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10-Q 1 d10q.htm FORM 10-Q Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 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: 0-27207

VITRIA TECHNOLOGY, INC.

(Exact Name of Registrant as Specified in Its Charter)

Delaware

77-0386311

(State or Other Jurisdiction of

Incorporation or Organization)

(I.R.S. Employer

Identification No.)

945 Stewart Drive

Sunnyvale, California 94085

(408) 212-2700

(Address, including Zip Code, of Registrant’s Principal Executive Offices

and Registrant’s Telephone Number, including Area Code)

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

The number of shares of Vitria’s common stock, $0.001 par value, outstanding as of July 31, 2003 was 32,672,901shares.

VITRIA TECHNOLOGY, INC.

Index

		Page
PART I: FINANCIAL INFORMATION

Item 1.	Condensed Consolidated Financial Statements and Notes

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

	Condensed Consolidated Statements of Operations for the three months and six months ended June 30, 2003 and June 30, 2002	4

	Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2003 and June 30, 2002	5

	Notes to the Condensed Consolidated Financial Statements	6

Item 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13

Item 3:	Quantitative and Qualitative Disclosures About Market Risk	27

Item 4:	Controls and Procedures	35

PART II: OTHER INFORMATION

Item 1:	Legal Proceedings	36

Item 2:	Changes in Securities and Uses of Proceeds	36

Item 3:	Defaults Upon Senior Securities	37

Item 4:	Submission of Matters to a Vote of Security Holders	37

Item 5:	Other Information	37

Item 6:	Exhibits and Reports on Form 8-K	38

Signatures		39

Certifications

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

Vitria Technology, Inc.

Condensed Consolidated Balance Sheets

(In thousands)

	June 30, 2003			December 31, 2002
	(unaudited)			(Note 1)
Assets
Current Assets:
Cash and cash equivalents	$	21,494		$	42,427
Short-term investments		82,991			75,436
Accounts receivable, net		10,843			15,108
Other current assets		3,172			3,111

Total current assets		118,500			136,082

Property and equipment, net		4,317			9,179
Other assets		1,101			1,363

Total assets	$	123,918		$	146,624

Liabilities and Stockholders’ Equity
Current Liabilities:
Accounts payable	$	1,398		$	2,264
Accrued payroll and related		4,602			6,157
Other accrued liabilities		5,657			8,715
Accrued restructuring expenses		7,201			4,258
Deferred revenue		15,994			13,430

Total current liabilities		34,852			34,824
Long-Term Liabilities:
Accrued restructuring expenses		13,167			8,936
Other long-term liabilities		200			916

Total long-term liabilities		13,367			9,852

Commitments and Contingencies
Stockholders’ Equity:
Preferred stock		—			—
Common stock		33			131
Additional paid-in capital		273,541			273,320
Unearned stock-based compensation		(225	)		(517	)
Notes receivable from stockholders		(193	)		(193	)
Accumulated other comprehensive income		674			620
Accumulated deficit		(197,635	)		(170,917	)
Treasury stock, at cost		(496	)		(496	)

Total stockholders’ equity		75,699			101,948

Total liabilities and stockholders’ equity	$	123,918		$	146,624

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

Vitria Technology, Inc.

Condensed Consolidated Statements of Operations

(In thousands, except per share amounts)

(unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2003			2002			2003			2002
Revenues:
License	$	4,192		$	10,047		$	14,741		$	20,001
Service and other		13,867			16,471			25,923			31,166

Total revenues		18,059			26,518			40,664			51,167

Cost of revenues:
License		207			1,974			301			2,429
Service and other		5,643			7,994			12,658			17,148

Total cost of revenues		5,850			9,968			12,959			19,577

Gross profit		12,209			16,550			27,705			31,590

Operating expenses:
Sales and marketing		10,178			19,460			23,198			45,159
Research and development		4,414			8,717			9,685			18,225
General and administrative		3,417			5,590			7,316			11,514
Stock-based compensation		126			276			279			1,285
Amortization of goodwill and intangible assets		—			213			—			731
Impairment of goodwill		—			7,047			—			7,047
Restructuring costs		337			17,346			14,345			17,346

Total operating expenses		18,472			58,649			54,823			101,307

Loss from operations		(6,263	)		(42,099	)		(27,118	)		(69,717	)
Interest income		344			766			766			1,730
Other income (expenses), net		118			563			(99	)		240

Net loss before income taxes		(5,801	)		(40,770	)		(26,451	)		(67,747	)
Provision for income taxes		202			206			267			397

Net loss	$	(6,003	)	$	(40,976	)	$	(26,718	)	$	(68,144	)

Basic and diluted net loss per share	$	(0.18	)	$	(1.26	)	$	(0.82	)	$	(2.11	)

Weighted average shares used in computing basic and diluted net loss per share		32,598			32,399			32,564			32,318

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

Vitria Technology, Inc.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(unaudited)

	Six Months Ended June 30,
	2003			2002
Operating activities:
Net loss	$	(26,718	)	$	(68,144	)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization of intangible assets		—			731
Impairment of goodwill		—			7,047
Loss on write-down of equity investments		300			164
Loss on disposal of fixed assets		2,371			451
Depreciation		2,756			3,528
Stock-based compensation		279			1,285
Changes in assets & liabilities:
Accounts receivable		4,265			19,970
Other current assets		(61	)		3,206
Other assets		(38	)		(298	)
Accounts payable		(866	)		(1,411	)
Other accrued liabilities		(4,613	)		(4,040	)
Accrued restructuring charges		7,174			14,910
Deferred revenue		2,564			(6,732	)
Other long term liabilities		(716	)		—

Net cash (used in) operating activities		(13,303	)		(29,333	)

Investing activities:
Purchases of property and equipment		(265	)		(1,994	)
Purchases of investments		(59,923	)		(89,995	)
Maturities of investments		52,296			121,226

Net cash provided by (used in) investing activities		(7,892	)		29,237

Financing activities:
Issuance of common stock, net		136			945

Net cash provided by financing activities		136			945

Effect of exchange rates on changes on cash and cash equivalents		126			796

Net increase (decrease) in cash and cash equivalents		(20,933	)		1,645
Cash and cash equivalents at beginning of period		42,427			60,479

Cash and cash equivalents at end of period	$	21,494		$	62,124

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

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1) Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim consolidated financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. In the opinion of the management of Vitria Technology, Inc., these unaudited condensed consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, which we consider necessary to fairly state Vitria’s financial position and the results of its operations and its cash flows. The balance sheet at December 31, 2002 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in Vitria’s Annual Report on Form 10-K for the year ended December 31, 2002. The results of Vitria’s operations for any interim period are not necessarily indicative of the results of the operations for any other interim period or for a full fiscal year.

Certain prior period amounts have been reclassified to conform to the current period presentation. Such reclassifications did not change the previously reported operating loss or net loss amounts.

Stock-based compensation

Vitria accounts for stock-based employee compensation arrangements using the intrinsic value method in accordance with the provisions of Accounting Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees, as amended by FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation, issued by the Financial Accounting Standards Board, and complies with the disclosure provisions of Statement of Financial Accounting Standards No. 123 (SFAS 123), Accounting for Stock-Based Compensation and SFAS No. 148, Accounting for Stock-based Compensation – Transition and Disclosure. Unearned compensation is amortized and expensed in accordance with Financial Accounting Standards Board Interpretation No. 28 using the multiple option approach.

Under APB 25 and related interpretations, unearned compensation is based on the difference, on the date of the grant, between the fair value of Vitria’s common stock and the exercise price. Under APB 25, no compensation expense is recognized in Vitria’s financial statements when the exercise price of Vitria’s employee stock options equals the market price of the underlying stock on the date of grant. Vitria has elected to follow APB 25 because the alternative fair value accounting provided for under SFAS 123 requires the use of option valuation models that were not developed for use in valuing employee stock options.

Pro forma information regarding net loss and net loss per share is required by SFAS 123. This information is required to be determined as if we had accounted for our employee stock options (including shares issued under our Employee Stock Purchase Plan, collectively called “stock based awards”), under the fair value method of that statement.

The fair value of our stock-based awards to employees in the table below was estimated using the Black-Scholes option-pricing model and the following weighted-average assumptions:

	Three months ended,				Six months ended,
	June 30, 2003		June 30, 2002		June 30, 2003		June 30, 2002
Risk-free interest	3.02	%	3.32	%	3.20	%	3.32	%
Expected lives (in years)	5		5		5		5
Dividend yield	0	%	0	%	0	%	0	%
Expected volatility	134	%	145	%	134	%	145	%

The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. Option valuation models require the input of highly subjective assumptions, including the expected volatility of the stock price. Because our stock based awards have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimates, in the opinion of management, the existing models do not necessarily provide a reliable single measure of the fair value of our stock based awards.

The following table illustrates the effect on net loss and loss per share if we had applied the fair value recognition provisions of SFAS 123 to employee stock-based compensation, including shares issued under our stock option plans and Employee Stock Purchase Plan (collectively “options”). For purposes of pro forma disclosures, the estimated fair value of the options is assumed to be amortized to expense over the options’ vesting periods using the multiple option approach. Pro forma information follows (in thousands, except per share amounts):

	Three months ended,						Six months ended,
	June 30, 2003			June 30, 2002			June 30, 2003			June 30, 2002
Net loss, as reported	$	(6,003	)	$	(40,976	)	$	(26,718	)	$	(68,144	)
Add: stock-based employee compensation expense included in reported net loss		126			276			279			1,285
Deduct: total stock-based compensation expense determined under the fair value based method for all awards		443			10,999			365			12,201

Pro forma net loss	$	(5,434	)	$	(29,701	)	$	(26,074	)	$	(54,658	)

Net loss per share as reported	$	(0.18	)	$	(1.26	)	$	(0.82	)	$	(2.11	)

Pro forma net loss per share	$	(0.17	)	$	(0.92	)	$	(0.80	)	$	(1.69	)

Total shares used in calculation		32,598			32,399			32,564			32,318

During the three and six months ended June 30, 2003, stock-based compensation expense determined under the fair value based method resulted in a positive number in the above table or a reduction in expense. This is the result of adjustments to reverse previously recognized stock-based compensation expense on employee options forfeited prior to the employee earning the award. Forfeitures refer to awards that do not vest because service or employment requirements are not met. In accordance with SFAS 123, we based our initial estimate of stock-based compensation expense on the total number of options granted. Adjustments are made in the period of forfeiture to reverse previously recognized stock-based compensation expense associated with the unearned portion of a forfeited award.

Because the determination of fair value of all options granted prior to the time we became a public entity excludes volatility factors, the above results may not be representative of future periods.

2) Net Loss Per Share

Basic net loss per share is calculated by dividing net loss by the weighted-average number of shares of common stock outstanding. Basic net loss per share does not include shares subject to Vitria’s right of repurchase, which lapses ratably over the related vesting term. Diluted net loss per share is calculated by dividing net loss by the weighted-average number of shares of common stock outstanding plus shares of potential common stock. Shares of potential common stock are composed of shares of common stock subject to Vitria’s right of repurchase and shares of common stock issuable upon the exercise of stock options (using the treasury stock method). The calculation of diluted net loss per share excludes shares of potential common stock if their effect is anti-dilutive.

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). All share amounts in the following table have been restated for all periods presented to reflect the reverse stock split which occurred during the current quarter (see Note 8).

	Three months ended						Six months ended
	June 30, 2003			June 30, 2002			June 30, 2003			June 30, 2002
Numerator for basic and diluted net loss per share:
Net loss	$	(6,003	)	$	(40,976	)	$	(26,718	)	$	(68,144	)

Denominator for basic and diluted net loss per share:
Weighted average shares of common stock outstanding		32,650			32,605			32,628			32,586
Less shares subject to repurchase		(52	)		(206	)		(64	)		(268	)

Denominator for basic and diluted net loss per share		32,598			32,399			32,564			32,318

Basic and diluted net loss per share	$	(0.18	)	$	(1.26	)	$	(0.82	)	$	(2.11	)

The following table sets forth the weighted average potential shares of common stock that are not included in the diluted net loss per share calculation above because to do so would be anti-dilutive for the periods indicated (in thousands). All share amounts in the following table have been restated for all periods presented to reflect the reverse stock split which occurred during the current quarter (see Note 8).

	Three months ended		Six months ended
	June 30, 2003	June 30, 2002	June 30, 2003	June 30, 2002
Weighted average effect of anti-dilutive securities:
Employee stock options (using the treasury stock method)	279	195	116	1,537
Common stock subject to repurchase agreements	52	206	64	268

Total	331	401	180	1,805

3) Comprehensive Loss

Comprehensive loss is comprised of net loss and other comprehensive income (loss) such as foreign currency translation gains (losses) and unrealized gains (losses) on available-for-sale marketable securities. Vitria’s total comprehensive loss was as follows (in thousands):

	Three months ended						Six months ended
	June 30, 2003			June 30, 2002			June 30, 2003			June 30, 2002
Net loss	$	(6,003	)	$	(40,976	)	$	(26,718	)	$	(68,144	)
Other comprehensive income (loss):
Foreign currency translation adjustment		(75	)		321			126			796
Unrealized gain (loss) on securities		(57	)		44			(72	)		(112	)

Comprehensive loss	$	(6,135	)	$	(40,611	)	$	(26,664	)	$	(67,460	)

4) Stock-Based Compensation

Stock-based compensation is broken down as follows (in thousands):

	Three months ended				Six months ended
	June 30, 2003		June 30, 2002		June 30, 2003		June 30, 2002
Cost of revenues	$	10	$	22	$	22	$	47
Sales and marketing		46		102		102		575
Research and development		46		100		102		214
General and administrative		24		52		53		449

Total stock-based compensation	$	126	$	276	$	279	$	1,285

5) Derivative Financial Instruments

In accordance with Financial Accounting Standards No. 133 (SFAS No. 133), Accounting for Derivative Instruments and Hedging Activities, Vitria recognizes all of our derivative instruments as either assets or liabilities in the balance sheet at fair value. The accounting for changes in the fair value (i.e., unrealized gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and on the type of hedging relationship. Derivatives that are not hedges must be adjusted to fair value through current earnings.

From time to time, we enter into foreign currency forward contracts to protect against a potential decline in value of assets and liabilities denominated in a currency other than the functional currency of Vitria or one of its subsidiaries. Gains and losses on these forward contracts as well as the offsetting losses and gains on the foreign denominated assets and liabilities are recognized in current earnings. There were no outstanding forward contracts at June 30, 2003.

6) Restructuring and Asset Impairments

In the year ended December 31, 2002 Vitria initiated actions to reduce our cost structure due to sustained negative economic conditions that have impacted our operations and resulted in lower than anticipated revenues. In April and August 2002 we reduced our workforce and consolidated our facilities. The restructuring actions in 2002 resulted in a reduction in workforce of approximately 285 employees or 33% of Vitria’s workforce measured as of the beginning of 2002 and affected all departments. Facilities in the United States and United Kingdom were consolidated and related leasehold improvements and equipment were written off. As a result of the restructuring actions, a charge of $19.5 million in the year ended December 31, 2002 was incurred. The restructuring charge included approximately $4.2 million of severance related charges and $15.4 million of committed excess facilities payments, which included $463,000 for the write-off of leasehold improvements and equipment in vacated buildings. As of June 30, 2003, $11.6 million of lease termination costs, net of anticipated sublease income, remains accrued from our 2002 restructuring actions and these amounts are expected to be fully utilized by fiscal 2013.

In the first quarter of 2003, we initiated actions to further reduce our cost structure. The plan was a combination of a reduction in workforce of approximately 100 employees, or 18% of the existing workforce, consolidations of facilities in the United States and United Kingdom and the associated disposal of leasehold improvements and equipment. The workforce reduction affected all functional areas and was largely completed in the quarter ended March 31, 2003. As a result of the restructuring plan, we incurred a charge of $14.0 million in the quarter ended March 31, 2003. This charge included approximately $2.0 million of severance related charges, $9.8 million of committed excess facilities payments, and $2.2 million in write-offs of leasehold improvements and equipment. The severance related charges consist of one-time termination benefits recognized and measured at fair value at the date the plan was communicated to the employees. All of the terminated employees had left Vitria by May 31, 2003. The excess facilities payments were measured at fair value as of the cease-use date of the facilities using a discount rate of 6%. All excess facilities were vacated prior to March 31, 2003. The leasehold improvements and equipment write-offs, which were associated with vacating the excess facilities, were based on net book value as of the date of abandonment. In the second quarter of 2003, we incurred a charge of $337,000 related to the restructuring which occurred in the first quarter of the current year. This charge was made up of $526,000 in severance charges, $62,000 in accretion charges and $22,000 in other facility related adjustments, offset by an adjustment of $273,000 due to a change in estimated sublease income for one of the restructured buildings which we subleased in the second quarter of 2003. As of June 30, 2003, $8.8 million of lease termination costs, net of anticipated sublease income, remains accrued from our 2003 restructuring actions and are expected to be fully utilized by fiscal 2013.

The total accrued liability for lease termination costs of $20.4 million at June 30, 2003 is net of $11.0 million of estimated sublease income. A portion of this liability is based on the fair value treatment required by SFAS 146, which we adopted as of January 1, 2003 (see Note 7). Aggregate future minimum lease payments for vacated facilities totaled $24.1 million at June 30, 2003 which is net of $2.3 million in contractual sublease income.

The facilities consolidation charges for all of our restructuring actions were calculated using management’s best estimates and were based upon the remaining future lease commitments for vacated facilities from the date of facility consolidation, net of estimated future sublease income. We have engaged brokers to locate tenants to sublease all of the excess facilities and, to date, have signed one sublease agreement for one of the buildings. The estimated costs of vacating these leased facilities were based on market information and trend analyses, including information obtained from third-party real estate sources. Our ability to generate our estimated sublease income is highly dependent upon the existing economic conditions, particularly lease market conditions in certain geographies, at the time we negotiate the sublease arrangements with third parties. While the amount we have accrued is our best estimate, these estimates are subject to change and may require routine adjustment as conditions change through the implementation period. If macroeconomic conditions related to the commercial real estate market continue to worsen, we may be required to increase our estimated cost to exit certain facilities.

As of June 30, 2003, $20.4 million of restructuring costs remained accrued for payment in future periods, as follows (in thousands):

	Facilities consolidation			Severance			Total
Fiscal year 2002 actions
Total charges	$	15,358		$	4,158		$	19,516
Cash payments		(4,075	)		(4,158	)		(8,233	)
Fixed asset writeoffs		(463	)		—			(463	)
Reclassification of deferred rent		747			—			747

Balance from fiscal year 2002 actions at June 30, 2003		11,567			—			11,567

Fiscal year 2003 actions
Total charges		12,141			2,477			14,618
Cash payments		(815	)		(2,477	)		(3,292	)
Fixed asset writeoffs		(2,251	)		—			(2,251	)
Facilities adjustments		(273	)		—			(273	)

Balance from fiscal year 2003 actions at June 30, 2003		8,802			—			8,802

Total accrual balance at June 30, 2003	$	20,369		$	—		$	20,369

At June 30, 2003, $7.2 million related to restructuring activities remained in current liabilities and $13.2 million remained in long-term liabilities. Cash payments totaling approximately $20.4 million, consisting entirely of lease payments, will be made through 2013.

7) Recent Accounting Pronouncements

In June 2002, the Financial Accounting Standard Board, or the FASB, issued Statement of Financial Accounting Standards No. 146 (SFAS 146), Accounting for Costs Associated with Exit or Disposal Activities. SFAS 146 eliminates the Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring). Under SFAS 146, liabilities for costs associated with an exit or disposal activity are recognized when the liabilities are incurred, and fair value is the objective for initial measurement of the liabilities. SFAS 146 will be effective for exit or disposal activities that are initiated after December 31, 2002. The provisions of SFAS 146 are required to be applied prospectively after the adoption date to newly initiated exit activities, and may affect the timing of recognizing future restructuring costs, as well as the amounts recognized. Existing restructuring initiatives will not be affected by the adoption of this Statement. We adopted SFAS 146 as of January 1, 2003 which has resulted in the fair value treatment of our restructuring actions taken in the quarter ended March 31, 2003.

In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), Guarantor’s Disclosure Requirements for Guarantees, Including Indirect Guarantees of Others. FIN 45 clarifies the guarantor’s requirements relating to the guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees and requires the guarantor to recognize at the inception of a guarantee a liability for the fair value of the guarantee obligation. FIN 45 also requires additional disclosures by a guarantor in its interim and annual financial statements about the obligation associated with guarantees issued. The provisions for the initial recognition and measurement of guarantees are effective on a prospective basis for guarantees that are issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. We have adopted the disclosure requirements for our financial statements as of December 31, 2002 and to

date, the adoption of FIN 45 has not had a material effect on our operations or on our financial condition. See Note 11 in our Annual Report on Form 10-K for the year ended December 31, 2002 for additional information on our warranty and indemnification practices. During the six months ended June 30, 2003, we did not record any provisions for any guarantees.

In January 2003, the FASB issued 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 for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provision of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. We do not expect the adoption of FIN 46 will have a material effect on our operations results or financial condition.

8) Reverse stock split

On May 19, 2003, our Board of Directors approved a one-for-four reverse split of our common stock. The reverse split was approved by Vitria stockholders on May 16, 2003 and implemented on May 27, 2003. Each four shares of our outstanding common stock automatically converted into one share of common stock.

All share and per share amounts have been restated for all periods presented to reflect this reverse stock split. The reverse split reduced the number of shares of our common stock outstanding at June 30, 2003 to approximately 33 million shares. In addition, the number of authorized shares of common stock was reduced from 600 million to 150 million shares.

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

The information in this discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 which are subject to the “safe harbor” created by those sections. These forward-looking statements are generally identified by words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “hope,” “assume,” “estimate” and other similar words and expressions. These forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially from those in the forward-looking statements, including, without limitation, the risks outlined under “Business Risks” in this quarterly report on Form 10-Q. These business risks should be considered in evaluating our prospects and future financial performance. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.

Overview

Vitria is a leading provider of business process, integration, and management solutions. Our products and services enable corporations in healthcare, finance, telecommunications and other markets to gain greater real-time operational visibility and control of strategic business processes that are currently fragmented across multiple systems, manual processes and trading partner interactions. To accomplish this, we develop and deliver the BusinessWare^{^®} business process integration software platform together with pre-built and configurable content to solve industry-specific problems, such as healthcare claims transaction management, straight-through processing in capital markets, telecommunications service provisioning, consolidated order management, and manufacturing and logistics. Vitria was incorporated in California in October 1994 and reincorporated in Delaware in July 1999.

Our flagship BusinessWare integration platform uses graphically modeled business process logic as the foundation for orchestrating complex, real-time interactions between dissimilar software applications, Web services, individuals, and trading partners over corporate networks and the Internet. By automating and measuring previously fragmented business processes from start to finish, our solutions are designed to:

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Accelerate process cycle times by removing delays caused by manual processes,

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Enhance executive and information technology, or IT, visibility into operational business performance by displaying process information in real time,

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Reduce time-consuming and error-prone manual processes,

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Enforce industry and company-specific best practices with automated business rules and workflows, and

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Ensure greater consistency and accuracy of data.

Solutions and Products

Vitria’s Business Process Integration Solutions

Vitria combines technology leadership with industry domain expertise in healthcare, finance and telecommunications to improve strategic business processes across systems, people and trading partners. Through pre-built and specifically configured business process integration solutions that preserve and extend a company’s existing technology investments, Vitria solutions are designed to provide real-time visibility and streamlined control over processes and data to reduce costs, increase revenues, improve customer experience, and ensure regulatory compliance.

Vitria has developed years of intellectual property around automating industry-specific business processes in the healthcare, finance and telecommunications markets that can be either pre-built and pre-packaged in software and bundled with the BusinessWare platform, or used by Vitria’s professional services to rapidly design and configure solutions. This focus on business process solutions allows Vitria to concentrate its product development and marketing efforts on demonstrating the measurable business value of process integration to business executives, in addition to demonstrating the technical value of our platform to information technology professionals. Examples of business process integration problems that Vitria has developed solutions for include:

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Claims Transaction Management: designed to provide healthcare insurance payers with greater visibility and acceleration of complete “submit-to-remit” claims lifecycle in order to reduce administrative costs and improve customer service.

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SWIFT Management: allows banks and brokerages to automatically generate messages that are compliant with the ever-changing requirements of the SWIFT financial network, convert between formats and repair failed trades in order to cut operational costs and optimize operations.

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Service Provisioning: allows telecommunications service providers to take and fulfill an order or change order efficiently and effectively, resulting in higher customer satisfaction, lower inventory costs and optimal use of service labor resources.

While each Vitria customer has unique aspects of their business processes, there are also many common elements to recurring business integration problems that lend themselves to a more standardized approach. A pre-built solutions approach is designed to satisfy customers’ desire for faster time-to-value, lower cost of implementation, and leveraging industry best practices. Pre-built solution components can include:

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business process models,

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human task automation,

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executive and other operational business dashboards,

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exception handling rules and workflows,

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data validation rules and data translations for common electronic documents,

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data translations between common applications,

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and application connectors.

Because these solution components are built on our general-purpose BusinessWare integration platform, each is fully configurable to meet customers’ specific business and technology requirements.

Vitria’s Health Insurance Portability and Accountability Act, or HIPAA, Compliance solution is an example of a pre-built solution. It provides transaction and code set compliance with federal HIPAA regulations that provides a pre-built, re-usable foundation for other business process improvements such as claims transaction management. Vitria intends to develop more pre-built solutions, including co-developing pre-built solutions with select systems integrators.

Vitria’s BusinessWare Platform

BusinessWare unifies the five elements that we believe are essential for business process integration software, all in a single platform:

(1)

Business Process Management, or BPM: BPM manages the steps of a cross-functional business process to ensure optimal completion of the process (e.g., from submission of a healthcare claim by a care provider to the remittance of payment). It uses graphical business process models together with automated human workflows to define, automate and orchestrate transactions and the exchange of information between internal business applications, people and external trading partners.

(2)

Business Analysis and Monitoring, or BAM: BAM provides real-time monitoring and analysis of business processes, providing greater visibility and business intelligence needed to optimize operational efficiency. Our two key BAM components, Cockpit and Analyzer, are designed to continuously gather business process data across applications, human workflows and trading partner interactions; analyze and visualize this data in real time; and enable business executives and process owners to identify and respond to both business and integration problems or opportunities as they occur.

(3)

Business Vocabulary Management, or BVM: BVM is comprised of content and tools that enable the flexible, scalable management of translations between industry-specific and application-specific data formats and meanings (vocabularies) as represented in electronic transactions between businesses (e.g. via Electronic Data Interchange, or EDI, or eXtensible Markup Language, or XML), and between a company’s internal applications. BVM uses automated exception handling, business rules-based validation and advanced data transformation designed to ensure that differences in how data is represented does not interfere with successful completion of a business transaction (e.g. fulfilling a customer’s order, processing a healthcare claim, or settling a financial transaction). To address the specific needs of each industry, BVM provides packaged vocabularies for various industries based on the specific business terms used within those industries.

(4)

Business-to-Business Integration, or B2B: B2B enables the secure and reliable completion of transactions and the exchange of business information between customers and partners over the Internet to support collaborative business processes. Combined with BPM and BAM, B2B helps companies manage their value chain interactions from end to end as an integrated part of their larger business processes.

(5)

Enterprise Application Integration, or EAI: EAI enables the secure and reliable movement of information in and out of internal business applications. By enabling internal applications to communicate with one another, EAI helps unify and improve enterprise processes while maximizing the value of a company’s application investments. Companies may use BusinessWare’s BPM, BAM and BVM capabilities to control business processes on top of industry-standard methods of transporting data from application to application (such as Web services and Java Messaging Service) or third-party EAI infrastructures.

BusinessWare allows customers to solve their business problems using graphical models rather than developing custom programs. Rather than writing new software programs, business managers can create visual diagrams of business processes, called “process models,” using a point-and-click user interface. BusinessWare then translates these process models into software programs that automate the flow of information across a company’s underlying IT systems.

Once customers use BusinessWare to define their business process models and integrate the underlying IT systems, people and partners, BusinessWare automatically controls the flow of information across the IT systems as specified by the process models. BusinessWare continuously analyzes the customer’s business processes and can automatically change the processes in response to this analysis. This capability allows companies to transform the information flowing through their IT systems into “actionable intelligence” that enables business managers to optimize their business operations.

CRITICAL ACCOUNTING POLICIES

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures. We evaluate our estimates, on an on-going basis, including those related to revenue recognition, allowances for doubtful accounts, goodwill and purchased intangibles—impairment assessments and restructuring charges. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which 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 from these estimates under different assumptions or conditions.

We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition

We derive revenues from software licenses to end users for BusinessWare and other products and related services, which include maintenance and support, consulting and training services. In accordance with the provisions of Statement of Position 97-2, Software Revenue Recognition, as amended, we record revenue from software licenses when a license agreement is signed by both parties, the fee is fixed or determinable, collection of the fee is probable and delivery of the product has occurred. For electronic delivery, the product is considered to have been delivered when the access code to download the software from the Internet has been provided to the customer. If an element of the agreement has not been delivered, revenue for the element is deferred based on vendor-specific objective evidence of fair value. If vendor-specific objective evidence of fair value does not exist for the undelivered element, all revenue is deferred until sufficient objective evidence exists or all elements have been delivered. We treat all arrangements with payment terms longer than normal not to be fixed or determinable. Our normal payment terms currently range from “net 30 days” to “net 90 days” for domestic and international customers, respectively. Revenue is generally deferred for those agreements which exceed our normal payment terms and are therefore assessed as not being fixed or determinable. Revenue under these agreements is recognized as payments become due unless collectibility concerns exist, in which case revenue is deferred until payments are received. Our assessment of collectibility is particularly critical in determining whether revenue should be recognized in the current market environment. If collectibility is not considered probable, revenue is recognized when the fee is collected. Revenue on arrangements with customers who are not the ultimate users, primarily third-party systems integrators, is not recognized until evidence of a sell-through arrangement to an end user has been received.

Service and other revenues include product maintenance, consulting, and training. Customers who license BusinessWare normally purchase maintenance contracts. These contracts provide unspecified software upgrades and technical support over a specified term, which is typically twelve months. Maintenance contracts are usually paid in advance, and revenues from these contracts are recognized ratably over the term of the contract. A majority of our customers use third-party system integrators to implement our products. Customers typically purchase additional consulting services from us to support their implementation activities. These consulting services are generally sold on a time and materials basis and recognized as the services are performed. We also offer training services which are sold on a per student or per class basis and recognized as the classes are attended.

Payments received in advance of revenue recognition are recorded as deferred revenue. When the software license arrangement requires us to provide consulting services for significant production, customization or modification of the software, or when the customer considers these services essential to the functionality of the

software product, both the product license revenue and consulting services revenue are recognized in accordance with the provision of Statement of Position 81-1, Accounting for Performance of Construction Type and Certain Production Type Contracts. We recognize revenue from these arrangements using the percentage of completion method based on cost inputs and, therefore, both product license and consulting services revenue are recognized as work progresses. These arrangements have not been common and, therefore, the significant majority of the Company’s license revenue in the past three years has been recognized under SOP 97-2.

Allowance for Doubtful Accounts

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to deliver required payments to us. These allowances are established through analysis of the credit worthiness of each customer, which is based on credit reports from third parties, analysis of published or publicly available financial information and customer specific experience including payment practices and history. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. When we believe a collectibility issue exists with respect to a specific receivable, we record an allowance to reduce that receivable to the amount that we believe is collectible.

Restructuring Charges

During the first six months of 2003, we recorded $14.4 million of restructuring charges related to the realignment of our business operations. In addition, we recorded $19.5 million in restructuring charges related to the realignment of our business operations in 2002. As of June 30, 2003 we have $20.4 million in accrued restructuring expenses, consisting primarily of lease payments, to be made through 2013. Aggregate minimum future lease payments due for abandoned properties totals $24.1 million at June 30, 2003 which is net of $2.3 million in contractual sublease income.

Only costs resulting from a restructuring plan that are not associated with, or that do not benefit, activities that will be continued are eligible for recognition as liabilities at the commitment date. These charges represent expenses incurred in connection with certain cost reduction programs that we have undertaken and consist primarily of the cost of involuntary termination benefits and remaining contractual lease payments and other costs associated with closed facilities, net of anticipated sublease income.

The charges for facility closure costs require the extensive use of estimates, including estimates and assumptions related to future maintenance costs, our ability to secure sub-tenants and anticipated sublease income to be received in the future. If we fail to make accurate estimates or to complete planned activities in a timely manner, we might record additional charges or reverse previous charges in the future. Such additional charges or reversals will be recorded to the restructuring charges line in our statement of operations in the period in which additional information becomes available to indicate our estimates should be adjusted.

RESULTS OF OPERATIONS

For the three and six months ended June 30, 2003 and 2002

The following table sets forth the results of operations for the three and six months ended June 30, 2003 and 2002, expressed as a percentage of total revenues.

	Three Months Ended June 30,				Six Months Ended June 30,
	2003		2002		2003		2002
Revenues
License	23	%	38	%	36	%	39	%
Service and other	77	%	62	%	64	%	61	%

Total revenues	100	%	100	%	100	%	100	%
Cost of revenues
License	1	%	8	%	1	%	5	%
Service and other	31	%	30	%	31	%	33	%

Total cost of revenues	32	%	38	%	32	%	38	%
Gross profit	68	%	62	%	68	%	62	%
Operating expenses
Sales and marketing	56	%	73	%	57	%	88	%
Research and development	24	%	33	%	24	%	36	%
General and administrative	19	%	21	%	18	%	23	%
Amortization of stock-based compensation	1	%	1	%	1	%	2	%
Amortization of goodwill and intangible assets	—	%	1	%	—	%	1	%
Impairment of goodwill	—	%	27	%	—	%	14	%
Restructuring charges	2	%	65	%	35	%	34	%

Total operating expenses	102	%	221	%	135	%	198	%
Loss from operations	(34	)%	(159	)%	(67	)%	(136	)%
Interest income	2	%	3	%	2	%	3	%
Other income (expenses), net	1	%	2	%	—	%	1	%

Net loss before income taxes	(31	)%	(154	)%	(65	)%	(132	)%
Provision for income taxes	1	%	1	%	1	%	1	%

Net loss	(32	)%	(155	)%	(66	)%	(133	)%

Revenues

We recognized approximately 43% of our revenues from customers outside the United States in the three months ended June 30, 2003 and 33% of our revenues from customers outside the United States in the six months ended June 30, 2003, compared to 30% in the three months ended June 30, 2002 and 29% in the six months ended June 30, 2002. For the next quarter, we believe international revenues will remain at approximately the same percentage of total revenues as the six months ended June 30, 2003.

Sales to our ten largest customers accounted for 35% of total revenues in the three months ended June 30, 2003 and 37% of total revenues in the six months ended June 30, 2003. Sales to our ten largest customers accounted for 38% of total revenues in the three months ended June 30, 2002 and 33% of total revenues in the six months ended June 30, 2002. No customer accounted for more than 10% of total revenues in the three months ended June 30, 2003 and one customer accounted for 11% of total revenues in the six months ended June 30, 2003. No customer accounted for more than 10% of total revenues in the three months or six months ended June 30, 2002. We expect that revenues from a limited number of customers will continue to account for a large percentage of total revenues in future quarters. Therefore, the loss or delay of individual orders could have a significant impact on revenues. Our ability to attract new customers will depend on a variety of factors, including the reliability, security, scalability and the overall cost-effectiveness of our products.

To date we have not experienced significant seasonality of revenue. Future results may be affected by the fiscal or quarterly budget cycles of our customers.

License. License revenues decreased 58% to $4.2 million in the three months ended June 30, 2003 from $10.0 million in the three months ended June 30, 2002. License revenues decreased 26% to $14.7 million in the six months ended June 30, 2003 from $20.0 million in the six months ended June 30, 2002. We believe that this decrease is a result of the general slowdown in information technology spending in our target markets, which has made it more difficult for us to grow our revenues.

Service and other. Service and other revenues decreased 16% to $13.9 million in the three months ended June 30, 2003 from $16.5 million in the three months ended June 30, 2002. Service and other revenues decreased 17% to $25.9 million in the six months ended June 30, 2003 from $31.2 million in the six months ended June 30, 2002. The decrease is primarily due to a decrease in consulting revenues due to fewer license deals in the current year which in turn required fewer consulting projects. This decrease was offset by $773,000 in consulting revenue recognized from consulting arrangements completed in prior periods but for which cash was collected during the second quarter of 2003.

Included in deferred revenue as of June 30, 2003 is approximately $750,000 of unrecognized revenues from Government grants which are subject to outstanding audits with the Government. We expect some of these audits will be resolved in 2003 which may result in repaying some amount to the Government and/or recognition of certain deferred Government grant revenues.

Cost of Revenues

License. Cost of license revenues consists of royalty payments to third parties for technology incorporated into our products. Cost of license revenues decreased 90% from $2.0 million in the three months ended June 30, 2002 to $207,000 in the three months ended June 30, 2003. Cost of license revenues decreased 88% from $2.4 million in the six months ended June 30, 2002 to $301,000 in the six months ended June 30, 2003. This fluctuation is due to the buying patterns of our customers, as cost of license revenues is dependent upon which products our customers purchase, and which of those purchased products have third-party technology incorporated into them.

Service and other. Cost of service and other revenues consists of salaries, facility costs, travel expenses and third party consultant fees incurred in providing customer support, training and implementation related services. Cost of service and other revenues decreased 29% from $8.0 million in the three months ended June 30, 2002 to $5.6 million in the three months ended June 30, 2003. This decrease is primarily due to a decrease of $1.4 million in salary and benefit expenses as well as reduced travel expenses of $517,000 arising from our workforce reductions and cost containment efforts. Cost of service and other revenues decreased 26% from $17.1 million in the six months ended June 30, 2002 to $12.7 million in the six months ended June 30, 2003. This decrease is primarily due to a decrease of $4.0 million in salary and benefit expenses as well as reduced travel expenses of $451,000 due to workforce reductions and cost containment efforts. For the next quarter, we expect that cost of service and other will remain flat compared to the quarter ended June 30, 2003.

Operating Expenses

Sales and marketing. Sales and marketing expenses consist of salaries, commissions, field office expenses, travel and entertainment, and promotional expenses. Sales and marketing expenses decreased 48% from $19.5 million in the three months ended June 30, 2002 to $10.2 million in the three months ended June 30, 2003. This decrease was primarily due to lower salary and benefit expenses of $4.7 million, lower commission expenses of $1.3 million, reduced travel expenses of $1.1 million and reduced facilities costs of $635,000 arising from our workforce reductions and facility closures, as well as related decreases in most other expense areas as a result of our cost containment efforts. Sales and marketing expenses decreased 49% from $45.2 million in the six months ended June 30, 2002 to $23.2 million in the six months ended June 30, 2003. This decrease was primarily due to lower salary and benefit expenses of $12.7 million, lower commission expense of $1.9 million, reduced travel expenses of $2.1 million and reduced facilities costs of $1.3 million arising from our workforce reductions and facility closures, as well as related decreases in most other expense areas as a result of our cost containment efforts. For the next quarter, we expect that sales and marketing expenses will remain flat compared to the quarter ended June 30, 2003.

Research and development. Research and development expenses include costs associated with the development of new products, enhancements to existing products, and quality assurance activities. These costs consist primarily of employee salaries, benefits, and the cost of consulting resources that supplement the internal development team. Research and development expenses decreased 49% from $8.7 million in the three months ended June 30, 2002 to $4.4 million in the three months ended June 30, 2003. This decrease was primarily due to a decrease of $2.8 million in salary expenses and a decrease of $559,000 in facilities costs arising from our workforce reductions and a reduction of $367,000 in the use of outside consultants, as well as related decreases in most other expense areas as a result of our cost containment efforts. Research and development expenses decreased 47% from $18.2 million in the six months ended June 30, 2002 to $9.7 million in the six months ended June 30, 2003. This decrease was primarily due to a decrease of $6.4 million in salary expenses and a decrease of $680,000 in facilities costs arising from our workforce reductions and a reduction of $574,000 in the use of outside consultants, as well as related decreases in most other expense areas as a result of our cost containment efforts. For the next quarter, we expect that research and development expenses will remain flat compared to the quarter ended June 30, 2003.

General and administrative. General and administrative expenses consist of salaries for administrative, executive and finance personnel, information systems costs, outside professional service fees and our provision for doubtful accounts. General and administrative expenses decreased 39% from $5.6 million in the three months ended June 30, 2002 to $3.4 million in the three months ended June 30, 2003. This decrease was primarily attributable to a decrease of $1.6 million in salaries and benefit expenses as a result of our workforce reductions, a reduction of $568,000 in the use of outside consultants, as well as related decreases in most other expense areas as a result of our cost containment efforts. General and administrative expenses decreased 37% from $11.5 million in the six months ended June 30, 2002 to $7.3 million in the six months ended June 30, 2003. This decrease was primarily attributable to a decrease of $2.6 million in salaries and benefit expenses as a result of our workforce reductions and a reduction of $1.1 million in the use of outside consultants, as well as related decreases in most other expense areas. For the next quarter, we expect that general and administrative expenses will remain flat compared to the quarter ended June 30, 2003.

Stock-based compensation. Total stock-based compensation expenses were $126,000 for the three months ended June 30, 2003 and $276,000 for the three months ended June 30, 2002. Total stock-based compensation expenses were $279,000 for the six months ended June 30, 2003 and $1.3 million for the six months ended June 30, 2002. Stocked based compensation includes the amortization of unearned employee stock-based compensation on options issued to employees prior to Vitria completing its initial public offering in September 1999 and is being amortized over a five-year vesting period. In the quarter ended March 31, 2002, we recorded $695,000 in additional non-cash stock-based compensation expense as a result of vesting modifications made to option grants for certain key executives who left Vitria during that quarter. We expect to recognize employee stock-based compensation expenses of approximately $144,000 for the six months ending December 31, 2003 and $81,000 for the year ending December 31, 2004. This unearned compensation expense will be reduced in future periods to the extent that options are cancelled prior to vesting.

Amortization of purchased intangible assets. Amortization of purchased intangible assets associated with the acquisition of XMLSolutions in April 2001 resulted in charges to earnings of $213,000 and $731,000 for the three and six months ended June 30, 2002, respectively. In the fourth quarter of 2002, we reduced the carrying value of all of our intangible assets associated with this purchase to zero. Therefore there was no amortization of intangible assets in the three and six months ended June 30, 2003.

Restructuring charges. In the year ended December 31, 2002 Vitria initiated actions to reduce our cost structure due to sustained negative economic conditions that have impacted our operations and resulted in lower than anticipated revenues. In April and August 2002 we reduced our workforce and consolidated our facilities. The restructuring actions in 2002 resulted in a reduction in workforce of approximately 285 employees or 33% of Vitria’s workforce measured as of the beginning of 2002 and affected all departments. Facilities in the United States and United Kingdom were consolidated and related leasehold improvement and equipment were written off. As a result of the restructuring actions, a charge of $19.5 million in the year ended December 31, 2002 was incurred. The restructuring charge included approximately $4.2 million of severance related charges and $15.4 million of committed excess facilities payments, which included $463,000 for the write-off of leasehold improvements and equipment in vacated buildings. As of June 30, 2003, $11.6 million of lease termination costs, net of anticipated sublease income, remains accrued from our 2002 restructuring actions and these amounts are expected to be fully utilized by fiscal 2013.

The facilities consolidation charges for all of our restructuring actions were calculated using management’s best estimates and were based upon the remaining future lease commitments for vacated facilities from the date of facility consolidation, net of estimated future sublease income. We have engaged brokers to locate tenants to sublease all of the excess facilities, and, to date, have signed one sublease agreement for one of the buildings. The estimated costs of vacating these leased facilities were based on market information and trend analyses, including information obtained from third-party real estate sources. Our ability to generate our estimated sublease income is highly dependent upon the existing economic conditions, particularly lease market conditions in certain geographies, at the time we negotiate the sublease arrangements with third parties. While the amount we have accrued is our best estimate, these estimates are subject to change and may require routine adjustment as conditions change through the implementation period. If macroeconomic conditions related to the commercial real estate market continue to worsen, we may be required to increase our estimated cost to exit certain facilities.

We expect to achieve annualized cost savings of approximately $38.0 million from our restructuring actions initiated in the year ended December 31, 2002 and an additional $14.0 million from our restructuring actions initiated in the first quarter of 2003.

Interest income and other income, net. Interest and other income, net, decreased $867,000, or 65%, from $1.3 million in the three months ended June 30, 2002 to $462,000 in the three months ended June 30, 2003. The decrease was primarily attributable to lower interest income due to lower cash and investment balances as well as the recognition of $290,000 of other income from a legal settlement fee in the three months ended June 30, 2002. Interest and other income, net, decreased $1.3 million, or 66%, from $2.0 million in the six months ended June 30, 2002 to $667,000 in the six months ended June 30, 2003. This decrease was primarily attributable to lower interest income due to lower cash and investment balances, the $290,000 legal settlement fee recognized as other income in 2002, as well as a charge of $300,000 for an other than temporary decline in value of our equity investment in a private company.

Provision for income taxes

We recorded an income tax provision of $202,000 and $267,000, respectively, for the three-month and six-month periods ended June 30, 2003. We recorded an income tax provision of $206,000 and $397,000, respectively, for the three-month and six-month periods ended June 30, 2002. Income tax provisions in all periods presented relate to income taxes currently payable on income generated in non-U.S. tax jurisdictions, state income taxes, and foreign withholding taxes incurred on software license revenue.

Liquidity and capital resources

	Six Months Ended June 30,						Percent Change
	2003			2002			Percent Change
	(in thousands)
Cash, cash equivalents and short term investments	$	104,485		$	145,840		(28	)%
Net cash used in operating activities		(13,303	)		(29,333	)	(55	)%
Net cash provided by (used in) investing activities		(7,892	)		29,237		(127	)%
Net cash provided by financing activities		136			945		(86	)%

As of June 30, 2003, we had approximately $104.5 million of cash, cash equivalents and short-term investments, and $13.4 million of long-term liabilities, compared to approximately $145.8 million of cash, cash equivalents and short-term investments with no long-term liabilities at June 30, 2002.

Net cash used in operating activities decreased $16.0 million, or 55%, in the six months ended June 30, 2003 compared to the six months ended June 30, 2002. This decrease was primarily due to a decrease in our net loss, a decrease in accounts receivable, a decrease in deferred revenue, and an increase in accrued restructuring expenses.

Net cash provided by (used in) investing activities decreased $37.1 million, or 127%, in the six months ended June 30, 2003 compared to the six months ended June 30, 2002. This decrease in the current period was primarily due the fact that we purchased more short-term investments than we sold, as compared to the prior period when we sold more short-term investments than we purchased.

Net cash provided by financing activities decreased $809,000, or 86%, in the six months ended June 30, 2003 as compared to the six months ended June 30, 2002. Net cash provided by financing activities in both the current and prior periods was primarily from the issuance of common stock offset by the repurchases of terminated employees’ stock options which had been exercised prior to vesting.

During the six months ended June 30, 2003, our net accounts receivable balance decreased $4.3 million from $15.1 million at December 31, 2002 to $10.8 million at June 30, 2003. The reason for the decrease was due to significant cash receipts collected from customers on completed consulting projects as well as lower revenues in the six months ended June 30, 2003. At June 30, 2003, our gross accounts receivable balance is $12.2 million with an allowance for doubtful accounts of $1.4 million.

During the six months ended June 30, 2003, our deferred revenue balance increased $2.6 million from $13.4 million at December 31, 2002 to $16.0 million at June 30, 2003. The primary reason for this increase in deferred revenue is an increase in support renewals which was due to the fact that a higher percentage of customers are renewing their annual maintenance. This increase was offset by a decrease in prepaid training and consulting as fewer customers decide to prepay for these services.

Contractual Cash Obligations

At June 30, 2003, we had contractual obligations and commercial commitments of approximately $31.9 million as shown in the table below. The table below (in thousands) excludes obligations related to accounts payable and accrued liabilities incurred in the ordinary course of business.

	Year ending December 31,												Total minimum payment
	2003		2004		2005		2006		2007		2008 and thereafter		Total minimum payment
Operating Leases	$	4,446	$	7,295	$	6,897	$	4,966	$	2,333	$	5,699	$	31,636
Capital Leases		48		96		72		—		—		—		216

Total	$	4,494	$	7,391	$	6,969	$	4,966	$	2,333	$	5,699	$	31,852

Operating lease commitments shown above, which are net of contractual sublease agreements, include $24.1 million of operating lease commitments under leases for vacated facilities which were recorded as accrued restructuring expenses in the accompanying balance sheet as of June 30, 2003. This $24.1 million lease commitment is net of $2.3 million in contractual sublease income. We do not have any material commercial commitments under lines of credit, standby lines of credit, standby repurchase obligations or other such arrangements, except as discussed below in the section entitled “Credit Facilities with Silicon Valley Bank.”

Off-Balance Sheet Arrangements

At June 30, 2003, Vitria did not have any off-balance sheet arrangements or relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which are typically established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Credit Facilities with Silicon Valley Bank

We have a $15.0 million revolving line of credit agreement with Silicon Valley Bank. Interest on outstanding borrowings accrues at the bank’s prime rate of interest. The facility is secured by all of Vitria’s assets. The agreement includes restrictive covenants which require us to maintain, among other things, a minimum cash, cash equivalents, and short-term investments balance of $80.0 million. As part of this $80.0 million balance, the agreement also requires us to maintain a minimum of $25.0 million in investments which are invested through Silicon Valley Bank. The line of credit serves as collateral for letters of credit and other commitments, even though these items do not constitute draws on the line of credit. Available advances under the line of credit are reduced by the amount of outstanding letters of credit and other commitments.

As of June 30, 2003, we had not borrowed against this line of credit. In connection with the line of credit agreement, we have outstanding letters of credit of approximately $10.2 million related to certain office leases at June 30, 2003.

Stock Repurchase Program

In July 2002, our Board of Directors announced a stock repurchase program under which we may repurchase up to an aggregate of 1.3 million shares of our common stock through July 2003. Under the program the repurchases will be made from time to time on the open market at prevailing market prices or in negotiated transactions off the market. The repurchases will be funded from available working capital. As of June 30, 2003, 124,000 shares had been repurchased in the open market at a total cost of approximately $496,000. No shares were repurchased during the six months ended June 30, 2003.

Operating Capital and Capital Expenditure Requirements

Estimated future uses of cash over the next twelve months are primarily to fund operations and to a lesser extent to fund capital expenditures. For the next twelve months, we expect to fund these uses from available cash balances, cash generated from operations, if any, and interest on available cash and investment balances. Our ability to generate cash from operations is dependent upon our ability to sell our products and services and generate revenue, as well as our ability to manage our operating costs. In turn, our ability to sell our products is dependent upon both the economic climate and the competitive factors of the marketplace in which we operate.

In the past, we have invested significantly in our operations. During the remainder of this fiscal year, we expect that operating expenses will be slightly lower than the first half of the year due to our continued cost containment efforts. However, we anticipate that operating expenses and planned capital expenditures will continue to constitute a material use of our cash resources. We expect total capital expenditures for fiscal year 2003 will be less than $1.0 million, which is substantially less than the $3.0 million we spent in fiscal year 2002. In addition, we may utilize cash resources to fund acquisitions or investments in other businesses, technologies or products lines. We believe that our available cash, cash equivalents and short-term investments will be sufficient to meet our working capital and operating expense requirements for at least the next twelve months. At some point in the future we may require additional funds to support our working capital and operating expense requirements or for other purposes and may seek to raise these additional funds through public or private debt or equity financings. If we need to seek additional financing, there is no assurance that this additional financing will be available, or if available, will be on reasonable terms and not dilutive to our stockholders.

We believe our success requires expanding our customer base and continuing to enhance our BusinessWare products. We intend to continue to invest selectively in sales, marketing and research and development. We expect our operating losses to decrease as we approach our expected break even towards the end of 2003. However, due to our restructuring obligations, we expect to remain cash flow negative at least through 2003. Our revenues, operating results and cash flows depend upon the volume and timing of customer orders and payments and the date of product delivery. Historically, a substantial portion of revenues in a given quarter have been recorded in the third month of that quarter, with a concentration of these revenues in the last two weeks of the third month. We expect this trend to continue and, therefore, any failure or delay in the closing of orders would have a material adverse effect on our quarterly operating results and cash flows. Since our operating expenses are based on anticipated revenues and because a high percentage of these expenses are relatively fixed, a delay in the recognition of revenue from one or more license transactions could cause significant variations in operating results from quarter to quarter and cause unexpected results. Revenues from contracts that do not meet our revenue recognition policy requirements for which we have been paid or have a valid receivable are recorded as deferred revenues. While a portion of our revenues each quarter is recognized from deferred revenue, our quarterly performance will depend primarily upon entering into new contracts to generate revenues for that quarter. New contracts may not result in revenue during the quarter in which the contract was signed, and we may not be able to predict accurately when revenues from these contracts will be recognized. Our future operating results and cash flows will depend on many factors, including the following:

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size and timing of customer orders and product and service delivery;

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level of demand for our professional services;

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changes in the mix of our products and services;

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ability to protect our intellectual property;

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actions taken by our competitors, including new product introductions and pricing changes;

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costs of maintaining and expanding our operations;

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introduction of new products;

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timing of our development and release of new and enhanced products;

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costs and timing of hiring qualified personnel;

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success in maintaining and enhancing existing relationships and developing new relationships with system integrators;

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technological changes in our markets, including changes in standards for computer and networking software and hardware;

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deferrals of customer orders in anticipation of product enhancements or new products;

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delays in our ability to recognize revenue as a result of the decision by our customers to postpone software delivery, or because of changes in the timing of when delivery of products or services is completed;

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customer budget cycles and changes in these budget cycles;

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external economic conditions;

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availability of customer funds for software purchases given external economic factors;

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costs related to acquisition of technologies or businesses;

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ability to successfully integrate acquisitions;

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changes in strategy and capability of our competitors; and

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liquidity and timeliness of payments from international customers.

As a result of these factors, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. It is likely that in some future quarter our operating results will be below the expectations of public market analysts and investors. In this event, the price of our common stock would likely decline.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

The following discussion about our risk management activities includes “forward-looking statements” that involve risks and uncertainties. Actual results could differ materially from those projected in the forward-looking statements for the reasons described under the caption “Risks Associated with Vitria’s Business and Future Operating Results.”

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates to our investment portfolio, which consists of short-term money market instruments and debt securities with maturities between 90 days and one year. We do not use derivative financial instruments in our investment portfolio. We place our investments with high credit quality issuers and, by policy, we limit the amount of credit exposure to any one issuer.

We mitigate default risk by investing in high credit quality securities and by monitoring the credit rating of investment issuers. The portfolio includes only marketable securities with active secondary or resale markets to ensure portfolio liquidity. These securities are generally classified as available for sale, and consequently, are recorded on the balance sheet at fair value with unrealized gains or losses reported, as a separate component of stockholders’ equity, net of tax. Unrealized gains and losses at June 30, 2003 were not material.

We have no cash flow exposure due to rate changes for cash equivalents and cash investments as all of these investments are at fixed interest rates.

There has been no material change in our interest rate exposure since June 30, 2003.

The following table set forth our weighted average interest rate for cash, cash equivalents and short-term investments for the six-month period ending June 30, 2003 (in thousands):

	June 30, 2003
	Fair Value		Weighted Average Interest Rate
Cash and cash equivalents	$	21,494	1.06	%
Short-term investments		82,991	1.60	%

Total cash and investment securities	$	104,485

Foreign Exchange Risk

As a global concern, we face exposure to adverse movements in foreign currency exchange rates. These exposures may change over time as business practices evolve and could have a material adverse impact on our financial position and results of operations. Historically, our primary exposures have related to non-U.S. dollar-denominated currencies, customer receivables, and inter-company receivables or payables with our foreign subsidiaries. Additionally, we provide funding to our foreign subsidiaries in Europe, Asia Pacific and Latin America.

In order to reduce the effect of foreign currency fluctuations, from time to time, we utilize foreign currency forward exchange contracts (forward contracts) to hedge certain foreign currency transaction exposures outstanding during the period. The gains and losses on the forward contracts help to mitigate the gains and losses on our outstanding foreign currency transactions. We do not enter into forward contracts for trading purposes. All foreign

currency transactions and all outstanding forward contracts are marked-to-market at the end of the period with unrealized gains and losses included in other income, net.

We had no outstanding forward contracts as of June 30, 2003.

RISKS ASSOCIATED WITH VITRIA’S BUSINESS AND FUTURE OPERATING RESULTS

Our operating results fluctuate significantly and an unanticipated decline in revenue may disappoint securities analysts or investors and result in a decline in our stock price.

Our quarterly operating results have fluctuated significantly in the past and may vary significantly in the future. If our operating results are below the expectations of securities analysts or investors, our stock price is likely to decline. Period-to-period comparisons of our historical results of operations are not necessarily a good predictor of our future performance.

Our revenues and operating results depend upon the volume and timing of customer orders and payments and the date of product delivery. Historically, a substantial portion of revenues in a given quarter have been recorded in the third month of that quarter, with a concentration of these revenues in the last two weeks of the third month. We expect this trend to continue and, therefore, any failure or delay in the closing of orders would have a material adverse effect on our quarterly operating results. Since our operating expenses are based on anticipated revenues and because a high percentage of these expenses are relatively fixed, a delay in the recognition of revenue from one or more license transactions could cause significant variations in operating results from quarter to quarter and cause unexpected results.

Our quarterly results depend primarily upon entering into new or follow-on contracts to generate revenues for that quarter. New contracts may not result in revenue in the quarter in which the contract was signed, and we may not be able to predict accurately when revenues from these contracts will be recognized. Our operating results are also dependent upon our ability to manage our cost structure.

We have incurred substantial operating losses since inception and we cannot guarantee that we will become profitable in the future.

We have incurred substantial losses since inception as we funded the development of our products and the growth of our organization. We have an accumulated deficit of $197.6 million as of June 30, 2003. Since the beginning of 2002, we have reduced our workforce by a total of 385 employees and consolidated certain facilities as part of our restructuring plan. As a result of these actions, we incurred restructuring charges of $19.5 million in 2002 and $14.3 million in the six months ended June 30, 2003. Despite these recent measures in order to remain competitive we intend to continue investing heavily in sales, marketing and research and development. As a result, we are likely to continue report future operating losses and cannot guarantee whether we will report net income in the future.

Our operating results are substantially dependent on license revenues our BusinessWare product and our business could be materially harmed by factors that adversely affect the pricing and demand for BusinessWare.

Since 1998, a majority of our total revenues has been derived from licensing our BusinessWare product and applications built using that product. We expect that will continue to be the case. Accordingly, our future operating results will depend on the demand for BusinessWare by existing and future customers, including new and enhanced releases that are subsequently introduced. If our competitors release new products that are superior to BusinessWare in performance or price, or we fail to enhance BusinessWare and introduce new products in a timely manner, demand for our product may decline. A decline in demand for BusinessWare as a result of competition, technological change or other factors would significantly reduce our revenues.

Failure to raise additional capital or generate the significant capital necessary to expand our operations and invest in new products could reduce our ability to compete and result in lower revenues.

During the six months ended June 30, 2003, we had a net loss of $26.7 million and our operating activities used $13.3 million of cash. As of June 30, 2003, we had approximately $104.5 million in cash and cash equivalents and short-term investments, and $13.4 million in long-term liabilities. We may need to raise additional funds, and we cannot be certain that we will be able to obtain additional financing on favorable terms, or at all. If we need additional capital and cannot raise it on acceptable terms, we may not be able to, among other things:

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develop or enhance our products and services;

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acquire technologies, products or businesses;

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expand operations, in the United States or internationally;

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hire, train and retain employees; or

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respond to competitive pressures or unanticipated capital requirements.

Our failure to do any of these things could result in lower revenues and could seriously harm our business.

The challenging economic environment in the United States and abroad, and especially the continued reluctance of companies to make significant expenditures on information technology, could reduce demand for our products and cause our revenues to continue to decline.

The downturn in the U.S. and the world economy may cause a further decline in capital allocations for software purchases. The delay in capital expenditures may cause a decrease in sales, may cause an increase in our accounts receivable and may make collection of license and support payments from our customers more difficult. Over approximately the past two years, we have experienced a general slow-down in the level of capital spending by some of our customers due to the general economic downturn, which has resulted in lower revenues. This slow-down in capital spending, if sustained in future periods, could result in reduced sales or the postponement of sales to our customers. There can be no assurance that the level of spending on information technology in general, or on business integration software by our customers and potential customers, will increase or remain at current levels in future periods. Lower spending on information technology could result in reduced license sales to our customers, reduced overall revenues, diminished margin levels, and could impair our operating results in future periods.

In addition, international events threaten to deepen and prolong the challenging economic environment. Terrorism and the threat thereof, as well as actual or threatened war or hostilities in various regions, could cause companies further to delay or moderate their capital expenditures, thereby potentially harming our financial performance.

We experience long and variable sales cycles, which could have a negative impact on our results of operations for any given quarter.

Our product is often used by our customers to deploy mission-critical solutions used throughout their organization. Customers generally consider a wide range of issues before committing to purchase our products, including product benefits, ability to operate with existing and future computer systems, ability to accommodate

increased transaction volume and product reliability. Many customers will be addressing these issues for the first time. As a result, we or other parties, including system integrators, must educate potential customers on the use and benefits of our product and services. In addition, the purchase of our products generally involves a significant commitment of capital and other resources by a customer. This commitment often requires significant technical review, assessment of competitive products, and approval at a number of management levels within the customer’s organization. Because of these issues, our sales cycle has ranged from six to nine months, and in some cases even longer, and it is very difficult to predict whether and when any particular license transaction might be completed. In addition, the downturn in the U.S. economy has caused some customers to increase budgetary controls or require additional management approvals within the customers’ organization prior to committing to significant capital purchases, either of which could result in an increased sales cycle.

Because a small number of customers have in the past accounted for a substantial portion of our revenues, our revenues could decline due to the loss or delay of a single customer order.

Sales to our ten largest customers accounted for 35% and 37% of total revenues in the three and six months ended June 30, 2003, respectively. Our license agreements do not generally provide for ongoing license payments. Therefore, we expect that revenues from a limited number of customers will continue to account for a significant percentage of total revenues in future quarters. Our ability to attract new customers will depend on a variety of factors, including the reliability, security, scalability, breadth and depth of our products, and cost-effectiveness of our products. The loss or delay of individual orders could have a significant impact on revenues and operating results. Our failure to add new customers that make significant purchases of our product and services would reduce our future revenues.

If we are not successful in developing industry specific solutions based on BusinessWare, our ability to increase future revenues could be harmed.

We have developed and intend to continue to develop solutions based on BusinessWare which incorporate business processes, connectivity and document transformations specific to the needs of particular industries, including telecommunications, financial services and healthcare industries. This presents technical and sales challenges and requires collaboration with third parties, including system integrators and standard organizations, and the commitment of significant resources. Specific industries may experience economic downturns or regulatory changes that may result in delayed spending decisions by customers or require changes to our products. If we are not successful in developing these targeted solutions or these solutions do not achieve market acceptance, our ability to increase future revenues could be harmed.

To date we have concentrated our sales and marketing efforts toward companies in the telecommunications, financial services, and healthcare industries. Customers in these new vertical markets are likely to have different requirements and may require us to change our product design or features, sales methods, support capabilities or pricing policies. If we fail to successfully address these new vertical markets we may experience decreased sales in future periods.

Our products may not achieve market acceptance, which could cause our revenues to decline.

Deployment of our products requires interoperability with a variety of software applications and systems and, in some cases, the ability to process a high number of transactions per second. If our products fail to satisfy these demanding technological objectives, our customers will be dissatisfied and we may be unable to generate future sales. Failure to establish a significant base of customer references will significantly reduce our ability to license our product to additional customers.

Our markets are highly competitive and, if we do not compete effectively, we may suffer price reductions, reduced gross margins and loss of market share.

The market for our products is intensely competitive, evolving and subject to rapid technological change. The intensity of competition is expected to increase in the future. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any one of which could significantly reduce our future revenues. Our current competitors include BEA Systems, IBM Corporation, IONA, Microsoft Corporation, Mercator Software, Sybase, SeeBeyond Technology, Tibco Software, and webMethods. In the future, some of these companies may expand their products to provide or enhance existing business process management, business analysis and monitoring, and business vocabulary management functionality. These or other competitors may merge to attempt the creation of a more competitive entity, or one that offers a broader solution than we provide. In addition, “in-house” information technology departments of potential customers have developed or may develop systems that provide for some or all of the functionality of our products. We expect that internally developed application integration and process automation efforts will continue to be a principal source of competition for the foreseeable future. In particular, it can be difficult to sell our product to a potential customer whose internal development group has already made large investments in and progress towards completion of systems that our product is intended to replace. Finally, we also face or may soon face direct and indirect competition from major enterprise software developers that offer integration products as a complement to their other enterprise software products. These companies may also modify their applications to be more easily integrated with other applications through web services or other means. Some of these vendors include JD Edwards, Oracle, PeopleSoft, Siebel Systems and SAP AG.

Many of our competitors have more resources and broader customer and partner relationships than we do. In addition, many of these competitors have extensive knowledge of our industry. Current and potential competitors have established or may establish cooperative relationships among themselves or with third-parties to offer a single solution and increase the ability of their products to address customer needs. Although we believe that our solutions generally compete favorably with respect to these factors, our market is relatively new and is evolving rapidly. We may not be able to maintain our competitive position against current and potential competitors, especially those with significantly greater resources.

Our revenues will likely decline if we do not develop and maintain successful relationships with system integrators.

System integrators install and deploy our products and those of our competitors, and perform custom integration of systems and applications. Some system integrators engage in joint marketing and sales efforts with us. If these relationships fail, we will have to devote substantially more resources to the sales and marketing, and implementation and support of our product than we would otherwise have to, and our efforts may not be as effective as those of the system integrators. In many cases, these parties have extensive relationships with our existing and potential customers and influence the decisions of these customers. We rely upon these firms for recommendations of our product during the evaluation stage of the purchasing process, as well as for implementation and customer support services. A number of our competitors have strong relationships with these system integrators and, as a result, these system integrators may recommend competitors’ products and services. In addition, a number of our competitors have relationships with a greater number of these system integrators and, therefore, have access to a broader base of enterprise customers. Our failure to establish or maintain these relationships would significantly harm our ability to license and successfully implement our software product. In addition, we rely on the industry expertise and reach of these firms. Therefore, this failure would also harm our ability to develop industry-specific products. We are currently investing, and plan to continue to invest, significant resources to develop and maintain these relationships. Our operating results could be harmed if these efforts do not generate license and service revenues necessary to offset this investment.

The cost and difficulty in implementing our product could significantly harm our reputation with customers, diminishing our ability to license additional products to our customers.

Our products are often purchased as part of large projects undertaken by our customers. These projects are complex, time consuming and expensive. Failure by customers to successfully deploy our products, or the failure by us or third-party consultants to ensure customer satisfaction, could damage our reputation with existing and future customers and reduce future revenues. In many cases, our customers must interact with, modify, or replace significant elements of their existing computer systems. The costs of our products and services represent only a portion of the related hardware, software, development, training and consulting costs. The significant involvement of third parties, including system integrators, reduces the control we have over the implementation of our products and the quality of customer service provided to organizations which license our software.

If our products do not operate with the many hardware and software platforms used by our customers, our business may fail.

We currently serve a customer base with a wide variety of constantly changing hardware, packaged software applications and networking platforms. If our products fail to gain broad market acceptance, due to their inability to support a variety of these platforms, our operating results may suffer. Our business depends, among others, on the following factors:

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our ability to integrate our product with multiple platforms and existing, or legacy, systems and to modify our products as new versions of packaged applications are introduced;

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the portability of our products, particularly the number of operating systems and databases that our products can source or target;

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our ability to anticipate and support new standards, especially Internet standards;

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the integration of additional software modules under development with our existing products; and

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our management of software being developed by third parties for our customers or use with our products.

If we fail to introduce new versions and releases of our products in a timely manner, our revenues may decline.

We may fail to introduce or deliver new products on a timely basis, if at all. In the past, we have experienced delays in the commencement of commercial shipments of our BusinessWare products. To date, these delays have not had a material impact on our revenues. If new releases or products are delayed or do not achieve market acceptance, we could experience a delay or loss of revenues and cause customer dissatisfaction. In addition, customers may delay purchases of our products in anticipation of future releases. If customers defer material orders in anticipation of new releases or new product introductions, our revenues may decline.

Our products rely on third-party programming tools and applications. If we lose access to these tools and applications, or are unable to modify our products in response to changes in these tools and applications, our revenues could decline.

Our programs utilize Java programming technology provided by Sun Microsystems. We also depend upon access to the interfaces, known as “APIs,” used for communication between external software products and packaged application software. Our access to APIs of third-party applications are controlled by the providers of these applications. If the application provider denies or delays our access to APIs, our business may be harmed. Some application providers may become competitors or establish alliances with our competitors, increasing the likelihood that we would not be granted access to their APIs. We also license technology related to the connectivity of our product to third-party database and other applications and we incorporate some third-party technology into our product offerings. Loss of the ability to use this technology, delays in upgrades, failure of these third parties to support these technologies, or other difficulties with our third-party technology partners could lead to delays in product shipment and could cause our revenues to decline.

We could suffer losses and negative publicity if new versions and releases of our products contain errors or defects.

Our products and their interactions with customers’ software applications and IT systems are complex and, accordingly, there may be undetected errors or failures when products are introduced or as new versions are released. We have in the past discovered software errors in our new releases and new products after their introduction which has resulted in additional research and development expenses. To date, these additional expenses have not been material. We may in the future discover errors in new releases or new products after the commencement of commercial shipments. Since many customers are using our products for mission-critical business operations, any of these occurrences could seriously harm our business and generate negative publicity.

If we fail to attract and retain qualified personnel, our ability to compete will be harmed.

We depend on the continued service of our key technical, sales and senior management personnel. None of these persons are bound by an employment agreement. The loss of senior management or other key research, development, sales and marketing personnel could have a material adverse effect on our future operating results. In addition, we must attract, retain and motivate highly skilled employees. We face significant competition for individuals with the skills required to develop, market and support our products and services. We cannot assure that we will be able to recruit and retain sufficient numbers of these highly skilled employees.

If we fail to adequately protect our proprietary rights, we may lose these rights and our business may be seriously harmed.

We depend upon our ability to develop and protect our proprietary technology and intellectual property rights to distinguish our products from our competitor’s products. The use by others of our proprietary rights could materially harm our business. We rely on a combination of copyright, patent, trademark and trade secret laws, as well as confidentiality agreements and licensing arrangements, to establish and protect our proprietary rights. Despite our efforts to protect our proprietary rights, existing laws afford only limited protection. Attempts may be made to copy or reverse engineer aspects of our products or to obtain and use information that we regard as proprietary. Accordingly, there can be no assurance that we will be able to protect our proprietary rights against unauthorized third party copying or use. Furthermore, policing the unauthorized use of our products is difficult, and expensive litigation may be necessary in the future to enforce our intellectual property rights.

Our products could infringe the intellectual property rights of others causing costly litigation and the loss of significant rights.

Software developers in our market will increasingly be subject to infringement claims as the number of products in different software industry segments overlap. Any claims, with or without merit, could be time-consuming, result in costly litigation, prevent product shipment or cause delays, or require us to enter into royalty or licensing agreements, any of which could harm our business. Patent litigation in particular has complex technical issues and inherent uncertainties. In the event an infringement claim against us is successful and we cannot obtain a license on acceptable terms or license a substitute technology or redesign our product to avoid infringement, our business would be harmed. Furthermore, former employers of our current and future employees may assert that our employees have improperly disclosed to us or are using confidential or proprietary information.

Our significant international operations may fail to generate significant product revenues or contribute to our drive toward profitability, which could result in slower revenue growth and harm our business.

We have opened international offices in countries including the United Kingdom, Japan, Germany, France, Italy, Brazil, Taiwan, Korea, Mexico, Singapore, Canada, Australia and Spain, and we may establish additional international offices. During the first six months of 2003, 33% of our revenue was derived from international markets. We anticipate devoting significant resources and management attention to expanding international opportunities. There are a number of challenges to establishing operations outside of the United States and we may be unable to successfully generate significant international revenues. If we fail to successfully establish our products in international markets, we could experience slower revenue growth and our business could be harmed. It may be difficult to protect our intellectual property in certain international jurisdictions.

We are at risk of securities class action litigation due to our expected stock price volatility.

In the past, securities class action litigation has often been brought against a company following a decline in the market price of its securities. This risk is especially acute for us because technology companies have experienced greater than average stock price volatility in recent years and, as a result, have been subject to, on average, a greater number of securities class action claims than companies in other industries. In November 2001 and in February 2003, Vitria and certain of our officers and directors were named as defendants in a class action shareholder complaints. See Part II Item 1 “Legal Proceedings” for more information regarding this litigation.

We have implemented anti-takeover provisions which could discourage or prevent a takeover, even if an acquisition would be beneficial to our stockholders.

Provisions of our amended and restated certificate of incorporation and bylaws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. These provisions include:

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establishment of a classified Board of Directors requiring that not all members of the Board of Directors may be elected at one time;

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authorizing the issuance of “blank check” preferred stock that could be issued by our Board of Directors of directors to increase the number of outstanding shares and thwart a takeover attempt;

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prohibiting cumulative voting in the election of directors, which would otherwise allow less than a majority of stockholders to elect director candidates;

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limitations on the ability of stockholders to call special meetings of stockholders;

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prohibiting stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders; and

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establishing advance notice requirements for nominations for election to the Board of Directors of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings

Section 203 of the Delaware General Corporations Law and the terms of our stock option plans may also discourage, delay or prevent a change in control of Vitria. In addition, as of June 30, 2003, our executive officers, directors and their affiliates beneficially own approximately 36% of our outstanding common stock. This could have the effect of delaying or preventing a change of control of Vitria and may make some transactions difficult or impossible without the support of these stockholders.

Item 4. CONTROLS AND PROCEDURES

Based on their evaluation as of June 30, 2003, our chief executive officer and chief financial officer, have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) were sufficiently effective to ensure that the information required to be disclosed by us in this quarterly report on Form 10-Q was recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and Form 10-Q. There were no changes in our internal controls over financial reporting during the quarter ended June 30, 2003 that have materially affected, or are reasonably likely to materially affect our internal controls over financial reporting.

Our management, including our chief executive officer and chief financial officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Vitria have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

PART II

OTHER INFORMATION

Item 1. Legal Proceedings

In November 2001, Vitria and certain of our officers and directors were named as defendants in a class action shareholder complaint filed in the United States District Court for the Southern District of New York, and captioned Kideys, et al., v. Vitria Technology, Inc., et al., Case No. 01-CV-10092. The plaintiffs allege that Vitria, certain of our officers and directors and the underwriters of our initial public offering (“IPO”), violated federal securities laws because Vitria’s IPO registration statement and prospectus contained untrue statements of material fact or omitted material facts regarding the compensation to be received by, and the stock allocation practices of, the IPO underwriters. The plaintiffs seek unspecified monetary damages and other relief. Similar complaints were filed in the same court beginning in January 2001 against numerous public companies that first sold their common stock since the mid-1990s. All of these IPO-related lawsuits were consolidated for pretrial purposes before United States Judge Shira Scheindlin of the Southern District of New York. Defendants filed a global motion to dismiss the IPO-related lawsuits on July 15, 2002. On February 19, 2003, Judge Scheindlin issued a ruling denying in part and granting in part the Defendants’ motions to dismiss. On June 18, 2003, Vitria’s Board of Directors approved a resolution accepting a settlement offer from the plaintiffs according to the terms and conditions of a comprehensive Memorandum of Understanding negotiated between the plaintiffs and the issuer defendants. Under the terms of the settlement, the plaintiff class will dismiss with prejudice all claims against Vitria and our current and former directors and officers, and Vitria will assign to the plaintiff class or its designee certain claims that Vitria may have against the underwriters of our IPO. In addition, the tentative settlement guarantees that, in the event that the plaintiffs recover less than $1.0 billion in settlement or judgment against the underwriter defendants in the IPO-related lawsuits, the plaintiffs will be entitled to recover the difference between the actual recovery and $1.0 billion from the insurers for the Issuers. Although Vitria has approved this settlement proposal in principle, it remains subject to a number of procedural conditions, as well as formal approval by the court. If approved, there will be no cash or other payment from Vitria to the plaintiff class or any other parties.

In February 2003, Vitria and certain of our officers and directors were named as defendants in a class action shareholder complaint filed in the United States District Court for the Southern District of Florida, captioned Liu v. Credit Suisse First Boston Corporation (“CSFB”), et al., Case No. 03-20459. In the complaint, the plaintiffs allege that CSFB knowingly conspired with dozens of issuers, including Vitria, to conduct initial public offerings based on misinformation about our future prospects and the proper pricing of their shares, in violation of the anti-fraud provisions of section 10(b) of the Securities Exchange Act of 1934. The complaint sought unspecified monetary damages and other relief. In June 2003, the plaintiffs filed an amended complaint which voluntarily dismissed Vitria and our officers and directors from the action without prejudice. This dismissal was reaffirmed in two orders issued by the court in July 2003. Accordingly, neither Vitria nor any of our officers and directors remains a party to this action.

With the exception of the above lawsuits, we are not currently party to any other material pending legal proceedings, except routine legal proceedings arising in the ordinary course of and incidental to our business. We do not believe that these other proceedings, individually or collectively, will harm our business.

Item 2. Changes in Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

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

The annual meeting of stockholders of Vitria Technology, Inc was held on May 16, 2003 for the purpose of:

(1)

electing two directors to our board of directors to serve until 2006 annual meeting of stockholders;

(2)

to approve amendments to our certificate of incorporation to effect a reverse stock split of our common stock pursuant to which any whole number of outstanding shares between and including two and six would be combined into one share of our common stock and to concurrently decrease the authorized number of shares of common stock on a proportional basis and to authorize our Board of Directors to select and file one such amendment;

(3)

to ratify the selection of Ernst & Young LLP as our independent auditors for the fiscal year ending December 31, 2003; and

(4)

to transact such other business as may properly come before the meeting or any adjournment or postponement thereof.

Proxies for the meeting were solicited pursuant to Section 14(a) of the Securities Exchange Act of 1934, as amended, and there was no solicitation in opposition of management’s solicitations. The final vote on the proposals were recorded as follows:

Proposal 1:

Election of two directors for three-year terms expiring at the 2006 annual meeting:

Nominee	For	Withheld
M. Dale Skeen, Ph.D.	117,268,451	2,746,291
William H. Younger, Jr.	118,655,432	1,359,310

Proposal 2:

Approval of amendments to our certificate of incorporation to effect a reverse stock split of our common stock pursuant to which any whole number of outstanding shares between and including two and six would be combined into one share of our common stock and to concurrently decrease the authorized number of shares of common stock on a proportional basis and to authorize our Board of Directors to select and file one such amendment:

For		Against		Abstain
119,287,554		717,136		10,052

Proposal 3:

The selection of Ernst & Young LLP as our independent auditors for the fiscal year ending December 31, 2003 was ratified by the following vote:

For		Against		Abstain
119,796,657		138,224		79,861

Item 5. Other Information

Consistent with Section 10A(i)(2) of the Securities Exchange Act of 1934, as added by Section 202 of the Sarbanes-Oxley Act of 2002, Vitria is responsible for disclosing the nature of the non-audit services approved by our Audit Committee during a quarter to be performed by Ernst & Young LLP, our independent auditor. Non-audit services are services other than those provided by Ernst & Young LLP in connection with an audit or a review of Vitria’s financial statements. During the second quarter of 2003 our Audit Committee approved Vitria to utilize non-audit services performed by Ernst & Young LLP as listed below:

•

Consultations with Ernst & Young LLP’s tax specialists with respect to certain matters pertaining to our foreign subsidiaries.

Item 6. Exhibits and Reports on Form 8-K

Exhibits


Exhibit 3.4		Certificate of Amendment of Amended and Restated Certificate of Incorporation, dated May 27, 2003.

Exhibit 10.15		Sublease, by and between Proxim, Inc. and Vitria Technology, Inc, dated June 6, 2003.

Exhibit 10.16		Second Loan Modification Agreement, by and between Silicon Valley Bank and Vitria Technology, Inc., dated June 26, 2003.

Exhibit 31.1		Certification of President and Chief Executive Officer as required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.

Exhibit 31.2		Certification of Chief Financial Officer as required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.

Exhibit 32.1		Certification of President and Chief Executive Officer as required by Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended.*

Exhibit 32.2		Certification of Chief Financial Officer as required by Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended.*

The certifications attached as Exhibit 32.1 and Exhibit 32.2 accompany this Quarterly Report on Form 10-Q, are not deemed filed with the Securities and Exchange Commission and are not to be incorporated by reference into any filing of Vitria Technology, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Form 10-Q, irrespective of any general incorporation language contained in such filing.

Reports on Form 8-K

Vitria filed a Current Report on Form 8-K, dated April 30, 2003, on April 30, 2003, reporting under “Item 9. Regulation FD Disclosure” rather than “Item 12. Disclosure of Results of Operations and Financial Condition,” its results for the three months ended March 31, 2003, as permitted by SEC Release No. 33-8216.

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.

Vitria Technology, Inc.

Date: August 13, 2003

/s/ JEFFREY J. BAIRSTOW

Jeffrey J. Bairstow

Chief Financial Officer