UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2003

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 0-31537

DOCENT, INC.

(Exact name of registrant as specified in its charter)

Delaware

77-0460705

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

2444 Charleston

Mountain View, California

94043

(Address of principal executive offices)

(Zip Code)

(650) 934-9500

(Registrant’s telephone number including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

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

As of October 31, 2003, the registrant had outstanding approximately 13,129,000 shares of Common Stock, $0.001 par value per share.

A copy of the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports are available for free on the Company’s website, www.docent.com, within 24 hours after such material is electronically filed with the Securities and Exchange Commission.

DOCENT, INC.

INDEX

		Page

Part I	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets at September 30, 2003 and December 31, 2002	3

	Condensed Consolidated Statements of Operations for the Three Months and Nine Months Ended September 30, 2003 and 2002	4

	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2003 and 2002	5

	Notes to Condensed Consolidated Financial Statements	6-12

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13-29

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30

Item 4.	Controls and Procedures	30

Part II.	OTHER INFORMATION

Item 1.	Legal Proceedings	31

Item 2.	Changes in Securities and Use of Proceeds	31

Item 3.	Defaults Upon Senior Securities	31

Item 4.	Submission of Matters to a Vote of Security Holders	31

Item 5.	Other Information	31

Item 6.	Exhibits and Reports on Form 8-K	31

PART I

DOCENT, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)	September 30, 2003 (Unaudited)			December 31, 2002 (1)
Assets
Current assets:
Cash and cash equivalents	$	30,890		$	36,968
Short term investments		1,999			3,974
Restricted cash		—			46
Accounts receivable, net		6,356			5,958
Prepaid expenses and other current assets		1,508			1,424

Total current assets		40,753			48,370
Property and equipment, net		2,333			3,118
Goodwill		760			760
Other intangible assets, net		917			1,577
Other assets		404			417

Total assets	$	45,167		$	54,242

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	1,309		$	1,032
Accrued payroll and related liabilities		1,900			2,478
Accrued liabilities		1,601			2,970
Current portion of restructuring accrual		671			888
Deferred revenue		7,639			6,626
Current portion of capital lease obligations		—			99

Total current liabilities		13,120			14,093
Restructuring accrual		532			1,096
Capital lease obligations		—			45

Commitments and Contingencies

Stockholders’ equity:
Preferred stock		—			—
Common stock		13			14
Additional paid-in capital		228,335			231,331
Receivables from stockholders		(154	)		(197	)
Unearned stock-based compensation		(301	)		(926	)
Treasury stock, at cost		—			(3,058	)
Accumulated deficit		(196,456	)		(188,228	)
Accumulated other comprehensive income		78			72

Total stockholders’ equity		31,515			39,008

Total liabilities and stockholders’ equity	$	45,167		$	54,242

⁽¹⁾

Derived from the Company’s audited financial statements as of December 31, 2002.

The accompanying notes are an integral part of these financial statements.

DOCENT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

	Three Months Ended September 30,						Nine Months Ended September 30,
(in thousands, except per share amounts)	2003			2002			2003			2002
Revenue:
License	$	2,953		$	2,496		$	9,657		$	9,602
Services and maintenance		4,091			3,560			12,117			11,105

Total revenue		7,044			6,056			21,774			20,707

Cost of revenue:
Cost of license		311			481			1,019			1,277
Cost of services and maintenance		1,882			1,987			6,144			6,934

Total cost of revenue		2,193			2,468			7,163			8,211

Gross profit:
License		2,642			2,015			8,638			8,325
Services and maintenance		2,209			1,573			5,973			4,171

Total gross profit		4,851			3,588			14,611			12,496

Operating expenses:
Research and development		2,484			2,536			7,369			8,699
Sales and marketing		4,075			4,571			12,162			17,222
General and administrative		1,045			1,479			3,623			4,351
Restructuring charges (credits)		—			(1,093	)		(327	)		3,193

Total operating expenses		7,604			7,493			22,827			33,465

Loss from operations		(2,753	)		(3,905	)		(8,216	)		(20,969	)
Interest expense		—			(6	)		(34	)		(142	)
Other income and (expense), net		87			(189	)		(73	)		(139	)
Interest income		87			215			291			823

Loss before provision for income taxes		(2,579	)		(3,885	)		(8,032	)		(20,427	)
Provision for income taxes		77			55			196			149

Net loss		(2,656	)		(3,940	)		(8,228	)		(20,576	)

Net loss per share – basic and diluted	$	(0.20	)	$	(0.28	)	$	(0.63	)	$	(1.47	)

Weighted average common shares outstanding		13,078			13,952			13,044			14,029

The accompanying notes are an integral part of these financial statements.

DOCENT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Nine Months Ended September 30,
(in thousands)	2003			2002
Cash flows from operating activities
Net loss	$	(8,228	)	$	(20,576	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		1,182			1,560
Amortization of deferred interest expense		—			38
Amortization of intangible assets		660			1,079
Amortization of unearned stock-based compensation		726			(545	)
Non-cash restructuring charges (credits)		(327	)		333
Acceleration of stock option vesting		—			15
Issuance of options in exchange for services		32			—
Changes in operating assets and liabilities:
Accounts receivable, net		(398	)		4,858
Prepaid expenses and other assets		(101	)		1,429
Accounts payable		277			(731	)
Accrued liabilities		(1,947	)		(1,120	)
Restructuring accrual		(454	)		(1,644	)
Deferred revenue		1,013			(741	)

Net cash used in operating activities		(7,565	)		(16,045	)

Cash flows from investing activities
Purchases of property and equipment		(367	)		(592	)
Restricted cash		46			(58	)
Sales of short term investments		29,007			57,805
Purchases of short term investments		(27,028	)		(30,901	)

Net cash provided by investing activities		1,658			26,254

Cash flows from financing activities
Proceeds from the employee stock purchase plan and exercises of common stock options and warrants, net		135			413
Proceeds from repayment of stockholder receivable		43			783
Repurchase of common stock		(207	)		(1,353	)
Repayments of capital lease obligations		(144	)		(165	)
Repayments of notes payable		—			(389	)

Net cash used in financing activities		(173	)		(711	)

Net increase (decrease) in cash and cash equivalents		(6,080	)		9,498
Cash and cash equivalents, beginning of period		36,968			28,460
Effect of exchange rate change on cash and cash equivalents		2			(119	)

Cash and cash equivalents, end of period	$	30,890		$	37,839

Supplemental disclosures of noncash investing and financing activities
Equipment acquired under capital leases	$	—		$	26

Unearned stock-based compensation	$	(36	)	$	(4,547	)

Unrealized gain (loss) on available for sale investments	$	(4	)	$	14

Adjustment to goodwill	$	—		$	140

Retirement of treasury stock	$	3,263		$	—

The accompanying notes are an integral part of these financial statements.

DOCENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Basis of Presentation

The accompanying unaudited interim condensed consolidated financial statements have been prepared by Docent, Inc. (the “Company”) in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X promulgated by the Securities Exchange Commission (the “SEC”). Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for annual financial statements. In the opinion of management, the interim consolidated financial statements include all normal recurring adjustments necessary for a fair presentation of the information required to be included. Operating results for the three and nine month periods ended September 30, 2003 are not necessarily indicative of the results that may be expected for any future periods, including the full fiscal year. Reference should also be made to the Annual Consolidated Financial Statements, Notes thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

Certain prior period amounts have been reclassified to conform to the current period presentation, including the reclassification of developed technology amortization associated with the acquisition of gForce. For the three and nine months ended September 30, 2002, $359,000 and $1,078,000, respectively, of amortization expense was reclassified from research and development expense to cost of license revenue. All share and per share data included in the condensed consolidated financial statements have been retroactively adjusted to reflect a one-for-three reverse split effective on October 22, 2002.

Net Loss Per Share

Basic and diluted net loss per share is computed by dividing the net loss for the period by the weighted average number of shares of common stock outstanding during the period. The calculation of diluted net loss per share excludes dilutive common equivalent shares since their effect is antidilutive. Dilutive common equivalent shares are comprised of common stock subject to repurchase rights and incremental shares of common stock issuable upon the exercise of stock options or warrants.

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2003			2002			2003			2002
Net loss	$	(2,656	)	$	(3,940	)	$	(8,228	)	$	(20,576	)

Basic and diluted shares:
Weighted average common shares outstanding		13,091			14,005			13,072			14,121
Weighted average unvested common shares subject to repurchase		(13	)		(53	)		(28	)		(92	)

Weighted average shares used to compute basic and diluted net loss per share		13,078			13,952			13,044			14,029

Net loss per share – basic and diluted	$	(0.20	)	$	(0.28	)	$	(0.63	)	$	(1.47	)

DOCENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Stock-Based Compensation

The Company accounts for its stock-based compensation plans under the intrinsic value method of accounting as defined by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”) and related interpretations. According to APB 25, compensation expense is generally recognized only when options are granted with a discounted exercise price. However, the Company has provided below the disclosure called for under SFAS No. 123, Accounting for Stock-Based Compensation and SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure. Had compensation cost for the Company’s stock-based compensation plan been determined based on the fair value at the grant dates for the awards under a method prescribed by SFAS No. 123, the Company’s net loss would have been increased to the pro forma amounts indicated below:

(in thousands, except per share data)	Three Months Ended September 30,						Nine Months Ended September 30,
	2003			2002			2003			2002
Net loss, as reported	$	(2,656	)	$	(3,940	)	$	(8,228	)	$	(20,576	)
Add: stock-based compensation expense included in reported net loss, net of related tax effects		181			417			758			(530	)
Deduct: total stock-based compensation expense determined under fair value method for all awards, net of related tax effects		(721	)		(1,408	)		(2,293	)		(1,319	)

Net loss, pro forma	$	(3,196	)	$	(4,931	)	$	(9,763	)	$	(22,425	)

Basic and diluted net loss per share, as reported		(0.20	)		(0.28	)		(0.63	)		(1.47	)

Basic and diluted net loss per share, pro forma		(0.24	)		(0.35	)		(0.75	)		(1.60	)

The Company calculated the value of stock-based awards on the date of grant using the Black-Scholes option pricing model with the assumptions in the following table:

	Option
	Three Months Ended September 30,		Nine Months Ended September 30,
	2003	2002	2003	2002
Dividend yield	0%	0%	0%	0%
Volatility	0.95	0.95	0.95	0.95
Risk free interest rate	2.99% -3.03%	1.74% -2.89%	1.00% - 3.03%	1.21% - 4.69%
Expected lives of options	4 years	4 years	4 years	1 – 4 years
Weighted average fair value	$2.16	$1.26	$1.81	$3.58

	Employee Stock Purchase Plan
	Three Months Ended September 30,		Nine Months Ended September 30,
	2003	2002	2003	2002
Dividend yield	0%	0%	0%	0%
Volatility	0.4975	0.9500	0.5539	0.9835
Risk free interest rate	1.04%	1.48%	.95% - 1.04%	1.48% - 1.85%
Expected lives of options	6 months	6 months	6 months	6 months
Weighted average fair value	$0.92	$0.43	$0.96	$0.44

DOCENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Comprehensive Loss

The components of comprehensive loss are net loss, foreign currency translation adjustments and unrealized gains and losses on available for sale investments. The total comprehensive loss was $2,729,000 for the three months ended September 30, 2003 and $3,923,000 for the three months ended September 30, 2002. The comprehensive loss was $8,222,000 for the nine months ended September 30, 2003 and $20,681,000 for the nine months ended September 30, 2002.

Intangible Assets

Intangible assets arose from Docent’s acquisition of the business and assets of gForce Systems. The intangible assets are being amortized on a straight-line basis over thirty-six months and consist of (in thousands):

	September 30, 2003							December 31, 2002
	Gross Carrying Amount		Accumulated Amortization			Net		Gross Carrying Amount		Accumulated Amortization			Net
Core technology		2,493		(1,628	)		865		2,493		(1,005	)		1,488
Patents		148		(96	)		52		148		(59	)		89

	$	2,641	$	(1,724	)	$	917	$	2,641	$	(1,064	)	$	1,577

The total estimated amortization expense related to intangible assets is provided in the table below (in thousands):

Fiscal Year
Remainder 2003	$	220
2004		697

	$	917

Restructuring Charge

In 2001 and 2002, the Company implemented restructuring programs to better align operating expenses with anticipated revenues.

During the third quarter of fiscal 2001, the Company recorded a restructuring charge that included $3.0 million in facility exit costs. During the fourth quarter of fiscal 2001, the Company adjusted these facility exit costs to increase the related charge by $112,000. The adjustment reflects the reduction of the estimated sublease income of a particular vacated facility.

During the first quarter of fiscal 2002, the Company recorded a $925,000 restructuring charge, which consisted of $886,000 in employee severance costs and $39,000 in other exit costs. The restructuring program resulted in a reduction in force across all company functions of approximately 17%, or 42 employees.

During the second quarter of fiscal 2002, the Company recorded a $3.1 million restructuring charge, which consisted of $2.1 million in facility exit costs, $822,000 in employee severance costs, $163,000 in equipment impairment, and $27,000 in other exit costs. The restructuring program resulted in a reduction in force across all company functions of approximately 17%, or 36 employees.

Also during the second quarter of fiscal 2002, the Company increased its estimate of the total costs associated with the above restructuring activities and recorded an adjustment of $298,000. The adjustment reflects a reduction of the estimated sublease income of one vacated facility in the amount of $372,000, partially offset by a credit of $74,000 resulting from the settlement cost of another lease obligation for a sum less than the amount previously recorded.

DOCENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

During the third quarter of fiscal 2002, the Company continued the announced second quarter restructuring actions. The Company recorded a $381,000 restructuring charge, which consisted of $271,000 in employee severance costs, and $110,000 in equipment impairment. The continued restructuring program resulted in a reduction in force across all company functions of approximately 5%, or nine employees.

Also during the third quarter of fiscal 2002, the Company settled a facility lease obligation of a vacated facility, associated with the above restructuring activities, and recorded an adjustment of $1.6 million. The adjustment reflects a reduction of the future monthly lease payments that were originally estimated to be $3.0 million, but were settled for $1.4 million.

During the second quarter of fiscal 2003, the Company recorded a $327,000 provision adjustment. The adjustment included $141,000 of other costs and $85,000 of employee severance, due to the finalization of payments associated with other costs and employee severance at lower amounts than previously estimated. The Company also recorded an adjustment of $101,000 related to a vacated facility associated with the above restructuring activities that was subleased during the quarter.

The following table depicts the restructuring activity during the nine months ended September 30, 2003 (in thousands):

Category	Balance at Dec. 31, 2002		Provision Adjustment			Cash Expenditures			Balance at Sept. 30, 2003
Vacated facilities	$	1,719	$	(101	)	$	(426	)	$	1,192
Employee severance		113		(85	)		(28	)		—
Other costs		152		(141	)		—			11

Total	$	1,984	$	(327	)	$	(454	)	$	1,203

The remaining cash expenditures will be paid monthly over a period ending May 2005.

Treasury Stock

During the three months ended September 30, 2003, the Company retired approximately 1,304,000 shares of previously issued, but not currently outstanding, common stock which had been acquired by the Company pursuant to its stock repurchase plan for $3.3 million. The retired shares have resumed the status of authorized and unissued shares of common stock. As of September 30, 2003, the Company had no issued Treasury Stock.

Stockholder Rights Plan

On January 28, 2003, the Company’s Board of Directors authorized a stockholder rights plan. Under the plan, each holder of shares of the Company’s common stock as of the close of business on February 10, 2003 received a right to buy one one-hundredth of a share of the Company’s Series A preferred stock at an exercise price of $15.00, subject to adjustment, if a person or group were to acquire, or to announce the intention to acquire, 20% or more of the Company’s outstanding shares of common stock. The Company’s Board of Directors has designated 2,000,000 shares of preferred stock as Series A preferred stock in connection with the plan.

DOCENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Commitments and Contingencies

Purchase commitment

In September 2002, the Company entered into an agreement with a third party software company to resell that company’s product through April 2005. Under the agreement, the Company committed to purchase $1.0 million of the third party software company’s software and pay the third party software company $1.0 million over the first year of the agreement for the distributed software. In September 2003, the Company amended the agreement to extend the $1.0 million commitment until April 2005. If the Company fails to resell $1.0 million of the third party company’s software by April 2005, the Company will pay the third party software company the remaining unsold balance due. As of September 30, 2003, the Company had purchased $114,000 under this agreement.

Legal contingencies

On May 31, 2002, IP Learn, LLC filed a patent infringement case against the Company in the United States District Court for the Northern District of California. In December 2002, IP Innovation, LLC filed a patent infringement case against the Company in the United States District Court for the Southern District of Texas. The Company believes that the patent infringement cases are without merit and intends to defend against them vigorously. However, if these third party claims for infringement and their patents are held to be valid, the Company may be required to license the patents on terms that may or may not be favorable or be forced to alter its website or its software product which is the subject of the patents, either of which results may adversely affect its results of operations.

Also, from time to time, the Company may become involved in litigation relating to claims arising from the Company’s ordinary course of business. The Company believes that there are no claims or actions pending or threatened against it, disposition of which would have a material adverse effect on its financial condition or results of operations.

10.

Income Taxes

The Company incurred operating losses for all periods from inception through September 30, 2003, and therefore has not recorded a provision for U.S. federal income taxes. The Company recorded a provision for foreign and state income taxes of $77,000 for the three months ended September 30, 2003, and $196,000 for the nine months ended September 30, 2003. The Company recorded a provision for foreign and state income taxes of $55,000 for the three months ended September 30, 2002, and $149,000 for the nine months ended September 30, 2002. The Company has recorded a valuation allowance for the full amount of its net deferred tax assets.

11.

Related Party Transactions

In March 2000, the Company entered into an alliance agreement with Accenture, which at the time was a stockholder of the Company and one of whose retired partners was a member of the Company’s Board of Directors until June 6, 2003. The alliance agreement provides for the resale of the Company’s software products and services by Accenture, the submission of joint proposals to potential clients where either the Company would be subcontracting the Company’s services to Accenture or Accenture would be subcontracting its services to the Company; the alliance agreement also provides for revenue sharing. The agreement terminates by its terms on March 31, 2005, with either party having the right to terminate the agreement before then without cause on 60 days’ notice.

From March 2000 to December 2002, Accenture’s holdings in the Company’s common stock on a fully diluted basis represented approximately 5.0% to 7.0% of the outstanding shares of the Company’s common stock. In December 2002, the Company believes that Accenture sold all of its Docent common stock and warrants.

DOCENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

During the nine months ended September 30, 2002, the Company recognized $324,000 of revenue from Accenture as part of this resale arrangement. During the nine months ended September 30, 2002, the Company recorded $316,000 as a reduction in revenues for amounts due to Accenture under the revenue sharing agreement with Accenture.

Concurrent with the alliance agreement, the Company entered into a consulting services agreement with Accenture pursuant to which the Company committed to purchase $2.0 million of consulting services from Accenture prior to April 1, 2003. As of September 30, 2003, the Company had only purchased $1.4 million of consulting services from Accenture. The Company did not record a liability associated with the remaining purchase commitment for this agreement as of September 30, 2003. If Accenture requests the remaining payments, Docent would use the additional services from Accenture and expense those services as they are provided.

12.

Recently issued accounting pronouncements

In November 2002, the EITF reached a consensus on Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. Issue 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of Issue 00-21 will apply to revenue arrangements entered into after June 30, 2003. The adoption of Issue 00-21 did not have a material effect on the Company’s consolidated financial position or results of operations.

In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. The Company did not create or acquire any new variable interest entities after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied beginning October 1, 2003. The Company does not believe that the adoption of this standard will have a material effect on its consolidated financial position or results of operations.

13.

Warranties and Indemnification

The Company generally provides to its customers a warranty for its software products and services for a period of 90 days, and accounts for its warranties under the FASB’s Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies.” The Company’s software products’ media are generally warranted to be free of defects in materials and workmanship under normal use and the products are also generally warranted to substantially perform as described in certain Company documentation. The Company’s services are generally warranted to be performed in a professional manner and to materially conform to the specifications set forth in a customer’s signed contract. In the event there is a failure of such warranties, the Company generally will correct or provide a reasonable work around or replacement product. The Company has not provided for a warranty accrual in any period presented. To date, the Company’s product warranty expense has not been significant.

The Company generally agrees to indemnify its customers against legal claims that the Company’s software products and professional services infringe certain third-party intellectual property rights and accounts for its indemnification obligations under FAS 5. In the event of such a claim, the Company is generally obligated to defend its customer against the claim and to either settle the claim at the Company’s expense or pay damages that the customer is legally required to pay to the third-party claimant. In addition, in the event of an infringement, the Company generally agrees to modify or replace the infringing product, or, if those options are not reasonably possible, in general, to refund the cost of the software paid to date upon the customers return of the software product. To date, the Company has not been required to make any payment resulting from infringement claims asserted against its customers. As such, the Company has not recorded a liability for infringement costs in any period presented.

14.

Subsequent Event

On October 20, 2003, the Company entered into an Agreement and Plan of Reorganization with Click2learn, Inc. (“Click2learn”). Under terms of the Agreement and Plan of Reorganization, which has been approved by the board of directors of each company, Click2learn and the Company will each be acquired by a new corporate entity. Stockholders of Click2learn will receive .4144 shares of common stock in the new company for each common share of Click2learn held on the closing date, or approximately 52% of the total outstanding common stock of the new company, without taking into account the exercise of options prior to the closing date. Stockholders of the Company will receive .9525 shares of common stock in the new company for each common share of the Company held on the closing date, or approximately 48% of the total outstanding common stock of the new company, without taking into account the exercise of options prior to the closing date. Outstanding options and warrants will be converted into options and warrants for the purchase of shares in the new corporation in accordance with the same exchange ratios. The transaction is anticipated to be a tax-free reorganization and/or a tax-free exchange for United States tax purposes.

ITEM 2

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

The following discussion and analysis should be read in conjunction with the Company’s Condensed Consolidated Financial Statements and related Notes thereto contained elsewhere in this document. Operating results for the three and nine month periods ended September 30, 2003 are not necessarily indicative of the results that may be expected for any future periods, including the full fiscal year. Reference should also be made to the Annual Consolidated Financial Statements, Notes thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations and Risk Factors contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

This discussion contains forward-looking statements that involve risks and uncertainties. These statements relate to our future plans, objectives, expectations and intentions, and the assumptions underlying or relating to any of these statements. These statements may be identified by the use of words such as “believe,” “expect,” “anticipate,” “intend,” “plan,” “will,” “would,” “should” and similar expressions. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could contribute to such differences include those discussed in this document, such as a significant decrease in our cash level, a material change in our operating losses and a failure to realize the anticipated cash savings from the three and nine months ended September 30, 2002 restructuring programs. Except as required by law, we undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

Overview

We were incorporated in June 1997 to develop, market and sell eLearning products. We provide infrastructure software and related services that allow our customers to create, deploy and manage learning and knowledge exchange over the Internet.

Critical Accounting Policies and Estimates

General

Discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States (GAAP). The preparation of these financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. On an on-going basis, we evaluate estimates based on historical experience and on various other assumptions that management believes to be reasonable under the circumstances. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates under different assumptions or conditions. We believe the following critical accounting policies involve our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements:

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Revenue Recognition

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Allowance for Doubtful Accounts

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Goodwill and Intangible Assets

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Restructuring

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Allowance for Deferred Tax Assets

In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application. There are also areas in which management’s judgment in selecting among available alternatives would not produce a materially different result. Our senior management has reviewed these critical accounting policies and related disclosures with our Disclosure Committee and the Audit Committee of our Board of Directors. See the Notes to Condensed Consolidated Financial Statements, which contain additional information regarding our accounting policies and other disclosures required by GAAP.

Revenue Recognition

Our revenue recognition policies are described below under “Sources of Revenue and Revenue Recognition.”

Allowance for Doubtful Accounts

We record allowances for estimated losses resulting from the inability of our customers to make required payments. We assess the credit worthiness of our customers based on multiple sources of information and analyze such factors as our historical bad debt experiences, industry and geographic concentrations of credit risk, economic trends and changes in customer payment terms. This assessment requires significant judgment. If the financial condition of our customers or any of the other factors we use to analyze credit worthiness were to worsen, additional allowances may be required, resulting in future operating losses that are not included in the allowance for doubtful accounts at September 30, 2003.

Goodwill and Intangible Assets

We make judgments about the recoverability of goodwill and intangible assets whenever events or changes in circumstances indicate that an indication of impairment in the remaining value of the assets recorded on our balance sheet may exist. We test the impairment of goodwill annually or more frequently if indicators of impairment arise. In order to estimate the fair value of intangible assets, we make various assumptions about the future prospects for the business to which the asset relates and typically estimate future cash flows to be generated by these businesses. Based on these assumptions and estimates, we determine whether we need to take an impairment charge to reduce the value of the asset stated on our balance sheet to reflect its estimated fair value. Assumptions and estimates about future values and remaining useful lives are complex and often subjective. They can be affected by a variety of factors, including external factors, such as industry and economic trends, and internal factors, such as changes in our business strategy and our internal forecasts. Although we believe the assumptions and estimates we have made in the past have been reasonable and appropriate, different assumptions and estimates could materially impact our reported financial results. More conservative assumptions of the anticipated future benefits from these businesses would result in greater impairment charges, which would increase our net loss and result in lower asset values on our balance sheet. Conversely, less conservative assumptions would result in smaller impairment charges, lower net loss and higher asset values. The Company intends to perform an annual impairment test of our goodwill and intangible assets as of October 1, 2003.

Restructuring

During fiscal years 2001 and 2002, we recorded significant accruals in connection with our restructuring programs. These accruals include estimates pertaining to the ability to sub-lease a facility in Mountain View, California. The actual costs have differed and may continue to differ from these estimates. These estimates will be reviewed and potentially revised on a quarterly basis and, to the extent that future vacancy rates and sublease rates vary adversely from those estimates, we may incur additional losses that are not included in the accrued facilities consolidation charge at September 30, 2003. Conversely, unanticipated improvements in vacancy rates or sublease rates, or termination settlements for less than our accrued amounts, may result in a reversal of a portion of the accrued balance and a benefit on our statement of operations in a future period. Such reversals would be reflected as a credit to restructuring charges.

Allowance for Deferred Tax Assets

A valuation allowance is recorded to reduce all of the deferred tax assets to the amount that is more likely than not to be realized by us. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future, an adjustment to the deferred tax asset would increase reported income or reduce loss in the applicable period and increase stockholders’ equity on the balance sheet in the period such determination was made.

Sources of Revenue and Revenue Recognition

We generate revenue from the sale of our products and services to enterprises, systems integrators, reseller partners, and content providers. To date, we have generated our license and services revenue primarily from direct sales, and to a lesser extent from referral sales by our system integrators, to enterprise customers.

Enterprise customers have the option of purchasing perpetual licenses or renting time-based licenses for the Docent Enterprise Suite^{^™}, that includes the Docent Learning Management Server^{^™}, Docent Learning Content

Management System^{^™}, Docent Exchange^{^™}, Docent Live!^{^™}, Docent Peak Performance^R, Docent Analytics^{^™}, and Content. Docent Live!, Docent Peak Performance and Content are third party products that we resell. Our perpetual licensees pay a one-time, initial fee based on the number of users and may enter into separate annual maintenance contracts that include the right to receive periodic unspecified upgrades, error corrections, and telephone and Web-based support. Our time-based licenses require license holders to pay a monthly fee, which is based on the number of users and includes maintenance and support. Customers with perpetual or time-based licenses may also outsource to Docent the hosting of their system on a third party’s server for a monthly fee and an initial set-up fee.

In conjunction with the licensing of our software, we offer implementation and training services. To date, most of our customer revenue has been generated by perpetual software licenses, and maintenance and consulting services.

We typically sign multi-year royalty agreements with our content providers to deliver their content over the Web. Under these agreements, we receive a minimum annual payment and a percentage of the revenue these content providers receive in excess of the minimum payment for content which they or third parties, such as resellers or system integrators described below, provide to customers. For that minimum payment, we provide our software and application hosting. In the first year of the agreement, as part of the minimum payment, we also provide professional services such as implementation and training. During subsequent years, these services are available for an additional fee. To date, almost all of our revenue from content providers has been insignificant and consisted of minimum annual payments.

We generate revenue from our reseller partners who purchase our products and maintenance services, together with content from our content providers, and resell them to our reseller partners’ customers. To date, resellers have typically sold perpetual licenses of our software and annual maintenance agreements. They usually provide additional professional services themselves, but may also resell some of our professional services. Generally, they receive a discount from our list license prices. When they resell content from our content providers, our content providers would receive revenue that is included in the calculation of the royalties we are entitled to receive from our content providers as described above.

Our revenue recognition policies are significant because our revenue is a key component of our results of operations. Revenue results are difficult to predict, and any shortfall in revenue or delay in recognizing revenue could cause our operating results to vary significantly from quarter to quarter. We follow detailed revenue recognition guidelines, which are discussed below. We recognize revenue in accordance with GAAP rules that have been prescribed for the software industry. The accounting rules related to revenue recognition are complex and are affected by interpretations of the rules and an understanding of industry practices, both of which are subject to change. Consequently, the revenue recognition accounting rules require management to make significant judgments.

In accordance with Statement of Position No. 97-2, Software Revenue Recognition, issued by the American Institute of Certified Public Accountants (SOP 97-2), as amended, we recognize revenue from licensing our software if all of the following conditions are met:

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There is persuasive evidence of an arrangement;

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We have delivered the product to the customer;

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Collection of the fees is probable; and

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The amount of the fees to be paid by the customer is fixed or determinable.

Revenue from sales to resellers is recognized upon the receipt of a purchase order or a sales contract from the reseller and when the end customer has been identified, provided all the conditions for revenue recognition set forth above have been met. No right of return exists for these sales.

For arrangements requiring customer acceptance, revenue recognition is deferred until the earlier of the end of the acceptance period or until written notice of acceptance is received from the customer.

We do not record revenue on sales to customers whose ability to pay is in doubt at the time of sale. Rather, revenue is recognized from these customers as cash is collected. The determination of a customer’s ability to pay requires significant judgment. In this regard, Docent management will consider, among other things, the geographic location of the customer, the financial viability of the customer, and the past payment histories of the customer in assessing a customer’s ability to pay.

Revenue arrangements with extended payment terms are generally considered not to be fixed or determinable and, accordingly, we do not recognize revenue on these arrangements until the customer payment becomes due. The determination of whether extended payment terms are fixed or determinable requires significant judgment by management, including assessing such factors as the past payment history with the individual customer and evaluating the risk of concessions over an extended payment period. The determinations that we make can materially impact the timing of recognition of revenues. Our normal payment terms currently range from “net 30 days” to “net 60 days,” which are not considered extended payment terms.

For arrangements involving time-based licenses, customers pay a fee based on the number of users, and such fees include maintenance and support. Objective evidence of fair value does not exist for the related maintenance and support, as maintenance and support are not offered separately for such time-based arrangements. In these cases, we recognize the entire arrangement fee ratably over the contractual maintenance and support period, which is generally one year. We have allocated the time-based license and maintenance revenue based on their relative costs.

Many of our software contracts include consulting implementation services. Consulting revenues from these contracts are generally accounted for separately from the license revenues because the consulting arrangements qualify as “service transactions” as defined in SOP 97-2. The more significant factors considered in determining whether the revenue should be accounted for separately include the nature of services (i.e., consideration of whether the services are essential to the functionality of the licensed product), degree of risk, availability of services from other vendors, timing of payments and impact of milestones or acceptance criteria on the realizability of the software license fee. Revenues for consulting services are generally recognized as the services are performed. If there is a significant uncertainty about the project completion date or receipt of payment for the consulting services, revenue is deferred until the uncertainty is sufficiently resolved. We estimate the percentage of completion on contracts with fixed or “not to exceed” fees on a monthly basis utilizing hours incurred to date as a percentage of total estimated hours to complete the project. If we do not have a sufficient basis to measure progress towards completion, revenue is recognized when we receive final acceptance from the customer. When total cost estimates exceed revenues, we accrue for the estimated losses immediately based upon an average fully burdened daily rate applicable to the consulting organization delivering the services. The complexity of the estimation process and issues related to the assumptions, risks and uncertainties inherent with the application of the percentage of completion method of accounting affect the amounts of revenue and related expenses reported in our operating results. A number of internal and external factors can affect our estimates, including labor rates, utilization and efficiency variances and specification and testing requirement changes.

For arrangements involving a significant amount of services related to installation, modification or customization of our software products, we recognize revenue using the percentage-of-completion method. However, where there are customer acceptance clauses that we do not have an established history of meeting or which are not considered to be routine, we recognize revenue when the arrangement has been completed and accepted by the customer.

For perpetual license arrangements that include multiple elements, such as a product license, maintenance and support, hosting and professional services, we allocate revenue to all undelivered elements, usually maintenance and support, hosting and professional services, based on objective evidence of the fair value of those elements. Fair value is specific to us and represents the price for which we sell each element separately. Any amount remaining is allocated using the residual method to the delivered elements, generally only the product license, and recognized as revenue when the conditions discussed above are satisfied.

We recognize revenue from fees for ongoing maintenance and support ratably over the period of the maintenance and support agreement, which is generally one year. We recognize revenue allocated to, or fees generated from, the separate selling of professional services as the related services are performed. Fees associated with hosting and application service provider (“ASP”) services are recognized ratably over the period of the hosting agreement, which is generally one year.

For arrangements with our content providers, the minimum fee is allocated among the separate elements, including professional services and hosting, based on the fair value of each of these elements. Any minimum royalty amount is recognized as revenue ratably over the period in which it is earned, which is generally one year. Any royalty over and above the minimum is recognized upon receipt of a revenue report from the content provider.

Customer billings that have not been recognized as revenue in accordance with the above policies are shown on the balance sheet as deferred revenue.

Costs and expenses

Our cost of license revenue includes the cost of amortized developed and core technology from the gForce acquisition, the cost of third party software and content we resell, and the cost of manuals, production media and shipping costs. Our cost of service and maintenance revenue includes salaries and related expenses of our professional services organization and charges related to hosting activities and other third party services.

Research and development, sales and marketing, and general and administrative expense categories include direct costs, such as salaries, employee benefits, travel and entertainment, and allocated communication, information technology, rent and depreciation expenses. Sales and marketing expenses also include sales commissions and expenditures related to public relations, advertising, trade shows and marketing campaigns. General and administrative expenses also include legal and financial services fees.

Stock-based compensation consists of two components. The first component is amortization of unearned stock-based compensation recorded in connection with stock option grants to our employees. This amount represents the difference between the deemed fair value of our common stock for accounting purposes on the date these stock options were granted and the exercise price of those options. This amount is included as a component of stockholders’ equity on our balance sheet and is being amortized on an accelerated basis by charges to operations over the vesting period of the options, consistent with the method described in Financial Accounting Standards Board Interpretation No. 28. The second component is the fair value of common stock and other equity instruments issued to non-employees in exchange for services. We use the Black-Scholes pricing model to estimate the fair value of other equity instruments granted to non-employees in accordance with Emerging Issues Task Force 96-18.

History of losses

We have incurred significant costs to develop our technology and products and to build our engineering, sales, marketing, professional services and administration departments. As a result, we have incurred significant losses since inception and, as of September 30, 2003, had an accumulated deficit of $196.5 million. We believe our success will depend on increasing our customer and partner base and continually enhancing our products. We expect to continue to incur operating losses at least through fiscal year 2003.

Results of Operations

Three and Nine Months Ended September 30, 2003 and 2002

Revenue

Total revenue increased $988,000, from $6.0 million for the three months ended September 30, 2002 to $7.0 million for the three months ended September 30, 2003. Total revenue increased $1.1 million, from $20.7 million for the nine months ended September 30, 2002 to $21.8 million for the nine months ended September 30, 2003. The increase in total revenue for the three months ended September 30, 2003 was primarily attributable to an increase in European sales and maintenance revenue from a larger installed base. The increase in total revenue for the nine months ended September 30, 2003 was primarily attributable to an increase in maintenance revenue.

Total license revenue increased $457,000, from $2.5 million for the three months ended September 30, 2002 to $3.0 million for the three months ended September 30, 2003. Total license revenue increased $55,000, from $9.6 million for the nine months ended September 30, 2002 to $9.7 million for the nine months ended September 30, 2003. The increase in license revenue for the three months ended September 30, 2003 was primarily attributable to an increase in European sales related to a significant customer sale in the three months ended September 30, 2003. License revenue was consistent for the nine months ended September 30, 2002 and 2003.

Total service and maintenance revenue increased $531,000, from $3.6 million for the three months ended September 30, 2002 to $4.1 million for the three months ended September 30, 2003. Total service and maintenance revenue increased $1.0 million, from $11.1 million for the nine months ended September 30, 2002 to $12.1 million for the nine months ended September 30, 2003. The increases in service and maintenance revenue in the three and nine month periods ended September 30, 2003 were primarily attributable to an increase in maintenance revenues from a larger installed base.

In the three months ended September 30, 2002 and 2003 and in the nine months ended September 30, 2002 and 2003, no customer accounted for sales greater than 10% of the Company’s total revenues.

Costs of revenue

Cost of license revenue decreased $170,000, from $481,000 for the three months ended September 30, 2002 to $311,000 for the three months ended September 30, 2003. Cost of license revenue decreased $258,000, from $1.3 million for the nine months ended September 30, 2002 to $1.0 million for the nine months ended September 30, 2003. The decrease in the three month period was primarily due to the decrease in amortization of developed and core technology. The decrease in the nine month period was primarily due to the decrease in amortization of developed and core technology, partially offset by an increase in cost of third-party products.

Amortization of developed and core technology decreased $140,000, from $360,000 for the three months ended September 30, 2002 to $220,000 for the three months ended September 30, 2003.

Amortization of developed and core technology decreased $419,000, from $1.1 million for the nine months ended September 30, 2002 to $660,000 for the nine months ended September 30, 2003. This decrease was partially offset by an increase in cost of third party products of $176,000, from $36,000 for the nine months ended September 30, 2002 to $212,000 for the nine months ended September 30, 2003.

Cost of service and maintenance revenue decreased $105,000, from $2.0 million for the three months ended September 30, 2002 to $1.9 million for the three months ended September 30, 2003. Cost of service and maintenance revenue decreased $790,000, from $6.9 million for the nine months ended September 30, 2002, to $6.1 million for the nine months ended September 30, 2003. The decrease in the three month period was primarily attributable to decreased personnel in our professional services organization, partially offset by an increase in expenses related to consultants. The decrease in the nine month period was attributable to decreased personnel in our professional services organization and a decrease in stock-based compensation. This was partially offset by an increase in expenses related to consultants.

Costs relating to service and maintenance personnel decreased $283,000, from $1.5 million for the three month period ended September 30, 2002 to $1.2 million for the three month period ended September 30, 2003. This was partially offset by an increase in expenses related to consultants of $192,000, from $495,000 in the three months ended September 30, 2002 to $687,000 in the three months ended September 30, 2003.

Costs relating to service and maintenance personnel decreased $603,000, from $4.7 million in the nine months ended September 30, 2002 to $4.1 million in the nine months ended September 30, 2003. Stock-based compensation decreased $178,000, from $233,000 in the nine months ended September 30, 2002 to $55,000 in the nine months ended September 30, 2003. This was partially offset by an increase in expenses related to consultants of $98,000, from $2.2 million in the nine months ended September 30, 2002 to $2.3 million in the nine months ended September 30, 2003.

Service and maintenance gross profit percentage increased from 44% gross profit for the three months ended September 30, 2002 to 54% gross profit for the three months ended September 30, 2003. Service and maintenance gross profit percentage increased from 38% gross loss for the nine months ended September 30, 2002 to 49% gross profit for the nine months ended September 30, 2003. The increases in service and maintenance gross profit percentage in the three and nine month periods ended September 30, 2003 were primarily attributable to an increase in maintenance revenues from a larger installed base.

Operating expenses

Research and development expenses. Research and development expenses were $2.5 million for the three months ended September 30, 2002 and 2003. Research and development expenses decreased $1.3 million, from $8.7 million for the nine months ended September 30, 2002 to $7.4 million for the nine months ended September 30, 2003. The decrease in the nine month period was primarily attributable to a decrease in the number of external development consultants. Expenses relating to external development consultants decreased $1.1 million, from $1.7 million in the nine months ended September 30, 2002 to $697,000 in the nine months ended September 30, 2003.

Sales and marketing expense. Sales and marketing expenses decreased $496,000, from $4.6 million for the three months ended September 30, 2002 to $4.1 million for the three months ended September 30, 2003. Sales and marketing expenses decreased $5.0 million, from $17.2 million for the nine months ended September 30, 2002 to $12.2 million for the nine months ended September 30, 2003. The decrease in the three month period was

attributable to a decrease in marketing activities, including trade shows, promotional materials and public relations and to a decrease in stock-based compensation.

Expenses relating to marketing activities decreased $314,000, from $761,000 in the three month period ended September 30, 2002 to $447,000 in the three month period ended September 30, 2003. Stock-based compensation decreased $100,000, from $172,000 for the three months ended September 30, 2002 to $72,000 for the three months ended September 30, 2003.

Expenses relating to sales and marketing personnel decreased $4.5 million, from $14.4 million for the nine months ended September 30, 2002 to $9.9 million for the nine months ended September 30, 2003.

General and administrative expense. General and administrative expense decreased $434,000, from $1.5 million for the three months ended September 30, 2002 to $1.1 million for the three months ended September 30, 2003. General and administrative expense decreased $728,000, from $4.4 million for the nine months ended September 30, 2002 to $3.6 million for the nine months ended September 30, 2003. The decrease in the three month period was primarily attributable to a decrease in outside professional service fees, such as attorneys and accountants, general and administrative personnel expenses, and stock-based compensation. The decrease in the nine month period was primarily attributable to a decrease in expenses related to general and administrative personnel and to a decrease in outside professional service fees, such as attorneys and accountants, partially offset by an increase in stock-based compensation and consulting expense.

Expenses relating to outside professional service fees decreased $278,000, from $419,000 for the three month period ended September 30, 2002 to $141,000 for the three month period ended September 30, 2003. Expenses relating to personnel decreased $85,000, from $836,000 for the three months ended September 30, 2002 to $751,000 for the three months ended September 30, 2003. Stock-based compensation decreased $85,000, from $158,000 for the three months ended September 30, 2002 to $73,000 for the three months ended September 30, 2003

Expenses relating to personnel decreased $1.2 million, from $3.4 million for the nine months ended September 30, 2002 to $2.2 million for the nine months ended September 30, 2003. Expenses relating to outside professional services decreased $516,000, from $1.3 million for the nine months ended September 30, 2002 to $746,000 for the nine months ended September 30, 2003. Stock-based compensation increased $820,000, from $444,000 of credit in the nine months ended September 30, 2002 to $376,000 in expense for the nine months ended September 30, 2003. Consulting expense increased $203,000, from $147,000 for the nine month period ended September 30, 2002 to $350,000 for the nine month period ended September 30, 2003.

Stock-based compensation. Stock-based compensation expense relating to common stock, options and warrants was $417,000 for the three months ended September 30, 2002 and $181,000 for the three months ended September 30, 2003. Stock-based compensation relating to common stock, options and warrants was a $530,000 credit for the nine months ended September 30, 2002 and $758,000 expense for the nine months ended September 30, 2003.

Stock-based compensation is being expensed using an accelerated amortization method; thus, more expenses were recorded early in the life of the options. The 2002 termination of certain Docent officers with unvested options, that had already been expensed under the accelerated method, created an overall stock-based compensation credit of $530,000 for the nine months ended September 30, 2002.

Restructuring charge. In 2001 and 2002, Docent implemented restructuring programs to better align operating expenses with anticipated revenues.

During the third quarter of fiscal 2001, Docent recorded a restructuring charge that included $3.0 million in facility exit costs. During the fourth quarter of fiscal 2001, Docent adjusted these facility exit costs to increase the related charge by $112,000. The adjustment reflects a reduction of the estimated sublease income of a particular vacated facility.

During the first quarter of fiscal 2002, Docent recorded a $925,000 restructuring charge, which consisted of $886,000 in employee severance costs and $39,000 in other exit costs. The restructuring program resulted in a reduction in force across all company functions of approximately 17%, or 42 employees.

During the second quarter of fiscal 2002, Docent recorded a $3.1 million restructuring charge, which consisted of $2.1 million in facility exit costs, $822,000 in employee severance costs, $163,000 in equipment impairment, and $27,000 in other exit costs. The restructuring program resulted in a reduction in force across all company functions of approximately 17%, or 36 employees.

Also during the second quarter of fiscal 2002, Docent increased its estimate of the total costs associated with the above restructuring activities and recorded an adjustment of $298,000. The adjustment reflects a reduction of the estimated sublease income of one vacated facility of $372,000, partially offset by a credit of $74,000 resulting from the settlement of another lease obligation for a sum less than the amount previously recorded.

During the third quarter of fiscal 2002, Docent continued the announced second quarter restructuring actions. Docent recorded a $381,000 restructuring charge, which consisted of $271,000 in employee severance costs, and $110,000 in equipment impairment. The continued restructuring program resulted in a reduction in force across all company functions of approximately 5%, or nine employees.

During the second quarter of fiscal 2003, Docent recorded a $327,000 provision adjustment. The adjustment included $141,000 of other costs and $85,000 of employee severance, due to the finalization of payments associated with other costs and employee severance at lower amounts than previously estimated. Docent also recorded an adjustment of $101,000 related to a vacated facility associated with the above restructuring activities that was subleased during the quarter.

The restructuring programs described above have saved Docent approximately $3.0 million of cash per quarter.

Interest expense, other income and expense, net, and interest income

Interest expense. Interest expense was $6,000 for the three months ended September 30, 2002 and none for the three months ended September 30, 2003. Interest expense decreased $108,000, from $142,000 for the nine months ended September 30, 2002 to $34,000 for the nine months ended September 30, 2003. These decreases were attributable to paying off capital lease and equipment loan balances in the first half of 2003.

Other income and expense, net. Other income and expense, net, increased $276,000, from $189,000 net expense for the three months ended September 30, 2002 to $87,000 net income for the three months ended September 30, 2003. Other income and expense, net, decreased $66,000, from $139,000 net expense for the nine months ended September 30, 2002 to $73,000 net expense for the nine months ended September 30, 2003. These decreases were attributable to foreign exchange gains and losses during the different periods in 2002 and 2003. Foreign exchange income increased $175,000, from a loss of $88,000 recorded in the three months ended September 30, 2002 compared to a foreign exchange gain of $87,000 in the three months ended September 30, 2003. Foreign exchange income decreased $92,000, from a gain of $137,000 recorded in the nine months ended September 30, 2002 compared to a foreign exchange gain of $45,000 for the nine months ended September 30, 2003.

Interest income. Interest income decreased $128,000, from $215,000 for the three months ended September 30, 2002 to $87,0000 for the three months ended September 30, 2003. Interest income decreased $532,000, from $823,000 for the nine months ended September 30, 2002 to $291,000 for the nine months ended September 30, 2003. These decreases were the result of lower average cash and investments balances maintained by the Company, reflecting the use of cash to fund operations, and lower interest rates.

Provision for income taxes

We incurred operating losses for all periods from inception through September 30, 2003, and therefore have not recorded a provision for U.S. income taxes. We recorded a provision for foreign and state income taxes of $77,000 for the three months ended September 30, 2003, and $196,000 for the nine months ended September 30, 2003. We recorded a provision for foreign and state income taxes of $55,000 for the three months ended September 30, 2002, and $149,000 for the nine months ended September 30, 2002. We have recorded a valuation allowance for the full amount of our net deferred tax assets.

Realization of the deferred tax assets is dependent on future earnings, the timing and amount of which are uncertain. Accordingly, a valuation allowance, in an amount equal to the net deferred tax assets as of September 30, 2003, has been established to reflect these uncertainties.

Liquidity and Capital Resources

Since inception, we have funded our losses through the sale of equity securities, from which we raised net proceeds of $172.1 million through September 30, 2003, and the sale of our software. As of September 30, 2003, we had approximately $30.9 million of cash and cash equivalents and $2.0 million of short-term investments.

Cash used in operating activities was $7.6 million for the nine months ended September 30, 2003, as compared to $16.0 million for the nine months ended September 30, 2002. The cash used during these periods was attributable to net losses of $8.2 million for the nine months ended September 30, 2003 and $20.6 million for the nine months ended September 30, 2002. During the nine months ended September 30, 2002, cash used to fund net losses was partially offset by a decrease in accounts receivable of $4.9 million. The decrease in accounts receivable was due to improved cash collections and lower revenue levels.

Our investment in property and equipment, excluding equipment acquired under capital leases, was $367,000 in the nine months ended September 30, 2003 and was $592,000 in the nine months ended September 30, 2002. During the first nine months of 2003, we sold $29.0 million of short term investments, offset by the purchase of $27.0 million of short term investments. During the first nine months of 2002, we sold $57.8 million of short term investments, partially offset by the purchase of $30.9 million of short term investments.

Cash used in financing activities was $173,000 during the nine months ended September 30, 2003, and cash used in financing activities was $711,000 for the nine months ended September 30, 2002. The cash used in financing activities in the first nine months of 2003 resulted from the repurchase of common stock of $207,000 and the repayment of capital lease obligations of $144,000, partially offset by proceeds from common stock purchases under our employee stock purchase plan and exercises of common stock options and warrants of $135,000. The cash used in financing activities in the first nine months of 2002 resulted primarily from the purchase of $1.4 million of common stock, partially offset by $783,000 of proceeds from the repayment of stockholder’s receivable.

We expect that current cash and short-term investment balances and cash flow from operations will be sufficient to meet our working capital and other capital requirements for at least the next 12 months.

Related Party

In March 2000, we entered into an alliance agreement with Accenture, which at the time was a stockholder of ours and one of whose retired partners was a member of our Board of Directors until June 6, 2003. The alliance agreement provides for the resale of our software products and services by Accenture, the submission of joint proposals to potential clients where either we would be subcontracting our services to Accenture or Accenture would be subcontracting its services to us; the alliance agreement also provides for revenue sharing. The agreement terminates by its terms on March 31, 2005, with either party having the right to terminate the agreement before then without cause on 60 days’ notice.

From March 2000 to December 2002, Accenture’s holdings in our common stock on a fully diluted basis represented approximately 5.0% to 7.0% of the outstanding shares of our common stock. In December 2002, we believe that Accenture sold all of its Docent common stock and warrants.

During the nine months ended September 30, 2002, we recognized $324,000 of revenue from Accenture as part of this resale arrangement. During the nine months ended September 30, 2002, we recorded $316,000 as a reduction in revenues for amounts due to Accenture under the revenue sharing agreement with Accenture.

Concurrent with the alliance agreement, we entered into a consulting services agreement with Accenture pursuant to which we committed to purchase $2.0 million of consulting services from Accenture prior to April 1, 2003. As of September 30, 2003, we had only purchased $1.4 million of consulting services from Accenture. We did not record a liability associated with the remaining purchase commitment for this agreement as of September 30, 2003. If Accenture requests the remaining payments, we would use the additional services from Accenture and expense those services as they are provided.

Factors That May Impact Future Operating Results and Stock Price

Our business and results of operations are likely to be affected by our announced merger with Click2learn Inc.

On October 20, 2003, we entered into an agreement to merge with Click2learn. The announcement of the merger could have an adverse effect on our revenue in the near-term if customers delay, defer or cancel purchases pending consummation of the planned merger due to potential uncertainty about the direction of the combined company’s product offerings and its support and service of existing products. To the extent that our announcement of the merger creates uncertainty among customers such that one or more large customers, or a significant group of small customers, delays purchase decisions pending consummation of the planned merger, our results of operations could be negatively affected. Decreased revenue could have a variety of adverse effects, including negative consequences to our relationships with, and ongoing obligations to, customers, suppliers, business partners, and others with whom we have business relationships. In addition, our quarterly operating results and revenue could be substantially below the expectations of market analysts, which could cause a decline in our stock price.

We may suffer additional adverse consequences if the merger with Click2learn were not to be completed.

If the planned merger with Click2learn is not completed, we could suffer a number of consequences that may adversely affect our business, results of operations and stock price, including the following:

•

We would not realize the benefits we expect from becoming part of a combined company with Click2learn, including the potentially enhanced financial and competitive position;

•

Activities relating to the merger and related uncertainties may divert our management’s attention from our day-to-day business and cause disruptions among our employees and to our relationships with customers and business partners, thus detracting from our ability to grow revenue and minimize costs and possibly leading to a loss of revenue and market position that we may not be able to regain if the transaction does not occur;

•

The market price of our common stock could decline following an announcement that the merger has been abandoned, to the extent that the current market price reflects a market assumption that the merger will be completed;

•

We could be required to pay Click2learn a $2.5 million termination fee if the merger agreement is terminated under certain specified conditions;

•

We would remain liable for our costs related to the transaction, such as legal and accounting fees and a portion of the investment banking fees;

•

We may not be able to continue our present level of operations and therefore may have to scale back our present level of business and consider additional reductions in force; and

•

We may not be able to take advantage of alternative business opportunities or effectively respond to competitive pressures.

In connection with the proposed merger, we and Click2learn expect to file a joint proxy statement/prospectus with the Securities and Exchange Commission. The joint proxy statement/prospectus will be mailed to all holders of our stock and will contain important information about us, Click2learn and the proposed merger, risks relating to the merger and the combined company, and related matters. We urge all of our stockholders to read the joint proxy statement/prospectus when it becomes available.

Our limited operating history subjects us to risks encountered by early stage companies and some of these risks are increased because we operate in a new and rapidly evolving market.

Because of our limited operating history, you must consider the risks, uncertainties and difficulties frequently encountered by companies in their early stages of development, particularly companies in new and rapidly evolving markets, including without limitation, the following:

•

risks that our revenue forecasts may be incorrect because of our limited sales to date and our long sales process, and

•

risks that our new products, such as Docent Live!, Docent Peak Performance and Docent Analytics, will fail to achieve market acceptance.

We have not been in business long enough to use our operating history as a reliable aid in predicting trends specific to our company, which limited history impairs our ability to make accurate business plans. Since the market for eLearning products is rapidly evolving, our operating history will be less relevant to future performance than the operating history of a company in an industry that is not subject to rapid change. In addition, since the market for eLearning products is new, we are limited in our ability to refer to industry trends as reliable predictors and to react to these trends. These limitations make it more difficult for us to anticipate the need for new products as the market for eLearning products changes, thus increasing our vulnerability to competition. As a result, we may either fail to increase, or suffer a decrease in, our market share, resulting in a decrease in our revenue.

We have a history of losses, expect future losses and may never achieve profitability.

We have experienced losses in each quarter since our inception and expect losses through at least the end of fiscal year 2003. We incurred net losses of $2.7 million for three months ended September 30, 2003, and $3.9 million for the three months ended September 30, 2002. We incurred net losses of $8.2 million for the nine months ended September 30, 2003, and net losses of $20.6 million for the nine months ended September 20, 2002. Our accumulated deficit as of September 30, 2003 was $196.5 million. We expect to derive substantially all of our revenue for the foreseeable future from the licensing of our Docent Learning Management Server and Docent Learning Content Management System, and providing related services. Over the longer term, we expect to derive revenue from new products such as Docent Live!, Docent Peak Performance, Docent Analytics, and Content, and services related to these offerings. In the future, we expect to continue to incur additional non-cash expenses relating to the amortization of deferred compensation and purchased intangible assets that will contribute to our net losses. As of September 30, 2003, we had an aggregate of $301,000 of deferred stock compensation and $917,000 of purchased intangible assets remaining to be amortized. As a result of all of the foregoing, we expect to incur losses for the foreseeable future and will need to generate significantly higher revenue in order to achieve profitability. If we achieve profitability, we may not be able to sustain it.

Fluctuations in our quarterly revenue and other operating results may cause our stock price to decline.

We believe that quarter-to-quarter comparisons of our revenue and other operating results are not meaningful and should not be relied on as indicators of our future performance. As a consequence of quarterly revenue fluctuations, our financial results may fall short of the expectations of investors. If this occurs, the price of our common stock would likely decline. Our quarterly revenues are especially subject to fluctuations because they depend on the sale of a small number of relatively large orders. Furthermore, our quarterly revenue may be affected significantly by changes in revenue recognition policies and procedures based on changes to or new applicable accounting standards and how these standards are interpreted. As a result, our revenue and results of operations will likely vary significantly from quarter to quarter. These variances may cause our stock price to fluctuate.

Our revenue could decrease and our costs could increase if we fail to adequately integrate with Click2learn or any other acquired businesses.

As part of our overall business strategy, we continually evaluate and may pursue acquisitions of, or mergers with, complementary businesses or technologies that would provide additional product or service offerings, additional industry expertise or an expanded geographic presence. We may not be able to locate attractive opportunities or acquire any we locate on favorable terms. If we do acquire technologies, products or businesses, including any as a result of the pending merger with Click2learn, or we form alliances with companies requiring technology investments or revenue commitments, we will face a number of risks to our business. The risks we may encounter include the potential for unknown liabilities of the acquired or combined business, potentially dilutive issuances of equity securities and the incurrence of debt. In addition, we may face difficulty in assimilating the acquired operations and employees or combining the product and service offerings of the constituent companies in any combination, managing product co-development activities with our alliance partners, retaining the key employees of the acquired or combined business, successfully integrating the acquired or combined technology and operations into our business and maintaining uniform standards, controls, policies and procedures. We may also lack the experience to enter into the new product or technology markets made available by new acquisitions, combinations or alliances. Failure to manage these alliance activities effectively and to integrate entities or assets that we acquire could adversely affect our operating results or financial condition.

In addition to the above-stated risks, under Statement of Financial Accounting Standards No. 142 (SFAS 142) “Goodwill and Other Intangible Assets,” our goodwill is not amortized but is instead reviewed at least annually for impairment. We test goodwill for impairment using the two-step process prescribed in SFAS 142. The first step is a screen for potential impairment, while the second step measures the amount of impairment, if any. If the above-stated risks should occur or if general macroeconomic conditions deteriorate, affecting our business and

operating results over the long-term, we could be required to record impairment charges related to goodwill, which could adversely affect our financial results.

Generally unfavorable economic conditions may cause our customers to reduce spending for new products and services, which would adversely affect our revenue.

The downturn in the economy has resulted in decreases in information technology spending in general. Our products and services require that our customers make a sizable initial investment in order to generate benefits from our products over time. Thus, in such an unfavorable economic environment, our enterprise customers have reduced and may further reduce the resources devoted to eLearning products and services, and in particular new products and services such as ours, before they cut back on other products and services, harming our revenue to a greater degree than the revenue of companies with different products and services.

Our direct sales cycle is lengthy and requires considerable investment with no assurance of when we will generate revenue from our efforts, if at all.

The period between our initial contact with a potential customer and that customer’s purchase of our products and services typically extends from six to nine months. The delay or failure to complete sales in a particular quarter could reduce our revenue in that quarter, as well as subsequent quarters over which revenue for the sale would likely be recognized. If our sales cycle unexpectedly lengthens in general or for one or more large orders, it would negatively affect the timing of our revenue and our revenue growth would be harmed. To sell our products and services successfully, we generally must educate our potential customers regarding the use and benefits of our products and services, which can require significant time, capital and other resources.

Although we must expend and allocate these resources prior to completing a sales transaction, we may never generate any revenue from these activities. In addition, many of our potential customers are large enterprises that generally take longer than smaller organizations to make significant business decisions. Any failure to meet investor expectations for a given quarter would likely cause the price of our common stock to decline.

We must generate significantly more revenue from our resellers to be successful and achieve profitability.

In order to be successful, we must increase and train our reseller sales force and enter into relationships with more resellers. The resellers will require time to learn about our products and services so that they may effectively resell and implement them. A significant portion of our future revenue is dependent on our success in attracting new resellers and the motivation and ability of our existing and future resellers to sell and implement our products and services.

Our lack of product diversification means that any decline in price or demand for our products and services would seriously harm our business.

Our Docent Learning Management Server and Docent Learning Content Management System products and related services have accounted for substantially all of our revenue and this situation is expected to continue for the foreseeable future. Consequently, a decline in the price of, or demand for, the Docent Learning Management Server and Docent Learning Content Management System products or services, or their failure to achieve broad market acceptance, would seriously harm our business.

If we lose key personnel, or are unable to attract and retain additional management personnel, we may not be able to successfully grow and manage our business.

We believe that our future success will depend upon our ability to attract and retain our key technical and management personnel. These employees are not subject to employment contracts. We may not be successful in retaining our key employees in the future or in attracting and assimilating replacement or additional key personnel. Any failure in retaining and attracting management personnel may impair our ability to rapidly grow and manage our business.

Difficulties we may encounter in managing our size could adversely affect our results of operations.

We have experienced a period of rapid and substantial growth of our business, followed by a period of rapid and substantial downsizing of our workforce. These periods have placed a serious strain on our managerial, administrative and financial personnel and our internal infrastructure. To manage the changes these periods of expansion and contraction of our business and personnel have brought to our operations and personnel, we will be required to improve existing and implement new operational, financial and management controls, reporting systems

and procedures. We may not be able to install adequate management information and control systems in an efficient and timely manner and our current or planned personnel systems, procedures and controls may not be adequate to support our future operations. If we are unable to manage further growth effectively, we will not be able to capitalize on attractive business opportunities.

Intense competition in our market segment could impair our ability to grow and to achieve profitability.

The market for our products and services is intensely competitive, dynamic and subject to rapid technological change. We expect the intensity of the competition and the pace of change to increase in the future. The relatively low barriers to entry in the eLearning market will encourage competition from a variety of established and emerging companies. Competitors vary in size and in the scope and breadth of the products and services offered. Many of our competitors have longer operating histories, substantially greater financial, technical, marketing or other resources, or greater name recognition than we have. As a result, our competitors may be able to respond more quickly than we can to new or emerging technologies and changes in customer requirements. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any one of which would seriously harm our business. Our current and potential competitors may develop and market new technologies that render our existing or future products and services obsolete, unmarketable or less competitive. Our current and potential competitors may make strategic acquisitions or establish cooperative relationships among themselves or with other learning solution providers, thereby increasing the availability of their services to address the needs of our current and prospective customers. We may not be able to compete successfully against our current and future competitors and competitive pressures that we encounter may seriously harm our business.

If we are unable to manage the complexity of conducting business globally, our international revenues may suffer.

International revenues accounted for approximately 28% of our total revenue for the three months ending September 30, 2003 and 28% of our total revenue for the nine months ending September 30, 2003. We intend to expand our international presence in the future. Conducting business outside of the United States is subject to certain risks, including:

•

changes in regulatory requirements and tariffs;

•

language barriers;

•

difficulties in staffing and managing foreign operations;

•

longer payment cycles and greater difficulty in collecting accounts receivable;

•

reduced protection of intellectual property rights;

•

potentially harmful tax consequences;

•

fluctuating exchange rates;

•

price controls and other restrictions on foreign currency;

•

difficulties in obtaining import and export licenses;

•

the burden of complying with a variety of foreign laws; and

•

political or economic constraints on international trade.

We might not successfully market, sell or distribute our products and services in foreign markets, and we cannot be certain that one or more of such factors will not materially adversely affect our future international operations, and consequently, our business and future growth.

Our market is subject to rapid technological change and if we fail to continually enhance our products and services, our revenue and business would be harmed.

We must continue to enhance and improve the performance, functionality and reliability of our products and services. The software and electronic commerce industries are characterized by rapid technological change, changes in user requirements and preferences, frequent new product and services introductions embodying new technologies, and the emergence of new industry standards and practices that could render our products and services obsolete. In the past, we have discovered that some of our customers desire additional performance and functionality not currently offered by our products. Our success will depend, in part, on our ability to internally develop and license leading technologies to enhance our existing products and services, to develop new products and services that address the increasingly sophisticated and varied needs of our customers, and to respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis. If we are unable to adapt our products and services to changing market conditions, customer requirements or emerging industry standards, we may not be able to increase our revenue and expand our business.

If any of our major system integrators and business outsource providers changes the focus of its business or fails to comply with the terms of its agreements with us, our revenue will be harmed.

Our business model is dependent on developing additional revenue through our system integrators and business outsource providers. If one or more of these companies no longer wishes to develop business in the knowledge exchange market, we will not materially benefit from our strategic alliance with that company. In addition, if one or more of these companies breaches its strategic alliance agreement with us, we may lose the potential for additional revenue. In addition, we will need to devote a substantial number of our personnel, as well as our financial resources, to developing and maintaining our relationships with these partners. Focusing our resources on these partnerships will impair our ability to develop revenues from direct sales and other sources, making us more dependent on our relationships with these partners. Therefore, if one or more of these relationships terminates, we could suffer a significant decrease in our revenue.

Our success depends upon the acceptance and successful integration by customers of our products. We often rely on third-party systems integrators to assist with implementation of our products. If large systems integrators fail to continue to support our solution or commit resources to us, if any of our customers is not able to successfully integrate our solution or if we are unable to adequately train our existing systems integration partners, our business, operating results and financial condition could suffer. In addition, we cannot control the level and quality of service provided by our current and future third-party system integrators.

We outsource the management and maintenance of our hosted and ASP solutions to third parties and will depend upon them to provide adequate management and maintenance services.

We rely on third parties to provide key components of our networks and systems. For instance, we rely on third-party Internet service providers to host the Docent Enterprise Suite for customers who desire to have these solutions hosted. We also rely on third-party communications service providers for the high-speed connections that link our and our Internet service providers’ Web servers and office systems to the Internet. Any Internet or communications systems failure or interruption could result in disruption of our service or loss or compromise of customer orders and data. These failures, especially if they are prolonged or repeated, would make our services less attractive to customers and tarnish our reputation.

Our products sometimes contain errors, and by releasing products containing defects our business and reputation may be harmed.

Our revenue may also decrease if previously undetected errors or performance problems in our existing or future products are discovered in the future or known errors considered minor by us are considered serious by our customers. Complex software products such as ours often contain unknown and undetected errors or performance problems. These errors or performance problems could result in lost revenue or delays in customer acceptance and may harm our business and reputation.

If third parties claim that we infringe on their patents, trademarks, or other intellectual property rights, it may result in costly litigation or require us to make royalty payments.

Currently, third parties have registered Docent or a variant thereof as a trademark in the United States and in some other jurisdictions outside the United States for use with goods or services, which could be construed to overlap those offered by Docent. Although Docent is a registered trademark for Class 35 business services in the United States, we may not be able to register Docent as a trademark in some countries, including the United States, for use with other goods or services due to existing registrations of third parties. Although third parties have not initiated formal infringement proceedings or any other formal challenges to Docent’s use of the Docent trademark, any claims, with or without merit, could cause costly litigation that could consume significant

management time. Docent has only two issued patents. Third parties alleging that Docent has infringed their patents have brought two patent infringement cases. These claims, which we believe to be without merit, and which we plan to vigorously defend. We may incur significant legal fees defending these claims, and they might divert management attention from operating our company. If we become liable to third parties for infringement claims, we may be required to license the patents on terms that may or may not be favorable or we may be forced to alter our website or our software product which is the subject of the infringement claim, either of which may adversely affect our revenue.

We may not be able to adequately protect our intellectual property, and our competitors may be able to offer similar products and services that would harm our competitive position.

Our success and ability to effectively compete is dependent on our ability to develop and maintain the proprietary aspects of our technology and operate without infringing on the intellectual property rights of others. We rely on a combination of trademark, trade secret and copyright law and contractual restrictions to protect the proprietary aspects of our technology. These legal protections afford only limited protection for our technology. Docent has only two issued patents. We seek to protect the source code for our software, documentation and other written materials under trade secret and copyright laws. We license our software pursuant to signed license or “shrink wrap” agreements, which impose restrictions on the licensee’s ability to use the software. Finally, we seek to avoid disclosure of our intellectual property by requiring employees and consultants with access to proprietary information to execute confidentiality agreements with us and by restricting access to our source code. Despite these precautions, third parties could copy or otherwise obtain and use our technology without authorization, or develop similar technology independently. Furthermore, effective protection of intellectual property rights is unavailable or limited in some foreign countries. Our protection of our intellectual property rights may not provide us with any legal remedy should our competitors independently develop similar technology, duplicate our products and services, or design around any intellectual property rights we hold.

We rely on third party software incorporated in certain of our products. Errors in this software or our inability to continue to license this software in the future would decrease our revenue and increase our costs.

Certain of our products incorporate third party software, and we expect to incorporate additional software as we broaden our product line and services. The operation of our products would be impaired if errors occur in the third party software that we incorporate, and we may incur additional costs to repair or replace the defective software. It may be difficult for us to correct any errors in third party software because the software is not within our control. Accordingly, our revenue would decrease and our costs would increase in the event of any errors in this software. Furthermore, it may be difficult for us to replace any third party software if a vendor seeks to terminate our license to the software. Intellectual property claims against these software products could adversely affect our revenue and increase our costs.

If we need additional financing, we may not obtain the required financing on favorable terms and conditions, or at all.

We require substantial working capital to fund our business operations. We have had significant operating losses and negative cash flow from operations since inception and expect this to continue for the foreseeable future. We currently anticipate that our available cash resources will be sufficient to meet our anticipated working capital and capital expenditure requirements without needing to raise additional capital for at least 12 months after the date of this filing. However, if we are unable to meet our working capital and capital expenditure requirements with the remaining proceeds from our initial public offering and from our revenue, we will need to raise additional funds earlier. If additional funds are raised through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced, stockholders may experience additional dilution and these newly issued securities may have rights, preferences or privileges senior to those of existing stockholders. Additional financing may not be available on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms, our ability to fund our operations, take advantage of unanticipated opportunities, develop or enhance our products and services or otherwise respond to competitive pressures would be significantly limited.

Our disaster recovery plan does not include redundant back-up computer systems, and a disaster could severely damage our operations.

Our disaster recovery plan does not include redundant back-up computer systems at an alternate site. A disaster could severely harm our business because our computer systems could be interrupted for an indeterminate length of time. Our operations depend upon our ability to maintain and protect the computer systems needed for our day-to-day operations. A number of these computer systems are located on or near known earthquake fault zones. Although these systems are designed to be fault tolerant, they are vulnerable to damage

from fire, floods, earthquakes, power loss, telecommunications failures and other events. Any damage to our facility could lead to interruptions in the services we provide to our customers and loss of customer information, and could substantially if not totally impair our ability to operate our business. The insurance we maintain may not be adequate to cover our losses resulting from disasters or other business interruptions.

Terrorism and the declaration of war by the United States against terrorism and other possible United States military actions may adversely affect our business.

The terrorist attacks that took place in the United States on September 11, 2001, the potential for future terrorist attacks in the United States, the declaration of war by the United States against terrorism, the military actions in Afghanistan and Iraq and other existing and possible United States military actions have created significant instability and uncertainty in the world which may continue to have a material adverse effect on world financial markets, including financial markets in the United States. In addition, such adverse political events may have an adverse impact on economic conditions in the United States. Unfavorable economic conditions in the United States may have an adverse effect on our business operations including, but not limited to, our ability to expand the market for our products, obtain financing as needed, enter into strategic relationships and effectively compete in the eLearning market.

A breach of Internet commerce security measures could reduce demand for our products and services which would in turn result in a reduction in our revenue.

A requirement of the continued growth of Web-based, business-to-business electronic commerce is the secure transmission of confidential information over public networks. Failure to prevent security breaches into our products or our customers’ networks, or well-publicized security breaches affecting the Internet in general, could significantly harm our growth and revenue. Advances in computer capabilities, new discoveries in the field of cryptography, or other developments may result in a compromise or breach of the algorithms we use to protect content and transactions or our products or within our customers’ networks or proprietary information in our databases. Anyone who is able to circumvent our security measures could misappropriate proprietary and confidential information or could cause interruptions in our operations. We may be required to expend significant resources to protect against such security breaches or to address problems caused by security breaches. Concerns over the security of the Internet and other online transactions and the privacy of users may also deter people from using the Internet to conduct transactions that involve transmitting confidential information.

We may become subject to government regulation and legal uncertainties that could reduce demand for our products and services or increase the cost of doing business, thereby adversely affecting our financial results.

We are not currently subject to direct regulation by any domestic or foreign governmental agency, other than regulations applicable to businesses generally, export control laws and laws or regulations directly applicable to Internet commerce. However, due to the increasing popularity and use of the Internet, it is possible that a number of laws and regulations may become applicable to us or may be adopted in the future with respect to the Internet covering issues such as:

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taxation;

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user privacy;

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content;

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right to access personal data;

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copyrights;

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distribution; and

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characteristics and quality of services.

The applicability of existing laws governing issues such as taxation, property ownership, copyrights, and other intellectual property issues, encryption, libel, export or import matters and personal privacy to the Internet is uncertain. The vast majority of these laws were adopted prior to the broad commercial use of the Internet and related technologies. As a result, they do not contemplate or address the unique issues of the Internet and related technologies. Changes to these laws, including some recently proposed changes, could create uncertainty in the Internet marketplace. Such uncertainty could reduce demand for our services or increase the cost of doing business due to increased costs of litigation or increased service delivery costs.

In addition, we could be liable for the misuse of personal information. The Federal Trade Commission, the European Union and certain state and local authorities have been investigating certain Internet companies regarding their use of personal information. We could incur additional expenses if new regulations regarding the use of personal information are introduced or if these authorities choose to investigate our privacy practices.

Our rights plan and the anti-takeover provisions in our charter documents could adversely affect the rights of the holders of our common stock.

Our Certificate of Incorporation and Bylaws contain provisions that could make it harder for a third-party to acquire us without the consent of our Board of Directors. For example, if a potential acquiror were to make a hostile bid for us, any acquiror holding less than fifty percent of the Company’s voting stock would not be able to call a special meeting of stockholders to remove our Board of Directors. A potential acquiror would also not be able to act by written consent without a meeting. In addition, our Board of Directors has staggered terms that make it difficult to remove all directors at once. The acquiror would also be required to provide advance notice of its proposal to remove directors at an annual meeting. The acquiror will not be able to cumulate votes at a meeting, which will require the acquiror to hold more shares to gain representation on the Board of Directors than if cumulative voting were permitted.

We have a stockholder rights plan. Under the plan, each holder of a share of our common stock has received a right to buy one one-hundredth of a share of our Series A preferred stock at an exercise price of $15.00, subject to adjustment, if a person or group were to acquire, or to announce the intention to acquire, 20% or more of our outstanding shares of common stock. Under this plan, our Board of Directors has the ability to issue preferred stock that would significantly dilute the ownership of a hostile acquiror. Our Board of Directors has designated 2,000,000 shares of preferred stock as Series A preferred stock in connection with our stockholder rights plan.

In addition, Section 203 of the Delaware General Corporation Law limits business combination transactions with 15% stockholders that have not been approved by the issuer’s board of directors. These provisions and other similar provisions make it more difficult or impossible for a third party to acquire us without negotiation. These provisions may apply even if the offer may be considered beneficial by some stockholders.

Our Board of Directors could choose not to negotiate with a potential acquiror that it did not feel was in our strategic interests. If the potential acquiror was discouraged from offering to acquire us or prevented from successfully completing a hostile acquisition by the anti-takeover measures described above, our stockholders could lose the opportunity to sell their Docent shares at a favorable price.

ITEM 3

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market and Currency Risk

Our market and currency risk disclosure set forth in Item 7A of our annual report on Form 10-K for the year ended December 31, 2002 has not changed significantly.

ITEM 4

CONTROLS AND PROCEDURES

We carried out an evaluation required by Rule 13a-15(b) of the Exchange Act, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic SEC reports. It should be noted that the design of any system of controls is based in part upon certain assumptions, and there can be no assurance that any design will succeed in achieving its stated goals. During the most recent fiscal quarter, there has not occurred any change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II

Item 1.

Legal Proceedings

On May 31, 2002, IP Learn, LLC filed a patent infringement case against Docent in the United States District Court for the Northern District of California. In December 2002, IP Innovation, LLC filed a patent infringement case against Docent in the United States District Court for the Southern District of Texas. Docent believes that the patent infringement cases are without merit and intends to defend against them vigorously. However, if these third party claims for infringement and their patents are valid, we may be required to license the patents on terms that may or may not be favorable or be forced to alter our website or our software product which is the subject of the patents, either of which results may adversely affect our results of operations.

Also, from time to time, we may become involved in litigation relating to claims arising from our ordinary course of business. We believe that there are no claims or actions pending or threatened against us, disposition of which would have a material adverse effect on our financial condition or results of operations.

Item 2.

Changes in Securities and Use of Proceeds

Not applicable.

Item 3.

Defaults Upon Senior Securities

Not applicable.

Item 4.

Submission of Matters to a Vote of Security Holders

Not applicable.

Item 5.

Other Information

Not applicable.

Item 6.

Exhibits and Reports on Form 8-K

Exhibits:

(a)

The exhibits listed on the accompanying index to exhibits are filed or incorporated by reference (as stated therein) as part of this report on 10-Q.

Form 8-K:

(a)

Report on Form 8-K/A filed on July 24, 2003 furnishing the three months ended June 30, 2003 Earnings Press Release.

(b)

Report on Form 8-K filed on October 20, 2003 furnishing the Agreement and Plan of Reorganization by and among Docent, Inc., Click2learn, Inc., Hockey Merger Corporation, Devil Acquisition Corporation and Canuck Acquisition Corporation.

(c)

Report on Form 8-K filed on October 21, 2003 furnishing the three months ended September 30, 2003 Earnings Press Release

SIGNATURES

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

Date: November 4, 2003

Docent, Inc. (Registrant)

BY:		/s/ R. ANDREW ECKERT

		R. Andrew Eckert President, Chief Executive Officer and Director


BY:		/s/ NEIL J. LAIRD

		Neil J. Laird Sr. Vice President and Chief Financial Officer

EXHIBIT INDEX

ITEM 6.

EXHIBITS AND REPORTS ON FORM 8-K


3.1		Amended and restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to the Company’s 10-Q filed on November 13, 2002).

3.2		Amended and restated Bylaws of the Company (incorporated by reference to Exhibit 3.3 to the Company’s registration statement on Form S-1 (File No. 333-34546)).

4.1		Form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 to the Company’s registration statement on Form S-1 (File No. 333-34546)).

10.1		Company’s 1997 Stock Option Plan (incorporated by reference to Exhibit 10.1 to the Company’s Registration Statement on Form S-1 (No. 333-34546)).

10.2		Company’s 2000 Omnibus Equity Incentive Plan (incorporated by reference to Exhibit 10.2 to the Company’s Registration Statement on Form S-1 (No. 333-34546)).

10.3		Company’s 2000 Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.3 to the Company’s Registration Statement on Form S-1 (No. 333-34546)).

10.4		Form of Directors’ and Officers’ Indemnification Agreement (incorporated by reference to Exhibit 10.4 to the Company’s Registration Statement on Form S-1 (No. 333-34546)).

10.5		Master Consulting Services dated April 1, 2000 between the Company and Accenture (incorporated by reference to Exhibit 10.11 to the Company’s Registration Statement on Form S-1 (No. 333-34546)).

10.6		Master Alliance Agreement dated June 30, 2000 between the Company and Accenture (incorporated by reference to Exhibit 10.13 to the Company’s Registration Statement on Form S-1 (No. 333-34546)).

10.7		Lease Agreement dated September 22, 1999 by and between the Company and Limar Realty Corp. #17 (incorporated by reference to Exhibit 10.22 to the Company’s Registration Statement on Form S-1 (No. 333-34546)).

10.8		Promissory Note from David Mandelkern to the Company (incorporated by reference to Exhibit 10.27 to the Company’s Registration Statement on Form S-1 (No. 333-34546)).

10.9		Stock Pledge Agreements dated July 9, 1997 by and between the Company and David Mandelkern (incorporated by reference to Exhibit 10.28 to the Company’s Registration Statement on Form S-1 (No. 333-34546)).

10.10		Employment Letter from the Company to R. Andrew Eckert dated December 11, 2001 (incorporated by reference to Exhibit 10.23 to the Company’s 10-K filed on April 1, 2002).

10.11		Form of Officers Change in Control Agreement entered into by the Company (incorporated by reference to Exhibit 10.24 to the Company’s 10-K filed on April 1, 2002).

10.12		Employment Letter from the Company to Neil J. Laird dated August 2, 2002 (incorporated by reference to Exhibit 10.20 to the Company’s 10-Q filed on August 13, 2002).

10.13		Consulting Agreement dated August 14, 2002 between the Company and Robert A. Lauer (incorporated by reference to Exhibit 10.17 to the Company’s 10-Q filed on November 13, 2002).

10.14		Remarketing Agreement dated April 23, 2002 between the Company and Interwise, Inc. (incorporated by reference to Exhibit 10.18 to the Company’s 10-Q filed on November 13, 2002).


10.15		First Amendment of the Remarketing Agreement dated September 30, 2002 between the Company and Interwise, Inc. (incorporated by reference to Exhibit 10.19 to the Company’s 10-Q filed on November 13, 2002).

10.16		Rights Agreement dated January 28, 2003 by and between Docent, Inc. and Computershare Trust Company, Inc. (incorporated by reference to Exhibit 99.1 to the Company’s 8-K filed on February 7, 2003).

10.17		Agreement and Plan of Reorganization dated as of October 20, 2003, by and among Docent, Inc., Click2learn, Inc., Hockey Merger Corporation, Devil Acquisition Corporation and Canuck Acquisition Corporation. (incorporated by reference to Exhibit 2.1 to the Company’s 8-K filed on October 21, 2003).

10.18		Amendment to Rights Agreement dated October 20, 2003 by and between Docent, Inc. and Computershare Trust Company, Inc. (incorporated by reference to Exhibit 4.2 to the Company’s 8-K filed on October 23, 2003).

10.19		Second Amendment of the Remarketing Agreement dated March 31, 2003 between the Company and Interwise, Inc.

*10.20		Third Amendment of the Remarketing Agreement dated June 25, 2003 between the Company and Interwise, Inc.

*10.21		Fourth Amendment of the Remarketing Agreement dated September 30, 2003 between the Company and Interwise, Inc.

31.1		Certification Pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934.

31.2		Certification Pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934.

32.1		Certification Pursuant to 18 U.S.C. Section 1350.

32.2		Certification Pursuant to 18 U.S.C. Section 1350.

Confidential treatment has been requested with respect to portions of this exhibit.

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DOCENT INC 10-Q