VIGNETTE CORP - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarter ended June 30, 2004

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 000-25375

VIGNETTE CORPORATION

(Exact name of registrant as specified in its charter)

Delaware

74-2769415

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

1301 South MoPac Expressway

Austin, Texas 78746

(Address of principal executive offices)

(512) 741-4300

(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 by Rule 12b-2 of the Act). Yes x No ¨

As of July 23, 2004, there were 288,970,046 shares of the registrant’s common stock outstanding.

VIGNETTE CORPORATION

FORM 10–Q QUARTERLY REPORT

For the quarter ended June 30, 2004

TABLE OF CONTENTS


		Page
Part I. Financial Information

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets at June 30, 2004 and December 31, 2003	2

	Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2004 and 2003	3

	Condensed Consolidated Statements of Cash Flows for the three and six months ended June 30, 2004 and 2003	4

	Notes to Condensed Consolidated Financial Statements	5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	44

Item 4.	Controls and Procedures	45

Part II. Other Information

Item 1.	Legal Proceedings	45

Item 4.	Submission of Matters to a Vote of Security Holders	46

Item 6.	Exhibits and Reports on Form 8-K	47

SIGNATURES		48

CERTIFICATIONS

PART I — FINANCIAL INFORMATION

ITEM 1 — FINANCIAL STATEMENTS

VIGNETTE CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

in thousands


	June 30, 2004		December 31, 2003
	(Unaudited)
ASSETS

Current assets:
Cash and cash equivalents	$	130,776	$	171,939
Short-term investments		46,096		67,574
Accounts receivable, net		37,071		29,987
Prepaid expenses and other current assets		5,440		6,425

Total current assets		219,383		275,925

Property and equipment, net		12,121		16,671
Investments		12,505		12,446
Long-term investments in marketable securities		5,221		—
Goodwill		129,642		46,969
Other intangibles, net		53,972		11,355
Other assets		2,671		2,750

Total assets	$	435,515	$	366,116

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Accounts payable and accrued expenses	$	51,308	$	30,695
Deferred revenue		37,520		34,164
Current portion of capital lease obligations		6		67
Other current liabilities		9,235		5,250

Total current liabilities		98,069		70,176

Deferred revenue, less current portion		1,062		1,303
Other long-term liabilities, less current portion		9,668		13,291

Total liabilities		108,799		84,770

Stockholders’ equity		326,716		281,346

Total liabilities and stockholders’ equity	$	435,515	$	366,116

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

VIGNETTE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

in thousands, except per share data


	Three Months Ended June 30,						Six Months Ended June 30,
	2004			2003			2004			2003
Revenue:
Product license	$	16,852		$	14,950		$	31,530		$	31,401
Services		29,960			25,368			54,962			49,713

Total revenue		46,812			40,318			86,492			81,114
Cost of revenue:
Product license		1,625			527			2,746			1,080
Amortization of acquired technology		2,806			800			4,774			1,600
Services		13,398			9,943			24,704			20,408

Total cost of revenue		17,829			11,270			32,224			23,088

Gross profit		28,983			29,048			54,268			58,026

Operating expenses:
Research and development (1)		10,300			10,559			20,449			22,668
Sales and marketing (1)		19,270			16,292			38,482			34,520
General and administrative (1)		4,466			3,643			9,261			8,444
Purchased in-process research and development, acquisition-related and other charges		974			1,128			6,897			2,270
Business restructuring charges (gain)		(519	)		(1,388	)		8,660			(1,388	)
Amortization of deferred stock compensation		211			237			367			614
Amortization of other intangibles		1,379			442			2,194			1,051

Total operating expenses		36,081			30,913			86,310			68,179

Loss from operations		(7,098	)		(1,865	)		(32,042	)		(10,153	)

Other income, net		1,126			1,276			1,635			2,311

Loss before provision for income taxes		(5,972	)		(589	)		(30,407	)		(7,842	)
Provision for income taxes		265			278			495			572

Net loss	$	(6,237	)	$	(867	)	$	(30,902	)	$	(8,414	)

Basic net loss per common share	$	(0.02	)	$	(0.00	)	$	(0.11	)	$	(0.03	)

Shares used in computing basic net loss per common share		288,114			252,369			278,768			251,803

(1)	Excludes amortization of deferred stock compensation as follows:


	Three Months Ended June 30,				Six Months Ended June 30,
	2004		2003		2004			2003
Research and development	$	1	$	85	$	47		$	200
Sales and marketing		—		19		(48	)		41
General and administrative		210		133		368			373

	$	211	$	237	$	367		$	614

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

VIGNETTE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

in thousands


	Six Months Ended June 30,
	2004			2003
Operating activities:
Net loss	$	(30,902	)	$	(8,414	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		5,012			7,836
Non-cash compensation expense		367			614
Amortization of intangible assets		7,083			2,884
Non-cash restructuring charges		2,331			—
Non-cash investment impairments		—			75
Non-cash deferred compensation		5			—
Purchased in-process research and development, acquisition-related and other charges		5,552			(181	)
Other charges		(568	)		—
Changes in operating assets and liabilities		(6,477	)		(22,907	)

Net cash used in operating activities		(17,597	)		(20,093	)

Investing activities:
Purchase of property and equipment		(2,422	)		(2,081	)
Purchase of business, net of cash acquired		(39,799	)		(15,449	)
Maturity of short-term investments, net		21,478			48,111
Sale (purchase) of restricted investments		183			563
Proceeds from sale of equity securities		824			—
Purchase of marketable securities		(5,332	)		(223	)
Other		(45	)		320

Net cash (used in) provided by investing activities		(25,113	)		31,241

Financing activities:
Payments on capital lease obligations		(72	)		(160	)
Proceeds from exercise of stock options and purchase of employee stock purchase plan shares		2,258			1,703
Payments for unvested common stock		(40	)		—

Net cash provided by financing activities		2,146			1,543

Effect of exchange rate changes on cash and cash equivalents		(599	)		1,881

Net change in cash and cash equivalents		(41,163	)		14,572
Cash and cash equivalents at beginning of period		171,939			216,076

Cash and cash equivalents at end of period	$	130,776		$	230,648

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

VIGNETTE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

June 30, 2004

NOTE 1 — General and Basis of Financial Statements

Vignette^® Corporation, along with its wholly-owned subsidiaries (collectively, the “Company” or “Vignette”), provides Web applications designed to help companies drive revenue growth, cost reductions, increased employee productivity and improved customer satisfaction. The Company’s portal, integration, content, analysis, document and records management, process and collaboration technologies give organizations the capability to provide a simple, personalized experience anytime, anywhere; integrate systems and information from inside and outside the organization; manage the lifecycle of enterprise information; and collaborate by supporting ad-hoc and business process-based information sharing. Together, the Company’s products and expertise help companies to harness the power of their information and the Web to deliver measurable improvements in business efficiency.

The Company was incorporated in Delaware on December 19, 1995. Vignette currently markets its products and services throughout the Americas, Europe, Asia and Australia. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation.

The unaudited interim condensed consolidated financial statements include the accounts of Vignette Corporation and its wholly-owned subsidiaries (collectively, the “Company” or “Vignette”). All material intercompany accounts and transactions have been eliminated in consolidation.

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States and are presented in accordance with the rules and regulations of the Securities and Exchange Commission applicable to interim financial information. Accordingly, certain footnote disclosures have been condensed or omitted. In the Company’s opinion, the unaudited interim condensed consolidated financial statements reflect all adjustments (consisting of only normal recurring adjustments) necessary for a fair presentation of the Company’s financial position, results of operations and cash flows for the periods presented. These financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto filed with the United States Securities and Exchange Commission in the Company’s annual report on Form 10-K for the year ended December 31, 2003. The results of operations for the three and six-month periods ended June 30, 2004 and 2003 are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year.

The balance sheet at December 31, 2003 has been derived from audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2003.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates, and such differences could be material to the financial statements. In particular, actual sublease income attributable to the consolidation of excess facilities might deviate from the assumptions used to calculate the Company’s accruals for facility lease commitments vacated as a result of both its business restructuring and recent acquisitions. It is reasonably possible that such sublease assumptions could change in the near term, requiring adjustments to future income.

VIGNETTE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

NOTE 2 — Stock-based Compensation

At June 30, 2004, the Company has five stock-based compensation plans. Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“Statement 123”), prescribes accounting and reporting standards for all stock-based compensation plans, including employee stock options. As allowed by Statement 123, the Company has elected to continue to account for its employee stock-based compensation using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. When the Company issues options or its stock to its employees at an exercise price equal to the market value of the underlying common stock on the date of grant, no stock-based compensation costs are recorded. In the event that options are granted or restricted shares are issued at an exercise price that is less than the market value of the underlying common stock on the date of grant or issuance, the Company records deferred compensation expense in an amount equivalent to the difference between the market value and the exercise price of the respective option or restricted stock. Deferred stock compensation is amortized on an accelerated basis over the options’ and restricted stock’s respective vesting periods, and is recorded as “Amortization of deferred stock compensation” in the Condensed Consolidated Statements of Operations.

The following table illustrates the effect on net loss and net loss per share if the Company had applied the fair value recognition provisions of Statement 123 to stock-based employee compensation (in thousands, except per share data):


	Three Months Ended June 30,						Six Months Ended June 30,
	2004			2003			2004			2003
Net loss:

Reported net loss	$	(6,237	)	$	(867	)	$	(30,902	)	$	(8,414	)
Add: Total stock-based employee compensation expense included in the determination of net loss as reported, net of related tax effects		211			237			367			614
Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(4,940	)		(24,164	)		(10,466	)		(48,815	)

Pro forma net loss	$	(10,966	)	$	(24,749	)	$	(41,001	)	$	(56,615	)

Basic net loss per share:

Reported net loss per share	$	(0.02	)	$	(0.00	)	$	(0.11	)	$	(0.03	)

Pro-forma net loss per share	$	(0.04	)	$	(0.10	)	$	(0.15	)	$	(0.22	)

Equity instruments issued to non-employees are recorded at their fair value in accordance with Statement 123 and Emerging Issues Task Force Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services.”

Option Exchange Offer

On February 12, 2004 the Company offered eligible employees the right to exchange certain outstanding options for new ones. The decline in the market value of the Company’s shares since 2000 has caused its stock price to fall substantially below the strike price of many employee stock options granted in recent years. This voluntary exchange program was designed to retain the Company’s employees and provide them with a long-term incentive to maximize stockholder value. The offer period ended on March 24, 2004. The exercise price of new options to be granted will depend on the closing price of our common stock on the grant date of September 28, 2004 and the total number of options issued is estimated to be 2.1 million, or approximately 40% of the total options canceled. The program has been organized to comply with FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation, and is not expected to result in any additional compensation charges or variable plan accounting.

VIGNETTE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

NOTE 3 — Business Combinations

Acquisition of Tower Technology Pty Ltd

On March 1, 2004 the Company acquired all issued and outstanding shares of Tower Technology Pty Limited (“Tower Technology”), a privately held Australian company and leading provider of enterprise document and records management solutions. The consideration paid to the Tower Technology stockholders was comprised of approximately 27.2 million shares of our stock and $49.8 million in cash, including a $3.8 million payment made in July 2004 in lieu of issuing additional shares. In addition, we incurred approximately $7.4 million in transaction costs. The results of Tower Technology’s operations have been included with ours for the period subsequent to the acquisition date. The Company’s consolidated financial statements include Tower Technology’s financial position and results of operations for the period subsequent to March 1, 2004.

In accordance with SFAS 141, Business Combinations, the total purchase consideration of $133.9 million, including transaction costs of $7.4 million, has been allocated to the assets acquired and liabilities assumed, including identifiable intangible assets, based on their respective fair values at the date of acquisition. Such allocation resulted in goodwill of $82.0 million. Goodwill is assigned at the enterprise level and is not expected to be deductible for income tax purposes.

The following unaudited condensed consolidated balance sheet data presents the fair value of the assets acquired and liabilities assumed. Such balance sheet information includes accruals related to employee severance, relocation and exit costs, as estimated on the date of acquisition (in thousands):


Cash and cash equivalents		$	9,100
Accounts receivable			8,387
Prepaid expenses and other current assets			1,007
Property and equipment			404
Other assets			75
Intangible assets subject to amortization
Technology (6 year useful life)	30,100
Customer relationships (4 year useful life)	18,200
Non-compete (6 year useful life)	1,400

In-process research and development	4,800

Total intangible assets			54,500
Goodwill			82,023

Total assets acquired			155,496

Accounts payable			(710	)
Accrued exit costs			(3,146	)
Accrued severance			(1,426	)
Accrued other expenses			(9,252	)
Deferred revenue			(7,037	)

Total liabilities assumed			(21,571	)

Net assets acquired		$	133,925

Accrued exit costs of $3.1 million relate to lease obligations for excess office space that the Company has vacated or intends to vacate under the approved facilities exit plan. The total lease commitments include the remaining lease liabilities and brokerage commissions, offset by estimated sublease income. The estimated costs of vacating these leased facilities, including estimated costs to sublease and sublease income, were based on market information and trend analysis as estimated by the Company. It is reasonably possible that actual results could differ from these estimates in the near term, and such differences would result in adjustments to the purchase price allocation and, ultimately, the amount allocated to goodwill. The impacted sites are office space located in Slough, United Kingdom; Boston, Massachusetts; Melbourne and Lane Cove, Australia and have lease commitments that expire as late as September 2008.

VIGNETTE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Accrued severance and relocation costs of $1.4 million relate to severance, payroll taxes, outplacement and relocation benefits for certain Tower Technology employees impacted by the approved plan of termination and relocation. Approximately 50 employees were severed in the sales, marketing, professional services, engineering and general and administrative departments.

The following table summarizes activity for exit costs, employee severance and relocation costs (in thousands):


	Exit Costs			Severance and relocation			Total
Initial accrual at March 1, 2004	$	3,146		$	1,426		$	4,572
Cash activity		—			(928	)		(928	)

Balance at March 31, 2004		3,146			498			3,644
Adjustment to accrual		90			42			132
Cash activity		(120	)		(442	)		(562	)

Balance at June 30, 2004	$	3,116		$	98			3,214

Less: current portion								(2,700	)

Long-term exit costs and severance and relocation							$	514

Severance and relocation costs are included in “Other current liabilities” on the Consolidated Balance Sheets. The Company estimates these costs will be substantially paid within three months of June 30, 2004.

Acquisition of Intraspect

On December 10, 2003, the Company acquired all issued and outstanding shares of Intraspect Software, Inc. (“Intraspect”) in exchange for $10 million in cash and approximately 4.2 million shares of Vignette common stock. Intraspect provided business collaboration solutions. The total purchase price, including $0.5 million in transaction costs related to banking, legal and accounting activities, was $20.4 million. By adding collaboration capabilities to its existing and future product suites, the Company has the ability to deliver a unified content management, portal and collaboration solution that incorporates business process and delivers advanced capabilities to harness the power of their information and the Web to deliver measurable improvements in business efficiency. The results of Intraspect’s operations have been included with those of the Company for the period subsequent to the acquisition date.

In accordance with SFAS 141 Business Combinations, the total purchase consideration has been allocated to the assets acquired and liabilities assumed, including identifiable intangible assets, based on their respective fair values at the date of acquisition. Such allocation resulted in goodwill of $16.0 million. Goodwill is assigned at the enterprise level and is not expected to be deductible for income tax purposes.

VIGNETTE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

The following table summarizes activity for exit costs, employee severance and relocation costs (in thousands):


	Exit Costs			Severance and Relocation			Total
Initial accrual at December 10, 2003	$	2,250		$	543		$	2,793
Adjustment to accrual		—			(30	)		(30	)

Cash activity		(67	)		(507	)		(574	)

Balance at December 31, 2003		2,183			6			2,189
Adjustment to accrual		13			141			154
Cash activity		(225	)		(147	)		(372	)

Balance at March 31, 2004		1,971			—			1,971

Adjustment to accrual		10			—			10

Cash activity		(209	)		—			(209	)

Balance at June 30, 2004	$	1,772		$	—			1,772

Less: Current portion								(817	)

Long-term exit costs and severance and relocation							$	955

Accrued exit costs of $2.3 million at acquisition date relate to lease obligations for excess office space that the Company has vacated under the approved facilities exit plan. The impacted site is office space located in Brisbane, California and has a lease commitment that expires in September 2006.

Accrued severance and relocation costs of $0.5 million at acquisition date relate to severance, payroll taxes, outplacement and relocation benefits for certain Intraspect employees impacted by the approved plan of termination and relocation. Approximately 10 employees were severed in the sales, marketing, professional services, engineering and general and administrative departments.

Acquisition of Epicentric

On December 3, 2002, the Company acquired all issued and outstanding shares of Epicentric, Inc. (“Epicentric”) for $29.1 million in cash, including $3.1 million in transaction costs related to banking, legal and accounting activities. Epicentric provided business portal solutions. By adding advanced portal and delivery management capabilities to its existing and future product suites, the Company has the capability to deliver real-time enterprise Web applications. The results of Epicentric’s operations have been included with those of the Company for the period subsequent to the acquisition date.

In accordance with SFAS 141, Business Combinations, the total purchase consideration has been allocated to the assets acquired and liabilities assumed, including identifiable intangible assets, based on their respective fair values at the date of acquisition. Such allocation resulted in goodwill of $33.0 million. Goodwill is assigned at the enterprise level and is not expected to be deductible for income tax purposes. The following unaudited condensed consolidated balance sheet data presents the fair value of the assets acquired and liabilities assumed.

Accrued exit costs of $9.8 million at acquisition date relate to lease obligations for excess office space that the Company has vacated under the approved facilities exit plan. The total lease commitments include the remaining lease liabilities and brokerage commissions, offset by estimated sublease income. The

VIGNETTE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

estimated costs of vacating these leased facilities, including estimated costs to sublease and sublease income, were based on market information and trend analysis as estimated by the Company. It is reasonably possible that actual results could differ from these estimates in the near term, and such differences would result in adjustments to the purchase price allocation and ultimately, the amount allocated to goodwill. Impacted sites include office space located in San Francisco, California; New York, New York; Chicago, Illinois; and Austin, Texas. The maximum lease commitment of such vacated properties extends through December 2006.

Accrued severance and relocation costs of $1.9 million at acquisition date relate to severance, payroll taxes, outplacement and relocation benefits for certain Epicentric employees impacted by the approved plan of termination and relocation. Approximately 85 Epicentric employees were severed in the sales, marketing, professional services, engineering and general and administrative departments.

The following table summarizes activity for exit costs, employee severance and relocation costs (in thousands):


	Exit Costs			Severance and Relocation			Total
Initial accrual at December 3, 2002	$	9,794		$	1,895		$	11,689

Cash activity		—			—			—

Balance at December 31, 2002		9,794			1,895			11,689
Adjustment to accrual		190			—			190
Cash activity		(3,692	)		(1,823	)		(5,515	)

Balance at December 31, 2003		6,292			72			6,364
Adjustment to accrual		(58	)		(69	)		(127	)

Cash activity		(519	)		—			(519	)

Balance at March 31, 2004		5,715			3			5,718
Adjustment to accrual		63			(3	)		60
Cash activity		(728	)		—			(728	)

Balance at June 30, 2004	$	5,050		$	—			5,050
Less: Current portion								(2,536	)

Long-term exit costs and severance and relocation							$	2,514

Pro forma results of operations

The following presents the unaudited pro forma combined results of operations of the Company with Tower Technology and Intraspect for the three and six months ended June 30, 2003 and 2004, after giving effect to certain pro forma adjustments. These unaudited pro forma results are not necessarily indicative of the actual consolidated results of operations had the acquisitions actually occurred on January 1, 2003 or of future results of operations of the consolidated entities (in thousands, except for per share data):


	Three months ended June 30,						Six months ended June 30,
	2004			2003			2004			2003
Revenue	$	46,812		$	52,707		$	91,726		$	106,081
Loss from operations		(7,098	)		(5,731	)		(29,924	)		(23,900	)
Net loss		(6,237	)		(5,206	)		(28,892	)		(24,424	)
Basic loss per share	$	(0.02	)	$	(0.02	)	$	(0.10	)	$	(0.09	)

VIGNETTE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

NOTE 4 — Intangible Assets

Intangible assets with indefinite lives

The changes in the carrying amount of goodwill, net of accumulated amortization and impairment charges, for the six months ended June 30, 2004, is as follows (in thousands):


	Goodwill
Balance at December 31, 2003	$	46,969
Tower Technology acquisition		82,023
Purchase price adjustments		650

Balance at June 30, 2004	$	129,642

The goodwill balance at December 31, 2003 pertains to the Epicentric business combination, completed in December 2002 and to the Intraspect business combination completed in December 2003. The goodwill balance as of June 30, 2004 includes the Tower Technology business combination and related purchase price adjustments.

In accordance with Statement 142, the Company assesses its goodwill on October 1 of each year or more frequently if events or changes in circumstances indicate that goodwill might be impaired.

Intangible assets with definite lives

Following is a summary of the Company’s intangible assets that are subject to amortization (in thousands):


	Six months ended June 30, 2004							Year ended December 31, 2003
	Gross Carrying Amount		Accumulated Amortization and Impairment			Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization and Impairment			Net Carrying Amount
Intellectual property purchases:
Capitalized research and development	$	700	$	(700	)	$	—	$	700	$	(583	)	$	117

Business combinations:
Technology		77,100		(44,589	)		32,511		47,000		(39,818	)		7,182
Non-compete contracts		2,200		(750	)		1,450		800		(433	)		367
Customer relationships		23,400		(3,389	)		20,011		5,200		(1,511	)		3,689

Total	$	103,400	$	(49,428	)	$	53,972	$	53,700	$	(42,345	)	$	11,355

The net carrying amount of intangible assets acquired in business combinations relates to the Epicentric, Intraspect, and Tower Technology purchases.

The Company’s intangible assets with definite lives are being amortized over the assets’ estimated useful lives using the straight-line method. Estimated useful lives range from two to six years. The Company periodically reviews the estimated useful lives of its identifiable intangible assets, taking into consideration any events or circumstances that might result in either a diminished fair value or revised useful life. Total amortization expense for the three and six months ended June 30, 2004 was $4.2 million and $7.0 million, respectively. Total amortization expense for the three and six months ended June 30, 2003 was $1.4 million and $2.9 million, respectively. Of these totals, $1.4 million and $2.2 million was recorded as “Amortization of intangible assets” in operating expenses for the three and six months ended June 30, 2004 and $0.4 million and $1.1 million for the three and six months ended June 30, 2003, respectively. The remaining $2.8 million and $4.8 million for the three and six months ended June 30, 2004 and the remaining $0.8 million and $1.6 million for the three and six months ended June 30, 2003 was recorded as a cost of revenue.

VIGNETTE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Estimated annual amortization expense (in thousands) for the six months ended December 31, 2004 and the next five years is as follows:


For the six months ended December 31, 2004	$	8,100
For the year ended December 31, 2005	$	11,300
For the year ended December 31, 2006	$	8,400
For the year ended December 31, 2007	$	8,400
For the year ended December 31, 2008	$	8,100
For the year ended December 31, 2009	$	8,100

NOTE 5 — Long-term Investments

Long-term investments are classified as available-for-sale and are presented at estimated fair market value with any unrealized gains or losses included in other comprehensive income (loss). The Company holds a less than 20% interest in, and does not exert significant influence over, any of the respective equity investees. The Company therefore applies the cost method. Long-term investments consisted of the following (in thousands):


	June 30, 2004		December 31, 2003
Restricted investments (cost approximates fair value)	$	10,023	$	10,229
Equity investments:
Common stock		1,354		465
Limited partnership interest		1,128		1,752

		12,505		12,446
Investments in marketable securities		5,221		—

Total long-term investments	$	17,726	$	12,446

Fair market values are based on quoted market prices where available. If quoted market prices are not available, management estimates fair value by using a composite of quoted market prices of companies that are comparable in size and industry classification to the Company’s non-public investments.

The Company held restricted investments in the form of a certificate of deposit and investment-grade securities placed with a high credit quality financial institution. Such restricted investments collateralize letters of credit related to certain leased office space security deposits. These investments will remain restricted to the extent that the security requirements exist.

During the quarter ended March 31, 2004, the Company received a cash distribution from its limited partner interest in the amount of approximately $0.8 million, which was recorded as a reduction in its carrying value. No such distributions were received during the second quarter ended June 30, 2004; however, the Company recorded an unrealized gain on an investment of $0.9 million.

The Company periodically analyzes its long-term investments for impairments considered other than temporary. In performing this analysis, the Company evaluates whether general market conditions which reflect prospects for the economy as a whole or information pertaining to the specific investment’s industry, or that individual company, indicates that an other than temporary decline in value has occurred. If so, the Company considers specific factors, including the financial condition and near-term prospect of each investment, any specific events that may affect the investee company, and the intent and ability of the Company to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. As a result of such review, the Company recognized no impairment charges during the three and six months ended June 30, 2004 and 2003. Such impairments are recorded in “Other income (expenses), net” on the Condensed Consolidated Statements of Operations.

VIGNETTE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

NOTE 6 — Business Restructuring

During fiscal year 2001, the Company’s management approved a restructuring plan to reduce headcount and infrastructure and to consolidate operations. The Company expanded the restructuring plan during 2002, 2003 and 2004. Components of business restructuring charges and the remaining restructuring accruals as of June 30, 2004 are as follows (in thousands):


	Facility Lease Commitments			Asset Impairments			Employee Separation and Other Costs			Total
Balance at December 31, 2000	$	—		$	—		$	—		$	—
Total restructuring charge		55,150			33,683			32,102			120,935
Cash activity		(12,397	)		(878	)		(22,773	)		(36,048	)
Non-cash activity		(292	)		(32,805	)		(1,918	)		(35,015	)

Balance at December 31, 2001		42,461			—			7,411			49,872
Effect of expanded restructuring plan		6,518			8,730			11,118			26,366
Adjustment to accrual		9,538			463			(545	)		9,456
Cash activity		(21,959	)		—			(11,342	)		(33,301	)
Non-cash activity		—			(9,193	)		(36	)		(9,229	)

Balance at December 31, 2002		36,558			—			6,606			43,164
Effect of expanded restructuring plan		9			—			2,076			2,085
Adjustment to accrual		(13,422	)		—			(3,349	)		(16,771	)
Cash activity		(10,620	)		—			(4,961	)		(15,581	)

Balance at December 31, 2003		12,525			—			372			12,897
Effect of expanded restructuring plan		5,950			2,331			898			9,179
Cash activity		(2,337	)		—			(771	)		(3,108	)
Non-cash activity		—			(2,331	)		—			(2,331	)

Balance at March 31, 2004		16,138			—			499			16,637
Adjustment to accrual		(747	)					228			(519	)
Cash activity		(1,757	)					(380	)		(2,137	)

Balance at June 30, 2004	$	13,634		$	—		$	347			13,981
Less: current portion											(8,296	)

Accrued restructuring costs, less current portion										$	5,685

At June 30 2004, remaining cash expenditures resulting from the restructuring are estimated to be $14.0 million and relate primarily to facility lease commitments. Excluding facilities lease commitments, the Company estimates that these costs will be substantially incurred within one year. The Company has substantially implemented its restructuring efforts initiated in conjunction with its restructuring plan; however, there can be no assurance that the estimated costs of the Company’s restructuring efforts will not change.

During 2003, the Company adjusted its existing restructuring accruals, resulting in a net restructuring gain of $15 million. A substantial portion of this income was the result of non-recurring charges related to changes in real estate restructuring assumptions. Specifically, during the fourth quarter the Company reevaluated its office space portfolio and decided to vacate its Austin, Texas headquarters and relocate to nearby office space that had previously been identified as restructuring space. This relocation resulted in a net benefit of approximately $14 million in the fourth quarter of 2003 based on the application of 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).” In the first quarter of 2004, the Company moved out of

VIGNETTE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

its existing headquarters and relocated to the nearby office space that now serves as its headquarters. As such, the Company recorded a restructuring charge of approximately $8 million in the first quarter of 2004 pursuant to FASB Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities.

Consolidation of excess facilities

Facility lease commitments relate to lease obligations for excess office space that the Company has vacated as a result of the restructuring plan. The Company continues to actively pursue integration strategies to dispose of all excess office space through subleasing and/or early termination negotiations where possible. Total lease commitments include the remaining lease liabilities and brokerage commissions, offset by estimated sublease income. The estimated costs of vacating these leased facilities, including estimated costs to sublease and any resulting sublease income, were based on market information and trend analysis as estimated by the Company. The Company continually assesses its real estate portfolio and may vacate and/or occupy other leased space as dictated by its analysis. It is reasonably possible that actual results could continue to differ from these estimates in the near term, and such differences could be material to the financial statements. In particular, actual sublease income attributable to the consolidation of excess facilities might deviate from the assumptions used to calculate the Company’s accrual for facility lease commitments. Facility lease commitments relate to the Company’s departure from certain office space in Austin, Texas; Brisbane and San Francisco, California; New York, New York; Boston and Waltham, Massachusetts; Slough, United Kingdom; Frankfurt, Germany; Paris, France; Madrid, Spain; and Lane Cove and Melbourne, Australia. The maximum lease commitment of such vacated properties extends through March 2010.

Asset impairments

Asset impairments relate to the impairment of certain fixed assets, prepaid royalties and intangible assets. These fixed assets were impaired as a result of the Company’s decision to vacate certain office space and align its infrastructure with current and projected headcount.

Employee separation and other costs

Employee separation and other costs include severance, related taxes, outplacement and other restructuring charges. As a result of the restructuring activities, the Company severed over 1,500 employees. Employee groups impacted by the restructuring efforts include personnel in positions throughout the sales, marketing, professional services, engineering and general and administrative functions in all geographies.

NOTE 7 — Commitments and Contingencies

Securities class action

On October 26, 2001, a class action lawsuit was filed against the Company and certain of its current and former officers and directors in the United States District Court for the Southern District of New York in an action captioned Leon Leybovich v. Vignette Corporation, et al., seeking unspecified damages on behalf of a purported class that purchased Vignette common stock between February 18, 1999 and December 6, 2000. Also named as defendants were four underwriters involved in the Company’s initial public offering of Vignette stock in February 1999 and the Company’s secondary public offering of Vignette stock in December 1999 – Morgan Stanley Dean Witter, Inc., Hambrecht & Quist, LLC, Dain Rauscher Wessels and U.S. Bancorp Piper Jaffray, Inc. A Consolidated Amended Complaint, which is now the operative complaint, was filed on April 19, 2002. The complaint alleges violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, based on, among other things, claims that the four underwriters awarded material portions of the shares in the Company’s initial and secondary public offerings to certain customers in exchange for excessive commissions. The complaint also asserts that the underwriters engaged in “tie-in arrangements” whereby certain customers were allocated shares of Company stock sold in its initial and secondary public offerings in exchange for an agreement to purchase additional shares in the aftermarket at pre-determined prices. With respect to the Company, the complaint alleges that the Company and its officers and directors failed to disclose the existence of these purported excessive commissions and tie-in arrangements in the prospectus

VIGNETTE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

and registration statement for the Company’s initial public offering and the prospectus and registration statement for the Company’s secondary public offering. The action is being coordinated with approximately 300 other nearly identical actions filed against other companies. On July 15, 2002, the Company moved to dismiss all claims against it. On October 9, 2002, the Court dismissed the Individual Defendants from the case without prejudice based upon Stipulations of Dismissal filed by the plaintiffs and the Individual Defendants. This dismissal disposed of the Section 15 and 20(a) control person claims without prejudice, since these claims were asserted only against the Individual Defendants. On February 19, 2003, the Court denied the motion to dismiss the complaint against the Company. The Company has approved a Memorandum of Understanding (“MOU”) and related agreements that set forth the terms of a settlement between the Company, the plaintiff class and the vast majority of the other approximately 300 issuer defendants. Among other provisions, the settlement contemplated by the MOU provides for a release of the Company and the individual defendants for the conduct alleged in the action to be wrongful. The Company would agree to undertake certain responsibilities, including agreeing to assign away, not assert, or release certain potential claims the Company may have against its underwriters. 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 MOU and related agreements are subject to a number of contingencies, including the negotiation of a settlement agreement and its approval by the Court. The Company cannot opine as to whether or when a settlement will occur or be finalized and is unable at this time to determine whether the outcome of the litigation will have a material impact on its results of operations or financial condition in any future period.

Litigation and other claims

The Company is also subject to various legal proceedings and claims arising in the ordinary course of business. The Company’s management does not expect that the outcome in any of these legal proceedings, individually or collectively, will have a material adverse effect on the Company’s financial condition, results of operations or cash flows.

Leases

The Company leases its office facilities and office equipment under various operating and capital lease agreements having expiration dates through 2011. Rent expense was $1.6 million and $1.4 million for the three months ended June 30, 2004 and June 30, 2003. Future minimum payments as of June 30, 2004 under these leases, including operating lease commitments for all vacated properties, are as follows (in thousands):


	Operating Leases		Sublease Income		Capital Leases
Remaining 2004	$	8,446	$	1,085	$	6
2005		14,717		2,021		—
2006		8,767		1,006		—
2007		5,576		712		—
2008		4,424		679		—
Thereafter		9,974		792		—

Total minimum lease payments	$	51,724				6

Total minimum sublease rentals			$	6,295		—

Amounts representing interest						—

Present value of net minimum lease payments (including current portion of $6)					$	6

We do not have any significant contractual obligations other than those leases disclosed above.

Product warranties

The Company offers warranties to its customers, requiring that the Company replace defective products within a specified time period from the date of sale. The Company records warranty costs as incurred and historically, such costs have not been material.

VIGNETTE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Software license indemnifications

Interpretation 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (“Interpretation 45”), requires that the Company recognize the fair value for certain guarantee and indemnification arrangements issued or modified by the Company after December 31, 2002. When the Company determines that a loss is probable, the estimated loss must be recognized as it relates to applicable guarantees and indemnifications. Some of the software licenses granted by the Company contain provisions that indemnify customers of the Company’s software from damages and costs resulting from claims alleging that the Company’s software infringes on the intellectual property rights of a third party. The Company records resulting costs as incurred and historically, such costs have not been material. Accordingly, the Company has not recorded a liability related to these indemnification provisions.

NOTE 8 — Comprehensive Income (Loss)

The Company’s comprehensive loss is included as a component of stockholders’ equity and is composed of (i) net loss, (ii) foreign currency translation adjustments and (iii) unrealized gains and losses on investments designated as available-for-sale. The following table presents the calculation of comprehensive loss (in thousands):


	Three Months Ended June 30,						Six Months Ended June 30,
	2004			2003			2004			2003
Net loss	$	(6,237	)	$	(867	)	$	(30,902	)	$	(8,414	)
Foreign currency translation adjustments		(478	)		731			(510	)		961
Unrealized gain (loss) on investments		763			(94	)		839			(304	)

Total comprehensive loss	$	(5,952	)	$	(230	)	$	(30,573	)	$	(7,757	)

NOTE 9 — Net Loss Per Share

Basic net loss per share is computed by dividing the net loss available to common stockholders for the period by the weighted average number of common shares outstanding during the period, excluding shares subject to repurchase or forfeiture. Pursuant to Statement of Financial Accounting Standards No. 128, Earnings Per Share, diluted net loss per share has not been presented, as the effect of the assumed exercise of stock options and contingently issued shares is antidilutive.

Common equivalent shares, consisting of unvested restricted common stock and incremental common shares issuable upon the exercise of stock options, are excluded from the diluted earnings per share calculation as their effect is anti-dilutive. There were approximately 0.7 million and 1.0 million restricted shares and 7.9 million and 9.6 million stock options outstanding using the treasury stock method as of June 30, 2004 and 2003, respectively.

VIGNETTE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

NOTE 10 — Accounts Payable and Accrued Expenses

Accounts payable and accrued expenses consist of the following (in thousands):


	June 30, 2004		December 31, 2003
Accounts payable	$	4,320	$	2,205
Accrued employee liabilities		11,524		9,324
Accrued restructuring charges		8,296		5,509
Accrued exit and severance costs		6,053		2,660
Accrued acquisition consideration		7,093		258
Accrued other charges		14,022		10,739

	$	51,308	$	30,695

NOTE 11 — Long-term Liabilities

Long-term liabilities consist of the following (in thousands):


	June 30, 2004		December 31, 2003
Accrued restructuring charges, net of current portion	$	5,685	$	7,388
Accrued exit and severance costs, net of current portion		3,983		5,893
Capital lease obligation, less current portion		—		10

	$	9,668	$	13,291

NOTE 12 — Stockholders’ Equity

Stockholders’ equity consists of the following (in thousands):


	June 30, 2004			December 31, 2003
Common stock	$	2,889		$	2,601
Additional paid-in capital		2,747,030			2,671,792
Deferred stock compensation		(843	)		(1,260	)
Accumulated other comprehensive income		1,027			697
Accumulated deficit		(2,423,387	)		(2,392,484	)

	$	326,716		$	281,346

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

The statements contained in this Quarterly Report on Form 10-Q that are not purely historical statements are forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934, including statements regarding our expectations, beliefs, hopes, intentions or strategies regarding the future. These forward-looking statements involve risks and uncertainties. Actual results may differ materially from those indicated in such forward-looking statements. We are under no duty to update any of the forward-looking statements after the date of this Quarterly Report on Form 10-Q to conform these statements to actual results. Factors that might cause or contribute to such a difference include, but are not limited to, those discussed elsewhere in this Report in the section entitled “Risk Factors That May Affect Future Results” and the risks discussed in our other historical Securities and Exchange Commission filings.

Overview

Vignette’s software and expertise help organizations harness the power of information and the Web to deliver measurable improvements in business efficiency. Vignette helps organizations increase productivity, reduce costs, improve user experiences and manage risk. Vignette’s Intranet, Extranet and Internet solutions incorporate portal, integration, enterprise content management and collaboration capabilities that can rapidly deliver unique advantages through an open, scalable and adaptable architecture that integrates with legacy systems. Vignette is headquartered in Austin, Texas, with local operations worldwide.

We offer six solutions to help enable customers to successfully and rapidly address pervasive business problems and achieve measurable increases in business efficiency:

•

Public Web Site and Brand Management helps customers gain control of their brand Web sites, commercial information publishing and e-commerce initiatives

•

Employee Intranets optimize productivity by connecting employees with the shared information, applications and tools they need to perform their jobs

•

Customer Self-Service gives customers a personalized window into their back-office systems to help enhance service and lower support costs

•

Supplier and Channel Interaction streamlines operations and enhances communications across a diverse trading network of suppliers, partners and distributors

•

Compliance and Governance efficiently manages and reliably reports on adherence to industry and government regulations

•

Standardization and Consolidation provides a common platform for customers’ information management and Web application needs

To address the particular size and requirements of our customers, we deliver our products in various suites. Additionally, we allow organizations the flexibility to purchase products individually. The Vignette Enterprise Services Foundation is a framework that describes our product capabilities covering six application services: portal, integration, content, collaboration, process, and analysis. Organizations may purchase products individually from these six service categories or pre-bundled in suites to meet their specific needs.

Vignette V7 Portal Services enable organizations to configure, deploy and manage multiple portals for various audiences in a business user-friendly development environment. These portals are managed through a single console to consolidate administration responsibilities.

Vignette V7 Integration Services provide unique capabilities to connect a broad range of unstructured, semi-structured and structured data (including transactional) sources.

Vignette V7 Content Services include library services, content type modeling, workflow, taxonomy, and search. Document and records management solutions are also available to expand the ability to capture, manage, utilize, retain and dispose of an organization’s enterprise content. In addition,

imaging and transactional “Web capture” functionality can effectively promote transitioning paper-based processes to digital processes, streamlining high-volume transaction processes and facilitating the centralized capture, storage and archival of an organization’s business content. This solution also effectively delivers risk and compliance management processes upon the breadth of an organization’s business content, documents, transactions, images, e-mails, rich media and Web transactions.

Vignette V7 Collaboration Services enhance the capability for knowledge-sharing for teams using workspaces. Our collaboration services also provide interaction management.

Vignette V7 Process Services provide a standards-based process workflow engine and graphical process modeler for building and deploying business processes across the enterprise application infrastructure.

Vignette V7 Analysis Services provide in-depth metrics and reporting based on Web logs, content delivery logs and process performance logs that drive return on investment through the analysis of content usage, Web site or application performance, and process performance.

Our solutions and products are supported by our professional services organization, Vignette Professional Services (“VPS”). VPS offers pre-packaged and custom services, using documented best practices, to help organizations define their online business objectives and deploy their applications. Our education, consulting and customer care teams give customers the benefit of our experience with thousands of customer implementations. We partner with a number of leading system integrators such as Accenture, EDS, Bearing Point and Deloitte Consulting to implement our software for their clients. In many cases, we work in blended teams to implement solutions. To ensure that we provide support to our customers on their chosen platform and infrastructure, we have long-standing relationships with key technology providers such as BEA Systems, IBM and Sun Microsystems.

We currently have 925 full-time employees, an increase of 13% from 815 at June 30, 2003. The increase was substantially the result of our recent acquisitions.

Recent Events

Tower Technology Acquisition

On March 1, 2004, we completed the acquisition of privately held Tower Technology Pty Limited (“Tower Technology”), a leading enterprise document and records management, imaging and workflow vendor. With the completion of the Tower Technology acquisition, we are able to offer enterprise content management capabilities for managing high volumes of documents, online transactions and records, in combination with our portal, Web content management and collaboration technologies. The consideration paid to the Tower Technology stockholders was comprised of approximately 27.2 million shares of our stock and $49.8 million in cash, including a $3.8 million payment made in July 2004 in lieu of issuing additional shares. In addition, we incurred approximately $7.4 million in transaction costs. The results of Tower Technology’s operations have been included with ours for the period subsequent to the acquisition date.

Option Exchange Offer

On February 12, 2004 we offered eligible employees the right to exchange certain outstanding options for new ones. The decline in the market value of our shares since 2000 has caused our stock price to fall substantially below the strike price of many employee stock options granted in recent years. This voluntary exchange program was designed to retain our employees and provide them with a long-term incentive to maximize stockholder value. The offer period ended on March 24, 2004. The exercise price of new options to be granted will depend on the closing price of our common stock on the grant date of September 28, 2004 and the total number of options issued is estimated to be 2.1 million or approximately 40% of the total options canceled. The program has been organized to comply with FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation, and is not expected to result in any additional compensation charges or variable plan accounting.

Overview of Second Quarter Results

Our financial results for the quarter ended June 30, 2004 were within our expectations.

Relative to the second quarter of 2004, total revenue for the first quarter increased 18% to $46.8 million, reflecting contributions from our recent Tower Technology and Intraspect acquisitions. International revenue represented approximately 39% of total revenue in the quarter. No single customer accounted for more than 10% of our revenues.

Total operating expenses were approximately $53.9 million and included $1.0 million for acquisition-related charges, $2.8 million for the amortization of acquired technology, $1.4 million for the amortization of intangible assets and $0.2 million for the amortization of deferred stock compensation. Most of these charges relate to our previous acquisitions. Also included in total operating expenses for the second quarter is $0.5 million for net restructuring income resulting primarily from changes in our non-operating real estate obligations. The remaining $48.0 million of operating expenses reflects an increase from the first quarter of 2004 primarily due to our first full quarter of combined operations following the completion of the Tower Technology acquisition.

Total deferred revenue at June 30, 2004 was approximately $38.6 million, an increase of $3.1 million as compared to December 31, 2003. Such increase for the quarter relates primarily to the deferred revenue we acquired through the Tower Technology business combination.

Our cash and short-term investment balance at June 30, 2004 was $176.9 million and we have no debt outstanding. In the quarter, our operating activities used approximately $7.5 million of cash. Such usage is primarily related to integration costs associated with our first quarter purchase of Tower Technology, restructuring and exit commitments, as well as net operating losses, excluding non-cash charges.

Forward-looking Information

During our second quarter 2004 financial results conference call dated July 22, 2004 we provided the following forward-looking information. Such information is current as of that date and relates to the quarter ended September 30, 2004.

We expect total revenue of approximately $45.0 million to $48.5 million with license revenue accounting for approximately 36% to 38% of total revenue and services revenue accounting for the remaining 62% to 64%.

We expect a gross margin of approximately 68% to 71%, depending on the mix of business in the quarter.

In terms of operating expenses, we expect research and development to be approximately 23% to 25% of revenue, sales and marketing to be approximately 39% to 41% of revenue, and general and administrative to be approximately 9% of revenue.

We expect other income and expenses for the quarter to be approximately $0.6 million and we expect to report a tax provision of approximately $0.3 million.

We expect other charges totaling approximately $5.4 million comprised of the following: $2.8 million related to the amortization of acquired technology; $0.2 million related to the amortization of deferred stock compensation; $1.4 million related to the amortization of intangible assets; and $1.0 million related to acquisition and integration charges. Including these charges, we expect a net loss of $0.02 to $0.03 per share assuming 288 million weighted average shares outstanding.

Outlook

Our objective is to maintain and extend our leadership position as a global provider of applications and products that enable organizations to harness the power of information and the Web to deliver measurable improvements in business efficiency. We will continue to focus on delivering sustained revenue growth and cash generation, expanding our customer base of Global 2000 organizations both at the enterprise and departmental levels, extending our technology and product leadership through internal investment in research and development, expanding our global sales capabilities and extending our partnership alliances with leading technology and services companies.

Our strategy from an execution and distribution perspective is to maintain focus on our selling approach and messaging. Specifically, we will increasingly focus on business problems and their corresponding solutions. We will address specific business imperatives, such as compliance, customer self-service, employee productivity, partner and supplier collaboration, demand generation and expense reduction through areas such as site consolidation and the elimination of manual paper processing. We will also focus on the indirect channel, particularly opportunities to expand our OEM business, and continue our commitment to customer service. We believe these efforts, combined with the new breadth of our solutions, will better position us to meet and exceed customer demands for an integrated set of best-of-breed applications and capture market share.

The primary risk to achieving our goals is competitive pressure, particularly from larger companies with much longer operating histories and greater resources. Moreover, many of these companies can adopt aggressive pricing policies and provide customers with consolidated offerings that may include some of our product capabilities. Other key risks include market acceptance of our products, successful integration of the Intraspect and Tower Technology acquisitions, the overall level of information technology spending and our ability to maintain control over expenses and cash. Our prospects must be considered in light of these risks, particularly given that we operate in new and rapidly evolving markets, have completed several acquisitions and face an uncertain economic environment. We may not be successful in addressing such risks and difficulties. Please refer to the “Risk Factors that May Affect Future Results” section for more information.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which were prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Estimates and assumptions are reviewed periodically. Actual results may differ from these estimates under different assumptions or conditions.

Management has discussed with and agreed upon the development and selection of the following critical accounting policies with the Audit Committee of the Board of Directors:

•

Revenue recognition;

•

Estimating the allowance for doubtful accounts;

•

Valuation of long-term investments;

•

Estimating business restructuring accruals; and

•

Valuation of goodwill and identifiable intangible assets.

Revenue recognition. Revenue consists of product and service fees. Product fee income is earned through the licensing or right to use our software and from the sale of specific software products. Service fee income is earned through the sale of maintenance and technical support, consulting services and training services.

We do not recognize revenue for agreements with rights of return, refundable fees, cancellation rights or acceptance clauses until such rights to return, refund or cancel have expired or acceptance has occurred.

We recognize revenue in accordance with Statement of Position (“SOP”) 97-2, Software Revenue Recognition, as amended by SOP 98-4 and SOP 98-9, and Securities and Exchange Commission Staff Accounting Bulletin (“SAB”) 101, Revenue Recognition in Financial Statements as revised by SAB 104.

Where software licenses are sold with maintenance or other services, we allocate the total fee to the various elements based on the fair values of the elements specific to us. We determine the fair value of each element in the arrangement based on vendor-specific objective evidence (“VSOE”) of fair value. VSOE of fair value is based upon the normal pricing and discounting practices for those products and services when sold separately and, for support services, is additionally measured by the renewal rate. If we do not have VSOE for one of the delivered elements of an arrangement, but do have VSOE for all undelivered elements, we use the residual method to record revenue. Under the residual method, the arrangement fee is first allocated to the undelivered elements based upon their VSOE of fair value; the remaining arrangement fee, including any discount, is allocated to the delivered element. If the residual method is not used, discounts, if any, are applied proportionately to each element included in the arrangement based on each element’s fair value without regard to the discount.

Revenue allocated to product license fees is recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, we have no significant remaining obligations with regard to implementation, and collection of a fixed or determinable fee is probable. We consider all payments outside our normal payment terms, including all amounts due in excess of one year, to not be fixed and determinable, and such amounts are recognized as revenue as they become due. If collectibility is not considered probable, revenue is recognized when the fee is collected. For software arrangements where we are obligated to perform professional services for implementation, we do not consider delivery to have occurred or customer payment to be probable of collection until no significant obligations with regard to implementation remain. Generally, this would occur when substantially all service work has been completed in accordance with the terms and conditions of the customer’s implementation requirements but may vary depending on factors such as an individual customer’s payment history or order type (e.g., initial versus follow-on).

Revenue from perpetual licenses that include unspecified, additional software products is recognized ratably over the term of the arrangement, beginning with the delivery of the first product.

Revenue allocated to maintenance and support is recognized ratably over the maintenance term (typically one year).

Revenue allocated to training and consulting service elements is recognized as the services are performed. Our consulting services are not essential to the functionality of our products as (i) such services are available from other vendors and (ii) we have sufficient experience in providing such services.

Deferred revenue includes amounts received from customers in excess of revenue recognized. Accounts receivable includes amounts due from customers for which revenue has been recognized.

We follow very specific and detailed guidelines, discussed above, in determining revenues; however, certain judgments and estimates are made and used to determine revenue recognized in any accounting period. Material differences may result in the amount and timing of revenue recognized for any period if different conditions were to prevail. For example, in determining whether collection is probable, we assess our customers’ ability and intent to pay. Our actual experience with respect to collections could differ from our initial assessment if, for instance, unforeseen declines in the overall economy occur and negatively impact our customers’ financial condition.

Allowance for doubtful accounts. We continuously assess the collectibility of outstanding customer invoices and in doing such, we maintain an allowance for estimated losses resulting from the non-collection of customer receivables. In estimating this allowance, we consider factors such as: historical collection experience, a customer’s current credit-worthiness, customer concentrations, age of the receivable balance, both individually and in the aggregate, and general economic conditions that may affect a customer’s ability to pay. Actual customer collections could differ from our estimates. For example, if the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Long-term investments. Long-term investments include investments in equity securities of both private and public companies and restricted certificates of deposit with original maturities in excess of one year. Long-term investments are recorded at their estimated fair value. We periodically analyze our long-term investments for impairments considered other than temporary. In performing this analysis, we evaluate whether general market conditions which reflect prospects for the economy as a whole, or information pertaining to an investment’s industry or that individual company, indicates that a decline in value that is other than temporary has occurred. If so, we consider specific factors, including the financial condition and near-term prospects of each investment, any event that may affect the investee company, and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. We record an investment impairment charge in the line item “Other income (expense), net” when we believe an investment has experienced a decline in value that is other than temporary.

Future adverse changes in market conditions or poor operating results of underlying investments could result in losses or an inability to recover the carrying value of the investments that may not be reflected in an investment’s current carrying value, thereby possibly requiring an impairment charge in the future.

Business restructuring. We vacated excess leased facilities as a result of the restructuring plan we initiated in 2001 and subsequently expanded in 2002, 2003 and 2004. We recorded an accrual for the remaining lease liabilities of such vacated properties as well as brokerage commissions, partially offset by estimated sublease income. We estimated the costs of these excess leased facilities, including estimated costs to sublease and sublease income, based on market information and trend analysis. We continually assess our real estate portfolio and may vacate or occupy other leased space as dictated by our analysis. Actual results could differ from these estimates. In particular, actual sublease income attributable to the consolidation of excess facilities might deviate from the assumptions used to calculate our accrual for facility lease commitments.

Goodwill and identifiable intangible assets. We adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (“Statement 142”) on January 1, 2002. In accordance with Statement 142, we replaced the ratable amortization of goodwill and other indefinite-lived intangible assets with a periodic review and analysis for possible impairment. We assess our goodwill on October 1 of each year and during an interim period if facts or circumstances would more likely than not suggest that the fair value of an identified reporting unit is below its carrying value. There was no impairment charge related to goodwill or other intangible assets in 2003 or during the quarter or six months ended June 30, 2004.

Results of Operations

The following table sets forth, for the periods indicated, certain items from our Condensed Consolidated Statements of Operations, expressed as a percentage of total revenues:


	Three Months Ended June 30,				Six Months Ended June 30,
	2004		2003		2004		2003
Revenue:
Product license	36	%	37	%	36	%	39	%
Services	64		63		64		61

Total revenue	100		100		100		100
Cost of revenue:
Product license	3		1		3		1
Amortization of acquired technology	6		2		5		2
Services	29		25		29		25

Total cost of revenue	38		28		37		28

Gross profit	62		72		63		72
Operating expenses:
Research and development	22		26		24		28
Sales and marketing	41		40		44		43
General and administrative	10		9		11		10
Purchased in-process research and development, acquisition-related and other charges	2		3		8		3
Business restructuring charges (gain)	(1	)	(3	)	10		(2	)
Amortization of deferred stock compensation	—		1		—		1
Amortization of intangibles	3		1		3		1

Total operating expenses	77		77		100		84

Loss from operations	(15	)	(5	)	(37	)	(12	)

Other income (expense), net	2		4		2		3

Loss before provision for income taxes	(13	)	(1	)	(35	)	(9	)
Provision for income taxes	1		1		1		1

Net loss	(13	)%	(2	)%	(36	)%	(10	)%

Comparison of the three and six months ended June 30, 2004 to the three and six months ended June 30, 2003 (in thousands, unless otherwise noted).

Revenue


	Three Months Ended June 30,						Six Months Ended June 30,
	2004		2003		fluctuation		2004		2003		fluctuation
Product license	$	16,852	$	14,950	13	%	$	31,530	$	31,401	—
Maintenance and support		18,386		15,776	17	%		34,096		30,490	12	%
Professional services		11,574		9,592	21	%		20,866		19,223	9	%

Total services revenue		29,960		25,368	18	%		54,962		49,713	11	%

Total revenue	$	46,812	$	40,318	16	%	$	86,492	$	81,114	7	%

Total revenue increased 16% in the three months ended June 30, 2004, compared to the three months ended June 30, 2003. This increase is primarily attributable to revenue generated from our recent business combinations with Intraspect and Tower Technology as partially offset by the continued challenges in information technology spending.

Total revenue increased 7% in the six months ended June 30, 2004 from $81.1 million in the six months ended June 30, 2003. This increase is primarily attributable to revenue generated from our recent business combinations.

Product license. Product license revenue increased 13% during the three months ended June 30, 2004 due to the addition of the collaboration product and document and records management, imaging, and workflow products to our suite of product offerings. Product license revenue remained flat in the six months ended June 30, 2004 compared to the six months ended June 30, 2003.

Services. Services revenue increased 18% in the three months ended June 30, 2004, compared to the same period in 2003 and 11% for the six months ended June 30, 2004 compared to the six months ended June 30, 2003. This increase was primarily driven by increased maintenance and support revenue attributable to our recent acquisitions of Intraspect and Tower Technology.

During the comparative three and six months ended June 30, 2004 and 2003, no single customer accounted for more than 10% of our total revenues. International revenue was $18.1 million and $9.6 million, or 39% and 24% of total revenues in the three months ended June 30, 2004 and 2003, respectively. International revenue was $30.3 million and $20.7 million or 35% and 26% of total revenues, in the six months ended June 30, 2004 and 2003, respectively. The significant increase in the proportion of revenue generated outside North America is primarily attributable to the Tower Technology acquisition.

Cost of Revenue

Cost of revenue consists of costs to manufacture, package and distribute our products and related documentation, the costs of licensing third-party software incorporated into our products, the amortization of certain acquired technology, and personnel and other expenses related to providing professional and maintenance services.

Cost of revenue amounts and percentages are as follows:


	Three Months Ended June 30,						Six Months Ended June 30,
	2004		2003		fluctuation		2004		2003		fluctuation
Product license	$	1,625	$	527	208	%	$	2,746	$	1,080	154	%
Amortization of acquired technology		2,806		800	251	%		4,774		1,600	198	%

Maintenance and support		3,656		2,010	82	%		6,161		4,195	47	%
Professional services		9,742		7,933	23	%		18,543		16,213	14	%

Total cost of services revenue		13,398		9,943	35	%		24,704		20,408	21	%

Total cost of revenue		17,829		11,270	58	%		32,224		23,088	40	%

Gross profit	$	28,983	$	29,048	0	%	$	54,268	$	58,026	(6	)%

As a percent of sales, gross profit represented 62% and 72% for the three months ended June 30, 2004 and June 30, 2003, respectively. For the six months ended June 30, 2004 and 2003, gross profit represented 63% and 72% respectively. The reduction in 2004 over 2003 was primarily due to the amortization of acquired technology related to our Intraspect and Tower Technology acquisitions as well as higher costs of supporting our expanded product offerings.

Operating expenses


	Three Months Ended June 30,								Six Months Ended June 30,
	2004			2003			fluctuation		2004		2003			fluctuation
Research and development	$	10,300		$	10,559		(2	)%	$	20,449	$	22,668		(10	)%
Sales and marketing		19,270			16,292		18	%		38,482		34,520		11	%
General and administrative		4,466			3,643		23	%		9,261		8,444		10	%
Purchased in-process research and development, acquisition- related and other charges		974			1,128		(14	)%		6,897		2,270		204	%
Business restructuring charges		(519	)		(1,388	)	(63	)%		8,660		(1,388	)	724	%
Amortization of deferred stock compensation		211			237		(11	)%		367		614		(40	)%
Amortization of intangible assets		1,379			442		212	%		2,194		1,051		109	%

Total operating expenses	$	36,081		$	30,913		17	%	$	86,310	$	68,179		27	%

Research and development. Research and development expenses consist primarily of personnel costs to support product development. Research and development expenses decreased 2% in the three months ended June 30, 2004 and 10% in the six months ended June 30, 2004 relative to the same periods in 2003. The decrease related primarily to our restructuring efforts via reduced engineering headcount, lower facilities expenses and other cost-saving measures. Despite this decrease, we believe that continued investment in research and development is critical to attaining our strategic objectives. We, therefore, expect that spending on research and development will increase in future periods, particularly in light of our acquisition of Tower Technology in March 2004.

Software development costs that were eligible for capitalization in accordance with Statement of Financial Accounting Standards No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed, were insignificant during the periods presented. Accordingly, such development costs have been expensed in the period incurred.

Sales and marketing. Sales and marketing expenses consist primarily of salaries and other related costs for sales, marketing and customer care personnel, sales commissions, public relations, marketing materials and tradeshows as well as bad debt charges. Sales and marketing expenses increased 18% in the three months ended June 30, 2004 and 11% in the six months ended June 30, 2004. The increase for the three and six months ended June 30, 2004 compared to the same period in 2003 is attributable to expansion of our direct sales organization. The increase for the six-month period ended June 30, 2004 compared to 2003 was also driven by bad debt charges recorded in the first quarter of 2004. We expect sales and marketing expenses to continue to fluctuate as a percentage of total revenue from period to period due to the timing of new product releases and entry into new market areas, investment in marketing efforts and the timing of domestic and international conferences and trade shows.

General and administrative. General and administrative expenses consist primarily of salaries and other related costs for human resources, finance, accounting, facilities, information technology and legal employees. General and administrative expenses increased 23% in the three months ended June 30, 2004 and 10% in the six months ended June 30, 2004. These increases are due primarily to increased costs associated with the recent growth of our business and increased costs of meeting regulatory reporting requirements. We expect general and administrative expenses in future periods to fluctuate as a percentage of total revenue from period to period based on regulatory requirements, legal proceedings and fees paid to outside professional service providers, particularly related to Sarbanes Oxley compliance activities.

Purchased in-process research and development, acquisition-related and other charges. Acquisition-related and other charges include costs incurred for employees and consultants and relate to product integration and cross training, other employee-related charges and Epicentric contingent compensation arrangements. The following table presents acquisition-related and other charges for the three months ended June 30, 2004 and 2003 (in thousands):


	Three Months Ended June 30,				Six Months Ended June 30,
	2004		2003		2004		2003
Purchased in-process research and development	$	—	$	—	$	4,800	$	—
Cross-training, product integration and other		494		6		1,290		302
Other employee-related charges		480		9		807		86
Contingent compensation		—		1,113		—		1,882

	$	974	$	1,128	$	6,897	$	2,270

Included in the acquired net assets of Tower Technology Pty Limited was purchased in-process research and development (“IPR&D”) efforts that we intended to substantially rework before integrating into our products (in thousands):

Acquired Company

Acquired IPR&D -

Project Description

Estimated

Fair Value

Current Status at

June 30, 2004

Tower Technology Pty Limited (2004)

Tower IDM 20.0^™—Collaborative document management functionality with process automation solutions and decentralization of configuration.

Tower Seraph 4.4^™—provides document review workflows, case management and Section 508 compliance

4,800

Application from this project is being reworked and is expected to be integrated into our product line within 15 months.

The amounts allocated to IPR&D were based on discounted cash flow models that employed cash flow projections for revenue based on the projected incremental increase in revenue that the acquired company expected to receive from the completed IPR&D. Such assumptions were based on management’s estimates and the growth potential of the market. Revenue for the projection periods assumed an annual compound growth rate of 17.5%. Cost of revenue, selling, general and administrative expense, and research and development expense were estimated as a percent of revenue based on the acquired company’s historical results and industry averages. These estimated operating expenses as well as capital charges and applicable income taxes were deducted to arrive at an estimated after-tax cash flow. The after-tax cash flow projections were discounted using a risk-adjusted rate of return ranging from 20% to 22%. Such discount rates were based on the company’s weighted average cost of capital of 20%, as adjusted upwards for the additional risk related to each projects’ development and success.

The resulting IPR&D was expensed at the time of purchase because technological feasibility had not been established and no future alternative uses existed. The efforts required to develop the purchased IPR&D into commercially viable products related to the completion of all planning, designing, prototyping, verification and testing activities that would be necessary to establish that the products could be produced to meet their design specifications, including functions, features and technical performance requirements. The timing for the completion of such efforts was expected to range between twelve and eighteen months.

Further, we were uncertain of our ability to complete the products within a timeframe acceptable to the market and ahead of competitors.

Business restructuring charges. In 2001, we initiated a restructuring program to align our expense and revenue levels and to better position us for growth and profitability. In 2002, 2003 and 2004, we expanded those restructuring efforts. Although we have substantially implemented our restructuring activities, there can be no assurance that the estimated costs of our restructuring efforts will not change. Components of business restructuring charges and the remaining restructuring accruals as of June 30, 2004 are as follows (in thousands):


	Facility Lease Commitments			Asset Impairments			Employee Separation and Other Costs			Total
Balance at December 31, 2000	$	—		$	—		$	—		$	—
Total restructuring charge		55,150			33,683			32,102			120,935
Cash activity		(12,397	)		(878	)		(22,773	)		(36,048	)
Non-cash activity		(292	)		(32,805	)		(1,918	)		(35,015	)

Balance at December 31, 2001		42,461			—			7,411			49,872
Effect of expanded restructuring plan		6,518			8,730			11,118			26,366
Adjustment to accrual		9,538			463			(545	)		9,456
Cash activity		(21,959	)		—			(11,342	)		(33,301	)
Non-cash activity		—			(9,193	)		(36	)		(9,229	)

Balance at December 31, 2002		36,558			—			6,606			43,164
Effect of expanded restructuring plan		9			—			2,076			2,085
Adjustment to accrual		(13,422	)		—			(3,349	)		(16,771	)
Cash activity		(10,620	)		—			(4,961	)		(15,581	)

Balance at December 31, 2003		12,525			—			372			12,897
Effect of expanded restructuring plan		5,950			2,331			898			9,179
Cash activity		(2,337	)		—			(771	)		(3,108	)
Non-cash activity		—			(2,331	)		—			(2,331	)

Balance at March 31, 2004		16,138			—			499			16,637
Adjustment to accrual		(747	)					228			(519	)
Cash activity		(1,757	)					(380	)		(2,137	)

Balance at June 30, 2004	$	13,634		$	—		$	347			13,981
Less: current portion											(8,296	)

Accrued restructuring costs, less current portion										$	5,685

Results for the first quarter of 2004 include net restructuring costs of $9.2 million. In the first quarter of 2004, we moved out of our existing headquarters and relocated to nearby office space that now serves as our headquarters. As such, we recorded a restructuring charge of approximately $8.0 million in the first quarter of 2004 pursuant to FASB Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities. In addition, we incurred severance and other real estate-related expenses of approximately $1.2 million resulting from our business combination with Tower Technology.

Remaining cash expenditures resulting from the restructuring are estimated to be $14.0 million and relate primarily to facility lease commitments, of which the remaining maximum lease commitment is eight years. We have substantially implemented our restructuring efforts initiated in conjunction with this restructuring plan; however, there can be no assurance that the estimated costs of our restructuring efforts will not change.

Facility lease commitments relate to lease obligations for excess office space that we have vacated as a result of the restructuring plan. The Company continues to actively pursue mitigation strategies to dispose of all excess office space through subleasing and/or early termination negotiations where possible. Total lease commitments include the remaining lease liabilities and brokerage commissions, offset by estimated sublease income. The estimated costs of vacating these leased facilities, including estimated costs to sublease and any resulting sublease income, were based on market information and trend analysis. We continually assess our estimates of our real estate portfolio and may vacate and/or occupy other leased space as dictated by its analysis. It is reasonably possible that actual results could continue to differ from these estimates in the near term, and such differences could be material to the financial statements. In particular, actual sublease income attributable to the consolidation of excess facilities might deviate from the assumptions used to calculate our accrual for facility lease commitments. Facility lease commitments relate to our departure from certain office space in Austin, Texas; Brisbane and San Francisco, California; New York, New York; Boston and Waltham, Massachusetts; Slough, United Kingdom; Frankfurt, Germany; Paris, France; Madrid, Spain; and Lane Cove and Melbourne, Australia. The maximum lease commitment of such vacated properties extends through March 2010.

Asset impairments relate to the impairment of certain fixed assets, prepaid royalties and intangible assets. These fixed assets were impaired as a result of our decision to vacate certain office space and align its infrastructure with current and projected headcount.

Employee separation and other costs include severance, related taxes, outplacement and other restructuring charges. As a result of the restructuring activities, we have severed over 1,500 employees during the past three years. Employee groups impacted by the restructuring efforts include personnel in positions throughout the sales, marketing, professional services, engineering and general and administrative functions in all geographies.

Amortization of deferred stock compensation. For stock options issued to employees and the Board of Directors, we record deferred compensation at the grant date if a difference exists between the exercise price and the market value of our common stock. For stock options issued to non-employee, non-director contractors, we record deferred compensation based on the fair value method. For restricted share issuances, we record deferred compensation equal to the market value on the issue date. Deferred stock compensation is amortized on an accelerated basis over the vesting periods of the applicable options and restricted share grants. Amortization of deferred stock compensation is attributable to the following cost categories (in thousands):


	Three Months Ended June 30,				Six Months Ended June 30,
	2004		2003		2004			2003
Cost of revenue - services	$	—	$	—	$	—		$	—
Research and development		1		85		47			200
Sales and marketing		—		19		(48	)		41
General and administrative		210		133		368			373

	$	211	$	237	$	367		$	614

Amortization of intangible assets. Intangible amortization expense increased 212% in the three months ended June 30, 2004, and 109% in the six months ended June 30, 2004 from the same periods in 2003. This increase related to amortization expense for assets assumed from the Intraspect and Tower Technology acquisitions. Amortization expense is recorded ratably over the estimated useful lives of the intangible assets which range from 2 to 6 years.

Other income and expense

Other income and expense, net consists primarily of interest income and expense, as well as recognized investment gains and losses.


	Three Months Ended June 30,						Six Months Ended June 30,
	2004		2003		fluctuation		2004		2003		fluctuation
Other income, net	$	1,126	$	1,276	(12	)%	$	1,635	$	2,311	(29	)%

Other income decreased 12% in the three months ended June 30, 2004 and 29% in the six months ended June 30, 2004 due to the lower cash balances available for investing as well as a general decline in investment yields on our lower cash, cash equivalents and short-term investment balances as partially offset by foreign currency gains incurred in the second quarter of 2004.

At June 30, 2004, our unrestricted, long-term strategic investments totaled $2.5 million. At June 30, 2004, we also had $5.2 million in unrestricted long-term marketable securities. Future adverse changes in market conditions or poor operating results of an investee could require future impairment charges.

Provision for income taxes

Income tax expense consists primarily of estimated withholdings and income taxes due in certain foreign jurisdictions.


	Three Months Ended June 30,						Six Months Ended June 30,
	2004		2003		fluctuation		2004		2003		fluctuation
Provision for income taxes	$	265	$	278	(5	)%	$	495	$	572	(13	)%

We have provided a full valuation allowance on our net deferred tax assets, which includes net operating loss, capital loss and research tax credit carryforwards, because of the uncertainty regarding their realization. Our accounting for deferred taxes under Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (“Statement 109”), involves the evaluation of a number of factors concerning the realizability of our deferred tax assets. In concluding that a full valuation allowance was required, we primarily considered such factors as our history of operating losses and expected future losses and the nature of our deferred tax assets.

Liquidity and Capital Resources

The following table presents selected financial statistics and information (dollars in thousands):


	June 30, 2004		December 31, 2003
Cash and cash equivalents	$	130,776	$	171,939
Short-term investments	$	46,096	$	67,574
Working capital	$	121,314	$	205,749
Current ratio		2.2:1		3.9:1
Days of sales outstanding – for the quarter ended		72		70

At June 30, 2004, we had $176.9 million in cash, cash equivalents and short-term investments and no debt. We generally invest cash exceeding our operating requirements in short-term, investment-grade securities and classify these investments as available-for-sale.

Net cash used in operating activities was $17.6 million and $20.1 million during the first six months of 2004 and 2003, respectively.

Net cash used in investing activities was $25.1 million during the first half of 2004 compared to net cash provided by investing activities of $31.2 million during the first six months of 2003. The increase in investing outflows was primarily due to the purchase of Tower Technology in the first quarter of 2004, as compared to 2003 when we had a net cash inflow resulting primarily from the maturity of our investments in short-term marketable securities, partially offset by purchase consideration for our acquisitions of Epicentric, Inc. and Intraspect Software, Inc. We expect that our future investing activities will generally consist of capital

Net cash provided by financing activities was $2.1 million and $1.5 million during the first six months of 2004 and 2003, respectively. Our financing activities consisted primarily of employee stock option exercises and purchases of employee stock purchase plan shares.

Our long-term investments are classified as available-for-sale and generally consist of common stock in publicly held technology companies, limited partnership interests in a technology incubator, and cash collateral pledged for certain lease obligations. At June 30, 2004, long-term investments totaled $12.5 million, compared to $12.4 million at December 31, 2003. We may continue to invest in companies strategic to our business; however, we do not expect future investments to significantly impact our liquidity position.

At June 30, 2004 and December 31, 2003, we had pledged $10.0 million and $10.2 million, respectively, as cash collateral for certain of our lease obligations. These investments will remain restricted to the extent that the security requirements exist.

We expect our existing cash, cash equivalents and short-term investment balances will continue to decline in the near future. We expect to fund our operations, capital expenditures and investments from a combination of available cash and short-term investment balances and, to a lesser extent, internally generated funds. The consideration paid to the Tower Technology stockholders was comprised of approximately 27.2 million shares of our stock and $49.8 million in cash, including a $3.8 million payment made in July 2004 in lieu of issuing additional shares. We believe that our existing balances will be sufficient to meet our working capital, capital expenditure and investment requirements for at least the next 12 months. We may require additional funds for other purposes and may seek to raise such additional funds through public and private equity financings or from other sources. However, there can be no assurance that additional financing will be available at all or that, if available, such financing will be obtainable on terms favorable to us or that any additional financing will not be dilutive.

Leases

Future minimum payments as of June 30, 2004 under these leases, including operating lease commitments for all vacated properties, are as follows (in thousands):


	Operating Leases		Sublease Income		Capital Leases
Remaining 2004	$	8,446	$	1,085	$	6
2005		14,717		2,021		—
2006		8,767		1,006		—
2007		5,576		712		—
2008		4,424		679		—
Thereafter		9,974		792		—

Total minimum lease payments	$	51,724				6

Total minimum sublease rentals			$	6,295		—

Amounts representing interest						—

Present value of net minimum lease payments (including current portion of $6)					$	6

We do not have any significant contractual obligations other than those leases disclosed above.

RISK FACTORS THAT MAY AFFECT FUTURE RESULTS

You should carefully consider the following risks before making an investment decision. The risks described below are not the only ones that we face. Our business, operating results or financial condition could be materially adversely affected by any of the following risks. The trading price of our common stock could decline due to any of these risks, and you as an investor may lose all or part of your investment. You should also refer to the other information set forth in this report, including our consolidated financial statements and the related notes.

Risks Related to Our Business

We Expect to Incur Future Losses

We have not consistently achieved profitability and we expect to incur net operating losses in the coming quarter and potentially in future quarters. To date, we have primarily funded our operations from the sale of equity securities. We expect to continue to incur significant product development, sales and marketing, and administrative expenses and, as a result, we will need to generate significant revenues to maintain profitability. We cannot be certain that we will generate sufficient revenues to achieve and maintain profitability. If we do return to profitability, we cannot be certain that we can sustain or increase profitability on a quarterly or annual basis in the future.

Our Limited Operating History Makes Financial Forecasting Difficult

We were founded in December 1995 and thus have a limited operating history. As a result of our limited operating history and the unpredictability of market demand since our inception, we cannot forecast revenue and operating expenses based on our historical results. Accordingly, we base our expenses in part on future revenue projections. Most of our expenses are fixed in the short term and we may not be able to quickly reduce spending if our revenues are lower than we had projected. Our ability to forecast accurately our quarterly revenue is limited because our software products have a long sales cycle that makes it difficult to predict the quarter in which sales will occur. We would expect our business, operating results and financial condition to be materially adversely affected if our revenues do not meet our projections and that net losses in a given quarter would be greater than expected.

Recent Acquisitions, Including Our Acquisitions of Epicentric, Inc., Intraspect Software, Inc. (“Intraspect”) and Tower Technology Pty Limited (“Tower Technology”), Could Be Difficult to Integrate, Disrupt Our Business, Dilute Stockholder Value and Adversely Affect Our Operating Results

We completed our acquisitions of Epicentric, Inc. in December 2002, Intraspect Software, Inc. in December 2003 and Tower Technology Pty Limited in March 2004. Failure to successfully address the risks associated with these acquisitions could harm our ability to fully integrate and market products based on the acquired technology. We may discover liabilities and risks associated with these acquisitions that were not discovered in our due diligence prior to signing the respective definitive merger agreements. Although, in each acquisition, a portion of the purchase price was placed in escrow to cover such liabilities, it is possible that the actual amounts required to cover such liabilities will exceed the escrow amount. Additionally, we may acquire other businesses in the future, which would complicate our management tasks. We may need to integrate widely dispersed operations that have different and unfamiliar corporate cultures. These integration efforts may not succeed or may distract management’s attention from existing business operations. Failure to successfully integrate acquisitions could seriously harm our business. Also, our existing stockholders would experience dilution if we financed subsequent acquisitions by issuing equity securities.

We Must Succeed in the Portal, Collaboration and Content Management Market as Well as the Enterprise Content Management and the Document and Records Management Markets if We Are to Realize the Expected Benefits of the Tower Technology and Intraspect Acquisitions

Our long-term strategic plan depends upon the successful development and introduction of products and solutions that address the needs of the portal, collaboration and content management market as well as the enterprise content management and the document and records management markets. For us to succeed in these markets, we must align strategies and objectives and focus a significant portion of our resources towards serving these markets. In addition, we must successfully integrate these various modules into a suite of closely interoperable solutions to maximize return on these investments.

The challenges involved in this integration include the following:

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coordinating and integrating international and domestic operations;

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combining product offerings and product lines quickly and effectively;

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successfully managing difficulties associated with transitioning current customers to new product lines;

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demonstrating to our customers that the acquisition will not result in adverse changes in customer service standards or business focus;

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retaining key alliances; and

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persuading our employees that our business cultures are compatible.

In addition, our success in this new market will depend on several factors, many of which are outside our control including:

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continued growth of the portal, collaboration and content management market;

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continued growth of the enterprise content management and document and records management markets;

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deployment of the combined companies’ products by enterprises; and

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emergence of substitute technologies and products.

If we are unable to succeed in this market, our business may be harmed and we may be prevented from realizing the anticipated benefits of the acquisitions.

We Must Overcome Significant Challenges in Integrating Business Operations and Product Offerings to Realize the Benefits of our Recent Acquisitions of Tower Technology and Intraspect

The Tower Technology and Intraspect acquisitions will not achieve their anticipated benefits unless we successfully combine and integrate business operations and products in a timely manner. Integration will be a complex, time-consuming and expensive process and may result in revenue disruption and operational difficulties if not completed in a timely and efficient manner. Prior to the acquisitions, each company operated independently, each with its own business, business culture, markets, clients, employees and systems. Following the acquisitions, we must operate as a combined organization utilizing common information communication systems, operating procedures, financial controls and human resource practices, including benefits, training and professional development programs. There may be substantial difficulties, costs and delays involved in the integration. These difficulties, costs and delays may include:

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the potential difficulties of integrating international and domestic operations;

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the potential disruption of our ongoing business and diversion of management resources;

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the possibility that the business cultures will not be compatible;

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the difficulty of incorporating acquired technology and rights into our products and services;

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unanticipated expenses related to integration of operations;

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the impairment of relationships with employees and customers as a result of any integration of new personnel;

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potential unknown liabilities associated with the acquired business and technology;

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costs and delays in implementing common systems and procedures, including financial accounting systems and customer information systems; and

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potential inability to retain, integrate and motivate key management, marketing, technical sales and customer support personnel.

We may not succeed in addressing these risks or any other problems encountered in connection with the acquisitions. If the benefits of the acquisitions do not exceed the costs associated with the acquisitions, including the dilution to our stockholders resulting from the issuance of shares in connection with the acquisitions, our financial results could be harmed.

Delays in the Integration of Tower Technology’s and Intraspect’s Technology Could Result in the Loss of the Benefits of the Acquisitions

We operate in a highly competitive environment, characterized by rapid technological change and evolution of standards and frequent new product introductions. To obtain the full potential benefits of the acquisition, we must promptly integrate our business operations, technology and product offerings. We cannot assure you that we will be able to integrate their technology offerings and operations quickly and smoothly. We may be required to spend additional time or money on integration that would otherwise be spent on developing our business or on other matters. If we do not integrate our operations and technology smoothly or if management spends too much time on integration issues, it could harm our business, financial condition and results of operations and diminish the benefits of the acquisition as well as harm our content management business.

Both Vignette and Tower Technology Have Incurred Significant Costs Associated With the Acquisition

We estimate that we have incurred direct transaction costs of approximately $4.7 million associated with the acquisition, which has been included as a part of the total purchase cost for accounting purposes. In addition, Tower Technology has incurred direct transaction costs of approximately $2.8 million. We believe the combined entity may incur charges to operations, which are not currently reasonably estimable, in the quarters which follow, to reflect costs associated with integrating the two companies. We incurred an in-process research and development charge of $4.8 million and we expect ongoing charges for amortization of intangibles, consisting primarily of purchased technology, acquired in the acquisition. There can be no assurance that the combined company will not incur additional material charges in subsequent quarters to reflect additional costs associated with the acquisition.

The Market Price of Our Common Stock May Decline as a Result of the Tower Technology and Intraspect Acquisitions

The market price of our common stock could decline as a result of the acquisitions, based on the occurrence of a number of events, including:

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the failure to successfully integrate;

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delays or failure in the integration of technology;

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the belief that we have not realized the perceived benefits of the acquisitions in a timely manner or at all;

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the issuance of our shares to the Tower Technology and Intraspect stockholders; and

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the potential negative effect of the acquisitions on our operating results, including the impact of amortization of intangible assets, other than goodwill, created by the acquisitions.

There May Be Sales of Substantial Amounts of Our Common Stock After the Tower Technology Acquisition, Which Could Cause Our Stock Price to Fall

A substantial number of shares of our common stock issued in connection with the Tower Technology acquisition may be sold into the public market. As a result, our stock price could fall. Of the approximately 27.2 million shares of our common stock issued in connection with the acquisition, approximately 11.9 million shares are immediately available for resale by the former shareholders of Tower Technology. Under the lock-up agreements, which could be modified at the discretion of management in favor of the former shareholders, the remaining shares will be released and available for sale in the public market in varying amounts between July 13, 2004 and February 25, 2005. In comparison, the average daily trading volume of our common stock for the three-month period ending on May 6, 2004 was approximately 1.6 million shares. A sale of a large number of newly-released shares of our common stock could therefore result in a sharp decline in our stock price. In addition, the sale of these shares could impair our ability to raise capital through the sale of additional stock.

Our Business May Become Increasingly Susceptible to Numerous Risks Associated with International Operations

International operations are generally subject to a number of risks, including:

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expenses associated with customizing products for foreign countries;

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protectionist laws and business practices that favor local competition;

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changes in jurisdictional tax laws including laws regulating intercompany transactions;

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dependence on local vendors;

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multiple, conflicting and changing governmental laws and regulations;

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longer sales cycles;

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difficulties in collecting accounts receivable;

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seasonality of operations;

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foreign currency exchange rate fluctuations; and

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political and economic instability.

The acquisition of Tower Technology substantially increases our international operations. We recorded 39% and 35% of our total revenue for the quarter and six months ended June 30, 2004, respectively, through licenses and services sold to customers located outside of the United States. We expect international revenue to remain a large percentage of total revenue and we believe that we must continue to expand our international sales activities to be successful. Our international sales growth will be limited if we are unable to establish appropriate foreign operations, expand international sales channel management and support organizations, hire additional personnel, customize products for local markets, develop relationships with international service providers and establish relationships with additional distributors and third-party integrators. In that case, our business, operating results and financial condition could be materially adversely affected. Even if we are able to successfully expand international operations, we cannot be certain that we will be able to maintain or increase international market demand for our products.

To date, a majority of our international revenues and costs have been denominated in foreign currencies. A majority of our international revenues and costs will be denominated in foreign currencies in the future. To date, we have not engaged in any foreign exchange hedging transactions and we are, therefore, subject to foreign currency risk.

We Expect Our Quarterly Revenues and Operating Results to Fluctuate

Our revenues and operating results have varied significantly from quarter to quarter in the past and we expect that our operating results will continue to vary significantly from quarter to quarter. A number of factors are likely to cause these variations, including:

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demand for our products and services;

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the timing of sales of our products and services;

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the timing of customer orders and product implementations;

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seasonal fluctuations in information technology purchasing;

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unexpected delays in introducing new products and services;

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increased expenses, whether related to sales and marketing, product development, product migration and customer support, or administration;

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changes in the rapidly evolving market for Web-based applications;

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the mix of product license and services revenue, as well as the mix of products licensed;

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the mix of services provided and whether services are provided by our own staff or third-party contractors;

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the mix of domestic and international sales;

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difficulties in collecting accounts receivable;

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costs related to possible acquisitions of technology or businesses;

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global events, including terrorist activities, military operations and widespread epidemics; and

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the general economic climate;

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changes to our licensing and pricing model.

Accordingly, we believe that quarter-to-quarter comparisons of our operating results are not necessarily meaningful. Investors should not rely on the results of one quarter as an indication of future performance.

We will continue to invest in our research and development, sales and marketing, professional services and general and administrative organizations. We expect such overall spending, in absolute dollars, will increase in future periods, particularly given our recent acquisitions. If our revenue expectations are not achieved, our business, operating results or financial condition could be materially adversely affected and net losses in a given quarter would be greater than expected.

Our Quarterly Results May Depend on a Small Number of Large Orders

In previous quarters, we derived a significant portion of our software license revenues from a small number of relatively large orders. Our operating results could be materially adversely affected if we are unable to complete a significant order that we expected to complete in a specific quarter.

If We Experienced a Product Liability Claim We Could Incur Substantial Litigation Costs

Since our customers use our products for mission-critical applications, errors, defects or other performance problems could result in financial or other damages to our customers. They could seek damages for losses from us, which, if successful, could have a material adverse effect on our business, operating results and financial condition. Although our license agreements typically contain provisions designed to limit our exposure to product liability claims, existing or future laws or unfavorable judicial decisions could negate or alter such limitation of liability provisions. Such claims, if brought against us, even if not successful, would likely be time consuming and costly.

We Face Intense Competition from Other Software Companies, Which Could Make it Difficult to Compete Successfully

Our market is intensely competitive. Our customers’ requirements and the technology available to satisfy those requirements continually change. We expect competition to persist and intensify in the future, including competition resulting from consolidations in the software industry.

Our principal competitors include: in-house development efforts by potential customers or partners; other vendors of software that directly address elements of Web-based applications; and developers of software that address only certain technology components of Web-based applications (e.g., content management, portal, document management, process, collaboration, integration or analytics). In addition, we face increased competition from large companies that includes capabilities similar to our software in larger integrated product offerings.

Many of these companies have longer operating histories and significantly greater financial, technical, marketing and other resources than we do. Many of these companies can also leverage extensive customer bases and adopt aggressive pricing policies to gain market share. Potential competitors may bundle or license their products in a manner that may discourage users from purchasing our products. In addition, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share.

Competitive pressures may make it difficult for us to acquire and retain customers and may require us to reduce the price of our software. We cannot be certain that we will be able to compete successfully with existing or new competitors. If we fail to compete successfully against current or future competitors, our business, operating results and financial condition would be materially adversely affected.

We Depend on Increased Business from Our Current and New Customers and, if We Fail to Grow Our Customer Base or Generate Repeat Business, Our Operating Results Could Be Harmed

If we fail to grow our customer base or generate repeat and expanded business from our current and new customers, our business and operating results would be seriously harmed. Many of our customers initially make a limited purchase of our products and services. Some of these customers may not choose to purchase additional licenses to expand their use of our products. Some of these customers have not yet developed or deployed initial applications based on our products. If these customers do not successfully develop and deploy such initial applications, they may not choose to purchase deployment licenses or additional development licenses. Our business model depends on the expanded use of our products within our customers’ organizations.

In addition, as we introduce new versions of our products or new products, our current customers may not require the functionality of our new products and may not ultimately license these products. Because the total amount of maintenance and support fees we receive in any period depends in large part on the size and number of licenses that we have previously sold, any downturn in our software license revenue would negatively impact our future services revenue. In addition, if customers elect not to renew their maintenance agreements, our services revenue could be significantly adversely affected.

We Have Relied and Expect to Continue to Rely on Sales of Our Earlier Vignette Software Versions for Revenue

We currently derive a substantial portion of our revenues from the product licenses and related upgrades, professional services and support of our earlier Vignette software versions. We continue to market and license our new-generation Vignette product offerings, but we cannot be certain how successful we will be. We expect that we will continue to receive some revenue from earlier versions for at least the next several quarters. If we do not continue to increase revenue related to our earlier software versions or generate revenue from new products and services, our business, operating results and financial condition would be materially adversely affected.

Our Future Revenue is Dependent Upon Our Ability to Successfully Market Our Existing and Future Products

We expect that our future financial performance will depend significantly on revenue from existing and future software products and the related tools that we plan to develop. There are significant risks inherent in a product introduction, such as our Vignette V7 software products and the recently acquired products. Market acceptance of these and future products will depend on continued market development for Web applications and services and the continued commercial adoption of Vignette V7. We cannot be certain that either will occur. We cannot be certain that our existing or future products will meet customer performance needs or expectations when released or that they will be free of significant software defects or bugs. If our products do not meet customer needs or expectations, for whatever reason, upgrading or enhancing the product could be costly and time consuming.

Our Operating Results May Be Adversely Affected by Small Delays in Customer Orders or Product Implementations

Small delays in customer orders or product implementations can cause significant variability in our license revenues and operating results for any particular period. We derive a substantial portion of our revenue from the sale of products with related services. In certain cases, our revenue recognition policy requires us to substantially complete the implementation of our product before we can recognize software license revenue, and any end-of-quarter delays in product implementation could materially adversely affect operating results for that quarter.

To Increase Market Awareness of Our Products and Generate Increased Revenue We Need to Continue to Strengthen Our Sales and Distribution Capabilities

Our direct and indirect sales operations must increase market awareness of our products to generate increased revenue. We cannot be certain that we will be successful in these efforts. Our products and services require a sophisticated sales effort targeted at the senior management of our prospective customers. All new hires will require training and will take time to achieve full productivity. We cannot be certain that our new hires will become as productive as necessary or that we will be able to hire enough qualified individuals or retain existing employees in the future. We plan to expand our relationships with systems integrators and certain third-party resellers to build an indirect influence and sales channel. In addition, we will need to manage potential conflicts between our direct sales force and any third-party reselling efforts.

Failure to Maintain the Support of Third-Party Systems Integrators May Limit Our Ability to Penetrate Our Markets

A significant portion of our sales are influenced by the recommendations of our products made by systems integrators, consulting firms and other third parties that help develop and deploy Web-based applications for our customers. Losing the support of these third parties may limit our ability to penetrate our markets. These third parties are under no obligation to recommend or support our products. These companies could recommend or give higher priority to the products of other companies or to their own products. A significant shift by these companies toward favoring competing products could negatively affect our license and services revenue. Additionally, these organizations may acquire or distribute software products that compete with our products in future periods. If they become our competitors, this could negatively affect our license and services revenue.

Our Lengthy Sales Cycle and Product Implementation Makes It Difficult to Predict Our Quarterly Results

We have a long sales cycle because we generally need to educate potential customers regarding the use and benefits of Web-based applications. Our long sales cycle makes it difficult to predict the quarter in which sales may fall. In addition, since we recognize a portion of our revenue from product sales upon implementation of our product, the timing of product implementation could cause significant variability in our license revenues and operating results for any particular period. The implementation of our products requires a significant commitment of resources by our customers, third-party professional services organizations or our professional services organization, which makes it difficult to predict the quarter when implementation will be completed.

We May Be Unable to Adequately Sustain a Profitable Professional Services Organization, Which Could Affect Both Our Operating Results and Our Ability to Assist Our Customers with the Implementation of Our Products

Customers that license our software often engage our professional services organization to assist with support, training, consulting and implementation of their Web solutions. We believe that growth in our product sales depends in part on our continuing ability to provide our customers with these services and to educate third-party resellers on how to use our products.

During recent quarters, our professional services organization achieved profitability. However, prior to 2000, services costs related to professional services had exceeded, or had been substantially equal to, professional services-related revenue. In this current economic climate, we make periodic capacity decisions based on estimates of future sales, anticipated existing customer needs, and general market conditions. Although we expect that our professional services-related revenue will continue to exceed professional services-related costs in future periods, we cannot be certain that this will occur.

We generally bill our customers for our services on a time-and-materials basis. However, from time to time we enter into fixed-price contracts for services, and may include terms and conditions that may extend the recognition of revenue for work performed into following quarters. On occasion, the costs of providing the services have exceeded our fees from these contracts and such contracts have negatively impacted our operating results.

We May Be Unable to Attract Necessary Third-Party Service Providers, Which Could Affect Our Ability to Provide Sufficient Support, Consulting and Implementation Services for Our Products

We are actively supplementing the capabilities of our services organization by contracting with and educating third-party service providers and consultants to also provide these services to our customers. We may not be successful in attracting additional third-party providers or in educating or maintaining the interest of current third-party providers. In addition, these third parties may not devote sufficient resources to these activities to meet customers’ demand to adequately supplement our services. Additionally, these organizations may acquire or distribute software products that compete with our products in future periods. If they become our competitors, this could negatively affect our revenue.

To Properly Manage Future Growth, We May Need to Continue to Improve Our Operational Systems on a Timely Basis

We have experienced periods of rapid expansion and contraction since our inception. Rapid fluctuations place a significant demand on management and operational resources. To manage such fluctuations effectively, we must continue to improve our operational systems, procedures and controls on a timely basis. If we fail to continue to improve these systems, our business, operating results and financial condition will be materially adversely affected.

We May Be Adversely Affected if We Lose Key Personnel

Our success depends largely on the skills, experience and performance of some key members of our management. If we lose one or more of our key employees, our business, operating results and financial condition could be materially adversely affected. In addition, our future success will depend largely on our ability to continue to attract and retain highly skilled personnel. Like other software companies, we face competition for qualified personnel, particularly in the Austin, Texas area. We cannot be certain that we will be successful in attracting, assimilating or retaining qualified personnel in the future.

If We are Unable to Meet the Rapid Changes in Software Technology, Our Existing Products Could Become Obsolete

The market for our products is marked by rapid technological change, frequent new product introductions and Internet-related technology enhancements, uncertain product life cycles, changes in customer demands, changes in packaging and combination of existing products and evolving industry standards. We cannot be certain that we will successfully develop and market new products, new product enhancements or new products compliant with present or emerging Internet technology standards. New products based on new technologies, new industry standards or new combinations of existing products as bundled products can render existing products obsolete and unmarketable. To succeed, we will need to enhance our current products and develop new products on a timely basis to keep pace with developments related to Internet technology and to satisfy the increasingly sophisticated requirements of our customers.

Internet commerce technology, particularly Web-based applications technology, is complex and new products and product enhancements can require long development and testing periods. Any delays in developing and releasing enhanced or new products could have a material adverse effect on our business, operating results and financial condition.

We Develop Complex Software Products Susceptible to Software Errors or Defects that Could Result in Lost Revenues, or Delayed or Limited Market Acceptance

Complex software products such as ours often contain errors or defects, particularly when first introduced or when new versions or enhancements are released. Despite internal testing and testing by current and potential customers, our current and future products may contain serious defects. Serious defects or errors could result in lost revenues or a delay in market acceptance, which would have a material adverse effect on our business, operating results and financial condition.

Our Product Shipments Could Be Delayed if Third-Party Software Incorporated in Our Products is No Longer Available

We integrate third-party software as a component of our software. The third-party software may not continue to be available to us on commercially reasonable terms. If we cannot maintain positive relationships and licenses to key third-party software, shipments of our products could be delayed or disrupted until equivalent software could be developed or licensed and integrated into our products, which could materially adversely affect our business, operating results and financial condition.

Our Business is Based on Our Intellectual Property and We Could Incur Substantial Costs Defending Our Intellectual Property from Infringement or a Claim of Infringement

In recent years, there has been significant litigation in the United States involving patents and other intellectual property rights. We could incur substantial costs to prosecute or defend any such litigation. Although we are not involved in any such litigation that we believe is material to our business, if we become a party to litigation in the future to protect our intellectual property or as a result of an alleged infringement of other’s intellectual property, we may be forced to do one or more of the following:

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cease selling, incorporating or using products or services that incorporate the challenged intellectual property;

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obtain from the holder of the infringed intellectual property right a license to sell or use the relevant technology, which license may not be available on reasonable terms;

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redesign those products or services that incorporate such technology; and

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refund a pro-rata portion of the original license consideration paid by the customer.

We rely on a combination of patent, trademark, trade secret and copyright law and contractual restrictions to protect our technology. These legal protections provide only limited protection. If we litigated to enforce our rights, it would be expensive, divert management resources and may not be adequate to protect our business.

Anti-Takeover Provisions in Our Corporate Documents and Delaware Law Could Prevent or Delay a Change in Control of Our Company

Certain provisions of our certificate of incorporation and bylaws may discourage, delay or prevent a merger or acquisition that a stockholder may consider favorable. Such provisions include:

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authorizing the issuance of “blank check” preferred stock;

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providing for a classified Board of Directors with staggered, three-year terms;

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prohibiting cumulative voting in the election of directors;

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requiring super-majority voting to effect certain amendments to our certificate of incorporation and bylaws;

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limiting the persons who may call special meetings of stockholders;

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prohibiting stockholder action by written consent; and

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establishing advance notice requirements for nominations for election to the Board of Directors or for proposing matters that can be acted on by stockholders at stockholder meetings.

Certain provisions of Delaware law and our stock incentive plans may also discourage, delay or prevent someone from acquiring or merging with us.

Further, in April 2002, our Board of Directors approved, adopted and entered into a shareholder rights plan referred to as the Plan. The Plan was not adopted in response to any attempt to acquire us, nor were we aware of any such efforts at the time of adoption.

The Plan was designed to enable our stockholders to realize the full value of their investment by providing for fair and equal treatment of all stockholders in the event that an unsolicited attempt is made to acquire us. Adoption of the Plan was intended to guard shareholders against abusive and coercive takeover tactics.

Under the Plan, stockholders of record as of the close of business on May 6, 2002, received one right to purchase a one one-thousandth of a share of Series A Junior Participating Preferred Stock, par $0.01 per share, at a price of $30.00 per one one-thousandth, subject to adjustment. The rights were issued as a non-taxable dividend and will expire 10 years from the date of the adoption of the rights Plan, unless earlier redeemed or exchanged. The rights are not immediately exercisable; however, they will become exercisable upon the earlier to occur of (i) the close of business on the tenth day after a public announcement that a person or group has acquired beneficial ownership of 15 percent or more of our outstanding common stock or (ii) the close of business on the tenth day (or such later date as may be determined by the Board of Directors prior to such time as any person becomes an acquiring person) following the commencement of, or announcement of an intention to make, a tender offer or exchange offer that would result in the beneficial ownership by a person or group of 15 percent or more of our outstanding common stock. If a person or group acquires 15 percent or more of our common stock, then all rights holders except the acquirer will be entitled to acquire our common stock at a significant discount. The intended effect will be to discourage acquisitions of 15 percent or more of our common stock without negotiation with the Board of Directors.

Terrorist Activities and Resulting Military and Other Actions Could Adversely Affect Our Business

The continued threat of terrorism within the United States and abroad, military action in other countries, and heightened security measures may cause significant disruption to commerce throughout the world. To the extent that such disruptions result in delays or cancellations of customer orders, a general decrease in corporate spending on information technology, or our inability to effectively market, sell and deploy our software and services, our business and results of operations could be materially and adversely affected. We are unable to predict whether the threat of terrorism or the responses thereto will result in any long-term commercial disruptions or if such activities or responses will have a long-term material adverse effect on our business, results of operations or financial condition.

If We Account for Our Employee Stock Option and Employee Stock Purchase Plans Using the Fair Value Method, Our Operating Results May be Adversely Affected

It is possible that future laws, rules or regulations will require us to treat all stock-based compensation as a compensation expense using the fair value method. We are not currently required to record any compensation expense using the fair value method in connection with option grants that have an exercise price at or above fair market value and for shares issued under our employee stock purchase plan. If we elected or were required to record an expense for our stock-based compensation plans using the fair value method, we could have significant accounting charges. For example, if we had accounted for stock-based compensation plans using the fair value method, our loss per share for the year ended December 31, 2003 would have been increased by $(0.17) per share.

We Have Incurred Increased Costs in Response to Recently Enacted and Proposed Regulations

Recently enacted and proposed changes in the laws and regulations affecting public companies, including but not limited to the Sarbanes-Oxley Act of 2002, have caused us to incur increased costs as we

evaluate and respond to the resulting requirements. The new rules could make it more difficult for us to obtain certain types of insurance, and we may incur higher costs to obtain coverage similar to our existing policies. Additionally, we have incurred and expect to incur on an ongoing basis increased accounting, audit and legal fees to assist us assess, implement and comply with such rules. The new and proposed rules could also make it more difficult for us to attract and retain qualified persons to serve on our Board of Directors. Although we are evaluating and monitoring developments with respect to these new and proposed rules, we cannot estimate the amount of the additional costs we may incur or the timing of such costs at this time.

Our Financial Statements Could be Impacted by Unauthorized and Improper Actions of Our Personnel

Our financial statements could be adversely impacted by our employees’ errant or improper actions. For instance, revenue recognition depends on, among other criteria, the terms negotiated in our contracts with our customers. Our personnel may act outside of their authority and negotiate additional terms without our knowledge. We have implemented policies to prevent and discourage such conduct, but there can be no assurance that such policies will be followed. For instance, in the event that our sales personnel have negotiated terms that do not appear in the contract and of which we are unaware, whether the additional terms are written or oral, we could be prevented from recognizing revenue in accordance with our plans. Furthermore, depending on when we learn of unauthorized actions and the size of transactions involved, we may have to restate our financial statements for a previously reported period, which would seriously harm our business, operating results and financial condition.

Risks Related to the Software Industry

Our Business is Sensitive to the Overall Economic Environment; a Continued Slowdown in Information Technology Spending Could Harm Our Operating Results

The primary customers for our products are enterprises seeking to launch or expand Web-based initiatives. The continued significant downturn in our customers’ markets and in general economic conditions that result in reduced information technology spending budgets would likely result in a decreased demand for our products and services and harm our business. Industry downturns like these have been, and may continue to be, characterized by diminished product demand, erosion of average selling prices, lower than expected revenues and difficulty making collections from existing customers.

Our Performance Will Depend on the Market for Web-Based Applications Software

The market for Web-based applications software is rapidly evolving. We expect that we will continue to need intensive marketing and sales efforts to educate prospective customers about the uses and benefits of our products and services. Accordingly, we cannot be certain that a viable market for our products will emerge or be sustainable. Enterprises that have already invested substantial resources in other methods of conducting business may be reluctant or slow to adopt a new approach that may replace, limit or compete with their existing systems. Similarly, individuals have established patterns of purchasing goods and services. They may be reluctant to alter those patterns. They may also resist providing the personal data necessary to support our existing and potential product uses. Any of these factors could inhibit the growth of online business generally and the market’s acceptance of our products and services in particular.

There is Substantial Risk that Future Regulations Could Be Enacted that Either Directly Restrict Our Business or Indirectly Impact Our Business by Limiting the Growth of Internet Commerce

As Internet commerce evolves, we expect that federal, state or foreign agencies will adopt regulations covering issues such as user privacy, pricing, content and quality of products and services. If enacted, such laws, rules or regulations could limit the market for our products and services, which could materially adversely affect our business, financial condition and operating results. Although many of these regulations may not apply to our business directly, we expect that laws regulating the solicitation, collection or processing of personal and consumer information could indirectly affect our business. The Telecommunications Act of 1996 prohibits certain types of information and content from being transmitted

over the Internet. The prohibition’s scope and the liability associated with a Telecommunications Act violation are currently unsettled. In addition, although substantial portions of the Communications Decency Act were held to be unconstitutional, we cannot be certain that similar legislation will not be enacted and upheld in the future. It is possible that such legislation could expose companies involved in Internet commerce to liability, which could limit the growth of Internet commerce generally. Legislation like the Telecommunications Act and the Communications Decency Act could dampen the growth in Web usage and decrease its acceptance as a communications and commercial medium.

The United States government also regulates the export of encryption technology, which our products incorporate. If our export authority is revoked or modified, if our software is unlawfully exported or if the United States government adopts new legislation or regulation restricting export of software and encryption technology, our business, operating results and financial condition could be materially adversely affected. Current or future export regulations may limit our ability to distribute our software outside the United States. Although we take precautions against unlawful export of our software, we cannot effectively control the unauthorized distribution of software across the Internet.

Risks Related to the Securities Markets

Our Stock May Not Meet Market Listing Requirements

On October 14, 2002, we received a notice from the Nasdaq Qualifications Department. Such notice indicated that our common stock had closed for 30 consecutive trading days below the applicable minimum bid price of $1.00. The Nasdaq affords a company 90 calendar days in which to demonstrate compliance with National Market Marketplace Rules; specifically, a company’s common stock must close at or above a bid price of $1.00 per share for a minimum of ten consecutive trading days. On November 13, 2002, our stock closed at or above a bid price of $1.00 per share for the tenth consecutive trading day, demonstrating compliance with the National Market Marketplace Rules.

There can be no assurance that we will maintain compliance with the minimum bid price trading requirements, or other requirements, for continued listing on the Nasdaq National Market. Noncompliance with Nasdaq’s Marketplace Rules may materially impair the ability of stockholders to buy and sell shares of our common stock and could have an adverse effect on the market price of, and the efficiency of the trading market for, our common stock, and could significantly impair our ability to raise capital in the public markets should we desire to do so in the future.

Our Stock Price May Be Volatile

The market price of our common stock has been highly volatile and has fluctuated significantly in the past. We believe that it may continue to fluctuate significantly in the future in response to the following factors, some of which are beyond our control:

•

variations in quarterly operating results;

•

changes in financial estimates by securities analysts;

•

changes in market valuations of Internet software companies;

•

announcements by us of significant contracts, acquisitions, restructurings, strategic partnerships, joint ventures or capital commitments;

•

loss of a major customer or failure to complete significant license transactions;

•

additions or departures of key personnel;

•

difficulties in collecting accounts receivable;

•

sales of common stock in the future; and

•

fluctuations in stock market price and volume, which are particularly common among highly volatile securities of Internet and software companies.

Our Business May Be Adversely Affected by Class Action Litigation Due to Stock Price Volatility

In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. We are a party to the securities class action litigation described in Part II, Item 1 of this Report. The defense of the litigation described in Part II, Item 1 may increase our expenses and divert our management’s attention and resources, and an adverse outcome could harm our business and results of operations. Additionally, we may in the future be the target of similar litigation. Future securities litigation could result in substantial costs and divert management’s attention and resources, which could have a material adverse effect on our business, operating results and financial condition.

We May Be Unable to Meet Our Future Capital Requirements

Although we expect our cash balances to decline in the near future, we expect the cash on hand, cash equivalents and short-term investments to meet our working capital and capital expenditure needs for at least the next 12 months. We may need to raise additional funds and we cannot be certain that we would be able to obtain additional financing on favorable terms, if at all. Further, if we issue equity securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of common stock. If we cannot raise funds, if needed, on acceptable terms, we may not be able to develop or enhance our products, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, which could have a material adverse effect on our business, operating results and financial condition.

We May Need to Raise Additional Capital Which May Be Dilutive to Our Stockholders

We may need to raise additional funds for other purposes and we cannot be certain that we would be able to obtain additional financing on favorable terms, if at all. Further, if we issue equity securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of common stock. If we cannot raise funds, if needed, on acceptable terms, we may not be able to develop or enhance our products, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, which could have a material adverse effect on our business, operating results and financial condition.

ITEM 3 — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currency Exchange Rate Risk

The majority of our operations are based in the United States of America and accordingly, the majority of our transactions are denominated in U.S. Dollars. We have operations throughout the Americas, Europe, Asia and Australia where transactions are denominated in the local currency of each location. As a result, our financial results could be affected by changes in foreign currency exchange rates. Although during the second quarter we did not use derivatives to hedge potential exposure to foreign currency exchange rate risk, the Company recently established a foreign exchange policy which will allow for limited, non-speculative hedging activities to protect against fluctuations for specific balance sheet transactions.

Interest Rate Risk

Cash, cash equivalents and short-term investments. Our interest income is sensitive to changes in the general level of U.S. interest rates, particularly since the majority of our investments are in short-term instruments. Due to the nature of our short-term investments, we have concluded that we do not have material interest risk exposure. Our investment policy requires us to invest funds in excess of current operating requirements in:

•

obligations of the U.S. government and its agencies;

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investment grade state and local government obligations;

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securities of U.S. corporations rated A1 or P1 by Standard & Poors or the Moody’s equivalents; and

•

money market funds, deposits or notes issued or guaranteed by U.S. and non-U.S. commercial banks meeting certain credit rating and net worth requirements with maturities of less than two years.

At June 30, 2004, our cash and cash equivalents consisted primarily of commercial paper. Our short-term investments will mature in less than one year from June 30, 2004 and were invested in corporate notes, corporate bonds and medium-term notes in large U.S. institutions and governmental agencies. These securities are classified as available-for-sale and are recorded at their estimated fair value.

Long-term investments. We invest in emerging technology companies considered strategic to our software business. At June 30, 2004, long-term investments consisted of common stock held in publicly-traded technology companies and a limited partnership interest in a technology incubator. We periodically analyze our long-term investments for impairments that could be considered other than temporary. Our investments in redeemable convertible preferred stock in privately-held technology companies were fully impaired as of June 30, 2002. Fair values were based on quoted market prices where available. If quoted market prices were not available, we use a composite of quoted market prices of companies that are comparable in size and industry classification to our portfolio. We classify our long-term investments as available-for-sale and recorded a cumulative net unrealized gain of approximately $0.9 million related to these securities at June 30, 2004.

In addition to strategic investments, we held $10.0 million and $10.2 million in restricted investments at June 30, 2004 and December 31, 2003, respectively. At June 30, 2004, restricted investments were composed of a certificate of deposit and investment grade securities placed with a high credit quality financial institution. Such restricted investments collateralize letters of credit related to certain leased office space security deposits. These investments will remain restricted to the extent that the security requirements exist. All restricted investments mature in 2004 and the average yield of these investments is approximately 1.25%.

ITEM 4 — CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures. Our management evaluated, with the participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

Changes in internal control over financial reporting. There was no change in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

ITEM 1 – LEGAL PROCEEDINGS

Securities class action

shares in the Company’s initial and secondary public offerings to certain customers in exchange for excessive commissions. The plaintiff also asserts that the underwriters engaged in “tie-in arrangements” whereby certain customers were allocated shares of Company stock sold in its initial and secondary public offerings in exchange for an agreement to purchase additional shares in the aftermarket at pre-determined prices. With respect to the Company, the complaint alleges that the Company and its officers and directors failed to disclose the existence of these purported excessive commissions and tie-in arrangements in the prospectus and registration statement for the Company’s initial public offering and the prospectus and registration statement for the Company’s secondary public offering. The Company believes that this lawsuit is without merit and intends to continue to defend itself vigorously.

Litigation and other claims

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

The annual meeting of the Company’s stockholders was held on May 21, 2004. At that meeting, two proposals were submitted to a vote of the Company’s stockholders. Proposal 1 was a proposal to elect two Class II directors (with Thomas E. Hogan and Michael D. Lambert being the nominees) to serve until the 2006 Annual Meeting of Stockholders. Proposal 2 was a proposal to ratify the appointment of Ernst & Young LLP as the Company’s independent public accountants for the fiscal year ending December 31, 2004.


	Number of Votes
Proposal	For	Against	Abstain/ Withhold	Broker Non-Vote
Proposal 1 – Election of directors:
Thomas E. Hogan	237,552,761	—	1,985,189	—
Michael D. Lambert	237,299,408	—	2,238,542	—
Proposal 2 – Ratification of Ernst & Young LLP appointment	235,750,330	3,503,521	284,099	—

ITEM 6 — EXHIBITS AND REPORTS ON FORM 8-K

(a)

Exhibits:


Exhibit Number		Description
31.1		Certification to the Securities and Exchange Commission by Registrant’s Chief Executive Officer, as required by Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification to the Securities and Exchange Commission by Registrant’s Chief Financial Officer, as required by Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certification pursuant to 18 U.S.C. § 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002

(b)	Reports on Form 8-K.

(i)

Vignette Corporation Press Release issued on April 29, 2004 (Items 7 and 12), announcing the financial results for the respective three month period ended March 31, 2004

(ii)

Vignette Corporation Press Release issued on May 10, 2004 (Items 5 and 7), regarding the appointment of Ms. Kathleen Earley to its Board of Directors.

(iii)

On May 17, 2004, Vignette Corporation amended its Form 8-K issued on March 5, 2004, to include audited financial statements of Tower Technology for the year ended June 30, 2003 and unaudited pro forma condensed income statements of Vignette Corporation and Tower Technology for the year ended December 31, 2003 and three months ended March 31, 2004.

(iv)

On June 28, 2004, Vignette Corporation issued Amendment No.1 (Items 2 and 7) to its amended Form 8K/A dated May 17, 2004, to include the unaudited condensed consolidated balance sheet as December 31, 2003 and unaudited statement of operations and unaudited statement of cash flows for the six months ended December 31, 2003 and 2002.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.


		VIGNETTE CORPORATION

Date: July 30, 2004		/s/ Charles W. Sansbury
		Charles W. Sansbury
		*Chief Financial Officer*
		(Duly Authorized Officer and Principal Financial Officer)