10-Q 1 j0190801e10vq.txt PRINTCAFE SOFTWARE UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003 OR [ ] 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 0-49710 PRINTCAFE SOFTWARE, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 25-1854929 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) FORTY 24TH STREET PITTSBURGH, PENNSYLVANIA 15222 (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code: (412) 456-1141 Indicate by check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No. [X] The number of shares of the registrant's common stock, $.0001 par value, outstanding as of the close of business on August 14, 2003 was 12,874,928. PRINTCAFE SOFTWARE, INC. INDEX PART I FINANCIAL INFORMATION PAGE NO. -------- ITEM 1 - Financial Statements: Consolidated Balance Sheets - December 31, 2002 and June 30, 2003 ...................................... 3 Consolidated Statements of Operations - Three months and Six months ended June 30, 2002 and 2003 ................. 4 Consolidated Statements of Cash Flows - Six months ended June 30, 2002 and 2003 .................................. 5 Notes to Consolidated Financial Statements ................................ 6 ITEM 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations .............................................. 11 ITEM 3 - Quantitative and Qualitative Disclosures About Market Risk ............. 23 ITEM 4 - Controls and Procedures ................................................ 23 PART II OTHER INFORMATION ITEM 1 Legal Proceedings .......................................................... 24 ITEM 2 Changes in Securities and Use of Proceeds .................................. 24 ITEM 4 Submission of Matters to a Vote of Security Holders ........................ 24 ITEM 6 - Exhibits and Reports on Form 8-K ......................................... 24 Signatures ...................................................................... 26

2 PRINTCAFE SOFTWARE, INC. PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS PRINTCAFE SOFTWARE, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)

See accompanying notes to consolidated financial statements. 3 PRINTCAFE SOFTWARE, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA)

See accompanying notes to consolidated financial statements. 4 PRINTCAFE SOFTWARE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED, IN THOUSANDS)

See accompanying notes to consolidated financial statements. 5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Printcafe Software, Inc. is a provider of software solutions designed specifically for the printing industry supply chain. Our enterprise resource planning and collaborative supply chain software solutions enable printers and print buyers to lower costs and improve productivity. Our procurement applications, which are designed for print buyers, facilitate collaboration between printers and print buyers over the Web. Our software solutions have been installed by more than 4,000 customers in over 8,000 facilities worldwide, including 24 of the 25 largest printing companies in North America and over 50 businesses in the Fortune 1000. On February 26, 2003, we entered into a merger agreement with Electronics for Imaging, Inc., or EFI. If the merger is completed, Printcafe would become a wholly-owned subsidiary of EFI. Under the terms of the merger agreement, each share of our common stock will be converted into $2.60 of consideration which will be paid, at the election of each of our stockholders, in shares of EFI's common stock or cash. EFI's common stock is traded on the NASDAQ National Market under the symbol "EFII". Our board of directors has approved the merger with EFI and has called a special meeting of our stockholders to vote on the merger. The merger will be adopted if the holders of a majority of our outstanding shares of common stock vote for the proposed merger with EFI. LIQUIDITY The Company believes that, based on current levels of operations and anticipated growth, cash from operations, together with cash currently available, will suffice to fund our operations through January 1, 2004. Poor financial results, unanticipated expenses or unanticipated opportunities that require financial commitments could give rise to additional financing requirements sooner than the Company expected. If the Company does not raise additional funds when needed, expenditures for expansion of product plans and other strategic initiatives might have to be delayed, scaled back or eliminated. If the Company does not complete the merger with EFI or complete a similar transaction with a third party, the Company does not expect to have sufficient cash to repay the $14,200 outstanding debt which becomes due and payable in January 2, 2004 without securing additional debt or equity financing. It is not expected that additional debt or equity financing would be available. If the Company is unable to pay these amounts when due, the lenders could proceed against the collateral. Should the merger with EFI not be successful, there is uncertainty as to the Company's ability to continue as a going concern through the year ending December 31, 2004. The financial statements do not include any adjustments relating to the recoverability and classification of assets or the amount and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The Company's continued existence is dependent upon its ability to generate sufficient cash flows from equity financing and successfully concluding additional license agreements. USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. INTERIM BASIS OF PRESENTATION The Company's financial statements include the accounts of the Company and its wholly-owned subsidiaries after the elimination of all significant intercompany balances and transactions. Amounts within the financial statements and footnote disclosures have been recorded in thousands except for the share and per share data. The accompanying consolidated financial statements as of June 30, 2003, and for the three and six month periods ended June 30, 2002 and 2003, respectively, are unaudited. The unaudited interim consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements and, in the opinion of management, reflect all adjustments, which include only normal, recurring accruals necessary to state fairly the Company's financial position as of June 30, 2003, and the results of operations and cash flows for the three and six month periods ended June 30, 2002 and 2003, respectively. These consolidated financial statements and notes thereto should be read in conjunction with the Company's audited consolidated financial statements and related notes included in its Form 10K, as filed with the Securities and Exchange Commission on March 21, 2003. The results for interim periods are not necessarily indicative of the expected results for any other interim period or the year ending December 31, 2003. The amounts included in the consolidated balance sheet at December 31, 2002 were derived from our audited financial statements. REVENUE RECOGNITION The Company's revenue recognition policy is governed by Statement of Position (SOP) 97-2, Software Revenue Recognition, issued by the American Institute of Certified Public Accountants (AICPA). The Company derives its revenues from licenses and subscriptions for its products as well as from the provision of related services, including installation and training, consulting, customer support, and maintenance contracts. Revenues are recognized only if persuasive evidence of an agreement exists, delivery has occurred, all significant vendor obligations are satisfied, the fee is fixed, determinable, and collectible and there is vendor-specific objective evidence (VSOE) to support the allocation of the total fee to a multi-element arrangement. The Company does not have VSOE for the license component or the fixed price installation component and these have historically been sold bundled together with post-contract support. Therefore, the Company follows the residual method as outlined in SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions, under which revenue is allocated to the undelivered elements and the residual amounts of revenue are allocated to the delivered elements. Many of the Company's agreements include warranty provisions. Historically, these provisions have not had a significant impact on the Company's revenue recognition. In those instances where customer acceptance may be in question, all revenue relating to that arrangement is deferred until the warranty period has expired. Additional revenue recognition criteria by revenue type are listed below. 6 LICENSE AND SUBSCRIPTION REVENUE: License and subscription revenue includes fees for perpetual licenses and periodic subscriptions. The Company recognizes revenues on license fees after a license agreement has been signed, the product has been delivered, the fee is fixed, determinable and collectible, and there is VSOE to support the allocation of the total fee to a multielement arrangement (if applicable). If VSOE cannot be obtained for certain elements of the contract, the Company recognizes revenue using the residual method under which revenue is allocated to the undelivered elements and the residual amounts of revenue are allocated to the delivered elements. The Company recognizes revenues on periodic subscriptions over the subscription term for unlimited subscriptions and based on the value of orders processed for its customers through the system for limited subscriptions. Revenue is recognized for subscription orders processed through resellers over the subscription term of the underlying agreement, beginning upon installation. MAINTENANCE REVENUE: Maintenance revenue is derived from the sale of maintenance and support contracts, which provide customers with the right to receive maintenance releases of the licensed products and access to customer support staff. Maintenance revenue is recognized on a straight-line basis over the term of the contract, which is typically one year. Payments for maintenance revenue are normally received in advance and are nonrefundable. PROFESSIONAL SERVICES AND OTHER REVENUE: Professional services and other revenue are derived from variable fees for installation, training, and consulting. Revenue for professional services such as installation and training, system integration projects, and consulting is primarily recognized as the services are performed. If these services are part of a multielement contract under which VSOE cannot be obtained for certain elements, they may be deferred either until acceptance of any related software or over the license period. FAIR VALUE OF FINANCIAL INSTRUMENTS For certain financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities, recorded amounts approximate fair value due to the relative short maturity period. On May 31, 2002 and June 10, 2002, the Company entered into new agreements for its related party debt. As a result, the carrying amount of this debt approximates market value as of June 30, 2003. The carrying amount of the line of credit approximates market value because it has an interest rate that varies with market interest rates. The fair values of the obligations under capital leases are estimated based on current interest rates available to the Company for debt instruments with similar terms, degrees of risk, and remaining maturities. The carrying values of these obligations approximate their respective fair values. The estimated fair values may not be representative of the actual values of these financial instruments that could have been realized as of the period end or that will be realized in the future. STOCK-BASED COMPENSATION AND WARRANTS Effective December 2002, the Company adopted the disclosure-only provisions of SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure (SFAS No. 148), which is consistent with the Company's utilization of the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation (SFAS No. 123). The Company accounts for equity instruments issued to non-employees and pursuant to strategic alliance arrangements in accordance with the provisions of SFAS No. 123, Emerging Issues Task Force (EITF) No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring or in Conjunction with Selling Goods or Services, and Emerging Issues Task Force (EITF) No. 01-9, Accounting for Consideration Given by Vendor to a Customer or a Reseller of the Vendor's Product. The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to employee stock-based awards:

The stock-based compensation income is a result of forfeitures upon termination of nonvested options. 7 RECENT ACCOUNTING PRONOUNCEMENTS VARIABLE INTEREST ENTITIES In January 2003, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 46, "Consolidation of Variable Interest Entities". This Interpretation applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that is acquired before February 1, 2003. The Company does not believe the provisions of this Interpretation Standard have an impact on its consolidated financial statements upon adoption. FINANCIAL INSTRUMENTS In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" ("SFAS No. 150"). The Statement improves the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. The new Statement requires those instruments be classified as liabilities in statements of financial position. SFAS No. 150 also requires disclosures about alternative ways of settling financial instruments and the capital structure of entities whose shares are mandatorily redeemable. Most of the guidance in SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company does not believe the provisions of this Statement will have an impact on its consolidated financial statements upon adoption. 2. NET LOSS PER SHARE Basic and diluted net loss per share have been computed using the weighted average number of shares of common stock outstanding during the period. Potential common shares issuable upon conversion of convertible preferred stock and exercise of stock options and warrants are excluded from historical diluted net loss per share because they would be antidilutive. At June 30, 2002 and 2003, 1,596,855 and 1,426,254 potential common shares, respectively, are excluded from the determination of diluted net loss per share, as the effect of such shares is antidilutive.

8 3. GOODWILL AND OTHER INTANGIBLE ASSETS Intangible assets and purchased technology are related mainly to the business acquisitions consummated in early 2000. Amortization is recorded on a straight-line basis over the estimated useful lives (generally three years) of the remaining assets and consists of the following at December 31, 2002 and June 30, 2003:

The Company previously adopted SFAS No. 142, Goodwill and Other Intangible Assets, which prohibits companies from amortizing goodwill and instead requires annual impairment testing of the goodwill. As a result, beginning January 1, 2002, the Company no longer amortizes goodwill. As of the adoption date, December 31, 2002 and June 30, 2003, the unamortized balance of goodwill was $22,480. Goodwill is subject to annual impairment testing. The Company previously adopted SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which requires the Company to review its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of long-lived assets may not be recoverable. No impairment charge has been recorded in any periods presented. 4. INITIAL PUBLIC OFFERING In June 2002, the Company issued 3,750,000 shares of its common stock at a price of $10.00 per share in its initial public offering. The Company received approximately $33,000 in proceeds, net of underwriting discounts, commissions, and offering expenses. Simultaneously with the closing of the initial public offering, each outstanding share of preferred stock was automatically converted into common stock based on the applicable conversion ratio. In connection with the offering, the Company repaid approximately $17,800 of related party debt. 5. COMMITMENTS AND CONTINGENCIES On February 19, 2003, Creo Inc. commenced an action in The Court of Chancery of the State of Delaware in and for New Castle County captioned Creo, Inc. v. Printcafe Software, Inc., Electronics For Imaging, Inc. (EFI), Marc D. Olin, Charles J. Billerbeck, Victor A. Cohn and Thomas J. Gill. Creo requested a temporary restraining order with respect to (a) triggering, exercising or otherwise giving effect to the stockholders' rights plan adopted by the Company, (b) enforcing any action taken or to be taken by us "with the intent or effect of impeding the operation of market forces in an open bidding contest for Printcafe," (c) taking any steps or actions to enforce the fee provided for in a letter agreement the Company entered into with EFI, (d) taking any steps or any actions to enforce an option the Company granted to EFI, (e) taking any steps or actions to enforce the no solicitation provisions of the standby credit letter that the Company entered into with EFI, (f) engaging in any "conduct intended to cause or having the effect of causing Printcafe to forgo the opportunity to explore and enter into economically more favorable transactions" and (g) entering into, or purporting to enter into, a merger agreement between EFI and the Company before the court finally rules on the action. On February 21, 2003 the court denied Creo's request for a temporary restraining order. The matter is still pending in the Delaware Chancery Court with respect to the other relief sought by Creo. The Company believes that the lawsuit is completely without merit and intends to vigorously defend itself. If this lawsuit is resolved unfavorably to us, our business and financial condition could be adversely affected and we may not be able to complete the merger. On June 25,2003 a securities class action complaint was filed against the Company, Marc Olin, President and Chief Executive Officer, and Joseph Whang, Chief Financial Officer and Chief Operating Officer, in the United States District Court for the Western District of Pennsylvania. The complaint alleges that the defendants violated Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 due to allegedly false and misleading statements in connection with the Company's initial public offering and subsequent press releases. The Company believes that the lawsuit is completely without merit and intends to vigorously defend itself. To date, the Company has not been required to file a response to the complaint and has not done so. In light of the early stage of this proceeding, the Company cannot predict with certainty the likely outcome of the action or the likely value of any of the related claims. The Company is involved in disputes and litigation in the normal course of business. In the opinion of management, the ultimate disposition of these matters is not expected to have a material adverse effect on the Company's business, financial condition, or results of operations. The Company has accrued for estimated losses in the accompanying financial statements for those matters where it believes that the likelihood that a loss has occurred is probable and the amount of loss is reasonably estimable. Although management currently believes the outcome of other outstanding legal proceedings, claims, and litigation involving the Company will not have a material adverse effect on its business, financial condition, or results of operations, litigation is inherently uncertain and there can be no assurance that existing or future litigation will not have a material adverse effect on the Company's business, financial condition, or results of operations. 9 6. COMPREHENSIVE LOSS The components of the Company's comprehensive loss for each period presented are as follows:

7. LINE OF CREDIT AND LONG-TERM DEBT On February 13, 2003, the Company entered into an agreement with EFI for a standby credit facility in the amount of $11,000 plus a working capital facility which will provide up to an additional $3,000 under certain circumstances. Under the terms of the standby credit facility, EFI is obligated to disburse up to $11,000 to the Company in the event that certain amounts under the Company's existing credit facilities become due and payable as a result of any action taken by the Company in order to facilitate the proposed business combination with EFI or certain other criteria. All loans made under this facility bear interest at the rate of 8% per annum payable on January 2, 2004. With certain exceptions, the maturity date would be accelerated if a business combination with EFI is not consummated on or before August 31, 2003 or upon the termination of the agreement. Subject to certain conditions, the credit facility also provides the Company with a working capital facility up to an aggregate amount of $3,000 to be disbursed in the event that, among other things, the Company's cash balance as of the close of business on the date notice is given by the Company is less than $1,000. The Company is obligated to use the proceeds of any exercise by EFI of the option agreement entered into on February 13, 2003 to pay down outstanding amounts under the standby credit facility. All loans under the working capital facility bear interest at a rate per annum equal to the prime rate as published, from time to time, by Citibank, plus two percent payable on the maturity date of the loans. In June 2003, the Company repaid the entire amount outstanding of $2,000 on its line of credit with National City Bank. After repayment, this facility was closed by the Company and National City Bank. As of June 30, 2003, the Company had a total of $1,764 of unamortized deferred interest and debt discount fees, which are reflected within the short-term debt related-party section of the Company's balance sheet. 8. NON-CASH DEFERRED STOCK-BASED COMPENSATION In February 2002, the Company's board of directors adopted the 2002 Key Executive Stock Incentive Plan. The Company reserved 766,520 shares of common stock for grants under the plan. During fiscal year 2002, the Company granted options to purchase 766,520 shares of common stock with an exercise price of $4.21 per share. In March 2002, the Company's board of directors adopted the 2002 Stock Incentive Plan. The Company has reserved 765,765 shares of common stock for grants under the plan. In April 2002, the Company granted options to purchase 381,603 shares of common stock, with an exercise price of $15.54 per share, to certain employees. In June 2002, the Company granted an additional 92,910 options to purchase common stock at an exercise price of $2.00 per share. These option grants, adjusted for any terminations and forfeitures during the period, resulted in $102 and $483 in non-cash stock compensation for the three and six months ended June 30, 2003, respectively. 10 9. STOCK OPTION On February 13, 2003, the Company entered into a stock option agreement with EFI granting them an option to purchase up to 2,126,574 shares of Common Stock at a purchase price equal to $2.60 per share. Subject to certain conditions, the option shares must be repurchased by the Company, at the request of EFI, at a price equal to the aggregate purchase price paid for such shares by EFI. In addition, subject to certain conditions, the Company may repurchase from EFI the option shares at a price equal to the price paid by EFI for those shares. In June 2003, EFI exercised this option and the Company received $5,529 in exchange for 2,126,574 shares of its common stock. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information in this discussion contains forward-looking statements that involve risks and uncertainties. These statements involve known and unknown risks, uncertainties, and other factors that may cause our actual results, performance, or achievements to be materially different from any future results, performances, or achievements expressed or implied by the forward-looking statements. In some cases, you can identify forward-looking statements by terms such as "may," "might," "will," "should," "could," "would," "plan," "expect," "intend," "believe," "goal," "estimate," "anticipate," "predict," "potential," or the negative of these terms, and similar expressions intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this Quarterly Report on Form 10-Q ("Form 10-Q"). You should read this Form 10-Q completely and with the understanding that our actual future results may be materially different from what we currently expect. We qualify all of our forward-looking statements by these cautionary statements. Factors that might cause or contribute to such a discrepancy include, but are not limited to, those discussed under the heading "Risk Factors That May Affect Future Results and Market Price of Stock" elsewhere in this Form 10-Q and the Risk Factors in our Form 10K dated March 21, 2003 and all other filings filed with the Securities and Exchange Commission. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes contained in this Form 10-Q. OVERVIEW GENERAL We have focused on developing software solutions designed specifically for the printing industry supply chain since our inception in 1987. In February 2000, Prograph Systems, our predecessor company, changed its name to printCafe, Inc., and we launched our Web-based products to complement our enterprise resource planning software. From February through April 2000, we acquired five complementary businesses for an aggregate purchase price of $137,300. We have also committed significant resources to develop, integrate, and market our products, expand our management team, and hire additional personnel. On June 18, 2002, we completed our initial public offering by issuing 3,750,000 shares of our common stock at a price of $10.00 per share. We incurred a net loss of $40,797 for the year ended December 31, 2002 and $14,909 in the first six months of 2003 and had an accumulated deficit of $249,599 as of June 30, 2003. The acquisitions we completed in early 2000 generated goodwill of $57,700, of which $22,480 remained unamortized as of June 30, 2003, and other intangible assets of $86,400, none of which remained unamortized as of June 30, 2003. In accordance with SFAS No. 142, we have performed the required annual impairment test of goodwill as of December 31, 2002 and determined that no impairment loss is required to be recognized. The other intangible assets are being amortized over a three-year period. Any future write-off of goodwill or other intangible assets as a non-cash charge could be significant and would likely harm our operating results. In addition, any future impairment loss recognition may adversely affect our ability to comply with the financial covenants in our installment note with National City Bank. As of June 30, 2003, we were not in compliance with the debt service coverage covenants of the installment note. We have received a waiver with respect to this default from National City Bank, which expires January 1, 2004. As of June 30, 2003, the outstanding principal balance of this note was $228. On February 26, 2003, we entered into a merger agreement with EFI. Upon completion of the merger, we would become a wholly-owned subsidiary of EFI. Our board of directors has approved the merger with EFI and has called a special meeting of our stockholders to vote on the merger. The merger will be adopted if the holders of a majority of our outstanding shares of common stock vote for the proposed merger with EFI. We will incur significant costs associated with the merger, including legal, accounting, financial printing and financial advisory fees. Many of these fees must be paid regardless of whether the merger is completed. We also may incur significant costs in defending ourselves in the lawsuit brought against us by Creo in February 2003 related to our transactions with EFI or the securities class action complaint filed against the Company in the June 2003 related to our initial public offering and certain subsequent press releases. In addition, our relationships with customers may be disrupted because of the diversion of management attention while negotiating the merger and as a result of any perceived uncertainty regarding the outcome of the merger. If customers delay decisions to license our products due to this uncertainty, our results of operations would be adversely affected. 11 SOURCES OF REVENUE Our revenue is derived principally from licenses and subscriptions of our products, maintenance contracts, and professional and other services, including implementation, consulting, and training. Our products are typically purchased under either a perpetual license or a time-based or usage-based subscription. We offer our enterprise resource planning and other client/server software to printers and print buyers under license agreements. We offer our Web-based products to printers and print buyers under subscription agreements, which typically have a term of three years. Our print buyer customers pay a subscription fee for our Web-based products based on the number of users of the website. Our printer customers can purchase either an unlimited subscription or a limited subscription for our Web-based products. The fee for the limited subscription is based on the value of print orders processed through the customer's website. Maintenance contracts are sold to customers, usually at the time of sale of a software license, under annual agreements that provide for automatic renewal, unless the customer cancels. We also provide professional services, which are offered at an hourly rate. We have derived most of our revenue from licenses of our software and the sale of related maintenance to printers. In the first quarter of 2001, we began to recognize revenue from the sale of our Web-based products to printers and began to market our Web-based solutions for print buyers. For the three and six months ended June 30, 2003 revenues from foreign customers approximated 15% of our total revenues. CRITICAL ACCOUNTING POLICIES AND ASSUMPTIONS Our discussion and analysis of the financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amount of assets, liabilities, revenues, and expenses, and related disclosure of contingent assets and liabilities. Our actual results may differ from those estimates. The following critical accounting policies affect the significant judgments and estimates we use in preparing our consolidated financial statements. ACCOUNTS RECEIVABLE The Company records an allowance against gross accounts receivable to provide for doubtful accounts. The allowance is estimated based on the age of the receivable, specific circumstances surrounding the collection of an invoice, and historical data on allowances as a percentage of aged accounts receivable balances. Actual collection on accounts may differ from the allowance the Company has estimated. REVENUE RECOGNITION We recognize revenue on our software products in accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition, which provides for recognition of revenue when persuasive evidence of an arrangement exists, delivery of the product has occurred, no significant obligations remain on our part with regard to implementation, the fee is fixed and determinable, and collectibility is probable. Our normal and customary payment terms provide for collection of the fee over fixed time periods, generally between one and six months. SOP 97-2 generally requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair value of each element. Revenue recognized from multiple-element arrangements is allocated to undelivered elements of the arrangement, such as maintenance and professional services, based on the relative fair value of each element. Our determination of fair value of each element in multi-element arrangements is based on vendor-specific objective evidence (VSOE). We limit our assessment of VSOE for each element to either the price charged when the same element is sold separately or the price established by management for an element not yet sold separately. We have VSOE for maintenance services and professional services. If evidence of fair value of all undelivered elements exists but evidence does not exist for one or more delivered elements, then revenue is recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the total fee is recognized as revenue. We generally recognize license revenue under the residual method upon delivery of our software to the customer, provided collection is probable. Revenue allocated to maintenance is recognized ratably over the maintenance term and revenue allocated to training and other service elements is recognized as the services are performed. Revenue from Web-based products is recognized ratably over the term of the subscription for unlimited subscriptions and is recognized based on usage, subject to a fixed term, for limited subscriptions. Many of our agreements include warranty provisions. Historically, these provisions have not had a significant impact on our revenue recognition. In those instances where customer acceptance may be in question, all revenue relating to that arrangement is deferred until the warranty period has expired. 12 CONTINGENCIES We are involved in disputes and litigation in the normal course of business. We are required to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses. A determination of the amount of reserves required, if any, for these contingencies are made after careful analysis of each individual issue. The required reserves may change in the future due to new developments in each matter or changes in insurance coverage or our approach, such as a change in settlement strategy. STOCK-BASED COMPENSATION We have elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations for our employee stock options because the alternative fair value accounting provided under SFAS No. 123, Accounting for Stock Based Compensation (SFAS 123), requires use of valuation models that were not developed for use in valuing employee stock options. In the first quarter of 2002, we granted options to purchase 766,520 shares of common stock, with an exercise price of $4.21 per share, to certain employees and directors. As a result, we recorded approximately $4,300 of deferred compensation. This amount represents the difference between the exercise price and the fair market value of our common stock on the date we granted these stock options. We will record stock-based compensation expense of approximately $1,100 annually over the vesting period of these options, which is generally four years. In April 2002, we granted options to purchase 381,603 shares of common stock, with an exercise price of $15.54 per share, to certain employees. We do not expect to record any stock-based compensation expense related to these options. We also granted options to purchase 92,910 shares of common stock to employees in June 2002, with an exercise price of $2.00 per share. As a result, we will record approximately $200 of stock-based compensation expense annually over the vesting period of these options, which is three years. For the three and six months ended June 30, 2003, we recorded $102 and $483, respectively, of stock-based compensation expense. WARRANTS We account for equity instruments issued to nonemployees and pursuant to strategic alliance agreements in accordance with the provisions of SFAS No. 123, Emerging Issues Task Force No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring or in Conjunction with Selling Goods or Services, and Emerging Issues Task Force No. 01-9, Accounting for Consideration Given by Vendor to a Customer or a Reseller of the Vendor's Product. Warrant expense represents charges associated with the issuance of warrants to purchase our common stock. To the extent that we derive revenue from agreements entered into in connection with the issuance of warrants, we offset this revenue by the expense associated with these warrants. Any amount of expense that exceeds revenue is recorded in sales and marketing, general and administrative, or interest expense, based upon the nature of the agreement. The amount of expense is equal to the fair value of vested warrants determined using Black-Scholes pricing models. During the quarters ending June 30, 2002 and 2003, there was no reduction of revenue or recognition of expense related to warrants. As of June 30, 2003, we had unvested warrants to purchase 43,899 shares of common stock, which have exercise prices ranging from $266.40 to $592.07 and vest upon attainment of performance criteria. Upon the vesting of warrants to purchase 13,119 of these shares of common stock, we will record warrant expense based upon fair value for each warrant, and upon the vesting of warrants to purchase 30,780 of these shares of common stock, we will reduce revenue generated from the warrant holder during the period when vesting occurs. We cannot predict the timing or amount of this reduction in revenue and increase in expense because the amount is calculated using the fair market value at the time of vesting. 13 INCOME TAXES Deferred income taxes are recognized for all temporary differences between tax and financial bases of our assets and liabilities, using the tax laws and statutory rates applicable to the periods in which the differences are expected to affect taxable income. As of June 30, 2003, we had significant net operating loss carryforwards available to offset future taxable income. The net operating loss carryforwards will expire beginning in 2011 through 2022. Federal and state tax rules impose substantial restrictions on the utilization of net operating loss and tax credit carryforwards in certain situations where changes occur in the stock ownership of a company. Utilization of our carryforwards is limited because of past ownership changes. In the event that we have a future change in ownership, utilization of these carryforwards could be further limited. We have established a 100% valuation allowance against deferred tax assets due to the uncertainty that future tax benefits can be realized from our net operating loss carryforwards and other deferred tax assets. RESTRUCTURING In August 2002, the Company announced a restructuring effecting an organizational realignment of the product management and customer service and support operations. This resulted in a restructuring charge of $525 in the quarter ended September 30, 2002. This charge consisted primarily of severance and benefits including involuntary termination and COBRA benefits, outplacement costs, and payroll taxes for the approximately 40 employees impacted by this restructuring. During the six months ended June 30, 2003, the Company paid all remaining expenditures relating to this restructuring. In May 2001, the Company announced a restructuring that primarily related to the consolidation of certain client support operations into existing facilities, resulting in a restructuring charge of $2,098. The plan included terminations of 45 employees and the reduction of leased office space. All remaining cash expenditures relating to these lease obligations were made during the first six months of 2003. We believe that these actions will not adversely impact our operations in the future because we have undertaken initiatives to manage and monitor our client and employee relations during the execution of these plans and subsequent to their completion. RESULTS OF OPERATIONS The following table sets forth statements of operations data for the periods indicated. The data has been derived from the unaudited consolidated financial statements contained in this Form 10-Q which, in the opinion of our management, include all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position and results of operations for the interim periods. The operating results for any period should not be considered indicative of results for any future period. This information should be read in conjunction with the unaudited consolidated financial statements contained elsewhere in this Form 10-Q, the Consolidated Financial Statements and Notes thereto included in our financial statements for the fiscal year ended December 31, 2002 filed on March 21, 2003 with the Securities and Exchange Commission as part of our Form 10-K and all other filings.

14 COMPARISON OF THE THREE AND SIX MONTHS ENDED JUNE 30, 2002 AND 2003 REVENUE LICENSE AND SUBSCRIPTION License and subscription revenue for the three months ended June 30, 2003 was $2,391, a 58% decrease from license and subscription revenue of $5,671 for the quarter ended June 30, 2002. License and subscription revenue for the six months ended June 30, 2003 was $4,955, a 56% decrease from license and subscription revenue of $11,284 for the six months ended June 30, 2002. The decrease in license and subscription revenue was primarily due to a reduction in the number of software licenses and subscriptions sold during 2003 as compared to 2002. The decrease primarily resulted from uncertainty surrounding the pending acquisition that was announced early in the first quarter as well as overall economic conditions. MAINTENANCE Maintenance revenue for the three months ended June 30, 2003 was $5,576, a 4% increase from maintenance revenue of $5,386 for the quarter ended June 30, 2002. Maintenance revenue for the six months ended June 30, 2003 was $11,319, a 5% increase from maintenance revenue of $10,763 for the six months ended June 30, 2002. The increase in maintenance revenue was primarily due to the increased number of license sales of our enterprise resource planning products in 2002 that, in turn, resulted in an increase in the number of our customers paying maintenance fees. PROFESSIONAL SERVICES AND OTHER Professional services and other revenue for the three months ended June 30, 2003 was $1,098 a 4% decrease from professional services and other revenue of $1,149 for the quarter ended June 30, 2002. Professional services and other revenue for the six months ended June 30, 2003 was $2,194, a 17% increase from professional services and other revenue of $1,874 for the six months ended June 30, 2002. This increase in professional services and other revenue was primarily due to training and implementation services provided to customers who purchased licenses for our enterprise resource planning products during the latter part of 2002 and first half of 2003. The increase from the first to the second quarter in each of 2003 and 2002 is attributable to revenue generated by our annual user conference which took place in the second quarter of each year. TOTAL COST OF REVENUE Cost of revenue includes direct labor and other direct costs relating to the delivery of our products and services. The cost of license and subscription revenue is primarily related to third party licenses that we resell with licenses and subscriptions of our products, as well as any hosting and communication costs. Cost of revenue for the quarter ended June 30, 2003 was $2,132, a 22% decrease from cost of revenue of $2,723 for the quarter ended June 30, 2002. Cost of revenue for the six months ended June 30, 2003 was $4,408, an 18% decrease from cost of revenue of $5,404 for the six months ended June 30, 2002. This decrease is due primarily to the decrease in license and subscription revenues. Cost of revenue as a percentage of revenue increased from 22% and 23% for the three and six months ended June 30, 2002, respectively, to 23% and 24% for the three and six months ended June 30, 2003. This increase is mainly attributable to the shift in the product mix as a higher percentage of revenue was provided by professional services in 2003 as compared to 2002. These services have a higher cost of goods sold as compared to licenses and subscriptions. OPERATING EXPENSES We classify our operating expenses into six general categories, based on the nature of the expenditure: sales and marketing, research and development, general and administrative, depreciation, amortization, and stock-based compensation and warrants. We allocate our total costs for overhead and facilities to each of the functional areas of our business that use these services based upon estimated usage. These allocated charges include general overhead items such as administrative salaries, professional fees, building rent, equipment leasing costs, and telecommunication charges. SALES AND MARKETING Sales and marketing expenses consist primarily of costs related to sales and marketing, employee compensation, travel, public relations, trade shows, and advertising. Sales and marketing expenses for the quarter ended June 30, 2003 were $4,421, a 3% decrease from sales and marketing expenses of $4,574 for the quarter ended June 30, 2002. Sales and marketing expenses for the six months ended June 30, 2003 were $8,630, a 1% increase from sales and marketing expenses of $8,521 for the six months ended June 30, 2002. These decrease in the second quarter was primarily due to reduced marketing expenditures mainly related to the user conference. The increase for the six months of 2003 compared to 2002 was mainly a result salary increases for employees. Sales and marketing expenses as a percentage of revenue increased from 38% and 36% for the three months and six months ended June 30, 2002, respectively, to 49% and 47% for the three and six months ended June 30, 2003, respectively, primarily due to a decrease in revenues. 15 RESEARCH AND DEVELOPMENT Research and development expenses consist primarily of expenses related to the development and upgrade of our existing proprietary software and expenses related to research and development for new product offerings. These expenses include employee compensation for research and development and third-party contract development costs. Research and development expenses for the quarter ended June 30, 2003 were $2,979, a 4% decrease from research and development expenses of $3,092 for the quarter ended June 30, 2002. Research and development expenses for the six months ended June 30, 2003 were $6,003, a 2% decrease from research and development expenses of $6,126 for the six months ended June 30, 2002. These decreases were mainly the result of small reductions in personnel offset by increased salary costs. Research and development expenses as a percentage of revenue increased from 25% and 26% for the three and six months ended June 30, 2002, respectively, to 33% for each of the three and six months ended June 30, 2003, resulting primarily from a decrease in revenue. GENERAL AND ADMINISTRATIVE General and administrative expenses consist primarily of compensation for executive and administrative personnel, travel expenses, professional advisory fees, and general overhead expenses that are not allocated to cost of revenue, product development, or sales and marketing. General and administrative expenses for the quarter ended June 30, 2003 were $2,653, an increase of 83% from general and administrative expenses of $1,451 for the quarter ended June 30, 2002. General and administrative expenses for the six months ended June 30, 2003 were $5,630, an increase of 74% from general and administrative expenses of $3,234 for the six months ended June 30, 2002. The increase in absolute dollars was primarily due to merger related fees of approximately $1,800 in the first half of 2003 that include investment banking, legal and accounting fees, expenses associated with being a public company that were not incurred during the first half of 2002 and additional bad debt expense recognized during the second quarter mainly resulting from uncertainty surrounding the merger with EFI. General and administrative expenses as a percentage of revenue increased from 12% and 13% for the three and six months ended June 30, 2002, respectively, to 29% and 30% for the three and six months ended June 30, 2003. The increase as a percentage of revenue resulted from these additional costs combined with the decrease in revenue. DEPRECIATION Depreciation expense consists primarily of the depreciation of equipment, furniture, fixtures, and leasehold improvements. Depreciation expense for the quarter ended June 30, 2003 was $286, a decrease of 60% from depreciation expense of $707 for the quarter ended June 30, 2002. Depreciation expense for the six months ended June 30, 2003 was $879, a decrease of 40% from depreciation expense of $1,470 for the six months ended June 30, 2002. These decreases are primarily attributable to certain computer equipment becoming fully depreciated and new equipment being purchased at a slower rate compared to prior periods. AMORTIZATION Amortization expense consists of the amortization of intangible assets such as purchased technology, customer lists, and patents. Amortization expense for the quarter ended June 30, 2003 was $43, a decrease of 99% from amortization expense of $7,392 for the quarter ended June 30, 2002. Amortization expense for the six months ended June 30, 2003 was $5,133, a decrease of 65% from amortization expense of $14,780 for the six months ended June 30, 2002. This decrease is primarily attributable to intangible assets relating to the acquisitions made during 2000 becoming fully amortized during the first six months of 2003. STOCK-BASED COMPENSATION AND WARRANTS Stock-based compensation and warrant expense relates to grants of employee stock options and issuances of stock with exercise prices lower than the fair value of the underlying shares at the time of grant or issuance, issuance of stock to employees as compensation and the issuance of options and warrants to third parties for services rendered. Stock-based compensation and warrants expense for the quarter ended June 30, 2003 was $102, a decrease from $334 for the quarter ended June 30, 2002. Stock-based compensation and warrants expense for the six months ended June 30, 2003 was $483, a decrease from stock-based compensation of $537 for the six months ended June 30, 2002. These changes are primarily attributable to the vesting provisions of the options granted in the first half of 2002. OTHER INCOME (EXPENSE) Other income (expense) consists primarily of interest expense related to our borrowings and amortization of debt origination fees. Interest expense for the quarter ended June 30, 2003 was $263, a decrease of $1,283 from the quarter ended June 30, 2002. Interest expense for the six months ended June 30, 2003 was $527, a decrease of $2,576 from the six months ended June 30, 2002. This decrease is primarily due to the repayment of $17,800 of indebtedness upon completion of our initial public offering and repayment of $1,050 of related-party debt during the first six months of 2003. Amortization of debt origination fees for the three and six months ended June 30, 2003 of $873 and $1,743, respectively, was recorded as a result of the restructuring of debt during the second quarter of 2002. 16 INCOME TAXES During the three and six months ended June 30, 2003, we incurred net losses for federal and state tax purposes and have not recognized any tax provision or benefits. At June 30, 2003, we had significant accumulated net operating loss carryforwards for federal and state tax purposes. The federal tax carryforwards expire in various years beginning in 2011 through 2022. Utilization of certain net operating loss carryforwards is subject to certain limitations. Events which cause limitations on the amount of net operating losses that we may use in any one year include, but are not limited to, a cumulative ownership change of more than 50% over a three-year period. LIQUIDITY AND CAPITAL RESOURCES As of June 30, 2003, we had $6,982 in cash and cash equivalents, a decrease of $1,793 from December 31, 2002. This decrease was primarily attributable to cash used by operations during the period including expenses related to the proposed merger of the Company with EFI, debt repayments of approximately $1,100, repayment of the line of credit of $2,000 offset by the proceeds received from the exercise of a stock option by EFI of $5,529. Net cash used by operating activities totaled $4,108 for the six months ended June 30, 2003, compared to $8,344 million of net cash used by operating activities for the quarter ended June 30, 2002. Net cash used in operating activities for the six months ended June 30, 2003 is primarily attributable to the net loss for the period (less non-cash expenses) in addition to an increase in other assets related to certain annual prepaid contracts offset by a reduction in accounts receivable resulting from the decrease in revenue. The Company has experienced some slowdown in collections due to the general economic condition of the printing industry; however, the Company is not aware of any material collectibility or billing issues with its customers. Net cash used by investing activities totaled $161 for the six months ended June 30, 2003, compared to $640 of net cash used by investing activities for the six months ended June 30, 2002. Cash used by investing activities during the first six months of 2003 and 2002 was primarily the result of the purchase of miscellaneous computer equipment. Net cash provided by financing activities was $2,476 for the six months ended June 30, 2003, compared to $11,965 for the six months ended June 30, 2002. Cash provided by financing activities during the first six months of 2003 was primarily attributable to the exercise of the EFI stock option offset by debt repayments of $1,100 and repayment of the line of credit of $2,000. Cash from financing activities in 2002 was primarily attributable to our initial public offering. The line of credit was subsequently closed after the repayment. We have entered into a $900 commercial installment note with National City Bank, which is payable monthly and matures on July 1, 2004. Borrowings under the installment note bear interest, which is payable monthly, at the annual rate of 7.62%. As of June 30, 2003, the outstanding principal balance of this note was $228. The installment note contains restrictive covenants, including a limitation on our ability to incur additional indebtedness or grant security interests in our assets, as well as requirements that we satisfy various financial conditions, including minimum tangible net worth and debt service coverage. As of June 30, 2003, we were not in compliance with the debt service coverage covenant of the installment note. We have received a waiver with respect to this default from National City Bank, which expires January 1, 2004. If we violate any of these financial covenants and are unable to obtain a waiver from National City Bank, then National City Bank could declare all amounts outstanding, together with accrued interest, to be immediately due and payable. Obligations under the installment note and line of credit are secured by all of our tangible and intangible personal property. On February 13, 2003, the Company entered into an agreement with EFI for a standby credit facility in the amount of $11,000 plus a working capital facility, which will provide up to an additional $3,000 under certain circumstances. Under the terms of the standby credit facility, EFI is obligated to disburse up to $11,000 to the Company in the event that certain amounts under the Company's existing credit facilities become due and payable as a result of any action taken by the Company in order to facilitate the proposed business combination with EFI or certain other criteria. All loans made under this facility bear interest at the rate of 8% per annum payable on January 2, 2004. With certain exceptions, the maturity date would be accelerated if a business combination with EFI is not consummated on or before August 31, 2003 or upon the termination of the agreement. Subject to certain conditions, the credit facility also provides the Company with a working capital facility up to an aggregate amount of $3,000 to be disbursed in the event that, among other things, the Company's cash balance as of the close of business on the date notice is given by the Company is less than $1,000. The Company is obligated to use the proceeds of any exercise by EFI of the option agreement entered into on February 13, 2003 to pay down outstanding amounts under the standby credit facility. All loans under the working capital facility bear interest at a rate per annum equal to the prime rate as published, from time to time, by Citibank, plus two percent payable on the maturity date of the loans. 17 We also have a license agreement with Creo Inc. which permits us to use some software owned by Creo in Web-based solutions we offer to printers. If the proposed merger with EFI is completed, Creo could terminate this license agreement. Creo must provide us with notice of its intention to terminate the license within 30 days after the consummation of the merger. The license would then terminate after the expiration of a 180-day transition period. During this 180-day transition period, the license fee we pay to Creo would increase from 10% to 25% of the revenue we generate from the sale of products using Creo's technology. During the three and six months ended June 30, 2003, we paid license fees to Creo of less than $100. We believe the 180-day transition period will be sufficient for us or EFI to develop software which provides substantially similar functionality to the technology we license from Creo. Accordingly, we do not believe that Creo's termination of the license agreement or the increased license fee percentage would have a material impact on our financial position, results of operations or liquidity in future periods. We believe that, based on current levels of operations and anticipated growth, our cash from operations, together with cash currently available, will suffice to fund our operations through January 1, 2004. Poor financial results, unanticipated expenses or unanticipated opportunities that require financial commitments could give rise to additional financing requirements sooner than we expect. If we do not raise additional funds when we need them, we might have to delay, scale back or eliminate expenditures for expansion of our product plans and other strategic initiatives. If we do not complete the merger with EFI or complete a similar transaction with a third party, we do not expect to have sufficient cash to repay the $14,200 of our outstanding debt which becomes due and payable in January 2004 without securing additional debt or equity financing; we do not expect that additional debt or equity financing would be available to us. If we are unable to pay these amounts when due, the lenders could proceed against the collateral. RISK FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK In addition to other information in this Form 10-Q, the following risk factors should be carefully considered in evaluating our business because such factors currently may have a significant impact on our business, operating results and financial condition. As a result of the risk factors set forth below and elsewhere in this Form 10-Q and in any other documents we file with the SEC, actual results could differ materially from those projected in any forward-looking statements. IF WE FAIL TO COMPLETE THE MERGER WITH EFI, WE MAY BE UNABLE TO REPAY $14.2 MILLION OF OUR OUTSTANDING DEBT WHICH BECOMES DUE IN JANUARY 2004 AND MAY NEED ADDITIONAL DEBT OR EQUITY FINANCING WHICH WE DO NOT EXPECT TO BE AVAILABLE. IF WE ARE UNABLE TO PAY THESE AMOUNTS WHEN DUE, THE LENDERS COULD PROCEED AGAINST THE COLLATERAL FOR THEIR LOANS. We entered into a merger agreement with EFI in February 2003. Under the terms of the merger agreement, we will become a wholly-owned subsidiary of EFI and EFI will assume all of our outstanding liabilities, including our debt obligations. The merger is subject to standard closing conditions, including the approval of the holders of a majority of our outstanding shares of common stock. If we do not complete the merger with EFI or complete a similar transaction with a third party, we do not expect to have sufficient cash to repay $14.2 million of our outstanding debt which becomes due and payable in January 2004 without securing additional debt or equity financing; we do not expect that debt or equity financing would be available. In addition, we cannot assure you that another company will be interested in acquiring us. We will incur significant costs associated with the merger, including legal, accounting, financial printing and financial advisory fees, which must be paid whether or not the merger is completed. IF WE FAIL TO COMPLETE THE MERGER WITH EFI, OUR STOCK PRICE MAY FALL. Under the terms of the EFI merger agreement, our stockholders will receive $2.60 per share in cash or EFI common stock at the closing of the merger. If EFI does not complete the merger for any reason, the price of a share of our common stock on the NASDAQ National Market may decline substantially. OUR PROPOSED MERGER WITH EFI MAY ADVERSELY AFFECT OUR SALES DUE TO CONCERNS OF OUR CUSTOMERS ABOUT OUR PRODUCT OFFERINGS AFTER COMPLETION OF THE MERGER. We receive a significant amount of our new sales from commercial printers. Although EFI is a leading provider of imaging solutions for network printing, EFI does not have a substantial base of customers in the commercial printing industry. The announcement of our merger with EFI may result in commercial printers delaying their decision to license our enterprise resource planning software, which would adversely impact our sales revenue. 18 THE SLOWDOWN IN THE ECONOMY HAS AFFECTED THE MARKET FOR INFORMATION TECHNOLOGY SOLUTIONS, INCLUDING DEMAND FOR OUR SOFTWARE PRODUCTS, AND OUR FUTURE FINANCIAL RESULTS MAY DEPEND, IN PART, UPON WHETHER THIS SLOWDOWN CONTINUES. A downturn in the demand for information technology products among our current and potential customers may result in decreased revenues or a lower growth rate for us. Potential customers may delay or forego the purchase of our products or may demand lower prices in order to purchase our products. A reduction in the demand for our software products or in the average selling price of our products would reduce our operating margins and adversely affect our operating results. IF OUR SOFTWARE PRODUCTS DO NOT ACHIEVE BROAD MARKET ACCEPTANCE, WE MAY NOT BECOME PROFITABLE AND OUR STOCK PRICE COULD DECLINE. Most print buyers, printers, and print industry raw material suppliers currently coordinate the design, specification, purchasing, and manufacture of print orders either through a combination of telephone, facsimile, e-mail, and paperwork or through proprietary software solutions. Web-based products are relatively new and rapidly evolving, and these products change the way in which print buyers, printers, and print industry raw material suppliers interact with one another. Widespread commercial acceptance of our Web-based products is important to our future success. If the market for Web-based print management products fails to grow or grows more slowly than we anticipate, then our operating results could be adversely affected. To date, most of our sales have been to printers, and our future growth is dependent upon our ability to increase sales to print buyers. The growth of our business also depends on our ability to enhance and develop our software products and to identify and develop new products that serve the needs of our customers. If our existing and potential customers do not adopt our software products, we may be unable to continue to grow our business and increase our revenues. As a result, we may not become profitable, or maintain profitability, and our stock price could decline. THE SALES CYCLE FOR MANY OF OUR PRODUCTS IS LONG, WHICH COULD CAUSE OUR REVENUE AND OPERATING RESULTS TO VARY SIGNIFICANTLY AND INCREASE THE RISK OF AN OPERATING LOSS FOR ANY GIVEN FISCAL QUARTER. A customer's decision to purchase and implement many of our products often involves a significant commitment of its resources and a lengthy product evaluation and qualification process. Approval at a number of management levels within a customer's organization is typical for many of our products. Companies often consider a wide range of issues before committing to purchase our software, including anticipated benefits and cost savings, ease of installation, ability to work with existing computer systems, functionality, and reliability. Many of our potential customers may be addressing these issues for the first time, and the use of our products may represent a significant change in their current print management practices. As a result, we often devote significant time and resources to educate potential customers about the use and benefits of our products. The sales process for most of our products frequently takes several months to complete, which may have an adverse impact on the timing of our revenue, and our operating results could be adversely affected. AN ADVERSE RULING IN CREO'S LAWSUIT AGAINST US COULD RESULT IN OUR INABILITY TO CONSUMMATE THE MERGER WITH EFI, WHICH MAY HAVE AN ADVERSE EFFECT ON OUR STOCK PRICE In February 2003 Creo Inc. sued us along with Marc Olin, EFI and our three independent directors which formed a special committee of the board of directors to consider strategic alternatives for Printcafe. The suit seeks to declare a Stockholders Rights Plan adopted by the special committee as unlawful, permanently bar the exercise of any rights under the Stockholders Rights Plan, and have an Option Agreement, Standby Credit Agreement and No-Talk Agreement with EFI declared unlawful and void. The matter is currently pending before Delaware Chancery Court. We intend to vigorously defend ourselves in this matter. If this lawsuit is resolved unfavorably to us, our business and financial condition could be adversely affected and we may not be able to complete our planned merger with EFI. CREO'S LAWSUIT AND THE PLANNED MERGER WITH EFI COULD DIVERT THE ATTENTION OF OUR KEY MANAGEMENT AND ADVERSELY AFFECT OUR OPERATING RESULTS Our success depends on the services of our current key management personnel, including Marc D. Olin, our Chairman, President and Chief Executive Officer, and Joseph J. Whang, our Chief Financial Officer and Chief Operating Officer. The lawsuit filed by Creo and the planned merger with EFI could divert the attention of our management and resources from our business, which could adversely affect our operating results. In addition, the litigation with Creo could be expensive which would adversely impact our operating results. 19 COMPETITION IN THE PRINTING INDUSTRY SUPPLY CHAIN FOR SOFTWARE PRODUCTS IS INTENSE, AND WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY. Our current and potential competitors include companies that offer software products and services to the printing industry supply chain, and companies that offer software products for enterprise resource planning, supply chain management, and procurement that are not customized for the printing industry. We expect competition to increase in the future. Some of our current or potential competitors have longer operating histories, larger customer bases, greater brand recognition, and significantly greater financial, marketing, and other resources. As a result, these competitors may be able to devote greater resources to the development, promotion, sale, and support of their products. In addition, these companies may adopt aggressive pricing policies and leverage their customer bases to gain market share. Moreover, our current and potential competitors may develop software products that are superior to or achieve greater market acceptance than ours. If we are unable to offer competitive software products and services, then our revenues will decline. UNPLANNED SYSTEM INTERRUPTIONS, CAPACITY CONSTRAINTS, OR SECURITY BREACHES COULD DISRUPT OUR BUSINESS AND DAMAGE OUR REPUTATION. We must offer customers of our Web-based products reliable, secure, and continuous service to attract and retain customers and persuade them to increase their reliance on our software products. As the volume of data traffic on our hosted Web sites increases, we must continually upgrade and enhance our technical infrastructure to accommodate the increased demands placed on our systems. Our operations also depend in part on our ability to protect our systems against physical damage from fire, earthquakes, power loss, telecommunications failures, computer viruses, unauthorized user access, physical break-ins, and similar events. Any interruption or increase in response time of our software products could damage our reputation, reduce customer satisfaction, and decrease usage of our services and the purchase of our products. The secure transmission of confidential information over public networks is a fundamental requirement for online communications and transactions. Third parties may attempt to breach our security or that of our customers. Any breach in our online security could make us liable to our customers, damage our reputation, and cause a decline in our revenues. We may need to spend significant resources to license technologies to protect against security breaches or to address problems caused by a security breach. IF OUR TECHNOLOGIES CONTAIN UNDETECTED ERRORS OR DEFECTS, WHICH INTERRUPT OUR OPERATIONS OR THOSE OF OUR CUSTOMERS, OUR BUSINESS COULD BE HARMED. Our technologies are highly technical and may contain undetected software code or other errors or suffer unexpected failures. Because of their nature, our client/server-based enterprise resource planning and other products can only be fully tested when deployed in our customers' networks. These errors or failures may disrupt our operations or those of our customers, damage our reputation, and result in loss of, or delay in, market acceptance of our software products. We may discover software errors in new releases of our software products after their introduction. We may experience delays in release, legal action by our customers, lost revenues, and customer frustration during the period required to correct these errors. Any of these problems could adversely affect our operating results. IF WE FAIL TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, OUR COMPETITIVE POSITION COULD BE HARMED. We regard our patents, copyrights, service marks, trademarks, trade secrets, and similar intellectual property as critical to our success. We rely on patent, trademark, and copyright law, trade secret protection, and confidentiality and/or license agreements with our employees, customers, and strategic partners to protect our proprietary rights. These precautions may not prevent misappropriation or infringement of our intellectual property. In addition, the status of United States patent protection in the software and Web industries is not well defined and will evolve as the United States Patent and Trademark Office grants additional patents. We do not know if any of our future patent applications will result in a patent being issued within the scope of the claims we seek, if at all, or whether any patents we may receive will be challenged or invalidated. In addition, the laws in foreign countries may not protect our proprietary rights to the same extent as laws in the United States. WE MAY FACE INTELLECTUAL PROPERTY CLAIMS THAT COULD BE COSTLY TO DEFEND AND COULD PREVENT US FROM SELLING OUR SOFTWARE PRODUCTS 20 Third parties may infringe or misappropriate our intellectual property or assert infringement claims against us. In addition, because the contents of patent applications in the United States are not publicly disclosed until the patent is issued, applications may have been filed by others that relate to our software products. From time to time we receive communications from third parties asserting that our products infringe, or may infringe, the intellectual property rights of third parties. Intellectual property litigation is expensive and time consuming and could divert management's attention from our business operations. This litigation could also require us to develop non-infringing technology or enter into royalty or license agreements with third parties. These royalty or license agreements, if required, may not then be available on acceptable terms, if at all. If we cannot develop or license non-infringing technology, then our operating results could be adversely affected. CREO COULD SUBSTANTIALLY INFLUENCE CORPORATE ACTIONS THAT CONFLICT WITH THE INTERESTS OF OUR PUBLIC STOCKHOLDERS. WE ALSO HAVE COMMERCIAL AGREEMENTS WITH CREO THAT ARE IMPORTANT TO OUR BUSINESS. Creo Inc. is our largest stockholder, has two representatives on our board of directors, and is a party to several commercial agreements with us. Creo beneficially owns 4,736,135 shares of our common stock which represents 44.5% of the voting power of our outstanding common stock. In addition, the two members of our board of directors appointed by Creo, Amos Michelson and Judi Hess, are executive officers of Creo. Creo could use its stock ownership or representation on our board of directors to substantially influence corporate actions that conflict with the interests of our public stockholders. In addition to the loan agreement we have with Iris Graphics, an affiliate of Creo, we have a strategic alliance agreement and a software license agreement with Creo. Under the strategic alliance agreement, we agreed with Creo to undertake joint sales and marketing efforts, not to compete with each other's business, and not to solicit the employment of each other's employees. In addition, we granted Creo an exclusive and perpetual right to provide, and a right of first refusal to develop, any content management and workflow products for us. Because we have granted these rights to Creo, we may not be able to obtain terms as favorable as those that might otherwise be available if we were able to negotiate freely with third parties. Under the software license agreement, Creo licenses us software which is used in our printChannel Classic product and which will be used in our printChannel I/O product. Creo may terminate the software license agreement in certain circumstances, including the termination of the strategic alliance agreement and the acquisition by a third party of more than fifty percent of our outstanding common stock. The strategic alliance agreement does not specify a termination date. Creo may also terminate the strategic alliance agreement or the software license agreement if we breach any provision of the agreements and do not remedy that breach within a specified period of time. If the agreements were to terminate, we could lose access to Creo's sales force and the other benefits derived from our joint marketing efforts, and Creo would be permitted to compete with us. Additionally, we would be required to develop software to replace the functionality licensed to us by Creo in our printChannel Classic product. The termination of the strategic alliance agreement and software license agreements and the resulting loss of these benefits could, among other things, reduce our revenues and significantly harm our business. WE MAY FAIL TO MEET QUARTERLY FINANCIAL EXPECTATIONS, WHICH MAY CAUSE THE MARKET PRICE OF OUR COMMON STOCK TO DECLINE. Our operating results are difficult to predict and may vary significantly from quarter to quarter in the future. Our historical financial results are not indicative of our future results. Our quarterly operating results may fluctuate as a result of many factors, including, but not limited to: - the size and timing of sales and deployment of our products; - market acceptance of and demand for our products; - variation in capital spending budgets of our customers; - the mix of distribution channels through which our products are sold; - the impairment of goodwill related to our past acquisitions; - the costs of integrating acquired companies; - technical difficulties or system outages; 21 - the amount and timing of operating costs and capital expenditures relating to expansion of our business; - the announcement or introduction of new products or services by our competitors; - changes in our pricing structure or that of our competitors; and - the relatively fixed nature of our operating expenses. As a result of the above factors, our quarterly operating results may fall below market analysts' expectations in future quarters, which could lead to a decline in the market price of our common stock. IF OUR SOFTWARE PRODUCTS DO NOT INTEGRATE WITH OUR CUSTOMERS' EXISTING SYSTEMS, ORDERS FOR OUR SOFTWARE PRODUCTS WILL BE DELAYED OR CANCELED, WHICH WOULD HARM OUR BUSINESS. Many of our customers require that our software products be designed to integrate with their existing systems. We may be required to modify our software product designs to achieve a sale, which may result in a longer sales cycle, reduced operating margins, and increased research and development expense. In some cases, we may be unable to adapt or enhance our software products to meet these challenges in a timely and cost-effective manner, or at all. If our software products do not integrate with our customers' existing systems, implementations could be delayed or orders for our software products could be canceled, which would harm our business, financial condition, and results of operations. IF WE FAIL TO DEVELOP AND SELL NEW PRODUCTS THAT MEET THE EVOLVING NEEDS OF OUR CUSTOMERS, OR IF OUR NEW PRODUCTS FAIL TO ACHIEVE MARKET ACCEPTANCE, OUR BUSINESS AND RESULTS OF OPERATIONS WOULD BE HARMED. Our success depends on our ability to anticipate our customers' evolving needs and to develop and market products that address those needs. The timely development of these products, as well as any additional new or enhanced products, is a complex and uncertain process. We may experience design, marketing, and other difficulties that could delay or prevent our development, introduction, or marketing of these and other new products and enhancements. We may not have sufficient resources to anticipate technological and market trends, or to manage long development cycles. The introduction of new or enhanced products also requires that we manage the transition from existing products to these new or enhanced products in order to minimize disruption in customer ordering patterns. We are currently in the process of developing software for print industry raw material suppliers. If we are unable to attract raw material suppliers as customers, then our Web-based products may not be as attractive to printers and print buyers and our business may be harmed. If we are not able to develop new products or enhancements to existing products on a timely and cost-effective basis, or if our new products or enhancements fail to achieve market acceptance, our ability to continue to sell our products and grow our business would be harmed. IF WE ARE UNABLE TO OBTAIN LICENSES OF THIRD-PARTY TECHNOLOGY ON ACCEPTABLE TERMS, OUR BUSINESS WOULD BE HARMED We integrate third-party licensed technology with our products. For example, our Web-based products are deployed on an Oracle database. From time to time we may be required to license additional technology from third parties to develop new products or product enhancements. Third-party licenses may not be available or continue to be available to us on acceptable terms. Our inability to maintain or acquire any third-party licenses required in our current products, including licenses from Oracle, or required to develop new products and product enhancements could require us to obtain substitute technology of lower quality or performance standards or at additional cost, which could seriously harm our business, financial condition, and results of operations. INCREASING GOVERNMENTAL REGULATION OF THE WEB AND LEGAL UNCERTAINTIES COULD DECREASE DEMAND FOR OUR WEB-BASED PRODUCTS OR INCREASE OUR COST OF DOING BUSINESS. In addition to regulations applicable to businesses generally, we are subject to laws and regulations directly applicable to the Web. Although there are currently few laws and regulations governing the Web, federal, state, local, and foreign governments are considering a number of legislative and regulatory proposals. As a result, a number of laws or regulations may be adopted regarding: - the pricing and taxation of goods and services offered over the Web; - intellectual property ownership; and - the characteristics and quality of goods and services offered over the Web. 22 Existing laws regarding property ownership, copyright, trademark, and trade secrets may be applied to the Web. The adoption of new laws or the adaptation of existing laws to the Web may decrease the growth in the use of the Web, which could in turn decrease the demand for our Web-based products, increase our cost of doing business, or otherwise adversely impact our ability to become profitable. The growth of Web-based commerce has been attributed by some to the lack of sales and value-added taxes on interstate sales of goods and services over the Web. Numerous state and local authorities have expressed a desire to impose such taxes on sales to consumers and businesses in their jurisdictions. The Internet Tax Non-Discrimination Act prevents imposition of such taxes through November 2003. If the federal moratorium on state and local taxes on Web sales is not renewed, or if it is terminated before its expiration, then sales of goods and services over the Web could be subject to multiple overlapping tax schemes, which could substantially hinder the growth of Web-based commerce, including sales of subscriptions to our Web-based products. WE HAVE LIMITED EXPERIENCE OPERATING INTERNATIONALLY, WHICH MAY MAKE IT DIFFICULT AND COSTLY TO EXPAND IN OTHER COUNTRIES To date, we have derived the substantial majority of our revenue from sales to customers in North America. As part of our business strategy, we plan to expand our international operations, focusing initially on the European market. We face many barriers to competing successfully internationally, including: - varying technology standards and capabilities; - insufficient or unreliable telecommunications infrastructure and Web access; - difficulties staffing and managing foreign operations; - fluctuations in currency exchange rates; - reduced protection for intellectual property rights in some countries; and - import and export restrictions and tariffs. As a result of these factors, we may not be able to successfully market, sell, or deliver our products in international markets. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK For the six months ended June 30, 2003, revenue from foreign customers approximated 15% of our total revenue. We have not had any material exposure to factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. However, in future periods, we expect to increase sales in foreign markets, including Canada and Europe. As our sales are made in U.S. dollars, a strengthening of the U.S. dollar could cause our products to be less attractive in foreign markets. Most of our cash equivalents, short-term investments, and capital lease obligations are at fixed interest rates. Therefore, the fair value of these investments is affected by changes in the market interest rates. However, because our investment portfolio is primarily composed of investments in money market funds and high-grade commercial paper with short maturities, we do not believe an immediate 10% change in market interest rates would have a material effect on the fair market value of our portfolio. Therefore, we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our investment portfolio. ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures Printcafe's management, with the participation of Printcafe's Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness Printcafe's disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that Printcafe's disclosure controls and procedures as of the end of the period covered by this report have been designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by Printcafe in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Printcafe believes that a controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. (b) Change in Internal Control over Financial Reporting No change in Printcafe's internal control over financial reporting occurred during Printcafe's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, Printcafe's internal control over financial reporting. 23 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On June 25, 2003 a securities class action complaint was filed against the Company, Marc Olin, President and Chief Executive Officer, and Joseph Whang, Chief Financial Officer and Chief Operating Officer, in the United States District Court for the Western District of Pennsylvania. The complaint alleges that the defendants violated Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 due to allegedly false and misleading statements in connection with the Company's initial public offering and subsequent press releases. The Company believes that the lawsuit is completely without merit and intends to vigorously defend itself. To date, the Company has not been required to file a response to the complaint and has not done so. In light of the early stage of this proceeding, the Company cannot predict with certainty the likely outcome of the action or the likely value of any of the related claims. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS On June 17, 2002, the Securities and Exchange Commission declared effective the Company's Registration Statement on Form S-1 (File No. 333-82646). The Registration Statement covered the sale of 4,212,000 shares of the Company's Common Stock (including an option to purchase 462,000 shares solely to cover over-allotment, if any) at an offering price of $10.00 per share. The managing underwriters in the offering were UBS Warburg LLC, Robertson Stephens, Inc., U.S. Bancorp Piper Jaffray Inc., and McDonald Investments Inc. (the "Underwriters"). On June 21, 2002, the Company sold to the Underwriters 3,750,000 shares of Common Stock for aggregate consideration of $37,500, less underwriting discounts and commissions of $2,625 and other expenses of $1,925 for net proceeds to the Company of $32,950, The other expenses of $1,925 were paid to third parties not affiliated with the Company. From the amount of net proceeds $23,200 in cash was used to pay outstanding debt, deferred interest, and prepayment fees. Of this amount, $16,900 was paid to Creo, Inc., which owns, through its subsidiary Creo SRL, approximately 30.2% of our outstanding common stock. Since the completion of our initial public offering, we have used additional amounts of the proceeds for general operating and corporate purposes. On February 13, 2003, the Company entered into a stock option agreement with EFI granting them an option to purchase up to 2,126,574 shares of Common Stock at a purchase price equal to $2.60 per share. On June 11, 2003, EFI exercised this option and the Company received approximately $5,529 exchange for 2,126,574 shares of its common stock. The issuances of the above securities were intended to be exempt from registration under the Securities Act in reliance on Section 4(2) thereof. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The following matters were submitted to a vote of the stockholders during the Company's annual stockholders meeting held on May 2, 2003. 1. Election of Class I Directors Votes Cast For Authority Withheld -------------- ------------------ Charles J. Billerbeck 8,090,993 35 Amos Michelson 8,089,287 1,741 2. Election of Class II Director Thomas J. Gill 8,090,993 35 3. Ratification of Ernst & Young LLP Votes Cast For Authority Withheld Abstentions as independent accountants -------------- ------------------ ----------- 8,091,028 --- ---

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS. 31.1 Section 302 Certification by the Chief Executive Officer 31.2 Section 302 Certification by the Chief Financial Officer 32.1 Section 906 Certification by the Chief Executive Officer and Chief Financial Officer relating to a periodic report containing financial statements 24 (b) Reports on Form 8-K. The following current reports on Form 8-K were filed by the Company during the second fiscal quarter: (1) Current report on Form 8-K dated April 15, 2003 setting forth the Company's preliminary earnings release for the quarter ended March 31, 2003. (2) Current report on Form 8-K dated April 29, 2003 setting forth the Company's earnings release for the quarter ended March 31, 2003. (3) Current report on Form 8-K dated June 26, 2003 setting forth a press release issued by the Company in response to a stockholder class action lawsuit. * * * * 25 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. PRINTCAFE SOFTWARE, INC. /s/ Marc D. Olin ------------------ Marc D. Olin President and Chief Executive Officer /s/ Joseph J. Whang ------------------- Joseph J. Whang Chief Financial Officer and Chief Operating Officer (Chief Accounting Officer) Date: August 14, 2003 26

PRINTCAFE SOFTWARE INC 10-Q