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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 September 30, 2004.
 
OR
 
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 0-15325


ASCENTIAL SOFTWARE CORPORATION
(Exact name of registrant as specified in its charter)
         
Delaware
(State or other jurisdiction of
incorporation or organization)
      94-3011736
(I.R.S. Employer
Identification No.)
 
50 Washington Street, Westborough, MA
(Address of principal executive office)
      01581
(Zip Code)
 
Registrant’s telephone number, including area code:
    (508) 366-3888

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     o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

YES     x       NO     o

At October 31, 2004, 58,753,212 shares of the registrant’s common stock were outstanding.


ASCENTIAL SOFTWARE CORPORATION
FORM 10-Q
Quarterly Period Ended September 30, 2004
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 Ex-10.1 Form of Stock Option Agreement
 Ex-10.2 Form of Non Qualified Stock Option Agreement
 Ex-10.3 Form of Stock Option Agreement
 Ex-31.1 Section 302 Certification of CEO
 Ex-31.2 Section 302 Certification of CFO
 Ex-32.1 Section 906 Certification of CEO
 Ex-32.2 Section 906 Certification of CFO

FORWARD-LOOKING STATEMENTS

Ascential, Ascential DataStage, Ascential QualityStage, Ascential ProfileStage and Ascential Enterprise Integration Suite are trademarks of Ascential Software Corporation or its affiliates and may be registered in the United States or other jurisdictions. Other marks are the property of the owners of those marks. This report contains forward-looking statements that are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or anticipated results. These risks and uncertainties include, but are not limited to, those set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Factors That May Affect Future Results” and elsewhere in, or incorporated by reference into, this report. Readers of this report should review carefully these factors as well as the description of risks and uncertainties, which, together with other detailed information about us, is contained in other documents and periodic reports that we file from time to time with the Securities and Exchange Commission. These forward-looking statements reflect management’s opinions only and only as of the date of this report and we disclaim any obligation to update or revise these statements.

   

   

   

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Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

ASCENTIAL SOFTWARE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In thousands, except per share data)
                                 
    Three Months Ended   Nine Months Ended
    September 30,
  September 30,
    2004
  2003
  2004
  2003
NET REVENUES
                               
Licenses
  $ 27,159     $ 22,353     $ 76,747     $ 62,539  
Services
    40,434       23,536       116,969       58,575  
 
   
 
     
 
     
 
     
 
 
 
    67,593       45,889       193,716       121,114  
 
   
 
     
 
     
 
     
 
 
COSTS AND EXPENSES
                               
 
Cost of licenses
    4,745       3,874       12,719       10,828  
Cost of services
    17,616       10,331       50,023       26,406  
Sales and marketing
    27,765       19,531       80,504       53,075  
Research and development
    9,805       6,834       29,347       17,714  
General and administrative
    7,195       6,472       19,038       19,843  
Merger, realignment and other charges
    151       1,654       1,007       2,086  
Write-off of acquired in-process research and development
          2,000             2,000  
 
   
 
     
 
     
 
     
 
 
 
    67,277       50,696       192,638       131,952  
 
   
 
     
 
     
 
     
 
 
Operating income (loss)
    316       (4,807 )     1,078       (10,838 )
 
OTHER INCOME
                               
Interest income, net
    2,152       2,661       6,119       8,846  
Other income, net
    182       576       602       652  
 
   
 
     
 
     
 
     
 
 
 
INCOME (LOSS) BEFORE INCOME TAXES
    2,650       (1,570 )     7,799       (1,340 )
Income tax expense
    327       129       1,872       198  
 
   
 
     
 
     
 
     
 
 
 
NET INCOME (LOSS)
  $ 2,323     $ (1,699 )   $ 5,927     $ (1,538 )
 
   
 
     
 
     
 
     
 
 
NET INCOME (LOSS) PER COMMON SHARE
                               
Basic
  $ 0.04     $ (0.03 )   $ 0.10     $ (0.03 )
Diluted
  $ 0.04     $ (0.03 )   $ 0.10     $ (0.03 )
SHARES USED IN PER SHARE CALCULATIONS
                               
Basic
    58,632       58,195       59,359       58,028  
Diluted
    59,207       58,195       61,007       58,028  

See Notes to Unaudited Condensed Consolidated Financial Statements.

   

   

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ASCENTIAL SOFTWARE CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(In thousands)
                 
    September 30,   December 31,
    2004
  2003
ASSETS
           
Current assets:
               
Cash and cash equivalents
  $ 100,952     $ 202,568  
Short-term investments
    370,573       313,681  
Accounts receivable, net
    47,335       42,034  
Recoverable income taxes
    3,306       1,276  
Other current assets
    15,047       22,035  
 
   
 
     
 
 
Total current assets
    537,213       581,594  
 
               
Property and equipment, net
    10,041       11,186  
Software development costs, net
    15,599       14,794  
Long-term investments
    2,740       2,301  
Goodwill
    330,788       324,327  
Intangible assets, net
    13,211       19,863  
Other assets
    10,667       12,014  
 
   
 
     
 
 
Total assets
  $ 920,259     $ 966,079  
 
   
 
     
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
           
Current liabilities:
               
Accounts payable
  $ 10,293     $ 16,878  
Accrued expenses
    18,387       14,433  
Accrued employee compensation
    15,297       24,207  
Income taxes payable
    55,240       62,327  
Deferred revenue
    43,252       41,106  
Accrued merger, realignment and other charges
    35,558       46,705  
Other current liabilities
    2,356       1,800  
 
   
 
     
 
 
 
Total current liabilities
    180,383       207,456  
 
Other long term liabilities
    1,725       937  
 
   
 
     
 
 
Commitments and contingencies (Note H)
               
 
Stockholders’ equity:
               
Preferred stock
           
Common stock
    690       685  
Additional paid-in capital
    652,917       647,199  
Treasury stock
    (130,069 )     (98,454 )
Retained earnings
    223,975       218,048  
Deferred compensation
    (1,068 )     (1,779 )
Accumulated other comprehensive loss
    (8,294 )     (8,013 )
 
   
 
     
 
 
 
Total stockholders’ equity
    738,151       757,686  
 
   
 
     
 
 
 
Total liabilities and stockholders’ equity
  $ 920,259     $ 966,079  
 
   
 
     
 
 

See Notes to Unaudited Condensed Consolidated Financial Statements.

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ASCENTIAL SOFTWARE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In thousands)
                 
    Nine Months Ended
    September 30,
    2004
  2003
CASH FLOWS FROM OPERATING ACTIVITIES
               
Net income (loss)
  $ 5,927     $ (1,538 )
Adjustments to reconcile net income (loss) to net cash and cash equivalents used in operating activities:
               
Depreciation and amortization
    11,029       6,573  
Amortization of capitalized software development costs
    5,893       5,152  
Write-off of acquired in-process research and development
          2,000  
Foreign currency transaction (gain) loss
    869       (4,796 )
Gain on sale of available for sale securities
    (511 )      
(Gain) loss on disposal of property and equipment
    (8 )     49  
Deferred income taxes
    1,976       215  
Provision for losses on accounts receivable
    379        
Non-cash merger, realignment and other charges
    1,007       2,086  
Stock-based employee compensation
    711       203  
Changes in operating assets and liabilities:
               
Accounts receivable
    (5,750 )     286  
Other current and non-current assets
    (128 )     4,989  
Accounts payable, accrued expenses and other liabilities
    (37,483 )     (21,381 )
Deferred revenue
    2,414       5,573  
 
   
 
     
 
 
Net cash and cash equivalents used in operating activities
    (13,675 )     (589 )
 
   
 
     
 
 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Purchases of available-for-sale securities
    (599,138 )     (630,982 )
Maturities of available-for-sale securities
    368,103       421,019  
Sales of available-for-sale securities
    173,688       275,278  
Business combination, net of cash acquired
          (83,675 )
Purchases of property and equipment
    (3,630 )     (2,531 )
Additions to capitalized software development costs
    (6,698 )     (5,530 )
Proceeds from sale of a product line and the database business
    6,800       109,328  
Purchase of strategic investments
    (562 )     (813 )
Other
          (178 )
 
   
 
     
 
 
Net cash and cash equivalents (used in) provided by investing activities
    (61,437 )     81,916  
 
   
 
     
 
 
CASH FLOWS FROM FINANCING ACTIVITIES
               
Extinguishment of debt
          (8,155 )
Payment of capital leases
    (469 )      
Purchases of treasury stock
    (31,615 )      
Cost associated with reverse split
          (202 )
Proceeds from issuance of common stock
    5,723       7,477  
 
   
 
     
 
 
Net cash and cash equivalents used in financing activities
    (26,361 )     (880 )
 
   
 
     
 
 
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
    (143 )     6,346  
 
   
 
     
 
 
(Decrease) increase in cash and cash equivalents
    (101,616 )     86,793  
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
    202,568       216,551  
 
   
 
     
 
 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
  $ 100,952     $ 303,344  
 
   
 
     
 
 

See Notes to Unaudited Condensed Consolidated Financial Statements.

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ASCENTIAL SOFTWARE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)
(In thousands)
                                 
    Three Months Ended   Nine Months Ended
    September 30,
  September 30,
    2004
  2003
  2004
  2003
Net income (loss)
  $ 2,323     $ (1,699 )   $ 5,927     $ (1,538 )
Other comprehensive income (loss):
                               
Unrealized gains (losses) on available-for-sale securities, net of tax
benefit (expense) of $0, $(197), $232 and $214 for the three months ended
September 30, 2004 and 2003, respectively, and the nine months ended
September 30, 2004 and 2003, respectively (See Note A)
    1,240       (348 )     (381 )     321  
Reclassification adjustment for realized (gains) losses included in net income
    86       (540 )     (511 )     (1,071 )
Change in cumulative foreign currency exchange translation adjustment
    160       523       611       1,117  
 
   
 
     
 
     
 
     
 
 
Other comprehensive income (loss)
    1,486       (365 )     (281 )     367  
 
   
 
     
 
     
 
     
 
 
Comprehensive income (loss)
  $ 3,809       (2,064 )   $ 5,646     $ (1,171 )
 
   
 
     
 
     
 
     
 
 

See Notes to Unaudited Condensed Consolidated Financial Statements.

   

   

   

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ASCENTIAL SOFTWARE CORPORATION
Notes to Unaudited Condensed Consolidated Financial Statements

Note A — Summary of Significant Accounting Policies

     Organization and Operations. Ascential Software Corporation (referred to as, “we” or the “Company”) was incorporated in Delaware in 1986 and, until the third quarter of 2001, operated under the name “Informix Corporation.” During the third quarter of 2001, we sold to International Business Machines Corporation (“IBM”) substantially all of the assets relating to our database management systems business, including the name “Informix,” for a purchase price of $1.0 billion in cash (the “IBM Transaction”). In connection with the sale to IBM, we changed our name to Ascential Software Corporation.

     We are a global provider of enterprise data integration software and services. We design, develop, market and support enterprise data integration software products and solutions to allow the Global 2000 and other large organizations and governmental institutions to turn vast amounts of disparate, unrefined data into reliable, reusable information assets. We also offer our customers a variety of services such as consulting, including implementation assistance and project planning and deployment, software product enhancements and support, and education.

     The principal geographic markets for our products are North America, Europe and Asia/Pacific. Our customers include businesses ranging from medium-sized corporations to Global 2000 companies, principally in financial services, insurance, healthcare, retail, manufacturing, consumer packaged goods, telecommunications and government.

     Basis of Presentation. The accompanying unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements for the year ended December 31, 2003 included in our most recent Annual Report on Form 10-K. In the opinion of our management, all significant adjustments, which are normal, recurring in nature and necessary for a fair presentation of the financial position and results of our operations, have been consistently recorded. The operating results for the interim periods presented are not necessarily indicative of expected performance for the entire year. The unaudited information should be read in conjunction with our audited consolidated financial statements, and the accompanying notes, for the year ended December 31, 2003 that are included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 15, 2004. Certain prior period amounts have been reclassified to conform to the current period presentation.

     Stock-Based Compensation. In December 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure (“SFAS No. 148”). SFAS No. 148 amends the disclosure requirements of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), to require prominent disclosure in our annual and interim financial statements regarding the method we use for stock-based compensation and the effect of the method we use on reported results. As permitted by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and SFAS No. 123, we utilize the intrinsic value method to account for awards to employees, directors, and officers under our plans. Under the intrinsic value method, we generally recognize no compensation expense with respect to such awards granted under the terms of our various stock option plans and issued under our Employee Stock Purchase Plan (“ESPP”). All options granted under our stock option plans for the periods presented were for a fixed number of shares and had an exercise price equal to the market value of the underlying common stock on the date of grant.

     Pro forma information regarding the net income (loss) and net income (loss) per share is required by SFAS No. 148, as if we accounted for our stock-based awards to employees under the fair value method of SFAS No. 123. The fair value of our stock-based awards to employees was estimated using the Black-Scholes option-pricing model. The fair value of our stock-based awards was estimated using the following assumptions:

                                 
    Three Months Ended   Nine Months Ended
    September 30,
  September 30,
    2004
  2003
  2004
  2003
Options:
                               
Risk-free interest rate
    3.43 %     2.92 %     3.41 %     2.89 %
Expected life (years)
    4.5       4.5       4.5       4.5  
Expected volatility
    100 %     81 %     103 %     82 %
Dividend rate
    %     %     %     %
Weighted average fair value of option grants
  $ 8.90     $ 10.95     $ 16.46     $ 9.96  
ESPP:
                               
Risk-free interest rate
    1.48 %     0.91 %     1.19 %     1.04 %
Expected life (years)
    0.25       0.25       0.25       0.25  
Expected volatility
    50 %     81 %     64 %     83 %
Dividend rate
    %     %     %     %
Weighted average fair value of ESPP purchases
  $ 3.81     $ 4.34     $ 5.82     $ 3.53  

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     For pro forma purposes, the estimated fair value of our stock-based awards is amortized over the awards’ vesting periods (for options) and the three-month purchase periods (for stock purchases under the ESPP). The following table illustrates the effect on net income and net income per share, as if we had applied the fair value method to stock-based employee compensation (in thousands, except per share data):

                                 
    Three Months Ended   Nine Months Ended
    September 30,
  September 30,
    2004
  2003
  2004
  2003
Net income (loss) as reported
  $ 2,323     $ (1,699 )   $ 5,927     $ (1,538 )
Add back:
                               
Stock-based compensation recognized in net income
    214       128       711       203  
Deduct:
                               
Total stock-based employee compensation expense
determined under the fair value based method for
all awards, net of related tax effects
    (7,134 )     (5,494 )     (24,689 )     (18,594 )
 
   
 
     
 
     
 
     
 
 
Net loss, pro forma
  $ (4,597 )   $ (7,065 )   $ (18,051 )   $ (19,929 )
 
   
 
     
 
     
 
     
 
 
Net income (loss) per common share:
                               
Basic, as reported
  $ 0.04     $ (0.03 )   $ 0.10     $ (0.03 )
Diluted, as reported
  $ 0.04     $ (0.03 )   $ 0.10     $ (0.03 )
Basic, pro forma
  $ (0.08 )   $ (0.12 )   $ (0.30 )   $ (0.34 )
Diluted, pro forma
  $ (0.08 )   $ (0.12 )   $ (0.30 )   $ (0.34 )
Shares used in calculations:
                               
Basic, as reported
    58,632       58,195       59,359       58,028  
Diluted, as reported
    59,207       58,195       61,007       58,028  
Basic and Diluted, pro forma
    58,632       58,195       59,359       58,028  

     Transfer of Financial Assets

     In June, 2004, we entered into a non-recourse receivables purchase agreement with a financial institution, providing for the sale of up to $10.0 million of trade accounts receivable. In the three and nine months ended September 30, 2004, we received approximately $4.7 and $7.7 million, respectively, for the sale of accounts receivable under this agreement. This arrangement is a means of accelerating cash collections in a manner that, we believe, is more cost-effective than offering early payment discounts. The transaction is considered a sale under the provisions of SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. Trade receivables that were sold during the first nine months of 2004, and not yet collected, amounted to $5.1 million and are excluded from our trade accounts receivable at September 30, 2004. The fees, losses and other amounts related to the Company’s sale and subsequent servicing of these receivables were not material to the Company’s consolidated financial statements.

Note B — Goodwill and Other Intangible Assets

     As of September 30, 2004, we had goodwill in the amount of $330.8 million. There was an increase of $6.5 million in the carrying value of goodwill from December 31, 2003. This change consists of a $6.7 million net increase associated with an adjustment to the assets and liabilities acquired in our acquisition, in 2003, of Mercator Software, Inc., which was subsequently converted into Mercator Software, LLC (“Mercator”), and a $0.2 million reduction related to tax refunds received related to Vality Technology Incorporated (“Vality”), which we acquired in 2002, for which no receivable had been recorded. We previously determined, in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”, that we would assess the impairment of goodwill and other intangible assets with indefinite lives annually in the fourth quarter, or more frequently if other indicators of impairment arise. Fluctuations in the price of our common stock could, at some point in time, be deemed to indicate that the fair value of the Company is less than its carrying value, thus indicating a potential impairment of the Company’s goodwill requiring further testing. The Company will continue to monitor market conditions to determine whether an impairment charge is warranted. Other intangible assets amounted to

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$13.2 million (net of accumulated amortization of $19.3 million) and $19.9 million (net of accumulated amortization of $12.8 million) at September 30, 2004 and December 31, 2003, respectively. These intangible assets consist primarily of customer relationships and developed technology acquired through business combinations. We are currently amortizing these assets over the estimated useful lives of each, generally ranging from five to seven years. There are no anticipated residual values related to these intangible assets. Amortization expense for the three and nine months ended September 30, 2004 was $2.2 million and $6.7 million, respectively. Amortization expense for the three and nine months ended September 30, 2003 was $1.5 million and $5.4 million, respectively. Amortization expense is currently anticipated to be $1.8 million for the remaining three months of 2004, and amortization expense for these intangible assets for each of the years ending December 31, 2005, 2006, 2007 and 2008 is currently anticipated to be $3.8 million, $2.9 million, $2.8 million and $1.9 million, respectively.

Note C — Net Income (Loss) Per Share

     The following table sets forth the computation of basic and diluted net income (loss) per common share (in thousands, except per share data):

                                 
    Three Months Ended   Nine Months Ended
    September 30,
  September 30,
    2004
  2003
  2004
  2003
Numerator:
                               
Net income (loss)
  $ 2,323     $ (1,699 )   $ 5,927     $ (1,538 )
 
   
 
     
 
     
 
     
 
 
Denominator:
                               
Denominator for basic net loss per common share —
Weighted-average shares outstanding
    58,632       58,195       59,359       58,028  
Effect of dilutive securities:
                               
Employee stock options
    575             1,648        
 
   
 
     
 
     
 
     
 
 
 
Denominator for diluted net loss per common share —
Adjusted weighted-average shares and assumed conversions
    59,207       58,195       61,007       58,028  
 
   
 
     
 
     
 
     
 
 
Basic net income (loss) per common share
  $ 0.04     $ (0.03 )   $ 0.10     $ (0.03 )
Diluted net income (loss) per common share
  $ 0.04     $ (0.03 )   $ 0.10     $ (0.03 )

     During the three and nine months ended September 30, 2003 we have excluded options to purchase 1.8 million and 1.2 million common shares, respectively, from our diluted calculation because the potential common shares associated with these options are anti-dilutive due to the net losses during those periods. These options have exercise prices ranging from $0.19 to $17.00 and $0.19 to $14.52 for the three and nine months ended September 30, 2003, respectively.

     Additionally, we excluded options to purchase common shares from our diluted net income (loss) per share calculation for the three and nine months ended September 30, 2004 and September 30, 2003 because the exercise prices of these options were equal to or exceeded the average market value of our common stock for the same periods and, therefore, these potential common shares were anti-dilutive. The following is a summary of the excluded potential shares:

                                 
    Three Months Ended   Nine Months Ended
    September 30,
  September 30,
    2004
  2003
  2004
  2003
Potential common shares:
                               
Number of stock options (thousands)
    9,030       8,065       5,695       8,572  
Range of exercise prices
  $ 12.92-233.29     $ 17.14-341.58     $ 18.00-233.29     $ 14.68-341.58  
Options expiring through
    2014       2013       2014       2013  

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Note D — Comprehensive Loss

     Accumulated other comprehensive loss on the balance sheet is comprised of the following at September 30, 2004 and December 31, 2003 (in thousands):

                 
    September 30,   December 31,
    2004
  2003
Cumulative foreign exchange translation adjustment
  $ (7,697 )   $ (8,308 )
Unrealized gains (losses) on available-for-sale securities, net of taxes of $0 at September 30, 2004 and $197 at December 31, 2003
    (597 )     295  
 
   
 
     
 
 
Accumulated other comprehensive loss
  $ (8,294 )   $ (8,013 )
 
   
 
     
 
 

Note E — Stockholders’ Equity

     The following table reconciles shares of common stock issued and outstanding at September 30, 2004 and December 31, 2003 (in thousands):

         
Reconciliation of shares of common stock issued (in thousands):
       
Shares issued at December 31, 2003
    68,478  
Shares issued upon exercises of stock options
    348  
Shares sold and issued to employees under our employee stock purchase plan
    129  
 
   
 
 
Shares issued at September 30, 2004
    68,955  
Less shares in treasury at September 30, 2004
    (10,258 )
 
   
 
 
Shares of common stock outstanding at September 30, 2004
    58,697  
 
   
 
 

     We had 10.3 million and 8.4 million shares of common stock in treasury at September 30, 2004 and December 31, 2003, respectively. Through the third quarter of 2004, we have repurchased an aggregate of 17.0 million shares of common stock, for an aggregate purchase price of $248.8 million, as part of our previously-approved stock repurchase program that commenced in the second quarter of 2001. We are authorized to repurchase up to $350.0 million of common stock under this program.

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Note F — Accrued Merger, Realignment and Other Charges

     The following table summarizes the components of the “Accrued merger, realignment and other charges” at September 30, 2004 and December 31, 2003 (in millions):

                 
    September 30,   December 31,
    2004
  2003
Facility and equipment charges resulting from the IBM Transaction
  $ 7.4     $ 8.8  
Facility, severance, and other accruals arising from the Mercator acquisition
    28.0       36.9  
Other merger and realignment charges
    0.2       1.0  
 
   
 
     
 
 
Total accrued merger, realignment and other charges
  $ 35.6     $ 46.7  
 
   
 
     
 
 

     The components of our merger, realignment and other charges are described below.

Facility and Equipment Charges Resulting from IBM Transaction

     As a result of the IBM Transaction, we no longer required as much facility space and, accordingly, recorded charges and adjustments during 2003 and 2002 for facilities and equipment costs related to our vacant, or partially vacant, facilities. During the nine months ended September 30, 2004 we recorded a charge of $1.0 million for additional facilities and equipment costs at both domestic and international locations as a result of changes in the estimates of remaining residual lease obligations and estimated sublease income. The accumulated charges were comprised of reserves for residual lease obligations and restoration costs and write-offs related to leasehold improvements and other fixed assets at these vacated, and partially vacated, facilities. The following table summarizes the accrual activity for the nine months ended September 30, 2004 (in millions):

                                 
    Accrual                   Accrual
    Balance at                   Balance at
    December 31,   Cash   Charges and   September
    2003
  Payments
  Adjustments
  30, 2004
Residual lease obligations and restoration costs
  $ 8.8     $ (2.4 )   $ 1.0     $ 7.4  

     The $7.4 million of residual lease obligations is comprised of $6.2 million of lease-related payments that we estimate we will make for these facilities through the end of each corresponding lease term, net of rental payments from IBM or other sublessees, and $1.2 million of estimated restoration costs for facilities that we have either exited or finalized plans to exit. The unpaid residual lease obligations and restoration costs at September 30, 2004 relate to facilities that we have exited or planned to exit, with leases that expire from 2004 through 2008.

     We may record additional adjustments or charges in the future due to changes in estimates arising from the size and quantity of our facilities that are being exited and the volatility of the real estate markets in which our facilities are located. As of September 30, 2004, barring unforeseen circumstances, we do not expect additional charges related to undiscounted lease obligations and restoration costs, excluding estimated sublease income, to exceed $1.7 million, the maximum estimated remaining unaccrued obligation under existing contractual lease terms.

Facility, Severance, and Other Accruals Arising from the Mercator Acquisition

     At the date of acquisition, Mercator had $10.5 million in “Accrued merger, realignment and other” costs, which we assumed at fair value. This reserve was recorded by Mercator prior to the acquisition for certain exit costs related to partially occupied Mercator facilities.

     As a result of restructuring actions taken in connection with the Mercator acquisition, an additional $33.8 million of merger-related costs were accrued in the purchase accounting for Mercator. These charges were primarily comprised of $17.4 million related to the closure of certain Mercator facilities as a consequence of the transaction, $14.4 million due to severance and related costs associated with terminating certain Mercator employees, and $2.0 million related to the resolution of certain other Mercator matters. The severance costs related to approximately 158 Mercator employees who were terminated as a result of the acquisition. We expect, barring unforeseen circumstances, that substantially all of these severance costs will be paid out by the end of 2004. The $26.1 million in facility exit costs accrued as of September 30, 2004 consists primarily of lease related payments on Mercator facilities for leases that expire at various dates through 2012, net of expected payments from subleases.

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     The following table summarizes the accrual activity for the nine months ended September 30, 2004 (in millions).

                                 
    Accrual                   Accrual
    Balance at                   Balance at
    December 31,   Cash   Charges and   September 30,
    2003
  Payments
  Adjustments
  2004
Residual lease obligations
  $ 28.4     $ (4.0 )   $ 1.7     $ 26.1  
Severance costs
    8.4       (7.5 )     0.8       1.7  
Other exit costs
    0.1             0.1       0.2  
 
   
 
     
 
     
 
     
 
 
Total
  $ 36.9     $ (11.5 )   $ 2.6     $ 28.0  
 
   
 
     
 
     
 
     
 
 

     During the nine months ended September 30, 2004, goodwill was adjusted to record additional employee severance costs of $0.8 million associated with the termination of certain Mercator employees in both domestic and foreign locations and $1.7 million as a result of a change in the estimate of our remaining residual lease obligations. We may record expenses in the future due to changes in estimates arising from the size and quantity of Mercator facilities being exited and the volatility of the real estate markets in which our facilities are located. Any such future expenses would be charged against income rather than goodwill. As of September 30, 2004, barring unforeseen circumstances, we do not expect future charges related to undiscounted lease obligations and restoration costs, excluding estimated sublease income, to exceed $17.8 million, the maximum remaining unaccrued obligation under existing contractual lease terms.

Other Merger and Realignment Charges

     In addition to the actions described above, in prior periods we recorded other charges related to realignment activities. As of September 30, 2004, there is $0.2 million of unpaid severance remaining in accrued costs associated with these activities. Barring unforeseen circumstances, we expect these remaining accrued severance costs to be paid out by December 31, 2004.

Note G — Business Segments

     We have two segments that report to our Chief Executive Officer (the “Chief Operating Decision Maker”). The first segment, Ascential Software, develops and markets data integration software and related services worldwide. The second segment, Informix Software, provided database management systems for data warehousing, transaction processing, and e-business applications. “We”, the “Company” or “Ascential Software Corporation” refers to Ascential Software and Informix Software on a combined basis. Segment operating performance is evaluated primarily on income before taxes. We completed the IBM Transaction during the third quarter of 2001. Accordingly, we derived no revenue from operations associated with the Informix Software segment after 2001, and the only remaining operating segment subsequent to the IBM Transaction is Ascential Software. Expenses continued to be incurred by the Informix Software segment related to the winding down of issues with respect to the sale of that business. Below is a summary of the results of operations based on the two segments for the three and nine months ended September 30, 2004 and 2003 (in millions):

                                 
    Three Months Ended   Nine Months Ended
    September 30,
  September 30,
    2004
  2003
  2004
  2003
Operating income (loss):
                               
Ascential Software
  $ 0.3     $ (4.0 )   $ 1.0     $ (7.9 )
Informix Software
          (0.8 )     0.1       (2.9 )
 
   
 
     
 
     
 
     
 
 
Total Ascential Software Corporation
  $ 0.3     $ (4.8 )   $ 1.1     $ (10.8 )
 
   
 
     
 
     
 
     
 
 
Income (loss) before income taxes:
                               
Ascential Software
  $ 2.7     $ (0.8 )   $ 7.7     $ 1.6  
Informix Software
          (0.8 )     0.1       (2.9 )
 
   
 
     
 
     
 
     
 
 
Total Ascential Software Corporation
  $ 2.7     $ (1.6 )   $ 7.8     $ (1.3 )
 
   
 
     
 
     
 
     
 
 

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     The operating income (loss) for Informix Software for the three and nine months ended September 30, 2004 and 2003 relates principally to the costs or recoveries from the settlement of disputes associated with the historical database operations (see Note H), adjustments to facility reserves recorded in connection with the IBM Transaction, and the general and administrative costs associated with consolidating the infrastructure of the database business into the infrastructure of our current operating business

     For the three and nine months ended and as of September 30, 2004 and September 30, 2003, all revenue, depreciation and amortization, identifiable assets and capital expenditures are related to the Ascential Software business segment.

Note H — Commitments and Contingencies

     We generally warrant that our unmodified software products, when used as specified, will substantially conform to the applicable user documentation for a specified period of time (generally 90 days in the United States, and longer in jurisdictions with applicable statutory requirements). Additionally, we generally warrant that our consulting services will be performed in a professional and workmanlike manner. Typically, liability for these warranties is limited to the amounts paid by the customer. If necessary, we would provide for the estimated cost of product and service warranties based on specific warranty claims and claim history; however, we have not incurred significant expense under our product or services warranties. As a result, we believe the estimated fair value of these agreements is immaterial. We also generally offer indemnification with respect to certain types of intellectual property claims and, occasionally, other matters.

     As part of the IBM Transaction, we entered into a master purchase agreement (the “MPA”) under which we agreed to indemnify IBM and its affiliates against any loss, claim, damage, liability or other expense incurred in connection with (i) any failure of any of our representations or warranties under the MPA to be true and correct in all respects; provided, however, that any such liability, in the aggregate, exceeds on a cumulative basis $10.0 million (and only to the extent of any such excess); (ii) any breach of any of our obligations under the MPA; (iii) any of the Excluded Liabilities, as defined in the MPA; or (iv) the operation or ownership of the Excluded Assets, as defined in the MPA. Our indemnification obligations with respect to certain representations and warranties under the MPA terminated on July 1, 2003.

     We are obligated to indemnify certain current and prior directors and officers for various matters arising from their actions during the period they were employed or associated with the Company. We have paid the legal fees of some former officers. We are entitled to seek reimbursement from such individuals for these payments if certain conditions are satisfied. Our indemnification obligations are defined by indemnification agreements, our charter and by-laws, and Delaware law. We are partially insured for certain other costs and losses that could be incurred by virtue of our future indemnification obligations. In the second quarter of 2004, we recorded a credit of $1.2 million, including $0.8 million of cash received, related to the resolution of an indemnification matter involving an officer of the Company prior to the IBM Transaction. In May 2002 and November 2003, we entered into standby letters of credit that expire by November 2006 and November 2007, respectively, which guarantee a total of $1.4 million of potential tax payments related to certain payments made to two of our former officers. These potential tax payments, which have been partially reserved based on management’s assessment of the potential payments, relate to severance paid to these former officers in accordance with change in control agreements that were triggered by the IBM Transaction. Payment under the standby letters of credit may be due upon final determination of these tax liabilities.

     During 2003, we issued a $2.5 million standby letter of credit to guarantee certain lease obligations pursuant to a lease between Mercator and the landlord of an office facility located in Wilton, Connecticut. The letter of credit is automatically extended annually, but not beyond July 1, 2013.

     We have also entered into standby letters of credit to guarantee approximately $0.2 million of lease payments for certain facilities in Europe. These guarantees do not have expiration dates and would allow landlords to obtain lease payments from our bank if we defaulted on our lease payment obligations.

     From time to time, in the ordinary course of business, the Company is involved in various legal proceedings and claims, including but not limited to those related to the operations of the former database business and/or asserted by former employees of the Company relating to their employment or compensation by the Company. The Company does not believe that any of these other proceedings and claims will have a material adverse effect on the Company’s business or financial condition.

Note I — Business Combinations

     On September 12, 2003, we completed the acquisition of Mercator. Mercator’s products addressed high performance, real time, complex data transformation and routing requirements in transaction oriented environments. We purchased Mercator to broaden and complement our existing enterprise data integration capabilities, increase our size and scale, and leverage the increased customer base of the combined companies. This acquisition also resulted in an in-place workforce of engineering, sales and marketing talent that we believe has the knowledge and expertise to complement our existing workforce. Upon the closing of the acquisition of Mercator on September 12, 2003, we established a reserve of $36.2 million to restructure and integrate the operations of Mercator. This restructuring reserve primarily includes the cost of severance for certain redundant general and administrative functions and the costs related to the closure of certain redundant facilities as discussed further in Note F.

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     The acquisition was accounted for under the purchase method of accounting and, accordingly, the results of operations of Mercator have been included in our consolidated financial statements since the date of the acquisition. We paid approximately $109.3 million in cash to acquire the outstanding shares of Mercator stock. In addition, the aggregate purchase price included $5.0 million for transaction costs and $15.7 million for the fair value of options to purchase shares of our common stock exchanged for Mercator stock options, offset by $2.4 million recorded in deferred compensation for the intrinsic value of unvested options to purchase our common stock that were issued in exchange for Mercator stock options. Of the $2.4 million recorded in deferred compensation, $1.9 million is being amortized to compensation expense over the remaining vesting period of the underlying options. The remaining $0.5 million was offset against the merger reserve (see Note F) related to the acceleration of the vesting of certain options of employees when they were terminated. During the three and nine months ended September 30, 2004, $0.2 and $0.7 million, respectively, was amortized to compensation expense.

     On January 27, 2004, we entered into a software purchase agreement with Phoenix Software International, Inc. pursuant to which we sold the rights to our Key/Master data entry software product line, formerly owned by Mercator. Accordingly, at December 31, 2003, this technology was recorded as an asset held for sale, as a component of other current assets, at a fair market value of $6.8 million. The total sales price of $6.8 million was received in the quarter ended March 31, 2004.

   

   

   

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

     The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains certain forward-looking statements relating to future events or our future financial performance which involve risks and uncertainties. Such forward-looking statements address, for example, the functionality, characteristics, quality and performance capabilities of our current and future products and technology; expansion of product offerings; expansion of worldwide distribution through alliances with recognized industry leaders; expected costs arising from the termination of our database business; our ability to leverage our substantial customer base and the completeness of our enterprise data integration offerings; our ability to leverage our global professional services organization to accelerate the adoption of our product offerings and provide value-added services to existing customers; potential liquidation of subsidiaries; residual values related to intangible assets; future amortization costs; costs associated with continued investment in research and development and investment in sales and marketing and product support; continued investments in property and equipment; sufficiency of Cash (as defined below) and short-term investments to meet working capital requirements, repurchases of our common stock, potential acquisitions, facilities, severance, obligations and restructuring initiatives; and expected amortization costs from strategic business combinations and technology purchases. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under “Factors That May Affect Future Results,” and elsewhere in this quarterly report on Form 10-Q. The following discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements and related notes appearing elsewhere in this report.

Overview

     We were incorporated in Delaware in 1986 and, until the third quarter of 2001, operated under the name “Informix Corporation”. Effective January 1, 2001, we consolidated our business units into two operating segments: (1) Informix Software, which operated our database software systems business, and (2) Ascential Software, which, at that time, operated our extract, transform and load (“ETL”) and digital asset management software and solutions business. During the third quarter of 2001, we completed the sale of the assets of our database business, including the name “Informix”, to IBM for $1.0 billion in cash, which we refer to as the “IBM Transaction” (see Note A of Notes to Unaudited Condensed Consolidated Financial Statements). In connection with the IBM Transaction, we changed our name to “Ascential Software Corporation” and changed the symbol under which our stock is traded on the NASDAQ National Market to “ASCL”. These changes became effective in July 2001. After the sale of the assets of our database business, our sole operating segment has been our Ascential Software business; however, we continue to incur costs associated with the termination of our database business. Barring unforeseen circumstances, remaining costs associated with the termination of our database business for the year ended December 31, 2004 are expected to be a relatively insignificant amount.

     Headquartered in Westborough, Massachusetts since July 2001, Ascential Software Corporation is a leading supplier of enterprise integration solutions to the Global 2000 and other large organizations. We believe that the Ascential Enterprise Integration Suite, built upon a highly scalable platform, is the industry’s only complete solution from a single vendor that is intended to address the full data integration life cycle, and turns corporate data into “Intelligent Information” — information that is reliable, relevant, and complete — so organizations can make better informed business decisions and drive their strategic application initiatives.

     Our products for automated data profiling, data quality management and cleansing and data extraction, transformation, and loading are built on an enterprise data integration platform of core integration offerings that are intended to provide end-to-end meta data (information about data) management for a clear, unambiguous definition and history of the data used to drive strategic enterprise applications. We also provide connectivity between virtually any standard data source and application as well as virtually unlimited scalability through our platform to manage the massive volumes of corporate data generated through high-performance processing. This complete offering is called the Ascential Enterprise Integration Suite and is currently, we believe, the only end-to-end enterprise integration platform of its type available from a single vendor.

     We also offer a full range of consulting, educational and support services to assist customers through all phases of a project. Based on demonstrated methodologies, these services represent years of accumulated intellectual capital in terms of knowledge and experience, gained through many successful engagements across a range of industries and enterprise application requirements.

     We support more than 3,000 customers in such industries as financial services, insurance, healthcare, retail, manufacturing, consumer packaged goods, telecommunications and government. We had 934 employees as of September 30, 2004.

     Enterprises are faced with managing the significant growth of data and gaining a more accurate view of the factors that impact their performance. Enterprises are also coping with the requirement to access data from an increasing number of disparate sources of data which frequently contain incomplete, inaccurate, inconsistent or duplicate information. We believe these organizations want to be able to use the data efficiently and effectively to increase their revenue and market share, decrease operating costs and improve asset utilization. Our overall business strategy is to establish Ascential Software Corporation as the leader in the enterprise data integration market by delivering what we believe to be the industry’s most comprehensive data integration product solution. We seek to accomplish this by continuing to expand our product offerings through internal development and strategic technology and business acquisitions. We are focused on efforts to accelerate revenue growth by leveraging our substantial customer base and the completeness of our enterprise data integration offerings, and by expanding our worldwide distribution through alliances with recognized industry leaders. We also intend to leverage our global professional services organization to accelerate the adoption of our product offerings and provide a variety of value-added services to our existing customers.

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     We use a number of key metrics internally to track our progress against these objectives. We measure and track the number of new customers signed each quarter, the number of our customers constituting Fortune 500 and Global 2000 companies, and the amount of incremental revenue generated from new projects within our existing installed base. We monitor the success of our strategic alliances by reviewing the revenue generated from these relationships and the number of license deals, and revenue generated or influenced by third parties, on a quarterly basis. In order to ensure that spending is consistently monitored and resources are used appropriately, we track revenue, headcount, and spending on a weekly basis. We regularly review relevant margin metrics, including license margins, maintenance margins, professional service margins, total service margins and operating margins. In addition, in order to maximize cash flow and to identify customer payment issues on a timely basis, we closely monitor cash collections and accounts receivable days sales outstanding (“DSO”).

     On September 12, 2003, we completed the acquisition of Mercator. The aggregate cash purchase price for all of the common stock of Mercator was approximately $94.9 million, net of $14.4 million of cash acquired from Mercator. In addition, all outstanding options to purchase shares of Mercator common stock were converted into options to purchase shares of our common stock, subject to certain adjustments.

     On January 27, 2004, we entered into a software purchase agreement with Phoenix Software International, Inc. pursuant to which we sold the rights to our Key/Master data entry software product line, formerly owned by Mercator. Accordingly, at December 31, 2003, this technology was recorded as an asset held for sale, as a component of other assets, at a fair market value of $6.8 million. The total sales price of $6.8 million was received in the quarter ended March 31, 2004.

Products and Services

     Our products are designed to operate as part of the Ascential Enterprise Integration Suite, or as stand-alone integration components. Our product functionality includes: automated data profiling to analyze and manage source data content and structure; data quality and cleansing to identify, correct and reconcile inaccurate or redundant data; and data extraction, transformation and loading to obtain data from a source, format it as required, and deliver it to a specified target. Our products are supported by a comprehensive platform of integration services that delivers end-to-end meta data management, connectivity between virtually any standard data source and application, and virtually unlimited scalability and performance in analytical, operational and transactional data environments. This combination of integration products built on a platform of integration services forms the Ascential Enterprise Integration Suite.

     The Ascential Enterprise Integration Suite offers a comprehensive, modular solution that can expand with business needs or as customer budgets dictate. Our customers can deploy the complete Ascential Enterprise Integration Suite to address the entire enterprise data integration life cycle, or use individual integration products as needed in support of more limited scope implementation requirements.

Critical Accounting Policies

     This discussion and analysis of our financial condition and results of operations is based upon our unaudited condensed 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 amount of assets and liabilities at the date of the financial statements, and revenues and expenses during the reporting periods. Areas where significant judgments are made include, but are not limited to, revenue recognition; allowance for doubtful accounts; capitalization of software development costs; business combinations; goodwill and intangible assets; income taxes; and merger, realignment and other charges. Actual results could differ materially from these estimates. For a more detailed explanation of the judgments made in these areas, please refer to the discussion of our critical accounting policies in our Annual Report on Form 10-K for the year ended December 31, 2003, as filed with the Securities and Exchange Commission (“SEC”) on March 15, 2004.

   

   

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RESULTS OF OPERATIONS

Executive Overview of Results of Operations

     The following table compares certain of our key financial metrics for the respective periods:

                                 
    Three Months Ended   Nine Months Ended
    September 30,
  September 30,
    2004
  2003
  2004
  2003
License revenue (in thousands)
  $ 27,159     $ 22,353     $ 76,747     $ 62,539  
Service revenue (in thousands)
    40,434       23,536       116,969       58,575  
 
   
 
     
 
     
 
     
 
 
Total revenue (in thousands)
  $ 67,593     $ 45,889     $ 193,716     $ 121,114  
 
   
 
     
 
     
 
     
 
 
Gross margin
    67 %     69 %     68 %     69 %
Services margin
    56 %     56 %     57 %     55 %
Operating margin
    %     (10 )%     1 %     (9 )%
Ending headcount
    934       995       934       995  
Average license revenue per quota carrying sales
representative (in thousands) (1)
  $ 299     $ 251     $ 856     $ 879  
Revenue per employee (in thousands)(2)
  $ 72     $ 57     $ 215     $ 169  
Average license selling price (in thousands) (3)
  $ 150     $ 127     $ 136     $ 123  
Days sales outstanding(4)
    63       76       *       *  

*   Not meaningful, since the Company does not evaluate and track DSO on a year-to-date basis.
 
(1)   For the three-month periods, the amount is calculated using license revenue divided by the number of sales representatives with sales quotas at the end of the period. For the nine-month periods, amount is calculated as the sum for each three-month period.
 
(2)   Calculated using total revenue divided by average number of employees for the respective period.
 
(3)   Calculated as total license revenue from transactions greater than $25,000 in license revenue, divided by total number of those transactions for the period.
 
(4)   Calculated by dividing net accounts receivable as of the balance sheet date, by the quotient determined by dividing the respective year’s third quarter revenue by ninety days. Accounts receivable and deferred revenue are reduced for certain amounts for which revenue has not been recognized. Accounts receivable has been reduced for amounts sold under a receivables purchase agreement as described in “Liquidity and Capital Resources”.
 
(5)   Headcount at September 30, 2003 includes approximately 400 employees acquired from Mercator on September 12, 2003. The expense associated with these employees and their activities only impacted two weeks of the three and nine months ended September 30, 2003, therefore headcount at June 30, 2003 of 614 is used for comparison purposes in our analysis of expenses in the following discussion.

     During the third quarter of 2004, we achieved total revenue growth of 47%, with 22% growth in license revenue, compared with the third quarter of 2003. During the nine months ended September 30, 2004, we achieved total revenue growth of 60%, with 23% growth in license revenue, compared to the first nine months of 2003. This overall growth was achieved primarily due to a higher average sales price on license transactions, a larger volume of license transactions, an expanded maintenance base including those customers acquired in the Mercator transaction, and an expanded professional services business. Our average license selling price, defined throughout to include transactions with more than $25,000 in license revenue, increased in both the three and nine month comparative periods by 18% and 11%, respectively. The volume of license transactions, defined throughout to include transactions with more than $25,000 in license revenue, increased 7% and 12% in the three and nine month comparative periods. Average license revenue per quota carrying sales representative, as defined in footnote (1) to the above table, increased to $299,000 in the third quarter of 2004 compared to $251,000 in the third quarter of 2003 and declined to $856,000 in the first nine months of 2004 compared to $879,000 in the first nine months of 2003. The increase in this metric in the quarter ended September 30, 2004 was driven by the increases in average selling price and volume discussed above. The decrease in the nine month period ended September 30, 2004 is a result of the addition, on a net basis, of 14 new sales representatives since December 31, 2003, who became gradually more productive throughout the nine month period ended September 30, 2004, therefore reducing the average for that period. Additionally, during the first nine months of 2004, we experienced longer sales cycles than we had experienced in the same periods of the previous year. We

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attribute this trend to an economic environment in which companies are very cautious in spending, particularly for the enterprise-scale projects in which we are often involved. The prevalence of vendors offering solutions for various aspects of data integration requirements appears to be increasing, causing customers to require more time to evaluate the various alternatives available to fulfill their requirements.

     The revenue growth that we have experienced, combined with the results of business management efforts and elimination of merger related costs, enabled us to improve several key margin metrics. The services margin improvement of two percentage points in nine month period ended September 30, 2004 was the result of an expanded maintenance base as well as more consulting engagements that extended throughout enterprises rather than a single department or division within an enterprise. Our operating margin improved from a loss of (10%) in the third quarter of 2003 to breakeven in the third quarter of 2004 and improved from a loss of ( 9%) in the first nine months of 2003 to 1% in the first nine months of 2004.

I. Revenue

     The following table and discussion compares our revenue by type for the three and nine months ended September 30, 2004 and 2003 (in millions):

                                 
    Three Months Ended   Nine Months Ended
    September 30,
  September 30,
    2004
  2003
  2004
  2003
License revenue
  $ 27.2     $ 22.4     $ 76.7     $ 62.5  
 
   
 
     
 
     
 
     
 
 
Service revenue:
                               
Maintenance revenue
    24.0       12.9       70.1       33.0  
Consulting and education revenue
    16.4       10.6       46.9       25.6  
 
   
 
     
 
     
 
     
 
 
Total service revenue
    40.4       23.5       117.0       58.6  
 
   
 
     
 
     
 
     
 
 
Total revenue
  $ 67.6     $ 45.9     $ 193.7     $ 121.1  
 
   
 
     
 
     
 
     
 
 
License revenue as a percent of total revenue
    40 %     49 %     40 %     52 %
Service revenue as a percent of total revenue
    60 %     51 %     60 %     48 %

     License revenue. License revenue for the quarter ended September 30, 2004 increased 21% to $27.2 million from $22.4 million for the quarter ended September 30, 2003. This $4.8 million increase was principally the result of an 18% increase in the average selling price of license transactions during the quarter. We primarily experienced this increase in connection with international transactions, including transactions with both new and existing customers, and transactions both directly with end user customers and those in which our products were resold by partners. We also experienced an increase in average selling price for transactions resold by partners in North America. We believe this reflects a trend to more enterprise level license transactions compared to departmental projects including, in 2004, transactions involving products acquired in the Mercator transaction. Additionally, although the number of total license transactions increased only 7% from the third quarter of 2003, the percentage of transactions sold directly to end user customers (including those influenced, but not resold, by strategic partners) increased relative to transactions resold by strategic partners. Transactions sold directly to end user customers are typically sold at higher prices and, therefore, this trend positively impacted the overall average license selling price. The third quarter of 2003 included one license transaction in excess of $2.0 million while the third quarter of 2004 included four transactions that were each slightly greater than $1.0 million in license revenue.

     License revenue for the nine months ended September 30, 2004 increased 23% to $76.7 million from $62.5 million for the nine months ended September 30, 2003. This $14.2 million increase was primarily the result of a 12% increase in the number of license transactions during the quarter and an 11% increase in the average price of licenses sold in those transactions. We experienced this increase worldwide and for new as well as existing customers. The volume of transactions in which our products were resold by strategic partners declined 16% while the average price of those transactions increased 38%. The volume of transactions entered into directly with end user customers (including those influenced, but not resold, by strategic partners) increased 44% while the average price of those transactions declined

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11% principally due to the inclusion, in the first nine months of 2003, of three license transactions totaling 13% of our license revenue while the first nine months of 2004, in total, did not have a similar concentration of sales.

     During the first nine months of 2004, we have experienced longer sales cycles than we experienced in the same periods of the prior year. We attribute this trend to an economic environment in which companies are very cautious in spending, particularly for the enterprise-scale projects in which we are often involved. The prevalence of vendors offering solutions for various aspects of data integration needs appears to be increasing, causing customers to require more time to evaluate the various alternatives available to fulfill their requirements.

     Service revenue. Total service revenue for the quarter ended September 30, 2004 increased by $16.9 million, or 72%, to $40.4 million from $23.5 million for the quarter ended September 30, 2003. Total service revenue for the nine months ended September 30, 2004 increased by $58.4 million, or 100%, to $117.0 million from $58.6 million for the nine months ended September 30, 2003.

     Maintenance revenue increased by $11.1 million, or 86%, to $24.0 million in the third quarter of 2004 from $12.9 million in the third quarter of 2003. Maintenance revenue increased by $37.1 million, or 112%, to $70.1 million in the first nine months of 2004 from $33.0 million in the first nine months of 2003. The increase in maintenance revenue is attributable to the installed base of customers acquired from Mercator as well as the increase in our installed base of customers following the license growth experienced during 2003 and 2004.

     Consulting and education revenue increased by $5.8 million, or 55%, to $16.4 million in the third quarter of 2004 from $10.6 million in the same period of 2003. Consulting and education revenue increased by $21.3 million, or 83%, to $46.9 million in the first nine months of 2004 from $25.6 million in the same period of 2003. The increase in consulting and education revenue correlates to an increase in the volume and average size of consulting engagements worldwide following the growth of license revenue experienced during 2003 and the first nine months of 2004. We believe the growth of our professional services business reflects increased customer adoption of our products and expanded deployment of our offerings. Additionally, our consulting engagements have increasingly extended throughout enterprises rather than a single department or division within an enterprise.

     Total Revenue. For the three and nine months ended September 30, 2004 and 2003, no single customer accounted for greater than 10% of total revenue. Total revenue derived from our relationship with IBM has doubled in the third quarter of 2004 compared to the third quarter of 2003 and has increased approximately 50% in the nine months ended September 30, 2004 compared to the same period of 2003.

II. Costs and Expenses

     The following table and discussion compares the costs and expenses for the three and nine months ended September 30, 2004 and 2003 (in millions):

                                 
    Three Months Ended   Nine Months Ended
    September 30,
  September 30,
    2004
  2003
  2004
  2003
Cost of licenses
  $ 4.7     $ 3.9     $ 12.7     $ 10.8  
Cost of services
    17.6       10.3       50.0       26.4  
Sales and marketing
    27.8       19.5       80.5       53.1  
Research and development
    9.8       6.8       29.4       17.7  
General and administrative
    7.2       6.5       19.0       19.8  
Merger, realignment and other charges
    0.2       1.7       1.0       2.1  
Write-off of acquired in-process research and development
          2.0             2.0  
 
   
 
     
 
     
 
     
 
 
Total costs and expenses
  $ 67.3     $ 50.7     $ 192.6     $ 131.9  
 
   
 
     
 
     
 
     
 
 

     Cost of licenses. Cost of licenses consists primarily of: (1) amortization of capitalized software development costs or acquired technology, (2) third-party royalties, and (3) distribution and manufacturing personnel costs.

     During the quarter ended September 30, 2004, cost of licenses increased $0.8 million, or 21%, to $4.7 million from $3.9 million in the same period of 2003. This increase was primarily the net result of two factors. First, amortization costs increased by $0.7 million due principally to $0.3 million of amortization expense associated with completed technology acquired through the Mercator acquisition and $0.4 million of increased amortization of capitalized development costs following the release of new products during 2004. We acquired $7.0 million of completed technology in connection with the Mercator acquisition in the third quarter of 2003 that

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is being amortized over five years and, accordingly, we began to recognize related amortization expense in September 2003. Future amortization costs may increase if we acquire new technology through strategic business combinations or technology purchases. Second, third-party royalty expenses increased by $0.1 million due principally to an increase in the number of transactions containing third-party products. This $0.1 million increase is net of a decline in amortization of prepaid license royalties that were fully amortized as of December 31, 2003.

     During the nine months ended September 30, 2004, cost of licenses increased $1.9 million, or 18%, to $12.7 million from $10.8 million in the same period of 2003. This increase is principally attributable to a $1.7 million increase in amortization costs consisting of $1.0 million due to the amortization of completed technology acquired through the Mercator acquisition and a $0.7 million increase in amortization of capitalized software development costs following the release of new products. There was also a $0.2 million increase in freight and other miscellaneous distribution costs.

     Cost of services. Cost of services consists of maintenance, consulting and education personnel expenses and third-party subcontracting costs. Cost of services for the three months ended September 30, 2004 increased 71%, or $7.3 million, to $17.6 million from $10.3 million in the same period of 2003. This net increase is a result of the impact of a combination of factors. We incurred $5.5 million in additional costs of consulting and education, principally relating to third party sub-contracting, costs associated with increased departmental headcount, travel costs and commissions associated with the generation of an additional $5.8 million in consulting and education revenue as compared to the third quarter of 2003. We also incurred $1.7 million in additional maintenance costs as compared to the third quarter of 2003. This increase in maintenance costs consists of $0.8 million of personnel-related costs following an increase in headcount from June 30, 2003 that was mostly related to the Mercator transaction, $0.6 million of costs associated with the subcontracting and outsourcing of various functions related to support obligations with respect to certain products acquired from Mercator that were determined not to be strategic, and $0.3 million in amortization of customer relationships acquired through the Mercator acquisition. We valued customer relationships acquired from Mercator in the third quarter of 2003 at $7.0 million, which is being amortized over five years and, accordingly, we began to recognize the associated amortization expense in September 2003.

     Cost of services for the nine months ended September 30, 2004 increased 89%, or $23.6 million, to $50.0 million from $26.4 million in the same period of 2003. This net increase is a result of the impact of a combination of factors. We incurred $16.6 million in additional costs of consulting and education, principally headcount, third-party subcontracting, commissions and travel associated with generating an additional $21.3 million in consulting and education revenue as compared to the first six months of 2003. We also incurred $7.1 million in additional maintenance costs associated with generating $37.1 million in additional maintenance revenue as compared to the first nine months of 2003. This increase in maintenance costs consists principally of $4.4 million of personnel related costs following a 114% increase in headcount from June 30, 2003, $1.8 million of costs associated with the subcontracting and outsourcing of various functions related to support obligations with respect to certain products acquired from Mercator that were determined not to be strategic and $0.9 million in amortization of customer relationships acquired through the Mercator acquisition.

     The following table depicts services margins for the three and nine months ended September 30, 2004 and 2003, respectively:

                                 
    Three Months Ended   Nine Months Ended
    September 30,
  September 30,
    2004
  2003
  2004
  2003
Maintenance margin
    82 %     80 %     81 %     81 %
Consulting and training margin
    19 %     27 %     21 %     21 %
Total service margin
    56 %     56 %     57 %     55 %

     The total services margin remained flat at 56% for the quarter ended September 30, 2004 relative to the same period of 2003 and increased to 57% for the nine months ended September 30, 2004 from 55% during the same period in 2003. This improvement on a year to date basis is due to a larger proportion of higher margin maintenance revenue in relation to total service revenue as compared to the same period of the prior year. The improvement in maintenance margins for the quarter principally results from our ability to leverage the use of on-line technical support to service our increased maintenance base. On a year to date basis, the impact of these factors on the maintenance margin was offset by the impact of the incremental costs associated with the outsourcing of various functions and the amortization of Mercator customer relationships, as discussed above. The decline in consulting and education margins for the quarter ended September 30, 2004 as compared to the same quarter of the prior year is a result of an increased use of subcontracted resources to service consulting engagements at a higher cost than our internal resources.

     Sales and marketing expenses. Sales and marketing expenses consist primarily of salaries, commissions, marketing, communications programs and related overhead costs. Sales and marketing expenses for the quarter ended September 30, 2004 increased 43%, or $8.3 million, to $27.8 million from $19.5 million for the same period of 2003. This increase is principally the result of a 42% increase in headcount from June 30, 2003 to September 30, 2004 resulting in increased personnel and related overhead costs.

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The remaining increase is attributable to a $1.8 million increase in commissions, a $0.7 million increase in travel costs and a $1.2 million increase in the cost of subcontracted resources. Sales and marketing expenses for the nine months ended September 30, 2004 increased 52%, or $27.4 million, to $80.5 million from $53.1 million for the same period of 2003. This increase is also due to the increased headcount previously discussed as well as $3.0 million in additional commissions associated with increased revenue, $3.5 million of additional subcontracting costs, a $2.7 million increase in travel costs and $1.3 million of additional marketing program expenditures associated with new products and increased marketing activities. The increases for both the three and nine month periods were partially offset by a decline in Mercator sales and marketing transition costs of $0.7 million. Total selling and marketing headcount was 329 at September 30, 2004, including 91 quota carrying sales representatives. This compares to 65 quota carrying sales representatives as of June 30, 2003 prior to the Mercator acquisition which increased to 89 as of September 30, 2003, following the Mercator acquisition.

     Research and development expenses. Research and development expenses consist primarily of salaries, project consulting and related overhead costs for development of our products. During the third quarter of 2004, our research and development efforts were principally focused on enhancements to the Ascential Enterprise Integration Suite to enable increased levels of integration, performance and scalability as well as enhanced interoperability among our products. Research and development expenses for the quarter ended September 30, 2004 increased 44%, or $3.0 million, to $9.8 million from $6.8 million for the same quarter of 2003. Research and development expenses for the nine months ended September 30, 2004 increased 66%, or $11.7 million, to $29.4 million from $17.7 million for the first nine months of 2003. These increases are primarily the result of a 59% increase in research and development headcount from 154 at June 30, 2003 to 245 at September 30, 2004, resulting in increased salary, overhead and related costs. This increase in headcount relates primarily to Mercator research and development personnel who became Ascential Software employees in September 2003 following the acquisition. In addition, in the third quarter of 2004 as compared to the third quarter of 2003 there was a $1.4 million increase in consultant and subcontractor costs, including off-shore resources, and a $0.4 million increase in facilities and equipment costs resulting from the larger employee base and increased development activity. In the nine months ended September 30, 2004 as compared to the nine months ended September 30, 2003, there was a $2.9 million increase in consultant and subcontractor costs, including off-shore resources, and a $1.4 million increase in facilities and equipment costs resulting from the larger employee base and increased development activity. These increases were offset by a reduction of $0.3 million in research and development transition costs related to the Mercator acquisition in the third quarter of 2003. In October 2004, we acquired the assets of iNuCom (India) Limited and its affiliate iNuCom.com, Inc. to create a facility dedicated primarily to research and development in Hyderabad, India for the purpose of reducing the costs associated with subcontracted offshore resources and maximizing the efficiency of research and development spending over the long term. Capitalization of software development costs during the third quarter and first nine months of 2004 related principally to the development of enhancements to the Ascential Enterprise Integration Suite and increased by approximately $0.6 million during the second quarter of 2004 and $1.2 million in the first nine months of 2004, respectively, as compared to the same periods in 2003 as a result of an increase in overall research and development spending and the nature and stage of development projects.

     General and administrative expenses. General and administrative expenses consist primarily of finance, legal, information systems, human resources, bad debt expense and related overhead costs. During the quarter ended September 30, 2004, general and administrative expenses increased 11%, or $0.7 million, to $7.2 million from $6.5 million for the third quarter of 2003. This increase is the net result of three principal factors. First, there was an increase in personnel and related overhead costs as a result of a 24% increase in headcount in general and administrative functions from June 30, 2003 to September 30, 2004 as well as an increase in the cost of subcontracted resources in order to scale our infrastructure to support our expanded operations and address new and enhanced regulatory requirements, including the Sarbanes-Oxley Act. Second, there was a decrease in the transition costs related to the wind down of our database business of $0.4 million. In the third quarter of 2004, transition activities netted to a credit of $0.2 million, including $0.3 million reversal of accruals for estimated database liabilities that were no longer required offset by $0.1 million of administrative and liquidation costs associated with the closure of subsidiaries. In the third quarter of 2003, transition costs totaled $0.2 million and consisted of $0.9 million of legal defense and dispute resolution costs and $0.6 million in administrative and liquidation costs related to the maintenance and closure of idle entities. These costs were offset by $1.3 million in reductions to expense related to the reversal of accruals for estimated database liabilities that were no longer required. Third, there was a decrease of $0.2 million in Mercator transition costs.

     During the nine months ended September 30, 2004, general and administrative expenses decreased 4% or $0.8 million, to $19.0 million from $19.8 million for the first nine months of 2003. This change is the net result of four principal factors. First, the transition costs related to the wind down of our database business decreased by $2.8 million. During the first nine months of 2004, the net impact of these transition activities was a net credit of $0.8 million for the resolution of disputes in connection with the historical database operations, a credit of $0.2 million for the reversal of accruals for estimated database liabilities that were no longer required and $0.3 million of administrative and liquidation costs associated with the closure of subsidiaries. During the first nine months of 2003, costs totaled $1.9 million and consisted of $2.4 million in legal costs related to disputes associated with the historical database operations, $0.8 million of administrative and liquidation costs associated with the closure of subsidiaries and $1.3 million of reductions to expense for the reversals of accruals for estimated database liabilities that were no longer required. Second, legal costs declined due principally to the inclusion, in the nine months ended September 30, 2003, of $1.1 million of costs associated with the settlement of a legal matter. Third, Mercator transition costs declined by $0.2 million. Fourth, these declines were offset by increased personnel and related overhead costs due to a 20% increase in headcount in general and administrative functions from June 30, 2003 to September 30, 2004 as well as an increase in the cost of subcontracted resources in order to scale our infrastructure to support our expanded operations and address new and enhanced regulatory requirements, including the Sarbanes-Oxley Act.

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     Merger, realignment and other costs. During the quarter and the nine months ended September 30, 2004, we recorded merger realignment and other costs totaling $0.2 million and $1.0 million, respectively. The charges in all periods are for adjustments to facility reserves recorded in connection with the IBM Transaction. The adjustments reflect updated estimates of remaining obligations on vacated facilities, net of sublease income.

     During the quarter and nine months ended September 30, 2003, we recorded realignment charges totaling $1.7 million and $2.1 million, respectively. These charges consist of $1.1 million of severance to terminate 17 employees in connection with the consolidation of our offices following the Mercator acquisition and adjustments to facility reserves totaling $0.6 million and $1.0 million in the three and nine months periods, respectively, to reflect updated estimates of obligations on vacated facilities, net of anticipated sublease income.

III. Other Income (Expense)

     The following table and discussion compares other income for the three and nine months ended September 30, 2004 and 2003 (in millions):

                                 
    Three Months Ended   Nine Months Ended
    September 30,
  September 30,
    2004
  2003
  2004
  2003
Interest income, net
  $ 2.2     $ 2.7     $ 6.1     $ 8.8  
Other income, net
    0.2       0.6       0.6       0.7  

     Interest income, net. Interest income for the three months ended September 30, 2004 decreased by $0.5 million, or 19%, from the same period of the prior year. Interest income for the nine months ended September 30, 2004 decreased by $2.7 million, or 31%, from the same period of the prior year. These decreases are principally attributable to an 18% decline in average cash balances from the periods ending September 30, 2003 to those ending September 30, 2004 mainly as a result of the use of cash paid to acquire Mercator and cash used to buy back shares of our common stock.

     Other income (expense), net. Other income (expense), net, for the three months ended September 30, 2004 consists of approximately $0.2 million of foreign currency gains, principally related to the revaluation of forward foreign currency contracts. Other income, net, for the three months ended September 30, 2003 consisted of $0.8 million of realized gains on investments offset by $0.2 million of foreign currency losses. We continue to liquidate various subsidiaries that were active prior to the IBM Transaction but that are no longer required for our ongoing operations and continue to evaluate our subsidiary structure as deemed appropriate to match current business needs. As these subsidiaries are liquidated, the cumulative translation adjustment that has been recorded on our balance sheet in connection with the historical monthly revaluation of their assets and liabilities will be recorded as other income or expense.

     Other income, net, for the nine months ended September 30, 2004 consists of approximately $0.6 million of realized gains on investments. Other income, net, for the nine months ended September 30, 2003 consisted of $1.5 million realized gains on investments offset by $0.8 million of foreign exchange losses.

IV. Income Taxes

     The following table and discussion compares the income tax expense (benefit) for the three and nine months ended September 30, 2004 and 2003 (in millions):

                                 
    Three Months Ended   Nine Months Ended
    September 30,
  September 30,
    2004
  2003
  2004
  2003
Income before income taxes
  $ 2.7     $ (1.6 )   $ 7.8     $ (1.3 )
Income tax expense
    0.3       0.1       1.9       0.2  
Effective tax rate
    12 %     6 %     24 %     15 %

     For the three and nine months ended September 30, 2004, the effective tax rate was 12% and 24%, respectively. This rate is lower than the composite U.S. federal and state statutory rate as a result of income generated in jurisdictions with lower tax rates and utilization of net operating loss carry-forwards. In addition, in the quarter ended September 30, 2004 we filed our tax return for 2003 and the actual tax liability for 2003 was less than the amount we had previously estimated.

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Liquidity and Capital Resources

     Our cash and cash equivalents (“Cash”) and short-term investments totaled $471.5 million at September 30, 2004 and consisted of $101.0 million in Cash and $370.6 million of short-term investments. At December 31, 2003, Cash and short-term investments totaled $516.2 million and consisted of $202.6 million in Cash and $313.7 million of short-term investments. The $44.7 million decrease in Cash and short-term investments for the nine months ended September 30, 2004 was primarily due to $31.6 million that was used to buy back shares of our common stock. Also, $13.7 million was used in operations, principally related to the payment of current liabilities and certain foreign taxes. The payment of current liabilities includes the use cash of approximately $13.7 million related to the payment of certain obligations, primarily for facilities, related to our merger and realignment activities. (See Note F of the Notes to condensed Consolidated Financial Statements). We also purchased $3.6 million of property and equipment and spent $6.7 million related to research and development projects that are capitalized. These uses of cash were partially offset by $6.8 million that was received in connection with the sale of the Key/Master data entry software product line (See Note I of the Notes to Condensed Consolidated Financial Statements) as well as $5.7 million in proceeds received from the issuance of common stock under our employee stock purchase plan and through the exercise of stock options.

     We plan to continue to invest in research and development activities as well as sales and marketing and product support to the extent required to continue to support our business and product roadmap. In October 2004, we acquired the assets of iNucom (India) Limited and its affiliate iNuCom.com, Inc. to create a facility dedicated primarily to research and development in Hyderabad, India for the purpose of reducing the costs associated with subcontracted offshore resources and maximizing the efficiency of research and development spending over the long term. Our investment in property and equipment is expected to continue, barring unforeseen circumstances, as we purchase computer systems for research and development, sales and marketing, and support and administrative staff. During the nine months ended September 30, 2004, we incurred capital expenditures of $3.6 million and capitalized software development costs totaling $6.7 million.

     On June 30, 2004, we entered into a non-recourse receivables purchase agreement with a financial institution, providing for the sale of up to $10.0 million of trade accounts receivable. In the three and nine months ended September 30, 2004, we received approximately $4.7 and $7.7 million, respectively, for the sale of accounts receivable under this agreement, which positively impacted our days sales outstanding (DSO). This arrangement is a means of accelerating cash collections in a manner that we believe is more cost-effective than offering early payment discounts. Trade receivables that were sold during the first nine months of 2004, and not yet collected, amounted to $5.1 million and are excluded from our trade accounts receivable at September 30, 2004. The fees, losses and other amounts related to the Company’s sale and subsequent servicing of these receivables were not material to the Company’s consolidated financial statements.

     As of September 30, 2004 we did not have any significant long-term debt or significant commitments for capital expenditures. We believe that our current Cash and short-term investments balances will be sufficient to meet our working capital requirements for at least the next twelve months. We also believe we have enough Cash and short-term investments to continue to fund any repurchases of our common stock under the previously announced $350 million stock repurchase program, and to fund the costs of current and future facilities, severance and other obligations in addition to current and future restructuring initiatives, if any. From the inception of the previously announced $350 million stock repurchase program through September 30, 2004, we have repurchased 17.0 million shares under the Program at a total cost of $248.8 million.

Additional Stock Option Disclosure

     The following information is presented pursuant to a proposal instituted by the American Electronics Association for technology companies to voluntarily expand disclosures relating to stock compensation.

     Option Program Description

     Our stock option program is a broad-based, long-term retention program that is intended to attract and retain talented employees and align stockholder and employee interests. We consider our option program critical to our operation and productivity; essentially all of our employees are eligible to participate.

     Option Plans

     In February 1989, we adopted the 1989 Outside Directors Stock Option Plan (as amended and restated, the “1989 Plan”), whereby non-employee directors are automatically granted options to purchase 20,000 shares upon election to the Board of Directors and options to purchase 15,000 shares annually thereafter and upon re-election. One-third of the options vest and become exercisable in each full year of the outside director’s continuous service as a director of our company and are issued with an exercise price equal to fair market value of our common stock determined as of the date of grant. A total of 650,000 shares of common stock have been authorized for issuance under the 1989 Plan.

     In March 1994, we adopted the 1994 Stock Option and Award Plan (as amended and restated, the “1994 Plan”). Incentive stock options, nonqualified stock options, restricted shares, or a combination thereof, can be granted to employees, at not less than the fair market value on the date of grant and generally vest in annual installments over two to four years. The Board or a committee made up solely of outside directors, and not less than two directors, administers the 1994 Plan. At present, the compensation committee of the Board of Directors administers and grants awards under the 1994 Plan, provided that during any fiscal year, no participant may receive stock options exercisable for more than 500,000 shares of common stock. No more than 20% of the maximum number of shares authorized for issuance under the 1994 Plan may be issued pursuant to restricted stock awards. However, the Board of Directors or the

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compensation committee may grant options exercisable for up to 1,000,000 shares of common stock during any fiscal year in which the individual first becomes an employee and/or is promoted from a position as a non-executive officer employee to a position as an executive officer. In April 2000, our Board of Directors approved an amendment to the 1994 Plan whereby the options are generally not exercisable until one year from the date of grant. A total of 8,250,000 shares of common stock have been authorized for issuance under the 1994 Plan.

     In July 1997, we adopted the 1997 Non-Statutory Stock Option Plan (as amended the “1997 Plan”), authorizing the grant of non-statutory stock options to employees and consultants. Terms of each option are determined by the Board of Directors or committee delegated such duties by the Board of Directors. A total of 425,000 shares of common stock have been authorized for issuance under the 1997 Plan.

     In July 1998, we adopted the 1998 Non-Statutory Stock Option Plan (as amended and restated, the “1998 Plan”). Under the 1998 Plan, options and restricted shares can be granted to employees and consultants with terms designated by the Board of Directors or committee delegated such duties by the Board of Directors. Options are issued at fair market value and generally vest over a four year period with 25% of the option shares vesting after one year and the remaining 75% of the option shares vesting in monthly increments over the following three years. A total of 8,125,000 shares of common stock have been authorized for issuance under the 1998 Plan.

     As a result of our acquisition of Mercator in September 2003, we assumed all outstanding Mercator stock options. Each Mercator stock option so assumed is subject to the same terms and conditions as the original grant and generally vests over four years and expires ten years from date of grant. Each option was adjusted at a ratio of approximately 0.1795 shares of common stock for each one share of Mercator common stock, and the exercise price was adjusted by dividing the exercise price by approximately 0.1795.

     As a result of our acquisition of Torrent Systems, Inc. (“Torrent”) in November 2001, we assumed all unvested outstanding Torrent stock options. Each Torrent stock option so assumed is subject to the same terms and conditions as the original grant and generally vests over four or five years and expires ten years from date of grant. Each option was adjusted at a ratio of approximately 0.0767 shares of common stock for each one share of Torrent common stock, and the exercise price was adjusted by dividing the exercise price by approximately 0.0767.

     Distribution and Dilutive Effect of Options to Executive Officers

     The following table summarizes employee and executive option grants for the periods set forth below.

                         
    Nine        
    Months        
    Ended        
    September 30,        
    2004
  2003
  2002
New grants during the period as a % of outstanding shares
    7.7 %     3.3 %     4.1 %
Grants to executive officers during the period as a % of total options granted
    21.6 %     0.0 %     37.4 %
Grants to executive officers during the period as a % of outstanding shares
    1.7 %     0.0 %     1.5 %
Cumulative options held by executive officers as a % of total options outstanding
    27.6 %     27.0 %     34.3 %

     General Option Information

     Following is a summary of activity for all stock option plans for the year ended December 31, 2003 and the nine months ended September 30, 2004:

                         
            Number of    
            Shares Underlying   Weighted -
    Shares Available   Outstanding   Average
    for Options
  Options
  Exercise Price
December 31, 2002
    5,156,507       7,199,994     $ 17.48  
Options assumed
          1,832,760       23.34  
Options granted
    (1,963,943 )     1,963,943       16.65  
Options exercised
          (2,054,193 )     12.60  
Options canceled
    466,688       (645,109 )     26.65  
Additional Shares Reserved
    5,500,000              
 
   
 
     
 
         
December 31, 2003
    9,159,252       8,297,395     $ 19.07  
Options granted
    (4,501,783 )     4,501,783       22.07  
Options exercised
          (347,930 )     9.96  
Options canceled
    620,983       (830,152 )     31.49  
 
   
 
     
 
         
September 30, 2004
    5,278,452       11,621,096     $ 19.62  
 
   
 
     
 
         

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     In-the-Money and Out-of – the-Money Option Information as of September 30, 2004

                                                 
    Exercisable
  Unexercisable
  Total
            Weighted           Weighted           Weighted
            Avg.           Avg.           Avg.
As of September 30, 2004
  Shares
  Exercise Price
  Shares
  Exercise Price
  Shares
  Exercise Price
In-the-Money (1)
    1,484,756     $ 10.15       1,384,476     $ 10.43       2,869,232     $ 10.29  
Out-of-the-Money (1)
    3,249,635     $ 24.72       5,502,229     $ 21.47       8,751,864     $ 22.68  
 
   
 
             
 
             
 
         
Total Options Outstanding
    4,734,391     $ 20.15       6,886,705     $ 19.25       11,621,096     $ 19.62  
 
   
 
             
 
             
 
         

(1)   In-the-Money options are those options with an exercise price less than the closing price of $13.47 as of September 30, 2004. Out-of-the-Money options are those options with an exercise price equal to or above the closing price of $13.47 as of September 30, 2004.

     Option Grants During the Nine Months Ended September 30, 2004

     The following table provides information relating to stock options awarded to each of our executive officers during the nine months ended September 30, 2004.

                                                 
  Individual Grants
  Potential Realizable
Values at Assumed
Annual Rates of Stock
                              Price Appreciation
    Number of   Percent of
Total Options
                  for Option Term
    Securities   Granted to                
    Underlying Options   Employees in   Exercise Price            
Name
  Granted
  2004 YTD
  Per Share
  Expiration Date
  5%
  10%
Peter Gyenes
    400,000       8.9 %   $ 27.10       1/9/2014     $ 6,817,218     $ 17,276,168  
Peter Fiore
    240,000       5.3 %   $ 27.10       1/9/2014     $ 4,090,331     $ 10,365,701  
Robert C. McBride
    150,000       3.3 %   $ 27.10       1/9/2014     $ 2,556,457     $ 6,478,563  
Scott N. Semel
    180,000       4.0 %   $ 27.10       1/9/2014     $ 3,067,748     $ 7,774,276  

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     The following table sets forth certain information regarding the exercise of stock options by our executive officers during the quarter ended September 30, 2004 and stock options held as of September 30, 2004 by our executive officers.

                                                 
                    Number of Securities Underlying   Value of Unexercised
                    Unexercised Options at   In-the-Money Options at
                    September 30, 2004
  September 30, 2004 (1)
    Shares                    
    Acquired   Value                
Name
  on Exercise
  Realized
  Exercisable
  Unexercisable
  Exercisable
  Unexercisable
Peter Gyenes
                1,025,741       707,295     $ 947,049     $ 1,006,211  
Peter Fiore
                475,184       371,252     $ 329,709     $ 282,502  
Robert C. McBride
                115,884       221,616     $ 124,944     $ 140,181  
Scott N. Semel
                47,263       242,112     $ 129,892     $ 176,451  


(1)   Based on the closing sales price of $13.47 of the underlying securities as of September 30, 2004, as reported on the NASDAQ National Market, minus the exercise price.

Equity Compensation Plan Information

     The following table provides information about common stock authorized for issuance under our equity compensation plans as of September 30, 2004:

                         
    (a)
  (b)
  (c)
                    Number of
                    securities
                    remaining available
    Number of           for future issuance
    securities to be   Weighted   under equity
    issued upon   average   compensation plans
    exercise of   exercise price of   (excluding
    outstanding   outstanding   securities
    options, warrants   options, warrants   reflected in column
Plan Category
  and rights(1)
  and rights
  (a))(2)
Equity compensation plans approved by security holders
    4,405,801     $ 22.04       3,838,389 (3)
Equity compensation plans not approved by security holders
    5,598,253     $ 16.67       2,657,719  
   
 
             
 
 
Total
    10,004,054     $ 19.04       6,496,108  
   
 
             
 
 

(1)   This table excludes an aggregate of 1,617,042 shares issuable upon exercise of outstanding options that were assumed in connection with various acquisition transactions. The weighted-average exercise price of the excluded options is $23.24.
 
(2)   In addition to being available for future issuance upon exercise of options that may be granted after September 30, 2004, 1,650,000 shares under the 1994 Plan and 1,625,000 under the 1998 Plan may be used for the award of restricted stock.
 
(3)   Includes 1,217,656 shares issuable under our 1997 Employee Stock Purchase Plan as of September 30, 2004.

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Factors That May Affect Future Results

If we do not make effective use of the proceeds of our substantial cash resources, our financial results could suffer and the value of our common stock could decline.

     Our ability to increase stockholder value is dependent, in part, on our effective use of the cash proceeds from the sale of our database business assets to IBM. We intend to use these funds to continue to operate our business, repurchase shares of our common stock and to finance any strategic acquisitions. We cannot ensure that these measures will improve our financial results or increase stockholder value.

If we are unable to increase revenue from, and expand the market share of, our products, our financial results will be materially adversely affected.

     If we do not increase sales of our enterprise data integration products, our financial results will be materially adversely affected. Our revenue is currently derived almost entirely from our Enterprise Data Integration Suite. In order to increase revenues and grow our business, we must be able to increase sales of these products and our share of the enterprise data integration market. We cannot ensure that our current customers will continue to purchase our data integration product offerings and related services and that new customers will choose our solutions over our competitors’ product offerings.

If the enterprise data integration market declines or does not grow, we may sell fewer products and services and our business may be unable to sustain its current level of operations.

     If the growth rates for the enterprise data integration market decline for any reason, there will be a decrease in demand for our products and services, which would have a material adverse effect on our financial results. We have invested substantial resources in developing data integration products and services to compete in this market. The market for these products and services is evolving, and its growth depends upon an increasing need to store and manage complex data and upon broader market acceptance of our products as a solution for this need. Declining demand for our products and services could threaten our ability to sustain our present level of operations and meet our expectations for future growth.

Intense competition could adversely affect our ability to sell our products and services.

     We may not be able to compete successfully against current and future competitors which could impair our ability to sell our products. The market for our products and services is highly competitive, diverse and subject to rapid change. In particular, we expect that the technology underlying our products and services will continue to change rapidly. It is possible that our products and solutions will be rendered obsolete by technological advances achieved by our competitors.

     We compete in the enterprise software market as a provider of complete end-to-end data integration functionality, including automated data profiling, data quality management and cleansing, and data extraction, transformation and loading (ETL). We currently face intense competition from a number of sources, including several large vendors who develop and market applications, development tools, decision support products, consulting services and/or complete database-driven solutions. Principal competitors relative to our Ascential DataStage ETL offering include other vendors that offer ETL functionality such as Informatica, SAS, Business Objects, Oracle and Cognos. We also face competition from private companies such as ETI, as well as various enterprise software vendors who have embedded ETL capabilities, and potential customers’ own internal development resources. Competitors for Ascential ProfileStage, our data profiling offering, include Avellino and Evoke, among others. Competitors for Ascential QualityStage, our data quality offering, include Firstlogic, Group One (a subsidiary of Pitney Bowes) and Trillium (a division of Harte-Hanks), among others. On occasion we also compete with combinations of vendors, as they seek to match the scope of the Ascential Enterprise Integration Suite. These competitors may be able to respond more quickly than we can to new or emerging technologies, evolving markets and changes in customer requirements. In addition, market consolidations could create more formidable competitors.

Competition may affect the pricing of our products or services and changes in product mix may occur, either of which may reduce our profit margins.

     Existing and future competition or changes in our product or service offerings or pricing could result in an immediate reduction in the prices of our products or services. In addition, a significant change in the mix of software products and services that we sell, including the mix between higher margin software and maintenance products and lower margin consulting and education, could materially adversely affect our operating results for future periods. Services margin could be negatively impacted by a reduction in the availability of appropriately skilled lower cost external resources. In addition, the pricing strategies of competitors in the software industry have historically been characterized by aggressive price discounting to encourage volume purchasing by customers. We may not be able to compete effectively against competitors who continue to aggressively discount the prices of their products.

Our current strategy contemplates possible future acquisitions, which will require us to incur substantial costs for which we may never realize the anticipated benefits.

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     On November 28, 2001 we completed the acquisition of Torrent, on April 3, 2002 we completed the acquisition of Vality, and on September 12, 2003 we completed the acquisition of Mercator. In addition, we acquired certain technology from Metagenix Inc. on March 31, 2002, and on October 1, 2004, we acquired the assets of iNuCom (India) Limited and its affiliate iNuCom.com, Inc. We consummated each transaction with the expectation that it would result in mutual benefits including, among other things, expanded and complementary product offerings, increased market opportunity, new technology and the addition of strategic personnel. Our business strategy contemplates the possibility of future acquisitions of complementary companies or technologies. Any potential acquisition may result in significant transaction expenses, increased interest and amortization expense, increased depreciation expense and increased operating expense, any of which could have a material adverse effect on our operating results. In addition, if we were to make a cash acquisition of substantial scale, it could reduce our cash reserves and affect our liquidity and capital resources.

     Achieving the benefits of any acquisition will depend in part on our ability to integrate an acquired business with our business in a timely and efficient manner. Our consolidation of operations following any acquisition may require significant attention from our management. The diversion of management attention and any difficulties encountered in the transition and integration process could have a material adverse effect on our ability to achieve expected net sales, operating expenses and operating results for any acquired business. We cannot ensure that we will realize any of the anticipated benefits of any acquisition, and if we fail to realize these anticipated benefits, our operating performance could suffer.

Our financial results are subject to fluctuations caused by many factors that could result in our failing to achieve anticipated financial results.

     Our quarterly and annual financial results have varied significantly in the past and are likely to continue to vary in the future due to a number of factors, many of which are beyond our control. In particular, if a large number of the orders that are typically booked at the end of a quarter are not booked, our net income for that quarter could be substantially below expectations. In addition, the failure to meet market expectations could cause a sharp drop in our stock price. These and any one or more of the factors listed below or other factors could cause us not to achieve our revenue or profitability expectations. These factors include:

    Changes in demand for our products and services, including changes in growth rates in the software industry as a whole and in the enterprise data integration market,

    The size, timing and contractual terms of large orders for our software products and services,

    Possible delays in or inability to recognize revenue as the result of revenue recognition rules,

    The budgeting cycles of our customers and potential customers,

    Any downturn in our customers’ businesses, in the domestic economy or in international economies where our customers do substantial business,

    Changes in our pricing policies resulting from competitive pressures, such as aggressive price discounting by our competitors, or other factors,

    Our ability to develop and introduce on a timely basis new or enhanced versions of our products and services,

    Unexpected needs for capital expenditures or other unanticipated expenses,

    Changes in the mix of revenues attributable to domestic and international sales, and

    Seasonal fluctuations in buying patterns.

Our recognition of deferred revenue is subject to future performance obligations and may not be representative of revenues for succeeding periods.

     The timing and ultimate recognition of our deferred revenue depends on our performance of various service obligations. Because of the possibility of customer changes in development schedules, delays in implementation and development efforts and the need to satisfactorily perform product support services, deferred revenue at any particular date may not be representative of actual revenue for any succeeding period.

Our common stock has been and likely will continue to be subject to substantial price and volume fluctuations that may prevent stockholders from reselling their shares at or above the prices at which they purchased their shares.

     Fluctuations in the price and trading volume of our common stock may prevent stockholders from selling their shares at or above the prices at which they purchased their shares. Stock prices and trading volumes for many software companies fluctuate widely for a number of reasons, including some reasons that may be unrelated to the companies’ businesses or financial results. This market volatility, as well as general domestic or international economic, market and political conditions, including threats of terrorism, could

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materially adversely affect the market price of our common stock without regard to our operating performance. In addition, our operating results may be below the expectations of public market analysts and investors, which could cause a drop in the market price of our common stock. The market price of our common stock has fluctuated significantly in the past and may continue to fluctuate significantly for a number of reasons, including:

    Market uncertainty about our business prospects or the prospects for the enterprise data integration market,

    Revenues or results of operations that do not meet or exceed analysts’ and investors’ expectations,

    The introduction of new products or product enhancements by us or our competitors,

    Any challenges integrating people, operations or products associated with recent acquisitions,

    General business conditions in the software industry, the technology sector, or in the domestic or international economies, and

    Uncertainty and economic instability resulting from terrorist acts and other acts of violence or war.

Our financial success depends upon our ability to maintain and leverage relationships with strategic partners.

     We may not be able to maintain our strategic relationships or attract sufficient additional strategic partners who are able to market our products and services effectively. Our ability to increase the sales of our products and our future success depends in part upon maintaining and expanding relationships with strategic partners. In addition to our direct sales force, we rely on relationships with a variety of strategic partners, including systems integrators, resellers and distributors in the United States and abroad. Further, we have become more reliant upon resellers in international areas in which we do not have a direct sales team. Our strategic partners may offer products of several different companies, including, in some cases, products that compete with our products. In addition, our strategic partners may acquire businesses or product lines that compete with our products. We have limited control, if any, as to whether these strategic partners devote adequate resources to promoting, selling and implementing our products. If our strategic partners do not devote adequate resources for implementation of our products and services, we could incur substantial additional costs associated with hiring and training additional qualified technical personnel to implement solutions for our customers. In addition, our relationships with our strategic partners may not generate enough revenue to offset the cost of the significant resources used to develop and support these relationships.

We may not be able to retain our key personnel and attract and retain the new personnel necessary to grow our businesses, which could materially adversely affect our ability to develop and sell our products, support our business operations and grow our business.

     The competition for experienced, well-qualified personnel in the software industry is intense. Our future success depends on retaining the services of key personnel in all functional areas of our company, including engineering, sales, marketing, consulting and corporate services. For instance, we may be unable to continue to develop and support technologically advanced products and services if we fail to retain and attract highly qualified engineers, and to market and sell those products and services if we fail to retain and attract well-qualified marketing and sales professionals. We may be unable to retain key employees in all of these areas and we may not succeed in attracting new employees. In addition, from time to time we may acquire other companies. In order to achieve the anticipated benefits of any acquisition we may need transitional or permanent assistance from key employees of the acquired company. If we fail to retain, attract and motivate key employees, including those of companies that we acquire, we may be unable to develop, market and sell new products and services, which could materially adversely affect our operating and financial results.

Failure to achieve and maintain effective internal controls could have a material adverse effect on our business, operating results and stock price.

     We are in the process of documenting and testing our internal control procedures in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act, which requires annual management assessments of the effectiveness of our internal controls over financial reporting and a report by our Independent Auditors addressing these assessments. During the course of our testing we may identify deficiencies that we may not be able to remediate in time to meet the deadline imposed by the Sarbanes-Oxley Act for compliance with the requirements of Section 404. If we fail to achieve and maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we and/or our independent auditors may not be able to conclude at each fiscal year-end that we have effective internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. In addition, we may incur increased costs in order to address the requirements of Section 404 and other provisions of the Sarbanes-Oxley Act, as well as other newly proposed or enacted rules of the Securities and Exchange Commission and the Nasdaq stock market. The extent and timing of incurrence of any such costs is difficult to predict. Moreover, effective internal controls, particularly those related to revenue recognition, are necessary for us to produce reliable financial reports and are important to helping prevent financial fraud. If we and/or our independent auditors cannot attest that we have effective internal controls over financial reporting in accordance with Section 404 of the Sarbanes Oxley Act, our business and operating results could be harmed, investors could lose confidence in our reported financial information, and the trading price of our stock could significantly decline.

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If we are required to treat employee stock option and employee stock purchase plans as a compensation expense, it could significantly reduce our net income and earnings per share.

     There has been ongoing public debate over whether shares issued under employee stock option and employee stock purchase plans should be treated as a compensation expense and, if so, how to properly value such charges. If we were required to record an expense for our stock-based compensation plans using the fair value method, we could have significant accounting charges. Although we are not currently required to record any compensation expense using the fair value method in connection with option grants that have an exercise price at or above fair market value and for shares issued under our employee stock purchase plan, it is possible that future laws or regulations will require us to treat all stock-based compensation as a compensation expense using the fair value method. Any such requirements could cause us to reduce our issuance of stock options or the availability of shares under our employee stock purchase program, which could impair our ability to attract and retain skilled resources.

Fluctuations in the value of foreign currencies could result in currency transaction losses.

     Despite efforts to manage foreign exchange risk, our hedging activities may not adequately protect us against the risks associated with foreign currency fluctuations, particularly in hyper-inflationary countries where hedging is not available or practical. As a consequence, we may incur losses in connection with fluctuations in foreign currency exchange rates. Most of our international revenue and expenses are denominated in local currencies. Due to the substantial volatility of currency exchange rates, among other factors, we cannot predict the effect of exchange rate fluctuations on our future operating results. Although we take into account changes in exchange rates in our pricing strategy, there would be a time lapse between any sudden or significant exchange rate movements and our implementation of a revised pricing structure.

     Accordingly, we may have substantial pricing exposure as a result of foreign exchange volatility during the period between pricing reviews. In addition, as noted previously, the sales cycles for our products are relatively long. Foreign currency fluctuations could, therefore, result in substantial changes in the financial impact of a specific transaction between the time of initial customer contact and revenue recognition. We have a foreign exchange hedging program that is intended to hedge the value of intercompany accounts receivable or intercompany accounts payable denominated in foreign currencies against fluctuations in exchange rates until such receivables are collected or payables are disbursed.

A portion of our product development is outsourced offshore, which poses significant risks.

     Certain of our technical and product development initiatives are conducted using offshore consultants in India, Sri Lanka, and elsewhere, and using employees in India. We currently plan to increase the proportion of development performed offshore in order to take advantage of cost efficiencies and a broader talent pool. However, we may not achieve significant cost savings or other benefits that we anticipate from this program and we may not be able to locate sufficient overseas staff with appropriate skill sets to meet our evolving needs. We have a heightened risk of exposure to changes in the economic, security and political conditions of India and other regions. Economic and political instability, military actions, and other unforeseen occurrences overseas could impair our ability to develop and introduce new software applications and functionality in a timely manner. Moreover, legislation may be adopted at the federal, state, or local level within the United States or elsewhere restricting acquisition of products or services with a significant offshore component, or customers may individually adopt policies favoring technology developed using local labor forces. In such cases, our competitive positioning may be impaired. Further risks include:

    difficulties in managing, operating, and staffing offshore operations;

    difficulties in obtaining or maintaining regulatory approvals or complying with foreign laws;

    reduced or less certain protection for intellectual property rights;

    differing technological advances, preferences or requirements;

    trade restrictions; and

    foreign currency fluctuations.

If we do not respond adequately to our industry’s evolving technology standards or do not continue to meet the sophisticated needs of our customers, revenues from our products and solutions may decline.

     Our future success will depend on our ability to address the increasingly sophisticated needs of our customers by supporting existing and emerging hardware, software, database and networking platforms. We will have to develop and introduce commercially viable enhancements to our existing and acquired products and services on a timely basis to keep pace with technological developments, evolving industry standards and changing customer requirements. If we do not enhance our products and services to meet these evolving needs, we will not license or sell as many products and services and our position in existing, emerging or potential markets could be eroded rapidly by other product advances. In addition, commercial acceptance of our products and services also

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could be adversely affected by critical or negative statements or reports by brokerage firms, industry and financial analysts and the media about us or our products or business, or by the advertising or marketing efforts of competitors, or by other factors that could adversely affect consumer perception.

     Our product development efforts will continue to require substantial financial and operational investment. We may not be able to internally develop new products and services quickly enough to respond to market forces. As a result, we may have to acquire technology or access to products or services through mergers and acquisitions, investments and partnering arrangements, any of which may require us to use significant financial resources. Alternatively, we may not be able to forge partnering arrangements or strategic alliances on satisfactory terms, or at all, with the companies of our choice.

Our future revenue and our ability to make investments in developing our products is substantially dependent upon our installed customer base continuing to license our products and renew our service agreements.

     We depend on our installed customer base for future revenue from services and licenses of additional products. If our customers fail to renew their maintenance agreements, our revenue will decline. Our maintenance agreements are generally renewable annually at the option of the customers and there are no minimum payment obligations or obligations to license additional software. Therefore, current customers may not necessarily generate significant maintenance revenue in future periods. In addition, customers may not necessarily purchase or license additional products or services. Our services revenue and maintenance revenue also depends upon the continued use of these services by our installed customer base, including the customers of acquired companies. Any downturn in software license revenue could result in lower services revenue in current or future quarters.

Seasonal trends in sales of our software products could adversely affect our quarterly operating results, and our lengthy sales cycles for products makes our revenues susceptible to fluctuations.

     Our sales of software products and services have been affected by seasonal purchasing trends that materially affect our quarter-to-quarter operating results. We expect these seasonal trends to continue in the future. Revenue and operating results in our first quarter are typically lower relative to other quarters because many customers make purchase decisions for the fourth quarter based on their calendar year-end budgeting requirements, and as a new year begins start planning for, but not implementing, new information technology spending until later in the year. In addition, revenue and operating results in our third quarter may be adversely affected by scheduling conflicts due to vacations and holidays, particularly abroad.

     Our sales cycles typically take many months to complete and vary depending on the product or service that is being sold. The length of the sales cycle may vary depending on a number of factors over which we have little or no control, including the size of a potential transaction and the level of competition that we encounter in our selling activities. The sales cycle can be further extended for sales made through resellers and third-party distributors.

The success of our international operations is dependent upon many factors that could adversely affect our ability to sell our products internationally and could affect our profitability.

     International sales represent approximately 48% of our total revenue for the nine months ended September 30, 2004. Our international operations are, and any expanded international operations will be, subject to a variety of risks associated with conducting business internationally that could adversely affect our ability to sell our products internationally and, therefore, our profitability, including the following:

    Difficulties in staffing and managing international operations,

    Problems in collecting accounts receivable,

    Longer payment cycles,

    Fluctuations in currency exchange rates,

    Seasonal reductions in business activity during the summer months in Europe and certain other parts of the world,

    Uncertainties relative to regional, political and economic circumstances,

    Recessionary environments in domestic or foreign economies and

    Increases in tariffs, duties, price controls or other restrictions on foreign currencies or trade barriers imposed by countries, and other changes in applicable foreign laws.

If we fail to protect our intellectual property rights, competitors may be able to use our technology or trademarks which would weaken our competitive position, reduce our revenue and increase costs.

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     Our business success will continue to be heavily dependent upon proprietary technology. We rely primarily on a combination of patent, copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect our proprietary rights. These means of protecting proprietary rights may not be adequate, and the inability to protect intellectual property rights may adversely affect our business and/or financial condition. We currently hold a number of United States patents and pending applications. There can be no assurance that any other patents covering our inventions will be issued or that any patent, if issued, will provide sufficiently broad protection or will prove enforceable in actions against alleged infringements. Our ability to sell or license our products and services and to prevent competitors from misappropriating our proprietary technology and trade names is dependent upon protecting our intellectual property. Our products are generally licensed to end users on a “right-to-use” basis under a license that restricts the use of the products for the customer’s internal business purposes.

     Despite such precautions, it may be possible for unauthorized third parties to copy aspects of our current or future products or to obtain and use information that we regard as proprietary. In addition, we have licensed the source code of our products to certain customers under certain circumstances and for restricted uses. We also have entered into source code escrow agreements with a number of our customers that generally require release of our source code to the customer in the event of bankruptcy, insolvency, or discontinuation of our business or support of a product line, in each case where support and maintenance of the product line is not assumed by a third party. We may also be unable to protect our technology because:

    Competitors may independently develop similar or superior technology,

    Policing unauthorized use of software is difficult,

    The laws of some foreign countries do not protect proprietary rights in software to the same extent as do the laws of the United States,

    “Shrink-wrap” and/or “click-wrap” licenses may be wholly or partially unenforceable under the laws of certain jurisdictions, and

    Litigation to enforce intellectual property rights, to protect trade secrets, or to determine the validity and scope of the proprietary rights of others could result in substantial costs and diversion of resources.

Our software may have defects and errors, which may lead to a loss of revenue or product liability claims.

     Software products are internally complex and occasionally contain defects or errors, especially when first introduced or when new versions or enhancements are released. Despite extensive testing, we may not detect errors in our new products, platforms or product enhancements until after we have commenced commercial shipments. If defects and errors are discovered in our existing or acquired products, platforms or product enhancements after commercial release, then potential customers may delay or forego purchases; our reputation in the marketplace may be damaged; we may incur additional service and warranty costs; and we may have to divert additional development resources to correct the defects and errors. If any or all of the foregoing occur, we may lose revenues or incur higher operating expenses and lose market share, any of which could severely harm our financial condition and operating results.

Claims by others that we infringe their intellectual property rights could harm our business and financial condition.

     The software industry is characterized by an increasing prevalence of patents and litigation regarding patent and other intellectual property rights. We cannot be certain that our products do not and will not infringe issued patents, patents that may issue in the future, or other intellectual property rights of third parties. From time to time we may face assertions by third parties that our products or technology infringe their patents or other intellectual property rights. Any claim of infringement could cause us to incur substantial costs defending against the claim, even if the claim is invalid, and could distract the attention of our management. If any of our products is found to violate third-party proprietary rights, we may be required to pay substantial damages. In addition, we may be required to re-engineer our products or obtain licenses from third parties to continue to offer our products. There are no assurances that any efforts to re-engineer our products or obtain licenses on commercially reasonable terms would be successful and, if not, such circumstances could have a material adverse effect on our business, financial condition and results of operations.

The loss of our rights to use software licensed to us by third parties could harm our business.

     In order to provide a complete product suite, we occasionally license software from third parties, and sub-license this software to our customers. In addition, we license software programs from third parties and incorporate these programs into our own software products. By utilizing third party software in our business, we incur risks that are not associated with developing software in-house. For example, these third party providers may discontinue or alter their operations, terminate their relationship with us, impose license restrictions or generally become unable to fulfill their obligations to us. If any of these circumstances were to occur, we may be forced to seek alternative technology that may not be available on commercially reasonable terms. In the future, we may be forced to obtain additional third party software licenses to enhance our product offerings and compete more effectively. We may not be able to obtain and maintain licensing rights to needed technology on commercially reasonable terms, which would harm our business and operating results.

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We have substantial real estate lease commitments for unoccupied space and restoration obligations, and if we are unable to sublet this space on acceptable terms our operating results and financial condition could be adversely affected.

     We are party to real estate leases worldwide for a total of approximately 471,000 square feet. At September 30, 2004, we actively utilized approximately 53% of this space, or 251,000 square feet. We retain unoccupied space as a result of the IBM Transaction and the Mercator acquisition. At September 30, 2004 approximately 47%, or 220,000 square feet is currently unoccupied. Approximately 29% or 63,000 square feet of this unoccupied space is sublet to a third party.

     At September 30, 2004, we had a restructuring reserve of $33.5 million associated with these leases comprised of $31.2 million for lease obligations and $2.3 million for restoration costs related to the disposition of this space as of September 30, 2004. In establishing this reserve, we assumed that we will be able to sublet the available space and receive approximately $24.5 million of sublease income relating to this space, $4.1 million for properties already sublet and $20.5 million from properties where a sublet is anticipated. We may not be able to sublet this space on the assumed terms and restoration costs may exceed our estimates. If we are unable to sublet this space on the assumed terms, or if restoration costs exceed our estimates, there may be an adverse effect on our operating results of up to $19.5 million resulting from additional restructuring costs.

Provisions in our charter documents may discourage potential acquisition bids and prevent changes in our management that our stockholders may favor. This could adversely affect the market price for our common stock.

     Provisions in our charter documents could discourage potential acquisition proposals and could delay or prevent a change in control transaction that our stockholders may favor. The provisions include:

    Elimination of the right of stockholders to act without holding a meeting,

    Certain procedures for nominating directors and submitting proposals for consideration at stockholder meetings and

    A board of directors divided into three classes, with each class standing for election once every three years.

     These provisions are intended to enhance the likelihood of continuity and stability in the composition of the Board of Directors and in the policies formulated by the Board of Directors and to discourage certain types of transactions involving an actual or threatened change of control. These provisions are designed to reduce our vulnerability to an unsolicited acquisition proposal and, accordingly, could discourage potential acquisition proposals and could delay or prevent a change in control. Such provisions are also intended to discourage certain tactics that may be used in proxy fights but could, however, have the effect of discouraging others from making tender offers for shares of our common stock, and consequently, may also inhibit fluctuations in the market price of our common stock that could result from actual or rumored takeover attempts. These provisions may also have the effect of preventing changes in our management.

     In addition, we have adopted a rights agreement, commonly referred to as a “poison pill,” that grants holders of our common stock preferential rights in the event of an unsolicited takeover attempt. These rights are denied to any stockholder involved in the takeover attempt which has the effect of requiring cooperation with our Board of Directors. This may also prevent an increase in the market price of our common stock resulting from actual or rumored takeover attempts. The rights agreement could also discourage potential acquirers from making unsolicited acquisition bids.

Provisions in our charter documents with respect to undesignated preferred stock may discourage potential acquisition bids.

     Our Board of Directors is authorized to issue up to approximately four million shares of undesignated preferred stock in one or more series. Our Board of Directors can fix the price, rights, preferences, privileges and restrictions of such preferred stock without any further vote or action by our stockholders. However, the issuance of shares of preferred stock may delay or prevent a change in control transaction without further action by our stockholders. As a result, the market price of our common stock and the voting and other rights of the holders of our common stock may be adversely affected. The issuance of preferred stock with voting and conversion rights may adversely affect the voting power of the holders of our common stock, including the loss of voting controls to others.

Delaware law may inhibit potential acquisition bids, which may adversely affect the market price for our common stock and prevent changes in our management that our stockholders may favor.

     We are incorporated in Delaware and are subject to the anti-takeover provisions of the Delaware General Corporation Law, which regulates corporate acquisitions. Delaware law prevents certain Delaware corporations, including us, whose securities are listed for trading on the NASDAQ National Market, from engaging, under certain circumstances, in a “business combination” with any “interested stockholder” for three years following the date that the stockholder became an interested stockholder. For purposes of Delaware law, a “business combination” would include, among other things, a merger or consolidation involving us and an interested stockholder and the sale of more than 10% of our assets. In general, Delaware law defines an “interested stockholder” as any entity or person beneficially owning 15% or more of the outstanding voting stock of a corporation and any entity or person affiliated with or controlling or controlled by such entity or person. Under Delaware law, a Delaware corporation may “opt out” of the anti-takeover provisions. We have not and do not intend to “opt out” of these anti-takeover provisions of Delaware law.

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Terrorist attacks, such as the attacks that occurred in New York and Washington, D.C. on September 11, 2001, and other acts of violence or war, may affect the markets in which we operate, our operations and our profitability.

     Terrorist attacks may negatively disrupt and negatively impact our operations. We are unable to predict whether there will be future terrorist attacks against the United States or United States businesses, or against other countries or businesses located in those countries. These attacks may directly impact our physical facilities and those of our suppliers or customers. Furthermore, these attacks may make the travel of our employees more difficult and expensive and ultimately may affect our sales.

     Also, as a result of terrorism or for other reasons, the United States may enter into an armed conflict that could have a further impact on our sales and our ability to deliver products to our customers. Political and economic instability in some regions of the world may also negatively impact our business generated in those regions. The consequences of any of these armed conflicts are unpredictable, and we may not be able to foresee events that could have an adverse effect on our business.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

     For quantitative and qualitative disclosures about market risk affecting the Company, see Item 7A “Quantitative and Qualitative Disclosures About Market Risk” of our Annual Report on Form 10-K for our fiscal year ended December 31, 2003. Our exposure to market risks has not changed materially since December 31, 2003.

Item 4. Controls and Procedures.

     The Company’s management, with the participation of the Company’s chief executive officer and chief financial officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of September 30, 2004. Based on this evaluation, the Company’s chief executive officer and chief financial officer concluded that, as of September 30, 2004, the Company’s disclosure controls and procedures were (1) designed to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to the Company’s chief executive officer and chief financial officer by others within those entities, particularly during the period in which this report was being prepared and (2) effective, in that they provide reasonable assurance that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

     No change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended September 30, 2004 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

     The Company is a defendant in one action filed against Unidata, Inc., a company that the Company merged with in 1998 (“Unidata”), in May 1996 in the U.S. District Court for the Western District of Washington, and was previously a defendant in another action filed in September 1996 in the U.S. District Court for the District of Colorado. The plaintiff, a company controlled by a former stockholder of Unidata and a distributor of its products in certain parts of Asia, alleged in both actions the improper distribution of certain Unidata products in the plaintiff’s exclusive territory and asserted damages of approximately $30.0 million (among other relief) under claims for fraud, breach of contract, unfair competition, racketeering and corruption, and trademark and copyright infringement. Unidata denied the allegations against it in its answers to the complaints. In the Colorado action, Unidata moved that the matter be resolved by arbitration in accordance with its distribution agreement with the plaintiff. In May 1999, the U.S. District Court for the District of Colorado issued an order compelling arbitration and in September 2000, the arbitrator issued an award against the Company for $3.5 million plus attorneys’ fees and expenses estimated to be approximately $0.8 million.

     The Company was also joined as a party in an action in China filed against Unidata, its former distributor and a customer, by the same plaintiff who filed the U.S. actions against Unidata and a related company. This action, filed in the Guangdong Provincial People’s Superior Court in China, arose out of the same facts at issue in the U.S. actions. The Company entered into a settlement agreement with the plaintiff pursuant to which, among other things, as each of the actions was dismissed, the underlying license terminated, certain intellectual property rights were assigned to the Company by the plaintiff, and the Company was obligated to pay into escrow, and then have released from escrow to the plaintiff, certain amounts totaling approximately $16.0 million to settle all claims in all pending litigation, with the exception of potential claims for indemnity between the Company and other co-defendants relating to attorneys’ fees and related amounts, if any, paid in settlement. Subsequently, the China and Denver actions were dismissed; the plaintiff’s claims in the Washington State action were dismissed; the license agreement was terminated; and the intellectual property rights were assigned to the Company as of the end of the second quarter of fiscal 2002 and the full amount escrowed was released to plaintiff. During the year ended December 31, 2002, the Company paid into escrow the entire amount of the settlement of approximately $16.0 million.

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     From time to time, in the ordinary course of business, the Company is involved in various other legal proceedings and claims, including but not limited to those related to the operations of the former database business and/or asserted by former employees of the Company relating to their employment or compensation by the Company. The Company does not believe that any of these other proceedings and claims will have a material adverse effect on the Company’s business or financial condition.

Item 2. Unregistered Sale of Equity Securities and Use of Proceeds.

     The following table summarizes our share repurchase activity in the quarter ended September 30, 2004 (in thousands):

                                   
                            (d) Maximum
Number
(or Approximate
                    (c) Total Number of   Dollar Value) of
                    Shares Purchased as   Shares that May Yet
    (a) Total Number of           Part of Publicly   Be Purchased Under
    Shares Purchased   (b) Average Price   Announced Plans or   the Plans or
    (1)
  Paid per Share
  Programs
  Programs
July 1-July 31
                    $ 101,207  
August 1 — August 31
                    $ 101,207  
September 1 — September 30
                    $ 101,207  
Total
                    $ 101,207  

(1) We publicly announced a $100 million common stock repurchase program (the “Program”) on April 26, 2001 under which our Board of Directors authorized the repurchase of common stock. We publicly announced on July 2, 2001 that the Program was increased from $100 million to $350 million. Under the Program, we may repurchase outstanding shares of our common stock from time to time in the open market and through privately negotiated transactions. Unless terminated earlier by resolution of our Board of Directors, the Program will expire when we have utilized the full amount of funds authorized for repurchase of shares under the Program.

Item 6. Exhibits

     
Exhibits
   
10.1(1)
  Form of Stock Option Agreement pursuant to Second Restated 1994 Stock Option and Award Plan
 
10.2(1)
  Form of Nonqualified Stock Option Agreement pursuant to Second Restated 1989 Outside Directors Stock Option Plan
 
10.3(1)
  Form of Stock Option Agreement pursuant to Amended and Restated 1998 Non-Statutory Stock Option and Award Plan
 
31.1(1)
  Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended
 
31.2(1)
  Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended
 
32.1(1)
  Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
32.2(1)
  Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(1)   Filed herewith.

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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.

         
Dated November 9, 2004        
    ASCENTIAL SOFTWARE CORPORATION
    By:   /s/ Robert C. McBride

Robert C. McBride
Vice President and Chief Financial Officer
(Principal Financial Officer and Principal
Accounting Officer); Duly Authorized Officer

         

         

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Index to Exhibits

     
10.1(1)
  Form of Stock Option Agreement pursuant to Second Restated 1994 Stock Option and Award Plan
 
10.2(1)
  Form of Nonqualified Stock Option Agreement pursuant to Second Restated 1989 Outside Directors Stock Option Plan
 
10.3(1)
  Form of Stock Option Agreement pursuant to Amended and Restated 1998 Non-Statutory Stock Option and Award Plan
 
31.1(1)
  Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended
 
31.2(1)
  Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended
 
32.1(1)
  Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
32.2(1)
  Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(1) Filed herewith.

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