UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2002

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____

Commission File Number: 0-25612

STARBASE CORPORATION

(Exact name of Registrant as specified in its charter)


Delaware		33-0567363
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)


4 Hutton Centre Drive, Suite 900 Santa Ana, California		92707
(Address of principal executive offices)		(Zip code)

(714) 445-4400
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) been subject to such filing requirements for the past 90 days.

Yes þ No o


Number of shares outstanding as of October 31, 2002:	Common Stock: Preferred Stock:		8,736,690 0

TABLE OF CONTENTS


		CONSOLIDATED BALANCE SHEETS
		CONSOLIDATED STATEMENTS OF OPERATIONS
		CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
		CONSOLIDATED STATEMENTS OF CASH FLOWS
		Notes to Consolidated Financial Statements
	ITEM 2 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
	ITEM 4 CONTROLS AND PROCEDURES
PART II
	ITEM 5 OTHER INFORMATION
	ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURES
CERTIFICATIONS
EXHIBIT INDEX
EXHIBIT 99.1
EXHIBIT 99.2
EXHIBIT 99.3

STARBASE CORPORATION

TABLE OF CONTENTS


PART I.		FINANCIAL INFORMATION




	ITEM 1.	Financial Statements




		Consolidated Balance Sheets (Unaudited) at September 30, 2002 and March 31, 2002	3




		Consolidated Statements of Operations (Unaudited) for the three and six month periods ended September 30, 2002 and 2001	4




		Consolidated Statements of Comprehensive Operations (Unaudited) for the three and six month periods ended September 30, 2002 and 2001	5




		Consolidated Statements of Cash Flows (Unaudited) for the six month periods ended September 30, 2002 and 2001	6




		Notes to Consolidated Financial Statements (Unaudited)	7




	ITEM 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	16




	ITEM 3.	Quantitative and Qualitative Disclosures about Market Risk	29




	ITEM 4.	Controls and Procedures	30




PART II.		OTHER INFORMATION




	ITEM 5.	Other Information	31




	ITEM 6.	Exhibits and Reports on Form 8-K	32




Signatures			33




Certifications			34

PART I ITEM 1
FINANCIAL STATEMENTS

STARBASE CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)


			September 30,			March 31,
			2002			2002

			(Unaudited)
Assets
Current Assets:
	Cash and cash equivalents		$	1,401		$	1,530
	Restricted cash			62			62
	Marketable securities			8			9
	Accounts receivable, net of allowances of $766 at September 30, 2001 and $1,561 at March 31, 2002			5,841			7,980
	Notes and other receivables, net of allowances of $150 at September 30, 2001 and March 31, 2002			—			14
	Prepaid expenses and other assets			817			704

		Total current assets		8,129			10,299
Property and equipment, net				3,273			4,503
Intangible assets, net				8,334			13,319
Goodwill				9,557			7,637
Note receivable from officer				111			109
Other non-current assets				369			620

Total assets			$	29,773		$	36,487

Liabilities and Stockholders’ Equity
Current Liabilities:
	Accounts payable		$	3,003		$	2,953
	Accrued compensation			1,953			2,344
	Other accrued liabilities			991			1,267
	Deferred revenue			6,898			6,598
	Current portion of long-term obligations			326			144

		Total current liabilities		13,171			13,306
Long-term liabilities:
	Long-term obligations, less current portion			6			42
	Convertible debentures			—			1,632

		Total long-term liabilities		6			1,674

		Total liabilities		13,177			14,980
Commitments and contingencies
Stockholders’ equity:
	Preferred stock, $.01 par value; 10,000,000 shares authorized, none issued and outstanding at September 30, 2002 and March 31, 2002			—			—
	Common stock, $.01 par value; 150,000,000 authorized; 8,736,690 and 7,965,548 shares issued and outstanding at September 30, 2002 and March 31, 2002			87			80
	Additional paid-in capital			203,404			201,747
	Accumulated deficit			(186,468	)		(179,770	)
	Deferred non-cash compensation			(265	)		(397	)
	Notes receivable			(36	)		(36	)
	Accumulated other comprehensive loss			(126	)		(117	)

		Total stockholders’ equity		16,596			21,507

Total liabilities and stockholders’ equity			$	29,773		$	36,487

The accompanying notes are an integral part of the consolidated financial statements

STARBASE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)


			Three months ended						Six months ended
			September 30,						September 30,

			2002			2001			2002			2001

			(Unaudited)						(Unaudited)
Revenues:
	License		$	4,997		$	6,119		$	10,088		$	13,506
	Maintenance			2,640			2,457			5,070			5,073
	Service			1,576			1,952			3,147			4,003

		Total revenues		9,213			10,528			18,305			22,582
Cost of Revenues:
	License			703			510			872			2,087
	Service			991			1,693			2,319			3,517
	Amortization and write-down of intangibles			1,291			4,510			2,583			6,263

		Total cost of revenues		2,985			6,713			5,774			11,867

Gross margin				6,228			3,815			12,531			10,715
Operating Expenses:
	Research and development			2,395			3,860			5,041			8,316
	Sales and marketing			5,019			6,857			10,116			14,996
	General and administrative			1,517			2,988			2,943			5,933
	Non-cash equity based compensation			122			148			298			338
	Amortization and write-down of intangibles			240			38,532			480			43,508

		Total operating expenses		9,293			52,385			18,878			73,091

	Operating loss			(3,065	)		(48,570	)		(6,347	)		(62,376	)
	Interest and other income (expense)			(29	)		9			(333	)		106

Loss before income taxes				(3,094	)		(48,561	)		(6,680	)		(62,270	)
	Provision for income taxes			10			30			18			87

Net loss			$	(3,104	)	$	(48,591	)	$	(6,698	)	$	(62,357	)

Per share data:
	Basic and diluted net loss per common share		$	(0.36	)	$	(7.10	)	$	(0.78	)	$	(9.14	)

	Basic and diluted weighted average common shares outstanding			8,595			6,841			8,580			6,822

The accompanying notes are an integral part of the consolidated financial statements

STARBASE CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
(in thousands)


		Three months ended						Six months ended
		September 30,						September 30,

		2002			2001			2002			2001

		(Unaudited)						(Unaudited)
Net loss		$	(3,104	)	$	(48,591	)	$	(6,698	)	$	(62,357	)
Other comprehensive loss:
	Foreign currency translation adjustments		(5	)		(13	)		(8	)		(35	)
	Unrealized loss on available for sale securities		—			—			(1	)		—

Total comprehensive loss		$	(3,109	)	$	(48,604	)	$	(6,707	)	$	(62,392	)

The accompanying notes are an integral part of the consolidated financial statements

STARBASE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)


				Six months ended
				September 30,

				2002			2001

				(Unaudited)
Cash Flows from Operating Activities:
	Net loss			$	(6,698	)	$	(62,357	)
	Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
		Depreciation and amortization			4,322			15,014
		Write-down of intangibles			—			36,300
		Provision for doubtful accounts			(234	)		1,350
		Non-cash equity based compensation			298			338
		Non-cash interest expense			272			—
		Changes in operating assets and liabilities, net of effects of acquisitions:
			Accounts receivable		2,373			4,293
			Notes and other receivables		14			1
			Prepaid expenses and other assets		157			128
			Other non-current assets		6			27
			Accounts payable and accrued liabilities		(778	)		(6,105	)
			Deferred revenue		300			(1,337	)

Net cash provided by (used in) operations					32			(12,348	)
Cash Flows from Investing Activities:
	Decrease in restricted cash				—			40
	Capital expenditures				(29	)		(756	)

Net cash used in investing activities					(29	)		(716	)
Cash Flows from Financing Activities:
	Borrowings under line of credit				—			1,500
	Proceeds from issuance of common stock:
		Exercise of options			—			665
	Payments on capitalized lease obligations				(124	)		(211	)

Net cash (used in) provided by financing activities					(124	)		1,954
Effect of exchange rate changes on cash and cash equivalents					(8	)		(35	)

Net decrease in cash and cash equivalents					(129	)		(11,145	)
Cash and cash equivalents, beginning of period					1,530			14,075

Cash and cash equivalents, end of period				$	1,401		$	2,930

Supplemental Cash Flow Information:
	Interest paid			$	90		$	58

	Income taxes paid			$	18		$	87

Non-cash investing and financing transactions:
	Capitalized lease and insurance financing			$	270		$	254

	Common stock issued in satisfaction of liabilities			$	202		$	—

	Conversion of convertible debentures to common stock			$	1,701		$	—

	Change in unrealized loss on securities available for sale			$	(1	)	$	—

The accompanying notes are an integral part of the consolidated financial statements

STARBASE CORPORATION
Notes to Consolidated Financial Statements
(Unaudited)

1. Basis of presentation

The accompanying unaudited interim consolidated financial statements of Starbase Corporation, a Delaware corporation (the Company), as of September 30, 2002, and for the three and six months ended September 30, 2002, and 2001, have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, 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 not been presented. The interim consolidated financial statements reflect all normal recurring adjustments that are, in the opinion of management, necessary for a fair presentation of the Company’s financial position, results of operations and cash flows for the period presented. The results of operations for the three and six months ended September 30, 2002 are not necessarily indicative of the operating results for the full year. The accompanying unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s annual report filed with the Securities and Exchange Commission on Form 10-K, for the year ended March 31, 2002.

On July 29, 2002, the stockholders of the Company approved a one-for-ten reverse split of the Company’s common stock effective on July 31, 2002. The consolidated financial statements and accompanying notes to the consolidated financial statements have been adjusted to reflect the effect of the one-for-ten reverse split for all periods presented.

Certain reclassifications have been made to the prior year’s consolidated financial statements to conform with current year’s presentation. Allowance for doubtful accounts expense previously classified as a sales and marketing expense is now classified as a general and administrative expense. As a result, for the three months ended September 30, 2001, sales and marketing expense decreased by $850,000 and general and administrative expense increased by $850,000. For the six months ended September 30, 2001, sales and marketing expense decreased by $1.4 million and general and administrative expense increased by $1.4 million.

Management plans and going concern

The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. Management believes, based upon projected operating needs, that the Company’s working capital is insufficient for the Company to maintain its current level of operating activities through March 31, 2003. As shown in the consolidated financial statements, the Company has also experienced recurring losses from operations and has negative working capital at September 30, 2002. These factors, among others, raise substantial doubt about the Company’s ability to continue as a going concern. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

The Company’s continuation as a going concern is dependant upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to obtain additional financing, and ultimately, to obtain successful operations. On May 22, 2002, the Company entered into a definitive purchase agreement to raise approximately $12.0 million through the sale of convertible preferred stock and warrants to institutional investors in a private placement. On July 29, 2002, the Company’s stockholders approved the financing and a one-for-ten reverse stock split at a special meeting of stockholders called for those purposes. Proceeds of the financing would have been used for working capital. In August 2002, the Company received notification from some investors that they were terminating their obligations under the purchase agreement, which was scheduled to close on August 13, 2002. As a result of the pending merger with Borland Software Corporation (Note 9), the Company terminated the private placement.

STARBASE CORPORATION
Notes to the Consolidated Financial Statements (Continued)
(Unaudited)

On October 8, 2002, the Company entered into an Agreement and Plan of Merger (Merger Agreement) with Borland Software Corporation, a Delaware corporation (Borland), and Galaxy Acquisition Corp., a Delaware corporation and wholly owned subsidiary of Borland (Purchaser). Pursuant to the Merger Agreement, on October 8, 2002, Purchaser commenced a tender offer (Offer) for all outstanding shares of the Company’s common stock at a price of $2.75 per share, net to the seller in cash, without interest, subject to certain conditions, including the tender, without withdrawal prior to the expiration of the Offer, of at least a majority of the Company’s outstanding shares of common stock, including shares subject to the Company’s stock options with an exercise price per share less than $2.75 (Note 9).

In connection with the Merger Agreement, Borland also agreed to provide the Company a bridge loan of up to $2 million. In October 2002, the Company borrowed $750,000 against the bridge loan.

The initial expiration date of the Offer was November 8, 2002. In accordance with the Merger Agreement, the Offer has been extended until November 22, 2002. At the time of the initial expiration of the Offer, 6,674,933 shares of the Company’s common stock, or approximately 76.3% of the outstanding common shares, had been tendered and not withdrawn in the Offer.

2. New accounting pronouncements

In June 2001, the Financial Accounting Standards Board (FASB) issued two new pronouncements: Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Goodwill and intangible assets with indefinite lives will remain on the balance sheet and not be amortized. On an annual basis, or when there is reason to suspect that their values have been diminished or impaired, these assets must be tested for impairment, and write-downs may be necessary. The Company implemented SFAS No. 141 on July 1, 2001. Such adoption had no impact on the Company’s consolidated financial position or results of operations though September 30, 2002. The Company adopted SFAS No. 142 on April 1, 2002. As a result, the Company has reclassified assembled workforce into goodwill and has ceased amortization of goodwill, reducing annual amortization expense by approximately $10.4 million. The Company will continue to amortize developed technology and customer lists over their remaining lives. SFAS No. 142 also required the Company to perform a transition impairment test for goodwill by determining if the fair value of the Company’s reporting units is less than the carrying value of the reporting units. The Company completed the transition impairment testing during the quarter ended September 30, 2002 and determined that it did not have a transition impairment of goodwill. The Company will perform subsequent annual impairment reviews during the fourth fiscal quarter of each year, or earlier if indicators of potential impairment exists. Future impairment reviews may result in charges against earnings to write-down the value of intangible assets.

A reconciliation of previously reported net loss and net loss per share to the amounts adjusted for the exclusion of goodwill amortization is as follows:


(In thousands, except per share amounts)	Three months ended						Six months ended
	September 30,						September 30,

	2002			2001			2002			2001

Reported net loss	$	(3,104	)	$	(48,591	)	$	(6,698	)	$	(62,357	)
Goodwill amortization		—			4,593			—			9,185

Adjusted net loss	$	(3,104	)	$	(43,998	)	$	(6,698	)	$	(53,172	)

Reported basic and diluted net loss per share	$	(0.36	)	$	(7.10	)	$	(0.78	)	$	(9.14	)
Goodwill amortization		—			0.67			—			1.35

Adjusted basic and diluted net loss per share	$	(0.36	)	$	(6.43	)	$	(0.78	)	$	(7.79	)

Basic and diluted weighted average common shares outstanding		8,595			6,841			8,580			6,822

STARBASE CORPORATION
Notes to the Consolidated Financial Statements (Continued)
(Unaudited)

The components of amortizing intangible assets as of September 30, 2002 are as follows:


(In thousands)	Gross Carrying Amount		Accumulated Amortization

Amortizing intangible assets
Patents and trademarks	$	20	$	20
Manufacturing license		385		139
Developed technology		19,489		11,773
Customer lists		1,969		1,597

Total	$	21,863	$	13,529

All identified intangible assets required to be amortized under SFAS No. 142 are amortized on a straight-line basis over their estimated lives. Estimated future amortization expense relating to these identified intangible assets is as follows:


(In thousands)
For years ended March 31,
2003	$	6,029
2004	$	4,707
2005	$	560
2006	$	82

Changes to goodwill during the six months ended September 30, 2002, including the effects of adopting SFAS No. 141 and SFAS No. 142, are as follows:


(In thousands)
Balance at March 31, 2002	$	7,637
Assembled workforce reclassified to goodwill		1,920

Balance at September 30, 2002	$	9,557

In August 2001, the FASB issued SFAS No. 144, Accounting for Impairment or Disposal of Long-Lived Assets. SFAS No. 144 addresses financial accounting and reporting for the impairment of long-lived assets and for the disposal of long-lived assets. SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and is effective for fiscal year beginning after December 15, 2001. The Company adopted SFAS No. 144 effective April 1, 2002. The adoption of this statement did not have a material impact on the Company’s consolidated financial position or results of operations.

In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which addresses financial accounting and reporting for costs associated with the exit or disposal activities and supersedes Emerging Issues Task Force (EITF) Issue 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in Restructuring). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF Issue 94-3, a liability for an exit cost, as defined in EITF 94-3, was recognized at the date of the entity’s commitment to an exit plan. SFAS No. 146 also establishes that the liability should be measured and recorded at fair value. The Company will adopt the provisions of SFAS No. 146 for exit or disposal activities that are initiated after March 31, 2002.

STARBASE CORPORATION
Notes to the Consolidated Financial Statements (Continued)
(Unaudited)

3. Composition of certain balance sheet captions


(In thousands)	September 30,			March 31,
	2002			2002

Property and equipment:
Computer hardware	$	2,552		$	2,527
Furniture and fixtures		1,335			1,330
Computer software		3,976			3,970
Leasehold improvements		707			707

		8,570			8,534
Less accumulated depreciation and amortization		(5,297	)		(4,031	)

	$	3,273		$	4,503

Intangible assets:
Patents and trademarks	$	20		$	20
Manufacturing license		385			385
Developed technology		19,489			19,489
Customer lists		1,969			1,969
Assembled workforce		—			2,907

		21,863			24,770
Less accumulated amortization		(13,529	)		(11,451	)

	$	8,334		$	13,319

Amounts recorded for non-cash equity based compensation for the three and six months ended September 30, 2002 and 2001 relate to the following consolidated statement of operations categories:


		Three months ended

(in thousands)	September 30, 2002			September 30, 2001

Research and development		$	—	$	24
Sales and marketing			15		18
General and administrative			107		106

		$	122	$	148


	Six months ended

(in thousands)	September 30, 2002		September 30, 2001

Research and development	$	—	$	48
Sales and marketing		34		36
General and administrative		264		254

	$	298	$	338

4. Net loss per share

Basic and diluted net loss per share is computed by dividing net loss by the weighted average number of common shares outstanding during the periods presented. Potentially dilutive shares, stock options, warrants, and Escrow Shares, have not been included where inclusion would be antidilutive. Escrow Shares (141,863) would have been released to the

STARBASE CORPORATION
Notes to the Consolidated Financial Statements (Continued)
(Unaudited)

founders upon attainment of certain defined cash flow requirements by October 21, 2002. The release of the Escrow Shares would have been deemed compensatory and, accordingly, would have resulted in charges to earnings equal to the fair market value of these shares recorded ratably over the period beginning on the date when management determined that the cash flow requirements were probable of being met and ending on the date when the goal was attained, causing the Escrow Shares to be released. Such charges could have substantially reduced the Company’s net income or increased the Company’s loss for financial reporting purposes in the periods such charges were recorded. Based upon historical and expected results, the Company has determined that the goal will not be met. On October 21, 2002, the Escrow shares were returned to the Company.

On July 29, 2002, the stockholders of the Company approved a one-for-ten reverse split of the Company’s common stock effective on July 31, 2002. Net loss per share for the periods presented reflect the one-for-ten reverse split.

Potentially dilutive securities, which consist of options to purchase 1,183,546 shares of common stock at prices ranging from $4.60 to $146.30 per share, warrants to purchase 383,691 shares of common stock at prices ranging from $3.20 to $68.13 per share and 141,863 common shares held in escrow were not included in the computation of diluted loss per share because such inclusion would have been antidilutive for the three and six month periods ended September 30, 2002. Potentially dilutive securities, which consist of options to purchase 831,632 shares of common stock at prices ranging from $6.25 to $146.30 per share, warrants to purchase 89,308 shares of common stock at prices ranging from $7.30 to $68.13 per share and 141,863 common shares held in escrow were not included in the computation of diluted loss per share because such inclusion would have been antidilutive for the three and six month periods ended September 30, 2001.

5. Equity transactions

On July 29, 2002, the stockholders of the Company approved a one-for-ten reverse split of the Company’s common stock. The reverse stock split was effective on July 31, 2002.

Warrants

Warrant activity for the six month period ended September 30, 2002 is as follows:


			Warrant Price
	Shares		Per Share

Outstanding at March 31, 2002		367,078	$	6.53-$68.13
Issued		31,250	$	3.20
Expired		14,637	$	38.80

Outstanding at September 30, 2002		383,691	$	3.20-$68.13

6. Stock option plans

1996 Plan

In September 1996, the stockholders of the Company approved the 1996 Stock Option Plan (1996 Plan) as amended and restated. The 1996 Plan provides for the grant of non-qualified and incentive stock options to employees, directors, officers and consultants. Options are granted at exercise prices equal to the fair market value of the common stock on the date of grant. Generally, twenty-five percent of the options are available for exercise at the end of one year, while the remainder of the grant is exercisable ratably over the next thirty-six month period, provided the optionee remains in service to the Company. A total of 283,333 shares of common stock have been authorized under the 1996 Plan, of which 126,773 were outstanding and none are available for future grants at September 30, 2002.

2001 Plan

In September 2001, the stockholders of the Company approved the 2001 Stock Plan (2001 Plan). The 2001 Plan provides for the grant of non-qualified and incentive stock options to employees, directors, officers and consultants. Options are granted at exercise prices equal to the fair market value of the common stock on the date of grant. Generally, twenty-five percent of the options are available for exercise at the end of one year, while the remainder of the grant is

STARBASE CORPORATION
Notes to the Consolidated Financial Statements (Continued)
(Unaudited)

exercisable ratably over the next thirty-six month period, provided the optionee remains in service to the Company. A total of 340,000 shares of common stock have been authorized under the 2001 Plan, of which 265,807 were outstanding and 74,193 are available for future grants at September 30, 2002.

Premia Plan

As a result of the acquisition of Premia Corporation, the Company assumed all of the outstanding options granted under the Premia ISO stock option plan (Premia Plan). At the date of acquisition, there were 27,008 options outstanding at a weighted-average exercise price of $14.80, of which 21,345 were exercisable at a weighted-average exercise price of $14.80. As of September 30, 2002, there were 16,025 options outstanding at a weighted-average exercise price of $14.80, of which 15,439 were exercisable at a weighted average exercise price of $14.80. No further options will be granted under the Premia Plan.

TBI Plan

As a result of the acquisition of Technology Builders, Inc., the Company assumed all of the outstanding options granted under the Technology Builders, Inc. Amended and Restated Stock Option and Incentive Stock Option Plan (TBI Plan). At the date of acquisition, there were 122,049 options outstanding at a weighted-average exercise price of $12.40, of which 78,795 were exercisable at a weighted-average exercise price of $8.90. As of September 30, 2002, there were 58,743 options outstanding at a weighted-average exercise price of $13.41, of which 49,194 were exercisable at a weighted-average exercise price of $11.64. No further options will be granted under the TBI Plan.

NSO Stock Option Program

The NSO Stock Option Program (NSO Program) allows the Company to grant nonstatutory stock options for employees, directors and consultants. Options are granted at exercise prices equal to the fair market value of the common stock on the date of grant. Generally, twenty-five percent of the options are available for exercise at the end of one year, while the remainder of the grant is exercisable ratably over the next thirty-six month period, provided the optionee remains in service to the Company. As of September 30, 2002, there were 1,549,777 options issued and outstanding at a weighted-average exercise price of $27.63, of which 891,567 were exercisable at a weighted-average price of $31.12.

Stock option activity for all plans for the six months ended September 30, 2002 was as follows:


				Weighted-
				Average Exercise
	Shares			Price

Outstanding at March 31, 2002		2,440,462		$	25.32
Granted		16,200		$	1.72
Lapsed or canceled		(439,537	)	$	33.65

Outstanding at September 30, 2002		2,017,125		$	23.32

Exercisable at September 30, 2002		1,183,546		$	26.04

Stock option summary information for stockholder approved plans (1996 Plan and 2001 Plan) at September 30, 2002 is as follows:


	Options Outstanding					Options Exercisable

			Weighted-
			Average	Weighted-				Weighted-
Range of			Remaining	Average Exercise				Average Exercise
Exercise Prices	Shares		Contractual Life	Price		Shares		Price

$0.00-$5.00		124,891	9.3 years	$	4.82		42,018	$	4.90
$5.01-$10.00		154,116	8.5 years	$	6.55		71,755	$	6.84
$10.01-$15.00		72,495	3.5 years	$	12.47		72,495	$	12.47
$15.01-$20.00		41,078	4.3 years	$	16.35		41,078	$	16.35

		392,580	7.4 years	$	8.12		227,346	$	10.00

STARBASE CORPORATION
Notes to the Consolidated Financial Statements (Continued)
(Unaudited)

Stock option summary information for assumed plans (Premia Plan and TBI Plan) at September 30, 2002 is as follows:


	Options Outstanding					Options Exercisable

			Weighted-
			Average	Weighted-				Weighted-
Range of			Remaining	Average Exercise				Average Exercise
Exercise Prices	Shares		Contractual Life	Price		Shares		Price

$5.01-$10.00		23,750	4.4 years	$	6.90		25,750	$	6.90
$10.01-$15.00		34,147	6.1 years	$	14.27		33,448	$	14.26
$20.01-$25.00		15,064	7.7 years	$	20.70		6,984	$	20.70
$30.01-$35.00		1,807	8.3 years	$	34.30		451	$	34.30

		74,768	5.9 years	$	13.71		64,633	$	12.39

Stock option summary information for the plan not approved by stockholders (NSO Program) at September 30, 2002 is as follows:


	Options Outstanding					Options Exercisable

			Weighted-
			Average	Weighted-				Weighted-
Range of			Remaining	Average Exercise				Average Exercise
Exercise Prices	Shares		Contractual Life	Price		Shares		Price

$0.00-$5.00		64,700	6.4 years	$	3.73		22,400	$	4.70
$5.01-$10.00		636,754	8.3 years	$	6.33		279,302	$	6.37
$10.01-$15.00		199,132	6.8 years	$	13.20		146,033	$	13.20
$15.01-$20.00		83,099	6.3 years	$	17.21		68,812	$	17.05
$20.01-$25.00		43,250	6.6 years	$	21.80		31,671	$	21.37
$25.01-$30.00		57,764	7.3 years	$	26.01		52,448	$	25.90
$30.01-$35.00		125,465	8.2 years	$	33.43		51,543	$	33.36
$35.01-$40.00		105,811	6.7 years	$	38.15		87,839	$	38.18
$40.01-$45.00		10,000	7.9 years	$	40.96		5,217	$	40.91
$45.01-$161.25		223,802	6.6 years	$	104.60		146,302	$	105.54

		1,549,777	7.5 years	$	27.63		891,567	$	31.12

7. Operating segment information

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the Company’s chief operating decision-maker, or decision-making group, in deciding how to allocate resources and in assessing performance. The operating segments of the Company are managed separately because each segment represents a strategic business unit that offers different products or services.

The Company’s reportable operating segments include Starbase product licenses, third party product licenses, maintenance and services. The Starbase product licenses operating segment develops and markets the Company’s software management tools for managing the development of software projects from beginning to end (Application Lifecycle Management). The third party product licenses operating segment resells other companies’ products. The maintenance operating segment provides after-sale support for software licenses. The services operating segment provides fee-based training and consulting services related to the Company’s products.

The Company does not allocate operating expenses to these segments, nor does it allocate specific assets to these segments. Therefore, segment information reported includes only revenues, cost of revenues and gross margin.

STARBASE CORPORATION
Notes to the Consolidated Financial Statements (Continued)
(Unaudited)

Operating segment data for the three and six months ended September 30, 2002 and 2001 was as follows:


			Starbase		Third party
			product		product
			licenses		licenses		Maintenance		Services		Total
(In thousands)
Three months ended September 30, 2002:
	Revenues		$	4,450	$	547	$	2,640	$	1,576	$	9,213
	Cost of revenues			1,452		436		106		991		2,985

		Gross margin	$	2,998	$	111	$	2,534	$	585	$	6,228

Three months ended September 30, 2001:
	Revenues		$	5,574	$	545	$	2,457	$	1,952	$	10,528
	Cost of revenues			4,741		216		63		1,693		6,713

		Gross margin	$	833	$	329	$	2,394	$	259	$	3,815


			Starbase		Third party
			product		product
			licenses		licenses		Maintenance		Services		Total
(In thousands)
Six months ended September 30, 2002:
	Revenues		$	9,391	$	697	$	5,070	$	3,147	$	18,305
	Cost of revenues			2,859		459		137		2,319		5,774

		Gross margin	$	6,532	$	238	$	4,933	$	828	$	12,531

Six months ended September 30, 2001:
	Revenues		$	11,777	$	1,729	$	5,073	$	4,003	$	22,582
	Cost of revenues			6,749		1,263		338		3,517		11,867

		Gross margin	$	5,028	$	466	$	4,735	$	486	$	10,715

8. Accounts receivable purchase agreement

On April 19, 2002, the Company entered into an Accounts Receivable Purchase Agreement with Silicon Valley Bank. The term of the Agreement is for one year and it allows the Company to sell up to $4.0 million of its accounts receivable with a finance charge equal to 5.0% above Prime Rate for the gross average daily outstanding balance and a collateral handling fee equal to 0.5% per month of the average daily outstanding balance. There is a minimum finance charge of $15,000 per month. In connection with this agreement, the Company issued to Silicon Valley Bank warrants to purchase 31,250 shares of its common stock at $3.20 per share. The fair value of these warrants, using the Black-Scholes model at the date of grant, was $78,000 and was recorded as non-cash equity compensation during the three months ended June 30, 2002. At September 30, 2002, the Company had not sold any of its accounts receivables to Silicon Valley Bank.

9. Subsequent events

STARBASE CORPORATION
Notes to the Consolidated Financial Statements (Continued)
(Unaudited)

prior to the expiration of the Offer, of at least a majority of the Company’s outstanding shares of common stock, including shares subject to the Company’s stock options with an exercise price per share less than $2.75.

In connection with the Merger Agreement, Borland also agreed to provide the Company a bridge loan of up to $2 million. In October 2002, the Company borrowed $750,000 against the bridge loan.

Additionally, in connection with the Merger Agreement, James Harrer, the Company’s President and CEO, and certain other the Company’s stockholders entered into agreements pursuant to which such stockholders agreed to tender shares of the Company held by them, which represent in the aggregate approximately 0.94% percent of the outstanding shares of the Company’s common stock as of October 8, 2002.

Borland and Purchaser commenced the Offer on October 11, 2002. The Offer and withdrawal rights were scheduled to expire at 12:00 midnight, New York City time, on November 8, 2002. On November 11, 2002, Borland extended its offer until 12:00 midnight, Eastern Standard Time, on Friday, November 22, 2002 in accordance with the Merger Agreement to obtain tenders of at least 90% of the outstanding shares of the Company’s common stock so that the Merger may be completed without a vote of the Company’s shareholders under applicable law.

As of midnight, Eastern Standard Time, on November 8, 2002, approximately 6,674,993 shares of the Company’s common stock, or approximately 76.3% of the outstanding shares had been tendered.

The Merger Agreement also provides that following consummation of the Offer and the satisfaction or waiver of certain conditions, Purchaser will be merged with and into the Company (Merger) with the Company surviving the Merger as a wholly owned subsidiary of Borland, and all remaining publicly held outstanding shares of the Company’s common stock (other than common shares held by stockholders who properly exercise appraisal right under applicable Delaware law) will be converted into the right to receive $2.75 per share, net, in cash, without interest.

On October 8, 2002, the Company entered into a Settlement Agreement and Release (Agreement) with World Web Investors, LLC (LLC) and ABN AMRO CAPITAL USA (ABM AMRO) to resolve certain claims and disputes relating to the Company’s acquisition of worldweb.net, Inc. Within 30 days following the execution of the Agreement the Company agreed to pay the LLC $50,000 in full settlement of legal fees. In addition, within 180 days of the Agreement, the Company agrees to pay the LLC $500,000 for full settlement of any and all claims by the LLC or any of its members, and ABN AMRO.

PART I

ITEM 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

The discussion in this Form 10-Q contains forward-looking statements that involve risks and uncertainties. The statements that are not purely historical are forward-looking statement within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Sections 21E of the Securities Exchange Act of 1934, as amended. We have based these forward-looking statements on currently available information and our current beliefs, expectation and projections about future events, including, among other things: successfully implementing our business strategy; maintaining and expanding market acceptance of the products we offer; and our ability to successfully compete in our marketplace. All forward-looking statements included in this document are based on the information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Actual results could differ materially from the results discussed herein. Factors that might cause or contribute to such differences include, but are not limited to, those discussed under the caption “Risk Factors” of this document and in our other filing with the Securities and Exchange Commission, including our Annual Report for the year ended March 31, 2002 on Form 10-K.

Overview

We provide software management tools and professional consulting services to assist our customers in managing their development projects from beginning to end (Application Lifecycle Management) and allowing them to develop their software solutions and applications in a more efficient manner. Our tools enable geographically dispersed software developers to work as a team over corporate intranets and the Internet. Our flagship product, StarTeam, focuses primarily on supporting joint development efforts regardless of the developers’ location. Our Caliber products provide requirements management capabilities that help customers define their software projects and meet end-user needs. Our CodeWright product helps our customers’ developers edit their software code with ease. In addition, we provide or resell other products to assist our customers with their software projects. Our customers include management information systems executives, software developers, sales and marketing personnel, graphic designers and Webmasters.

Significant accounting policies

Revenue recognition

Revenue is recognized if the criteria of Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended, are met. If the arrangement does not require significant production, modification, or customization of software, revenue is recognized when all of the following criteria are met:

	•		Persuasive evidence of an arrangement exists.

	•		Delivery (passage of title) has occurred.

	•		The vendor’s fee is fixed or determinable.

	•		Collectibility is probable.

License revenues from sales of software licenses are recognized upon shipment of the related products and transfer of title. Maintenance revenue is deferred and recognized ratably over the contractual maintenance period, generally one year. Service revenue from training and consulting is recognized after the related services have been performed.

If the requirements of SOP 97-2, including evidence of an arrangement, delivery, fixed or determinable fee, collectibility, or vendor-specific objective evidence about the value of an element are not met at the date of shipment, revenue recognition is deferred until such elements are known or resolved.

License revenues from sales of software licenses through indirect channels are recorded upon shipment when an end-user purchase order has been obtained and collectibility is assured on standard payment terms. No provision for estimated returns is recorded, as historically such returns have been minimal.

Accounts Receivable

We sell our products worldwide. We perform ongoing credit evaluations of our customers and generally do not require collateral. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. The amount of our reserves is based on historical experience and our analysis of the accounts receivable balances outstanding. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required which would result in an additional general and administrative expense in the period such determination was made. While such credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past.

Intangible Assets

In June 2001, the Financial Accounting Standards Board (FASB) issued two new pronouncements: Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Goodwill and intangible assets with indefinite lives will remain on the balance sheet and not be amortized. On an annual basis, or when there is reason to suspect that their values have been diminished or impaired, these assets must be tested for impairment, and write-downs may be necessary. We implemented SFAS No. 141 on July 1, 2001. Such adoption had no impact on our consolidated financial position or results of operations though September 30, 2002. We adopted SFAS No. 142 on April 1, 2002. As a result, the Company has reclassified assembled workforce into goodwill and has ceased amortization of goodwill, reducing annual amortization expense by approximately $10.4 million. We will continue to amortize developed technology and customer lists over their remaining lives. SFAS No. 142 also required the Company to perform a transition impairment test for goodwill by determining if the fair value of the Company’s reporting units is less than the carrying value of the reporting units. The Company completed the transition impairment testing during the quarter ended September 30, 2002 and determined that it did not have a transition impairment of goodwill. The Company will perform subsequent annual impairment reviews during the fourth fiscal quarter of each year, or earlier if indicators of potential impairment exists. Future impairment reviews may result in charges against earnings to write-down the value of intangible assets.

A reconciliation of previously reported net loss and net loss per share to the amounts adjusted for the exclusion of goodwill amortization is as follows:


(In thousands, except per share amounts)	Three months ended						Six months ended
	September 30,						September 30,

	2002			2001			2002			2001

Reported net loss	$	(3,104	)	$	(48,591	)	$	(6,698	)	$	(62,357	)
Goodwill amortization		—			4,593			—			9,185

Adjusted net loss	$	(3,104	)	$	(43,998	)	$	(6,698	)	$	(53,172	)

Reported basic and diluted net loss per share	$	(0.36	)	$	(7.10	)	$	(0.78	)	$	(9.14	)
Goodwill amortization		—			0.67			—			1.35

Adjusted basic and diluted net loss per share	$	(0.36	)	$	(6.43	)	$	(0.78	)	$	(7.79	)

Basic and diluted weighted average common shares outstanding		8,595			6,841			8,580			6,822

Research and development costs

We expense research and development costs as incurred as the technological feasibility of the new software products and the enhancements of existing software products is not established until all product development is substantially completed.

Results of Operations

The following table summarizes our results of operations as a percentage of total revenue for the three and six months ended September 30, 2002 and 2001.


			Three months ended						Six months ended
			September 30,						September 30,

			2002			2001			2002			2001

Revenues:
	License			54.2	%		58.2	%		55.1	%		59.8	%
	Maintenance			28.7			23.3			27.7			22.5
	Service			17.1			18.5			17.2			17.7

		Total revenues		100.0			100.0			100.0			100.0
Cost of revenues:
	License			7.6			4.8			4.8			9.2
	Service			10.8			16.1			12.7			15.6
	Amortization and write-down of intangibles			14.0			42.9			14.0			27.8

		Total cost of revenues		32.4			63.8			31.5			52.6

Gross margin				67.6			36.2			68.5			47.4
Operating expenses:
	Research and development			26.0			36.7			27.5			36.8
	Sales and marketing			53.4			73.2			54.0			72.4
	General and administrative			17.6			20.3			17.4			20.3
	Non-cash equity based compensation			1.3			1.4			1.6			1.5
	Amortization and write-down of intangibles			2.6			365.9			2.6			192.7

		Total operating expenses		100.9			497.5			103.1			323.7

Loss from operations				(33.3	)		(461.3	)		(34.7	)		(276.3	)
Interest and other income (expense)				(0.3	)		0.0			(1.8	)		0.5

Loss before income taxes				(33.6	)		(461.3	)		(36.5	)		(275.8	)
Provision for income taxes				0.1			0.2			0.1			0.3

Net loss				(33.7	)%		(461.5	)%		(36.6	)%		(276.1	)%

Three Months Ended September 30, 2002 and 2001

Revenues

Revenues were $9.2 million and $10.5 million for the three month periods ended September 30, 2002 and 2001, respectively, representing a decrease of $1.3 million or 12%. International revenues accounted for less than 10% of total revenue in the three months ended September 30, 2002 and 28% of total revenue in the three months ended September 30, 2001.

License — License revenues were $5.0 million and $6.1 million for the three month periods ended September 30, 2002 and 2001, respectively, representing a decrease of $1.1 million or 18%. License revenues represented 54.2% and 58.2% of total revenues for the three months ended September 30, 2002 and 2001, respectively. The decrease in license revenues was due to decreased demand for our CaliberRM products.

Maintenance — Maintenance revenues were $2.6 million and $2.5 million for the three month periods ended September 30, 2002 and 2001, respectively, representing an increase of $183,000 or 7%. Maintenance revenues represented 28.7% and 23.3% of total revenues for the three months ended September 30, 2002 and 2001, respectively. The increase in maintenance revenues was due to increased renewal maintenance contracts sold.

Service — Service revenues were $1.6 million and $2.0 million for the three month periods ended September 30, 2002 and 2001, respectively, representing a decrease of $376,000 or 19%. Service revenues represented 17.1% and 18.5% of

total revenues for the three months ended September 30, 2002 and 2001, respectively. The decrease in service revenues was due to fewer billable headcount available to perform training and consulting.

Cost of Revenues

License — License cost of revenues consists primarily of manufacturing and related costs such as media, documentation, product assembly and royalties. License cost of revenues was $703,000 and $510,000 for the three month periods ended September 30, 2002 and 2001, respectively, representing an increase of $193,000 or 38%. License cost of revenues as a percentage of license revenue was 14.1% and 8.3% for the three months ended September 30, 2002 and 2001, respectively. The increase in license cost of revenues was due to lower margin sales of third party products resulting in higher license cost of revenues.

Service — Service cost of revenues consists of the costs associated with performing training and consulting services. Service cost of revenues was $991,000 and $1.7 million for the three month periods ended September 30, 2002 and 2001, respectively, representing a decrease of $702,000 or 41%. Service cost of revenues as a percentage of service revenue was 62.9% and 86.7% for the three months ended September 30, 2002 and 2001, respectively. The decrease in service costs of revenues was due to lower salary expense as a result of lower headcount in the services organization along with the lower costs related to the decrease in personnel.

Amortization and write-down of intangibles — Amortization of intangibles consists of the amortization of developed technology associated with the Premia, Genitor, worldweb.net and Technology Builders acquisitions. Amortization of intangibles was $1.3 million and $4.5 million for the three months ended September 30, 2002 and 2001, respectively, representing a decrease of $3.2 million or 71%. Amortization and write-down of intangibles as a percentage of total revenue was 14.0% and 42.9% for the three months ended September 30, 2002 and 2001, respectively. As a result of the continuing deterioration of the economy, the resulting decrease in IT spending and the lack of demand for the products obtained in the weoldweb.net acquisition, during the three months ended September 30, 2001, we evaluated the recoverability of the amounts recorded for developed technology acquired in the worldweb.net acquisition. We compared the carrying amounts of intangible assets to current cash flow forecasts and the original cash flow forecasts at the date of acquisition and determined that the amount recorded for developed technology was impaired. As a result, during the quarter ended September 30, 2001, we wrote down the value of developed technology by $2.7 million.

Gross Margin

Gross margin was $6.2 million and $3.8 million for the three months ended September 30, 2002 and 2001, respectively, representing an increase of $2.4 million or 63%. Gross margin was 67.6% and 36.2% of total revenues for the three months ended September 30, 2002 and 2001, respectively. The increase in gross margin was due to lower amortization and write-down of intangibles partially offset by lower margin on third party products we resell.

Operating Expenses

Research and development expenses — Research and development expenses include salaries and other expenses related to the development of new products and the enhancements of our current products. Research and development expenses were $2.4 million and $3.9 million for the three months ended September 30, 2002 and 2001, respectively, representing a decrease of $1.5 million or 38%. The decrease in research and development expenses was due to lower salary and other personnel expenses associated with a 38% reduction in research and development headcount from the prior year.

Sales and marketing — Sales and marketing expenses were $5.0 million and $6.9 million for the three months ended September 30, 2002 and 2001, respectively, representing a decrease of $1.9 million or 27%. The decrease in sales and marketing expenses was due to lower salary and other personnel expenses associated with a 32% reduction in sales and marketing headcount from the prior year.

General and administrative — General and administrative expenses were $1.5 million and $3.0 million for the three months ended September 30, 2002 and 2001, respectively, representing a decrease of $1.5 million or 49%. The decrease in general and administrative expenses was due to lower salary and other personnel expenses associated with a 14% reduction in general and administrative headcount from the prior year along with lower legal and allowance for doubtful accounts expenses.

Non-cash equity based compensation — Non-cash equity based compensation was $122,000 and $148,000 for the three months ended September 30, 2002 and 2001, respectively, representing a decrease of $24,000. Non-cash equity based compensation expense represents the fair market value at the date of grant of stock options and warrants to purchase our common stock granted to non-employees amortized over the vesting period.

Amounts recorded for non-cash equity based compensation for the three months ended September 30, 2002 and 2001 relate to the following consolidated statement of operations categories:


	Three months ended

(in thousands)	September 30, 2002		September 30, 2001

Research and development	$	—	$	24
Sales and marketing		15		18
General and administrative		107		106

	$	122	$	148

Amortization and write-down of intangibles — Amortization of intangibles was $240,000 and $38.5 million for the three months ended September 30, 2002 and 2001, respectively. On April 1, 2002, we adopted SFAS No. 142. As a result, we ceased amortization of goodwill and subsumed assembled workforce assets of $1.9 million into goodwill. The remaining balance of unamortized goodwill is $9.6 million at September 30, 2002. As a result of the continuing deterioration of the economy, the resulting decrease in IT spending and the lack of demand for the products obtained in the worldweb.net acquisition, during the quarter ended September 30, 2001, we compared the carrying amounts of goodwill acquired in the worldweb.net and ObjectShare acquisitions to current cash flow forecasts and the original cash flow forecasts at the date of acquisitions and determined that the amounts recorded for goodwill were impaired. As a result, we wrote-down the value of goodwill related to worldweb.net by $23.4 million and the value of goodwill related to ObjectShare by $7.7 million. We compared the carrying amount of customer lists acquired in the TBI acquisition to current cash flow forecasts and the original cash flow forecasts at the date of acquisition and determined that the amount recorded for customer lists was impaired. As a result, we wrote down the value of customer lists related to TBI by $792,000. We also wrote-down the values recorded for assembled workforce related to worldweb.net and TBI by $859,000 and $838,000, respectively, to reflect the substantial reduction in workforce.

Interest and other income (expense) — Interest and other income was $(29,000) and $9,000 for the three months ended September 30, 2002 and 2001, respectively, representing a decrease of $38,000. The decrease was due to lower interest income resulting from less cash being available to invest.

Provision for income taxes — Provision for income taxes was $10,000 and $30,000 for the three months ended September 30, 2002 and 2001, respectively, representing a decrease of $20,000. This represents the minimum amount required for state taxes. The Company has not recorded a current or deferred provision for deferral income taxes for any period to date, as a result of losses incurred since its inception.

Six Months Ended September 30, 2002 and 2001

Revenues

Revenues were $18.3 million and $22.6 million for the six month periods ended September 30, 2002 and 2001, respectively, representing a decrease of $4.3 million or 19%. International revenues accounted for less than 10% of total revenue for the six months ended September 30, 2002 and 17% of total revenue in the six months ended September 30, 2001.

License — License revenues were $10.1 million and $13.5 million for the six month periods ended September 30, 2002 and 2001, respectively, representing a decrease of $3.4 million or 25%. License revenues represented 55.1% and 59.8% of total revenues for the six months ended September 30, 2002 and 2001, respectively. The decrease in license revenues was due to decreased demand for our CaliberRM, CodeWright and eXpressroom products and a decrease in the amount of third party products we resold.

Maintenance — Maintenance revenues were $5.1 million for the six month periods ended September 30, 2002 and 2001. Maintenance revenues represented 27.7% and 22.5% of total revenues for the six months ended September 30, 2002 and 2001, respectively.

Service — Service revenues were $3.1 million and $4.0 million for the six month periods ended September 30, 2002 and 2001, respectively, representing a decrease of $856,000 or 21%. Service revenues represented 17.2% and 17.7% of total revenues for the six months ended September 30, 2002 and 2001, respectively. The decrease in service revenues was due to fewer billable headcount available to perform training and consulting.

Cost of Revenues

License — License cost of revenues consists primarily of manufacturing and related costs such as media, documentation, product assembly and royalties. License cost of revenues was $872,000 and $2.1 million for the six month periods ended September 30, 2002 and 2001, respectively, representing a decrease of $1.2 million or 58%. License cost of revenues as a percentage of license revenue was 8.6% and 15.5% for the six months ended September 30, 2002 and 2001, respectively. The decrease in license cost of revenues was due to lower third party product sales resulting in a reduction of license cost of revenues.

Service — Service cost of revenues consists of the costs associated with performing training and consulting services. Service cost of revenues were $2.3 million and $3.5 million for the six month periods ended September 30, 2002 and 2001, respectively, representing a decrease of $1.2 million or 34%. Service cost of revenues as a percentage of service revenue was 73.7% and 87.9% for the six months ended September 30, 2002 and 2001, respectively. The decrease in service costs of revenues was due to lower salary expense as a result of lower headcount in the services organization along with the lower costs related to the decrease in personnel.

Amortization and write-down of intangibles — Amortization of intangibles consists of the amortization of developed technology associated with the Premia, Genitor, worldweb.net and Technology Builders acquisitions. Amortization of intangibles was $2.6 million and $6.3 million for the six months ended September 30, 2002 and 2001, respectively, representing a decrease of $3.7 million. Amortization and write-down of intangibles as a percentage of total revenue was 14.0% and 27.8% for the six months ended September 30, 2002 and 2001, respectively. As a result of the continuing deterioration of the economy, the resulting decrease in IT spending and the lack of demand for the products obtained in the worldweb.net acquisition, during the three months ended September 30, 2001, we evaluated the recoverability of the amounts recorded for developed technology acquired in the worldweb.net acquisition. We compared the carrying amounts of intangible assets to current cash flow forecasts and the original cash flow forecasts at the date of acquisition and determined that the amount recorded for developed technology was impaired. As a result, during the quarter ended September 30, 2001, we wrote down the value of developed technology by $2.7 million.

Gross Margin

Gross margin was $12.5 million and $10.7 million for the six months ended September 30, 2002 and 2001, respectively, representing an increase of $1.8 million or 17%. Gross margin was 68.5% and 47.4% of total revenues for the six months ended September 30, 2002 and 2001, respectively. The increase in gross margin was a result of lower amortization and write-down of intangible expense partially offset by lower margin on third party product we resell.

Operating Expenses

Research and development expenses — Research and development expenses include salaries and other expenses related to the development of new products and the enhancements of our current products. Research and development expenses were $5.0 million and $8.3 million for the six months ended September 30, 2002 and 2001, respectively, representing a decrease of $3.3 million or 39%. The decrease in research and development expenses was due to lower salary and other personnel expenses associated with a 38% reduction in research and development headcount from the prior year.

Sales and marketing — Sales and marketing expenses were $10.1 million and $15.0 million for the six months ended September 30, 2002 and 2001, respectively, representing a decrease of $4.9 million or 33%. The decrease in sales and marketing expenses was due to lower salary and other personnel expenses associated with a 32% reduction in sales and marketing headcount from the prior year.

General and administrative — General and administrative expenses were $2.9 million and $5.9 million for the six months ended September 30, 2002 and 2001, respectively, representing a decrease of $3.0 million or 50%. The decrease in general and administrative expenses was due to lower salary and other personnel expenses associated with a 14% reduction in general and administrative headcount from the prior year along with lower legal and allowance for doubtful accounts expenses.

Non-cash equity based compensation — Non-cash equity based compensation was $298,000 and $338,000 for the six months ended September 30, 2002 and 2001, respectively, representing a decrease of $40,000. Non-cash equity based compensation expense represents the fair market value at the date of grant of stock options and warrants to purchase our common stock granted to non-employees amortized over the vesting period.

Amounts recorded for non-cash equity based compensation for the six months ended September 30, 2002 and 2001 relate to the following consolidated statement of operations categories:


	Six months ended

(in thousands)	September 30, 2002		September 30, 2001

Research and development	$	—	$	48
Sales and marketing		34		36
General and administrative		264		254

	$	298	$	338

Amortization and write-down of intangibles — Amortization and write-down of intangibles was $480,000 and $43.5 million for the six months ended September 30, 2002 and 2001, respectively. This includes amortization of goodwill, customer list and assembled workforce associated with the SITE, Premia, ObjectShare, worldweb.net and Technology Builders acquisitions.

As a result of the continuing deterioration of the economy, the resulting decrease in IT spending and the lack of demand for the products obtained in the worldweb.net acquisition, during the quarter ended September 30, 2001, we compared the carrying amounts of goodwill acquired in the worldweb.net and ObjectShare acquisitions to current cash flow forecasts and the original cash flow forecasts at the date of acquisitions and determined that the amounts recorded for goodwill were impaired. As a result, we wrote-down the value of goodwill related to worldweb.net by $23.4 million and the value of goodwill related to ObjectShare by $7.7 million. We compared the carrying amount of customer lists acquired in the TBI acquisition to current cash flow forecasts and the original cash flow forecasts at the date of acquisition and determined that the amount recorded for customer lists was impaired. As a result, we wrote down the value of customer lists related to TBI by $792,000. We also wrote-down the values recorded for assembled workforce related to worldweb.net and TBI by $859,000 and $838,000, respectively, to reflect the substantial reduction in workforce.

Interest and other income (expense) — Interest and other income (expense) was $(333,000) and $106,000 for the six months ended September 30, 2002 and 2001, respectively, representing a decrease of $439,000. The decrease was due to lower interest income resulting from less cash being available to invest.

Provision for income taxes — Provision for income taxes was $18,000 and $87,000 for the six months ended September 30, 2002 and 2001. This represents the minimum amount required for state taxes. The Company has not recorded a current or deferred provision for deferral income taxes for any period to date, as a result of losses incurred since its inception.

Inflation

Inflation has not had a significant effect on our results of operations of financial position for the three and six month periods ended September 30, 2002 and 2001.

Liquidity and Capital Resources

We have funded our business, to date, primarily from the issuance of equity and debt securities. Cash and cash equivalents as of September 30, 2002 were $1.4 million and as March 31, 2002 were $1.5 million. At September 30, 2002 we had negative working capital of $5.0 million, compared to negative working capital of $3.0 million at March 31, 2002.

Net cash provided by operating activities was $32,000 for the six months ended September 30, 2002 and net cash used in operating activities was $12.3 million for the six months ended September 30, 2001. The increase in cash provided by operating activities was due to a lower net loss, an increase in deferred revenue and a decrease in accounts payable partially offset by an increase in write-down of intangibles and depreciation and amortization expense and decrease in accounts receivable.

Net cash used in investing activities was $29,000 and $716,000 million for the six months ended September 30, 2002 and 2001, respectively. The decrease was due to a decrease in capital expenditures.

Net cash used in financing activities was $124,000 for the six months ended September 30, 2002 and net cash provided by financing activities was $2.0 million for the six months ended September 30, 2001.

Accounts receivable, net of allowances decreased to $5.8 million at September 30, 2002 from $8.0 million at March 31, 2002. The decrease was a result of lower sales volume along with an improvement in our collection efforts as our Days Sales Outstanding (DSO) improved to 59 days at September 30, 2002 from 66 days at March 31, 2002.

Minimum rental commitments under lease agreements at September 30, 2002 are as follows:


		Non-cancelable
Year ending March 31,		Operating Leases

		(In thousands)
	2003	$	2,476
	2004		2,310
	2005		2,352
	2006		1,431

Total payments		$	8,569

Management believes, based upon projected operating needs, that our working capital is insufficient for us to maintain our current level of operating activities through March 31, 2003. We have also experienced recurring losses from operations and have negative working capital at September 30, 2002. These factors, among others, raise substantial doubt about our ability to continue as a going concern. On May 22, 2002, we entered into a definitive purchase agreement to raise approximately $12.0 million through the sale of convertible preferred stock and warrants to institutional investors in a private placement. On July 29, 2002, our stockholders approved the financing and a one-for-ten reverse stock split at a special meeting of stockholders called for those purposes. Proceeds of the financing would have been be used for working capital. In August 2002, we received notification from some investors that they were terminating their obligations under the purchase agreement, which was scheduled to close on August 13, 2002. As a result of the pending merger with Borland Software Corporation, we terminated the private placement.

In connection with the Merger Agreement, Borland also agreed to provide the Company a bridge loan of up to $2 million. In October 2002, the Company borrowed $750,000 against the bridge loan.

New Accounting Standards

141 on July 1, 2001. Such adoption had no impact on our consolidated financial position or results of operations though June 30, 2002. We adopted SFAS No. 142 on April 1, 2002. As a result, the Company has reclassified assembled workforce into goodwill and has ceased amortization of goodwill, reducing annual amortization expense by approximately $10.4 million. We will continue to amortize developed technology and customer lists over their remaining lives. SFAS No. 142 also required the Company to perform a transition impairment test for goodwill by determining if the fair value of the Company’s reporting units is less than the carrying value of the reporting units. The Company completed the transition impairment testing during the quarter ended September 30, 2002 and determined that it did not have a transition impairment of goodwill. The Company will perform subsequent annual impairment reviews during the fourth fiscal quarter of each year, or earlier if indicators of potential impairment exists. Future impairment reviews may result in charges against earnings to write-down the value of intangible assets.

In August 2001, the FASB issued SFAS No. 144, Accounting for Impairment or Disposal of Long-Lived Assets. SFAS No. 144 addresses financial accounting and reporting for the impairment of long-lived assets and for the disposal of long-lived assets. SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and is effective for fiscal year beginning after December 15, 2001. We adopted SFAS No. 144 effective April 1, 2002. The adoption of this statement did not have a material impact on our consolidated financial position or results of operations.

In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which addresses financial accounting and reporting for costs associated with the exit or disposal activities and supersedes Emerging Issues Task Force (EITF) Issue 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in Restructuring). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF Issue 94-3, a liability for an exit cost, as defined in EITF 94-3, was recognized at the date of the entity’s commitment to an exit plan. SFAS No. 146 also establishes that the liability should measured and recorded at fair value. We will adopt the provisions of SFAS No. 146 for exit or disposal activities that are initiated after March 31, 2002.

Risk Factors

Our business is subject to a variety of risks and special considerations. As a result, our prospective investors should carefully consider the risks described below, and the other information in this document, before deciding to invest in the shares.

Our business, financial condition and results of operations could be adversely affected by any of the following risks. If we are adversely affected by such risks, then the trading price of our common stock could decline, and you could lose all or part of your investment.

RISKS ASSOCIATED WITH THE COMPANY

WE HAVE A HISTORY OF LOSSES AND WE EXPECT TO INCUR FUTURE LOSSES IF WE ARE UNABLE TO SUCCESSFULLY AND COST EFFECTIVELY DEVELOP, MARKET AND DISTRIBUTE OUR PRODUCTS

Since our inception, we have had a history of losses and, as of September 30, 2002, we had an accumulated deficit of $186.5 million. Further, the cash requirements to run our business have been and will continue to be significant. In the past, we had negative cash flow from operations. We anticipate incurring additional losses until we can successfully develop, market and distribute our products. Developing our software products is difficult and time consuming and requires the coordinated participation of various technical and marketing personnel and, at times, independent third-party suppliers. If our personnel and third parties are unable to work together and coordinate their efforts in order to quickly and cost-efficiently develop our products, the development process may encounter delays, which could lead to increased operating expenses and future losses. The likelihood of the success of our business must be considered in light of the problems, expenses, difficulties, complications and unforeseen delays frequently encountered in connection with the development of new software technologies. Further, our ability to achieve or sustain our revenue or profit goals depends on a number of factors outside of our control, including the extent to which:

	•		there is market acceptance of commercial services utilizing our products;

	•		our competitors announce and develop competing products or significantly lower their prices; and

	•		our customers promote our product.

IF WE ARE UNABLE TO ACHIEVE POSITIVE OPERATING RESULTS OR OUR PENDING MERGER WITH BORLAND SOFTWARE CORPORATION IS NOT COMPLETED, WE MAY NEED TO RAISE ADDITIONAL CAPITAL AND MAY NOT BE ABLE TO CONTINUE TO OPERATE AS A GOING CONCERN

In the past, we have used cash from outside financing to fund our operations. If we cannot achieve positive operating results and positive cash flow, we may need to raise additional funds. There can be no assurances that funds may be raised on acceptable terms or when needed, if at all. If we cannot raise necessary funds on acceptable terms, we may not be able to develop or enhance our products, take advantage of future opportunities or respond to competitive pressures or unanticipated capital requirements, which could have a material adverse effect on our business, operating results and financial condition. If we are unable to achieve positive operating results and are unable to raise additional funds, we may need, among other things, to sell our assets, to further reduce our workforce or to close facilities.

At September 30, 2002, our current capital resources were $7.2 million and consisted of $1.4 million of cash and $5.8 million of accounts receivable. We also had $6.3 million in liabilities that will need to be paid with cash and negative working capital of $5.0 million.

Our independent auditors’ report from Deloitte and Touche LLP dated May 28, 2002 indicated a substantial doubt about our ability to continue as a going concern. Management also believes, based upon projected operating needs, that our working capital is insufficient for us to maintain our current level of operating activities through March 31, 2003. We have also experienced recurring losses from operations and have negative working capital at September 30, 2002. These factors, among others, raise substantial doubt about our ability to continue as a going concern. On May 22, 2002, we entered into a definitive purchase agreement to raise approximately $12.0 million through the sale of convertible preferred stock and warrants to institutional investors in a private placement. On July 29, 2002, our stockholders approved the financing and a one-for-ten reverse stock split at a special meeting of stockholders called for those purposes. Proceeds of the financing would have been used for working capital. In August, we received notification from some investors that they were terminating their obligations under the purchase agreement, which was scheduled to close on August 13, 2002. As a result of the pending merger with Borland Software Corporation we terminated the private placement.

In connection with the Merger Agreement, Borland also agreed to provide the Company a bridge loan of up to $2 million. In October 2002, the Company borrowed $750,000 against the bridge loan.

WE HAVE PREVIOUSLY INCURRED AND MAY INCUR FUTURE IMPAIRMENT LOSSES RELATED TO INTANGIBLE ASSETS FROM PRIOR ACQUISITIONS WHICH COULD NEGATIVELY AFFECT OUR FUTURE OPERATING RESULTS

During the year ended March 31, 2002, we had an impairment write-down of $64.8 million related to intangible assets from prior acquisitions. If our operating performance and the overall market environment do not improve, we may incur additional write-downs of our remaining intangible assets that could adversely affect our financial position, our operating results and our ability to raise additional financing.

WE RELY HEAVILY ON SALES OF STARTEAM AND IF IT DOES NOT SUSTAIN MARKET OR IT DECREASES IN ACCEPTANCE, WE ARE LIKELY TO EXPERIENCE LARGER LOSSES

For the quarter ended September 30, 2002, we generated 47% of our total revenues and 57% of our licensing revenues from licenses of our StarTeam product line. We believe that revenues generated from StarTeam will continue to account for a large percentage of our revenues for the foreseeable future. A decline in the price of, or demand for, StarTeam would have a material adverse effect on our business, operating results and financial condition. The following events may reduce the demand for StarTeam:

	•		competition from other products;

	•		flaws in our software products or incompatibility with third-party hardware or software products;

	•		negative publicity or evaluation of our company; or

	•		obsolescence of the hardware platforms or software environments in which our systems run.

In addition, our future financial performance will depend upon successfully developing and selling enhanced versions of StarTeam. If we fail to deliver product enhancements or new products for our customers, it will be difficult for us to succeed.

IF WE DO NOT CONTINUE TO RECEIVE REPEAT BUSINESS FROM EXISTING CUSTOMERS, OUR REVENUE WILL SUFFER

We generate a significant amount of our software license revenues from existing customers. Most of our current customers initially purchase a limited number of licenses as they implement and adopt our products. Even if the customer successfully uses our products, customers may not purchase additional licenses to expand the use of our products. Purchases of expanded licenses by these customers will depend on their success in deploying our products, their satisfaction with our products and support services and their use of competitive alternatives. A customer’s decision to widely deploy our products and purchase additional licenses may also be affected by factors that are outside of our control or which are not related to our products or services. In addition, as we deploy new versions of our products or introduce new products, our current customers may not require the functionality of our new products and may decide not to license these products.

IF WE ARE UNABLE TO FURTHER INTEGRATE THE OPERATIONS OF TECHNOLOGY BUILDERS, INC., WE MAY NOT BE ABLE TO SUCCESSFULLY CONTINUE TO DEVELOP AND MARKET TECHNOLOGY BUILDERS’ PRODUCTS AND OUR REVENUES MAY SUFFER

We acquired Technology Builders, Inc. on February 23, 2001. The success of this acquisition will depend on our ability to:

	•		successfully integrate and manage its technology and operations;

	•		retain its software developers;

	•		develop and market new products and enhance existing products based on its technology; and

	•		retain its customer base.

Our failure to successfully address the risks associated with our acquisition of Technology Builders could hurt our ability to develop and market products based on Technology Builders’ technology.

RISKS ASSOCIATED WITH THE INDUSTRY

WE FACE INTENSE COMPETITION FOR APPLICATION SOFTWARE WHICH COULD MAKE IT DIFFICULT FOR US TO ACQUIRE AND RETAIN CUSTOMERS AND ADVERSELY AFFECT OUR OPERATING RESULTS

The application software market is intensely competitive and rapidly evolving. Our customers’ requirements and the technology available to satisfy those requirements continually change. We expect competition to intensify in the future. Our principal competitors include in-house development efforts by potential customers or partners, vendors of code management software, and vendors of content management software. Many of these companies have longer operating histories and significantly greater financial, technical, marketing and other resources than we do. Many of these companies can also leverage extensive customer bases and adopt aggressive pricing policies to gain market share. Potential competitors may bundle their products in a manner that may discourage users from purchasing our products. In addition, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share.

Competitive pressures may make it difficult for us to acquire and retain customers and may require us to reduce the price of our software in order to attract new customers and keep existing customers. If we have to reduce the purchase price of our software, our revenues may decrease. If we fail to compete successfully against current or future competitors, we could lose customers and our business, operating results and financial condition would suffer.

IF WE FAIL TO ESTABLISH AND MAINTAIN STRATEGIC RELATIONSHIPS, THE MARKET ACCEPTANCE OF OUR PRODUCTS AND OUR FINANCIAL PERFORMANCE MAY SUFFER

To date, the majority of our revenue came from our direct sales efforts. To offer products and services to a larger customer base, our direct sales force depends on strategic partnerships and marketing alliances to obtain customer leads, referrals and distribution. If we are unable to maintain our existing strategic relationships or fail to enter into additional strategic relationships, our ability to increase our sales will be harmed. We would also lose anticipated customer introductions and co-marketing benefits. In addition, our strategic partners may not regard us as significant for their own businesses. Therefore, they could reduce their commitment to us or terminate their relationships with us, pursue other

partnerships or relationships, or attempt to develop or acquire products or services that compete with our products and services. Even if we succeed in establishing these relationships, they may not result in additional customers or revenues.

WE HAVE LIMITED EXPERIENCE CONDUCTING OPERATIONS INTERNATIONALLY, WHICH MAY MAKE OVERSEAS EXPANSION MORE DIFFICULT AND COSTLY

To date, we have derived most of our revenues from sales to North American customers. We plan to expand our international operations in the future. There are many barriers and risks to competing successfully in the international marketplace, including:

	•		costs of customizing products for foreign countries;

	•		foreign currency risks;

	•		dependence on local vendors;

	•		compliance with multiple, conflicting and changing governmental laws and regulations;

	•		longer sales cycles; and

	•		import and export restrictions and tariffs.

As a result of these competitive barriers to entry and risks, we cannot assure you that we will be able to successfully market, sell and deliver our products and services in international markets.

IF WE FAIL TO EFFECTIVELY MANAGE AND SUPPORT OUR ANTICIPATED GROWTH IN OPERATIONS, WE MAY NOT ACHIEVE FUTURE REVENUE GROWTH AND PROFITABILITY

To succeed in the implementation of our business strategy, we must rapidly execute our sales strategy, further develop and enhance products and expand our service capabilities. To manage anticipated growth resulting from this strategy, we must:

	•		continue to implement and improve our operational, financial and management information systems;

	•		hire, train and retain qualified personnel;

	•		continue to expand and upgrade core technologies; and

	•		effectively manage multiple relationships with our customers, applications developers and other third parties.

If we fail to manage and support our growth as planned, our business strategy, the anticipated growth in revenues and our profitability may not be achieved.

WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, WHICH COULD RESULT IN THE USE OF OUR TECHNOLOGY BY COMPETITORS OR OTHER THIRD PARTIES RESULTING IN LOWER SALES OF OUR PRODUCTS

Our success depends significantly on our ability to protect our proprietary technologies. If we are not adequately protected, our competitors could use the intellectual property that we have developed to enhance their products and services to our detriment. We rely on a combination of trade secrets, patents, confidentiality provisions and other contractual provisions to protect our proprietary rights, but these legal means provide only limited protection.

OUR PRODUCTS USE TECHNOLOGY THAT MAY INFRINGE ON THE PROPRIETARY RIGHTS OF THIRD PARTIES, WHICH MAY EXPOSE US TO LITIGATION AND OTHER COSTS

As the number of entrants into our market increases, the possibility of a patent infringement claim against us grows. For example, we inadvertently may be infringing a patent of which we are unaware. In addition, because patent applications can take many years to issue, there may be a patent application now pending of which we are unaware, which will cause us to infringe such patent when it is issued in the future. To address any patent infringement claims, we may have to enter into royalty or licensing agreements on commercial terms that are not favorable to us. A successful claim of patent infringement against us, or our failure to license the infringed or similar technology, may cause us to delay or cancel shipment of our products or result in significant costs. This could hurt our revenues and profitability and result in a material adverse effect on our business, operating results and financial condition. In addition, any infringement claims, with or without merit, would be time-consuming and expensive to litigate or settle and could divert management attention from administering our core business.

OUR FAILURE TO DELIVER DEFECT-FREE SOFTWARE COULD RESULT IN GREATER LOSSES AND HARMFUL PUBLICITY

Our software products are complex and may contain defects or failures. Moreover, third parties may develop and spread computer viruses that may damage the functionality of our software products. Any of these events may result in delayed or lost revenues, loss of market share, failure to achieve market acceptance, reduced customer satisfaction, diversion of development resources, product liability or warranty claims against us, and damage to our reputation. Although we maintain liability insurance, this insurance coverage may not be adequate to cover losses from claims against us. Further, defending a product liability lawsuit, regardless of its merits, could harm our business because it entails substantial expense and diverts the time and attention of key management personnel.

RISKS ASSOCIATED WITH OUR COMMON STOCK

IF OUR OUTSTANDING WARRANTS AND OPTIONS ARE EXERCISED, THERE WILL BE FURTHER DILUTION TO OUR COMMON STOCKHOLDERS

As of September 30, 2002, we had 383,691 warrants to purchase the equivalent number of shares of our common stock outstanding at prices ranging from $3.20 to $68.13. In addition, as of September 30, 2002, we had 2,017,125 stock options granted outstanding with a weighted-average exercise price of $23.32, of which 1,183,546 are exercisable at a weighted-average exercise price of $26.04. Exercise of either the outstanding warrants or granted stock options will dilute the position of our common stockholders.

ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We do not use derivative financial instruments for our investment purposes, nor do we have any foreign exchange hedging contracts.

Exchange Rate Risk

We have minimal risk related to currency fluctuations. Less than 10% of our revenues are from sources outside the United States and all sales are denominated in U.S. dollars. We have subsidiaries in Canada and the United Kingdom; therefore, we are subject to exchange rate risk related to the translation and consolidation of our subsidiaries’ financial statements.

Interest Rate Risk

We may be exposed to interest rate risk related to the Accounts Receivable Purchase Agreement that we entered into with Silicon Valley Bank in April 2002, which allows us to sell up to $4.0 million of our accounts receivable with a finance charge equal to 5.0% above Prime Rate.

Intangible Asset Risk

We have a substantial amount of intangible assets. During the 2002 fiscal year, as a result of the deterioration of the economy, the decrease in information technology spending, the lack of demand for the products obtained in the worldweb.net acquisition and the significant reduction in headcount, we recorded a write-down of intangible assets of $64.8 million. Future deterioration of the economy could result in further impairment of our intangible assets, requiring us to record an additional write down expense.

ITEM 4
CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended (Exchange Act)) as of a date within 90 days prior to the filing date of this quarterly report (Evaluation Date). Based on such evaluation, such officers have concluded that, as of the Evaluation Date, our disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to us (including our consolidated subsidiaries) required to be included in our periodic filings under the Exchange Act.

Changes in Internal Controls

Since the Evaluation Date, there have not been any significant changes in our internal controls or in other factors that could significantly affect such controls.

PART II

ITEM 5
OTHER INFORMATION

On October 8, 2002, the Company entered into an Agreement and Plan of Merger (Merger Agreement) with Borland Software Corporation, a Delaware corporation (Borland), and Galaxy Acquisition Corp., a Delaware corporation and wholly owned subsidiary of Borland (Purchaser). The Merger Agreement provides for Purchaser commencing a tender offer (Offer) for all outstanding shares of the Company’s common stock at a price of $2.75 per share, net to the seller in cash, without interest, subject to certain conditions, including the tender, without withdrawal prior to the expiration of the Offer, of at least a majority of the Company’s outstanding shares of common stock, including shares subject to the Company’s stock options with an exercise price per share less than $2.75.

In connection with the Merger Agreement, Borland also agreed to provide the Company a bridge loan of up to $2 million. In October 2002, the Company borrowed $750,000 against the bridge loan.

As of midnight, Eastern Standard Time, on November 8, 2002, approximately 6,674,993 shares of the Company’s common stock, or approximately 76.3% of the outstanding shares had been tendered.

The Merger Agreement also provides that following consummation of the Offer and the satisfaction or waiver of certain conditions, Purchaser will be merged with and into the Company (Merger) with the Company surviving the Merger as a wholly owned subsidiary of Borland, and all remaining outstanding shares of the Company’s common stock will be converted into the right to receive $2.75 per share, net, in cash, without interest.

For further information refer to the Company’s Solicitation/Recommendation Statement on Schedule 14D-9 filed with the Securities and Exchange Commission on October 11, 2002, as amended.

ITEM 6
EXHIBITS AND REPORTS ON FORM 8-K

(a)

Exhibits


Exhibit		Ref./
Number	Description Of Document	Page

99.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.




99.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.




99.3	Settlement Agreement and Release with World Web Investors, LLC and ABN AMRO CAPITAL USA.

(b)

Reports on Form 8-K

In a report filed on Form 8-K, dated October 8, 2002, the Company reported the Agreement and Plan of Merger with Borland Software Corporation

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

STARBASE CORPORATION
(Registrant)

November 19 , 2002

Date

/s/ James A. Harrer

James A. Harrer
Chief Executive Officer

/s/ Douglas S. Norman

Douglas S. Norman
Chief Financial Officer

CERTIFICATIONS

I, James A. Harrer, certify that:

	1.		I have reviewed this quarterly report on Form 10-Q of Starbase Corporation;

	2.		Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

	3.		Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

	4.		The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

		a)	designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

		b)	evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

		c)	presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

		a)	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

		b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

/s/ James A. Harrer

Chief Executive Officer

Date: November 19, 2002

I, Douglas S. Norman, certify that:

	1.		I have reviewed this quarterly report on Form 10-Q of Starbase Corporation;

	2.		Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

	3.		Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

	4.		The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

		a)	designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

		b)	evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

		c)	presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

		a)	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

		b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

/s/ Douglas S. Norman

Chief Financial Officer

Date: November 19, 2002

EXHIBIT INDEX


Exhibit		Ref./
Number	Description Of Document	Page

99.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.




99.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.




99.3	Settlement Agreement and Release with World Web Investors, LLC and ABN AMRO CAPITAL USA.

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

STARBASE CORP 10-Q