NIKU CORP - 10-Q Quarterly Report

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:

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

As of November 30, 2004, there were approximately 12,746,306 shares of the registrant’s common stock outstanding.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

The accompanying unaudited condensed consolidated financial statements have been prepared by Niku Corporation (the “Company”) and reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the interim periods presented. Such adjustments are of a normal recurring nature. The condensed consolidated results of operations for the interim periods presented are not necessarily indicative of the results for any future interim period or for the entire fiscal year. Certain information and footnote disclosures normally included in the annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations regarding interim financial statements. The unaudited condensed consolidated financial statements and notes included herein should be read in conjunction with the consolidated financial statements and notes for the fiscal year ended January 31, 2004, included in the Company’s fiscal 2004 Annual Report on Form 10-K.

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

The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and reported consolidated results of operations during the reporting period. Estimates are used for, but not limited to, revenue recognition, allowance for doubtful accounts, depreciation and amortization, taxes, restructuring, accrued liabilities and contingencies. Actual results could differ from those estimates.

The Company derives its revenue principally from licenses of its products, maintenance and support, and delivery of implementation services. The Company offers its products primarily through its direct sales force. The Company also offers its products indirectly through certain channel partners.

Revenue from license fees is recognized in accordance with Statement of Position 97-2, Software Revenue Recognition (SOP 97-2), as amended by SOP 98-9, which permits revenue recognition when (1) persuasive evidence of an arrangement exists, (2) delivery of the product has occurred and no significant obligations of the Company with regard to implementation remain, (3) the fee is fixed or determinable, and (4) collectibility is probable. The Company defines each of the four criteria above as follows:

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

Delivery has occurred. The Company’s software may be either physically or electronically delivered to the customer. Delivery is deemed to have occurred upon meeting one of the following criteria as set forth in the revenue contract: (1) the shipment or electronic delivery of the product, (2) notification of receipt of the product by the customer or (3) notification by the customer of acceptance if required by the terms of the contract. If

undelivered features or services exist in an arrangement which are essential to the functionality of the delivered product, revenue is recognized when these features or services are delivered. If there are sales to channel partners, they are recognized upon sell-through to the end-user customer.

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

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

Revenue from multiple-element software arrangements is recognized using the residual value method. The determination of the fair value of maintenance, support, implementation and hosting services is based on the objective evidence of the fair value of each element that is specific to the Company. The Company’s determination of fair value of each element in multiple-element arrangements is based on vendor-specific objective evidence (VSOE). The VSOE for each element is established when the same element is sold separately. The Company has analyzed and determined that it has sufficient VSOE to allocate revenue to the maintenance and support, implementation, and hosting services components of its perpetual license arrangements. VSOE for maintenance and support is determined based upon the customer’s renewal rates for this element. VSOE for implementation services is determined based upon the engagement labor rates for this element. VSOE for hosting services is determined based upon the rates applicable to the duration of the hosting arrangement, when the same element is sold separately.

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

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

Indemnification and warranty provisions within the Company’s customer license and service agreements are generally consistent with those prevalent in the Company’s industry. The duration of the Company’s product warranties generally does not exceed 90 days following delivery of the Company’s products. The Company has not historically incurred significant obligations under customer indemnification or warranty provisions. Accordingly, the Company does not maintain accruals for potential customer indemnification or warranty-related obligations.

The Company makes estimates of the collectibility of accounts receivable and regularly reviews the adequacy of its allowance for doubtful accounts after considering the amount of the aged accounts receivable, the age of each invoice, each customer’s expected ability to pay, and collection history with each customer. The Company reports charges to the allowance for doubtful accounts as a portion of selling, general and administrative expenses. The Company reviews any invoice greater than 30 days past due to determine if an allowance is appropriate based on the risk category using the factors discussed above. In addition, the Company maintains a reserve for all invoices by applying a percentage to aging categories based on historical loss experience. Assumptions and judgments regarding collectibility of accounts could differ from actual events. As of October 31, 2004, the accounts receivable balance was $13.1 million, net of an allowance for doubtful accounts of $0.4 million. As of January 31, 2004, the accounts receivable balance was $7.8 million, net of an allowance for doubtful accounts of $0.8 million. The decrease in the allowance for doubtful accounts is in part the result of collecting a settlement on a receivable that was specifically reserved. In addition, during the Company’s regular review of its allowance for doubtful accounts, it was determined that the allowance for doubtful accounts should be adjusted downward by $0.2 million during the third quarter of fiscal 2005 to reflect the Company’s actual recent historical loss experience.

At October 31, 2004, options to purchase approximately 52,000 shares of common stock were outstanding that the Company repriced in November 2001 in a manner that gave rise to variable accounting treatment whereby the aggregate intrinsic value of the outstanding repriced options is continuously remeasured and a credit or charge is recorded to stock-based compensation expense each period based on the closing price of the Company’s common stock at the end of the period. The Company recorded a charge of $0.3 million to stock-based compensation expense in the third quarter of fiscal 2005 as a result of this remeasurement.

Stock-based compensation is attributable to repriced options in the following functional groups (in thousands):

In future periods, stock-based compensation related to repriced options will vary based on the number of repriced options outstanding and the Company’s stock price on the financial statement reporting date. As of October 31, 2004, there were repriced options outstanding to purchase approximately 52,000 shares of common stock.

The Company uses the intrinsic-value method to account for all of its employee stock-based compensation plans prescribed by Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees and Financial Accounting Standards Board (“FASB”) Interpretation (“FIN”) No. 44, Accounting for Certain Transactions Involving Stock Compensation. Stock-based compensation is being amortized over the vesting period of the individual award in a manner consistent with the method described in FIN No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Awards Plans. The Company

accounts for equity instruments issued to non-employees in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation and Emerging Issues Task Force (“EITF”) Statement No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.

In December 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure - SFAS No. 123, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. This statement also amends the disclosure requirements of SFAS No. 123 to require more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. During March 2004, the FASB issued an exposure draft of a new standard entitled “Share Based Payment,” which would amend SFAS No. 123, “Accounting for Stock-Based Compensation.” The new accounting standard, as proposed, would require the expensing of stock options issued by the Company in the financial statements using a fair-value-based method and would be effective for periods beginning after June 15, 2005. Depending on the method adopted by the Company to calculate stock-based compensation expense upon the adoption of this standard, the following pro forma disclosure may not be indicative of the stock-based compensation expense to be recognized in periods beginning after June 15, 2005.

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

The fair value of each option is estimated on the date of grant using the Black-Scholes option pricing model, with no expected dividends and the following weighted-average assumptions:

In June 2004, the Emerging Issues Task Force (“EITF”) issued EITF No. 03-01, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments (“EITF 03-01”). EITF 03-01 includes new guidance for evaluating and recording impairment losses on debt and equity investments, as well as new disclosure requirements for investments that are deemed to be temporarily impaired. The accounting guidance of EITF 03-01 was initially effective for reporting periods beginning after June 15, 2004, while the disclosure requirements for debt and equity securities accounted for under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, are effective for annual periods ending after December 15, 2003. In September 2004, the FASB issued a final FASB Staff Position, FSP EITF 03-01-1, that delays the effective date for the measurement and recognition guidance of EITF 03-01. Adoption of EITF 03-01 will not have a material impact on the Company’s consolidated financial position or results of operations.

During March 2004, the FASB issued an exposure draft of a new standard entitled “Share Based Payment,” which would amend SFAS No. 123, “Accounting for Stock-Based Compensation.” The new accounting standard, as proposed, would require the expensing of stock options issued by the Company in its financial statements using a fair-value-based method and would be effective for periods beginning after June 15, 2005. See “Stock-Based Compensation” above for pro forma disclosures regarding the effect on net income (loss) and net income (loss) per share if we had applied the fair value recognition provisions of SFAS No. 123. Depending on the method adopted by the Company to calculate stock-based compensation expense upon the adoption of this standard, the pro forma disclosures above may not be indicative of the stock-based compensation expense to be recognized in periods beginning after June 15, 2005.

The Company recorded restructuring charges in connection with vacating certain leased facilities pursuant to a restructuring program as required under EITF No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in Restructuring). The fair value of costs associated with vacated leased facilities include remaining lease liabilities and brokerage fees, offset by estimated sublease income. Estimated sublease income is determined by taking into consideration the type and condition of the subject property, information regarding the local commercial real estate market and expectations about time to obtain a sublessee determined with input from local commercial real estate brokerages. The Company reviews these estimates in the second and fourth quarter of each fiscal year or anytime it has persuasive evidence that a change in the estimate has occurred. No additional charges were taken during the third quarter of fiscal 2005.

In the second quarter of fiscal 2005, the Company recorded $1.2 million in restructuring charges primarily as a result of the Company’s revised assessment of sublease opportunities for facilities the Company had previously vacated. Due to the availability of competing office space near a partially vacated facility in California, the Company revised its sublease estimate for this facility, which resulted in a restructuring charge of $0.8 million. The Company also determined that it would not be able to sublease the vacated space in both of its vacated and partially vacated New York City facilities as early as originally estimated. The Company therefore revised its sublease estimates for both of these facilities resulting in charges of $0.2 million for each facility for a total charge of $0.4 million.

In the first quarter of fiscal 2005, the Company recorded restructuring charges of $0.6 million. These charges were primarily the result of decreasing market rents for one of the Company’s New York City facilities for which the Company recorded a charge of $0.4 million, and the determination that the Company would not be able to sublease a portion of one of its partially vacated California facilities because of the short remaining term under the lease which expires in June 2005 for which the Company recorded a charge of $0.2 million. If

estimates regarding future sublease income change further, the Company could be required to record additional net lease commitment costs.

The table below represents restructuring activities in the quarter ended October 31, 2004 (in thousands):

The table below represents restructuring activities during the nine months ended October 31, 2004 (in thousands):

The Company expects that of the restructuring charges accrued as of October 31, 2004, other exit costs, primarily related to legal and administrative costs for liquidation of various foreign subsidiaries, will be paid no later than December 2005, and the net lease commitments on vacated leased facilities will be paid no later than February 2011.

As of October 31, 2004, future lease payments, net of estimated sublease income, relating to facilities that the Company vacated pursuant to the restructuring program amount to $2.6 million, $1.5 million, $1.2 million, $1.1 million and $0.9 million for the twelve months ending October 31, 2005, 2006, 2007, 2008 and 2009, respectively, and $1.2 million thereafter. Other restructuring costs accrued as of October 31, 2004 included $0.2 million in legal and accounting fees to dissolve our inactive subsidiaries. These amounts are recorded in accrued

restructuring and long-term accrued restructuring on the Condensed Consolidated Balance Sheets. As of October 31, 2004, estimated sublease income related to these vacated facilities amounts to $1.3 million, $1.4 million, $1.4 million, $1.1 million, and $1.1 million for the twelve months ending October 31, 2005, 2006, 2007, 2008 and 2009, respectively, and $1.3 million thereafter.

Basic net income (loss) per share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per share is computed by dividing net income (loss) by the sum of the weighted-average number of common shares outstanding and the potential number of dilutive common shares outstanding during the period. Potential common shares consist of the shares issuable upon exercise of stock options and shares issuable upon exercise of warrants, using the treasury stock method.

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

The following table sets forth the potential common shares that were excluded from the net income (loss) per share computations because the exercise prices were greater than the average market price of the common shares during the period and were therefore not dilutive (in thousands):

The nine month weighted-average exercise price of anti-dilutive options outstanding as of October 31, 2004 and 2003 that were not included in the above calculation, was $10.34 and $4.02 per share, respectively. There were no anti-dilutive warrants outstanding as of October 31, 2004. The weighted-average exercise price of anti-dilutive warrants as of October 31, 2003 was $4.55 per share.

At January 31, 2004, the Company’s chief executive officer owed the Company $430,000 under the terms of an existing loan. During the first quarter of fiscal year 2005, the loan balance was paid in full, including interest. As of October 31, 2004, there was no outstanding principal or interest owed on this loan.

Comprehensive income (loss) for the three and nine months ended October 31, 2004 and 2003, respectively, includes foreign currency translation adjustments in addition to net income. Tax effects of the “other” components of comprehensive income have not been material. Accumulated other comprehensive income as of October 31, 2004 and January 31, 2004 was $0.4 million and $0.4 million, respectively, and was comprised of accumulated foreign currency translation adjustments.

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

The Company’s operating decisions are made by a committee, which is comprised of the Chief Executive Officer and the Chief Financial Officer. The Chief Executive Officer and the Chief Financial Officer review financial information presented on a consolidated basis for purposes of making operating decisions and assessing financial performance. The Company operates in a single reporting segment, specifically, the license, implementation and support of its software.

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

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

There were no customers individually representing 10% or more of accounts receivable as of October 31, 2004 and 2003, respectively. There were no customers individually representing 10% or more of total revenue for the three and nine months ended October 31, 2004. There was one customer representing more than 20% and nearly 10% of total revenue in the three and nine months ended October 31, 2003, respectively.

The Company had no borrowings under its bank line of credit as of October 31, 2004. The history and terms of the line of credit are as follows: on July 18, 2003, the Company entered into a $5.0 million line of credit with a financial institution. The line of credit is secured by the Company’s tangible and intangible assets and accrues interest at prime rate plus 0.50% per annum (5.25% as of October 31, 2004). In July 2004, the line of credit was extended through August 2005 and certain financial covenants were amended. These amended covenants require (1) minimum cash and cash equivalent balances equal to at least 1.25 times the outstanding principal balance at each month end, (2) that the Company has no line of credit balance owing under the agreement for at least 30 days each calendar year, and (3) annual profitability determined in accordance with generally accepted accounting principles in the United States of America (“US GAAP”) of at least $1 (excluding restructuring charges for vacated facilities and stock-based compensation). As of October 31, 2004, the Company was in compliance with all financial covenants.

In August 2003, the Company entered into a non-cancelable master lease agreement with a computer equipment vendor. The agreement enables the Company to lease equipment from the vendor under a capital lease. At October 31, 2004, obligations for equipment held under the lease were approximately $0.6 million.

Interest expense was $15,000 and $3,000 during the three-month periods ended October 31, 2004 and 2003, respectively. Interest expense was $45,000 and $141,000 during the nine-month periods ended October 31, 2004 and 2003, respectively.

The Company uses forward exchange contracts primarily to hedge foreign currency exposure. In general, the forward foreign exchange contracts have terms of six months or less. Gains and losses on the settled contracts are included in “Interest and other income (expense), net” in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). As of October 31, 2004, the Company had no forward contracts outstanding.

they failed to disclose that the managing underwriters allegedly (i) solicited and received commissions from certain investors in exchange for allocating to them shares of Company stock in connection with the IPO and (ii) entered into agreements with their customers to allocate such stock to those customers in exchange for the customers agreeing to purchase additional shares of the Company in the aftermarket at pre-determined prices. The Company believes that the claims asserted against it in these cases are without merit. On August 8, 2001 the Court ordered that these actions, along with hundreds of IPO allocation cases against other issuers, underwriters and directors and officers, be transferred to one judge for coordinated pre-trial proceedings. In July 2002, omnibus motions to dismiss the complaints based on common legal issues were filed on behalf of all issuers, underwriters and directors and officers. By order dated October 8, 2002, the Court dismissed the Company’s officers and directors from the case without prejudice. In an opinion issued on February 19, 2003, the Court granted in part and denied in part the motions to dismiss. The complaints against the Company and the other issuers and underwriters were not dismissed as a matter of law. The plaintiffs and the issuer defendants (along with the individual officer and director defendants of such issuers) have agreed to settle the cases. In June 2004, final settlement papers were executed, submitted to the Court, and the parties are awaiting approval by the Court. No amount is accrued as of October 31, 2004 as a loss in this matter is not considered probable.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes contained herein and the information contained in our Annual Report on Form 10-K for the fiscal year ended January 31, 2004 and in our other filings with the Securities and Exchange Commission.

This discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act. Words such as “expects,” “anticipates,” “intends,” “could,” “may,” “believes” or “estimates” or similar language identify forward-looking statements, as do the negative of these terms and other comparable terminology, including, but not limited to, the following:

These forward-looking statements involve known and unknown risks and uncertainties. Our actual results may differ materially from those contemplated by the forward-looking statements. Factors that might cause or contribute to these differences include, but are not limited to, those discussed in the section of this report entitled “Factors That May Affect Future Results”, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and sections in other documents filed with the SEC under similar captions. You should consider the risk factors and uncertainties under the caption “Factors That May Affect Future Results,” among other things, in evaluating our prospects and future financial performance. These forward-looking statements are made as of the date of this report. We disclaim any obligation to update or alter these forward-looking statements in this report or such other document in which they are found, whether as a result of new information, future events or otherwise, or any obligation to explain the reasons why actual results may differ.

We provide IT management and governance (IT-MG) software for large enterprises. Our core product, Clarity, centralizes IT oversight and governance functions while permitting distributed management of IT activities. At a strategic level, customers deploy our solutions to align IT initiatives with business priorities, control IT costs and meet increased compliance requirements. At a tactical level, customers use our products to achieve more efficient use of IT resources and deliver controlled and predictable execution of projects, programs and initiatives.

We were incorporated in Delaware in January 1998. Our principal executive offices are located at 305 Main Street, Redwood City, CA 94063, and our telephone number is (650) 298-4600. Our website is http://www.niku.com. The information on our website does not constitute part of this report.

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

In the third quarter of fiscal 2005, license revenue, total revenue and net income increased compared to the third quarter of fiscal 2004. License revenue increased 22% to $7.4 million, total revenue increased 32% to $16.6 million and net income increased 207% to $1.4 million in the third quarter of fiscal 2005 compared to the third quarter of fiscal 2004. During the nine months ended October 31, 2004, license revenue, total revenue and net income also increased compared to the same period last year. License revenue increased 69% to $20.9 million, total revenue increased 43% to $46.3 million and net income increased 315% to $2.4 million in the nine months ended October 31, 2004 compared to the nine months ended October 31, 2003. We believe these increases were the result of our increasing presence and leadership in the IT-Management and Governance market. We will continue to invest in our direct sales resources and to build our indirect channels to broaden our distribution capabilities.

In September 2004, we held our first Global User Conference since 2000. Over 300 customers and partners attended this three day event.

During the nine months ended October 31, 2004, our unrestricted cash and cash equivalents balance increased by $1.4 million to $24.6 million as a result of higher earnings and continuing strong collections during the period. Our accounts receivable balance at the end of the third quarter of fiscal 2005 increased $6.7 million to $13.1 million compared to $6.4 million at the end of the third quarter of fiscal 2004. Our days sales outstanding, which represents the average number of days that passed before we collected payment from our customers, was 71 days at the end of the third quarter of fiscal 2005 compared to 46 days at the end of the third quarter of fiscal 2004. The increase in days sales outstanding was mainly due to an increasing number of license transactions and a greater percentage of license transactions occurring late in the quarter compared to the prior period.

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires us to utilize accounting policies and make estimates and assumptions that affect our reported results. Accounting policies, methods and estimates are an integral part of the consolidated financial statements prepared by management and are based upon management’s current judgments. Those judgments are normally based on knowledge and experience with regard to past and current events and assumptions about future events. Certain accounting policies, methods and estimates are particularly sensitive because of their significance to the financial statements and because of the possibility that future events affecting them may differ markedly from management’s current judgments. While there are a number of accounting policies, methods and estimates affecting our financial statements, our critical accounting policies include:

Our management has reviewed our critical accounting policies, our critical accounting estimates, and the related disclosures with our Disclosure and Audit Committees. These policies and our procedures related to these policies are described further in our Annual Report on Form 10-K for the year ended January 31, 2004 in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” under the heading “Critical Accounting Policies, Methods and Estimates.”

We had no significant change to our critical accounting policies and estimates since our previous filing on Form 10K, as filed with the SEC on April 14, 2004.

The following table sets forth, for the periods indicated, selected consolidated financial data as a percentage of total revenue:

The following table sets forth, for the periods indicated, our revenue (in thousands, except percentages):

License. License revenue consists of revenue from licenses of our software products. License revenue accounted for 45% and 48% of total revenue for the three-month periods ended October 31, 2004 and 2003, respectively. License revenue increased by 22% or $1.4 million to $7.4 million in the third quarter of fiscal 2005 compared to the third quarter of fiscal 2004. This increase was the result of a greater number of transactions and an increase in the average transaction size, excluding one large multi-million dollar transaction in the third quarter of fiscal 2004. License revenue accounted for 45% and 38% of total revenue for the nine-month periods ended October 31, 2004 and 2003, respectively. License revenue increased by 69% or $8.5 million to $20.9 million in the nine months ended October 31, 2004 compared to the nine months ended October 31, 2003. This increase was the result of a greater number of transactions and an increase in the average transaction size, excluding the same large multi-million dollar transaction in the nine months ended October 31, 2003.

Disaggregated revenue information is as follows (in thousands, except percentages):

Maintenance and Support. Maintenance and support revenue consists of revenue from maintenance and support contracts. Maintenance and support revenue increased by 13% or $0.5 million to $4.3 million in the third quarter of fiscal 2005 compared to the third quarter of fiscal 2004. Maintenance and support revenue increased by 7% or $0.8 million to $12.8 million in the nine months ended October 31, 2004 compared to the nine months ended October 31, 2003. The increase in maintenance and support revenue for both the third quarter and nine months ended October 31, 2004 compared to the same periods last year is a direct result of new licenses and more customer renewals.

Implementation Services. Implementation services revenue consists of revenue from the delivery of implementation services. Implementation services revenue increased by 81% or $2.2 million to $4.8 million in the third quarter of fiscal 2005 compared to the third quarter of fiscal 2004. Implementation services revenue increased by 56% or $4.5 million to $12.6 million in the nine months ended October 31, 2004 compared to the nine months ended October 31, 2003. The growth in implementation services for both the third quarter and nine months ended October 31, 2004 compared to the same periods last year is a direct result of an increase in new license transactions and customers requesting implementation services. In addition, implementation services revenue increased as a result of additional users being implemented at existing customers.

The following table sets forth, for the periods indicated, our cost of revenue (in thousands, except percentages):

Cost of License Revenue. Cost of license revenue consists of royalties payable to third parties for software that is either embedded in or bundled with our software products, new product packaging, documentation, and shipping costs. Cost of license revenue increased 16% in the third quarter of fiscal 2005 compared to the third quarter of fiscal 2004, primarily due to an increase in license revenue. Cost of license revenue increased 140% in the nine months ended October 31, 2004 as compared to the nine months ended October 31, 2003, primarily due to the 69% increase in license revenue, partially offset by a reversal of $0.1 million of accrued royalty during the nine months ended October 31, 2003.

Cost of Maintenance Revenue. Cost of maintenance revenue consists of personnel-related expenses for our maintenance and support services to our customers and an allocation of overhead costs for information technology and facilities. Cost of maintenance increased 25% or $0.1 million to $0.7 million in the third quarter of fiscal 2005 compared to the third quarter of fiscal 2004 primarily due to an increase in compensation expenses

relating to an increase in headcount. Cost of maintenance increased 27% or $0.4 million to $2.0 million in the nine months ended October 31, 2004 compared to the nine months ended October 31, 2003 primarily due to an increase in compensation expenses related to an increase in headcount.

Cost of Implementation Services Revenue. Cost of implementation services revenue consists of personnel-related expenses and the costs of third parties contracted to provide implementation services to our customers and an allocation of overhead costs for information technology and facilities. Cost of implementation services increased 47% or $1.2 million to $3.7 million in the third quarter of fiscal 2005 compared to the third quarter of fiscal 2004 primarily due to an increase of $0.8 million in services from third party contractors for our implementation services and an increase of $0.3 million in compensation expenses relating to an increase in headcount. Cost of implementation services increased 38% or $2.6 million to $9.6 million in the nine months ended October 31, 2004 compared to the nine months ended October 31, 2003 primarily due to an increase of $1.5 million in services from third party contractors for our implementation services, an increase of $0.7 million in compensation expenses due to an increase in headcount and a $0.2 million increase in personnel bonuses.

The following table sets forth, for the periods indicated, our operating expenses (in thousands, except percentages):

Sales and Marketing. Sales and marketing expenses consist primarily of personnel-related costs including salaries, benefits, bonuses and commissions; travel; marketing programs including customer conferences, promotional materials, trade shows and advertising; and bad debt allowances. Sales and marketing expenses increased 33% or $1.6 million in the third quarter of fiscal 2005 as compared to the third quarter of fiscal 2004. This increase includes $0.5 million in increased commissions on higher license revenue levels, $0.5 million in headcount and salary increases, $0.4 million in increased travel and $0.2 million in increased marketing activities. As a part of our regular review of our bad debt allowance, we determined that the allowance for bad debt should be adjusted downward to reflect our actual recent historical loss experience. Accordingly, we reversed $0.2 million of the bad debt allowance in the third quarter of fiscal 2005. Sales and marketing expenses increased 49% or $5.8 million in the nine months ended October 31, 2004 as compared to the nine months ended October 31, 2003. This increase includes $2.2 million in increased commissions on higher license revenue levels, $1.7 million in headcount additions, $0.8 million in increased travel, $0.7 million in increased marketing activities and $0.4 million in increased reseller fees and translation costs. Sales and marketing expense is likely to continue to increase in future periods as we continue to build out our sales and marketing infrastructure.

Research and Development. Research and development expenses consist primarily of personnel-related costs associated with the development of new products, the enhancement of existing products and quality assurance and testing costs. Research and development expenses increased 9% or $0.2 million in the third quarter of fiscal 2005 as compared with the third quarter of fiscal 2004. Research and development expenses increased 6% or $0.3 million in the nine months ended October 31, 2004 as compared with the nine months ended October 31, 2003. The increase for both the three and nine months ended October 31, 2004 was primarily due to salary and bonus increases related to headcount additions partially offset by a decrease in depreciation of $0.1 million for the nine month period ended October 31, 2004 due to assets becoming fully depreciated.

General and Administrative. General and administrative expenses consist primarily of personnel-related costs and other related costs for finance, human resources, information technology and legal department employees, professional services fees, and other general corporate expenses. General and administrative expenses increased by 1% in the third quarter of fiscal 2005 as compared with the third quarter of fiscal 2004. Although headcount increased from the prior period and we had expenses relating to Sarbanes-Oxley compliance during the third quarter of fiscal 2005, a reduction in facilities expense and depreciation charges offset these increases. During the third quarter of fiscal 2005, we did not record bonus expense due to management’s conclusion that bonuses had been adequately accrued for as of October 31, 2004. General and administrative expenses increased by 21% or $1.0 million in the nine months ended October 31, 2004 as compared with the nine months ended October 31, 2003 primarily due to $0.8 million in services related to Sarbanes-Oxley compliance and $0.2 million related to a corporate bonus plan initiated this year. We experienced a decrease in general and administrative expenses in the third quarter of fiscal 2005 compared to each of the first two quarters as our expenses of complying with Sarbanes-Oxley decreased in the third quarter of fiscal 2005, as we near completion of our assessment of our internal controls over financial reporting.

Restructuring. In the three months ended October 31, 2004, we did not need to record any restructuring charges. Total restructuring charges for the nine months ended October 31, 2004 were $1.8 million related to estimate revisions of sublease income for our vacated or partially vacated facilities. Our policy is to review our sublease estimates in the second and fourth quarters of the fiscal year unless we receive evidence that a material change has occurred. The revisions to the estimates resulted from the fact that we will not realize the sublease opportunities as early as originally estimated. Due to the availability of competing office space near a partially vacated facility in California, we revised our sublease estimate for this facility, which resulted in an additional restructuring charge of $0.8 million in the second quarter of fiscal 2005. We also determined that we would not be able to sublease the vacated space in our partially vacated New York City facility as early as originally estimated. We revised the sublease estimate for this facility resulting in a charge of $0.2 million and we revised the sublease estimate for our subleased facility in New York City resulting in a charge of $0.2 million for a total charge of $0.4 million in the second quarter of fiscal 2005. In addition to the charges taken in the second quarter, we recorded restructuring charges of $0.6 million in the first quarter of fiscal 2005. These charges were the result of decreasing market rents for our partially vacated New York City facility for which we recorded a charge of $0.4 million, and the determination that we would not be able to sublease a partially vacated California facility because of the short remaining term under the lease which expires in June 2005, for which we recorded a charge of $0.2 million. At the end of the second quarter of fiscal 2005, we had two partially vacated facilities for which we were seeking sublease tenants. In November 2004, we executed a sublease for a portion of the partially vacated facility in California for which we have received the landlords required consent. In addition, we are currently in negotiations with a potential sublease tenant for our partially vacated facility in New York City. If the agreement for the New York City facility is finalized, we will have the remaining portion of the partially vacated facility in California to sublease. Also, the current sublease for our vacated New York City facility will expire in April 2005. Unless the current sublease tenant renews for an additional term, we will have to remarket the facility. If estimates regarding future sublease income change further, we could be required to record additional net lease commitment costs.

Stock-based Compensation. We continue to incur stock-based compensation for outstanding stock options that were repriced in November 2001 to the extent that the price of our common stock on the last day of a quarter exceeds the price at which the options were repriced. Based on the stock price of $14.60 as of October 31, 2004, we recorded approximately $0.3 million of stock-based compensation expense in the third quarter of fiscal 2005 relating to repriced options to purchase approximately 52,000 shares of common stock. This was the direct result of our stock price increasing from $9.29 at the end of the second quarter to $14.60 at the end of the third quarter. Stock-based compensation expense for the nine months ended October 31, 2004 was $0.3 million. Stock-based compensation expense for the three and nine months ended October 31, 2003 was $0.1 million and $0.2 million, respectively. The stock-based compensation for the three and nine months ended October 31, 2003 related to the amortization of stock options granted to our chief executive officer that were repriced in October 2002 and the amortization of stock options granted below fair market value prior to our initial public offering in February 2000.

The following table sets forth the amortization of stock-based compensation for the following functional groups in the accompanying Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) (in thousands):

The following table sets forth our interest and other income (expense), net for the periods indicated, (in thousands):

Interest and other income (expense), net, consists of interest income, interest expense and other non-operating income and expenses consisting primarily of foreign exchange gains and losses. The increase during the three and nine months ended October 31, 2004 compared to the same periods last year is primarily due to a decrease in foreign exchange losses incurred as a result of the revaluation of our intercompany balances. Foreign exchange gains were $55,000 and $76,000 for the three months ended October 31, 2004 and 2003, respectively. Foreign exchange losses were $66,000 and $198,000 for the nine months ended October 31, 2004 and 2003, respectively. Additionally, the increases were the result of increased interest earnings on higher cash balances and reduced interest expense on lower debt balances compared to the prior periods.

The provision for income taxes increased 522% from $32,000 for the third quarter of fiscal 2004 to $199,000 for the third quarter of fiscal 2005. The provision increased 310% from $91,000 for the nine months ended October 31, 2003 to $373,000 for the nine months ended October 31, 2004. The increase in both of these periods is attributable to profitability being achieved in fiscal 2005, compared to losses in fiscal 2004, resulting in increased foreign income taxes and corporate minimum taxes in the United States which cannot be offset by our net operating loss carryforwards. Additionally, we had increased sales to foreign locations requiring foreign withholding taxes.

The following table sets forth, as of the periods indicated, our cash and cash equivalents, working capital and stockholders’ equity (in thousands, except percentages):

Since inception, we have financed our operations through private and public sales of our capital stock, bank loans, equipment leases, and our business activities including licensing our software, providing related implementation services and maintenance fees. The cash from these sources is used for working capital and capital expenditures for our business. As of October 31, 2004, we had cash and cash equivalents of $24.6 million. We also maintained restricted cash in the amount of $1.0 million in the form of a certificate of deposit securing a letter of credit for a leased facility. As of October 31, 2004, we had no bank borrowings under our revolving credit facility. As of October 31, 2004, we had working capital of $16.6 million, compared to working capital of $10.5 million as of January 31, 2004. The increase in working capital as of October 31, 2004 is primarily attributable to positive operating cash flows driven by an increase in sales as well as proceeds from stock option and warrant exercises. As of October 31, 2004, we had no material commitments for capital expenditures. Our liquidity could be negatively impacted by factors discussed under “Factors That May Impact Future Operating Results.”

Net cash provided by operating activities was $3.2 million during the nine months ended October 31, 2004. The principal sources of cash generated by operating activities in fiscal 2005 was net income from our business of $2.4 million, adjusted for non-cash expenses of $2.7 million related primarily to restructuring expenses of $1.8 million, depreciation of $0.7 million, amortization of stock based compensation of $0.3 million and an offsetting decrease in the bad debt allowance of $0.1 million. Our cash flows were also favorably impacted by an increase in accounts payable and accrued liabilities of $4.5 million related to increases for outside services of $2.5 million, taxes payable of $0.9 million, accounting and legal fees of $0.4 million, employee related cost of $0.4 million and Sarbanes-Oxley compliance services of $0.3 million and a decrease in prepaid and other assets of $0.7 million. These activities were offset by an increase in accounts receivable of $5.1 million primarily due to an increase in license transactions in the last month of the quarter ended October 31, 2004, a decrease in accrued restructuring of $1.3 million representing payments made on vacated facilities and a decrease in deferred revenue of $0.6 million due to the cyclical nature of maintenance renewals whereby more renewals occur closer to our fiscal year ending January 31.

Net cash used in operating activities was $5.2 million during the nine months ended October 31, 2003. The primary uses of cash during this period were the net loss of $1.1 million, adjusted for non-cash expenses of $2.1 million related to depreciation of $1.2 million, bad debt expense of $0.4 million, amortization of deferred stock compensation of $0.2 million, and restructuring expense of $0.3 million, a reduction of accounts payable balances of $1.3 million, a decrease in accrued restructuring of $3.4 million attributable to payments for vacated facilities as well as lease termination fees, a decrease in deferred revenue of $2.2 million due to the cyclical nature of maintenance renewals whereby more renewals occur closer to our fiscal year end and an increase in prepaid expenses of $0.4 million primarily for directors and officers and business insurance renewals and prepaid rent. These uses of cash were offset by a decrease in accounts receivable of $0.4 million and an increase in accrued liabilities of $0.4 million.

Net cash provided by investing activities was $0.6 million and $0.4 million in the nine months ended October 31, 2004 and 2003, respectively. Net cash provided by investing activities in the nine months ended October 31, 2004 was primarily due to proceeds of $0.4 million received from the repayment of a loan by our chief executive officer and a release of investments of restricted cash for $0.1 million. Net cash provided by investing activities in the nine months ended October 31, 2003 was primarily due to a release of investments of restricted cash and a decrease in deposits and other assets as a result of receiving proceeds from the repayment of a loan from our chief executive officer.

Net cash used in financing activities was $2.5 million for the nine months ended October 31, 2004. Net cash provided by financing activities was $9.8 million for the nine months ended October 31, 2003. The principal use of cash in financing activities during the nine months ended October 31, 2004 was for repayment on our bank line of credit for $4.3 million and repayment of our capital lease obligations for $0.2 million offset by proceeds from the issuance of common stock upon exercise of stock options and warrants for $2.0 million. The principal sources of cash generated from financing activities during the nine months ended October 31, 2003 was net

proceeds from the issuance of common stock and warrants in connection with our private placement for $10.2 million and proceeds from a bank line of credit for $4.3 million, offset by repayment of a bank term loan for $4.8 million.

We had no outstanding borrowings under our bank line of credit as of October 31, 2004. The history and terms of this credit facility are as follows: on July 18, 2003, we entered into a $5.0 million line of credit with a financial institution. The line of credit is secured by our tangible and intangible assets and accrues interest at the prime rate plus 0.50% per annum (5.25% as of October 31, 2004). In July 2004, the line of credit was extended through August 2005 and certain financial covenants were amended. These amended covenants require: (1) minimum cash and cash equivalent balances equal to at least 1.25 times the outstanding principal balance at each month end, (2) that we have no line of credit balance owing under the agreement for at least 30 days each calendar year, and (3) annual profitability determined in accordance with US GAAP of at least $1 (excluding restructuring charges for vacated facilities and stock-based compensation). As of October 31, 2004, we were in compliance with all financial covenants.

In November 2004, we filed a “shelf” registration statement on Form S-3. Under this shelf process, we may sell common stock, preferred stock, debt securities and warrants for debt and equity securities, and the selling stockholders identified in the registration statement may sell common stock that is currently outstanding, from time to time in one or more offerings up to an aggregate public offering price of $100,000,000. We will not receive any of the proceeds from the sale of our common stock by the selling stockholders. We anticipate that the net proceeds from the sale of the securities that we may offer under this process will be used for general corporate purposes. In addition, we may use a portion of any net proceeds from the securities offered by us to acquire complementary products, technologies or businesses. We will have significant discretion in the use of any net proceeds.

In August 2003, we entered into a non-cancelable master lease agreement with a computer equipment vendor. The agreement enables us to lease equipment from the vendor under a capital lease. At October 31, 2004, obligations for equipment held under the lease were approximately $0.6 million.

We believe that cash flows from operations together with existing cash and cash equivalents will be sufficient to meet our current expectations for working capital and capital expenditure requirements for at least the next twelve months based on, among other things, our current revenue and expense projections.

We do not use off-balance-sheet arrangements with unconsolidated entities or related parties. Accordingly, our liquidity and capital resources are not subject to off-balance-sheet risks from unconsolidated entities. As of October 31, 2004, we did not have any off-balance-sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

The following table summarizes our contractual obligations at October 31, 2004 and the effect these contractual obligations are expected to have on our liquidity and cash flows in future periods (in thousands):

In June 2004, the Emerging Issues Task Force (“EITF”) issued EITF No. 03-01, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments (“EITF 03-01”). EITF 03-01 includes new guidance for evaluating and recording impairment losses on debt and equity investments, as well as new disclosure requirements for investments that are deemed to be temporarily impaired. The accounting guidance of EITF 03-01 was initially effective for reporting periods beginning after June 15, 2004, while the disclosure requirements for debt and equity securities accounted for under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, are effective for annual periods ending after December 15, 2003. In September 2004, the FASB issued a final FASB Staff Position, FSP EITF 03-01-1, that delays the effective date for the measurement and recognition guidance of EITF 03-01. Adoption of EITF 03-01 will not have a material impact on our consolidated financial position or results of operations.

During March 2004, the FASB issued an exposure draft of a new standard entitled “Share Based Payment,” which would amend SFAS No. 123, “Accounting for Stock-Based Compensation.” The new accounting standard, as proposed, would require the expensing of stock options issued by us in the financial statements using a fair-value-based method and would be effective for periods beginning after June 15, 2005. See “Stock-Based Compensation” in Note 1 for pro forma disclosures regarding the effect on net income (loss) and net income (loss) per share if we had applied the fair value recognition provisions of SFAS No. 123. Depending on the method adopted by us to calculate stock-based compensation expense upon the adoption of Share Based Payment, the pro forma disclosures in Note 1 may not be indicative of the stock-based compensation expense to be recognized in periods beginning after June 15, 2005.

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

Until fiscal 2004, we experienced losses each year since inception, and we could experience losses in the future.

We were incorporated in January 1998. Until fiscal 2004, our first profitable year, we experienced losses each year since inception. Although our financial results improved substantially in fiscal 2004 and 2005, these improvements may not continue, and we may incur losses in the future. Additional losses would materially and adversely affect our business, including our ability to make the investments necessary to execute on our business plan.

Our quarterly financial results have fluctuated significantly in the past, and may fluctuate significantly in the future.

Our quarterly operating results have fluctuated significantly in the past and may continue to fluctuate in the future. Our quarterly operating results are likely to be particularly affected by the number of customers licensing our products during any quarter and the size of such licensing transactions. We have limited visibility into our future revenue, especially license revenue, which often has been heavily concentrated in the third month of each quarter. Since we forecast our expenses and develop our hiring plans based in part on future revenue projections, our operating results would be adversely affected if we cannot meet those revenue projections.

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

The failure of the IT-MG market to grow rapidly would impede our ability to meet our growth objectives.

Our ability to grow is constrained by the pace at which enterprises adopt IT management and governance as a category requiring sustained investment. Because we operate in a relatively new market, it takes time and effort to educate potential customers with regard to the benefits of our products and services. We cannot be certain that a viable market for our products will emerge or be sustainable. If the IT-MG market fails to develop, or develops

more slowly than expected, demand for our products would be less than anticipated and our business and operating results would be seriously harmed.

Our market is highly competitive which could make it difficult for us to attract customers, cause us to reduce prices, and result in poor operating results.

The market for our products and services is competitive, dynamic and subject to frequent technological changes. We expect the intensity of competition and the pace of change to increase in the future. Our products compete with products of varying functionality offered by competing software vendors and products that have been developed by potential customers’ in-house development organizations. The primary competitive factors include product functionality, scalability, security, platform support for other enterprise requirements, ease of deployment, ease of use, price, and worldwide sales, support and professional services capabilities. Some of our competitors include:

We may not be able to maintain our competitive position against current or potential competitors, especially those with significantly greater financial, marketing, service, support, technical and other resources. Competitors with greater resources may be able to undertake more extensive marketing campaigns, conduct broader sales distribution, adopt more aggressive pricing policies, offer a broader range of products and make more attractive offers to potential employees, distributors, resellers or other strategic partners. We expect additional competition from other established and emerging companies as the market for our products and services continues to develop.

We experience seasonality in our sales, which could cause our quarterly operating results to fluctuate from quarter to quarter.

We experience seasonality in the licensing of our products and sales of our services. For example, revenue has typically been lower in our first fiscal quarter due to patterns in the capital budgeting and purchasing cycles of our current and prospective customers. For the same reasons, we also expect that revenues in European markets may decline during July, the last month of our second fiscal quarter, and August, the first month of our third fiscal quarter. These seasonal variations in our revenue are likely to lead to fluctuations in our quarterly operating results.

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

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

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

Implementation of products as complex as those we offer may be costly and time-consuming. Customers could become dissatisfied with our products if implementation requires more time, expense or resources than they expected. Additionally, our financial results would be adversely impacted if, for customer satisfaction and reputation reasons, we do not bill our customers for time and expenses we incur in connection with these implementation issues. As part of the implementation, our products must integrate with many of our customers’ existing computer systems and software programs. Integrating with a number of computer systems and software programs can be time consuming and expensive and could lead to customer dissatisfaction and increased expenses. In the event that customers become dissatisfied with this process, our reputation may be harmed and the acceptance of our products by the market may decrease. It is difficult and expensive to recruit, train and retain qualified personnel to perform implementation services, and we may from time to time have inadequate levels of staffing to perform these services. As a result, our growth could be limited due to our lack of capacity to provide those services, or we could experience deterioration in service levels or decreased customer satisfaction, any of which would harm our business.

Our products may contain undetected defects and errors which could result in loss of or delay in revenue, failure to achieve market acceptance, or increased costs and other liabilities.

Products as complex as those we offer may contain undetected defects or errors. Despite internal testing and testing by our customers or potential customers, defects or errors may occur in our existing or future products. Such errors could result in additional development costs, diversion of technical and other resources from our other development efforts, or the loss of credibility with our current and prospective customers. In the future, if we are not able to detect and correct errors prior to release, we may experience a loss of or delay in revenue, failure to achieve market acceptance and increased costs to correct errors, any of which could adversely affect our operating results.

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

We must attract and retain qualified personnel, which is particularly difficult for us because we compete with other technology-related companies and are located in the San Francisco Bay area, where there is intense competition for personnel.

Our success depends on our ability to attract and retain qualified, experienced employees. We compete for experienced engineering, sales and consulting personnel with software vendors and other technology firms and consulting and professional services companies. It is particularly difficult to recruit and retain personnel in the San Francisco Bay area, where our headquarters is located. Although we provide compensation packages that include stock options, cash incentives and other employee benefits, we may not be able to attract, assimilate and retain highly qualified employees in the future.

The success of our business depends on the efforts and abilities of our senior management and other key personnel.

We depend on the continued services and performance of our senior management and other key personnel. Although we recently entered into a one year employment agreement with our Chief Executive Officer, we do

not have long term employment agreements with any of our key personnel. The loss of any of our executive officers or other key employees could hurt our business and result in significant disruption to our ongoing operations.

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

International revenue represented 38% of our total revenue for the first nine months of fiscal 2005, making international activities a significant part of our business. Accordingly, we are exposed to risks that we would not face if we conducted our operations only in the United States. These include:

Because we rely on sales of one product suite, Clarity, which accounts for substantially all of our revenue, if this product loses market acceptance our financial condition and results of operations will suffer.

Revenues from licenses of, and services related to, Clarity accounted for substantially all of our total revenue in fiscal 2004 and in the nine months ended October 31, 2004. We believe that revenue generated from Clarity will continue to account for a large portion of our revenue for the foreseeable future. A decline in the price of Clarity, or our inability to increase license sales of Clarity, would harm our business and operating results more seriously than it would if we had several different products and services to sell. In addition, our future financial performance will depend upon successfully developing and selling enhanced versions of Clarity, such as Clarity 7.5, which we expect to release in December 2004 and is subject to customer acceptance.

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

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

Additionally, we design our products to work with databases such as Oracle Database Server and Microsoft SQL Server, operating systems such as Sun Solaris, Microsoft Windows, HP UX, IBM AIX and application servers such as IronFlare Orion, BEA WebLogic, and IBM WebSphere. Any changes to those products or

increasing popularity of other products might require us to modify one or both of our products or services and could cause us to delay releasing future products and enhancements. As a result, the timing and nature of new product introductions or product modifications, and increases and decreases in the market acceptance of these products, could delay our product development, increase our research and development expenses and cause customers to delay evaluation, purchase and deployment of our products, all of which could adversely affect our operating results.

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

We regard substantial elements of our products as proprietary and the steps we take to protect our intellectual property may be inadequate, time-consuming, and expensive. These steps, however, may be unable to prevent third parties from infringing upon or misappropriating our intellectual property, which could significantly harm our business and our ability to compete. For example, notwithstanding the security systems in place in 2002, Business Engine Corporation (Business Engine), a competitor, entered our network and misappropriated sales and development documents. As a result of this intrusion, we pursued litigation against Business Engine and the Department of Justice filed criminal charges against the then chief technology officer of Business Engine. While the former Business Engine chief technology officer pled guilty in the criminal action and the civil litigation resulted in the payment to us by Business Engine of $5 million in fiscal 2003 and an agreement by Business Engine to have its products monitored by a third party for a year, it also required us to devote management time and expense to prosecute the litigation against Business Engine.

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

Our standard product licenses provide that we agree to indemnify our customers against claims that our products infringe upon the intellectual property rights of others. There have been an increasing number of software patents issued, and this increased issuance rate heightens the likelihood of infringement claims. These claims, even if not meritorious, could be expensive and divert management’s attention from operating our business. We could incur substantial costs in defending ourselves and our customers against infringement claims. From time to time, in the past we have and in the future we expect to receive notices of potential infringement from third parties demanding that we cease any infringement and inviting us to take a license in order to continue marketing our products. If we become liable to third parties for infringement of their intellectual property rights, we could be required to pay a substantial damage award and to develop non-infringing technology, obtain one or more licenses for us and our customers from third parties, or cease selling the products that contain the infringing intellectual property. We may be unable to develop non-infringing technology or obtain a license at a reasonable cost, or at all. If any of the foregoing were to occur, there would be significant harm to our business.

We have filed for three copyright registrations. Although registration is not required to obtain protection under copyright laws, if our registration applications are rejected, or we fail to register copyrights for some of our products or do not file in a timely manner, it may limit our ability to seek certain remedies available under such laws. Currently, we have one issued patent and two other patent applications pending. Our current patent and patents that may be issued in the future may not provide us with competitive advantages over, or may be challenged by, third parties. We received U.S. registration of the trademarks Niku, the Niku logo, and Do What Matters. These registrations may not provide us with significant protection for our trademarks.

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

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

If we are unable to reach a favorable conclusion after assessing the effectiveness of our internal control over financial reporting, or if our independent auditors are unable to provide an unqualified attestation report, our stock price could be adversely affected.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 and beginning with our Annual Report on Form 10-K for the year ending January 31, 2005, our management will be required to report on, and our independent auditors to attest to, the effectiveness of our internal controls over financial reporting as of January 31, 2005. The rules governing the standards that must be met for management to assess our internal controls over financial reporting are new and complex, and require significant documentation, testing and possible remediation. We are currently in the process of reviewing, documenting and testing our internal controls over financial reporting, which has and will likely continue to result in increased expenses and the devotion of significant management and other internal resources. We may encounter unforeseen problems or delays in completing the implementation of any changes necessary to make a favorable assessment of our internal controls over financial reporting and any requested improvements necessary to receive a favorable attestation. If we cannot favorably assess the effectiveness of our internal controls over financial reporting, or if our independent auditors are unable to provide an unqualified attestation report on our assessment, investor confidence and our stock price could be adversely affected.

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

Provisions of Delaware law and our certificate of incorporation and bylaws could have the effect of delaying or preventing a change in control, even if a change in control presumably would be beneficial to our stockholders. Relevant provisions include those:

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

Sales of a significant volume of stock by certain stockholders that have not entered into lock-up agreements could cause our stock price to decline.

We cannot predict what effect, if any, future sales of our common stock, or the availability of common stock for future sale, will have on the market price of our common stock. Sales of substantial amounts of our common stock in the public market, or the perception that such sales could occur, could adversely affect the market price of our common stock and may make it more difficult for you to sell your common stock at a time and price which you deem appropriate.

The issuance of preferred stock could adversely affect the rights of holders of our common stock.

We are authorized, subject to limitations imposed by Delaware law, to issue preferred stock in one or more series, to establish from time to time the number of shares to be included in each series, and to fix the rights, preferences and privileges of the shares of each wholly unissued series and any of its qualifications, limitations or restrictions. Our board of directors can also increase or decrease the number of shares of any series, but not below the number of shares of such series then outstanding, without any further vote or action by the stockholders. Our board may authorize the issuance of preferred stock with voting, conversion or liquidation rights that could adversely affect the rights of the holders of our common stock and could also adversely affect the market price of our common stock.

We develop products in the United States and market our products in North America, Europe and the Asia-Pacific region. International sales are made mostly from our foreign subsidiaries in their respective countries and are typically denominated in the local currency of each country. Our foreign subsidiaries incur most of their expenses in local currency as well. Our international business is subject to risks, including, but not limited to, unique economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility. Accordingly, our future results could be materially adversely impacted by changes in these or other factors.

Approximately 37% of our total revenue was made in currencies other than U.S. dollars in the third quarter of fiscal 2005. In addition to this revenue, our exposure to foreign exchange rate fluctuations arises from intercompany transactions in which certain costs incurred in the United States are charged to our foreign subsidiaries. Intercompany transactions are typically denominated in the functional currency of the foreign subsidiaries in order to centralize foreign exchange risk in the parent company in the United States. We are also exposed to foreign exchange rate fluctuations because the financial results of our foreign subsidiaries are translated into U.S. dollars during consolidation. We expect that exchange rate fluctuations will affect our financial results in the future.

We use forward exchange contracts primarily to hedge foreign currency exposure. In general, our forward foreign exchange contracts have terms of six months or less. Gains and losses on the settled contracts are included in “Interest and other income (expense), net” in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) filed as part of this report. As of October 31, 2004, we had no forward contracts outstanding.

We will continually assess our needs to utilize financial instruments to hedge currency exposures in the future.

Our exposure to market risk for changes in interest rates relates primarily to our cash and cash equivalents. We do not use derivative financial instruments for speculative or trading purposes. Our cash and cash equivalents

consist primarily of demand deposits, certificates of deposit and money market accounts that mature in three months or less. Due to the short-term nature of our cash and cash equivalents, we believe that there is no material market or interest rate risk exposure on our cash and cash equivalents. We believe our interest rate exposure on our line of credit is insignificant due to the short-term nature of our borrowings. Therefore, we do not believe an immediate 10% increase or decrease in interest rates would have a material effect on our financial position or results of operations.

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (pursuant to Rules 13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of such period, our disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports we file under the Securities Exchange Act of 1934, as amended.

There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act of 1934, as amended) during the fiscal quarter to which this report relates that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Final settlement papers for litigation relating to a number of initial public offerings (“IPO”), including that of the Company, are in the process of being signed by the parties and approved by the Court. The Company does not presently expect to make any payment under the pending settlements. The history of this litigation is as follows: In August 2001, Goldman, Sachs and Co., Dain Rauscher Wessels, U.S. Bancorp Piper Jaffray and Thomas Weisel Partners, the managing underwriters of the Company’s IPO, the Company, and certain of the Company’s officers and directors, were named as defendants in a number of purported securities class actions in United States District Court for the Southern District of New York arising out of the Company’s IPO in February 2000. The complaints in these actions alleged, among other things, that the registration statement and prospectus filed with the Securities and Exchange Commission for purposes of the IPO were false and misleading because they failed to disclose that the managing underwriters allegedly (i) solicited and received commissions from certain investors in exchange for allocating to them shares of Company stock in connection with the IPO and (ii) entered into agreements with their customers to allocate such stock to those customers in exchange for the customers agreeing to purchase additional shares of the Company in the aftermarket at pre-determined prices. The Company believes that the claims asserted against it in these cases are without merit. On August 8, 2001 the Court ordered that these actions, along with hundreds of IPO allocation cases against other issuers, underwriters and directors and officers, be transferred to one judge for coordinated pre-trial proceedings. In July 2002, omnibus motions to dismiss the complaints based on common legal issues were filed on behalf of all issuers, underwriters and directors and officers. By order dated October 8, 2002, the Court dismissed the Company’s officers and directors from the case without prejudice. In an opinion issued on February 19, 2003, the Court granted in part and denied in part the motions to dismiss. The complaints against the Company and the other issuers and underwriters were not dismissed as a matter of law. The plaintiffs and the issuer defendants (along with the individual officer and director defendants of such issuers) have agreed to settle the cases. In June 2004, final settlement papers were executed, submitted to the Court, and the parties are awaiting approval by the Court.

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

On December 1, 2004 the Company filed a Current Report on form 8-K to announce the appointment of Samuel T. Spadafora to the Company’s Board of Directors.

On November 23, 2004 the Company filed a Current Report on Form 8-K to announce a material definitive agreement the Company entered into and the resignation of Val E. Vaden from the Company’s Board of Directors.

On November 16, 2004 the Company furnished a Current Report on Form 8-K to announce its financial results for the quarter ended October 31, 2004.

On August 17, 2004, the Company furnished a Current Report on Form 8-K to announce its financial results for the quarter ended July 31, 2004.

On May 18, 2004, the Company furnished a Current Report on Form 8-K to announce its financial results for the quarter ended April 30, 2004.

Pursuant to the requirements of the Securities Exchange Act of 1934 the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in Redwood City, County of San Mateo, State of California, on the 6^th day of December 2004.


NIKU CORPORATION (Registrant)

By:		/S/ JOSHUA PICKUS
		Joshua Pickus President and Chief Executive Officer

		/S/ MICHAEL SHAHBAZIAN
		Michael Shahbazian Chief Financial Officer


Delaware		77-0473454
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)


		Page No.
PART I.	FINANCIAL INFORMATION

Item 1.	Condensed Consolidated Financial Statements (unaudited):

	Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) (unaudited) for the Three and Nine Months Ended October 31, 2004 and October 31, 2003	3
	Condensed Consolidated Balance Sheets (unaudited) as of October 31, 2004 and January 31, 2004	4
	Condensed Consolidated Statements of Cash Flows (unaudited) for the Nine Months Ended October 31, 2004 and 2003	5

	Notes to Condensed Consolidated Financial Statements (unaudited)	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	32

Item 4.	Controls and Procedures	33

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings	34

Item 6.	Exhibits and Reports on Form 8-K	34

Signatures		36

Exhibit Index		37


	Three Months Ended October 31,				Nine Months Ended October 31,
	2004		2003		2004		2003
Revenue:
License	$	7,404	$	6,048	$	20,919	$	12,392
Maintenance and Service		9,160		6,487		25,349		19,990

Total revenue		16,564		12,535		46,268		32,382

Cost of revenue:
License		295		254		875		364
Maintenance and Service		4,416		3,089		11,611		8,546

Total cost of revenue		4,711		3,343		12,486		8,910


Gross profit		11,853		9,192		33,782		23,472

Operating expenses:

Sales and marketing		6,385		4,800		17,512		11,746
Research and development		2,073		1,901		5,935		5,615
General and administrative		1,778		1,758		5,829		4,826
Restructuring and other		—		312		1,810		1,960
Stock-based compensation		326		93		314		228

Total operating expenses		10,562		8,864		31,400		24,375

Income (loss) from operations		1,291		328		2,382		(903	)

Interest and other income (expense), net		274		149		342		(99	)

Income (loss) before income taxes		1,565		477		2,724		(1,002	)

Provision for income taxes		199		32		373		91

Net income (loss)	$	1,366	$	445	$	2,351	$	(1,093	)

Basic net income (loss) per share	$	0.11	$	0.04	$	0.19	$	(0.10	)

Weighted average common shares used in computing basic net income (loss) per share		12,585		11,933		12,392		11,435

Diluted net income (loss) per share	$	0.10	$	0.04	$	0.18	$	(0.10	)

Weighted average common shares used in computing diluted net income (loss) per share		13,293		12,461		13,043		11,435

Comprehensive income (loss):
Net income (loss)	$	1,366	$	445	$	2,351	$	(1,093	)
Foreign currency translation adjustments		140		89		72		181

Comprehensive income (loss)	$	1,506	$	534	$	2,423	$	(912	)


	October 31, 2004		January 31, 2004
ASSETS
Current Assets:
Cash and cash equivalents	$	24,640	$	23,200
Restricted cash		982		—
Accounts receivable, net of allowances of $374 and $797 as of October 31, 2004 and January 31, 2004, respectively		13,050		7,794
Prepaid expenses and other current assets		1,641		2,345

Total current assets		40,313		33,339

Restricted cash, less current portion		—		1,108
Property and equipment, net		1,204		1,281
Deposits and other assets		298		888

Total assets	$	41,815	$	36,616

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current Liabilities:
Accounts payable	$	2,634	$	320
Accrued liabilities		9,285		7,075
Accrued restructuring		2,764		1,812
Bank borrowings		—		4,250
Short-term portion of capital lease obligations		387		121
Deferred revenue		8,693		9,305

Total current liabilities		23,763		22,883

Long-term accrued restructuring		5,967		6,430
Long-term portion of capital lease obligations		194		108

Total liabilities		29,924		29,421

Stockholders’ equity		11,891		7,195

Total liabilities and stockholders’ equity	$	41,815	$	36,616


	Nine Months Ended October 31,
	2004			2003
Cash flows from operating activities:
Net income (loss)	$	2,351		$	(1,093	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation		711			1,190
Restructuring and other		1,810			342
Stock-based compensation		314			228
Provision for (recovery of) doubtful accounts receivable		(114	)		423
Issuance of common stock for services received		—			20
Gain on sale of property and equipment		(3	)		(14	)
Changes in operating assets and liabilities:
Accounts receivable, net		(5,142	)		409
Prepaid expenses and other current assets		704			(384	)
Accounts payable		2,314			(1,270	)
Accrued liabilities		2,210			429
Accrued restructuring		(1,321	)		(3,365	)
Deferred revenue		(612	)		(2,156	)

Net cash provided by (used in) operating activities		3,222			(5,241	)


Cash flows from investing activities:
Purchases of property and equipment		(111	)		(84	)
Proceeds from sale of property and equipment		3			35
Releases of investments of restricted cash, net		126			229
Deposits and other assets		590			232

Net cash provided by investing activities		608			412


Cash flows from financing activities:
Proceeds from issuance of common stock upon exercise of stock options and warrants		1,959			128
Issuance of common stock and warrants in connection with a private placement, net		—			10,164
Proceeds from (repayment of) bank line of credit, net		(4,250	)		4,250
Repayment of bank term loan		—			(4,750	)
Repayment of capital lease obligations		(170	)		(41	)

Net cash provided by (used in) financing activities		(2,461	)		9,751

Net increase in cash and cash equivalents		1,369			4,922
Effect of exchange rate changes		71			162
Cash and cash equivalents, beginning of period		23,200			16,670

Cash and cash equivalents, end of period	$	24,640		$	21,754


Supplemental disclosures of cash flow information:
Cash paid for interest during the period	$	25		$	138

Cash paid for income taxes during the period	$	136		$	147


Noncash investing and financing activities:
Deferred stock-based compensation	$	—		$	123

Property and equipment acquired under capital lease	$	512		$	159

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	Accrued as of July 31, 2004		Restructuring Charges in the Three Months Ended October 31, 2004		Paid In the Three Months Ended October 31, 2004			Accrued as of October 31, 2004
Restructuring initiated in fiscal 2003:
Net lease commitment costs on vacated facilities	$	559	$	—	$	(126	)	$	433
Computer and car leases		18		—		—			18
Other exit costs		209		—		(37	)		172
Restructuring initiated in fiscal 2002:
Net lease commitment costs on vacated facilities		8,385		—		(277	)		8,108

Total	$	9,171	$	—	$	(440	)	$	8,731


	Accrued as of January 31, 2004		Restructuring Charges (Credits) in the Nine Months Ended October 31, 2004			Paid In the Nine Months Ended October 31, 2004			Accrued as of October 31, 2004
Restructuring initiated in fiscal 2003:
Net lease commitment costs on vacated facilities	$	590	$	221		$	(378	)	$	433
Computer and car leases		79		(49	)		(12	)		18
Other Exit Costs		354		(69	)		(113	)		172
Restructuring initiated in fiscal 2002:
Net lease commitment costs on vacated facilities		7,219		1,707			(818	)		8,108

Total	$	8,242	$	1,810		$	(1,321	)	$	8,731


	Three Months Ended October 31,				Nine Months Ended October 31,
	Three Months Ended October 31,				Nine Months Ended October 31,
	2004		2003		2004		2003
Services:
Maintenance and support	$	4,322	$	3,815	$	12,760	$	11,918
Implementation services		4,838		2,672		12,589		8,072

	$	9,160	$	6,487	$	25,349	$	19,990


	Three Months Ended October 31,				Nine Months Ended October 31,
	2004		2003		2004		2003
Revenue:
License	44.7	%	48.2	%	45.2	%	38.3	%
Maintenance and Service	55.3		51.8		54.8		61.7

Total revenue	100.0		100.0		100.0		100.0

Cost of revenue:
License	1.8		2.0		1.9		1.1
Maintenance and Service	26.7		24.6		25.1		26.4

Total cost of revenue	28.4		26.7		27.0		27.5

Gross profit	71.6		73.3		73.0		72.5

Operating expenses:
Sales and marketing	38.5		38.3		37.8		36.3
Research and development	12.5		15.2		12.8		17.3
General and administrative	10.7		14.0		12.6		14.9
Restructuring and other	—		2.5		3.9		6.1
Stock-based compensation	2.0		0.7		0.7		0.7

Total operating expenses	63.8		70.7		67.9		75.3

Operating income (loss)	7.8		2.6		5.1		(2.8	)

Interest and other income (expense), net	1.7		1.2		0.7		(0.3	)

Income (loss) before income taxes	9.4		3.8		5.9		(3.1	)

Provision for income taxes	1.2		0.3		0.8		0.3

Net income (loss)	8.2		3.6		5.1		(3.4	)


	Three Months Ended October 31,						Nine Months Ended October 31,
	2004		2003		Change %		2004		2003		Change %
License	$	7,404	$	6,048	22	%	$	20,919	$	12,392	69	%
Maintenance and Service		9,160		6,487	41	%		25,349		19,990	27	%

Total revenue	$	16,564	$	12,535	32	%	$	46,268	$	32,382	43	%


	Three Months Ended, October 31,				Nine Months Ended October 31,
	2004		2003		2004		2003
Cost of Service	$	23	$	8	$	20	$	10
Sales and marketing		33		10		32		39
Research and development		263		70		256		83
General and Administrative		7		5		6		96

Total stock-based compensation	$	326	$	93	$	314	$	228


	Payments Due by Period
	Total		Less Than 1 Year		1-3 Years		4-5 Years		After 5 Years
Line of credit ^(a)	$	—	$	—	$	—	$	—	$	—
Operating leases ^(b)		19,122		5,263		9,215		2,111		2,533
Capital leases		581		387		194		—		—
Purchase orders		2,958		2,899		59		—		—

Net contractual obligations	$	22,661	$	8,549	$	9,468	$	2,111	$	2,533


Number		Exhibit Title

3.1⁽¹⁾		Amended and Restated Certificate of Incorporation.

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

3.3⁽³⁾		Certificate of Amendment to the Amended and Restated Certification of Incorporation dated December 3, 2003.

3.4⁽⁴⁾		Registrant’s Amended and Restated Bylaws.

10.1⁽⁵⁾		Form of Employment Agreement between the Company and Joshua Pickus, dated November 18, 2004.

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

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

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

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


	Three Months Ended October 31,				Nine Months Ended October 31,
	2004		2003		2004		2003
Expected life (years)	4.0		4.0		4.0		3.0
Risk-free interest rate	2.85	%	3.08	%	2.75	%	2.03	%
Volatility	133	%	148	%	132	%	144	%