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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended March 31, 2004

For the transition period from                      to                     

Commission file number 0-21958

QRS Corporation

(Exact name of registrant as specified in its charter)

1400 Marina Way South, Richmond, CA 94804

(Address of principal executive offices, including zip code)

(510) 215-5000

(Registrant’s phone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES  x    NO  ¨

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

As of May 3, 2004, 15,939,155 shares of the issuer’s common stock, par value $.001 per share, were outstanding.

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FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains statements which constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to a number of risks and uncertainties. All statements that are not historical facts are forward-looking statements, including statements regarding our business strategy, future operations, future financial position, estimated revenues or earnings (losses), projected costs, prospects, plans and objectives. These statements appear in a number of places and can be identified by the use of forward-looking terminology such as “believes,” “expects,” “may,” “estimates,” “will,” “should,” “plans” or “anticipates” or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy.

Actual results may vary materially from those in the forward-looking statements as a result of various factors which are identified in “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this document. These factors include: general economic and business conditions; specific conditions in the retail industry; competition; changes in senior management; rapid technological change in our industry; dependence upon key customers and their trading partners; ability to introduce and market acceptance of new products and services; the ability to successfully integrate and manage acquired businesses and technologies; customers’ willingness to purchase products or services offered through or in conjunction with third parties; dependence upon IBM for electronic commerce service; dependence on third parties for licenses to technology that is integrated into certain products and services offered by us; and the ability to protect our proprietary technology and information. No assurance can be given that these are all of the factors that could cause actual results to vary materially from the forward-looking statements. All forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q. Readers should not place undue reliance on these forward-looking statements and are cautioned that any such forward-looking statements are not guarantees of future performance. We assume no obligation to update any forward-looking statements.

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QRS CORPORATION

FORM 10-Q

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PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

QRS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

AS OF MARCH 31, 2004 AND DECEMBER 31, 2003

(In thousands, except share and per share amounts)

(Unaudited)

See Notes to Condensed Consolidated Financial Statements

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QRS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

FOR THE THREE MONTHS ENDED MARCH 31, 2004 AND 2003

(In thousands, except per share amounts)

(Unaudited)

See Notes to Condensed Consolidated Financial Statements.

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QRS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED MARCH 31, 2004 AND 2003

(In thousands)

(Unaudited)

See Notes to Condensed Consolidated Financial Statements

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QRS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.    GENERAL

QRS Corporation (“QRS,” the “Company,” “we” or “us”) is a technology company that serves the global retail trading community with collaborative commerce solutions. We manage the flow of critical commerce information and leverage our retail technology expertise to address fundamental industry challenges such as global data synchronization, compliance mandates, transaction management and global trade management. Our solutions help customers expand into new markets and channels, improve operational efficiency and differentiate their brand. Currently we have more than 10,000 customers, as measured by the number of total, unique corporate customers that purchased or licensed our products and services during 2003.

We have prepared the Condensed Consolidated Balance Sheet as of March 31, 2004 and the Condensed Consolidated Statements of Operations and Comprehensive Income and the Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and 2003, without audit. In the opinion and to the knowledge of management, all adjustments necessary to present fairly the financial position, results of operations and cash flows at March 31, 2004 and 2003 and for all periods presented have been made. The Condensed Consolidated Balance Sheet as of December 31, 2003 is derived from our audited consolidated financial statements as of that date.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted as permitted by regulations of the Securities and Exchange Commission. These interim Condensed Consolidated Financial Statements should be read in conjunction with the annual audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2003.

The preparation of our Condensed Consolidated Financial Statements in conformity with generally accepted accounting principles necessarily requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the balance sheet dates and the reported amounts of revenue and expenses for the periods presented. Actual amounts may differ from such estimates.

The results of operations for the three months ended March 31, 2004 are not necessarily indicative of the operating results anticipated for any other interim period or for the full year.

Recent Accounting Pronouncements

In January 2003, the FASB issued FIN 46, “Consolidation of Variable Interest Entities.” This interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” addresses consolidation by business enterprises of variable interest entities that possess certain characteristics. FIN 46 requires that if a business enterprise has a controlling financial interest in a variable interest entity, the assets, liabilities, and results of the activities of the variable interest entity must be included in the Consolidated Financial Statements with those of the business enterprise. FIN 46 applies immediately to variable interest entities created after January 31, 2003 and to variable interest entities in which an enterprise obtains an interest after that date. We do not have any ownership in any variable interest entities as of March 31, 2004. We will apply the consolidation requirement of FIN 46 in future periods if we should own any interest in any variable interest entity.

In May 2003, the FASB issued FAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” FAS 150 establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) because that financial instrument embodies an obligation (or right) of the issuer. It is to be implemented by reporting the cumulative effect of a change in accounting principle for financial instruments created before the issuance date of FAS 150 and still existing at the beginning of the interim period of adoption. We do not have any financial instruments with characteristics of both liabilities and equity as of March 31, 2004. The FASB has deferred the effective date of paragraphs 9, 10 and 22 of FAS 150. During 2003, we adopted all other provisions of FAS 150 and the adoption had no material effect on our financial position or results of operations. We continue to evaluate the impact that adoption of paragraphs 9, 10 and 22 will have on our financial position or results of operations.

In December 2002, the FASB issued FAS 148, “Accounting for Stock-Based Compensation Costs-Transition and Disclosure.” FAS 148 amends FAS 123, “Accounting for Stock-Based Compensation,” and provides alternative methods of transition for an entity that voluntarily changes to the fair value-based method of accounting for stock-based compensation. It also requires additional disclosures about the effects on reported net income of an entity’s accounting policy with respect to stock-

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based compensation. We account for stock-based compensation in accordance with APB Opinion No. 25, “Accounting for Stock Issued to Employees” and have adopted the disclosure-only alternative of FAS 123. We adopted the disclosure provisions of FAS 148 in December 2002.

The following table illustrates the effect on our net income and net income per share if we would have applied the fair value recognition provisions of FAS 123 to stock-based compensation (in thousands, except per share amounts):

The weighted average fair value of options granted during the first quarter 2004 and the first quarter 2003 was $5.89 and $3.37, respectively. Such fair values of each option grant were estimated on the date of grant using the multiple options method of the Black-Scholes pricing model with the following weighted-average assumptions used for grants made in first quarter 2004 and first quarter 2003: risk-free interest rates are 2.61% in 2004 and 3.25% in 2003; expected volatility is 109% in 2004 and 100% in 2003; expected lives in 2004 and 2003 are 12 to 18 months beyond each incremental vesting period (total life of 2 to 5.5 years, depending on each grant’s individual vesting schedule). No dividends are assumed for any plan in any year.

The fair value of the stock purchases made under the employee stock purchase program was determined using the Black-Scholes pricing model with the following weighted-average assumptions: risk-free interest rate is 2.61%; expected volatility is 109%; expected life is 6 months. No dividends are assumed.

2.    OTHER INTANGIBLE ASSETS

Other intangible assets include acquired technology with an estimated useful life of 6 years; customer lists with useful lives of 3.5 to 5 years and a weighted average estimated useful life of 4.8 years; customer contracts with useful lives of 5 to 7 years and a weighted average estimated useful life of 6.4 years; and non-compete agreements purchased in connection with the acquisitions of businesses with estimated useful lives of 3 years. These intangible assets continue to be amortized on a straight-line basis over their useful lives.

As of March 31, 2004, other intangible assets consisted of the following (in thousands):

The estimated future amortization expense of other intangible assets as of March 31, 2004 is as follows (in thousands):

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3.    RESTRUCTURING EXPENSES

As part of our 2001 restructuring activities, we made certain estimates of sublease income on the vacated facility adjacent to our corporate headquarters in Richmond, California; however, due to a prolonged difficult real estate market in the Bay Area, those original estimates proved optimistic. As a result, during 2003 we began reevaluating our assumptions surrounding our sublease loss accrual, including discussions with our landlord to renegotiate the terms of our lease. We recorded a $3.7 million restructuring expense for the year ended December 31, 2003 based on the terms of a non-binding Letter of Intent with the landlord to reduce the term of the lease and our total cash commitments over the remaining life of the lease.

During January 2004, we finalized agreements with our landlord to sublet the facility to an affiliate of our landlord and reduce our total cash commitments over the remaining life of the lease by $6.4 million. The sublease agreement for full contract rent and operating expenses from October 1, 2008 through the lease termination on June 30, 2011 is collateralized by a $4.0 million Deed of Trust. The agreements with our landlord required us in the first quarter 2004 to deposit $3.6 million of base rent for the period October 1, 2006 through September 30, 2008 in an escrow account for disbursement over the related rental period. The funds held in escrow are classified as restricted cash in the Condensed Consolidated Balance Sheets as of March 31, 2004. Under the terms of the agreements with our landlord, we also settled a $0.8 million common area maintenance obligation related to our headquarters facility for $0.2 million which we paid during the first quarter of 2004. The remaining $0.6 million liability was allocated between our headquarters facility and the vacated adjacent facility based on square footage. As a result, $0.3 million will be recognized ratably as a reduction in operating expenses over the remaining headquarters lease term and $0.3 million was reclassified from deferred rent and other liabilities to the sublease loss accrual for our vacant Richmond, California facility. We believe that the sublease loss accrual related to this facility as of March 31, 2004 will cover all of our revised obligations under the final agreements.

During 2003, we also completed a review of our overall cost structure with the goals of creating better alignment with our growth strategy and finding additional efficiencies. As a result, we centralized substantially all of our development team to our Richmond, California headquarters and streamlined other parts of our operations, primarily general and administrative services. These actions resulted in a restructuring charge of $1.9 million in the year ended December 31, 2003, consisting of $1.2 million related to the closure of our Wakefield, Massachusetts facility, $0.1 million related to the write-off of certain equipment and leasehold improvements and $0.7 million related to the severance of 43 employees located in Wakefield, Massachusetts; Richmond, California and New York, New York.

The following is a summary of the restructuring liabilities from December 31, 2003 to March 31, 2004 (in thousands):

We expect to pay remaining employment severance obligations related to restructuring activities by the second quarter of 2004. Based on the terms of the agreements with our landlord described above and actual subleases in effect on other properties, $3.0 million of the total facilities closure liability of $10.5 million has been classified as a current liability and the remaining $7.5 million has been classified as non-current with payments through 2008.

During the first quarter of 2004, we also incurred $0.3 million of severance expense from the termination of 36 employees unrelated to restructuring activities. $0.1 million was included in cost of revenue, sales and marketing, and service and product development expenses, respectively, in the Condensed Consolidated Statements of Operations and Comprehensive Income.

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4.    EARNINGS (LOSS) PER SHARE

We calculate basic earnings per share (EPS) and diluted EPS in accordance with FAS 128, “Earnings Per Share.” Basic EPS is calculated by dividing net earnings for the period by the weighted average common shares outstanding for that period, excluding unvested restricted share rights. Diluted EPS takes into account the effect of dilutive instruments, such as stock options and restricted share rights, and uses the average share price for the period in determining the number of incremental shares that are to be added to the weighted average number of shares outstanding pursuant to the treasury stock method.

The following is a summary of the calculation of the number of shares used in calculating basic and diluted earnings (loss) per share:

Additionally, potentially dilutive shares at March 31, 2004 and 2003 were 3,108,656 and 3,242,391 shares, respectively, with weighted average exercise prices of $12.00 and $13.60, respectively. These potentially dilutive shares have been excluded from the shares used in calculating diluted net income per share since the options’ and warrants’ exercise prices exceed the average fair market value of the stock during the period.

5.    INCOME TAXES

We recorded $0.02 million of income tax expense for the three months ended March 31, 2004 and no income tax expense for the three months ended March 31, 2003. Income tax expense for the first quarter 2004 represents various state and foreign tax obligations. We did not incur any current federal tax expense during the first quarter 2004 or 2003 primarily because of the effect of temporary differences arising from the deduction of capitalized service and product development costs for tax purposes, which resulted in a deferred tax liability. The deferred tax liability is offset by our unrecognized deferred tax asset. A valuation allowance has been placed against the remainder of our deferred tax asset.

6.    COMMON STOCK, RESTRICTED SHARE RIGHTS, TREASURY STOCK AND STOCK OPTIONS

At March 31, 2004, there were 16,161,994 shares of our common stock issued of which 15,928,263 were outstanding. Employee and director stock-based compensation expense was $239,000 and $28,000 during the three months ended March 31, 2004 and 2003, respectively. Stock-based compensation expense associated with non-employees was $20,000 for the three months ended March 31, 2004. There was no stock-based compensation expense associated with non-employees for the three months ended March 31, 2003.

Restricted Share Rights

On March 18, 2003, we granted a total of 40,000 common stock restricted share rights to two executives under the provisions of the 1993 Stock Option/Stock Issuance Plan (the “1993 Plan”). These common stock restricted share rights will vest on January 1, 2006 for one executive and March 18, 2006 for the other executive and become issuable as long as the executive remains employed by the Company through that date. The fair value of the 40,000 common stock restricted share rights granted was $0.2 million based on the market price of our common stock, which was $5.25 per share at March 18, 2003.

On October 1, 2003, October 22, 2003, November 19, 2003 and December 3, 2003, we granted 155,000; 20,000; 55,000 and 15,000 common stock restricted share rights, respectively, under the provisions of the 1993 Plan. These common stock restricted share rights will vest at various dates through December 2, 2006 and become issuable as long as the grantee remains employed by or a director of the Company through the vesting dates. The fair value of the 245,000 common stock restricted share rights granted was $2.2 million based on the market prices of our common stock, which was $8.50 per share at October 1, 2003, $10.11 per share at October 22, 2003, $10.23 per share at November 19, 2003 and $8.84 per share at December 3, 2003.

On January 27, 2004, we granted 34,813 common stock restricted share rights under the provisions of the 1993 Plan. These common stock restricted share rights will vest January 27, 2007 and become issuable as long as the grantee remains employed by the Company through that date. The fair value of the 34,813 common stock restricted share rights granted was $0.3 million based on the market price of our common stock, which was $9.18 per share at January 27, 2004.

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The fair value of all common stock restricted share rights is included in the financial statements as deferred compensation, and is being amortized ratably over the vesting period. During the first quarter 2004, we issued 10,416 shares of common stock, of which 3,723 shares were surrendered to the Company as payment of minimum payroll tax withholding.

The following table shows the activity under the common stock restricted share rights program:

Treasury Stock

During the three months ended March 31, 2004, we did not repurchase any shares of our common stock.

Stock Option Plans

The following table shows the activity under our stock options plans:

7.    COMMITMENTS AND CONTINGENCIES

We use IBM Information Exchange as the Value Added Network (VAN) over which we provide customers with some of our QRS Exchange^™ products and services, such as Data Exchange, QRS Catalogue^™, QRS Web Forms^™ and QRS Managed EC^™. We depend on IBM Information Exchange for a substantial part of our revenue. In July 2002, we entered into a three-year agreement with IBM effective July 1, 2002 and ending June 30, 2005. Pursuant to the agreement, we pay fees to IBM based on our usage of its network and other specified services, subject to minimum payments set forth in the agreement. During April 2004, we modified our agreement with IBM to eliminate our obligation to purchase specified minimum annual amounts of IBM’s Business Exchange Services – Internet Transfer (BES-IT), formerly Internet Data and Document Exchange (IDDX).

We have established two irrevocable letters of credit with Wells Fargo Bank, N.A. as security for real property leases in the amounts of $0.4 million and $0.2 million. These letters of credit remained outstanding as of March 31, 2004 and are collateralized by two certificates of deposit, which are classified as other assets in the Condensed Consolidated Balance Sheets. In the first quarter 2004, $3.6 million of cash was placed in escrow to fund various future lease payments for the period October 1, 2006 through September 30, 2008 as discussed in Note 3. Restructuring Expenses above. The funds held in escrow are classified as restricted cash in the Condensed Consolidated Balance Sheets as of March 31, 2004.

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We have made guarantees and indemnities, under which we may be required to make payments to a guaranteed or indemnified party, in relation to certain transactions. In connection with some of our facility leases, we have indemnified the lessors for certain claims that could arise from our use of the facility. In connection with some of our vendor and partner agreements, we have indemnified the vendors and partners for certain claims that could arise from these agreements. Typically, these guarantees and indemnities do not provide for any limitation of the maximum potential future payments we could be obligated to make. We have not recorded any liability for these guarantees and indemnities in the accompanying Condensed Consolidated Balance Sheets.

Pursuant to our Bylaws and indemnification agreements with each of our directors and executive officers, we are obligated to indemnify each of them against expenses and losses incurred for claims brought against them by reason of being a director or executive officer of the Company. The term of the indemnification period is for the director’s or officer’s lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have a director’s and officer’s liability insurance policy that may be called upon to contribute to the satisfaction of any liability. We believe the estimated fair value of these indemnification agreements is minimal. No liability associated with this indemnification has been recorded.

Under the terms of our Enterprise Software Applications license agreements and certain other sales agreements with our customers, in the event the software, products or services sold infringe upon any patent, copyright, trademark or any other proprietary right of a third party, we must indemnify our customer and licensees against any loss, expense or liability from any damages that may be awarded against its customer. In the event our customer cannot use the software or service due to infringement and we can not obtain the right to use, replace or modify the license, product or service in a commercially feasible manner so that it no longer infringes, we may terminate the license and agreement and provide our customer a pro-rata refund of the fees paid by our customer for the infringing license, product or service. The agreements typically do not stipulate a maximum liability that can be incurred under the indemnification. No liability associated with this indemnification has been recorded.

In connection with the merger agreement relating to our 2000 acquisition of Image Info, we would have been required to pay the former shareholders of Image Info an additional $2.5 million in 2002 if revenue attributable to the acquired business for 2001 met the minimum amount described in the merger agreement. The deferred acquisition payment was accounted for in the acquisition cost for the original transaction and included as a liability in our Condensed Consolidated Balance Sheets. We determined that the revenue attributable to the acquired business did not reach the minimum amount required for 2001. On October 8, 2002, Craig Schlossberg, purporting to act on behalf of the former shareholders of Image Info, Inc. filed a lawsuit against the Company and WS Acquisition Corp., one of our wholly-owned subsidiaries (which was renamed Image Info, Inc.), in the Superior Court of California for the City and County of San Francisco, alleging claims for breach of contract and seeking to recover $2.5 million, plus interest, under a provision of the merger agreement. We vigorously defended the lawsuit, which we believed was without merit.

To avoid further litigation, in April 2004, we reached a mutually satisfactory settlement agreement with the former shareholders of Image Info that resolves the lawsuit and terminates all claims against the Company. The action has been dismissed. Under the terms of the settlement agreement, we paid $1.9 million during the second quarter 2004 which was less than the $2.5 million liability classified as deferred acquisition payment in our Condensed Consolidated Balance Sheets as of December 31, 2003. We have accounted for this settlement as the resolution of a contingency which occurred prior to the issuance of these financial statements (a Type I subsequent event). Accordingly, the effect of this settlement on our liability has been recorded in the first quarter 2004 operating results as a benefit of $0.6 million.

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of the Private Securities Litigation Act of 1995. Forward-looking statements are not guarantees of future performance and involve a number of risks and uncertainties. Our actual results could differ materially from those indicated by forward-looking statements as a result of various factors, including but not limited to those set forth under this Item, as well as those discussed elsewhere in this report and those that may be identified from time to time in our reports and registration statements filed with the Securities and Exchange Commission.

This discussion should be read in conjunction with the Condensed Consolidated Financial Statements and related Notes included in Item 1 of this quarterly report and the Consolidated Financial Statements and related Notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our annual report on Form 10-K as filed with the Securities and Exchange Commission on March 15, 2004.

Overview

We are a technology company that serves the global retail trading community with collaborative commerce solutions. We manage the flow of critical commerce information and leverage our retail technology expertise to address fundamental industry challenges such as global data synchronization, compliance mandates, transaction management and global trade management. Our solutions help customers expand into new markets and channels, improve operational efficiency and differentiate their brand.

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Our products and services help thousands of retailers, vendors, suppliers and brand manufacturers from a variety of retail segments, including general merchandise and apparel, consumer packaged goods, health and beauty, consumer electronics, hardlines, do-it-yourself, sporting goods and grocery. Our products and services are typically used with our customers’ enterprise information technology systems in order to deliver greater benefits and efficiencies to these customers.

We market our products and services in three Solutions Groups: Software Applications, Trading Community Management and Global Services. The following chart shows our current product set within each Solutions Group:

Our Software Applications, which represented 27% of revenue in the first quarter 2004, support product information management and data synchronization; and collaborative product planning, design, production and shipment. Our Software Applications include both Enterprise Software Applications installed on customers’ computer systems and hosted applications installed on our computer systems.

Our Trading Community Management Solutions Group, which represented 53% of revenue in the first quarter 2004, allows retailers, vendors and their trading partners to exchange electronic business documents, such as purchase orders, invoices and advance ship notices. These electronic transactions are conducted over a proprietary value-added network (VAN) or over the Internet.

Our Global Services, which represented 20% of revenue in the first quarter 2004, include the collection, analysis and delivery of pricing, promotion and distribution information; software implementation and integration services; and technical support and training services for our various solutions.

Revenue from our traditional business, including our Trading Community Management Solutions Group and our QRS Catalogue^™ product, totaled approximately 79% of our overall revenue. This revenue is billed to customers on a month-to-month basis or under contractual arrangements generally ranging from one to three years.

Our first quarter 2004 results were consistent with our expectations, as revenue of $30.5 million remained steady with the $30.7 million reported in the fourth quarter of 2003. Revenue from our traditional business, such as QRS Exchange^™ and QRS Catalogue^™, and ongoing cost containment efforts helped us to achieve a profitable quarter. We launched QRS IMPACT^™ during the first quarter, which contributed to an increase in operating expenses, and recently released QRS QuickSync^™, a cost-effective, easy-to-implement product information management solution designed for suppliers needing to comply with retailer mandates. Gross margin remained steady at 49% for the first quarter 2004.

During the first quarter 2004, unit pricing for QRS Exchange^™ rose slightly due to previously announced pricing actions, despite slight volume declines compared to the first and fourth quarters of 2003. Also during the first quarter 2004, we continued to experience a significant decline in leased lines and dial-up connectivity services due to technological obsolescence. The changing technology landscape and the growth of other providers have resulted in continuing price competition, particularly for our QRS Exchange^™ products.

We are focused on introducing new products and services that can generate new revenue to offset the decline in revenue from our traditional business. We expect to maintain profitability by continuing to reduce the cost structure of our traditional business, investing the cash it generates in the development and launch of new products and services. We believe these new products and services will create long-term growth and position QRS for leadership in collaborative commerce solutions for the retail industry.

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Revenue and Cost of Revenue

The following table sets forth the revenue, cost of revenue, gross profit and gross margin for our three Solution Groups for the three months ended March 31, 2004 and 2003 (in thousands) and associated headcount information at March 31, 2004 and 2003:

Software Applications

The Software Applications Solutions Group includes QRS Catalogue^™, a hosted application; and Enterprise Software Applications, primarily QRS Sourcing^™. Going forward, any license revenue from our recently introduced QRS IMPACT^™ and QRS QuickSync^™ products will be included in Enterprise Software Applications. We plan to recognize QRS IMPACT^™ and QRS QuickSync^™ license and professional services revenue after each customer implementation is completed.

Revenue for the Software Applications Solutions Group increased $0.1 million, or 1%, in the first quarter 2004 compared to both the first and fourth quarters of 2003. The improvement over the fourth quarter 2003 was due to the $0.4 million increase in QRS Catalogue^™ revenue related to growth in the number of trading partnerships established among our existing customer base, which offset certain retailer customer consolidations. The QRS Catalogue^™ revenue increase was offset by the $0.2 million decline in Enterprise Software Applications revenue from the fourth quarter 2003 to the first quarter 2004. During the first quarter 2004, we continued to recognize license revenue from an existing customer as the professional services were delivered using the percentage-of-completion methodology. The year-over-year increase in Software Applications revenue was primarily related to the amount of deferred license revenue recognized in each period.

For the first quarter 2004 and all periods presented, QRS Catalogue^™ comprised the substantial majority of revenue for the Software Applications Solutions Group. We expect that retailers will continue to reorganize their operations to reduce cost and improve efficiency. To the extent that such reorganizations reduce the number of their retail operations, the number of their trading partnerships could also be reduced, which, under our present pricing structure, would reduce QRS Catalogue^™ revenue in future periods.

Gross margin for the Software Applications Solutions Group was 75% during the first quarter 2004 compared to 73% reported for the fourth quarter 2003. This improvement was primarily due to the decline in Enterprise Software Applications amortization expense resulting from the fourth quarter 2003 impairment of IBM CrossWorlds licenses. Gross margin for the first quarter 2004 increased by 3 percentage points over the 72% reported in the first quarter 2003, resulting primarily from reductions in customer support headcount, which occurred as part of our restructuring activities in the third quarter 2003.

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Trading Community Management

The Trading Community Management Solutions Group includes QRS Exchange^™ products and services: Data Exchange, Internet Transaction Exchange, Enterprise Business Exchange, QRS Web Forms^™, QRS Managed EC^™, QRS Compliance Link^™, QRS EDIINT Gateway^™ and Access Services. Revenue consists primarily of fees charged for the transmission of standard business documents measured in kilocharacters (KCs) over the IBM VAN, monthly fees for leased line connections, and fees for EDI translation services. Revenue is recognized in the month that the services are performed.

Trading Community Management revenue for the first quarter 2004 declined $0.4 million, or 2%, from the fourth quarter 2003, and $0.5 million, or 3%, from the first quarter 2003.

Data Exchange revenue for the first quarter 2004 increased from the prior quarter and year-over-year, as volume declines were counterbalanced by an increase in unit pricing. The increase in unit pricing is primarily related to the implementation of standard minimum pricing thresholds for our lower volume and mid-tier customers, previously announced in the second quarter of 2003. We do not believe that the long-term pricing pressure has abated in our Data Exchange business. If in future periods we are required to reduce prices further, these reductions in our net revenue per kilocharacter may reduce our Trading Community Management revenue to the extent that pricing changes are not offset by increased unit volume or other factors.

Offsetting the increase in Data Exchange revenue, Access Services revenue declined from the prior quarter by 11% and on a year-over-year basis by 31% as newer technology alternatives replaced our leased lines and dial-up connectivity services and put pricing pressure on those same services. We expect further declines in Access Services revenue in future years as new technologies continue to replace and lower the market price of these services. Additionally, revenue from QRS Managed EC^™ services targeted towards small- and medium-sized businesses declined 20% from the prior quarter and 32% on a year-over-year basis due to a drop in the number of customers and revenue per customer.

Trading Community Management gross margin for the first quarter 2004 declined to 51% from 54% in the fourth quarter 2003 and 52% in the first quarter 2003. The trends in gross margin are primarily due to the revenue decline in Access Services and QRS Managed EC^™ while costs for those products have remained relatively flat. On a year-over-year basis, the decline in payments under our agreement with IBM was offset by costs allocated from our self-hosted data center. Additionally, during the first quarter 2004, our use of purchased network services from IBM fell below specified minimum amounts per the terms of our contract, causing our Trading Community Management gross margin to decrease. Other Trading Community Management cost of revenue components include: customer support services, including QRS Managed EC^™ personnel; technical support personnel; and amortization of capitalized service and product development costs for technology used in our QRS Managed EC^™ operations center.

Global Services

The Global Services Solutions Group consists primarily of QRS Retail Intelligence Services^SM; QRS Professional Services^SM, primarily services provided to help our customers with the implementation of our licensed software products; and maintenance for our QRS Sourcing^™ product, including post-contract support services for licensed software applications.

Global Services revenue for the first quarter 2004 increased $0.1 million, or 2%, from the fourth quarter 2003 and $0.2 million, or 3%, over the first quarter 2003 primarily resulting from growth in our QRS Retail Intelligence Services^SM business. QRS Retail Intelligence Services^SM revenue of $5.2 million in the first quarter 2004 increased 5% from the $4.9 million reported in the fourth quarter 2003 and 10% from the $4.7 million reported in the first quarter 2003. These improvements were offset by a significant decline in QRS Professional Services^SM revenue over the prior quarter caused by fewer professional services engagements for existing QRS Sourcing^™ customers. On a year-over-year basis, maintenance revenue for our QRS Sourcing^™ product was reduced. We expect QRS Professional Services^SM and software maintenance revenue from QRS Sourcing^™ to continue to decline.

Cost of revenue for Global Services consists primarily of outsourcing costs for QRS Retail Intelligence Services^SM field personnel and of payroll for software application consultants and technical support personnel for our licensed software applications. Global Services gross margin improved to 13% in the first quarter 2004, compared to 12% for the fourth quarter 2003 and 11% in the first quarter 2003. Headcount reductions in our QRS Professional Services^SM team and declining technical support costs contributed to the improvement in gross margin over the prior quarter. On a year-over-year basis, gross margin increased due to cost savings resulting from our third quarter 2003 restructuring activities that reduced customer support personnel dedicated to our licensed software applications.

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Operating Expenses

The following table sets forth operating expenses (in thousands) and the related percentages of total revenue for the three months ended March 31, 2004 and 2003 and associated headcount information at March 31, 2004 and 2003:

Operating expenses for the first quarter 2004, which totaled $13.8 million, were down from the $21.3 million reported for the fourth quarter 2003 and from the $14.4 million reported for the first quarter 2003. Operating expenses for the first quarter 2004 included a benefit of $0.6 million due to a favorable legal settlement related to a deferred acquisition payment as discussed further below. Operating expenses for the fourth quarter 2003 included a $6.3 million impairment loss associated with the write-down of intangible and other assets, and a $1.8 million expense to license the technology used in our QRS IMPACT^™ product. We experienced an increase in sales and marketing expenses in the first quarter 2004 associated with the launch of QRS IMPACT^™ which was offset by a reduction in amortization expense resulting from the fourth quarter 2003 impairment of intangible assets.

Sales and Marketing Expenses

Sales and marketing expenses consist primarily of personnel and related costs in our sales and marketing organizations as well as the costs of various marketing programs. At March 31, 2004, we had 66 full-time employees in our sales organization, comprised of 59 employees located in North America and 7 employees located in Europe, primarily in the United Kingdom.

Sales and marketing expenses for the first quarter 2004, which totaled $6.3 million, were up 16% from the $5.4 million reported for the fourth quarter 2003, and up 8% from the $5.8 million reported in the first quarter 2003. The increased spending resulted primarily from the first quarter 2004 launch of QRS IMPACT^™ and the expansion of our enterprise software sales team to improve our solution selling capability. Additionally, we participated in trade shows and held our annual customer conference to support the launch of QRS IMPACT^™, resulting in increased marketing, travel and meeting costs of $0.6 million over the prior quarter and $0.4 million over the prior year. The provision for bad debt in the first quarter 2004 also grew by $0.2 million, compared to both the first and fourth quarters of 2003 due to changes in the aging of our accounts receivable.

Service and Product Development Expenses

Service and product development expenditures consist primarily of personnel, consulting and equipment costs related to research, development and enhancements of our products, a portion of which is capitalized under American Institute of Certified Public Accountants’ (AICPA) Statement of Position (SOP) 98-1, “Accounting for Costs of Computer Software Developed or Obtained for Internal Use.” For our hosted and internal use products, we capitalize, as prescribed by SOP 98-1, all the costs incurred during the application development stage, which include designing the software configuration and interfaces, coding, installation and testing. For our Enterprise Software Applications, we capitalize products and enhancements once they reach technological feasibility until they are released for sale, under the provisions of FAS 86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.”

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We review service and product development expenses, capitalized costs and licensed technology on a combined basis in order to measure our investment in new and existing products. The following table sets forth (in thousands) total service and product development expenditures for the three months ended March 31, 2004, December 31, 2003 and March 31, 2003: