UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

OR

Commission File Number: 0-19417

PROGRESS SOFTWARE CORPORATION

14 Oak Park
Bedford, Massachusetts 01730
(Address of principal executive offices)
Telephone Number: (781) 280-4000

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 þ No o

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

As of March 31, 2005, there were 37,228,000 shares of the registrant’s Common Stock, $.01 par value per share, outstanding.

PROGRESS SOFTWARE CORPORATION

FORM 10-Q

FOR THE THREE MONTHS ENDED FEBRUARY 28, 2005

INDEX

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PART 1. FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

Condensed Consolidated Balance Sheets (unaudited)

See notes to unaudited condensed consolidated financial statements.

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Condensed Consolidated Statements of Operations (unaudited)

See notes to unaudited condensed consolidated financial statements.

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Condensed Consolidated Statements of Cash Flows (unaudited)

See notes to unaudited condensed consolidated financial statements.

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Notes to Unaudited Condensed Consolidated Financial Statements

Note 1: Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared by Progress Software Corporation (the Company) pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the audited financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended November 30, 2004.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements have been prepared on the same basis as the audited financial statements, and include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of the interim periods presented. The operating results for the interim periods presented are not necessarily indicative of the results expected for the full fiscal year.

In light of recent views expressed by the Securities and Exchange Commission with respect to accounting for auction rate securities (ARS), the Company has reclassified the accompanying November 30, 2004 condensed consolidated balance sheet to no longer report ARS as cash equivalents. Such investments are now reported within the Company’s short-term investments. The amount reclassified from cash and equivalents to short-term investments at November 30, 2004 was $71.5 million. Net cash used for investing activities within the condensed consolidated statement of cash flows for the three months ending February 29, 2004 has also been reclassified to conform to this presentation. The reclassifications to the prior period financial statements did not affect the Company’s key financial indicators such as total cash and short-term investments, total assets, shareholders’ equity, revenue, income from operations, net income, diluted earnings per share or cash flows from operating activities. In addition, the Company does not believe a reader’s ability to understand other key aspects of the Company’s financial position or operations that might be pertinent to an investment decision has been affected as a result of the reclassifications. As a result, the Company believes the effects of these reclassifications are not material to the Company’s previously issued consolidated financial statements.

Note 2: Stock-based Compensation

The Company uses the intrinsic value method to measure compensation expense associated with the grants of stock options and awards to employees. The Company accounts for stock options and awards to non-employees using the fair value method. The Company has not granted any stock options or awards to non-employees, except to outside directors.

Under the intrinsic value method, compensation associated with stock options and awards to employees is determined as the excess, if any, of the current fair value of the underlying common stock on the date compensation is measured over the price an employee must pay to exercise the option or award. Under the fair value method, compensation associated with stock options and awards is determined based on the estimated fair value of the option or award itself, measured using either current market data or an established option pricing model. The measurement date for employee options and awards is generally the date of grant.

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Had the Company used the fair value method to measure compensation related to stock options and awards to employees, pro forma net income and pro forma earnings per share would have been as follows:

In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (SFAS 123R). This Statement is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS 123R requires a company to measure the grant date fair value of equity awards given to employees in exchange for services and recognize that cost over the period that such services are performed. SFAS 123R is effective for the first interim or annual reporting period that begins after June 15, 2005.

The Company is currently evaluating the two methods of adoption allowed by SFAS 123R: the modified-prospective transition method and the modified-retrospective transition method. Adoption of SFAS 123R will materially increase stock compensation expense and decrease net income and diluted earnings per share. In addition, SFAS 123R requires that the excess tax benefits related to stock compensation be reported as a cash inflow from financing activities rather than as a reduction of taxes paid in cash from operations.

Note 3: Earnings Per Share

Basic earnings per share is calculated using the weighted average number of common shares outstanding. Diluted earnings per share is computed on the basis of the weighted average number of common shares outstanding plus the effect of outstanding stock options using the treasury stock method. The following table sets forth the calculation of basic and diluted earnings per share on an interim basis:

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Note 4: Income Taxes

The Company provides for income taxes at the end of each interim period based on the estimated effective tax rate for the full fiscal year. Cumulative adjustments to the tax provision are recorded in the interim period in which a change in the estimated annual effective rate is determined. The IRS is currently examining the Company’s United States income tax returns for fiscal years through 2002. The Company has provided reserves for certain tax matters, both domestic and foreign, which it believes could result in additional tax being due. Any additional assessment or reduction of these contingent liabilities will be reflected in the Company’s effective tax rate in the period when the audit is completed.

Note 5: Comprehensive Income

The components of comprehensive income include net income, foreign currency translation adjustments, unrealized gains and losses on foreign exchange hedging contracts and unrealized gains and losses on investments. The following table sets forth the calculation of comprehensive income on an interim basis:

Note 6: Segment Information

The Company conducts business through four principal operating units. The first operating unit conducts business as the Progress OpenEdge Division (OED) and provides the OpenEdge platform, a set of development and deployment technologies, which includes the OpenEdge RDBMS, for building business applications. The second operating unit, Sonic Software Corporation, provides a set of standards-based integration products and services. The third operating unit, ObjectStore, provides advanced data management software for developing real-time applications. The fourth operating unit, DataDirect Technologies, was acquired in December 2003 and provides standards-based data connectivity software.

Segment information is presented in accordance with SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information.” This standard is based on a management approach which requires segmentation based upon the Company’s internal organization and disclosure of revenue and operating income based upon internal accounting methods.

Based upon the aggregation criteria for segment reporting, the Company has two reportable segments: Application Development & Deployment, which primarily includes OED, ObjectStore and DataDirect Technologies, and Enterprise Application Integration, which includes Sonic Software and certain Sonic-related international sales and marketing functions within OED. The Company has aggregated its segment data based on similar utilization characteristics, such as deployment and integration, of the primary products in each operating unit. The Company does not internally report its assets, capital expenditures, interest income or provision for income taxes by segment.

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The following table sets forth revenue and income from operations from the Company’s reportable segments on an interim basis:

Amounts included under Eliminations represent intersegment sales, which are accounted for as if made under an equivalent arms-length basis arrangement. Total revenue from the Sonic product line, generated by both segments, was $6.6 million in the first three months of fiscal 2005 as compared to $6.1 million in the first three months of fiscal 2004.

Note 7: Subsequent Event

On April 7, 2005, the Company acquired privately-held Apama, Inc. (Apama) for an aggregate purchase price of approximately $25 million, net of cash acquired. Apama is a provider of event stream processing software focused on the financial services industry. Apama will become part of the ObjectStore operating unit. The acquisition will be accounted for as a purchase, and accordingly, the results of operations of Apama will be included in the Company’s operating results from the date of acquisition. In addition, the Company is implementing an employee retention program by which payments will be made over the next twelve months to Apama employees, if they meet certain employment criteria. If all retention criteria are met, the Company will be obligated to pay a total of $4 million in retention payments. The purchase price was paid in cash from available funds.

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

Cautionary Statements

The Private Securities Litigation Reform Act of 1995 contains certain safe harbor provisions regarding forward-looking statements. This Form 10-Q, and other information provided by the Company or statements made by its directors, officers or employees from time to time, may contain “forward-looking” statements and information, which involve risks and uncertainties. Actual future results may differ materially. Statements indicating that the Company “expects,” “estimates,” “believes,” “is planning” or “plans to” are forward-looking, as are other statements concerning future financial results, product offerings or other events that have not yet occurred. There are several important factors that could cause actual results or events to differ materially from those anticipated by the forward-looking statements. Such factors are described below in greater detail under the heading “Factors That May Affect Future Results” and include, but are not limited to, the timing of the receipt and shipment of new orders, the success of the Company’s distribution channels, the timely release of enhancements to the Company’s products, the growth rates of certain market segments, the positioning of the Company’s products in those market segments, success in the enterprise service bus market, variations in the demand for professional services and software license maintenance, including technical support, global economic conditions, pricing pressures and the competitive environment in the software industry, the impact of recent acquisitions and any future acquisitions on the Company’s business and the Company’s ability to penetrate international markets and manage its international operations. Although the Company has sought to identify the most significant risks to its business, the Company cannot predict whether, or to what extent, any of such risks may be realized, nor can there be any assurance that the Company has identified all possible issues which the Company might face. The Company undertakes no obligation to update any forward-looking statements it makes.

Overview

The Company develops, markets and distributes software to simplify and accelerate the development, deployment, integration and management of business applications. The mission of the Company is to deliver software products and services that empower partners and customers to improve their development, deployment, integration and management of quality applications worldwide. The Company’s products include development tools, databases, application servers, messaging servers, application management tools, data connectivity products and integration products for distributed and Web-based applications as well as for client/server applications. The Company, through its various operating units, markets its products globally to a broad range of organizations in manufacturing, distribution, finance, retail, healthcare, telecommunications, government and many other fields.

A significant portion of the Company’s revenue is derived from international operations. In the first quarter of fiscal 2005 as well as in fiscal years 2002 through 2004, the weakening of the U.S. dollar against most major currencies, primarily the euro and the British pound, positively affected the Company’s results. Prior to that, the U.S. dollar was stronger and the Company’s results were adversely affected.

In recent years, the Company has completed a number of acquisitions, including eXcelon Corporation in December 2002, DataDirect Technologies Limited in December 2003 and Persistence Software Inc. (Persistence) in November 2004. These acquisitions were designed to expand the size and breadth of the Company’s business and/or add complementary products and technologies to existing product sets.

The Company conducts business through four operating units. The Company’s principal operating unit conducts business as the Progress OpenEdge Division (OED). OED provides the Progress® OpenEdgeÔ platform, a set of development and deployment technologies, including the OpenEdge RDBMS, one of the leading embedded databases, for building business applications. Sonic Software Corporation is focused on enterprise application integration and the emerging market for enterprise service bus (ESB) and operates as a subsidiary of the Company. Sonic Software Corporation delivers a distributed, standards-based communications and integration infrastructure, built on an ESB that integrates existing business applications and orchestrates business processes across the extended enterprise. The third operating unit is ObjectStore, a division of PSC, providing advanced data management software for developing high performance real-time applications which require processing of large amounts of data. The operations of Persistence were integrated into ObjectStore. The ObjectStore division is also

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responsible for the PeerDirect product line. The fourth operating unit, the DataDirect division of PSC, provides standards-based data connectivity software.

Critical Accounting Policies

Management’s discussion and analysis of financial condition and results of operations are based upon the Company’s consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America. The Company makes estimates and assumptions in the preparation of its consolidated financial statements that affect the reported amounts of assets and liabilities, revenue and expenses and related disclosures of contingent assets and liabilities. The Company bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances. However, actual results may differ from these estimates.

The Company has identified the following critical accounting policies that require the use of significant judgments and estimates in the preparation of its consolidated financial statements. This listing is not a comprehensive list of all of the Company’s accounting policies. For further information regarding the application of these and other accounting policies, see Note 1 in the Notes to Consolidated Financial Statements in Item 8 of the Company’s Annual Report on Form 10-K.

Revenue Recognition — The Company’s revenue recognition policy is significant because revenue is a key component affecting results of operations. In determining when to recognize revenue from a customer arrangement, the Company is often required to exercise judgment regarding the application of its accounting policies to a particular arrangement. For example, judgment is required in determining whether a customer arrangement has multiple elements. If such a situation exists, judgment is also involved in determining whether vendor-specific objective evidence (VSOE) of fair value for the undelivered elements exists. While the Company follows specific and detailed rules and guidelines related to revenue recognition, significant management judgments and estimates are made and used in connection with the revenue recognized in any reporting period, particularly in the areas described above as well as collectibility. If management made different estimates or judgments, material differences in the timing of the recognition of revenue could occur.

Allowance for Doubtful Accounts — The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make required payments. This allowance is established using estimates that the Company makes based on factors such as the composition of the accounts receivable aging, historical bad debts, changes in payment patterns, changes to customer creditworthiness and current economic trends. If the Company used different estimates, or if the financial condition of customers were to deteriorate, resulting in an impairment of their ability to make payments, additional provisions for doubtful accounts would be required and would increase bad debt expense.

Goodwill and Intangible Assets — The Company has goodwill and net intangible assets of $105.5 million at February 28, 2005. The Company assesses the impairment of goodwill and identifiable intangible assets on an annual basis and whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable. An impairment charge would be recorded if such an assessment were to indicate that the fair value of such assets was less than the carrying value. Judgment is required in determining whether an event has occurred that may impair the value of goodwill or identifiable intangible assets. Factors that could indicate that an impairment may exist include significant underperformance relative to plan or long-term projections, strategic changes in business strategy, significant negative industry or economic trends or a significant decline in the stock price of the Company for a sustained period of time. The Company utilizes discounted cash flow models or valuation reports from third-party firms to determine the fair value of its reporting units. The Company must make assumptions about future cash flows, future operating plans, discount rates and other factors in the models and valuation reports. Different assumptions and judgment determinations could yield different conclusions that would result in an impairment charge to income in the period that such change or determination was made.

Deferred Income Taxes — The Company had a net deferred tax asset of $29.1 million, including $12.5 million in other current assets and $16.6 million in other assets, at February 28, 2005. The Company records valuation allowances to reduce deferred tax assets to the amount that is more likely than not to be realized. The Company

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considers scheduled reversals of temporary differences, projected future taxable income, ongoing tax planning strategies and other matters in assessing the need for and the amount of a valuation allowance. If the Company were to change its assumptions or otherwise determine that it was unable to realize all or part of its net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period that such change or determination was made.

Results of Operations

The following table sets forth certain income and expense items as a percentage of total revenue, and the percentage change in dollar amounts of such items compared with the corresponding period in the previous fiscal year:

The Company’s total revenue increased 13% from $86.4 million in the first quarter of fiscal 2004 to $97.7 million in the first quarter of fiscal 2005. Total revenue would have increased by approximately 10% if exchange rates had been constant in the first quarter of fiscal 2005 as compared to the exchange rates in effect in the first quarter of fiscal 2004. In addition to the positive effect of changes in exchange rates, the Company’s revenue increased due to growth in sales volume across all of the Company’s major product lines.

Total revenue from the Progress OpenEdge product line increased 6% from $71.5 million in the first quarter of fiscal 2004 to $76.0 million in the first quarter of fiscal 2005. Total revenue from the DataDirect product line increased 68% from $5.1 million in the first quarter of fiscal 2004 to $8.6 million in the first quarter of fiscal 2005. Total revenue from the ObjectStore product line, including amounts associated with the recently acquired Persistence products, increased 81% from $3.7 million in the first quarter of fiscal 2004 to $6.6 million in the first quarter of fiscal 2005. Total revenue from the Sonic product line increased 8% from $6.1 million in the first quarter of fiscal 2004 to $6.6 million in the first quarter of fiscal 2005.

Software license revenue increased 11% from $33.9 million in the first quarter of fiscal 2004 to $37.6 million in the first quarter of fiscal 2005. Software license revenue would have increased by approximately 8% if exchange rates had been constant in the first quarter of fiscal 2005 as compared to the exchange rates in effect in the first quarter of fiscal 2004. The increase in software license revenue was primarily due to growth from the Company’s newer product lines, DataDirect, ObjectStore and Sonic, which accounted for 34% of software license revenue in the first quarter of fiscal 2005 as compared to 24% in the first quarter of fiscal 2004. Software license revenue from sales to direct end users increased at a greater rate of growth in the first quarter than sales through indirect channels,

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including application partners which have written software applications utilizing OED technology and resell the Company’s products in conjunction with the sale of their applications.

Maintenance and services revenue increased 15% from $52.5 million in the first quarter of fiscal 2004 to $60.2 million in the first quarter of fiscal 2005. The increase in maintenance and services revenue was primarily the result of growth in the Company’s installed customer base, renewal of maintenance agreements and an increase in professional services revenue.

Total revenue generated in markets outside North America increased 9% from $50.5 million in the first quarter of fiscal 2004 to $55.0 million in the first quarter of fiscal 2005 and represented 56% of total revenue in the first quarter of fiscal 2005 as compared to 59% in the first quarter of fiscal 2004. The three major regions outside of North America, consisting of Europe, Middle East and Africa (EMEA), Latin America and Asia Pacific, each grew in the first quarter of fiscal 2005 as compared to the first quarter of fiscal 2004. Total revenue generated in markets outside North America would have represented 55% of total revenue in the first quarter of fiscal 2005 if exchange rates had been constant in the first quarter of fiscal 2005 as compared to the exchange rates in effect in the first quarter of fiscal 2004.

The Company expects total revenue in the second quarter of fiscal 2005 to be in the range of $98 million to $100 million, representing an increase of 8% to 10% as compared to the second quarter of fiscal 2004. The Company anticipates total revenue for fiscal 2005 to be in the range of $395 million to $405 million, representing an increase of 9% to 12% over fiscal 2004. This revenue expectation assumes the continued success of the Company’s application partners and other channel partners, continued improvement in the Company’s ability to generate new business in end user accounts, the ability to successfully integrate the products and personnel from Persistence and continued growth from the newer product sets, especially the DataDirect, ObjectStore and Sonic product lines. External factors, such as geopolitical issues or a significant strengthening of the U.S. dollar against currencies from which the Company derives a significant portion of its business, could negatively impact this revenue expectation.

Cost of software licenses consists primarily of cost of product media, documentation, duplication, packaging, royalties and amortization of capitalized software costs. Cost of software licenses decreased 25% from $2.6 million in the first quarter of fiscal 2004 to $2.0 million in the first quarter of fiscal 2005 and decreased as a percentage of software license revenue from 8% to 5%. The dollar decrease for the first quarter was primarily due to lower royalty expense for products and technologies licensed or resold from third parties and lower costs for documentation and media. Cost of software licenses as a percentage of software license revenue may vary from period to period depending upon the relative product mix. The Company expects costs of software licenses to range from 5% to 8% of the related software license revenue in a given period.

Cost of maintenance and services consists primarily of costs of providing customer technical support, education and consulting. Cost of maintenance and services increased 9% from $12.8 million in the first quarter of fiscal 2004 to $14.0 million in the first quarter of fiscal 2005 and decreased as a percentage of maintenance and services revenue from 24% to 23%. The maintenance and services revenue margin improvement was due to the fact that maintenance revenue, which has a substantially higher margin than professional services revenue, represented a slightly greater proportion of the total maintenance and services revenue in the first quarter of fiscal 2005. The dollar increase was due to greater usage of third-party contractors for service engagements and higher headcount-related expenses. The Company’s technical support, education, and consulting headcount increased by 1% from the end of the first quarter of fiscal 2004 to the end of the first quarter of fiscal 2005.

Sales and marketing expenses increased 6% from $36.2 million in the first quarter of fiscal 2004 to $38.3 million in the first quarter of fiscal 2005, but decreased as a percentage of total revenue from 42% to 39%. The increase in sales and marketing expenses was due to the addition of sales and marketing expense in the ObjectStore group related to the acquisition of Persistence in the fourth quarter of fiscal 2004. Expenses also increased in the first quarter due to year-over-year changes in exchange rates, as a significant percentage of sales and marketing expenses are incurred outside of North America. The Company’s sales, sales support and marketing headcount decreased by 3% from the end of the first quarter of fiscal 2004 to the end of the first quarter of fiscal 2005.

Product development expenses increased 12% from $14.6 million in the first quarter of fiscal 2004 to $16.4 million in the first quarter of fiscal 2005 and remained the same percentage of total revenue at 17%. The dollar increase was

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primarily due to expenses related to the development team associated with the recently acquired Persistence products and greater use of outside contractors. No software development costs were capitalized in the first quarter of fiscal 2005 as compared to $0.3 million in the first quarter of fiscal 2004. The Company’s product development headcount decreased 1% from the end of the first quarter of fiscal 2004 to the end of the first quarter of fiscal 2005.

General and administrative expenses include the costs of the finance, human resources, legal, information systems and administrative departments of the Company. General and administrative expenses increased 10% from $9.7 million in the first quarter of fiscal 2004 to $10.7 million in the first quarter of fiscal 2005 and remained the same percentage of total revenue at 11%. The dollar increase was primarily due to headcount related costs, additional professional service fees for audit and legal expenses and the impact of changes in exchange rates, partially offset by lower transition and integration costs associated with acquisitions. The Company’s general and administrative headcount decreased 1% from the end of the first quarter of fiscal 2004 to the end of the first quarter of fiscal 2005.

Amortization of acquired intangibles increased from $1.6 million in the first quarter of fiscal 2004 to $2.0 million in the first quarter of fiscal 2005. The increase was primarily due to amortization expense associated with the acquisition of Persistence in November 2004. The Company expects amortization of acquired intangibles to total approximately $2.0 million in the second quarter of fiscal 2005 and to total approximately $7.9 million for fiscal 2005.

Acquired in-process research and development from the acquisition of DataDirect totaled $2.6 million in the first quarter of fiscal 2004 and was expensed when the acquisition was consummated because the technological feasibility of products under development at the time of the acquisition had not been achieved and no alternate future uses had been established. The value of in-process research and development was determined based on an independent appraisal from a third party.

Income from operations as a percentage of total revenue increased from 7% in the first quarter of fiscal 2004 to 15% in the first quarter of fiscal 2005. If the Company is able to meet its forecasted revenue target and expenses occur as planned for the remainder of the fiscal year, the Company expects operating income as a percentage of revenue to be between 15% and 17% for all of fiscal 2005.

Other income (expense), net decreased from $0.4 million in the first quarter of fiscal 2004 to ($0.7) million in the first quarter of fiscal 2005. The decrease was primarily due to higher foreign exchange losses in the first quarter of fiscal 2005 as compared to the first quarter of fiscal 2004, primarily related to the timing of recording foreign exchange hedging expenses, which more than offset an increase in interest income. The increase in interest income was primarily due to slightly higher interest rates and higher average cash and short-term investment balances.

The Company’s effective tax rate was 31% in the first quarter of fiscal 2004 as compared to 32% in the first quarter of fiscal 2005. The IRS is currently examining the Company’s United States income tax returns for fiscal years through 2002. The Company has provided reserves for certain tax matters, both domestic and foreign, which it believes could result in additional tax being due. Any additional assessment or reduction of these contingent liabilities will be reflected in the Company’s effective tax rate in the period when the audit is completed. Excluding the impact of the results of the IRS audit, the Company estimates that its effective tax rate will remain at approximately 32% for all of fiscal 2005.

Liquidity and Capital Resources

At the end of the first quarter of fiscal 2005, the Company’s cash and short-term investments totaled $204.7 million. The increase of $13.4 million since the end of fiscal 2004 resulted primarily from cash generated from operations and proceeds from exercises of stock options and stock issuances under the Company’s stock purchase plan, partially offset by capital expenditures and common stock repurchases.

The Company generated $14.2 million in cash from operations in the first three months of fiscal 2005 as compared to $13.3 million in the first three months of fiscal 2004. The increase in cash generated from operations in the first three months of fiscal 2005 as compared to the first three months of fiscal 2004 was primarily due to increased profitability, partially offset by net working capital uses.

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Accounts receivable increased by $7.4 million from the end of fiscal 2004. This increase resulted in accounts receivable days sales outstanding (DSO) increasing by 6 days to 65 days at the end of the first quarter of fiscal 2005 as compared to 59 days at the end of fiscal 2004 and decreasing by 4 days from 69 days at the end of the first quarter of fiscal 2004. The increase in DSO is primarily related to the impact of maintenance renewal billings, as the first quarter of each fiscal year typically has the highest portion of such billings relative to the full year. The Company targets a DSO range of 60 to 80 days.

The Company purchased property and equipment totaling $2.1 million in each of the first three months of fiscal 2004 and fiscal 2005. The purchases consisted primarily of computer equipment. The Company financed these purchases primarily from cash generated from operations.

The Company purchased and retired approximately 46,000 shares of its common stock for $1.0 million in the first three months of fiscal 2004 and approximately 265,000 shares of its common stock for $5.8 million in the first three months of fiscal 2005. The Company financed these purchases primarily from cash generated from operations.

In September 2004, the Board of Directors authorized, for the period from October 1, 2004 through September 30, 2005, the purchase of up to 10,000,000 shares of the Company’s common stock, at such times that the Company deems such purchases to be an effective use of cash. Shares that are repurchased may be used for various purposes, including the issuance of shares pursuant to the Company’s stock option and stock purchase plans. A total of 9,712,000 shares of common stock remained available for repurchase under this authorization at February 28, 2005.

On April 7, 2005, the Company acquired privately-held Apama, Inc. (Apama) for an aggregate purchase price of approximately $25 million, net of cash acquired. Apama is a provider of event stream processing software focused on the financial services industry. Apama will become part of the ObjectStore operating unit. The acquisition will be accounted for as a purchase, and accordingly, the results of operations of Apama will be included in the Company’s operating results from the date of acquisition. In addition, the Company is implementing an employee retention program by which payments will be made over the next twelve months to Apama employees, if they meet certain employment criteria. If all retention criteria are met, the Company will be obligated to pay a total of $4 million in retention payments. The purchase price was paid in cash from available funds.

In connection with the purchase of a building adjacent to the Company’s headquarters in November 2004, the Company was required to assume an existing mortgage on the building of $2.4 million. Principal payments on this long-term debt in the first three months of fiscal 2005 totaled approximately $0.1 million.

The Company includes standard intellectual property indemnification provisions in its licensing agreements in the ordinary course of business. Pursuant to the Company’s product license agreements, the Company will indemnify, hold harmless, and agree to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally business partners or customers, in connection with certain patent, copyright or other intellectual property infringement claims by third parties with respect to the Company’s products. Other agreements with the Company’s customers provide indemnification for claims relating to property damage or personal injury resulting from the performance of services by the Company or its subcontractors. Historically, the Company’s costs to defend lawsuits or settle claims relating to such indemnity agreements have been insignificant. Accordingly, the estimated fair value of these indemnification provisions is immaterial.

The Company is subject to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these claims cannot be predicted with certainty, management does not believe that the outcome of any of these legal matters will have a material adverse effect on the Company’s consolidated financial position or results of operations.

The Company believes that existing cash balances together with funds generated from operations will be sufficient to finance the Company’s operations and meet its foreseeable cash requirements (including planned capital expenditures, lease commitments, debt payments, potential cash acquisitions and other long-term obligations) through at least the next twelve months.

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Off-Balance Sheet Arrangements

The Company’s only significant off-balance sheet commitments relate to operating lease obligations. The Company has no “off balance arrangements” within the meaning of Item 303(a)(4) of Regulation S-K. Future annual minimum rental lease payments are detailed in Note 10 of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended November 30, 2004.

New Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board issued SFAS No. 123R, “Share-Based Payment” (SFAS 123R). This Statement is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS 123R requires a company to measure the grant-date fair value of equity awards given to employees in exchange for services and recognize that cost over the period that such services are performed. SFAS 123R is effective for the first interim or annual reporting period that begins a