaction, and therefore whether we should recognize the revenue, we make estimates regarding the creditworthiness of the customer. Initial creditworthiness is assessed through Dun & Bradstreet, similar credit rating agencies or the customer’s SEC filings. Creditworthiness for transactions to existing customers is assessed through a review of their prior payment history. We do not request collateral from our customers. If we determine that collection of a fee is not reasonably assured, we defer the fee and recognize revenue at the time collection becomes reasonably assured, which is generally upon the receipt of payment.

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Revenues from maintenance and support services are recognized ratably on a straight-line basis over the term that the maintenance service is provided. Revenues from consulting and education services are recognized either as the services are performed, ratably over a subscription period, or upon completing a project milestone if defined in the agreement. Consulting and education services, including implementation, are not considered essential to the functionality of our products as these services do not alter the product capabilities, do not require specialized skills and may be performed by the customer or other vendors.

In the event that we were to revise our estimates and judgments regarding the above, or regarding other aspects of our revenue recognition policies and practices, the timing and amounts of our reported revenue could be materially affected.

Accounts Receivable Valuation and Reserves

We maintain allowances for estimated losses resulting from the inability of our customers to make required payments. Accounts receivable are reduced by an allowance for amounts that may become uncollectible in the future. The estimated allowance for uncollectible amounts is based primarily on a specific analysis of accounts in the receivable portfolio and on our history of write-offs of accounts receivable. While we believe the allowance to be adequate, if the financial condition of our customers were to deteriorate, resulting in impairment of their ability to make payments, additional allowances would be required and bad debt expense would increase by the amount we increased the allowances. In addition to the allowance for uncollectible amounts, we also provide an allowance for sales returns based on historical return rates. If we were to experience return rates exceeding those provided for, an additional allowance for sales returns would be required, our total revenues would be reduced and our loss increased by the amount we increased the allowances. Historically very few of our returns and uncollectible receivables have been significant or have had a material impact on our financial position or results of operations

Valuation of Intangible Assets and Goodwill

Effective January 1, 2002, we adopted the provisions of SFAS No. 142, Goodwill and Other Intangible Assets. Under SFAS No. 142, instead of amortizing goodwill and certain other long-lived assets over time, we carry the asset on our balance sheet at its stated value and test it for impairment. The test is performed both annually and on an interim basis if an event or circumstance indicates that it is more likely than not that an impairment loss has been incurred. If it is determined that the carrying amount of goodwill exceeds its implied fair value, then a loss in operations to the extent of the impairment must be recorded. Because such impairment losses can occur irregularly and in varying amounts, our operating results may be subject to volatility if we have goodwill and other non-amortizing assets on our balance sheet from time to time. We do not currently carry any goodwill on our balance sheet.

When we acquired MindLever in April 2001, we allocated approximately $5.9 million of the purchase price of approximately $7.2 million to goodwill. We also allocated approximately $2.1 million of the MindLever purchase price to developed technology and know-how and $300,000 to assembled workforce. This amount of $2.4 million was being amortized over a period of three years. These allocations represented management’s estimate of the excess of the purchase price over the fair value of the identifiable intangible net assets that we acquired in the transaction. In December 2002, we conducted our first annual impairment test of the goodwill under SFAS No. 142. To measure the value of the goodwill, we used a combination of the market value of the Company and the net present value of the cash flows that we estimated our assets would produce over their useful lives. We determined that the value of the goodwill was zero. Accordingly, we recorded an impairment charge of $5.9 million, representing the entire carrying amount of goodwill, in the fourth quarter of 2002.

Accounting for Income Taxes

The preparation of our consolidated financial statements requires us to estimate our income taxes in each of the jurisdictions in which we operate, including those outside the United States, which may be subject to certain

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risks that ordinarily would not be expected in the United States. The income tax accounting process requires us to estimate our actual current exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in the recognition of deferred tax assets and liabilities. We must then record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized.

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against deferred tax assets. We have recorded a net deferred tax asset of $30.4 million as of December 31, 2003, primarily consisting of certain net operating losses and tax credits carried forward before they expire. We have booked a valuation allowance in the full amount of this asset, $30.4 million, as of December 31, 2003, due to uncertainty about our ability to utilize any of our deferred tax assets. The valuation allowance is based on our estimates of taxable income by the jurisdictions in which we operate and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to adjust our valuation allowance, which could materially impact our financial position and results of operations.

Results of Operations

The following table sets forth operating data expressed as percentages of total revenues for each period indicated.

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Comparison of 2003 and 2002

Revenues ($ In Millions)

Total revenues increased by $9.6 million, or 29%, to $43.0 million for 2003, from $33.4 million for 2002. The increase was attributable to a significant increase in license and software services revenues as well as continued growth in maintenance revenues. We believe that revenues will continue to grow at a similar rate in 2004 in the range of 25% to 30% based on our plan to increase spending in sales and marketing in 2004, our realignment of the inside sales organization with the field sales force, expansion of our network of value-added resellers and changes in our sales strategy to focus on selling, both at the executive level and in new departments and divisions within our existing strategic accounts. However, we expect license revenues to represent a greater portion of total revenues in 2004 as we generally recognize license revenues up front, upon shipment of the licenses to the customer, compared with software services revenues that generally are recognized over time as the service is used. See “Business—Strategy” in Item 1 of this Report.

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Cost of license revenues. Cost of license revenues increased by $147,000, or 34%, to $581,000 for 2003, from $434,000 for 2002. The increase was attributable to higher royalty fees and fulfillment costs resulting from a higher volume of license revenues in 2003. Since a significant portion of our license costs represent royalties that we pay to third parties on a per unit rate of product sold, primarily on server units, we expect that cost of license revenues will vary in the future based upon the unit volume of products sold. Cost of license revenues was 1% of license revenues for both 2003 and 2002.

Amortization of acquired developed technology. In connection with our acquisition of MindLever in April 2001, we allocated approximately $2.1 million to acquired developed technology, which is being amortized over a three-year estimated useful life. Amortization of acquired developed technology was $700,000 for 2003 and 2002. In the first half of 2004, we will incur $233,000 in amortization costs, after which the acquired developed technology asset will be fully amortized and no further costs will be incurred.

Cost of software services revenue. Cost of software services revenue increased by $41,000, or 2%, to $2.3 million for 2003, from $2.2 million for 2002 due to an increase in the use of technical support services resulting from the growth in the number of ASP service customers added in 2003. Cost of software services revenue was 28% of software services revenue for 2003 and 41% of software services revenue for 2002. This decline in costs as a percentage of software services revenue reflects the increase in software services revenue in 2003 combined with a proportionally lower amount of additional ASP service costs reflecting the increased capacity of our ASP services as the result of our latest product release in June 2003. We anticipate that the cost of software services revenue will increase in absolute dollars to the extent that we must expand the capacity of our ASP service to meet increased demand.

Cost of maintenance and professional services revenue. Cost of maintenance and professional services revenue increased by $99,000, or 2%, to $4.2 million for 2003, from $4.1 million for 2002. This increase was attributed to higher compensation expenses related to higher salaries. Cost of maintenance and professional services revenue was 29% of maintenance and professional services revenue for 2003 and 34% of maintenance and professional services revenue for 2002 reflecting the growth in higher margin maintenance services as compared to consulting and education services, which have a lower margin. We anticipate that the cost of maintenance and professional services revenue will increase in absolute dollars but decline as a percentage of revenues to the extent that we continue to acquire new customers and generate associated maintenance and professional services revenues.

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Sales and marketing expenses. Sales and marketing expenses increased by $823,000, or 4%, to $21.5 million for 2003, from $20.7 million for 2002. The increase resulted from an increase in sales commissions and bonuses due to a higher amount of orders received in 2003. This increase was partially offset by a reduction in bad debt expense due to the impact of a large write-off, which was taken in the prior year and, to a lesser extent, a reduction in marketing programs, including advertising and tradeshows. Sales and marketing expenses were 50% of total revenues for 2003 and 62% of total revenues for 2002. In 2004, we expect that sales and marketing expenses will increase in both absolute dollars and as a percent of total revenues as we plan to increase sales and marketing expenses in 2004 by approximately $8 million or approximately $2 million per quarter. The increase in sales and marketing will be used to fund new marketing programs to promote sales of our products and services into the on-line business communications and collaboration market, to increase the size of our sales organization and strengthen our sales operations infrastructure. In addition to the increase of $8 million, we expect sales commission and bonus expenses to increase in relation to the expected growth in total revenues. We can give no assurance that our strategic efforts will succeed or that we will achieve the increase in sales that we hope for as a result. See “Factors That Could Affect Future Results—We may not successfully execute our strategic plan despite our significant planned investments,” below.

Product development expenses. Product development expenses decreased by $531,000, or 4%, to $11.5 million for 2003, from $12.0 million for 2002. The decrease resulted from a small decline in the average engineering headcount for 2003; a decrease in outside translation costs as certain translation activities were either not required for recent product releases or were completed in-house in 2003 and a reduction in depreciation expense as various capital assets became fully depreciated in 2003 and are still in service. Product development expenses were 27% of total revenues for 2003 and 36% of total revenues for 2002. We expect product development expenses to increase slightly in absolute dollars in future periods as we make small investments to develop new, and enhance existing, products to address the on-line business communications and collaboration market, including adding research and development personnel, consulting services and the replacement of older computer equipment. Product development expenses as a percentage of revenues are expected to decline.

General and administrative expenses. General and administrative expenses increased by $807,000, or 10%, to $8.6 million for 2003, from $7.8 million for 2002. The increase was primarily due to increased recruiting costs attributed to the hiring of our new president and CEO, as well as increases in salaries and bonuses and incremental fees for consulting, legal and audit to comply with the regulations under the Sarbanes-Oxley Act of 2002. General and administrative expenses were 20% of total revenues for 2003 and 23% of total revenues for 2002. We expect our general and administrative expenses, primarily consulting, legal and audit fees, will increase slightly as the result of continued costs to comply with new and recently enacted regulations for public companies by the U.S. government, such as the Sarbanes-Oxley Act of 2002 and costs associated with defending pending lawsuits. See Item 3, “Legal Proceedings.”

Stock compensation charges. We incurred charges of $677,000, or 1% of total revenues for 2003, a decrease of $75,000 from $752,000, or 2% of total revenues, for 2002. This decrease was related to a decrease in stock compensation charges as certain stock options related to these charges in previous years have fully vested or were cancelled upon the termination of the option holder’s employment in 2003. The options were related to the compensation expenses associated with the issuance of stock options in 1999 and 2000 with an exercise price lower than the fair market value on the date of grant. These options, which vest over periods of between four and five years, will result in additional compensation expense of approximately $47,000 in 2004 and 2005. Partially offsetting the effect of the vesting or cancellation of the options, was an increase related to a non-cash charge in the third quarter of 2003 of approximately $300,000 for the acceleration of vesting and the extension of the time period to exercise certain stock options under the terms of a severance agreement with our former president and chief operating officer.

Impairment charges. Under SFAS No. 142, goodwill is not amortized but is reviewed at least annually for impairment. See “Critical Accounting Policies and Estimates” above. In 2002, we recorded an impairment charge of $5.9 million related to goodwill associated with our April 2001 acquisition of MindLever. This charge

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amounted to a write-off of the entire amount of the goodwill asset associated with the MindLever acquisition, and materially affected our results of operations for that year. During 2003, we did not carry any goodwill asset on our books.

Merger transaction costs. In 2002, we recorded a charge of $1.2 million for costs incurred related to the proposed merger with SmartForce PLC. The costs consisted primarily of advisory, legal and retainer fees. We did not incur any such costs in 2003.

Restructuring and severance charges. During the year ended 2003, we incurred severance charges totaling $1.2 million, of which $493,000 was related to the retirement of our former president and chief operating officer in 2003 and $662,000 was related to the departure of several members of the executive management team in connection with a restructuring of the leadership of our domestic sales, marketing and business operations teams in the fourth quarter of 2003. In 2003, we also recorded an additional $300,000 charge in connection with the retirement of our former president and chief operating officer, allocated to compensation expense; (see “Stock Compensation Charges” above). In each of the departures described above, the severance costs consisted of guaranteed salary and bonus and related employee benefits ranging from six months to one year and are to be paid out over the next 12 months. We do not expect to incur any further charges related to these employee departures. In April 2002, in light of changing market dynamics and economic factors, we reduced our workforce by approximately 10% or 30 positions, primarily in the product development group, and in the sales and services departments, both domestically and internationally. As a result of the restructuring, the Company recorded a charge in 2002 of $439,000 for the associated severance payments, benefits and outplacement services provided to the employees affected by this restructuring. The entire amount of this restructuring charge was paid in 2002 and no further charges related to this restructuring were incurred in 2003.

Interest income. Interest income decreased by $359,000 to $391,000 for 2003, from $750,000 for 2002. The decrease was primarily attributable to declines in both the total average balances of, and average interest rates for, cash, cash equivalents and short- and long-term investments in 2003.

Interest expense and other income (expense), net. Interest expense decreased by $54,000 to $131,000 for 2003, from $185,000 for 2002. The decrease was primarily attributable to a decline in the average balance outstanding on our term loans as the result of principal payments made on these loans during the year. Other expense decreased by $127,000 to $2,000 of other income for 2003, from other expense of $125,000 for 2002.

Comparison of 2002 and 2001

Revenues ($ In Millions)

Total revenues decreased by $5.7 million, or 15%, to $33.4 million for 2002, from $39.1 million for 2001. The decrease was attributable to a significant decrease in software license revenue, partially offset by increased revenues from both software services and maintenance and professional services.

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Cost of license revenues. Cost of license revenues decreased by $71,000, or 14%, to $434,000 for 2002, from $505,000 for 2001. Cost of license revenues was 1% of license revenues for both 2002 and 2001. The decrease in dollar amount was primarily attributable to a lower volume of license sales in 2002, partially offset by an increase in certain annual royalty costs over the prior year.

Amortization of acquired developed technology. Amortization of acquired developed technology increased by $233,000 to $700,000 for 2002, from $467,000 for 2001 to reflect a full year of amortization in 2002 compared with eight months in 2001 from the date of the MindLever acquisition.

Cost of software services revenues. Cost of software services revenues remained relatively flat in 2002 as compared to 2001, increasing $57,000, or 3%, to $2.2 million. Cost of software services revenues was 41% of software services revenues for 2002 and 81% of software services revenues for 2001, reflecting the growth in software service revenues for 2002 combined with a proportionally lower amount of additional ASP service costs for the same period. We incurred substantial costs in 2001 related to start-up and support services to build out our initial ASP service capacity, some of which was carried over through 2002.

Cost of maintenance and professional services revenues. Cost of maintenance and professional services revenues decreased $241,000, or 6%, to $4.1 million for 2002 from $4.4 million for 2001. Cost of maintenance and professional services revenues were 34% of maintenance and professional services revenues for 2002 and 57% of maintenance and professional services revenues for 2001.

Sales and marketing expenses. Sales and marketing expenses decreased by $4.8 million, or 19%, to $20.7 million for 2002, from $25.5 million for 2001. The decrease was primarily attributable to a 2002 reduction in marketing programs, including advertising, trade shows, and promotional expenses and, to a lesser extent, a decrease in sales commissions due to lower revenues. Sales and marketing expenses were 62% of total revenues for 2002 and 65% of total revenues for 2001.

Product development expenses. Product development expenses decreased by $527,000, or 4%, to $12.0 million for 2002, from $12.5 million for 2001. The decrease resulted from a decline in consulting costs as we reduced our use of outside consultants in 2002, and shifted the work in-house to existing employees to save costs; a decrease in recruitment fees as the number of new hires for the product development organization in 2002 declined by 14 over 2001 and a policy change in 2002 to eliminate the use of employment agencies in recruitment to save costs. Product development expenses were 36% of total revenues for 2002 and 32% of total revenues for 2001.

General and administrative expenses. General and administrative expenses increased by $425,000, or 6%, to $7.8 million for 2002, from $7.4 million for 2001. The increase was primarily due to increases in the cost of

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directors and officers liability insurance and increases in 2002 in legal costs associated with the securities class action lawsuit and the settlement of a patent infringement lawsuit (see Item 3, “Legal Proceedings”). General and administrative expenses were 23% of total revenues for 2002 and 19% of total revenues for 2001.

Compensation charge for issuance of stock options. We incurred a charge of $752,000, or 2%, of total revenues for 2002, a decrease of $135,000 from $887,000, or 2%, of total revenues in 2001, related to the issuance of stock options in 1999 and 2000 with an exercise price lower than the fair market value on the date of grant.

Acquired in-process research and development. In connection with the MindLever acquisition in April 2001, we recorded a charge of $2.2 million, or 31%, of the $7.2 million in total consideration and liabilities assumed, for In-Process Research and Development costs, or IPRD. The value allocated to the project identified as IPRD was charged to operations in the second quarter of 2001.

Amortization of goodwill and other intangible assets. In connection with our acquisition of MindLever in April 2001, we allocated approximately $5.9 million to goodwill and $300,000 to other intangible assets for assembled workforce. Prior to the adoption of SFAS No. 142, goodwill and other intangible assets were amortized over their useful estimated lives of five and three years, respectively. For 2001, amortization of goodwill and assembled workforce was $783,000, and $66,000, respectively. Upon adoption of SFAS No. 142, we combined assembled workforce with goodwill and did not amortize goodwill for 2002.

Interest income. Interest income decreased by $1.5 million to $750,000 for 2002, from $2.2 million for 2001. Interest income consists of interest on our cash, cash equivalents and short-term investments. The decrease was attributable to declines in both the average balances of, and average interest rates for, cash, cash equivalents and short-term investments in 2002.

Interest expense and other income (expense). Interest expense decreased by $60,000 to $185,000 for 2002, from $245,000 for 2001. The decrease was primarily attributable to the decrease in interest on our term loans as the result of a decrease in the bank’s prime rate in 2002. Other expense decreased by $9,000 to $125,000 for 2002, from $134,000 for 2001.

Loss on sale of short-term investments. In January 2001, we liquidated, prior to maturity, certain short-term debt obligations of California-based utilities when their ratings dropped below investment grade, which resulted in a realized loss of approximately $772,000.

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Quarterly Results of Operations

The following table presents our unaudited quarterly results of operations for 2002 and 2003. You should read the following table in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this report. We have prepared this unaudited information on a basis consistent with the audited consolidated financial statements contained in this report and it includes all adjustments, consisting of normal recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the quarters presented. You should not draw any conclusions about our future results from the results of operations for any quarter.