NIKU CORP - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

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

For the quarterly period ended July 31, 2003

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

For the transition period from to

Commission File Number: 000-28797

NIKU CORPORATION

(Exact name of registrant as specified in its charter)


DELAWARE		77-0473454

(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

305 Main Street
Redwood City, CA 94063
(Address of principal executive offices)

Telephone: (650) 298-4600
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (l) 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 o

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

The number of shares outstanding of the registrant’s common stock as of August 31, 2003 was 11,931,402.

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION
	Item 1. Financial Statements
		CONDENSED CONSOLIDATED BALANCE SHEETS
		CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
		CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
		NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures About Market Risk
	Item 4. Controls and Procedures
PART II: OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 2. Changes in Securities and Use of Proceeds
	Item 4. Submission of Matters to a Vote of Security Holders
	Item 6. Exhibits and Reports on Form 8-K
SIGNATURE
Exhibit Index
EXHIBIT 10.1
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

NIKU CORPORATION AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
FOR THE PERIOD ENDED JULY 31, 2003

INDEX


		Page

PART I Financial Information
Item 1. Financial Statements (unaudited):
	Condensed Consolidated Balance Sheets		3
	Condensed Consolidated Statements of Operations and Comprehensive Loss		4
	Condensed Consolidated Statements of Cash Flows		5
	Notes to Condensed Consolidated Financial Statements		6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			11
Item 3. Quantitative and Qualitative Disclosures About Market Risk			25
Item 4. Controls and Procedures			26
PART II Other Information
Item 1. Legal Proceedings			26
Item 2. Changes in Securities and Use of Proceeds			27
Item 4. Submission of Matters to a Vote of Security Holders			27
Item 6. Exhibits and Reports on Form 8-K			27
Signatures			29

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

NIKU CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)


			July 31,		January 31,

			2003		2003

ASSETS
Current Assets:
	Cash and cash equivalents		$	21,675	$	16,670
	Current portion of restricted cash			—		229

		Total cash, cash equivalents and current portion of restricted cash		21,675		16,899
	Accounts receivable, net			4,572		7,211
	Prepaid expenses and other current assets			2,154		1,687

		Total current assets		28,401		25,797
Restricted cash				1,108		1,108
Property and equipment, net				1,758		2,515
Deposits and other assets				908		1,143

		Total assets	$	32,175	$	30,563

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current Liabilities:
	Accounts payable		$	1,668	$	2,422
	Accrued liabilities			4,635		6,180
	Accrued restructuring			2,327		5,550
	Bank borrowings and other short-term obligations			4,264		1,051
	Deferred revenue			7,373		9,375

		Total current liabilities		20,267		24,578
Long-term accrued restructuring				6,896		6,209
Long-term portion of bank borrowings				—		3,750

		Total liabilities		27,163		34,537
Stockholders’ equity (deficit)				5,012		(3,974	)

		Total liabilities and stockholders’ equity (deficit)	$	32,175	$	30,563

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

NIKU CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
(in thousands, except per share data)
(unaudited)


			Three Months Ended						Six Months Ended
			July 31,						July 31,

			2003			2002			2003			2002

Revenue:
	License		$	3,131		$	3,961		$	6,344		$	9,652
	Services			6,877			6,533			13,503			14,969

		Total revenue		10,008			10,494			19,847			24,621

Cost of revenue:
	License			134			303			110			619
	Services (exclusive of stock-based compensation of $1 and ($31) for the three months ended July 31, 2003 and 2002 and $2 and ($291) for the six months ended July 31, 2003 and 2002, respectively)			2,807			3,517			5,457			7,283

		Total cost of revenue		2,941			3,820			5,567			7,902

		Gross profit		7,067			6,674			14,280			16,719

Operating expenses:
	Sales and marketing (exclusive of stock-based compensation of $12 and $109 for the three months ended July 31, 2003 and 2002 and $29 and ($1,841) for the six months ended July 31, 2003 and 2002, respectively)			3,364			7,414			6,946			15,561
	Research and development (exclusive of stock-based compensation of $5 and ($392) for the three months ended July 31, 2003 and 2002 and $13 and ($1,598) for the six months ended July 31, 2003 and 2002, respectively)			1,817			3,993			3,714			8,022
	General and administrative (exclusive of stock-based compensation of $56 and $13 for the three months ended July 31, 2003 and 2002 and $91 and ($217) for the six months ended July 31, 2003 and 2002, respectively)			1,531			2,331			3,068			4,538
	Restructuring and other			1,648			30,405			1,648			29,567
	Stock-based compensation			74			(301	)		135			(3,947	)
	Asset impairment and other			—			425			—			425

		Total operating expenses		8,434			44,267			15,511			54,166

		Operating loss		(1,367	)		(37,593	)		(1,231	)		(37,447	)
Interest and other income (expense), net				(273	)		312			(307	)		432

		Net loss	$	(1,640	)	$	(37,281	)	$	(1,538	)	$	(37,015	)

Basic net loss per share			$	(0.14	)	$	(5.03	)	$	(0.14	)	$	(4.99	)

Shares used in computing basic net loss per share				11,907			7,414			11,182			7,414

Diluted net loss per share			$	(0.14	)	$	(5.03	)	$	(0.14	)	$	(4.99	)

Shares used in computing diluted net loss per share				11,907			7,414			11,182			7,414

Comprehensive loss:
	Net loss		$	(1,640	)	$	(37,281	)	$	(1,538	)	$	(37,015	)
	Foreign currency translation adjustments			86			57			92			118

		Comprehensive loss	$	(1,554	)	$	(37,224	)	$	(1,446	)	$	(36,897	)

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

NIKU CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)


				Six Months Ended
				July 31,

				2003			2002

Cash flows from operating activities:
	Net loss			$	(1,538	)	$	(37,015	)
	Adjustments to reconcile net loss to net cash used in operating activities:
		Depreciation			812			2,361
		Restructuring and other			30			7,962
		Stock-based compensation			135			(3,947	)
		Provision for doubtful accounts receivable			204			128
		Cancellation of interest on notes receivable from stockholders			—			116
		Interest on notes receivable from stockholders			—			(46	)
		Issuance of common stock for services received			6			—
		Changes in operating assets and liabilities:
			Accounts receivable		2,435			5,844
			Prepaid expenses and other current assets		(497	)		2,720
			Accounts payable		(754	)		137
			Accrued liabilities		(1,545	)		(7,826	)
			Accrued restructuring		(2,536	)		18,242
			Deferred revenue		(2,002	)		(2,248	)

			Net cash used in operating activities		(5,250	)		(13,572	)

Cash flows from investing activities:
	Purchases of property and equipment				(36	)		(2,436	)
	Releases of investments of restricted cash, net				229			3,978
	Deposits and other assets				235			756

			Net cash provided by investing activities		428			2,298

Cash flows from financing activities:
	Issuance of common stock				119			388
	Issuance of common stock and warrants in connection with a private placement, net				10,171			—
	Proceeds (repayment) from bank line of credit, net				4,250			(22,000	)
	Repayment of bank term loan				(4,750	)		—
	Repayment of debt and capital lease obligations				(37	)		(170	)

			Net cash provided by (used in) financing activities		9,753			(21,782	)

Net increase (decrease) in cash and cash equivalents					4,931			(33,056	)
Effect of exchange rate changes					74			34
Cash and cash equivalents, beginning of period					16,670			51,585

Cash and cash equivalents, end of period				$	21,675		$	18,563

Supplemental disclosures of cash flow information:
	Cash paid for interest during the period			$	137		$	34

Noncash investing and financing activities:
	Deferred stock-based compensation			$	40		$	—

	Reversal of deferred stock-based compensation			$	—		$	19,224

	Repurchases of common stock in settlement of notes receivable from stockholders			$	—		$	675

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

NIKU CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared by Niku Corporation (Company) and reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the interim periods presented. Such adjustments are of a normal recurring nature. The condensed consolidated results of operations for the interim periods presented are not necessarily indicative of the results for any future interim period or for the entire fiscal year. Certain information and footnote disclosures normally included in the annual consolidated financial statements prepared in accordance with generally accepted accounting principles have been omitted, although the Company believes that the disclosures included are adequate to make the information presented not misleading. The unaudited condensed consolidated financial statements and notes included herein should be read in conjunction with the consolidated financial statements and notes for the fiscal year ended January 31, 2003, included in the Company’s fiscal 2003 Annual Report on Form 10-K, as amended.

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Unless otherwise specified, references to the Company are references to the Company and its consolidated subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America 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 consolidated financial statements and reported consolidated results of operations during the reporting period. Estimates are used for, but not limited to, revenue recognition, allowance for doubtful accounts, depreciation and amortization, sales returns, taxes, impairment, restructuring, accrued liabilities and contingencies. Actual results could differ from those estimates.

Reclassification

Certain reclassifications have been made to prior period amounts to conform to the current period presentation.

Stock Split

On November 21, 2002, the Company effected a one-for-ten reverse stock split of its outstanding common stock. All information regarding common stock, stock options, warrants and income (loss) per share amounts reflects the reverse stock split.

Stock-Based Compensation

The Company uses the intrinsic-value method to account for all of its employee stock-based compensation plans prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees and FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation. Stock-based compensation is being amortized over the vesting period of the individual award in a manner consistent with the method described in Financial Accounting Standards Board (FASB) Interpretation No. 28. The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123, Accounting for Stock-Based Compensation and EITF 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.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure. This statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. This statement also amends the disclosure requirements of SFAS No. 123 to require more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported

results. The Company adopted the annual disclosure requirements of SFAS No. 148 in fiscal 2003. The Company adopted the interim disclosure requirements of SFAS 148 during the first quarter of fiscal 2004.

Under the intrinsic-value method used by the Company to account for its employee stock-based compensation, no compensation cost has been recognized for any stock options granted or restricted stock sold because the exercise price of each option or purchase price of each share of restricted stock equaled or exceeded the fair value of the underlying common stock as of the grant date for each stock option or purchase date of each restricted stock share, except for stock options granted and restricted stock sold from January 31, 1998 through February 28, 2000 (from inception until the Company’s initial public offering) and certain stock options granted in November 2001. With respect to the stock options granted and restricted stock sold from January 31, 1998 to February 28, 2000 and certain stock options granted in November 2001, the Company recorded deferred stock compensation for the difference at the grant or issuance date between the exercise price of each stock option granted or purchase price of each restricted share sold and the fair value of the underlying common stock and such difference is being amortized over the vesting period, consistent with the method described in FASB Interpretation No. 28.

Had compensation costs been recorded by the Company in its consolidated statements of operations in accordance with SFAS No. 123 for all of the Company’s stock-based compensation plans, net income (loss) and basic and diluted net income (loss) per share would have been as follows (in thousands, except per share data):


		Three Months Ended						Three Months Ended						Six Months Ended
		April 30,						July 31,						July 31,

		2003			2002			2003			2002			2003			2002

Net income (loss), as reported		$	102		$	266		$	(1,640	)	$	(37,281	)	$	(1,538	)	$	(37,015	)
Add: Stock-based employee compensation expenses included in reported net income (loss), net of related tax effects			61			(3,646	)		74			(301	)		135			(3,947	)
Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects			(468	)		(2,381	)		(1,221	)		561			(1,689	)		(1,821	)

Pro forma net income (loss)		$	(305	)	$	(5,761	)	$	(2,787	)	$	(37,021	)	$	(3,092	)	$	(42,783	)

Net income (loss) per share:
	Basic	$	0.01		$	0.04		$	(0.14	)	$	(5.03	)	$	(0.14	)	$	(4.99	)

	Diluted	$	0.01		$	0.03		$	(0.14	)	$	(5.03	)	$	(0.14	)	$	(4.99	)

Pro forma net income (loss) per share:
	Basic	$	(0.03	)	$	(0.78	)	$	(0.23	)	$	(4.99	)	$	(0.28	)	$	(5.77	)

	Diluted	$	(0.03	)	$	(0.74	)	$	(0.23	)	$	(4.99	)	$	(0.28	)	$	(5.77	)


		Years Ended January 31,

		2003			2002			2001

Net income (loss), as reported		$	(37,794	)	$	(291,546	)	$	(130,876	)
Add: Stock-based employee compensation expenses included in reported net income (loss), net of related tax effects			(3,647	)		14,402			29,045
Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects			(1,654	)		(23,964	)		(52,048	)

Pro forma net income (loss)		$	(43,095	)	$	(301,108	)	$	(153,879	)

Net income (loss) per share:
	Basic	$	(4.96	)	$	(39.20	)	$	(19.57	)

	Diluted	$	(4.96	)	$	(39.20	)	$	(19.57	)

Pro forma net income (loss) per share:
	Basic	$	(5.66	)	$	(40.49	)	$	(23.01	)

	Diluted	$	(5.66	)	$	(40.49	)	$	(23.01	)

The pro forma net income (loss) and basic and diluted pro forma net income (loss) per share for the three months ended April 30, 2003 and 2002 and for the years ended January 31, 2003, 2002 and 2001 have been presented here to revise the amounts previously disclosed in the Company’s quarterly report on Form 10-Q for the quarter ended April 30, 2003 and annual report on Form 10-K/A for the year ended January 31, 2003.

2. Repricing of Stock Options

On November 12, 2001, the Company’s board of directors, acting pursuant to existing terms of the Company’s stock option plans, approved the repricing of approximately 890,000 outstanding stock options with exercise prices above $7.50. The exercise prices of all such stock options were repriced to $7.50, which was the fair market value of the Company’s stock on November 12, 2001. There were no changes to the vesting schedules or other terms of the repriced stock options. Stock options held by the Company’s former chief executive officer, former executive vice president of strategy and planning, board of directors and non-employees were not repriced. The Company has accounted for the repriced stock options using variable accounting whereby the aggregate intrinsic value of the repriced stock options is continuously remeasured and amortized to stock-based compensation expense over the vesting periods. On April 15, 2003, the Company announced a voluntary stock option exchange program for its employees. Under the program, the Company’s employees were given the opportunity to exchange outstanding stock options previously granted to them with an exercise price greater than or equal to $7.50 per share for a new stock option exercisable for 1.15 shares for each share subject to the tendered stock options, to be granted at a future date, at least six months and a day from the cancellation date. The exercise price of these new stock options will be equal to the fair market value of the Company’s common stock on the date of grant. On the grant date, the new stock options will be vested as to the number of stock options that would have been vested on such date had the old stock options not been tendered plus the number of shares that would have been vested had the old stock option been

exercisable for 15% more shares. The Company’s chief executive officer, chief financial officer, members of the board of directors and non-employees were not eligible to participate in the program. The stock option exchange program did not result in any additional compensation charges or variable plan accounting. On April 15, 2003, stock options for 622,511 shares of common stock were eligible to be exchanged. On May 13, 2003, the Company’s employees tendered stock options for 525,031 shares of common stock. The Company expects to grant its employees stock options to purchase 603,785 shares of common stock at least six months and a day from May 13, 2003. As a result of this stock option exchange program, the Company will no longer incur stock-based compensation for outstanding stock options for approximately 298,000 shares of common stock that were previously repriced in November 2001. The Company will continue to incur stock-based compensation for outstanding stock options for approximately 73,000 shares of common stock that were previously repriced in November 2001 that were not tendered pursuant to the stock option exchange program to the extent that the Company’s stock price increases above $7.50. As of July 31, 2003, the Company had outstanding repriced stock options for approximately 73,000 shares of common stock that were subject to variable accounting. Based on the stock price as of July 31, 2003, the Company recorded no stock-based compensation in the second quarter of fiscal 2004 and in the six months ended July 31, 2003 relating to these repriced stock options. As of July 31, 2003, deferred stock-based compensation relating to these repriced stock options was zero, reflecting the intrinsic value of unvested repriced stock options as of July 31, 2003.

In October 2002, the Company cancelled stock options to purchase 55,000 shares of common stock held by its chief executive officer and immediately thereafter granted him stock options to purchase 150,000 shares of common stock at a price of $1.50, which was the closing price of its common stock on the grant date. As a result, based on the closing price of its common stock of $4.67 on April 30, 2003, the Company recorded $35,000 in stock-based compensation in the first quarter of fiscal 2004. In May 2003, the Company’s chief executive officer exercised all of his repriced stock options to purchase 55,000 shares of common stock and the Company recorded an additional $56,000 in stock-based compensation in May 2003. As all such repriced options were exercised, the Company will no longer be required to record additional stock-based compensation relating to these stock options in the future.

3. Restructuring and Other

In the second quarter of fiscal 2004, the Company recorded $1.6 million in restructuring charges as a result of the Company’s current assessment of sublease opportunities for facilities the Company had previously vacated. In the second quarter of fiscal 2004, the Company also terminated a facility lease in Waltham, Massachusetts. The consideration for this termination included the release to the landlord of a $30,000 security deposit and a lease termination payment of $135,000. The table below represents restructuring activities in the second quarter of fiscal 2004 (in thousands):


				Restructuring
		Accrued		Charges in the			Write Offs in the			Paid in the			Accrued
		as of		Three Months Ended			Three Months Ended			Three Months Ended			as of
		April 30, 2003		July 31, 2003			July 31, 2003			July 31, 2003			July 31, 2003

Restructuring initiated in fiscal 2003
	Severance	$	548		(5	)		—			(531	)	$	12
	Net lease commitment costs on vacated facilities		1,271		314			—			(289	)		1,296
	Computer and car leases		206		5			—			(41	)		170
	Other exit costs		541		(34	)		—			83			590
Restructuring initiated in fiscal 2002
	Net lease commitment costs on vacated facilities		5,842		1,368			(30	)		(192	)		6,988
	Exit costs for business line		173		—			—			(6	)		167

		$	8,581	$	1,648		$	(30	)	$	(976	)	$	9,223

The Company expects that of the restructuring and other charges accrued as of July 31, 2003, severance costs will be paid by the third quarter of fiscal 2004, exit costs for business line (related to legal vertical market) will be paid no later than May 2004, and the net lease commitments on vacated leased facilities will be paid no later than February 2011.

The Company’s restructuring activities for the six months ended July 31, 2003 were as follows (in thousands):


				Restructuring
		Accrued		Charges in the			Write Offs in the			Paid in the			Accrued
		as of		Six Months Ended			Six Months Ended			Six Months Ended			as of
		January 31, 2003		July 31, 2003			July 31, 2003			July 31, 2003			July 31, 2003

Restructuring initiated in fiscal 2003
	Severance	$	1,031		(5	)		—			(1,014	)	$	12
	Net lease commitment costs on vacated facilities		3,635		314			—			(2,653	)		1,296
	Computer and car leases		303		5			—			(138	)		170
	Other exit costs		588		(34	)		—			36			590
Restructuring initiated in fiscal 2002
	Net lease commitment costs on vacated facilities		6,029		1,368			(30	)		(379	)		6,988
	Exit costs for business line		173		—			—			(6	)		167

		$	11,759	$	1,648		$	(30	)	$	(4,154	)	$	9,223

4. Net Loss Per Share

Basic net loss per share is computed using the weighted-average number of outstanding shares of common stock. Diluted net loss per share is computed using the weighted-average number of shares of common stock outstanding and, when dilutive, potential common shares from options and warrants to purchase common stock using the treasury stock method. The following potential common shares have been excluded from the computation of diluted net loss per share because the effect would have been antidilutive (in thousands):


	July 31,

	2003		2002

Shares issuable under stock options		1,215		1,217
Shares issuable under warrants		406		196

The weighted-average exercise price of anti-dilutive options outstanding as of July 31, 2003 and 2002 was $3.86 and $15.40 per share, respectively. The weighted-average exercise price of anti-dilutive warrants as of July 31, 2003 and 2002 was $4.55 and $27.20 per share, respectively.

5. Debt

The Company had a term loan for $5.0 million from a financial institution, which it entered into in September 2002. The term loan was secured by the Company’s tangible and intangible assets, accrued interest at 7.50% per annum and was to mature on February 15, 2004. The Company was required to make quarterly payments of principal and interest on a five-year amortization schedule. The Company had repaid $750,000 plus interest through June 2003. On the maturity date, the remaining principal balance of $3.8 million was to have been due. There were no financial covenants for the quarter ended July 31, 2003. On July 23, 2003, the Company terminated the term loan and repaid $4.3 million outstanding balance of the loan as of such date plus accrued interest.

On July 18, 2003, the Company entered into a $5.0 million line of credit with the same financial institution. The Company had borrowings of $4.3 million as of July 31, 2003, which it repaid in August 2003. The line of credit is secured by the Company’s tangible and intangible assets, accrues interest rate at prime rate plus 0.50% per annum (currently at 4.50%) and expires in July 2004. The line of credit has certain financial covenants, including covenants requiring 1) minimum cash and cash equivalent balance equal to or at least 1.25 times the outstanding principal line balance at each month end, 2) minimum liquidity of $10 million at the end of each fiscal quarter and 3) annual GAAP profitability of at least $1 (excluding restructuring charges for vacated facilities and stock-based compensation) for the period from May 1, 2003 to April 30, 2004. As of July 31, 2003, the Company was in compliance with all financial covenants.

6. Notes Receivable from Stockholder

In November 1999, the Company loaned $1,250,000 to its then president, vertical markets, Joshua Pickus, who is now its chief executive officer, secured by a stock pledge agreement and personal assets, in connection with his purchase of 125,000 shares of the Company’s restricted common stock. The loan initially accrued interest at 6.08% and was to mature in November 2002. In May 2002, the Company extended the maturity date of the loan to November 2004 and reduced the interest rate to 3.21%. In July 2002, the Company repurchased these 125,000 shares of common stock from Mr. Pickus for $675,000, the fair market value of the common stock at that time, and Mr. Pickus used all of this consideration to repay the equivalent principal amount of the note. In connection with this repayment, the Company cancelled $116,000 in accrued interest, which was recorded as compensation expense. The remaining amount of the loan of $674,000, including $99,000 in accrued interest, was reclassified to other assets in the second quarter of fiscal 2003 as there was no longer common stock to secure the loan. This loan remains secured by the personal assets of Mr. Pickus.

On March 16, 2003, Mr. Pickus made a $150,000 payment against this loan, which reduced the interest outstanding as of the date of payment to zero and reduced the principal outstanding to $537,000. On June 2, 2003, Mr. Pickus made a $120,000 payment against this loan which reduced the interest outstanding as of the date of payment to zero and reduced the principal outstanding to $421,000.

7. Segment Reporting

SFAS No. 131, Disclosure About Segments of an Enterprise and Related Information, establishes standards for the reporting by public business enterprises of information about operating segments, products and services, geographic areas and major customers. The method for determining what information to report is based on the way that management organizes the operating segments within the Company for making operational decisions and assessments of financial performance.

The Company’s chief operating decision makers are considered to be the chief executive officer and the chief financial officer. The chief executive officer and the chief financial officer review financial information presented on a consolidated basis for purposes of making operating decisions and assessing financial performance. The Company operates in a single segment: software.

Disaggregated product information is as follows (in thousands):


		Three Months Ended				Six Months Ended
		July 31,				July 31,

		2003		2002		2003		2002

License		$	3,131	$	3,961	$	6,344	$	9,652
Services:
	Consulting		2,925		2,226		5,400		5,680
	Maintenance		3,952		4,307		8,103		9,289

		$	10,008	$	10,494	$	19,847	$	24,621

The Company markets its products primarily from its operations in the United States. International sales are primarily to customers in the United Kingdom, the Netherlands and the rest of Europe. Revenue is attributed to the location of the customers. Geographic information regarding the Company’s revenue is as follows (in thousands):


	Three Months Ended				Six Months Ended
	July 31,				July 31,

	2003		2002		2003		2002

United States	$	6,611	$	7,150	$	12,136	$	15,024
United Kingdom		1,353		1,563		2,565		4,261
The Netherlands		847		534		2,396		1,280
Europe Others		1,197		1,247		2,750		4,056

	$	10,008	$	10,494	$	19,847	$	24,621

The Company’s long-lived assets residing in countries other than in the United States are insignificant.

There were no customers individually representing more than 10% of gross accounts receivables (including unbilled accounts receivable) as of July 31, 2003 and January 31, 2003, respectively. There were no customers individually representing more than 10% of total revenue in the second quarter of fiscal 2004 and 2003 and in the six months ended July 31, 2003 and 2002, respectively.

8. Litigation

these actions, along with hundreds of IPO allocation cases against other issuers, underwriters and directors and officers, be transferred to one judge for coordinated pre-trial proceedings. In July 2002, omnibus motions to dismiss the complaints based on common legal issues were filed on behalf of all issuers, underwriters and directors and officers. By order dated October 8, 2002, the Court dismissed the Company’s officers and directors from the case without prejudice. In an opinion issued on February 19, 2003, the Court granted in part and denied in part the motions to dismiss. The complaints against the Company and the other issuers and underwriters were not dismissed as a matter of law. These cases remain at a preliminary stage and no discovery proceedings have taken place in relation to the issuers. The Company believes that the claims asserted against it in these cases are without merit and the Company intends to defend vigorously against them. These cases seek compensatory damages in unspecified amounts as well as other relief. A proposed settlement between the plaintiffs and issuer defendants is in the process of being negotiated and approved.

9. Subsequent Event

In the Company’s annual meeting held on September 10, 2003, the Company’s stockholders approved an amendment to the Company’s amended and restated certificate of incorporation to reduce the number of authorized shares of common stock from 250,000,000 to 60,000,000.

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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes contained herein and the information contained in our annual report on Form 10-K, as amended, for the fiscal year ended January 31, 2003 and in our other filings with the Securities and Exchange Commission. This discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act. Any statements herein that are not statements of historical fact may be deemed to be forward-looking statements. We may identify these statements by the use of words such as “believe,” “expect,” “anticipate,” “intend,” “potential,” “strategy,” “plan” and similar expressions. These forward-looking statements involve known and unknown risks and uncertainties. Our actual results may differ materially from those set forth in these forward-looking statements as a result of a number of factors, including those described under the caption “Factors That May Affect Future Results” herein and in our annual report on Form 10-K, as amended, for the year ended January 31, 2003 and in our other filings with the Securities and Exchange Commission. These forward-looking statements speak only as of the date of this quarterly report. We do not assume any duty to update them.

Overview

We provide portfolio management software for large enterprises. Our principal customers within these enterprises are information technology departments, new product development groups and consulting organizations. Our software provides executives with current and accurate information on the status of their projects, programs, resources and budgets, giving them the ability to manage their portfolio with control and predictability. Our software also allows project managers and members of project teams to schedule projects, collaborate and communicate on tasks and deliverables, track time and expense, and create and disseminate best practices for project and program management. Our software is based on a web services architecture that is delivered through a web browser. It is designed to integrate easily with other applications through extensible markup language (XML) and to be scalable to support tens of thousands of users.

Critical Accounting Policies, Methods and Estimates

Accounting policies, methods and estimates are an integral part of the consolidated financial statements prepared by management and are based upon management’s current judgments. Those judgments are normally based on knowledge and experience with regard to past and current events and assumptions about future events. Certain accounting policies, methods and estimates are particularly sensitive because of their significance to the financial statements and because of the possibility that future events affecting them may differ markedly from management’s current judgments. While there are a number of accounting policies, methods and estimates affecting our financial statements, areas that are particularly significant include revenue recognition, allowance for doubtful accounts, impairment of long-lived assets and restructuring reserves for vacated leased facilities.

Revenue Recognition

We derive our revenue principally from licenses of our products, maintenance and support of our products, and delivery of implementation services for our products. We offer our products primarily through our direct sales force. We also offer our products indirectly through certain channel partners.

Revenue from license fees is recognized in accordance with Statement of Position 97-2, Software Revenue Recognition (SOP 97-2), as amended by SOP 98-9, which permits revenue recognition when (1) persuasive evidence of an arrangement exists, (2) delivery of the product has occurred and no significant obligations of ours with regard to implementation remain, (3) the fee is fixed or determinable, and (4) collectibility is probable. If there are sales to channel partners, they are recognized upon sell-through to the end-user customer. We define each of the four criteria above as follows:

Persuasive evidence of an arrangement exists. Our customary practice is to have a written contract, which is signed by both the customer and us, or a purchase order from those customers who have previously negotiated a license agreement with us.

Delivery has occurred. Our software may be either physically or electronically delivered to the customer. Delivery is deemed to have occurred upon meeting one of the following criteria as set forth in the revenue contract: (1) the shipment or electronic delivery of the product, (2) notification of receipt of the product by the customer or (3) notification by the customer of acceptance when such acceptance is required by the terms of the contract. If undelivered products or services exist in an arrangement that are essential to the functionality of the delivered product, revenue is recognized when these products or services are delivered.

The fee is fixed or determinable. We negotiate the fees for our products at the outset of an arrangement. In these arrangements, the majority of the licenses are perpetual and related fees are nonrefundable. The fees are generally due within six months or less. We consider fees relating to arrangements with payment terms extending beyond six months not to be fixed or determinable. If the fee is not fixed or determinable, revenue is recognized as payments become due from the customer.

Collectibility is probable. Collectibility is evaluated on a customer-by-customer basis. A customer’s purchase order or waiver of purchase order is generally required with each arrangement. Where appropriate, new customers are subject to a credit review process, which evaluates the customers’ financial position (e.g. cash position and credit rating) and their ability to pay, and existing customers are subject to a review of payment histories. If collectibility is not considered probable at the outset of an arrangement in accordance with our credit review process, revenue is recognized when the fee is collected.

Revenue from multiple-element software arrangements is recognized using the residual value method. The determination of the fair value of maintenance and support and implementation services is based on the objective evidence of the fair value of each element that is specific to us. Our determination of fair value of each element in multiple-element arrangements is based on vendor-specific objective evidence (VSOE). The VSOE for each element is established when the same element is sold separately. We have analyzed and determined that we have sufficient VSOE to allocate revenue to the maintenance and support services and implementation services components of our perpetual license arrangements. VSOE for maintenance and support is determined based upon the customer’s annual renewal rates for this element. We sell our implementation services separately and have established VSOE on that basis.

Assuming all other revenue recognition criteria are met, revenue from licenses is recognized upon delivery using the residual method in accordance with SOP 98-9. Our software products are fully functional upon delivery and implementation and do not require significant modifications. The customer may implement using their own resources or obtain the services of other implementation service organizations to provide these services. Therefore, our implementation services are not considered essential to the functionality of the other elements of the arrangement. The revenue allocable to the implementation services is generally recognized as services are performed. Maintenance and support revenue is deferred and recognized on a straight-line basis over the contractual service period, which is typically one year.

Deferred revenue includes amounts billed to customers for which revenue has not been recognized. Deferred revenue generally results from the following: (1) maintenance and support, (2) implementation services not yet rendered for which we have been paid and (3) transactions in which one of the four revenue recognition criteria has not been met but cash has been received.

Accounts Receivable

Accounts receivable are recorded net of allowances for doubtful accounts and totaled $4.6 million and $7.2 million as of July 31, 2003 and January 31, 2003, respectively. The allowances for doubtful accounts were $915,000 and $1.0 million as of July 31, 2003 and January 31, 2003, respectively. We regularly review the adequacy of our allowance for doubtful accounts after considering the amount of the aged accounts receivable, the age of each invoice, each customer’s expected ability to pay and our collection history with each customer. We review any invoice greater than 30 days past due to determine if an allowance is appropriate based on the risk category using the factors discussed above. In addition, we maintain a reserve for all invoices by applying a percentage to aging

categories based on historical loss experience. The allowance for doubtful accounts represents our best estimate, but changes in circumstances such as our customers’ financial positions may result in a requirement for additional allowances in the future.

Impairment Assessment

We evaluate our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Factors we consider important that could trigger an impairment review include, but are not limited to, a significant decline in our stock price for a sustained period, our market capitalization relative to net book value, significant underperformance relative to historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for our overall business, and significant negative industry or economic trends. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If these assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. The estimate of fair value of an asset considers prices for similar assets and the results of valuation techniques to the extent available under the circumstances. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

There were no asset impairment and other charges in the second quarter of fiscal 2004 or the six months ended July 31, 2003. In the second and third quarter of fiscal 2003, we recorded $425,000 and $75,000, respectively, in asset impairment charges related to a $500,000 strategic equity investment we made in a private company in April 2000. In April 2000, we purchased 75,000 shares of the private company’s common stock at $6.67 per share. In performing an impairment assessment, we consider the private company’s current solvency, future access to capital and recent equity transactions. Based on an analysis of these factors, including the terms in a proposed financing in the second quarter of fiscal 2003, which indicated that its price per share has dropped to $0.32 per share, we determined that the investment impairment was other than temporary and recorded an asset impairment charge in the second and third quarter of fiscal 2003.

Restructuring Reserves for Vacated Leased Facilities

We have recorded restructuring charges in connection with vacating certain leased facilities pursuant to our restructuring program. Costs associated with vacated leased facilities include remaining lease liabilities and brokerage fees, offset by estimated sublease income. Estimated sublease income is determined by taking into consideration the type and condition of the subject property, information regarding the local commercial real estate market and expectations about time to obtain a sublessee provided by local commercial real estate brokerages. We regularly review these estimates in the second quarter and fourth quarter of each year or anytime we have persuasive evidence that a change in estimate has occurred. In the second quarter of fiscal 2004, we recorded an additional $1.6 million in restructuring reserves as a result of our current assessment of sublease opportunities for facilities previously vacated. To the extent that these estimates continue to change due to changes in market conditions, the actual restructuring expenses for vacated leases could vary by material amounts.

Future lease payments, net of estimated sublease income, relating to facilities that we vacated pursuant to our restructuring program amounted to $1.6 million, $1.4 million, $1.2 million, $1.1 million and $922,000 for the twelve months ending July 31, 2004, 2005, 2006, 2007 and 2008, respectively, and $2.3 million thereafter. These amounts are recorded in accrued restructuring and long-term accrued restructuring on the condensed consolidated balance sheets

Private Placement of Common Stock and Warrants to Purchase Common Stock

Reverse Stock Split

On November 21, 2002, we effected a one-for-ten reverse stock split of our outstanding common stock. All information regarding common stock, stock options, warrants and income (loss) per share amounts reflects the reverse stock split.

Repricing of Stock Options

On November 12, 2001, our board of directors, acting pursuant to existing terms of our stock option plans, approved the repricing of approximately 890,000 outstanding stock options with exercise prices above $7.50. The exercise prices of all such stock options were repriced to $7.50, which was the fair market value of our stock on November 12, 2001. There were no changes to the vesting schedules or other terms of the repriced options. Stock options held by our former chief executive officer, former executive vice president of strategy and planning, board of directors and non-employees were not repriced. We have accounted for the repriced stock options using variable accounting whereby the aggregate intrinsic value of the repriced stock options is continuously remeasured and amortized to stock-based compensation expense over the vesting periods. On April 15, 2003, we announced a voluntary stock option exchange program for our employees. Under the program, our employees were given the opportunity to exchange outstanding stock options previously granted to them with an exercise price greater than or equal to $7.50 per share for a new stock option exercisable for 1.15 shares for each share subject to the tendered stock options, to be granted at a future date, at least six months and a day from the cancellation date. The exercise price of these new stock options will be equal to the fair market value of our common stock on the date of grant. On the grant date, the new stock options will be vested as to the number of stock options that would have been vested on such date had the old stock options not been tendered plus the number of shares that would have been vested had the old stock option been exercisable for 15% more shares. Our chief executive officer, chief financial officer, members of the board of directors and non-employees were not eligible to participate in the program. The stock option exchange program did not result in any additional compensation charges or variable plan accounting. On April 15, 2003, stock options for 622,511 shares of common stock were eligible to be exchanged. On May 13, 2003, our employees tendered stock options for 525,031 shares of common stock. We expect to grant our employees stock options to purchase 603,785 shares of common stock at least six months and a day from May 13, 2003. As a result of this stock option exchange program, we will no longer incur stock-based compensation for outstanding stock options for approximately 298,000 shares of common stock that were previously repriced in November 2001. We will continue to incur stock-based compensation for outstanding stock options for approximately 73,000 shares of common stock that were previously repriced in November 2001 that were not tendered pursuant to the stock option exchange program to the extent that our stock price increases above $7.50. Based on the stock price as of July 31, 2003, we recorded no stock-based compensation in the second quarter of fiscal 2004 and in the six months ended July 31, 2003 relating to these repriced stock options. As of July 31, 2003, deferred stock-based compensation relating to these repriced stock options was zero, reflecting the intrinsic value of unvested repriced stock options as of July 31, 2003.

In October 2002, we cancelled stock options to purchase 55,000 shares of common stock held by our chief executive officer and immediately thereafter granted him stock options to purchase 150,000 shares of common stock at a price of $1.50, which was the closing price of our common stock on the grant date. As a result, based on the closing price of our common stock of $4.67 on April 30, 2003, we recorded $35,000 in stock-based compensation in the first quarter of fiscal 2003. In May 2003, our chief executive officer exercised all of his repriced stock options to purchase 55,000 shares of common stock, and we recorded an additional $56,000 in stock-based compensation in May 2003. As all such repriced options were exercised, we will no longer be required to record additional stock-based compensation relating to these stock options in the future.

Pro Forma Financial Results

We prepare and release quarterly unaudited financial statements prepared in accordance with generally accepted accounting principles in the United States of America (GAAP). We also disclose and discuss certain non-GAAP pro forma financial information in the quarterly and annual financial results press release and investor conference call. This non-GAAP pro forma financial information excludes certain non-cash and special charges, consisting primarily of stock-based compensation, restructuring and other charges and impairment charges. We believe that the presentation of non-GAAP pro forma information may be of use to investors because we have historically provided such information and understand that some investors consider it useful in evaluating our on-going operations. However, we urge investors to carefully review the GAAP financial information included as part of our quarterly reports on Form 10-Q and our annual reports on Form 10-K. The investors should also read the portions of our quarterly and annual financial results press releases which compare GAAP financial information with the non-GAAP pro forma financial results, and include a reconciliation of the GAAP and non-GAAP pro forma financial information.

Results of Operations

The following table sets forth certain items in our condensed consolidated statements of operations for the three and six months ended July 31, 2003 and 2002 and expressed as a percentage of total revenue:

Comparison of Three and Six Months Ended July 31, 2003 and 2002


			Three Months Ended						Six Months Ended
			July 31,						July 31,

			2003			2002			2003			2002

Revenue:
	License			31.3	%		37.7	%		32.0	%		39.2	%
	Services			68.7			62.3			68.0			60.8

		Total revenue		100.0			100.0			100.0			100.0

Cost of revenue:
	License			1.3			2.9			0.5			2.5
	Services			28.1			33.5			27.5			29.6

		Total cost of revenue		29.4			36.4			28.0			32.1

		Gross profit		70.6			63.6			72.0			67.9

Operating expenses:
	Sales and marketing			33.6			70.6			35.0			63.2
	Research and development			18.2			38.1			18.7			32.6
	General and administrative			15.3			22.2			15.5			18.4
	Restructuring and other			16.5			289.7			8.3			120.1
	Stock-based compensation			0.6			(2.8	)		0.6			(16.0	)
	Asset impairment and other			—			4.0			—			1.7

		Total operating expenses		84.2			421.8			78.1			220.0

		Operating loss		(13.6	)		(358.2	)		(6.1	)		(152.1	)
Interest and other income, net				(2.8	)		2.9			(1.6	)		1.8

		Net loss		(16.4	)%		(355.3	)%		(7.7	)%		(150.3	)%

Revenue

License. License revenue consists of revenue from licenses of our software products. License revenue was $3.1 million and $4.0 million in the second quarter of fiscal 2004 and 2003, respectively, decreasing 21.0% period over period. License revenue was $6.3 million and $9.7 million in the six months ended July 31, 2003 and 2002, respectively, decreasing 34.3% period over period. We believe that the decrease in license revenue in absolute dollars in the second quarter of fiscal 2004 from the second quarter of fiscal 2003 and in the six months ended July 31, 2003 from the six months ended July 31, 2002 was primarily attributable to a slowdown in corporate information technology spending, a restructuring program we implemented in fiscal 2003 in response to such slowdown in spending that reduced the number of revenue producing account executives, and a decline in the average size of our license sales in part as a result of fewer seats being purchased or a decrease in per seat price. The slowdown in corporate information technology spending was primarily due to deteriorating business conditions for our customers.

Services. Services revenue consists of revenue from the delivery of implementation services and maintenance and support contracts. Services revenue from implementation services was $2.9 million and $2.2 million in the second quarter of fiscal 2004 and 2003, respectively, increasing 31.4% period over period. Services revenue from implementation services was $5.4 million and $5.7 million in the six months ended July 31, 2003 and 2002, respectively, decreasing 4.9% period over period. The increase in services revenue from implementation services in absolute dollars in the second quarter of fiscal 2004 from the second quarter of fiscal 2003 was primarily due to higher utilization of our professional services organization and services revenue from implementation services deferred from the first quarter of fiscal 2004. The decrease in services revenue from implementation services in absolute dollars in the six months ended July 31, 2003 from the six months ended July 31, 2002 was primarily attributable to a decrease in the size of the implementation services organization pursuant to the restructuring program we implemented in fiscal 2003 which reduced revenue generating implementation services consultants and a decrease in license revenue that led to a decrease in demand for implementation services, offset by an increase in utilization in the second quarter of fiscal 2004. Services revenue from maintenance and support contracts was $4.0 million and $4.3 million in the second quarter of fiscal 2004 and 2003, respectively, decreasing 8.2% period over period. Services revenue from maintenance and support contracts was $8.1 million and $9.3 million in the six months ended July 31, 2003 and 2002, respectively, decreasing 12.7% period over period. The decrease in services revenue from maintenance and support in absolute dollars in the second quarter of fiscal 2004 from the second quarter of fiscal 2003 and in the six months ended July 31, 2003 from the six months ended July 31, 2002 was primarily attributable to a decrease in the number of supported users for maintenance renewals and the absence of amortization of deferred maintenance revenue from the ABT acquisition in the second quarter of fiscal 2004 and in the six months ended July 31, 2003, compared to $386,000 and $764,000 of such amortization in the second quarter of fiscal 2003 and in the six months ended July 31, 2002.

Cost of Revenue

Cost of license revenue. Cost of license revenue includes royalties due to third parties for embedding their technologies in our products, product packaging, documentation and shipping costs. Cost of license revenue was $134,000 and $303,000 in the second quarter of fiscal 2004 and 2003, respectively, representing 4.3% and 7.6% of total license revenue in the respective period. Cost of license revenue was $110,000 and $619,000 in the six months ended July 31, 2003 and 2002, respectively, representing 1.7% and 6.4% of total license revenue in the respective period. The decrease in cost of license revenue in absolute dollars in the second quarter of fiscal 2004 from the second quarter of fiscal 2003 and in the six months ended July 31, 2003 from the six months ended July 31, 2002 was primarily attributable to a decline in license revenue and the reversal of $110,000 in royalties previous accrued as a result of a settlement during the first quarter of fiscal 2004 with a third party vendor. Royalties are calculated and paid quarterly based on among other things, percentage of total license revenue, number of seats sold or number of servers on which our customers have our product installed. There were no significant changes in the number of third party technologies we embedded in our products in the second quarter of fiscal 2004 and the six months ended July 31, 2003, compared to the second quarter of fiscal 2003 and the six months ended July 31, 2002.

Cost of services revenue. Cost of services revenue includes salaries and related expenses for our implementation services and maintenance and support personnel and the costs of third parties contracted to provide implementation services to our customers. Cost of services revenue was $2.8 million and $3.5 million in the second quarter of fiscal 2004 and 2003, respectively, representing 40.8% and 53.8% of total services revenue in the respective period. Cost of services revenue was $5.5 million and $7.3 million in the six months ended July 31, 2003 and 2002, respectively, representing 40.4% and 48.7% of total services revenue in the respective period. The decrease in cost of services revenue in absolute dollars in the second quarter of fiscal 2004 from the second quarter of fiscal 2003 was primarily attributable to a $542,000 decrease in facility and information technology (IT) department costs and a $177,000 reduction in salaries and benefits resulting from reductions in headcount effected pursuant to the restructuring program we implemented in fiscal 2003. The decrease in cost of services revenue in absolute dollars in the six months ended July 31, 2003 from the six months ended July 31, 2002 was primarily attributable to a $1.1 million decrease in facility and IT department costs and a $504,000 decrease in salaries and benefits resulting from reductions in headcount effected pursuant to the restructuring program we implemented in fiscal 2003.

Operating Expenses

Sales and marketing. Sales and marketing expenses consist primarily of salaries and benefits, marketing costs, commissions, bonuses, travel and bad debt expense. Sales and marketing expenses were $3.4 million and $7.4 million in the second quarter of fiscal 2004 and 2003, respectively, representing 33.6% and 70.6% of total revenue in each respective period. Sales and marketing expenses were $6.9 million and $15.6 million in the six months ended July 31, 2003 and 2002, respectively, representing 35.0% and 63.2% of total revenue in each respective period. The decrease in sales and marketing expenses in absolute dollars in the second quarter of fiscal 2004 from the second quarter of fiscal 2003 was primarily attributable to a $1.5 million reduction in salaries and benefits resulting from reductions in headcount effected pursuant to the restructuring program we implemented in fiscal 2003, a $1.6 million decrease in facility and IT department costs and a $201,000 decrease in commissions. The decrease in sales and marketing expenses in absolute dollars in the six months ended July 31, 2003 from the six months ended July 31, 2002 was primarily attributable to a $3.5 million decrease in salaries and benefits resulting from reductions in headcount effected pursuant to the restructuring program we implemented in fiscal 2003, a $3.2 million decrease in facility and IT department costs and a $664,000 decrease in commissions.

Research and development. Research and development expenses consist primarily of salaries and benefits associated with the development of new products, the enhancement of existing products and quality assurance and testing costs. Research and development expenses were $1.8 million and $4.0 million in the second quarter of fiscal 2004 and 2003, respectively, representing 18.2% and 38.1% of total revenue in each respective period. Research and development expenses were $3.7 million and $8.0 million in the six months ended July 31, 2003 and 2002, respectively, representing 18.7% and 32.6% of total revenue in each respective period. The decrease in research and development expenses in absolute dollars in the second quarter of fiscal 2004 from the second quarter of fiscal 2003 was primarily attributable to a $1.2 million decrease in facility and IT department costs and a $699,000 decrease in salaries and benefits resulting from reductions in headcount effected pursuant to the restructuring program we implemented in fiscal 2003. The decrease in research and development expenses in absolute dollars in the six months ended July 31, 2003 from the six months ended July 31, 2002 was primarily attributable to a $2.4 million decrease in facility and IT department costs and a $1.5 million decrease in salaries and benefits resulting from reductions in headcount effected pursuant to the restructuring program we implemented in fiscal 2003.

General and administrative. General and administrative expenses consist primarily of salaries and benefits and other related costs for finance, human resource, information technology and legal department employees, professional services fees and other general corporate expenses. General and administrative expenses were $1.5 million and $2.3 million in the second quarter of fiscal 2004 and 2003, respectively, representing 15.3% and 22.2% of total revenue in each respective period. General and administrative expenses were $3.1 million and $4.5 million in the six months ended July 31, 2003 from 2002, respectively, representing 15.5% and 18.4% of total revenue in each respective period. The decrease in general and administrative expenses in absolute dollars in the second quarter of fiscal 2004 from the second quarter of fiscal 2003 was primarily attributable to a $406,000 decrease in facility and IT department costs, a $224,000 decrease in salaries and benefits resulting from reductions in headcount effected pursuant to the restructuring program we implemented in fiscal 2003 and a $142,000 decrease in legal fees. The decrease in general and administrative expenses in absolute dollars in the six months ended July 31, 2003 from the six months ended July 31, 2002 was primarily attributable to a $727,000 decrease in facility and IT department costs, a $250,000 decrease in salaries and benefits resulting from reductions in headcount effected pursuant to the restructuring program we implemented in fiscal 2003 and a $269,000 decrease in legal fees.

Stock-based compensation. Amortization of stock-based compensation was $74,000 and ($301,000) in the second quarter of fiscal 2004 and 2003 and $135,000 and ($3.9 million) in the six months ended July 31, 2003 and 2002, respectively. The stock-based compensation in the second quarter of fiscal 2004 and in the six months ended July 31, 2003 related to the amortization of stock options granted to our chief executive officer that were repriced in October 2002 and the amortization of stock options granted below fair market value prior to our initial public offering in February 2000. The recovery of stock-based compensation in the second quarter of fiscal 2003 and in the six months ended July 31, 2002 was attributable to variable accounting applied to our stock options that were repriced in the fourth quarter of fiscal 2002. As a result of a stock option exchange program we initiated in May 2003 and the exercise of stock options for 55,000 shares of common stock by our chief executive officer in May 2003, we will no longer incur stock-based compensation for outstanding stock options for approximately 298,000 shares of common stock that were previously repriced in November 2001 and outstanding stock options for 55,000 shares of common stock that were previously repriced in October 2002. We will continue to incur stock-based compensation for outstanding stock options for approximately 73,000 shares of common stock that were previously repriced in November 2001 that were not tendered pursuant to the stock option exchange program to the extent that our stock price increases above $7.50.

Stock-based compensation by functional group for the second quarter of fiscal 2004 and 2003 and in the six months ended July 31, 2003 and 2002 are as follows (in thousands):


	Three Months Ended					Six Months Ended
	July 31,					July 31,

Services	$	1	$	(31	)	$	2	$	(291	)
Sales and marketing		12		109			29		(1,841	)
Research and development		5		(392	)		13		(1,598	)
General and administrative		56		13			91		(217	)

	$	74	$	(301	)	$	135	$	(3,947	)

Restructuring and other. In the second quarter of fiscal 2004, we recorded $1.6 million in restructuring charges as a result of our current assessment of sublease opportunities for facilities that we had previously vacated. In the second quarter of fiscal 2004, we also terminated a facility lease in Waltham, Massachusetts. The consideration for this termination included the release to the landlord of a $30,000 security deposit and a lease termination payment of $135,000. There were no restructuring charges in the first quarter of fiscal 2004.

We recorded $30.4 million and $29.6 million in restructuring and other charges in the second quarter of fiscal 2003 and in the six months ended July 31, 2002, respectively. In the second quarter of fiscal 2003, we implemented a restructuring program. At the end of such quarter, we restructured our operations and reduced our workforce by approximately 72 employees. These headcount reductions affected all of our functional groups.

We also vacated certain facilities, moved back to our former headquarters, which we had previously vacated in August 2001, and engaged in negotiations to terminate the lease for a significant facility in Redwood City, California, which we terminated in the third quarter of fiscal 2003. The $18.9 million in net lease commitments on vacated facilities recorded in the second quarter of fiscal 2003 includes $18.8 million in cash and non-cash costs related to the proposed termination costs for the facility lease in Redwood City, California and $2.3 million in net lease commitments for certain other facilities that we vacated and leases we terminated, offset by $2.2 million of previously accrued deferred rent under such leases. Our future liabilities under the Redwood City, California lease prior to the proposed termination were approximately $121.7 million.

During the second quarter of fiscal 2003, we also terminated a facility lease in Danville, California. Our future liabilities under this lease prior to termination approximated $2.7 million. The consideration for this termination included the release to the landlord of a $534,000 security deposit, a lease termination payment of $216,000 and $42,000 in fair value for warrants to purchase 15,000 shares of common stock at an exercise price of $0.10 per share.

We retired $7.1 million in property and equipment in connection with vacating certain facilities. We also terminated an equipment lease and purchased the leased assets for $2.0 million. Our future liabilities under this equipment lease prior to termination approximated $380,000. Of the $2.0 million in purchase price, $1.1 million was written off as a restructuring cost due to equipment no longer in use as a result of restructuring.

The $2.4 million in net lease commitments on vacated facilities recorded in the second quarter of fiscal 2003 relating to restructuring activities in fiscal 2002 included a $4.3 million decrease in estimated future sublease income for certain facilities, $1.8 million in settlement of claims asserted in the lawsuit brought by the landlord of our former headquarters, $388,000 in proposed termination costs for a lease in Lincolnshire, Illinois and $296,000 in legal fees, offset by $4.4 million for the reversal of future lease payments that had been previously accrued, net of estimated sublease income, relating to our former headquarters and the Lincolnshire, Illinois lease. Subsequent to the end of the second quarter of fiscal 2003, we terminated the lease in Lincolnshire, Illinois. Our future liabilities under this lease prior to the proposed termination were approximately $692,000, net of estimated sublease income.

In the first quarter of fiscal 2003, we recorded a credit of $838,000 in restructuring and other charges related primarily to the value of 39,052 shares of our common stock recovered from escrow accounts in which they had been placed in conjunction with acquisitions of ABT Corporation, Proamics Corporation and 600 Monkeys Inc. in fiscal 2001. We valued these escrow shares based on our stock price on the date these shares were recovered. The weighted average price per share for these escrow shares was $20.06.

Interest and Other Income (Expense), Net

Interest income and other income (expense), net. Interest income and other income (expense), net, consists of interest income, interest expense and other non-operating expenses. Interest income and other income (expense), net was ($273,000) and $312,000 in the second quarter of fiscal 2004 and 2003 and ($307,000) and $432,000 in the six months ended July 31, 2003 and 2002, respectively. The change to a net interest expense and other expense in the second quarter of fiscal 2004 from a net interest income and other income in the second quarter of fiscal 2003 and in the six months ended July 31, 2003 from the six month ended July 31, 2002 was primarily attributable to foreign exchange losses we incurred from the revaluation of our intercompany balances and interest expense from the $5.0 million bank borrowings under a term loan.

Liquidity and Capital Resources

Since inception, we have financed our operations through private and public sales of our capital stock, bank loans, equipment leases, and cash from sales of our products and delivery of related services. The cash from these sources is used for working capital for our business. As of July 31, 2003, we had cash and cash equivalents of $21.7 million. We also had restricted cash in the amount of $1.1 million in the form of a certificate of deposit securing a letter of credit for a leased facility. We had bank borrowings under a bank line of credit of $4.3 million as of July 31, 2003, of which the entire amount was repaid in August 2003. As of July 31, 2003, we had working capital of $8.1 million, compared to working capital of $1.2 million as of January 31, 2003. The increase in working capital as of July 31, 2003 was primarily attributable to increases in cash and cash equivalents in connection with our recent private placement described below, an increase in prepaid expenses and a decrease in accrued restructuring, offset in part by a reclassification of long-term portion of bank borrowings to short-term bank borrowings and a decrease in net accounts receivable. We believe that cash from operations and existing cash, including approximately $10.2 million net proceeds from the private placement, will be sufficient to meet our current expectations for working capital and expense requirements for at least the next twelve months. As of July 31, 2003, we had no material commitments for capital expenditures. Our liquidity could be negatively impacted by factors discussed under “Factors That May Affect Future Results.”

subsequently issued the remaining 1,538,495 shares of our common stock and warrants to purchase 192,314 shares of common stock. Total net proceeds from the private placement approximated $10.2 million.

Net cash used in operating activities was $5.3 million and $13.6 million in the six months ended July 31, 2003 and 2002, respectively. Net cash used in operating activities in the six months ended July 31, 2003 was primarily attributable to decreases in accrued restructuring, deferred revenue, accrued liabilities and a net loss of $1.5 million, offset in part by a decrease in accounts receivable. Net cash used in operating activities in the six months ended July 31, 2002 was primarily attributable to a net loss of $37.0 million and a decrease in accrued liabilities, offset in part by an increase in accrued restructuring, non-cash restructuring charges and a decrease in net accounts receivable.

Net cash provided by investing activities was $428,000 and $2.3 million in the six months ended July 31, 2003 and 2002, respectively. Net cash provided by investing activities in the six months ended July 31, 2003 was primarily attributable to a release of investments of restricted cash and a decrease in deposits and other assets. Net cash provided by investing activities in the six months ended July 31, 2002 was primarily attributable to a release of investments of restricted cash, offset in part by purchases of property and equipment.

Net cash provided by (used in) financing activities was $9.8 million and ($21.8 million) in the six months ended July 31, 2003 and 2002, respectively. Net cash provided by financing activities in the six months ended July 31, 2003 was primarily attributable to net proceeds from the issuance of common stock and warrants in connection with the private placement and proceeds from a bank line of credit, offset in part by repayment of a bank term loan. Net cash used in financing activities in the six months ended July 31, 2002 was primarily attributable net repayment of bank line of credit.

We had a term loan for $5.0 million from a financial institution, which we entered into in September 2002. The term loan was secured by our tangible and intangible assets, accrued interest at 7.50% per annum and was to mature on February 15, 2004. We were required to make quarterly payments of principal and interest on a five-year amortization schedule. We had repaid $750,000 plus interest through June 2003. On the maturity date, the remaining principal balance of $3.8 million was to have been due. There were no financial covenants for the quarter ended July 31, 2003. On July 23, 2003, we terminated the term loan and repaid $4.3 million outstanding balance of the loan as of such date plus accrued interest.

On July 18, 2003, we entered into a $5.0 million line of credit with the same financial institution. We had borrowings of $4.3 million as of July 31, 2003, which we repaid in August 2003. The line of credit is secured by our tangible and intangible assets, accrues interest rate at prime rate plus 0.50% per annum (currently at 4.50%) and expires in July 2004. The line of credit has certain financial covenants, including covenants requiring 1) minimum cash and cash equivalent balance equal to or at least 1.25 times the outstanding principal line balance at each month end, 2) minimum liquidity of $10 million at the end of each fiscal quarter and 3) annual GAAP profitability of at least $1 (excluding restructuring charges for vacated facilities and stock-based compensation) for the period from May 1, 2003 to April 30, 2004. As of July 31, 2003, we were in compliance with all financial covenants.

Future minimum lease and termination payments under operating leases and payments under bank borrowings are as follows as of July 31, 2003 (in thousands):


	Operating		Bank
Twelve Months Ended July 31,	Leases		Borrowings		Total

2003	$	4,316	$	4,250	$	8,566
2004		3,261		—		3,261
2005		1,704		—		1,704
2006		1,375		—		1,375
2007		1,061		—		1,061
Thereafter		2,377		—		2,377

Total payments	$	14,094	$	4,250	$	18,344

Included in the lease payments above are the following amounts, net of estimated sublease income, relating to facilities that we have vacated pursuant to our restructuring program: $1.6 million, $1.4 million, $1.2 million, $1.1 million and $922,000 for the twelve months ended July 31, 2004, 2005, 2006, 2007 and 2008, respectively, and $2.3 million thereafter. These amounts are recorded in accrued restructuring and long-term accrued restructuring on the condensed consolidated balance sheets. We regularly review the estimates for sublease income in the second and fourth quarter of each year or anytime we have persuasive evidence that a change of

estimate has occurred. In the second quarter of fiscal 2004, we recorded an additional $1.6 million in restructuring reserves due to our current assessment of sublease opportunities for our vacated facility leases. To the extent that these estimates change due to changes in market condition, the actual restructuring payments could vary by material amounts.

We have working capital of $8.1 million as of July 31, 2003. We believe that cash from operations and existing cash will be sufficient to meet our current expectations for working capital and expense requirements for at least the next twelve months based on, among other things, our current revenue and expense projections. However, we may require additional financing in the future. If we are unable to raise capital in the event of ongoing losses and depletion of our available cash resources, the absence of funding would have a material adverse effect on our business. If we issue additional equity securities, stockholders will experience additional dilution and the new equity securities may have rights, preferences or privileges senior to those of the then existing holders of our common stock.

Recent Accounting Pronouncements

In April 2003, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement is effective for contracts entered into or modified after June 30, 2003, and the guidance should be applied prospectively. We have not determined the impact that the adoption of SFAS No. 149 will have on our financial position or results of operations.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. The provisions of SFAS No. 150 apply immediately to all financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We do not expect the impact the adoption of SFAS No. 150 will have a material effect on our financial position or results of operations.

In November 2002, FASB issued FASB Interpretation No. 45, or FIN No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN No. 45 provides expanded accounting guidance surrounding liability recognition and disclosure requirements related to guarantees, as defined by this Interpretation. We had no existing guarantees as of April 30, 2003, and the adoption of FIN No. 45 did not have a material effect on our financial position or results of operations. Indemnification and warranty provisions 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 90 days following delivery of our products. We have not incurred significant obligations under customer indemnification or warranty provision historically. Accordingly, we do not maintain accruals for potential customer indemnification or warranty-related obligations.

In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities. FIN No. 46 expands upon existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities and activities of another entity. A variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN No. 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or is entitled to receive a majority of the entity’s residual returns or both. The consolidation requirements of FIN No. 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. We do not have any ownership in any variable interest entities as of July 31, 2003. We will apply the consolidation requirement of FIN No. 46 in future periods if we should own any interest in any variable interest entity.

FACTORS THAT MAY AFFECT FUTURE RESULTS

The occurrence of any of the following risks could materially and adversely affect our business, financial condition and operating results. In this case, the trading price of our common stock, which has been extremely volatile, could decline and you might lose all or part of your investment.

We have a history of losses and an accumulated deficit. Continued losses could deplete our cash resources and may cause us to be unable to implement our business plan.

We were incorporated in January 1998 and began licensing our software in December 1998. Until recently, we experienced GAAP losses for almost every quarter of our history, and have not yet been profitable on an annual basis. We had net loss of $37.8 million in the year ended January 31, 2003. We had an accumulated deficit of $501.3 million as of July 31, 2003. Although our financial results have improved recently, these improvements may not continue, and we may incur losses in the future. Additional losses will reduce the cash available to us to run our business, and unless financing is available to us from other sources, we may become unable to implement our business plan.

Our quarterly financial results have fluctuated significantly in the past, and if our future results are below our expectations or those of our investors, the price of our common stock would likely decline.

Our quarterly operating results have fluctuated significantly in the past and may continue to fluctuate in the future. Our quarterly operating results are likely to be particularly affected by the number of customers licensing our products during any quarter and the size of such licensing transactions, which could be impacted during a new release cycle. In addition, we may be unable to accurately forecast our operating results because our business and the market in which we operate are changing rapidly.

We have limited visibility into our future revenue, especially license revenue, which historically has been heavily concentrated in the third month of each quarter due to traditional buying patterns in the software industry in which customers often defer purchases until the third month of a vendor’s fiscal quarter. Since we forecast our expenses based in part on future revenue projections, our operating results would be adversely affected if we cannot meet those revenue projections.

Other factors that could affect our quarterly operating results include:

• changes in the pricing of our products and services or those of our competitors or the announcement or introduction of new products or services by us or our competitors;

• the renewal or non-renewal of annual maintenance contracts to our customers;

• the demand for professional services to implement our products and our efficiency in rendering such services;

• variability in the mix of our product and services revenue in any quarter;

• the amount and timing of operating expenses and capital expenditures relating to the business;

• the application of variable accounting to stock options that were previously repriced but not exchanged by our employees pursuant to our stock option exchange program;

• changes in foreign exchange rates; and

• changes in restructuring accruals based on changes in sublease estimates for lease facilities we vacated.

Due to these and other factors, we believe that period-to-period comparisons of our results of operations are not meaningful and should not be relied upon as indicators of our future performance. If we are unable to meet the expectations of investors with regard to our future operating results, the price of our common stock would likely decline.

The decline in spending on information technology has decreased the demand for our products and services, has adversely affected our revenue and may continue to adversely affect our revenue in the future.

Our total revenue was $10.0 million in the second quarter of fiscal 2004, compared to $10.5 million in the second quarter of fiscal 2003 and $19.8 million in the six months ended July 31, 2003, compared to $24.6 million in the six months ended July 31, 2002. Our license revenue was $3.1 million in the second quarter of fiscal 2004, compared to $4.0 million in the second quarter of fiscal 2003 and $6.3 million in the six months ended July 31, 2003, compared to $9.7 million in the six months ended July 31, 2002. While we cannot specifically correlate the impact of macro-economic conditions on our sales activities, we believe that the economic conditions have contributed to a decrease in demand in our market, and in particular, have increased the average length of our sales

cycles and decreased the size of our license transactions. To the extent that the current economic climate remains depressed or worsens, or international conflicts develop or worsen, the demand for our products and services, and therefore future revenue, may be further reduced. We may not be able to respond to future revenue reductions in a sufficiently timely manner to avoid future losses. Even if economic conditions improve and international conflicts diminish, corporations may not increase their information technology spending in our market and we may be unable to maintain or improve revenue levels.

Our products have a long sales cycle, which increases the cost of completing sales and renders completion of sales less predictable.

The sales cycle for our products is long, typically from six to nine months, making it difficult to predict the quarter in which we may recognize revenue from a sale, if at all. Our lengthy sales cycle increases our costs and may cause license revenue and other operating results to vary significantly from period to period. Our products often are part of significant strategic decisions by our customers regarding their information systems. Accordingly, the decision to license our products typically requires significant pre-purchase evaluation. We spend substantial time providing information to prospective customers regarding the use and benefits of our products. During this evaluation period, we may expend significant funds in sales and marketing efforts. If anticipated sales from a specific customer for a particular quarter are not realized in that quarter, our operating results may be adversely affected.

We experience seasonality in our sales both in the United States and in our European operations, which could cause our quarterly operating results to fluctuate and could deplete our cash reserves.

We experience seasonality in the licensing of our products and sales of our services. For example, revenue historically has been lower in our first fiscal quarter due to patterns in the capital budgeting and purchasing cycles of our current and prospective customers. We also expect that revenue may decline during July and August, particularly in European markets, such as France, Germany, the United Kingdom and the Netherlands. These seasonal variations in our revenue are likely to lead to fluctuations in our quarterly operating results depleting our cash reserves and adversely affecting our ability to pursue business opportunities.

Because the application of our product is complex, our products, including our recently released Niku 6, may contain undetected defects and errors which could result in loss of or delay in revenue, failure to achieve market acceptance or increased costs and liabilities.

Products as complex as those we offer or are developing, including our flagship product Niku 6, may contain undetected defects or errors. Despite internal testing and testing by our customers or potential customers, defects or errors may occur in our existing or future products and services. From time to time in the past, versions of our software that have been delivered to customers have contained errors. Such errors could result in additional development costs, diversion of technical and other resources from our other development efforts, or the loss of credibility with our current and prospective customers. In the future, if we are not able to detect and correct errors prior to release, we may experience a loss of or delay in revenue, failure to achieve market acceptance and increased costs to correct errors, any of which could significantly harm our business.

Defects or errors could also result in tort or warranty claims. Warranty disclaimers and liability limitation clauses in our customer agreements may not be enforceable. Furthermore, our errors and omissions insurance may not adequately cover us for claims. If a court were to refuse to enforce the liability-limiting provisions of our contracts for any reason, or if liabilities arose that were not contractually limited or adequately covered by insurance, our business could be harmed.

Implementation of our products may be costly and time-consuming, and customers may become dissatisfied with the implementation time, expense or personnel requirements, which could harm our reputation and adversely affect market acceptance of our products.

Implementation of our products may be costly and time-consuming. Customers could become dissatisfied with our products if implementation requires more time, expense or personnel than they expected. Additionally, our losses could increase if, for customer satisfaction and reputation reasons, we do not bill our customers for time and expenses we incur in connection with these implementation issues, which would adversely affect our operating results. As part of the implementation, our products must integrate with many of our customers’ existing computer systems and software programs. Integrating with a number of computer systems and software programs can be time consuming and expensive and could lead to customer dissatisfaction and increased expenses. In the event that customers become dissatisfied with this process, our reputation may be harmed and the acceptance of our products by the market may decrease.

Market acceptance of our products and services may suffer if we are unable to enhance our products to meet the rapid technological changes in our industry.

Rapidly changing technology and standards may impede market acceptance of our products and services. Our business relies primarily on our licensing the rights of two of our products and their components. Our new products have been designed based upon currently prevailing technologies such as extensible markup language (XML), extensible stylesheet language (XSL), Java Two Platform Enterprise Edition (J2EE) and Simple Object Access Protocol (SOAP). If new technologies emerge that are incompatible with one or both of our products, our products could become obsolete and our existing and potential customers might seek alternatives. We may not be able to adapt quickly to a new technology.

Additionally, we design our products to work with databases such as Oracle Database Server and SQL Server and operating systems such as Sun Solaris, Microsoft Windows and HP UX. Any changes to those databases or operating systems, or increasing popularity of other databases or operating systems, might require us to modify one or both of our products or services and could cause us to delay releasing future products and enhancements. As a result, the timing and nature of new product introductions or product modifications, and increases and decreases in the market acceptance of databases and operating systems, as well as web servers and other enterprise and Internet-based applications could delay our product development, increase our research and development expenses and cause customers to delay evaluation, purchase and deployment of our products.

Because a significant part of our revenues comes from our international operations, we are subject to risks inherent in doing business in foreign countries that could impair our results of operations.

In the second quarter of fiscal 2004, international revenue represented 33.9% of our total revenue, compared to 43.8% in the first quarter of fiscal 2004 and 31.9% in the second quarter of fiscal 2003. In the second quarter of fiscal 2004, international license revenue represented 25.2% of our license revenue, compared to 45.4% in the first quarter of fiscal 2004 and 20.9% in the second quarter of fiscal 2003. International activities are a significant part of our business.

As we operate internationally, we are exposed to risks that we would not face if we conducted our operations only in the United States. These include:

• currency exchange rate fluctuations, particularly in countries where we sell our products in denominations other than U.S. dollars, such as in France, Germany, the Netherlands and the United Kingdom or have exposures in intercompany accounts denominated in foreign currencies;

• seasonal fluctuations in purchasing patterns in other countries, particularly declining sales during July and August in certain relevant European markets;

• difficulties in collecting accounts receivable in foreign countries; particularly European countries in which collections take considerably more time than the United States and collections are more difficult to effect;

• the burdens of complying with a wide variety of foreign laws and reduced protection for intellectual property rights in some countries;

• the need to develop internationalized versions of our products and marketing and sales materials; and

• tariffs, export controls and other trade barriers.

Our market is highly competitive and characterized by rapid technological change which could make it difficult for us to attract customers, cause us to reduce prices and result in reduced gross margins or loss of market share.

The market for our products and services is competitive, dynamic and subject to frequent technological changes. We expect the intensity of competition and the pace of change to increase in the future. Our products compete with products of varying functionality offered by competing software vendors and products that have been developed by potential customers’ in-house developments and IT organizations. The primary competitive factors include price, product functionality, product installation, product integration, ability to scale, worldwide sales infrastructure, worldwide support infrastructure, and worldwide professional services infrastructure. Some of our competitors include:

• providers of project management, portfolio management and portfolio analysis software; and

• enterprise software providers such as Lawson, Mercury Interactive, Microsoft, Oracle, Peoplesoft, SAP and Siebel Systems; and

• providers of professional services automation software.

A number of companies offer products that provide some of the functionality of our products. We may not be able to maintain our competitive position against current or potential competitors, especially those with significantly greater financial, marketing, service, support, technical and other resources. Competitors with greater resources may be able to undertake more extensive marketing campaigns, adopt more aggressive pricing policies and make more attractive offers to potential employees, distributors, resellers or other strategic partners. We expect additional competition from other established and emerging companies as the market for our software continues to develop. We may not be able to compete successfully against current and future competitors.

If we deplete our limited working capital we may not be able to raise additional funds in the future and might be unable to execute our business plan.

As of July 31, 2003, we had cash and cash equivalents of $21.7 million. This amount includes net proceeds of approximately $10.2 million from a private placement we completed in April 2003 and $4.3 million in bank borrowings under a line of credit. The line of credit was repaid in full in August 2003. We believe that cash from operations and existing cash will be sufficient to meet our current expectations for working capital and expense requirements for at least the next twelve months based on, among other things, our current revenue and expense projections. However, we may require additional financing. If we were unable to raise capital in the event of ongoing losses and depletion of our available cash resources, the absence of funding would have a material adverse effect on our business. If we issue additional equity securities, stockholders will experience additional dilution and the new equity securities may have rights, preferences or privileges senior to those of the then existing holders of our common stock.

If we are unable to protect and enforce our intellectual property rights, our competitors might be able to use our technologies to develop their own products, which would harm our ability to compete.

We regard substantial elements of our products as proprietary and protect them by relying on copyright, trade secrets, patent, trademark and service mark laws and restrictions, as well as non-disclosure agreements and confidentiality procedures and contractual provisions. Any steps we take to protect our intellectual property may be inadequate, time-consuming and expensive. We may be unable to prevent third parties from infringing upon or misappropriating our intellectual property, which could harm our business and our ability to compete.

We rely to a large degree on copyright laws with respect to our software, but we have not made any copyright registration with any government entity with respect to our products. Although registration is not required to obtain protection under copyright laws, our failure to register may limit our ability to seek certain remedies available under such laws. We are currently pursuing one patent application but no patent has issued. We received U.S. registration of the trademarks Niku, the Niku logo, and Do What Matters. These registrations may not provide us with significant protection for our trademarks. It is possible that no patents will issue from our current or future patent applications. Any patents that do issue may not provide us with any competitive advantages over, or may be challenged by, third parties.

The copyright and trade secret laws, which are the principal source of protection for our intellectual property, offer only limited protection. In addition, legal standards relating to the validity, enforceability and scope of protection of intellectual property rights in software are uncertain and still evolving, and the future viability or value of any of our intellectual property rights is uncertain. Effective trademark, copyright and trade secret protection may not be available in every country in which our products are distributed or made available.

Although we have taken precautionary measures to maintain our proprietary information, others may acquire equivalent information or otherwise gain access to or disclose our proprietary information. In the event that we are unable to meaningfully protect our rights to our proprietary information, our ability to compete will likely be harmed.

We indemnify our customers against infringement claims involving our products, which could require us to incur substantial costs defending our rights and the interests of our customers.

Our standard product licenses provide that we agree to indemnify our customers against claims that our products infringe upon the intellectual property rights of others. These claims, even if not meritorious, could be expensive and divert management’s

attention from operating our business. We could incur substantial costs in defending ourselves and our customers against infringement claims. If we become liable to third parties for infringement of their intellectual property rights, we could be required to pay a substantial damage award and to develop non-infringing technology, obtain one or more licenses for us and our customers from third parties or cease selling the products that contain the infringing intellectual property. We may be unable to develop non-infringing technology or obtain a license at a reasonable cost, or at all. If we are unable to license our technology, we would be unable to support our operations.

Because our stock price is volatile and the trading volume is low, you may not be able to resell your shares at or above the price that your paid, or at all.

The market price of our common stock is extremely volatile and has ranged from over $100 per share to less than $1.00 per share since February 2000 and typically has a low trading volume. We cannot predict the extent to which investor interest in our stock will create or sustain an active trading market. If a more active market does develop, the price of our stock may be highly volatile. The sale of a larger block of our shares could depress the price of our shares to a greater degree than a company that typically has a higher volume of trading in its securities. As a result, the investors in our stock may not be able to liquidate their investment without considerable delay, if at all.

Provisions of Delaware law, our certificate of incorporation and bylaws, certain voting agreements and the concentration of stock ownership could delay or prevent a change of control, even if doing so would benefit our stockholders.

Provisions of Delaware law, our certificate of incorporation and bylaws, certain voting agreements of our stockholders and the concentration of ownership of our stock could have the effect of delaying or preventing a change in control, even if a change in control would presumably be beneficial to our stockholders. These provisions include:

• authorizing the issuance of preferred stock without stockholder approval;

• prohibiting cumulative voting in the election of directors;

• requiring two-thirds of the outstanding shares to approve amendments to some provisions of our certificate of incorporation and bylaws;

• requiring a majority of the stockholders to call stockholders meetings; and

• prohibiting stockholder actions by written consent.

In addition, Farzad and Rhonda Dibachi, our former chief executive officer and executive vice president of strategy and planning, and Limar Realty Corp. #30, the landlord for a significant facility in Redwood City, California, whose lease we terminated in fiscal 2003, have entered into voting agreements in which they have agreed, in the case of the Dibachis, to vote as recommended unanimously by the board and, in the case of Limar, to vote as recommended by the board or in the same proportion as other votes cast on a given matter (excluding votes by the Dibachis). These provisions could delay or prevent an attempt to replace or remove our management and may make it more difficult for another party to take over our company without the approval of our board.

Further, Walden VC and its related funds beneficially own 21% of our outstanding common stock. This concentration of ownership gives Walden significant power to effect the outcome of matters requiring shareholder approval, including the election of directors or to delay or prevent a change of control of the business that may be in the best interests of other stockholders.

A large percentage of our stock is concentrated with a few shareholders. If any one of those shareholders or a combination of multiple shareholders elected to sell a substantial amount of our common stock it could cause our stock price to decline.

A significant amount of our outstanding stock is now owned by one institution and a few individual investors. Any sales of substantial amounts of our common stock in the public market, or the perception that such sales might occur, could harm the market price of our common stock.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We develop products in the United States and market our products in North America and Europe and to a lesser degree in Asia. As a result, our financial results may be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Approximately 33.9% and 38.9% of our total revenue was made in currencies other than U.S. dollars in the second quarter of fiscal 2004 and in the six months ended July 31, 2003. Our exposures to foreign exchange rate fluctuations also arise in part from intercompany accounts with our foreign subsidiaries. These intercompany accounts are typically denominated in the local currency of the foreign subsidiary. We expect that exchange rate fluctuations will affect our financial results in the future. We currently do not use financial instruments to hedge operating expenses of our European subsidiaries. As of July 31, 2003, we had a deposit of approximately 1.8 million Euros to minimize our exposures from intercompany accounts with foreign subsidiaries. We will continue to assess if there is a need to utilize financial instruments to hedge currency exposures in the future.

Our exposure to market risk for changes in interest rates relates primarily to our cash and cash equivalents and outstanding debt obligations. We do not use derivative financial instruments for speculative or trading purposes. Our cash and cash equivalents consist primarily of demand deposits, certificates of deposits and money market accounts that mature in three months or less. Due to the short-term nature of our cash and cash equivalents, we believe that there is no material market or interest rate risk exposure on our cash and cash equivalents. We do not believe that we have interest rate exposure on our bank term loan because the interest rate is fixed. We do not believe an immediate 10% increase or decrease in interest rate would have a material effect on our consolidated financial position and results of operations.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this report, our chief executive officer and chief financial officer carried out an evaluation of the effectiveness of our disclosure controls and procedures (pursuant to Rules 13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934, as amended). Based upon that evaluation, our chief executive officer and chief financial officer concluded that as of the end of such period our disclosure controls and procedures are effective and timely.

Changes in Internal Controls Over Financial Reporting

There was no significant change in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred over the period covered by this quarterly report on Form 10-Q that materially affected or is reasonably likely to materially affect our internal control over financial reporting.

PART II: OTHER INFORMATION

Item 1. Legal Proceedings

In August 2001, Goldman, Sachs and Co., Dain Rauscher Wessels, U.S. Bancorp Piper Jaffray and Thomas Weisel Partners, the managing underwriters of the Company’s initial public offering (IPO), the Company, and certain of the Company’s officers and directors, were named as defendants in a number of purported securities class actions in United States District Court for the Southern District of New York arising out of the Company’s initial public offering in February 2000. The complaints in these actions allege, among other things, that the registration statement and prospectus filed with the Securities and Exchange Commission for purposes of the IPO were false and misleading because they failed to disclose that the managing underwriters allegedly (i) solicited and received commissions from certain investors in exchange for allocating to them shares of Company stock in connection with the IPO and (ii) entered into agreements with their customers to allocate such stock to those customers in exchange for the customers agreeing to purchase additional shares of ours in the aftermarket at pre-determined prices. On August 8, 2001 the Court ordered that these actions, along with hundreds of IPO allocation cases against other issuers, underwriters and directors and officers, be transferred to one judge for coordinated pre-trial proceedings. In July 2002, omnibus motions to dismiss the complaints based on common legal issues were filed on behalf of all issuers, underwriters and directors and officers. By order dated October 8, 2002, the Court dismissed the Company’s officers and directors from the case without prejudice. In an opinion issued on February 19, 2003, the Court granted in part and denied in part the motions to dismiss. The complaints against the Company and the other issuers and underwriters were not dismissed as a matter of law. These cases remain at a preliminary stage and no discovery proceedings have taken place in relation to the issuers. The Company believes that the claims asserted against it in these cases are without merit and the Company intends to defend vigorously against them. These cases seek compensatory damages in unspecified amounts as well as other relief. A proposed settlement between the plaintiffs and issuer defendants is in the process of being negotiated and approved.

Item 2. Changes in Securities and Use of Proceeds

In February 2003, we entered into a common stock and warrant purchase agreement with various investors led by Walden VC, providing for the issuance of 3,088,230 shares of our common stock at a price of $3.35 per share and warrants to purchase 386,034 shares of common stock at a price of $0.40 per warrant in connection with a private placement. The warrants have an exercise price of $3.40. In February 2003, we issued 1,549,735 shares of our common stock and warrants to purchase 193,720 shares of common stock in connection with initial closing of this private placement. In April 2003, our stockholders approved and we subsequently issued the remaining 1,538,495 shares of our common stock and warrants to purchase 192,314 shares of common stock. These shares and warrants were issued in a private placement exempt from registration under the Securities Act of 1933 pursuant to Section 4(2) and Regulation D of the Act. The aggregate offering price for the securities was approximately $10.5 million and total net proceeds from the private placement were approximately $10.2 million. On April 30, 2003, we filed a Registration Statement on Form S-3, as amended (No. 333-104860) to register these shares. The Securities and Exchange Commission declared the Registration Statement effective on August 8, 2003.

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

The annual meeting of Niku Corporation was held on September 10, 2003, during which the following three proposals were voted on as follows:

Proposal 1: Election of Directors


	For	Withheld
Ravi Chiruvolu	10,636,558	134,309
Matt Miller	10,756,966	13,901
Joshua Pickus	10,298,390	472,477
Peter Thompson	10,756,389	14,028
Edward F. Thompson	10,636,457	134,410
Val E. Vaden	10,639,356	131,511

Proposal 2: To approve an amendment to the amended and restated certificate of incorporation to reduce the number of authorized shares of common stock


For	Against	Abstain
10,743,277	22,817	4,773

Proposal 3: Ratification of Independent Auditors


For	Against	Abstain
10,748,982	8,544	13,341

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

The following exhibits are filed as part of, or incorporated by reference into, this quarterly report on Form 10-Q:


Number		Exhibit Title
3.1 (1)		Registrant’s Amended and Restated Certificate of Incorporation.

3.2 (2)		Certificate of Amendment to the Amended and Restated Certificate of Incorporation dated November 20, 2002.

3.3 (3)		Registrant’s Amended and Restated Bylaws.

10.1		Business Loan Agreement, Commercial Security Agreement and Promissory by and between Mid Peninsula


Number		Exhibit Title
		Bank and the Registrant, dated July 18, 2003.

31.1		Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certificate of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certificate of Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002.

(1) Incorporated by reference to the Registrant’s Fiscal 2000 Annual Report on Form 10-K filed on April 28, 2000.

(2) Incorporated by reference to the Current Report on Form 8-K filed on November 21, 2002.

(3) Incorporated by reference to the Registrant’s Fiscal 2003 Annual Report on Form 10-K filed on April 15, 2003.

(b) Reports on Form 8-K

On May 5, 2003, we filed a current report on Form 8-K to announce our preliminary financial results for the quarter ended April 30, 2003.

On May 15, 2003, we filed a current report on Form 8-K to announce our financial results for the quarter ended April 30, 2003.

On August 21, 2003, we filed a current report on Form 8-K to announce our financial results for the quarter ended July 31, 2003.

SIGNATURE

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.


			NIKU CORPORATION

Date: September 12, 2003	By:	/s/	Joshua Pickus

			Joshua Pickus
			Chief Executive Officer

Date: September 12, 2003	By:	/s/	Michael Shahbazian

			Michael Shahbazian
			Chief Financial Officer
			(Chief Accounting Officer)

Exhibit Index


Number		Exhibit Title
10.1		Business Loan Agreement, Commercial Security Agreement and Promissory by and between Mid Peninsula Bank and the Registrant, dated July 18, 2003.

31.1		Certificate of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certificate of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certificate of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certificate of Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002.

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	•		changes in the pricing of our products and services or those of our competitors or the announcement or introduction of new products or services by us or our competitors;

	•		the renewal or non-renewal of annual maintenance contracts to our customers;

	•		the demand for professional services to implement our products and our efficiency in rendering such services;

	•		variability in the mix of our product and services revenue in any quarter;

	•		the amount and timing of operating expenses and capital expenditures relating to the business;

	•		the application of variable accounting to stock options that were previously repriced but not exchanged by our employees pursuant to our stock option exchange program;

	•		changes in foreign exchange rates; and

	•		changes in restructuring accruals based on changes in sublease estimates for lease facilities we vacated.

	•		currency exchange rate fluctuations, particularly in countries where we sell our products in denominations other than U.S. dollars, such as in France, Germany, the Netherlands and the United Kingdom or have exposures in intercompany accounts denominated in foreign currencies;

	•		seasonal fluctuations in purchasing patterns in other countries, particularly declining sales during July and August in certain relevant European markets;

	•		difficulties in collecting accounts receivable in foreign countries; particularly European countries in which collections take considerably more time than the United States and collections are more difficult to effect;

	•		the burdens of complying with a wide variety of foreign laws and reduced protection for intellectual property rights in some countries;

	•		the need to develop internationalized versions of our products and marketing and sales materials; and

	•		tariffs, export controls and other trade barriers.

	•		enterprise software providers such as Lawson, Mercury Interactive, Microsoft, Oracle, Peoplesoft, SAP and Siebel Systems; and

	•		providers of professional services automation software.

	•		authorizing the issuance of preferred stock without stockholder approval;

	•		prohibiting cumulative voting in the election of directors;

	•		requiring two-thirds of the outstanding shares to approve amendments to some provisions of our certificate of incorporation and bylaws;

	•		requiring a majority of the stockholders to call stockholders meetings; and

	•		prohibiting stockholder actions by written consent.

(1)		Incorporated by reference to the Registrant’s Fiscal 2000 Annual Report on Form 10-K filed on April 28, 2000.

(2)		Incorporated by reference to the Current Report on Form 8-K filed on November 21, 2002.

(3)		Incorporated by reference to the Registrant’s Fiscal 2003 Annual Report on Form 10-K filed on April 15, 2003.

		On May 5, 2003, we filed a current report on Form 8-K to announce our preliminary financial results for the quarter ended April 30, 2003.

		On May 15, 2003, we filed a current report on Form 8-K to announce our financial results for the quarter ended April 30, 2003.

		On August 21, 2003, we filed a current report on Form 8-K to announce our financial results for the quarter ended July 31, 2003.