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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

For the quarterly period ended March 31, 2004

OR

For the transition period from              to             

Commission file number 0-22158

NetManage, Inc.

(Exact name of registrant as specified in its charter)

10725 North De Anza Boulevard

Cupertino, California 95014

(Address of principal executive offices, including zip code)

(408) 973-7171

(Registrant’s telephone 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  ¨    No  x

Number of shares of registrant’s common stock outstanding as of April 30, 2004: 8,826,573.

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NetManage, Inc.

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NETMANAGE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements

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NETMANAGE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

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

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NETMANAGE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

(Unaudited)

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

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NETMANAGE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

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

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NETMANAGE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Interim financial data

The accompanying interim unaudited condensed consolidated financial statements of NetManage, Inc. (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“generally accepted accounting principles”) for interim financial information and in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation. Actual results for fiscal year 2004 could differ materially from those reported in this quarterly report on Form 10-Q. The Company believes the results of operations for interim periods are subject to fluctuation and may not be an indicator of future financial performance. The financial statements should be read in conjunction with the audited financial statements and notes thereto, included in the Company’s annual report on Form 10-K for the year ended December 31, 2003, as filed with the Securities and Exchange Commission.

2. Consolidation

The interim unaudited condensed consolidated financial statements include the Company’s accounts and those of its wholly owned subsidiaries. All inter-company accounts and transactions have been eliminated.

3. Summary of significant accounting policies

Use of estimates

The preparation of the condensed consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Foreign currency translation, foreign exchange contracts and comprehensive loss

The functional currency of the Company’s foreign subsidiaries is the local currency. Gains and losses resulting from the translation of the foreign subsidiaries’ financial statements are reported as a separate component of stockholders’ equity. Gains and losses resulting from foreign currency transactions are included in net loss.

The Company currently does not enter into financial instruments for either trading or speculative purposes.

Comprehensive loss is comprised of net loss and other comprehensive items such as foreign currency translation gain/loss and unrealized gains or losses on marketable securities classified as available for sale.

Short-term investments

The Company accounts for its investments under the provisions of Statement of Financial Accounting Standards, or SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. Under SFAS No. 115, the Company’s investments classified as available-for-sale securities are reported at fair value, with unrealized gains and losses, net of tax, reported in the balance sheet as “Accumulated other comprehensive loss”. Held-to-maturity securities are valued using the amortized cost method. At March 31, 2004 and December 31, 2003, the fair value of the time deposit investments, which have original maturities in excess of 90 days, approximated amortized cost and, as such, gross unrealized holding gains and losses were not material. The fair value of the available-for-sale securities was determined based on quoted market prices at the reporting dates for those instruments. The carrying value of the Company’s short-term investments by major security type consisted of the following as of March 31, 2004 and December 31, 2003 (in thousands):

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Goodwill and other intangible assets, net

Effective January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangibles Assets. Under SFAS No. 142, goodwill is no longer subject to amortization over its estimated useful life. Rather, SFAS No. 142 requires that goodwill and other intangible assets deemed to have an indefinite useful life be reviewed for impairment upon adoption of SFAS No. 142 and at least annually thereafter, SFAS No. 142 was adopted on January 1, 2002.

Intangible assets with determinable useful lives are amortized on a straight-line basis over their estimated useful lives ranging from two to seven years. The following table provides a summary of the carrying amounts of other intangible assets (in thousands):

The aggregate amortization expense for the three months ended March 31, 2004 was $0.4 million. The aggregate amortization expense for the three months ended March 31, 2003 was $0.5 million.

Estimated future amortization for the remainder of 2004 is $1.1 million at which point the intangible assets will be fully amortized.

Accrued liabilities and restructuring

Accrued liabilities at March 31, 2004 and December 31, 2003 consisted of the following (in thousands):

In June 2002, the Financial Accounting Standards Board, or FASB, issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous

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accounting guidance, principally Emerging Issues Task Force, or EITF, Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF No. 94-3, a liability for an exit cost was recognized at the date of the commitment to an exit plan. SFAS No. 146 also requires that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146, which the Company adopted for restructuring activities initiated after December 31, 2002, may affect the timing of recognizing future restructuring costs as well as the amounts recognized.

Concentrations of credit risk

Financial instruments, which subject the Company to concentrations of credit risk, consist principally of cash investments and trade receivables. The Company has a cash investment policy that limits the amount of credit exposure to any one issuer and restricts placement of these investments to issuers evaluated as creditworthy. Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers comprising the Company’s customer base and their dispersion across many different industries and geographies. There were no customers that accounted for more than 10% of consolidated revenues in the three month period ended March 31, 2004 and 2003.

Accounting for stock based compensation

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock Based Compensation-Transition and Disclosure-an Amendment of FASB Statement No.123, which provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has adopted the amended annual and interim disclosure requirements of SFAS No. 123.

SFAS No. 123, Accounting for Stock-Based Compensation, encourages all entities to adopt a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the fair value of the award which is recognized over the service period, which is usually the vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. Stock options issued under the Company’s stock option plans have no intrinsic value at the grant date. Accordingly, under APB Opinion No. 25, no compensation cost is recognized. The Company has elected to continue with the method of accounting prescribed in APB Opinion No. 25 and, as a result, must provide pro forma disclosures of net loss and loss per share and other disclosures as if the fair value based method of accounting had been applied. Had compensation cost for the Company’s outstanding stock options been determined based on the fair value at the grant dates for awards under those plans consistent with the method prescribed by SFAS No. 123, the Company’s net loss and loss per share would have been adjusted to the pro forma amounts indicated below (in thousands except per share data):

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The fair value of each option granted is estimated on the date of grant using the Black-Scholes model with the following assumptions used for grants during the applicable periods:

Stock option exchange offer

On May 16, 2003 the Company announced a voluntary stock option exchange program for certain of its employees. The offer to exchange options, or Offer, was open to eligible option holders, excluding non-employee members of the board of directors and non-exempt employees, holding options to purchase shares of the Company’s common stock with an exercise price per share of $1.50 or greater. In accordance with the terms of the Offer, participating employees tendered eligible options in exchange for replacement options. These replacement options were granted to employees at least six months and one day following the date their original options were tendered and cancelled. Under the terms of the Offer, replacement options vest and become exercisable for the balance of the option shares in accordance with the same type of installment vesting schedule that was in effect for the cancelled options, but measured from the grant date of the replacement options. In addition, no vesting credit was provided for the period between the date the original options were tendered and the date the replacement options were granted.

On June 13, 2003, employees tendered options to purchase an aggregate of 542,150 shares in connection with the Offer. These options were cancelled under the Company’s 1992 Stock Option Plan as amended and restated, and the 1999 Non-statutory Stock Option Plan as amended following their exchange. Subject to the continued employment of the employees who exchanged options, replacement options were granted on or around December 16, 2003. As of December 16, 2003, the number of tendered options eligible for replacement were reduced to 531,047 due to the termination of certain NetManage employees after June 13, 2003.

The exercise price of the replacement options of $4.78 per share was based on the fair market value of the Company’s common stock on the date the replacement options were granted. The fair market value of the Company’s common stock was equal to the last reported sale price of its common stock on the Nasdaq National Market on December 16, 2003.

The exchange program is being accounted for in accordance with FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation—an Interpretation of APB Opinion No. 25 and results in no compensation expense.

Net loss per share

Basic net loss per share data has been computed using the weighted-average number of shares of common stock outstanding during the indicated periods. Diluted net loss per share data has been computed using the weighted-average number of shares of common stock and potential dilutive common shares. Potential dilutive common shares include dilutive shares issuable upon the exercise of outstanding common stock options computed using the treasury stock method. For the three month periods ended March 31, 2004 and 2003, the number of shares used in the computation of diluted loss per share was the same as those used for the computation of basic loss per share. For the three month periods ended March 31, 2004 and 2003, potentially dilutive securities (primarily stock options) are as shown in the following table and were not included in the computation of diluted net loss per share because to do so would have been anti-dilutive.

Income taxes

As part of the process of preparing its consolidated financial statements, the Company is required to estimate its income taxes in each of the jurisdictions in which the Company operates. This process involves estimating the Company’s actual current tax 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 deferred tax assets and liabilities, which are included in the Company’s consolidated balance sheet. The Company must then assess the likelihood that its deferred tax assets will be recovered from future taxable income and to the extent the Company believes that recovery is not likely, it must establish a valuation allowance. To the extent the Company

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establishes a valuation allowance or its allowance in a period changes, the amount recognized as a provision for income taxes in the statement of operations could change. The income tax provision of $50,000 for the quarter ended March 31, 2004 resulted primarily from an international tax provision of $31,000 and U.S. state tax expense of $19,000. The income tax benefit of $317,000 for the quarter ended March 31, 2003 resulted primarily from German tax refunds of $481,000, and a U.S. tax benefit of $2,000, offset in part by an international tax expense of $166,000.

Recent accounting pronouncements

The FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”) in January 2003, and a revised interpretation of FIN 46 (FIN 46-R”) in December 2003. FIN 46 requires certain variable interest entities (“VIEs”) to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The provisions of FIN 46 are effective immediately for all arrangements entered into after January 31, 2003. Since January 31, 2003, the Company has not invested in any entities it believes are variable interest entities for which the Company is the primary beneficiary. For all arrangements entered into after January 31, 2003, the Company is required to continue to apply FIN 46 through the end of the first quarter of fiscal 2004. The Company is required to adopt the provisions of FIN 46-R with respect to any such arrangements entered into after January 31, 2003, beginning in the second quarter of fiscal 2004. For arrangements entered into prior to February 1, 2003, the Company is required to adopt the provision of FIN 46-R in the second quarter of fiscal 2004. The adoption of FIN 46-R did not have an impact on the financial position, results of operations or cash flows of the Company.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The Company currently has no financial instruments which meet these requirements.

In April 2003 the FASB issued SFAS No. 149, Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities. This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts. The Statement clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, clarifies when a derivative contains a financing component, amends the definition of an underlying derivative to conform it to language used in FASB Interpretation FIN No. 45, and amends certain other existing pronouncements. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. All provisions of the Statement, except those related to forward purchases or sales of “when-issued” securities, should be applied prospectively. The Company currently has no instruments that meet the definition of a derivative, and therefore, the adoption of this Statement had no impact on the Company’s financial position or results of operations.

In November 2002, the FASB issued FIN 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, which addresses the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees. FIN 45 also requires the recognition of a liability by a guarantor at the inception of certain guarantees that are entered into or modified after December 31, 2002. The adoption of FIN 45 did not have a material affect on the financial statements.

Reclassifications

Certain reclassifications have been made to the 2003 financial statements to conform to the current year presentation.

4. Restructuring of operations

On January 31, 2003, the Company announced a restructuring of operations designed to refocus its operations around its core business functions, to relocate certain of its functional operations to the Company’s corporate headquarters, and to reduce operating expenses. As part of the restructuring, the Company reduced its workforce in excess of 30%. As of March 31, 2004 the Company recorded a total of $3.0 million in charges to operating expenses related to these restructuring activities. The distribution of the reduction in workforce was as follows:

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The restructuring charge for the three month period ended March 31, 2004 includes approximately $9,000 of employee severance and related expenses, and the reduction of approximately $0.2 million facility expenses related to the reversal of restructuring costs for our leased facility in Ottawa, due to the sublease of space during the quarter. The Company anticipates that the execution of the restructuring actions will require total cash expenditures of $3.0 million, which is expected to be funded from operations and existing cash balances. As of March 31, 2004, the Company had incurred net costs totaling $3.0 million related to the restructuring, which required $2.7 million in cash expenditures. The remaining reserve related to this restructuring is approximately $0.3 million, and is included in accrued liabilities as of March 31, 2004.

The following table lists the components of the January 2003 restructuring reserve for the three month period ended March 31, 2004 (in thousands):

On August 8, 2002, the Company announced a restructuring of its operations designed to re-align its core business functions and reduce operating expenses. As part of the restructuring, the Company intended to reduce its workforce by approximately 26% and recorded a $4.6 million charge to operating expenses in the third quarter of 2002. The restructuring charge included approximately $2.6 million of expenses related to facilities no longer needed for Company operations and $2.0 million of employee severance and other related expenses. In March 2003, based on a review of current operations, the decision was made to revise the original restructuring plan by retaining certain personnel in European locations who had been identified for termination and certain related offices that had been identified for closure. This decision resulted in a $1.2 million reversal of the restructuring accrual as of March 31, 2003, and a corresponding reduction of restructuring expense for the three months then ended. Such reversal was comprised of expected employee costs of approximately $0.8 million and expected facilities expenses of approximately $0.4 million. In June 2003, the Company recorded an additional $40,000 in restructuring expense relating to employee severance and other related expenses in Latin America. In September 2003, the Company recorded a reduction in obligations of approximately $25,000. This reduction resulted from the following: i) a reduction of the estimate of excess facility costs of approximately $0.9 million from the continued use of facilities scheduled for closure; ii) an offsetting change in estimate of approximately $1.0 million, resulting from the Company’s inability to sublet its excess space at certain facilities as the result of the short remaining lease term for these facilities and the slow real estate market that does not support subleasing of the facilities; iii) a reduction of approximately $46,000 in estimated property and equipment costs used in on-going operations instead of disposal; iv) a reduction in the estimated exit costs (moving, broker fees, travel, temporary labor costs) of approximately $64,000; and v) a reduction in expected employee related costs of approximately $19,000.

The distribution of the reduction in workforce as of March 31, 2004 was as follows:

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As of March 31, 2004, the Company had incurred costs totaling $2.8 million related to this restructuring accrual which will require $2.6 million in cash expenditures. The remaining reserve related to this restructuring is approximately $0.5 million, and is included in accrued liabilities as of March 31, 2004. In March 2004, the Company recorded a further reduction in restructuring expenses composed of approximately $36,000 in reduced employee severance costs in Belgium and approximately $6,000 in facilities expenses primarily as a result of foreign exchange adjustments on future commitments.

The following table lists the components of the August 2002 restructuring reserve for the three month period ended March 31, 2004 (in thousands):

In the fourth quarter of 1999, following the acquisitions of Wall Data, Incorporated and Simware Inc., the Company initiated a plan to restructure its worldwide operations in order to integrate the operations of the two acquired companies. In connection with this plan, the Company recorded a $3.8 million charge to operating expenses in 1999. The remaining reserve related to this restructuring is approximately $26,000, and is included in accrued liabilities as of March 31, 2004.

The following table lists the components of the restructuring reserve for the three month period ended March 31, 2004 (in thousands):

In August 1998, following the acquisition of FTP Software Inc., the Company initiated a plan to restructure its worldwide operations as a result of business conditions and in connection with the integration of the operations of FTP. In connection with this plan, the Company recorded a $7.0 million charge to operating expenses in 1998. In March 2004, the Company recorded an increase in the restructuring expense of approximately $19,000 related to the Company’s inability to sublease excess space and approximately $9,000 related to foreign exchange adjustments on long term lease commitments. The remaining reserve related to this restructuring at March 31, 2004 is approximately $0.3 million and is included in accrued liabilities.

The following table lists the components of the FTP restructuring reserve for the three month period ended March 31, 2004 (in thousands):

5. Commitments and contingencies

Legal proceedings

The information required by this item is incorporated herein by reference from the information contained in our Form 10-K for the fiscal year ended December 31, 2003 under the caption “Legal Proceedings.”

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In addition, the Company may be contingently liable with respect to certain asserted and unasserted claims that arise during the normal course of business. Management believes the impact, if any, resulting from these matters would not have a material impact on the Company’s financial statements.

Leases

Facilities and equipment are leased under non-cancelable operating leases expiring on various dates through the year 2011. The company does not have any capital leases. As of March 31, 2004, future minimum rental and lease payments, net of any sublease income, under non-cancelable operating leases are as follows:

Other

As an element of its standard commercial terms, the Company includes an indemnification clause in its software licensing agreements that indemnifies the licensee against liability and damages (including legal defense costs) arising from any claims of patent, copyright, trademark, or trade secret infringement by the Company’s software. The Company’s indemnification limitation is the cost to defend any third party claim brought against the Company’s customers and to the maximum a refund of the purchase price.

6. Segment information

The Company determines its segments based on how its Chief Executive Officer assesses performance and allocates resources. Through the fourth quarter of 2003, the Company presented segment information based on two reportable segments: Host Access and Host Integration. In the eyes of our customers and industry analysts, these two markets have merged. Beginning in January 2004, NetManage’s Chief Executive Officer no longer evaluates the business by those former segments but views the business within a single segment.

The Company now markets its products under the NetManage Host Access Platform (HAP) which incorporates the Company’s complete range of access, presentation and integration services designed to provide NetManage’s customers with a wide range of flexible options to help address their evolving business needs in this area. NetManage’s HAP includes solutions from both of the Company’s major product lines: RUMBA providing client-side solutions and OnWeb providing server-side solutions. These two product lines have similar economic characteristics and are similar with respect to the nature of the products, the nature of the production processes, the type of customer that the products are sold to and the methods used to distribute the products.

8. Related party transactions

On May 28, 2003, the Company entered into an independent contractor services agreement with Dr. Shelley Harrison, a director of the Company, pursuant to which Dr. Harrison will receive compensation in consideration for consultancy and advisory services he is providing the Company over a two-year period. The terms of the agreement require the Company to pay Dr. Harrison a fixed fee of $0.1 million per year, and a one time grant to Dr. Harrison of an option to purchase 146,800 shares of the Company’s common stock, at an exercise price of $1.92 per share (which represents the quoted market price of the stock at the date of grant). The option vests on a monthly basis over the two-year term of the agreement. The option expires five years from the date of issuance. The fair value of the option was determined using the Black-Scholes option pricing model with the following assumptions: stock price $2.95—$9.65; no dividends; risk free interest rate of 2.00%—2.89%; volatility of 63%—99%; and a contractual life of five years. The fair value of the option is subject to change over the vesting period of the option based on changes in the underlying assumptions (variable award accounting). For the three months ended March 31, 2004, the Company had recorded approximately $0.5 million in compensation expense under this agreement, based on an aggregate option fair value of $1.0 million. In connection with his entering into the agreement, Dr. Harrison resigned from the Company’s Audit Committee effective May 28, 2003. For the three months ended March 31, 2004, the Company recorded total aggregate cash and non-cash compensation of $0.6 million under General and Administrative expense in the Consolidated Statements of Operations.

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Item 2 — Management’s discussion and analysis of financial condition and results of operations.

Some of the statements contained in this Quarterly Report on Form 10-Q are forward-looking statements, including, but not limited to, those specifically identified as such, that involve risks and uncertainties, including those set forth below under the heading “Factors that may affect our future results and financial condition” and elsewhere in this report. The statements contained in this report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act, including, without limitation, statements regarding our expectations, beliefs, intentions or strategies regarding the future. These statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results to differ materially from those implied by the forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. All forward-looking statements included in this Report are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements.

Overview

We have operations worldwide with sales offices located in the United States, Europe, Canada, and Israel. We develop and market software and service solutions that are designed to enable our customers to access and leverage the considerable investment they have in their host-based business applications, processes and data. Our business is primarily focused on providing a broad spectrum of specific personal computer and network or application server-based software and tools. These products are designed to allow our customers to access and use their mission-critical line-of-business host applications and resources; to publish information from existing host systems in a web presentation, particularly to new users, via the Internet; to create new web-based applications that leverage their existing business processes and applications; and, to ensure the continued operation of these solutions through the incorporation and deployment of innovative, real-time, Internet-based support solutions.

Our business is targeted at taking advantage of the trend of many major corporations worldwide to adopt Web-based business processes, Business-to-Business, or B2B, or Business-to-Consumer, or B2C, initiatives. In this market, we aim to enable our customers to bridge between their existing access systems and technologies, Business-to-Employee, or B2E processes, and those required to compete in the B2B and B2C marketplaces. The corporate resources internal to the organization, those behind existing B2E solutions, are the basis of any eBusiness transformation for an existing company. Alongside these solutions, we are focused on providing products that are designed to allow existing corporate business processes to be extended to external users, and products that are designed to allow new business processes to be created in support of corporate eBusiness B2B and B2C initiatives. We also focus on taking advantage of major current industry trends: the expansion of the Internet and its adoption as the eCommerce and eBusiness infrastructure; the continued mobilization of personal computer users and the adoption of mobile information access and display devices; and the availability of broader access to corporate data and information for people internal and external to an organization.

We develop and market software solutions that allow our customers to access and leverage applications, business processes and data on International Business Machines Corporation (IBM) corporate mainframe computers and compatibles, IBM midrange computers such as iSeries (formerly AS/400), and on UNIX based servers. We provide professional support, maintenance, and technical consultancy services to our customers in association with the products we develop and market.

Our principal products are compatible with Microsoft Windows Sever 2003, Windows XP, Windows 2000, Windows NT, Windows 98, Windows 95, and Windows 3.x operating systems, on IBM operating systems, Novell, Inc. operating systems and various implementations of the industry standard UNIX operating system such as IBM’s AIX, Hewlett-Packard Company’s HP/UX, Sun Microsystems Inc.’s Solaris, and the open source Linux system.

We market our products under the NetManage HAP which incorporates our complete range of access, presentation and integration services designed to provide our customers with a wide range of flexible options to help address their evolving business needs in this area. Both our RUMBA® products and OnWeb® products are integral components of the NetManage HAP.

HAP ties together our RUMBA desktop host access technologies and our server-based OnWeb solution for access, presentation, and integration services. As a result, customers can extend host applications to support new Web-based business initiatives, consolidate and integrate host-based information, and operate normal business processes as they migrate to packaged applications using a variety of Web services.

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Results of operations

During the past several years, we have implemented initiatives designed to control costs and reduce operating expenses, including the discontinuance of several low revenue-generating products and the implementation of worldwide restructurings of our operations.

For the three month period ended March 31, 2004 as compared to March 31, 2003, we experienced a reduction in revenues, which we believe relate to the recent depressed North American and European economies. Customers, because of uncertainties within their own businesses, postponed or canceled decisions to purchase technology. However, we anticipate improvements in the current business environment through the remainder of 2004. Until we have positive reinforcement on the improving economy we will continue to focus on improving our operations and reduce our operating expenses to bring them more in line with our anticipated revenue levels.

On January 31, 2003, NetManage announced a restructuring of its operations designed to meet those goals. As part of the restructuring, NetManage reduced its workforce in excess of 30%. As of March 31, 2004, we have recorded a total of $3.0 million in charges to operating expenses related to these restructuring activities, consisting of approximately $0.5 million of expenses related to leased facilities no longer needed for the Company’s operations and $2.5 million of employee severance and other related expenses (See Note 4 to Financial Statements- Restructuring of operations).

On August 8, 2002, we announced a restructuring of our operations designed to re-align our core business functions and reduce operating expenses. As part of this restructuring, we intended to reduce our workforce by approximately 26% and recorded a $4.6 million charge to operating expenses in the third quarter of 2002. The restructuring charge included approximately $2.6 million of expenses related to facilities no longer needed for company operations and $2.0 million of employee severance and other related expenses for employee terminations. In March 2003, based on a review of current operations, we decided to revise the original restructuring plan by retaining certain personnel in European locations who had been identified for termination and certain related offices that had been identified for closure. This decision resulted in a $1.2 million reversal of the restructuring accrual as of March 31, 2003, and a corresponding reduction of restructuring expense for the three months then ended. Such reversal was comprised of expected employee costs of approximately $0.8 million and expected facilities expenses of approximately $0.4 million. In June 2003, NetManage recorded an additional $40,000 in restructuring expense relating to employee termination costs in Latin America. In September 2003, the Company recorded a reduction in obligations of approximately $25,000 associated with the August 2002 restructuring. The reduction resulted from the following: (i) a reduction of facility costs of approximately $0.9 million from the continued use of facilities scheduled for closure; (ii) an offsetting change in estimate of approximately $1.0 million, resulting from the Company’s inability to sublet its excess space as a result of the short remaining lease term for these facilities and the slow real estate market that does not support subleasing of the facilities; (iii) a reduction of approximately $46,000 in estimated property, plant, and equipment costs used in on-going operations instead of being disposed; (iv) a reduction in the estimated exit costs (moving, broker fees, travel, temporary labor costs) of approximately $64,000, and; (v) a reduction in expected employee related costs of approximately $19,000.

The Company has recorded other restructuring charges in the past as described in Note 4 to Financial Statements – Restructuring of operations.

Over the last three years, we have experienced significant revenue reduction in each quarter compared to the same quarter of the previous year. This trend continued, to a lesser extent in the first quarter of 2004. In some cases, customers chose to reduce the number of desktop units at the time of annual maintenance renewal to reflect a reduction-in-force at their facilities, or they continued to postpone buying decisions due to budget constraints. There can be no assurance that revenues will increase at all in future periods, but we are encouraged about recent positive changes to the North America economy.

Because we generally ship software products within a short period after receipt of an order, we do not have a material backlog of unfilled orders, and revenues in any quarter are substantially dependent on orders booked in that quarter. Our operating expense levels are based, in part, on our expectation of future revenues and, to a large extent, are fixed. In the first quarter of 2004, operating expenses, excluding restructuring charges, continued to decline when compared to the first quarter of 2003, and may fluctuate as a percentage of net revenues as we develop and introduce new products.

As described herein, under the heading “Factors that may affect our future results and financial condition,” acquisitions involve a number of risks, including risks relating to the integration of the acquired company’s operations, personnel, and products. There can be no assurance that the integration of previously acquired companies, or the integration of any future acquisitions, will be accomplished successfully, and the failure to effectively accomplish any of these integrations could have a material adverse effect on our results of operations and financial condition.

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Three months ended March 31, 2004 compared to March 31, 2003 (dollars in millions):

Net revenues

Our revenues are derived from the sale of software licenses and related services, which include maintenance and support, consulting and training services. License fees are earned under software license agreements with end-users and resellers and are generally recognized as revenue upon shipment of the software if collection of the resulting receivable is probable, the fee is fixed and determinable and vendor-specific objective evidence exists to allocate the total fee to all undelivered elements of the arrangement. Certain of our sales are made to domestic distributors under agreements allowing right-of-return and price protection on unsold merchandise. Accordingly, we defer recognition of such sales until the distributor sells the merchandise. Our international distributors do not have return rights and, as such, we generally recognize sales to international distributors upon shipment, if all other revenue recognition criteria have been met.

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Services revenues are derived from software updates for existing software products, user documentation and technical support, generally under annual service agreements. These revenues are recognized ratably over the terms of such agreements. If the services are included in the initial licensing fee, the fair value of the services is unbundled and recognized ratably over the related service period. Service revenues derived from consulting and training are deferred and subsequently recognized when the services are performed, and the collection is deemed probable.

License fees decreased $1.2 million, and services revenues decreased $1.0 million, a total of $2.2 million for the three month period ended March 31, 2004 as compared to the same period in 2003. We believe these decreases result primarily from customer decisions to cancel or postpone purchases of our products, due to the recent slow down in the North American and European economies, competitive pressures on our average selling prices, and financial pressures experienced by our customers and targeted customers.

We have operations worldwide with sales offices located in the United States, Europe, Canada, and customer support and research and development facilities in Canada and Israel. Revenues outside of the United States and Canada as a percentage of total net revenues were approximately 27% and 26% for the three months ended March 31, 2004 and 2003, respectively.

There were no customers that accounted for more than 10% of consolidated revenues in each of the three month periods ended March 31, 2004 and 2003.

Gross margin

Gross margin for both license fees and services decreased in absolute dollars for the three months ended March 31, 2004 as compared to the first quarter of 2003, primarily because of the decline in net revenues of 16%, but was offset in part by cost reductions associated with the reduction in headcount of 9 full time employees in the Operations, Customer Support, and Consulting groups, the reduction of the number of software distribution centers, and the implementation of electronic distribution initiatives.

Gross margin for license fees as a percentage of net revenues decreased from 39.0% to 37.0% for the three month period ending March 31, 2004 as compared to the same period in 2003, primarily because of the 20.0% reduction in license fees, offset in part by the above noted expense reduction measures. The gross margin for services increased from 48.2% to 52.1% primarily because of cost reductions, offset in part by a reduction in services revenues of 12.3%.

Gross margin for amortization of intangibles consists of the amortization of developed technology recorded as a result of software and developed technology acquired through several acquisitions. Amortization of developed technology is recorded on a straight-line basis over the estimated life of five years.

Gross margin as a percentage of net revenues may fluctuate in the future due to increased price competition, the mix of distribution channels that we use, the mix of license fee revenues versus service revenues, the mix of products sold, and the mix of international versus domestic revenues. We typically recognize higher gross margins on direct sales than sales through our indirect distribution channels, which generally carry lower margins.

Research and development

Research and development, or R&D, expenses consist primarily of salaries and benefits, occupancy and travel expenses, and fees paid to outside consultants. R&D expenses decreased in dollar amounts and as a percentage of net revenues for the three month period ended March 31, 2004 as compared to the same period in 2003, primarily as a result of a reduction in headcount of 13 full-time employees, and ongoing cost reduction efforts in 2004 and 2003.

Software development costs are accounted for in accordance with SFAS No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed, under which we are required to capitalize software development costs after technological feasibility is established, which we categorize as a working model and beta version of the software. The establishment of technological feasibility and the ongoing assessment of the recoverability of these costs requires considerable judgment by management with respect to certain external factors; including, but not limited to, anticipated future gross product revenue, estimated economic life, and changes in technology. Costs that do not qualify for capitalization are charged to R&D expense when incurred. We did not capitalize any software development costs in the three months ended March 31, 2004.

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Sales and marketing

Sales and marketing expenses consist primarily of the salaries of sales and marketing personnel, commissions, advertising and promotional expenses, occupancy and related costs. Sales and marketing expenses decreased in dollar amounts and as a percentage of net revenues for the three period month ended March 31, 2004 as compared to the same periods in 2003, primarily due to a reduction in headcount of 31 full-time sales employees and support staff from the first quarter of 2003 to the first quarter of 2004 and our ongoing cost reduction efforts in 2003 and 2004. Sales and marketing expenses for the three month period ended March 31, 2003 also included an allocation of approximately $0.1 million for a Company sales incentive goal for 2003., It was concluded that the sales incentive was not achieved, and we reversed $0.1 million in sales and marketing expense in the quarter ended March 31, 2004. In the first quarter of 2004, a corporate bonus, which related to and was accrued for in the fourth quarter of 2003 was paid.

General and administrative

General and administrative expenses consist primarily of salaries, benefits, accounting, operating, legal, and proportionate shares of occupancy and IT expenses for our human resources, legal, finance and general management functions. General and administrative expenses increased in the first quarter to $2.9 million from $2.7 million for the same period in 2003, and were 24.4% versus 19.1% as a percentage of net revenues for the three month period ended March 31, 2004 and 2003. The increase as a percentage of net revenues is primarily attributable to the decrease in net revenues over the same period of time. The primary reason for the increase in general and administrative expenses was the variable compensation costs for stock options, as described in Note 8 to Financial Statements “Related party transactions”.

Interest income (expense) and other, net

Interest income (expense) and other, net for the three months March 31, 2004 and 2003, respectively, are comprised of the following table:

The reduction in earned interest results from a reduction of our cash balances, and approximately 0.15% lower effective annual interest rates during the three month period ended March 31, 2004 as compared to the same period in 2003.

Transaction gains and losses from foreign currency activity exclude activity flowing through our inter-company accounts (see below).

Foreign currency transaction gains (losses)

For the three month period ended March 31, 2004, we recorded a transaction loss of approximately $0.6 million. For the three months ended March 31, 2003, we recorded a small transaction gain. These transaction gains and losses are attributable to fluctuations related primarily to the Israeli Shekel in relation to the Euro and U.S. dollar (USD). For the three month periods ended March 31, 2004 and 2003, the relationship of the Israeli Shekel to the Euro and to the USD was as follows:

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In those periods where the foreign currency change is positive, we recorded a transaction loss related to fluctuations related primarily in the Israeli Shekel. Conversely, in those periods where the foreign currency change is negative, we recorded a transaction gain.

Provision for income taxes

Our effective tax rate for 2004 is less than 1% due to our current tax loss position. Income taxes include primarily international taxes and state taxes. The income tax provision of $50,000 for the quarter ended March 31, 2004 resulted primarily from an international tax provision of $31,000, and U.S. state tax expense of $19,000. The income tax benefit of $317,000 for the three months ended March 31, 2003 resulted primarily from German tax refunds of $481,000, and a U.S. tax benefit of $2,000, offset in part by an international tax expense of $166,000.

Liquidity and capital resources