UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

Commission File Number 0-25361

ONYX SOFTWARE CORPORATION

1100 – 112 ^th Avenue NE
Suite 100
Bellevue, Washington 98004
(Address of principal executive offices) (Zip code)

(425) 451-8060
(Registrant’s telephone number)

     Indicate by check whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x  No  o

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

     The number of shares of common stock, par value $0.01 per share, outstanding on April 28, 2004 was 14,497,189.

ONYX SOFTWARE CORPORATION

CONTENTS

PART I—FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS

See accompanying notes to condensed consolidated financial statements.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes to condensed consolidated financial statements.

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

See accompanying notes to condensed consolidated financial statements.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes to condensed consolidated financial statements.

ONYX SOFTWARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Description of Business and Basis of Presentation

Description of the Company

     Onyx Software Corporation and subsidiaries (Company) is a leading provider of enterprise-wide customer relationship management (CRM) solutions designed to promote strategic business improvement and revenue growth by enhancing the way businesses market, sell and service their products. Using the Internet in combination with traditional forms of interaction, including phone, mail, fax and e-mail, the Company’s solution helps enterprises to more effectively acquire, manage and maintain customer, partner and other relationships. The Company markets its solution to companies that want to merge new, online business processes with traditional business processes to enhance their customer-facing operations, such as marketing, sales, customer service and technical support. The Company’s solution uses a single data model across all customer interactions, resulting in a single repository for all marketing, sales and service information. It is fully integrated across all customer-facing departments and interaction media. The Company’s solution is designed to be easy to use, widely accessible, rapidly deployable, scalable, flexible, customizable and reliable, which can result in a comparatively low total cost of ownership and rapid return on investment. The Company was incorporated in the state of Washington on February 23, 1994 and maintains its headquarters in Bellevue, Washington.

Interim Financial Information

     The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed, or omitted, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). In the Company’s opinion, the statements include all adjustments necessary (which are of a normal and recurring nature) for a fair presentation of the results for the interim periods presented. These financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2003, included in its Form 10-K filed with the SEC on March 15, 2004. The Company’s results of operations for any interim period are not necessarily indicative of the results of operations for any other interim period or for a full fiscal year.

Reverse Stock Split

     On July 23, 2003, the Company’s shareholders approved a one-for-four reverse stock split. All share and per share amounts in the accompanying condensed consolidated financial statements have been adjusted to reflect this reverse stock split.

Reclassifications

     The Company reclassified prior quarter amounts for long-term accrued liabilities and long-term deferred revenue to conform with the current quarter presentation. Long-term accrued liabilities are liabilities that will not be settled within one year and long-term deferred revenue are revenues that will not be recognized within one year. Such reclassifications had no impact on the results of operations or shareholders’ equity for any quarter presented.

2. Summary of Significant Accounting Policies

Principles of Consolidation

     The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect amounts reported in the financial statements. Changes in these estimates and assumptions may have a material impact on the financial statements. The Company has used

estimates in determining certain provisions, including uncollectible trade accounts receivable, useful lives for property and equipment, intangible assets, tax liabilities and restructuring liabilities.

Revenue Recognition

     The Company recognizes revenue in accordance with accounting standards for software companies, including Statement of Position (SOP) 97-2, “Software Revenue Recognition,” as amended by SOP 98-9, and related interpretations, including Technical Practice Aids.

     The Company generates revenue through two sources: (a) software license revenue and (b) support and service revenue. Software license revenue is generated from licensing the rights to use the Company’s products directly to end-users and vertical service providers (VSPs) and indirectly through value-added resellers (VARs) and, to a lesser extent, through third-party products the Company distributes. Support and service revenue is generated from sales of customer support services, consulting services and training services performed for customers that license the Company’s products.

     License revenue is recognized when a noncancellable license agreement becomes effective as evidenced by a signed contract, the product has been shipped, the license fee is fixed or determinable, and collectibility is probable.

     In software arrangements that include rights to multiple software products and/or services, the Company allocates the total arrangement fee among each of the deliverables using the residual method, under which revenue is allocated to undelivered elements based on vendor-specific objective evidence of fair value of such undelivered elements and the residual amounts of revenue are allocated to delivered elements. Elements included in multiple-element arrangements could consist of software products, maintenance (which includes customer support services and unspecified upgrades), or consulting services. Vendor-specific objective evidence is based on the price charged when an element is sold separately or, in the case of an element not yet sold separately, the price established by authorized management, if it is probable that the price, once established, will not change once the element is sold separately.

     Standard terms for license agreements call for payment within 90 days. Probability of collection is based on the assessment of the customer’s financial condition through the review of its current financial statements or credit reports. For follow-on sales to existing customers, prior payment history is also used to evaluate probability of collection. Revenue from distribution agreements with VARs is typically recognized on the earlier of receipt of cash from the VAR or identification of an end-user. In the latter case, probability of collection is evaluated based on the creditworthiness of the VAR. The Company’s agreements with its customers, VSPs and VARs do not contain product return rights.

     Revenue from maintenance arrangements is recognized ratably over the term of the contract, typically one year. Consulting revenue is primarily related to implementation services performed on a time-and-materials basis or, in certain situations, on a fixed-fee basis, under separate service arrangements. Revenue from consulting and training services is recognized as services are performed. Standard terms for renewal of maintenance arrangements, consulting services and training services call for payment within 30 days.

     Fees from licenses sold together with consulting services are generally recognized upon shipment of the software, provided that the above criteria are met, payment of the license fees do not depend on the performance of the services, and the consulting services are not essential to the functionality of the licensed software. If the services are essential to the functionality of the software, or payment of the license fees depends on the performance of the services, both the software license and consulting fees are recognized under the percentage of completion method of contract accounting.

     If the fee is not fixed or determinable, revenue is recognized as payments become due from the customer. If a nonstandard acceptance period is provided, revenue is recognized upon the earlier of customer acceptance and the expiration of the acceptance period.

Cash Equivalents and Restricted Cash

     The Company considers all highly liquid investments with a remaining maturity of three months or less at the date of purchase to be cash equivalents. At December 31, 2003 and March 31, 2004, the Company’s cash equivalents consisted of money market funds.

     Separately, the Company had $1.3 million in restricted cash at March 31, 2004, which was security for its credit line with Silicon Valley Bank that supports its outstanding letters of credit.

Stock-Based Compensation

     The Company applies the intrinsic-value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, including Financial Accounting Standards Board (FASB) Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation,” an interpretation of APB Opinion No. 25, issued in March 2000, to account for its fixed-plan stock options. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. Under APB Opinion No. 25, because the exercise price of the Company’s employee stock options generally equals the fair value of the underlying stock on the date of grant, no compensation expense is generally recognized.

     Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation,” (SFAS 123) established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS 123. The following table illustrates the effect on net loss had the fair-value-based method been applied to all outstanding and unvested awards in each period.

Other Comprehensive Income

     SFAS No. 130, “Reporting Comprehensive Income,” establishes standards for the reporting and display of comprehensive income and its components in the financial statements. The only items of other comprehensive income that the Company currently reports are foreign currency translation adjustments. Total comprehensive loss for the three months ended March 31, 2003 and 2004 was $3.3 million and $103,000, respectively, which included a translation gain of approximately $129,000 and $492,000, respectively.

3. Restructuring and Other Related Charges

     Restructuring and other related charges represent the Company’s efforts to reduce its overall cost structure. In April and again in September 2001, the Company approved a restructuring plan to reduce headcount, reduce infrastructure and eliminate excess and duplicate facilities. In April 2003, the Company approved a restructuring plan to reduce additional headcount. During 2001, 2002, and 2003, the Company recorded approximately $51.8 million, $8.5 million and $1.4 million, respectively, in restructuring and other related charges. During the first quarter of 2004, the Company recorded approximately $484,000 in restructuring and other related charges.

     The components of the first quarter 2004 charges and a roll-forward of the related liability follow (in thousands):

     The Company issued three five-year warrants to Hines in January 2003 for the purchase of up to an aggregate of 198,750 shares of the Company’s common stock, including a warrant to purchase 66,250 shares of common stock at an exercise price of $10.38 per share, a warrant to purchase 66,250 shares of common stock at an exercise price of $12.11 per share and a warrant to purchase 66,250 shares of common stock at an exercise price of $13.84 per share. If the Company either undergoes a change

of control or issues securities with rights and preferences superior to the Company’s common stock before January 2005, Hines will have the option of canceling any unexercised warrants and receiving a cash cancellation payment of $18.40 per share in the case of the $10.38 warrants, $16.00 per share in the case of the $12.11 warrants and $13.92 per share in the case of the $13.84 warrants. These contingent cash payments aggregate $3.2 million. The Company also entered into a registration rights agreement with Hines, pursuant to which the Company filed a registration statement on February 14, 2003 covering the resale of the shares of the Company’s common stock subject to purchase by Hines under the warrants. The warrant value as of December 31, 2002 was estimated at $920,000 based on (a) the estimated value of the warrants using the Black-Scholes model with an expected dividend yield of 0.0%, a risk-free interest rate of 5.0%, volatility of 85% and an expected life of five years and (b) the estimated value of the cash cancellation payments in the event of a change in control. The warrants are subject to variable accounting and the Company is required to mark the warrants to market at each reporting period. At March 31, 2004, the warrant value was estimated at $443,000 using similar assumptions to those used at December 31, 2002, and is included in long-term liabilities.

     The accounting for excess facilities is complex and requires judgment, as a consequence of which adjustments may be required to the Company’s current restructuring charge. In particular, based on the terms of the warrants issued in connection with the partial lease termination of excess facilities in Bellevue, Washington, the warrants are subject to variable accounting and will be marked to market at each reporting period. Future cash outlays are anticipated through July 2006 unless estimates and assumptions change or the Company is able to negotiate to exit certain leases at an earlier date.

     The current portion of restructuring-related liabilities totaled $1.8 million at March 31, 2004, the long-term portion of restructuring-related liabilities totaled $291,000 at March 31, 2004 and the value of the warrants issued in connection with the termination of certain facility lease obligations was $443,000 at March 31, 2004.

4. Litigation and Contingencies

     The Company, several of its officers and directors and Dain Rauscher Wessels have been named as defendants in a series of related lawsuits filed in the United States District Court for the Western District of Washington on behalf of purchasers of publicly traded Onyx common stock during various time periods. The consolidated amended complaint in these lawsuits alleges that the Company violated the Securities Act of 1933, as amended ( Securities Act), and the Securities Exchange Act of 1934, as amended (Exchange Act) and seeks certification of a class action for purchasers of the Company’s common stock in February 12, 2001 public offering and on the open market during the period January 23, 2001 through July 24, 2001. The parties have executed an agreement to settle the matter on terms that will not require a payment by any of the defendants, inasmuch as the settlement consideration will be paid entirely by insurance proceeds. The court has preliminarily approved the settlement and has set a final approval hearing for June 10, 2004. None of the complaints or claims specifies the amount of damages to be claimed.

     The Company’s directors and some of its officers have been named as defendants in a shareholder derivative lawsuit filed in the Superior Court of Washington in and for King County. The complaint alleges that the individual defendants breached their fiduciary duty and their duty of care to the Company by allegedly failing to supervise the Company’s public statements and public filings with the SEC. The complaint alleges that, as a result of these breaches, misinformation about the Company’s financial condition was disseminated into the marketplace and filed with the SEC. The complaint asserts that these actions have exposed the Company to harmful and costly securities litigation that could potentially result in an award of damages against the Company, and seeks to recover on behalf of the Company any amounts the Company is required to pay in that litigation. The parties have executed an agreement to settle the matter on terms that will not require a payment by any of the defendants, inasmuch as the settlement consideration will be paid entirely by insurance proceeds. The settlement agreement will be presented to the court for approval. The settlements of both the derivative action and the putative class action described above are contingent on both settlements receiving final court approval.

     The Company, one of its officers and one of its former officers have also been named as defendants in a lawsuit filed in the United States District Court for the Southern District of New York on behalf of purchasers through December 6, 2000 of the Company’s common stock sold under the February 12, 1999 registration statement and prospectus for the Company’s initial public offering. The complaint alleges that the Company and the individual defendants violated the Securities Act by failing to disclose excessive commissions allegedly obtained by the Company’s underwriters pursuant to a secret arrangement whereby the underwriters allocated initial public offering shares to certain investors in exchange for the excessive commissions. The complaint also asserts claims against the underwriters under the Securities Act and the Exchange Act in connection with the allegedly undisclosed commissions. The parties have agreed in principle to settle the matter, along with similar lawsuits against more than 300 other issuers. The terms of the settlement, which are in the process of being definitively documented, would require the Company and the other issuers to contribute to the settlement, which is being funded by a

consortium of insurance carriers for the various issuers, only in the event that their carriers become insolvent or their insurance coverage is exhausted. The Company believes it is unlikely that any such contribution by the Company will be required.

     In the event any of the above settlements do not receive final court approval, the Company intends to vigorously defend itself and, where applicable, its officers and directors against these lawsuits and claims, and believes it has several meritorious defenses and, in certain instances, counterclaims. If the Company is not successful in its defense of these claims, however, the Company could be forced to make significant payments to the plaintiffs and their lawyers and such payments, if not covered by the Company’s insurance carriers, could harm its financial condition, operating results and cash flows. Even if these claims are not successful, the litigation could result in substantial costs to the Company and could divert management’s time and attention away from business operations. The uncertainty associated with this unresolved litigation may also impair the Company’s relationships with existing customers and the Company’s ability to obtain new customers.

5. Earnings (Loss) Per Share

     Basic earnings (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share reflects the potential dilution of securities by including other common stock equivalents, including stock options and convertible preferred stock, in the weighted average number of common shares outstanding for a period, if dilutive.

6. Line of Credit

     In documents dated March 28, 2003 and May 5, 2003, the Company amended its Loan and Security Agreement with Silicon Valley Bank (SVB), which was originally entered into in February 2002, and entered into a second Loan and Security Agreement with SVB that is intended to take advantage of a loan guarantee by the Export Import Bank of the United States (Exim Bank). The loan documents were further amended on January 12, 2004 to revise the tangible net worth covenant and the accounts receivable advance rates beginning with the month ended December 31, 2003. Effective March 31, 2004, the Company amended its Loan and Security Agreement and its Loan and Security Agreement (Exim Program) with SVB. Under the terms of these agreements, the Company has a total $10.0 million working capital revolving line of credit and a $500,000 term loan facility with SVB. The $10.0 million working capital revolving line of credit is split between an $8.0 million

domestic facility and a $2.0 million Exim Bank facility. All of the facilities are secured by accounts receivable, property and equipment and intellectual property. The domestic facility allows the Company to borrow up to the lesser of (a) 70% of eligible domestic and individually approved foreign accounts receivable and (b) $8.0 million. The Exim Bank facility allows the Company to borrow up to the lesser of (a) 75% of eligible foreign accounts receivable and (b) $2.0 million. The amount available to borrow under the working capital revolving line of credit is reduced by reserves for outstanding standby letters of credit issued by SVB on the Company’s behalf and 50% of any borrowings under the term loan facility. If the calculated borrowing base falls below the reserves, SVB may require the Company to cash secure the amount by which the reserves exceed the borrowing base. The amount required to be restricted under the loan agreement was $1.3 million, measured as of March 31, 2004. Due to the variability in the Company’s borrowing base, the Company may be subject to restrictions on its cash at various times throughout the year. Any borrowings will bear interest at SVB’s prime rate, which was 4.00% as of March 31, 2004, plus 1.5% (plus 2% for the term loan facility), subject to a minimum rate of 6.0%. The loan agreements require that the Company maintain certain financial covenants based on its adjusted quick ratio and tangible net worth. The Company was in compliance with these covenants, as amended, at March 31, 2004. The Company is also prohibited under the loan and security agreements from paying dividends. The facilities expire in March 2005. Based on the outstanding standby letters of credit relating to long-term lease obligations totaling $6.5 million at March 31, 2004, no additional amounts are currently available under the revolving credit facilities. At March 31, 2004, no amount was borrowed under the term loan facility.

7. Segment and Geographic Information

     The Company and its subsidiaries are principally engaged in the design, development, marketing and support of enterprise-wide CRM solutions designed to promote strategic business improvement and revenue growth by enhancing the way businesses market, sell and service their products. Substantially all revenue results from licensing the Company’s software products and related consulting and customer support (maintenance) services. The Company’s Chief Executive Officer and Chief Financial Officer, who are the Company’s chief operating decision makers, review financial information presented on a consolidated basis, accompanied by disaggregated information about revenue by geographic region for purposes of making operating decisions and assessing financial performance. Accordingly, the Company considers itself to be in a single industry segment, specifically the license, implementation and support of its software applications, and to have only one operating segment. The Company does not prepare reports for, or measure the performance of, its individual software applications and, accordingly, the Company has not presented revenue or any other related financial information by individual software product.

     The Company evaluates the performance of its geographic regions primarily based on revenues. In addition, the Company’s assets are primarily located in its corporate office in the United States and not allocated to any specific region. The Company does not produce reports for, or measure the performance of, its geographic regions on any asset-based metrics. Therefore, geographic information is presented only for revenues.

     Total revenues outside of North America for the three months ended March 31, 2003 and 2004 were $5.2 million and $5.2 million, respectively.

     The following geographic information is presented for the three months ended March 31, 2003 and 2004 (in thousands):

8. Guarantees

     In the ordinary course of business, we are not subject to potential obligations under guarantees that fall within the scope of FASB Interpretation No. 45 “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”, except for standard indemnification and warranty provisions that are contained within many of our customer license and service agreements, and give rise only to the disclosure requirements prescribed by FIN No. 45.

     Indemnification and warranty provisions contained within our customer license and service agreements are generally consistent with those prevalent in our industry. The duration of our product warranties generally does not exceed 180 days following delivery of our products. We have not incurred significant obligations under customer indemnification or warranty provisions historically and do not expect to incur significant obligations in the future. Accordingly, we do not maintain accruals for potential customer indemnification or warranty-related obligations.

9. Onyx Japan

     In September 2000, the Company entered into a joint venture with Softbank Investment Corporation and Prime Systems Corporation to create Onyx Software Co., Ltd. (Onyx Japan), a Japanese corporation, for the purpose of distributing the Company’s technology and product offerings in Japan. In October 2000, the Company made an initial contribution of $4.3 million in exchange for 58% of the outstanding common stock of Onyx Japan. The Company’s joint venture partners invested an additional $3.1 million for the remaining 42% of the common stock of Onyx Japan. Because the Company has a controlling interest, Onyx Japan has been included in its consolidated financial statements. The minority shareholders’ interest in Onyx Japan’s earnings or losses is separately reflected in the statement of operations.

     Under the terms of the joint venture agreement, Prime Systems may, at any time, sell its shares of Onyx Japan stock to a third party, provided that it notifies the Company 90 days prior to doing so. The Company has a right of first refusal to purchase any of Prime Systems’ shares that are offered for resale at the same price for which those shares are being offered to a third party. Further, either the Company or Prime Systems may terminate the joint venture agreement at its discretion . If Prime Systems exercises its right of termination, the Company has the right, at its election, to either (a) buy Prime Systems’ shares at the current fair market value as determined by an appraiser or (b) force a liquidation of Onyx Japan.

     The Company has entered into a distribution agreement with Onyx Japan, which was approved by the minority shareholders, that provides the Company with a fee based on license and maintenance revenues in Japan. During the first quarter of 2003 and 2004, fees charged under this agreement were $135,000 and $145,000, respectively. The intercompany fees are eliminated in consolidation; however, the Company allocates 42% of the fees to the minority shareholders.

     Although profitable in each of the last three quarters ended March 31, 2004, Onyx Japan incurred substantial losses in previous quarters. The minority shareholders’ capital account balance as of March 31, 2004 was $180,000. Additional Onyx Japan losses above approximately $429,000 in the aggregate will be absorbed 100% by the Company, as compared to 58% in prior periods.

     Restructuring efforts carried out in the second half of 2002 significantly reduced the operating expenses of Onyx Japan and increased the probability that Onyx Japan can be cash flow positive, as evidenced by the recent profits generated by Onyx Japan. Nevertheless, additional funding may be required to continue the operation of the joint venture. If Onyx Japan incurs losses in future periods and no additional capital is invested, the Company may have to further restructure Onyx Japan’s operations.

10. Liquidity

     The Company has a total $10.0 million working capital revolving line of credit and a $500,000 term loan facility with SVB. The $10.0 million working capital revolving line of credit is split between an $8.0 million domestic facility and a $2.0 million Exim Bank facility. All of the facilities are secured by accounts receivable, property and equipment and intellectual property. The domestic facility allows the Company to borrow up to the lesser of (a) 70% of eligible domestic and individually approved foreign accounts receivable and (b) $8.0 million. The Exim Bank facility allows the Company to borrow up to the lesser of (a)&