UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

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 March 31, 2004

[  ] 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: 000-25781

NET PERCEPTIONS, INC.

7700 France Avenue South
Edina, Minnesota 55435
(Address of principal executive offices, Zip Code)

(952) 842-5000
(Registrant’s telephone number, including area code)

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

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

As of April 30, 2004, there were outstanding 28,283,347 shares of the registrant’s Common Stock, $0.0001 par value.

NET PERCEPTIONS, INC.
FORM 10-Q
For the Quarter Ended March 31, 2004

TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

NET PERCEPTIONS, INC.

CONSOLIDATED BALANCE SHEETS

See accompanying notes to the consolidated financial statements.

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NET PERCEPTIONS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes to the consolidated financial statements.

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NET PERCEPTIONS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes to the consolidated financial statements.

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NET PERCEPTIONS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)

Note 1. Basis of Presentation

     In the opinion of management, the accompanying unaudited financial statements contain all adjustments necessary to fairly present the Company’s financial position, results of operations and cash flows for the periods presented. These adjustments consist of normal, recurring items. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts therein. Due to the inherent uncertainty involved in making estimates, actual results in future periods may differ from those estimates.

     Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These financial statements should be read in conjunction with the Company’s financial statements and notes thereto for the year ended December 31, 2003, which are contained in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 13, 2004. The results of operations for the interim periods presented are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year.

     The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant inter-company accounts and transactions have been eliminated. The Company views its operations and manages its business as one segment, the development and marketing of computer software and related services. Factors used to identify the Company’s single operating segment include the organizational structure of the Company and the financial information available for evaluation by the chief operating decision maker in making decisions about how to allocate resources and assess performance. In addition, the Company does not allocate operating expenses to any segments nor does it allocate specific assets to any segments. Therefore, segment information is identical to the consolidated balance sheet and consolidated statement of operations.

     Accumulated other comprehensive income (loss) consists entirely of unrealized gain (loss) on available-for-sale investments. Changes in unrealized gain (loss) on available-for-sale investments were $0 and $(2) during first quarter of 2004 and 2003, respectively. Comprehensive income equaled net income for the three months ended March 31, 2004. Comprehensive loss was $2,401 for the three months ended March 31, 2003.

Note 2. Stock-based compensation

     In December 2002, the FASB issued SFAS 148, “Accounting for Stock-Based Compensation—Transition and Disclosure, an Amendment to FASB Statement No. 123.” The Company has chosen to continue with its current practice of applying the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” The Company has adopted the disclosure requirements of SFAS No. 148 in its discussion of stock-based employee compensation but the alternative transition options made available by the standard have not been implemented.

     The intrinsic value method is used to account for stock-based compensation plans. If compensation expense had been determined based on the fair value method, net income (loss) and net income (loss) per share would have been adjusted to the pro forma amounts indicated below:

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Note 3. Per Share Data

     Basic earnings per share is computed using net income (loss) and the weighted average number of common shares outstanding. Diluted earnings per share reflects the weighted average number of common shares outstanding plus any potentially dilutive shares outstanding during the period. Potentially dilutive shares consist of shares issuable upon the exercise of stock options. Shares used in the diluted net income (loss) per share for the three months ended March 31, 2004 and March 31, 2003, exclude the impact of 289 and 2,499 potential common shares from exercise of stock options, respectively, which were anti-dilutive.

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Note 4. Restructuring Related Charges and Impairments

     During 2003, 2002 and 2001, the Company instituted certain restructuring plans to better align its cost structure with its business outlook and general economic conditions. Under the restructuring plans, the Company recorded restructuring related charges totaling $2,300, $768 and $15,600 during 2003, 2002 and 2001, respectively.

     In March 2001 the Company reduced its workforce by approximately 46%, or 124 positions throughout the organization, and recorded a charge of $13,920 to reorganize the Company and exit certain facilities in various United States and international locations. This $13,920 charge included $10,200 related to facility consolidation, $1,190 of employee termination costs and $2,530 of losses on the disposal of assets and other restructuring charges. During the third quarter of 2001, the Company reduced its workforce by 45 employees and recorded an additional $1,771 restructuring related charge. This $1,771 charge included $878 for estimated losses on the disposal of fixed assets, $449 for leasehold write-offs related to facility consolidation and $444 for employee severance payments. During the fourth quarter of 2001, the total restructuring charge was decreased by $140 to reflect the actual costs of exiting certain marketing activities in connection with the restructuring.

     In the first quarter of 2002 the Company further reduced its workforce by 15% or 15 positions, and recorded $367 in related employee termination costs. During the second quarter of 2002 the Company recorded restructuring related charges of $401, of which $139 related to employee termination costs due to a reduction in workforce by 18 positions or 21%, $291 represented the write-down of certain fixed assets and $(29) was a reversal of previously recorded restructuring related charges resulting from revised estimates of other costs.

     The Company recorded restructuring related charges of $1,200 in the first quarter of 2003 related primarily to the closure of operations in three satellite offices, employee termination costs due to a reduction of workforce by 22 positions and $413 for estimated losses on the disposal of fixed assets. The Company recorded additional restructuring related charges of $1,051 in the third quarter of 2003 related primarily to the termination of three real estate lease agreements, and employee termination costs due to a reduction of workforce by 12 positions. The aggregate cash payments for the lease terminations were approximately $5.4 million.

     The Company’s remaining commitments as of March 31, 2004 consisted primarily of obligations under one operating lease. The following table summarizes this contractual lease obligation as of March 31, 2004:

     The operating lease obligation relates to one remaining vacated facility in San Francisco, CA, the majority of which is sublet. The Company currently occupies approximately 1,500 square feet of office space pursuant to a month-to-month lease in Edina, Minnesota.

     The following table presents a summary of the restructuring related activities and accrued restructuring charges as of March 31, 2004:

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Note 5. Commitments and Contingencies

Litigation

     On November 2, 2001, Timothy J. Fox filed a purported class action lawsuit against the Company, FleetBoston Robertson Stephens, Inc., the lead underwriter of the Company’s April 1999 initial public offering, several other underwriters who participated in the initial public offering, Steven J. Snyder, the Company’s then president and chief executive officer, and Thomas M. Donnelly, the Company’s chief financial officer. The lawsuit was filed in the United States District Court for the Southern District of New York and has been assigned to the judge who is also the pretrial coordinating judge for substantially similar lawsuits involving more than 300 other issuers. An amended class action complaint, captioned In re Net Perceptions, Inc. Initial Public Offering Securities Litigation, 01 Civ. 9675 (SAS), was filed on April 22, 2002, expanding the basis for the action to include allegations relating to the Company’s March 2000 follow-on public offering in addition to those relating to its initial public offering.

     The amended complaint generally alleges that the defendants violated federal securities laws by not disclosing certain actions taken by the underwriter defendants in connection with the Company’s initial public offering and follow-on public offering. The amended complaint alleges specifically that the underwriter defendants, with the Company’s direct participation and agreement and without disclosure thereof, conspired to and did raise and increase their underwriters’ compensation and the market prices of the Company’s common stock following its initial public offering and in its follow-on public offering by requiring their customers, in exchange for receiving allocations of shares of the Company’s common stock sold in its initial public offering, to pay excessive commissions on transactions in other securities, to purchase additional shares of the Company’s common stock in the initial public offering aftermarket at pre-determined prices above the initial public offering price, and to purchase shares of the Company’s common stock in its follow-on public offering. The amended complaint seeks unspecified monetary damages and certification of a plaintiff class consisting of all persons who acquired the Company’s common stock between April 22, 1999 and December 6, 2000. The plaintiffs have since agreed to dismiss the claims against Mr. Snyder and Mr. Donnelly without prejudice, in return for their agreement to toll any statute of limitations applicable to those claims; and those claims have been dismissed without prejudice. On July 15, 2002, all of the issuer defendants filed a joint motion to dismiss the plaintiffs’ claims in all of the related cases. On February 19, 2003, the court ruled against the Company on this motion.

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     A special committee of the Company’s board of directors has authorized the Company to negotiate a settlement of the pending claims substantially consistent with a memorandum of understanding negotiated among class plaintiffs, issuer defendants and their insurers. Any such settlement would be subject to approval by the court.

     The Company believes that the allegations against it are without merit. However, the Company is unable to predict the outcome or ultimate effect of this litigation.

     On October 29, 2003, a purported class action lawsuit was filed against the Company, its current directors and unnamed defendants in the District Court, Fourth Judicial District, of the State of Minnesota, County of Hennepin captioned Don Blakstad, on Behalf of Himself and All others Similarly Situated, vs. Net Perceptions, Inc., John F. Kennedy, Ann L. Winblad, John T. Riedl and Does 1-25, inclusive, File No. 03-17820. The complaint alleged, among other things, that defendants breached their fiduciary duties of loyalty, due care, independence, good faith and fair dealing and sought to enjoin the proposed liquidation of the Company and to recover reasonable attorneys’ and experts’ fees. On November 24, 2003, defendants filed a motion to dismiss the lawsuit, and by order dated March 8, 2004, the court dismissed the complaint with prejudice. By letter dated March 9, 2004, the plaintiff requested the court’s permission to file a motion to reconsider the decision dismissing the complaint with prejudice. On March 18, 2004, the court denied the plaintiff’s request. On April 9, 2004, the plaintiff filed a notice of appeal and statement of the case with the Court of Appeals of the State of Minnesota and, on April 22, 2004, defendants filed their statement of the case with the Court of Appeals. Defendants continue to believe that the claims in this lawsuit are without merit, and are in fact moot, and intend to continue to vigorously defend them during this appeals process.

Contingencies

     As permitted under Delaware law, the Company has agreements whereby it indemnifies its officers and directors for certain events or occurrences while the officer or director is, or was serving, at its request in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has insurance that limits its exposure and enables the Company to recover a portion of any future amounts paid. As a result of the insurance coverage, the Company believes the estimated fair value of these indemnification agreements is minimal. All of these indemnification agreements were grandfathered under the provisions of FIN No. 45 as they were in effect prior to December 31, 2002. Accordingly, the Company believes the liability for these agreements as of March 31, 2004 is not material.

     In the past, the Company entered into standard indemnification agreements from time to time in the ordinary course of its business. Pursuant to these agreements, the Company indemnifies, holds harmless, and agrees to reimburse the indemnified party for losses suffered or incurred by the indemnified party, which is generally the business partner or customer, in connection with any U.S. patent, or any copyright or other intellectual property infringement claim by any third party with respect to the use of the Company’s products. The term of these indemnification agreements is generally perpetual. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. The Company has never incurred any costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the Company believes the estimated fair value of these agreements is minimal. Accordingly, the Company believes the liability for these agreements as of March 31, 2004 is not material.

Note 6. Income Taxes

     For federal income tax purposes, the Company has available federal net operating loss carry-forwards of approximately $119,000 and research and development credit carry-forwards of $151 at December 31, 2003. The net operating loss and research and development credit carry-forwards expire in 2011 through 2022 if not previously utilized. The utilization of these carry-forwards may be subject to limitations based on past and future changes in ownership of the Company pursuant to Internal Revenue Code Section 382. A sale of the Company at this time may result in a substantial limitation to these net operating loss carry-forwards under Internal Revenue Code Section 382. Future tax benefits have not been recognized in the financial statements, as their utilization is considered uncertain based on the weight of available information.

Note 7. Recently Issued Accounting Pronouncements

     In January 2003, the FASB issued Interpretation No. (“FIN”) 46, “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51”. FIN No. 46 requires certain variable interest entities, or VIEs,

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to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest, or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. In December 2003, the FASB issued FIN No. 46-R, “Consolidation of Variable Interest Entities”, which represents a revision to FIN No. 46. The provisions of FIN No. 46-R are effective for interests in VIEs as of the first interim or annual period ending after December 15, 2003. The Company currently has no contractual relationship or other business relationship with a variable interest entity and therefore the adoption of FIN No. 46 and FIN No. 46-R did not have a material effect on its consolidated financial position, results of operations or cash flows.

Note 8. Gain on Sale of Patents

     On March 31, 2004, the Company completed the sale of its patent portfolio to Thalveg Data Flow LLC for $1,800 pursuant to a patent purchase agreement entered into on December 30, 2003 and amended on March 31, 2004. The patent purchase agreement includes a royalty-free, non-exclusive license back to the Company. The license is transferable, subject to certain restrictions applicable to the transferee relating to revenues that can be generated by products covered by the license.

Note 9. Subsequent Events

     On April 21, 2004, the Company announced the simultaneous signing and closing of a strategic investment into the Company by Olden Acquisition LLC (“Olden”), an affiliate of Kanders & Company, Inc., for the purpose of initiating a strategy to redeploy the Company’s assets and use its cash and cash equivalent assets to enhance stockholder value. As part of the Company’s asset redeployment strategy, the Company will attempt to sell or otherwise dispose of the remaining assets used in its historical operating business. The Company issued and sold to Olden a 2% ten-year Convertible Subordinated Note, which is convertible after one year (or earlier upon a call by the Company and in certain other circumstances) at a conversion price of $0.45 per share of the Company’s common stock into approximately 19.9% of the outstanding common equity of the Company as of the closing date. Proceeds to the Company from this transaction totaled approximately $2.5 million before transaction expenses. Interest on the note accrues semi-annually but is not payable currently or upon conversion of the note.

     In addition, on April 21, 2004, the Company’s board of directors voted to increase its size from three to four members. Ann Winblad resigned as a director and Warren B. Kanders and Nicholas Sokolow were appointed to fill the vacancies, so that the Board is now comprised of the two new directors and John F. Kennedy and John T. Riedl. In addition, Mr. Kanders was appointed as the Executive Chairman of the Board and Nigel P. Ekern was appointed as Chief Administrative Officer and Secretary to oversee the Company’s operations and to assist with the Company’s asset redeployment strategy. Effective April 21, 2004, Thomas M. Donnelly resigned as the Company’s President. Effective upon the filing with the Securities and Exchange Commission of this Quarterly Report on Form 10-Q, Mr. Donnelly will resign as Chief Financial Officer and Treasurer, at which time he will receive severance payments in accordance with a separation agreement with the Company. Mr. Donnelly will continue to serve as a part-time consultant for a limited transition period.

     In connection with this transaction, the Company also entered into a Registration Rights Agreement, which requires the Company, upon request of the purchaser of the note or its assignee, to register under the Securities Act of 1933, as amended, the resale of the shares of common stock into which the note is convertible.

     Also in connection with this transaction, the board of directors adopted an amendment to the Company’s Rights Agreement such that the transaction would not trigger the rights thereunder.

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

Special Note Regarding Forward-Looking Statements

     This Quarterly Report on Form 10-Q (including exhibits and information incorporated by reference herein) contains both historical and forward-looking statements that involve risks, uncertainties and assumptions. The statements contained in this report that are not purely historical are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, including statements regarding our expectations, beliefs, intentions or strategies for the future. All forward-looking statements included in this Quarterly Report on Form 10-Q (including exhibits and information incorporated by reference herein) are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Our actual results and actual events could differ materially from those described in our forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in Item 2 of this report (“Management’s Discussion and Analysis of Financial Condition and Results of Operations”) under the heading “Risk Factors That May Affect Our Future Results” and those described in our previous filings with the Securities and Exchange Commission. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date that they were made. We undertake no obligation to publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect the occurrence of unanticipated events.

     References in this Quarterly Report on Form 10-Q to “Net Perceptions,” the “Company,” “we,” “our” and “us” refer to Net Perceptions, Inc. and, if so indicated or the context so requires, includes our wholly owned subsidiary Knowledge Discovery One, Inc. (which we refer to in this report as “KD1”). On September 9, 2003, KD1 was merged with and into the Company.

OVERVIEW

     The following discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this report.

     We were incorporated in Delaware in July 1996, and our initial product was shipped in January 1997. From inception through late 2000, we expanded our organization by hiring personnel in key areas, particularly marketing, sales and research and development. Our total number of employees was 315 on December 31, 2000. During 2001, 2002 and 2003, we instituted certain restructuring plans to align our cost structure with our business outlook and general economic conditions. In connection with our restructuring activities, our total number of employees was reduced to 98 as of December 31, 2001, 52 as of December 31, 2002, and 9 as of December 31, 2003. As of May 7, 2004, the Company has four employees, three of whom are executive officers.

     We have sustained losses on an annual basis since inception. As of March 31, 2004, we had an accumulated deficit of $221 million. Our net loss was $5.3 million for the year ended December 31, 2003, compared to a net loss of $16.7 million in the prior year. The losses referred to in this paragraph resulted from costs incurred in the development and marketing of our products and services, significant costs incurred related to restructuring activities, significant costs for outside professional services related to the exploration of various strategic alternatives for the Company, as well as a decline in our revenues since the third quarter of 2000.

     In February 2003, we engaged Piper Jaffray to act as our financial advisor in connection with the potential sale of the Company. On September 2, 2003, we paid a return of capital cash distribution to stockholders of record as of August 18, 2003 in the amount of $1.50 per share or a total of approximately $42.2 million, which was reflected as a reduction to additional paid-in capital. We also reduced our workforce by twelve positions to ten full-time employees. In addition, as a result of the cash distribution paid on September 2, 2003, our board of directors approved an adjustment to our outstanding options that took effect on the close of business on September 3, 2003. The adjustment was to in no event reduce the exercise price of any options to less than $0.01 per share or increase the number of shares subject to such options to a number exceeding the number of shares of common stock that are registered and available for issuance. In accordance with Financial Accounting Standards Board Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation – an Interpretation of APB No. 25,” there was no accounting consequence due to the changes made to the exercise price or the number of shares other than future potential dilution to stockholders because the aggregate intrinsic value of each award immediately after the

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change was not greater than the aggregate intrinsic value of the award immediately before the change and the ratio of the exercise price per share to the market value per share was not reduced.

     On October 21, 2003, we announced that our board of directors had unanimously approved a Plan of Complete Liquidation and Dissolution, referred to as the plan of liquidation. The plan of liquidation was submitted to the Company’s stockholders for approval and adoption at a special meeting of stockholders originally scheduled for March 12, 2004, which was adjourned and was reconvened on March 23, 2004. At the reconvened special meeting, the proposal to approve and adopt the plan of liquidation did not receive the affirmative vote of a majority of the 28,145,338 shares of common stock outstanding as of the record date for the special meeting required to approve the proposal. Of the 15,773,134 shares represented in person or by proxy at the reconvened special meeting, 13,810,233 shares voted in favor of the proposal, 1,925,694 shares voted against and 37,207 shares abstained.

     On March 31, 2004, we and Thalveg Data Flow, LLC, (“Thalveg”) executed an amendment to the patent purchase agreement which had been entered into on December 30, 2003, and we completed the sale of our patent portfolio provided for therein for a purchase price of $1.8 million in cash. The patent purchase agreement, as amended, includes a royalty-free, non-exclusive license back to us. The license is transferable, subject to certain restrictions applicable to the transferee relating to revenues that can be generated by products covered by the license. This transaction did not involve any of our other intellectual property rights or assets, including our proprietary software products.

     In addition, on March 31, 2004 we announced that we had granted to a software company a non-exclusive source code license to a portion of the Company’s intellectual property and sold certain technology related to a product discontinued in 2002. The aggregate consideration for this sale and license was $325,000.

     On April 1, 2004, we entered into an agreement with Tornago Systems, Inc., or Tornago, a corporation formed by three non-officer former employees, to fulfill existing prepaid customer support obligations in exchange for future cash payments of approximately $60,000. This amount represents approximately 60% of the remaining prepaid deferred maintenance revenue amounts under the existing end user contracts when measured from April 1, 2004. The Company will continue to recognize the deferred revenue as earned and the $60,000 will be reflected as cost of revenue. Under the terms of the agreement, Tornago received a non-transferable license to relevant intellectual property solely to provide support and consulting services to end users of our products. Under the agreement, we will receive a 15% royalty on any follow-on services sold by Tornago through April 1, 2006.

     In connection with the agreement with Tornago, we terminated the employment of the remaining members of our engineering staff, effective March 31, 2004, and paid severance to these employees in accordance with existing agreements.

     While we expect to continue to service our existing customers through Tornago and may continue to derive a declining level of revenues from software licenses and royalties, software maintenance and professional services relating to existing customers, we are no longer actively marketing or directly supporting our products and have not retained any employees to do so. We expect that the size of our customer base will decline and we do not expect that future product or service revenues, if any, will be significant. We anticipate that our operating expenses will continue to decline in 2004, but will continue to constitute a material use of our cash resources. We expect to incur additional losses and continued negative cash flow for the foreseeable future. While we reported a net profit for the first quarter of 2004 due to the Thalveg transaction, we do not expect to generate an operating profit for 2004 or the foreseeable future. Our ability to become profitable will depend, among other things, on our identification and acquisition of a new operating business and the success of that business.

RECENT DEVELOPMENTS

     On April 21, 2004, we announced the simultaneous signing and closing of a strategic investment into the Company by Olden Acquisition LLC (“Olden”), an affiliate of Kanders & Company, Inc., for the purpose of initiating a strategy to redeploy our assets and use our cash and cash equivalent assets to enhance stockholder value. As part of our asset redeployment strategy, we will attempt to sell or otherwise dispose of the remaining assets used in our historical operating business. We issued and sold to Olden a 2% ten-year Convertible Subordinated Note, which is convertible after one year (or earlier upon a call by the Company and in certain other circumstances) at a conversion price of $0.45 per share of Company common stock into approximately 19.9% of the outstanding common equity of Net Perceptions as of the closing date. Proceeds to the Company from this transaction totaled approximately $2.5 million before transaction expenses. Interest on the note accrues semi-annually but is not payable currently or upon conversion of the note.

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     In addition, on April 21, 2004, our board of directors voted to increase its size from three to four members. Ann Winblad resigned as a director and Warren B. Kanders and Nicholas Sokolow were appointed to fill the vacancies, so that the Board is now comprised of the two new directors and John F. Kennedy and John T. Riedl. In addition, Mr. Kanders was appointed as the Executive Chairman of the Board and Nigel P. Ekern was appointed as Chief Administrative Officer and Secretary to oversee our operations and to assist with our asset redeployment strategy. Effective April 21, 2004, Thomas M. Donnelly resigned as our President. Effective upon the filing with the Securities and Exchange Commission of this Quarterly Report on Form 10-Q, Mr. Donnelly will resign as Chief Financial Officer and Treasurer, at which time he will receive severance payments in accordance with a separation agreement with the Company. Mr. Donnelly will continue to serve as a part-time consultant for a limited transition period.

     As part of our asset redeployment strategy, we are currently working to identify suitable merger or acquisition opportunities that can serve as a platform for future growth. Although we are not targeting specific business industries for potential mergers or acquisitions, we plan to seek businesses with cash flow, experienced management teams, and operations in markets offering stability and growth potential. In addition, we believe that our common stock, which is publicly traded on the NASDAQ Small Cap Market, offers us flexibility as acquisition currency and will enhance our attractiveness to potential merger partners or acquisition candidates.

     Period-to-period comparisons of our operating results should not be relied upon as predictive of future performance. Our prospects must be considered in light of the foregoing and the risks identified below under the heading “Factors That May Affect Our Future Results.” We may not be successful in addressing these risks.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

     Our discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to bad debts, investments, intangible assets, restructuring liabilities, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

     We believe the following critical accounting policies affect significant judgments and estimates used in the preparation of our consolidated financial statements. Events occurring subsequent to the preparation of the consolidated financial statements, such as those described in the section of this report entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Overview,” may cause us to re-evaluate these policies.

     Revenue Recognition. Our revenues are recognized in accordance with the American Institute of Certified Public Accountants Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” as amended by SOP 98-4 and SOP 98-9, as well as Technical Practice Aids issued from time to time by the American Institute of Certified Public Accountants and in accordance with the Securities and Exchange Commission Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition in Financial Statements.” We derive revenues from software licenses, software maintenance and professional services. Maintenance includes telephone and Web-based technical support, bug fixes and rights to unspecified upgrades on