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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended April 30, 2004

For the transition period from              to             

Commission File number 000-25829

PORTAL SOFTWARE, INC.

(Exact name of registrant as specified in its charter)

(408) 572-2000

(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 Exchange Act). Yes  x        No  ¨

On May 31, 2004, 42,587,278 shares of the Registrant’s Common Stock, $0.001 par value, were outstanding.

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PORTAL SOFTWARE, INC.

FORM 10-Q

QUARTER ENDED APRIL 30, 2004

INDEX

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ITEM 1. FINANCIAL STATEMENTS

PORTAL SOFTWARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value)

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

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PORTAL SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts; unaudited)

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

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PORTAL SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands; unaudited)

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

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PORTAL SOFTWARE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Significant Accounting Policies:

Nature of Business and Basis of Presentation

Portal Software, Inc., or Portal, develops, markets (includes licensing), and supports product-based customer management and billing software solutions primarily for telecommunications and information service providers. Portal’s convergent platform enables service providers to deliver voice, data, video and content services with multiple networks, payment models, pricing plans and value chains. Portal markets its products worldwide through a combination of a direct sales force and distribution partners. Substantially all of Portal’s license revenues are derived from sales of its Portal Infranet^® product line.

The accompanying condensed consolidated financial statements include the accounts of Portal and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The condensed consolidated balance sheet at April 30, 2004, the condensed consolidated statements of operations for the three months ended April, 30, 2004 and 2003 and the condensed consolidated statements of cash flows for the three months ended April 30, 2004 and 2003 are not audited. In the opinion of management, these financial statements reflect all adjustments (consisting of normal recurring adjustments and non-recurring adjustments) that are necessary for a fair presentation of the results for and as of the periods shown. A non-recurring restructuring charge of $0.4 million was included in the Company’s results for the quarter ended April 30, 2004. The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year or for any future period. The condensed consolidated financial statement information as of January 31, 2004 is derived from audited financial statements as of that date. These financial statements should be read in conjunction with the financial statements and related notes included in Portal’s Annual Report on Form 10-K for the fiscal year ended January 31, 2004 filed with the Securities and Exchange Commission.

On September 3, 2003, the Company’s Board of Directors approved a reverse stock split of the Company’s common stock at a ratio of one-for-five, causing each outstanding share of common stock to convert automatically into one-fifth of a share of common stock. The reverse split became effective at the close of business on September 26, 2003. In lieu of fractional shares, stockholders received a cash payment based on an average trading price of the common stock prior to the effectiveness of the reverse split. Stockholders’ equity has been restated to give retroactive recognition to the reverse split for all periods presented by reclassifying the excess par value resulting from the reduced number of shares from common stock to paid-in capital. All references to common share and per common share amounts for all periods presented have been restated to reflect this reverse split.

Fiscal year

We adopted a 52/53 week fiscal accounting year commencing with our 2004 fiscal year. Each quarter consists of 13 weeks ending on a Friday. Our 2005 fiscal year began on January 31, 2004, the day following the last day of our 2004 fiscal year, and will end on January 28, 2005. Accordingly, all references as of and for the period ended April 30, 2003 reflect amounts as of and for the period ended May 2, 2003. All references as of and for the period ended January 31, 2004 reflect amounts as of and for the period ended January 30, 2004. The quarter ended April 30, 2004 was comprised of 91 days while the quarter ended April 30, 2003 was comprised of 92 days.

Foreign Currency

Portal considers the functional currency of its foreign subsidiaries to be the local currency. Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date and revenue, costs and expenses are translated at average rates of exchange in effect during the year. Translation gains and losses are reported within accumulated other comprehensive loss. For the quarter ended April 30, 2004, Portal recorded $0.4 million in net foreign exchange losses primarily as a result of remeasuring foreign denominated accounts to the functional currency. Net foreign exchange gains resulting from the remeasurement of foreign denominated accounts to the functional currency were immaterial for the quarter ended April 30, 2003.

Use of Estimates

The preparation of 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, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates are used for, but are not limited to, revenue recognition, allowances for doubtful accounts, long-lived assets, restructuring accruals, and income taxes. These estimates are based upon information available as of the date of the financial statements. Actual results could differ materially from those estimates.

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Revenue Recognition

Portal recognizes revenue in accordance with current generally accepted accounting principles that have been prescribed for the software industry. Revenue recognition requirements are very complex and are affected by interpretations of the rules and industry practices, both of which are subject to change.

Revenue from license fees is recognized when persuasive evidence of an arrangement exists, delivery of the product has occurred, the fee is fixed or determinable and collectibility is probable. Pursuant to the requirements of Statement of Position (“SOP”) 97-2 “Software Revenue Recognition” and SOP 98-9 “Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions,” Portal uses the residual method to recognize revenue when a license agreement includes one or more elements to be delivered at a future date and vendor specific objective evidence of the fair value (“VSOE”) of all undelivered elements exists. VSOE for undelivered elements is based on normal pricing for those elements when sold separately and, for maintenance services, is additionally measured by the renewal rate. The software is considered to have been delivered when Portal has provided the customer with the access codes that allow for immediate possession of the software. The Company’s assessment of a customer’s creditworthiness is a factor in the determination of whether or not collectibility is probable. The determination of creditworthiness requires the exercise of judgment, which affects Portal’s revenue recognition. If a customer is deemed to not be creditworthy, all revenue under arrangements with that customer is recognized upon receipt of cash. Additionally, when Portal enters into contracts with industry-standard payment terms, it is Portal’s policy to recognize such revenue when the customer is deemed to be creditworthy and collection of the receivable is probable. Revenue from arrangements with resellers who are not the ultimate users is not recognized until evidence of an arrangement with an end user has been received. Should Portal enter into a transaction with a customer to purchase the customer’s products contemporaneously with the customer’s purchase of software from Portal, Portal’s policy is to recognize the amount of license fees paid to Portal net of the fees paid for the customer’s products.

Services revenues are primarily comprised of revenue from product deployment, configuration, installation, follow-on enhancements and other consulting fees, solutions development, maintenance agreements and training. When license arrangements include services, the license fees are recognized upon delivery, provided that (1) the criteria set forth in the above paragraph have been met, (2) payment of the license fees is not dependent upon the performance of the services, (3) the services are not essential to the functionality of the software, and (4) VSOE exists on the undelivered services. When software services are not considered essential, which has been the case in the majority of the Company’s license arrangements, the Company recognizes time and materials service contracts as the services are performed. Fixed price services contracts are recognized on a proportional performance basis as determined by the relationship of contract costs incurred to date and the estimated total contract costs, which are regularly reviewed during the life of the contract, subject to meeting agreed upon milestones. In the event that a milestone has not been reached, the associated direct costs deferred and revenue is not recognized until the milestone has been accepted by the customer.

To date, Portal has been able to estimate efforts required under its services contracts, including its fixed price contracts. In the event that cost estimates exceed total expected revenues, Portal’s policy is to accrue for the estimated losses if and when the losses become evident.

For arrangements that do not meet the above criteria, both the license revenues and services revenues are recognized under a contract accounting method in accordance with the provisions of SOP 81-1, “Accounting for Performance of Construction Type and Certain Production Type Contracts.” Portal follows the percentage-of-completion method where reasonably dependable estimates of progress toward completion of a contract can be made. The Company estimates the percentage-of-completion on contracts utilizing costs incurred to date as a percentage of the total costs at project completion, subject to meeting agreed milestones. In the event that a milestone has not been reached, the associated direct costs are deferred and revenue is not recognized until the milestone has been accepted by the customer. Recognized revenues and profit are subject to revisions as the contract progresses to completion. Revisions in profit estimates are charged to income in the period in which the facts that give rise to the revision become known.

Maintenance agreements provide technical support and include the right to unspecified upgrades on an if-and-when-available basis. For those customers that have purchased maintenance, Portal offers timely access to new product versions and software updates. Maintenance revenue is deferred and recognized on a straight-line basis as services revenue over the life of the related agreement, which is typically one year. Customer advances and billed amounts due from customers in excess of revenue recognized are generally recorded as deferred revenue.

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Deferred revenue was comprised of the following (in thousands, unaudited):

Concentration of Credit Risk

Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash equivalents, short-term investments and trade accounts receivable. Our investment policy limits the amount of credit risk exposure to any one issuer. Portal is exposed to credit risks in the event of default by the issuers to the extent of the amount recorded on the balance sheet.

Substantially all of Portal’s software and services have been sold to North American, European and Asia-Pacific telecommunication and information service providers, including mobile wireless companies, broadband, electronic content and Internet access companies, as well as other Internet and e-commerce companies. Accordingly, adverse economic trends affecting the communications industry may increase our credit risk in our trade accounts receivable. Portal has adopted credit policies and standards intended to accommodate industry growth and inherent risk. Portal performs ongoing credit evaluations of our customers’ financial condition. Portal does not require collateral.

Affiliates majority-owned by Vodafone Group Plc (“Vodafone”), as publicly reported by Vodafone, accounted for 40% of revenue recognized during each of the quarters ended April 30, 2004 and April 30, 2003. One majority owned Vodafone affiliate, Vodafone Global Products and Services Limited, accounted for 18% of revenues during the quarter ended April 30, 2004. One majority owned Vodafone affiliate, Vodafone Omnitel, accounted for 22% of revenues during the three months ended April 30, 2003. No other customer accounted for more than 10% of revenues during the quarters ended April 30, 2004 and April 30, 2003. Net accounts receivable from affiliates majority-owned by Vodafone was $6.8 million as of April 30, 2004.

Guarantees

Our license agreements include indemnification for infringements of third-party intellectual property rights and also include certain warranties. No amounts have been accrued relating to those indemnities and warranties, as we do not believe any losses are probable. We have also issued letters of credit totaling $10.1 million related to our leased facilities, a bank guarantee for $0.6 million to support outstanding loans secured by buildings owned by Portal and $0.9 million for a bank guarantee issued in support of Portal’s compliance with performance obligations to a customer. In the event Portal defaults on the terms of the underlying agreements, the beneficiaries may draw on these letters of credit. The requirements to maintain the letters of credit correspond to the terms of the underlying agreements which expire at various dates through 2021.

Our software license agreements also generally include a warranty that our software products will substantially operate as described in the applicable program documentation for a period of 90 days after delivery. We also warrant that services we perform will be provided in a manner consistent with industry standards. To date, we have not incurred any material costs associated with these warranties.

As permitted under our Restated Certificate of Incorporation, Bylaws and the Delaware General Corporation Law, we have entered into agreements whereby we indemnify our officers and directors for certain events or occurrences while the officer or director is, or was, serving at our request in such capacity.

Segment Information

Portal operates solely in one business segment, the development and marketing of business software and related services. Portal’s foreign operations consist of sales, marketing and support activities through its foreign subsidiaries and an overseas reseller network as well as an engineering and development center in India. Portal’s CEO has responsibility as the chief operating decision maker (CODM) as defined by SFAS 131. The CODM reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenues and certain direct expenses by geographic region for purposes of making operating decisions and assessing financial performance. Portal’s assets are primarily located in its corporate office in the United States and are not allocated to any specific region, therefore Portal does not produce reports for, or measure the performance of, its geographic regions based on any asset-based metrics. As a result, geographic information is presented only for revenues.

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Portal’s revenue to external customers outside of North America represented 89% of total revenues in the quarter ended April 30, 2004, compared to approximately 78% in the comparable period ended April 30, 2003 and were derived from sales to Europe (which is defined by Portal as Europe, Middle East and Africa) and Intercontinental (which is defined by Portal as Asia-Pacific, Japan and Central and South America (including Mexico)). For the quarters ended April 30, 2004 and 2003, European revenues were $21.3 million and $20.6 million, respectively, and Intercontinental revenues were $6.6 million and $4.4 million, respectively.

Cash, Cash Equivalents, Short-Term and Long-Term Investments

Portal considers all highly liquid, low-risk debt instruments with an original maturity, at the date of purchase, of three months or less to be cash equivalents. At January 31, 2004 and 2003, cash equivalents and short-term investments consisted primarily of commercial paper, corporate notes, money market funds and government securities.

Portal classifies, at the date of acquisition, its cash equivalents and short-term investments as available-for-sale in accordance with the provisions of the Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standards Number 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”). Securities are reported at fair market value, with the related unrealized gains and losses included within stockholders’ equity. Debt and discount securities are adjusted for straight-line amortization of premiums and accretion of discounts to maturity, both of which are included in interest income. Realized gains and losses are recorded using the specific identification method and are immaterial for all periods presented.

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The following summarizes Portal’s cash, cash equivalents and investments (in thousands, unaudited):

Available-For-Sale Securities

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The estimated fair value of short-term investments classified by date of maturity is as follows (in thousands, unaudited):

Restricted investments represent collateral for outstanding letters of credit and bank guarantees. The collateral amounts are typically in excess of the face value of the letters of credit and bank guarantees in order to account for potential fluctuations in the value of the investments and exchange rates. As of April 30, 2004, restricted short-term investments of $1.1 million combined with restricted long-term investments of $13.4 million represent collateral for five letters of credit and two bank guarantees. As of April 30, 2004 the five letters of credit totaling $12.6 million were issued in lieu of a cash security deposit and are renewable annually and expire on various dates from October 31, 2004 through March 5, 2021. One bank guarantee for $0.8 million relates to outstanding loans secured by buildings owned by Portal and expires on December 31, 2017. The other bank guarantee for $1.1 million was issued in support of Portal’s compliance with performance obligations to a customer and expires on April 15, 2005. Restricted investments consist of corporate notes and U.S. Government securities maturing over a period of one to two years.

Portal also invests in equity instruments of privately held companies for business and strategic purposes. These investments are included in other assets, in the amount of $1.5 million (total investment of $2.0 million net of a valuation allowance of $0.5 million) as of April 30, 2004. The investments are accounted for using the cost method as Portal does not have the ability to exercise significant influence over the operations of these companies and Portal’s investment is less than 20% of the outstanding voting shares in each entity. Portal monitors its investments for other than temporary impairment, basing its assessment on a review of the investee’s operations and other indicators. Other indicators include, but are not limited to, capital resources, prospects of receiving additional financing, down rounds and prospects for liquidity of the related securities.

Impairment of Long-Lived Assets

Portal evaluates the carrying value of long-lived assets and intangible assets whenever certain events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When indicators of impairment exist, the estimated future net undiscounted cash flows associated with the asset are compared to the asset’s carrying amount to determine if impairment has occurred. If such assets are deemed impaired, an impairment loss equal to the amount by which the carrying amount exceeds the fair value of the assets is recognized. If quoted market prices for the assets are not available, the fair value is calculated using the present value of estimated net cash flows.

Net Loss Per Share

The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share data; unaudited):

Portal has excluded outstanding stock options from the calculation of diluted loss per share because all such securities are antidilutive for all periods presented. The total number of shares excluded from the calculations of diluted net loss per share was 2,011,000 and 917,000 for the quarters ended April 30, 2004 and April 30, 2003, respectively. Such securities, had they been dilutive, would have been included in the computations of diluted net loss per share using the treasury stock method.

Stock-Based Compensation

Portal has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion Number 25, “Accounting for Stock Issued to Employees” and related interpretations in

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accounting for its employee and director stock-based awards. An alternative method prescribed by Statement of Financial Accounting Standards Number 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), as amended by Statement of Financial Accounting Standards Number 148 “Accounting for Stock-Based Compensation – Transition and Disclosure” (“SFAS 148”), encourages but does not require companies to record compensation cost for stock-based employee compensation plans at fair value. The alternative fair value accounting provided for under SFAS 123 requires use of option valuation models that were not developed for use in valuing employee stock-based awards. Under APB Opinion Number 25, Portal does not recognize compensation expense with respect to such awards if the exercise price equals or exceeds the fair value of the underlying security on the date of grant and other terms are fixed.

These models were developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because Portal’s stock-based awards have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock-based awards.

In November 2002, the Compensation Committee of Portal’s Board of Directors approved a plan to reprice stock options for employees. The plan excluded the Chief Executive Officer and members of the Board of Directors. Under this plan, 4,154,999 options were repriced. These options became subject to variable accounting prospectively whereby stock-based compensation for the options is re-measured quarterly and recorded as compensation expense in the Consolidated Statements of Operations for each reporting period until such options are exercised or expire.

The weighted average fair value, per share, of options granted for the quarter ended April 30, 2004 and 2003 was $5.40 and $3.04, respectively.

Summarized below are the pro forma effects on net loss and net loss per share as if Portal had elected to use the fair value approach prescribed by SFAS 123 for valuing options and shares granted under its employee stock purchase plan (in thousands, except per share amounts; unaudited):

Comprehensive Loss

Comprehensive loss is comprised of net loss and other comprehensive income (loss), which includes certain changes in the equity of the Company. Details comprising comprehensive loss is as follows (in thousands; unaudited):

Note 2. Restructuring

In fiscal 2003 and 2002 Portal’s Board of Directors approved the implementation of restructuring plans to effect a change in the Company’s operations and cost structure to more fully align with its revised business strategy requiring a greater focus on the

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needs of diversified telecommunications service providers. The plans included reductions in workforce of approximately 250 employees in fiscal 2003 and 320 employees in fiscal 2002, facilities reductions and asset write-offs. These workforce reductions affected substantially all of the Company’s organizations located in North America and Europe. The Company recorded restructuring charges of $36.5 million and $41.3 million for the fiscal years 2003 and 2002, respectively. The restructuring charges recorded in fiscal 2003 included approximately $6.2 million of severance related amounts, $17.1 million of committed excess facilities, primarily related to lease expenses net of anticipated sublease income, $11.7 million in asset write-offs and $1.5 million for other costs. The restructuring charges recorded in fiscal 2002 included approximately $6.9 million of severance related amounts, $20.4 million of committed excess facilities, primarily related to lease expenses net of anticipated sublease income, and $13.1 million in asset write-offs.

The fiscal 2003 restructuring plan specifically identified facilities to be vacated, throughout North America and internationally in Germany, Japan and the United Kingdom. Portal vacated the facilities on various dates, as planned, through September 2002. A portion of Portal’s headquarters was also vacated by December 2002. The planned exit dates for each facility were considered when calculating the restructuring charges. Prior to vacating these facilities, or portions thereof that Portal intends to sublease, rental expense continued to be included in operating expenses. Portal was successful in negotiating the termination of some of its leases. The restructuring accrual reflects the terms of these renegotiated agreements.

Severance payments are expected to be paid through the end of fiscal 2005. The long-term portion of the accrued restructuring costs is made up of lease payments for vacated facilities, net of expected sublease income, and is currently expected to be paid through 2013. Actual future cash requirements may differ materially from the accrual, particularly if actual sublease income is significantly different from current estimates, if the Company is successful or unsuccessful in its efforts to renegotiate facility leases, or if it is unsuccessful in its attempts to sublet the facilities within a timely manner. During the quarter ended April 30, 2004, the Company recorded a $0.4 million restructuring charge. This was comprised of a $1.9 million increase in an accrual related to extending the time period the Company estimated one of its facilities would be vacant. This increase was partially offset by the reduction in an accrual for a guarantee for which the Company was relieved in the quarter relating to a bank loan due to payment of the loan by the borrower. This resulted in a $1.5 million credit included in the “other” category.

A summary of accrued restructuring costs is as follows (in thousands, unaudited):

The restructuring accrual for facilities as of April 30, 2004 of $25.7 million included approximately $18.7 million for future minimum lease payments and $7.0 million for semi-fixed facility related operating costs. If we are unable to find suitable sublessees for our unused facilities, our maximum exposure for future additional lease payments and variable facility-related operating costs which are not included in the accrued restructuring amounts related to facilities is $41.2 million.

Note 3. Interest and Other Income, Net

Interest and other income, net primarily represents net interest income, and net gains and losses resulting from foreign currency exchange rate changes and other income (loss).

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The following table sets forth information regarding the Company’s interest and other income, net (in thousands, unaudited):

Note 4. Income Taxes

For the three months ended April 30, 2004 the Company recorded a provision for income taxes of $0.5 million, which includes accruals for income tax in foreign jurisdictions and foreign withholding taxes on revenue. With respect to deferred taxes, the Company has recorded a valuation allowance to reduce its deferred tax assets to zero, as it is more likely than not that these assets will not be realized. While Portal has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event Portal was to determine that it would be able to realize its deferred tax assets in the future, an adjustment to the deferred tax asset would increase income in the period such determination was made. Portal will continue to evaluate the realizability of the deferred tax assets on a quarterly basis.

Note 5. Commitments and Contingencies

Legal Matters

On July 9, 2001, a purported class action complaint was filed in the United States District Court for the Southern District of New York against Portal, certain of its officers and several underwriters of Portal’s initial public offering (“IPO”). The lawsuit alleges violations of Section 11 of the Securities Act of 1933, as amended, and Section 10(b) of the Securities Exchange Act of 1934, as amended, arising from alleged improprieties by the underwriters in connection with our 1999 IPO and follow-on public offering, and claims to be on behalf of all persons who purchased Portal Software shares from May 5, 1999 through December 6, 2000. Four additional nearly identical class actions were also filed in July and August 2001 based on essentially the same facts and allegations. Specifically, the complaints allege the underwriters charged certain of their customers fees in excess of those disclosed in the prospectus and engaged in certain allegedly improper activities in connection with the distribution of the IPO shares. The complaint was subsequently amended to allege similar claims with respect to our secondary public offering in September 1999.

The cases were consolidated into a single action, and a consolidated amended complaint was filed on April 19, 2002. These actions are part of the litigation known as the “IPO Securities Litigation,” which has been brought against over 300 issuers and nearly 50 underwriters alleging claims virtually identical to those alleged against us. The action seeks damages in an unspecified amount. A motion to dismiss addressing issues common to the companies and individuals who have been sued in these actions has been denied. This action is being coordinated with approximately three hundred other nearly identical actions filed against other companies. On February 19, 2003, the Court denied the motion to dismiss the complaint against the Company.

Portal has approved a Memorandum of Understanding (“MOU”) and related agreements which set forth the terms of a settlement proposal presented to all between the Company, the plaintiff class and the vast majority of the other approximately 300 issuer defendants. In this settlement, plaintiffs will dismiss and release all claims against Portal and its executive officers named in the suit, in exchange for a contingent payment by the insurance companies collectively responsible for insuring the issuers in all of the public offering cases, and for the assignment or surrender of control of certain claims Portal may have against its underwriters. Neither Portal nor its executive officers named in the suit will be required to make any cash payments in the settlement, unless the pro rata amount paid by the insurers in the settlement exceeds the amount of the insurance coverage, a circumstance which Portal does not believe will occur. It is anticipated that any potential financial obligation of the Company to plaintiffs pursuant to the terms of the MOU and related agreements will be covered by existing insurance. Therefore, the Company does not expect that the settlement will involve any payment by the Company. The parties have negotiated a settlement agreement, which has not yet been executed. The agreement will be subject to approval by the court, which cannot be assured, after class members are given the opportunity to object to the settlement, or opt out of the settlement.

On November 13, 2003, Portal announced that its results for the quarter ended October 31, 2003 would be lower than previously estimated. On November 20, 2003, a purported class action complaint was filed in the United States District Court for the Northern District of California against Portal, and certain of its officers and directors. The lawsuit claims to be on behalf of all persons who purchased Portal shares from May 20, 2003 through November 13, 2003 (the “Class Period”). Several similar class actions have also been filed in the same court based on essentially the same facts and allegations. These cases were consolidated on February 4, 2004, and a lead plaintiff and lead plaintiff’s counsel were appointed on March 25, 2004. On May 24, 2004, the lead plaintiff filed a consolidated amended complaint alleging violations of Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934, as amended, arising from allegations that during the Class Period Portal recognized revenue improperly and failed to disclose declining demand for its products and services. The consolidated amended complaint seeks damages in an unspecified amount. Portal is scheduled to respond to the consolidated amended complaint on July 6, 2004.

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On November 17, 2003, a stockholder derivative action was filed in the Superior Court of California, County of San Mateo against the members of the Board of Directors and certain officers of Portal alleging breach of fiduciary duty and other violations of state law. A second similar action was filed in the Superior Court of California, County of San Mateo on November 25, 2003. These complaints are based on allegations that the defendants misrepresented Portal’s financial projections in connection with the quarter ended October 31, 2003, and that certain of the defendants violated state laws relating to insider trading. The actions seek damages in an unspecified amount, disgorgement of improper profits and attorney’s fees, among other forms of relief. In February 2004, both derivative actions were transferred to Santa Clara County Superior Court. The plaintiff in the second action has agreed, and the Court has so ordered, that the proceedings in the second action be stayed pending the conclusion of the first filed action. The plaintiff in the first filed action is scheduled to file an amended complaint on or about September 30, 2004.

Portal believes that the claims asserted by these lawsuits are without merit, and intends to defend these actions vigorously. However, due to the inherent uncertainties of litigation, Portal cannot accurately predict the ultimate outcome of the litigation. An unfavorable outcome in litigation could materially and adversely affect Portal’s business and could result in payment of significant damages by Portal, all of which would harm our financial condition and results of operations.

Note 6. Recent Accounting Pronouncements

In December 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities- An Interpretation of Accounting Research Bulletin No. 51,” (FIN 46R). FIN 46R requires an investor with a majority of the variable interests (primary beneficiary) in a variable interest entity (VIE) to consolidate the entity and also requires majority and significant variable interest investors to provide certain disclosures. A VIE is an entity in which the voting equity investors do not have a controlling financial interest, or the equity investment at risk is insufficient to finance the entity’s activities without receiving additional subordinated financial support from other parties. Application of FIN 46R is required in financial statements of companies that have interests in variable interest entities or potential variable interest entities commonly referred to as special purpose entities for periods ending after December 15, 2003. Application by companies for all other types of entities is required in financial statements for periods ending after March 15, 2004. The Company had no investments in variable interest entities as of April 30, 2004.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations may contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, including, but not limited to, statements relating to future revenue and product sales, gross margins, product development, operating expenses and the sufficiency of financial resources to support our future operations, and are subject to the Safe Harbor provisions created by that statute. Such statements are based on current expectations which involve inherent risks and uncertainties, including those discussed below and under the heading “Risks Associated with Our Business and Future Operating Results” that could cause actual results to differ materially from those expressed. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Business

We develop, market, provision, and support customer management and billing (“CM&B”) solutions primarily for telecommunications and information service providers. Our convergent platform enables service providers to deliver voice, data, video and content services with multiple networks, payment models, pricing plans and value chains.

We believe that the growth and rapid change in the telecommunications and information service provider market provide a unique opportunity for our solutions which provide real-time, flexible and scalable solutions for these markets. To fully realize this opportunity, we must expand our penetration in this market to enable us to increase our revenues and to achieve profitability and positive cash flow.

While we currently provide solutions for some of the leading global telecommunications and information service providers, we face competitors with substantially greater financial resources than us. As such, we must demonstrate to our customers our ability to successfully compete with larger solution providers, our ability to provide an equal or greater ability to support our products today and in the future and our ability to continue to enhance our products to support this rapidly changing market.

Financial

Beginning with fiscal 1997, substantially all of our revenues have come from the license of one product line, Portal Infranet, and from related services. Revenues consist of Infranet licenses, professional services and maintenance fees. License revenues are comprised of perpetual or multi-year license fees, which are primarily derived from contracts with telecommunications and information service providers. Professional services include implementation services, training, business consulting, operational support services and solutions development. Solutions development consists of custom engineered development efforts tailored to the needs of specific customers. These services are provided throughout the customer lifecycle. We believe that future revenues will be generated primarily from the following sources:

We have established a series of relationships with systems integrators and hardware platform, software and service providers. We have derived, and anticipate that we will continue to derive, some portion of our revenues from customers that have significant relationships with our integration and platform partners.

As a result of continuing consolidation in the telecommunications and information provider industries and the reduction in capital available for emerging companies, we expect to derive an increasing portion of our total revenues from large telecommunications and information service providers. We continue to focus on increasing the number of arrangements involving solutions development services. One of the impacts of this change to more arrangements involving solutions development services is that solutions development services revenue would be recognized under the percentage of completion method as services revenue, rather than being recorded as license revenue upon initial delivery.

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The portion of our total revenues that is derived from international operations has increased substantially in recent years. In the first quarter ended April 30, 2004, international revenues were 89% and U.S. revenues were 11% of our total revenues. As a result, we face greater exposure to the risks associated with international operations. We believe that in the future a larger portion of our services revenues will be based on fixed price contracts and that our future contracts will contain a larger component of solutions development services. This could result in a higher portion of revenue being recognized under the percentage of completion method or increase the risk of delays in achieving contractual milestones. In addition, our margins and overall profitability on fixed price contracts could be more difficult to estimate than on time and materials contracts. For a description of factors that may affect our future results see “Risks Associated with Our Business and Future Operating Results.”

In addition to making critical accounting estimates, we must ensure that our financial statements are properly stated in accordance with GAAP. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application, while in other cases, management’s judgment is required in selecting among available alternative accounting standards that allow different accounting treatment for similar transactions (e.g., stock-based compensation, restructuring activities, depreciation methodology, etc.). We believe that the following accounting policies are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management’s judgments and estimates:

Our management has reviewed our critical accounting policies, critical accounting estimates, and the related disclosures with the Audit Committee. Additional information about these critical accounting policies may be found in the Company’s Annual Report on Form 10-K for the year ended January 31, 2004, in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” under the heading “Critical Accounting Policies and Estimates.”

On September 3, 2003, our Company’s Board of Directors approved a reverse stock split of our common stock at a ratio of one-for-five, causing each outstanding share of common stock to convert automatically into one-fifth of a share of common stock. The reverse split became effective at the close of business on September 26, 2003. In lieu of fractional shares, stockholders received a cash payment based on an average trading price of the common stock prior to the effectiveness of the reverse split. All references to share and per share amounts for all periods presented have been restated to reflect this reverse split.

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RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, each item from our consolidated statements of operations, the relative percentage that those amounts represent to consolidated revenues (unless otherwise indicated) and the percentage change in those amounts from period to period. All percentages are calculated using actual amounts rounded to the nearest thousand.

The decrease in revenues during the quarter ended April 30, 2004 was the result of a decrease in our license revenues partially offset by an increase in maintenance revenues and increased demand for our professional services, primarily solutions development, which increased our professional services revenue. License fees revenues decreased in the quarter ended April 30, 2004 when compared to the quarter ended April 30, 2003 due to a reduction in the number of large customer orders in the quarter ended April 30, 2004 when compared to the quarter ended April 30, 2003.

Services revenues increased in the quarter ended April 30, 2004 compared to the quarter ended April 30, 2003 primarily due to revenue recognized from the completion of milestones on our solutions development efforts. In addition, services revenue increased due to the increased demand for our implementation services from wireless operators and content providers. Wireless customers have purchased smaller licenses initially for internal purposes and then have entered into professional services engagements spanning multiple quarters prior to making a decision to purchase additional licenses to be used in a production environment based on a specific number of subscribers. This has led to an increase in the overall volume of consulting services performed during the quarter ended April 30, 2004.

Affiliates majority-owned by Vodafone Group Plc (“Vodafone”), as publicly reported by Vodafone, accounted for 40% of revenue recognized during each of the quarters ended April 30, 2004 and April 30, 2003. One majority owned Vodafone affiliate, Vodafone Global Products and Services Limited, accounted for 18% of revenues during the quarter ended April 30, 2004. One majority owned Vodafone affiliate, Vodafone Omnitel, accounted for 22% of revenues during the three months ended April 30, 2003. No other customer accounted for more than 10% of revenues during the quarters ended April 30, 2004 or April 30, 2003. Net accounts receivable from affiliates majority-owned by Vodafone was $6.8 million as of April 30, 2004.

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Geographical Revenues

North American revenues, which are defined as revenues from the United States and Canada, decreased in the quarter ended April 30, 2004 compared with the quarter ended April 30, 2003 primarily due to the shift from Internet based customers to customers in the wireless industry. North American wireless carriers largely outsource their billing applications to billing providers, and have not allocated significant funds to internal billing projects due to ongoing consolidations within the industry. In addition, we experienced a decline in the volume of orders in North America in the quarter ended April 30, 2004 when compared with the quarter ended April 30, 2003. Revenues for EMEA, defined as Europe, Middle East and Africa increased in the quarter ended April 30, 2004 compared with the quarter ended April 30, 2003 primarily as a result of our success in obtaining new business with wireless and content service providers in this region. In addition, EMEA revenues increased due to the completion of certain milestones on consulting projects that resulted in revenue recognized on these projects. Intercontinental revenues, which are defined by us as Asia-Pacific, Japan and Central and South America (including Mexico) increased in the quarter ended April 30, 2004 when compared with the quarter ended April 30, 2003 primarily as a result of obtaining new business with a wireless provider in Japan, and with wireless and cable providers in Central and South America (including Mexico).

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Cost of License Fees

Cost of license fees consists of the cost of software used in the fulfillment process and third-party royalty obligations with respect to third-party technology included in Portal Infranet. These costs decreased due to a reduction in third party royalty obligations in the quarter ended April 30, 2004 compared to the quarter ended April 30, 2003.

Cost of Services

Cost of services primarily consists of personnel and related costs for our professional service and maintenance offerings. We also include personnel and related costs of employees in our research and development function who spend time working on billable professional services engagements, primarily on solutions development projects. The increase in cost of services for the quarter ended April 30, 2004 from the quarter ended April 30, 2003 is primarily due to increases in headcount, including $1.9 million of costs transferred from research and development for the time research and development personnel worked on billable solutions development engagements, and increased subcontractor expense. The increased headcount was required to accommodate the higher demand for our professional services offerings which resulted in the increase in our services revenues this quarter. Gross margin for services was approximately 41% for the quarter ended April 30, 2004 compared with approximately 37% for the quarter ended April 30, 2003. Service gross margins improved due to higher margins on maintenance, increased demand for our service offerings and increased efficiencies in our professional services organization as a result of higher utilization rates. For the quarter ended April 30, 2004 we also incurred significant costs on a professional services engagement for which we did not have an executed agreement with the customer and, therefore, did not recognize any related revenue. Should the Company fail to enter into a consulting agreement with this customer, Portal may not record any revenue associated with our consulting efforts. With a contract executed, our margins would have been higher for the quarter ended April 30, 2004. Because we incurred these costs in the first quarter, to the extent that we are able to recognize the related revenues resulting from executing the contract in future periods, our margins on this project in these future periods may be higher than the margins for this project in the quarter ended April 30, 2004. There can be no assurance that current margin levels can be maintained in the future.

Amortization of Purchased Developed Technology

For the quarters ended April 30, 2004 and 2003, we amortized purchased developed technology related to our investment in Solution42 in the amount of $0.7 million. Amortization of purchased developed technology will continue to negatively impact our operating results in the future. Future amortization expense of the remaining purchased developed technology is currently estimated to be $1.3 million in the remainder of fiscal year 2005.

Research and Development Expenses

Research and development expenses consist primarily of personnel and related costs for our development and certain technical support efforts. Research and development expenses were $7.6 million for the quarter ended April 30, 2004, as compared to $7.2 million for the quarter ended April 30, 2003. This increase in the quarter ended April 30, 2004 was due to higher headcount related expenses partially offset by the transfer of $1.9 million of costs to cost of services expense for the time research and development personnel worked on billable solutions development engagements. Research and development expense increased as a percentage of revenue from the quarter ended April 30, 2003 to the quarter ended April 30, 2004 due to an increase in research and development costs in absolute dollar terms and a decrease in revenue during the same period. We have not capitalized any software development costs to date.

Sales and Marketing Expenses