Prepared by R.R. Donnelley Financial -- Amend. No. 1 to Form 10-Q for Period Ended 04/30/02

10-Q/A 1 d10qa.htm AMEND. NO. 1 TO FORM 10-Q FOR PERIOD ENDED 04/30/02 Prepared by R.R. Donnelley Financial -- Amend. No. 1 to Form 10-Q for Period Ended 04/30/02

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q/A

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

For the Quarter Ended April 30, 2002

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 000-25829

PORTAL SOFTWARE, INC.

(Exact Name of Registrant as Specified in Its Charter)

Delaware		77-0369737
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

10200 South De Anza Boulevard

Cupertino, California 95014

(Address of Principal Executive Offices)

Registrant’s Telephone Number, Including Area Code: (408) 572-2000

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 ¨

On July 31, 2002 176,539,966 shares of the Registrant’s Common Stock, $0.001 par value, were outstanding.

PORTAL SOFTWARE, INC.

FORM 10-Q/A

QUARTER ENDED APRIL 30, 2002

INDEX

		Page
Part I: Financial Information

Item 1:	Financial Statements (Unaudited)

	Condensed Consolidated Balance Sheets at April 30, 2002 and January 31, 2002	3

	Condensed Consolidated Statements of Operations for the three months ended April 30, 2002 and 2001	4

	Condensed Consolidated Statements of Cash Flows for the three months ended April 30, 2002 and 2001	5

	Notes to Unaudited 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	32

Part II: Other Information

Item 1:	Legal Proceedings	33

Item 6:	Exhibits and Reports on Form 8-K	35

Signatures		36

Item 1:

FINANCIAL STATEMENTS

PORTAL SOFTWARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

	April 30, 2002			January 31, 2002
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	18,285		$	36,318
Short-term investments		74,308			75,463
Accounts receivable, net of allowance for doubtful accounts of $4,892 and $7,869 at April 30, 2002 and January 31, 2002, respectively		21,981			22,323
Restricted short-term investments		1,609			1,718
Deferred income taxes		2,485			2,733
Prepaids and other current assets		5,634			5,083

Total current assets		124,302			143,638
Property and equipment, net		42,210			43,146
Purchased developed technology, net		6,650			7,315
Restricted long-term investments		15,411			15,414
Other assets		3,051			3,693

	$	191,624		$	213,206


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	5,072		$	4,079
Accrued compensation		13,543			12,136
Accrued restructuring expenses		31,352			34,981
Other accrued liabilities		16,716			17,571
Current portion of capital lease obligations		384			587
Deferred revenue		29,812			37,466

Total current liabilities		96,879			106,820
Long-term notes payable		1,652			1,658
Long-term portion of capital lease obligations		—			11
Long-term deferred income taxes		2,485			2,733
Other long-term liabilities		40			49

Commitments and contingencies

Stockholders’ equity:
Common stock, $0.001 par value		175			175
Additional paid-in capital		536,426			536,249
Accumulated other comprehensive loss		(354	)		(709	)
Notes receivable from stockholders		(79	)		(79	)
Deferred stock compensation		(225	)		(335	)
Accumulated deficit		(445,375	)		(433,366	)

Stockholders’ equity		90,568			101,935

	$	191,624		$	213,206

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

PORTAL SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts; unaudited)

	Three Months Ended April 30,
	2002			2001
Revenues:
License fees	$	12,708		$	20,768
Services		18,404			23,799

Total revenues		31,112			44,567

Costs and expenses:
Cost of license fees		115			216
Cost of services		10,949			20,666
Amortization of purchased developed technology		665			863
Research and development		11,618			17,468
Sales and marketing		14,900			27,376
General and administrative		4,394			10,487
Amortization of deferred stock compensation(1)		110			562
Amortization of goodwill		—			15,348

Total costs and expenses		42,751			92,986

Loss from operations		(11,639	)		(48,419	)
Interest and other income, net		698			2,494

Income (loss) before income taxes		(10,941	)		(45,925	)
Provision for income taxes		(1,068	)		(897	)

Net loss	$	(12,009	)	$	(46,822	)

Basic and diluted net loss per share	$	(0.07	)	$	(0.28	)

Shares used in computing basic and diluted net loss per share		174,892			169,687

(1)

Amortization of deferred stock compensation relates to the following expense categories:

Cost of services	$	17	$	91
Research and development		38		181
Sales and marketing		31		163
General and administrative		24		127

Total	$	110	$	562

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

PORTAL SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands; unaudited)

	Three Months Ended April 30,
	2002			2001
OPERATING ACTIVITIES:
Net loss	$	(12,009	)	$	(46,822	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		3,679			3,422
Amortization of deferred stock compensation		110			562
Amortization of purchased intangibles and goodwill		665			16,211
Gain on sale of investments		(92	)		—
Changes in operating assets and liabilities:
Accounts receivable, net		343			7,107
Prepaids and other current assets		(550	)		583
Other assets		890			(224	)
Accounts payable		993			(634	)
Accrued compensation		1,408			(4,800	)
Other accrued liabilities		(4,743	)		(9,821	)
Deferred revenue		(7,655	)		2,500

Net cash used in operating activities		(16,961	)		(31,916	)

INVESTING ACTIVITIES:
Purchases of short-term investments		(57,455	)		(51,265	)
Sales of short-term investments		45,755			20,197
Maturity of short-term investments		12,591			44,297
Purchases of property and equipment		(2,322	)		(6,530	)
Proceeds from sale of private equity investments		—			1,112

Net cash provided by (used in) investing activities		(1,431	)		7,811

FINANCING ACTIVITIES:
Repayments of notes payable		(6	)		(247	)
Principal payments under capital lease obligations		(214	)		(679	)
Proceeds from issuance of common stock, net of repurchases		176			1,040

Net cash provided by financing activities		(44	)		114

Effect of exchange rate on cash and cash equivalents		403			(100	)

Net decrease in cash and cash equivalents		(18,033	)		(24,091	)
Cash and cash equivalents at beginning of period		36,318			69,323

Cash and cash equivalents at end of period	$	18,285		$	45,232

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

PORTAL SOFTWARE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1) Significant Accounting Policies:

Nature of Business and Basis of Presentation

Portal Software, Inc. or Portal, develops, markets and supports product-based customer management and billing solutions for communications and content service providers. Portal’s convergent platform enables service providers to deliver voice, data, video and content services with multiple networks, payment models, pricing plans and value chains. Portal markets its products worldwide through a combination of a direct sales force and distribution partners. Substantially all of Portal’s license revenues are derived from sales of its Infranet product line.

The accompanying unaudited condensed consolidated financial statements include the accounts of Portal and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The balance sheet at April 30, 2002 and the statement of operations and cash flows for the three months ended April 30, 2002 and 2001 are not audited. In the opinion of management, these financial statements reflect all adjustments that are necessary for a fair presentation of the results for and as of the periods shown. The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year or for any future period. The condensed consolidated financial statement information as of January 31, 2002 is derived from audited financial statements as of that date. These financial statements should be read in conjunction with the financial statements and related notes included in Portal’s Annual Report on Form 10-K/A for the year ended January 31, 2002 filed with the Securities and Exchange Commission on August 27, 2002.

Revenue Recognition

License revenues are comprised of fees for multi-year or perpetual licenses, which are primarily derived from contracts with corporate customers and resellers. Revenue from license fees is recognized when persuasive evidence of an arrangement exists, delivery of the product has occurred, no significant Portal obligations with regard to implementation remain, the fee is fixed or determinable and collectibility is probable. We recognize license revenue using the residual method. The software is considered to have been delivered when Portal has provided the customer with the access codes that allow for immediate possession of the software. If the fee due from the customer is not fixed or determinable, revenue is recognized as payments become due from the customer. If collectibility is not considered probable, revenue is recognized when the fee is collected. Revenue from arrangements with customers who are not the ultimate users (resellers) is not recognized until evidence of an arrangement with an end user has been received. Portal’s policy should we enter into a transaction with a customer to purchase the customer’s products contemporaneously with the customer’s purchase of software from Portal, is to recognize the amount of license fees paid to Portal net of the fees paid for the customer’s products.

Services revenues are primarily comprised of revenue from systems integration or other consulting fees, maintenance agreements and training. Arrangements that include software services are evaluated to determine whether those services are essential to the functionality of other elements of the arrangement. When software services are considered essential, license and service revenue under the arrangement is recognized using contract accounting. When software services are not considered essential, which has been the case in the majority of our license arrangements, the revenue related to the license is recorded upon delivery and the revenue related to the fair value of the software services is recognized as the services are performed. Fair value is based on the price charged when these services are sold separately. Maintenance agreements provide technical support and include the right to unspecified upgrades on an if-and-when-available basis. Maintenance revenue is deferred and recognized on a straight-line basis as services revenue over the life of the related agreement, which is typically one year. Customer advances and billed amounts due from customers in excess of revenue recognized are generally recorded as deferred revenue.

Portal’s revenue recognition policy takes into consideration the creditworthiness of the customer in determining the probability of collection as a criterion for revenue recognition. The determination of creditworthiness requires

PORTAL SOFTWARE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

the exercise of judgment, which affects Portal’s revenue recognition. If a customer is deemed to be not creditworthy, all revenue under arrangements with that customer is recognized upon receipt of cash. The creditworthiness of customers is re-assessed on a regular basis and revenue is deferred until cash receipt, if appropriate. Additionally, Portal enters into contracts with payment terms that extend beyond its normal credit period, which is currently 60 days. For such transactions, it is Portal’s policy to recognize such revenue only when payments are due, provided that the customer is deemed to be creditworthy.

Concentration of Credit Risk

Substantially all of Portal’s software and services have been sold to North American, European and Asia-Pacific communication and content service providers, including mobile wireless companies, broadband, electronic content and Internet access companies, as well as other Internet and e-commerce companies. Accordingly, adverse economic trends affecting the communications industry may increase our credit risk. Portal performs ongoing credit evaluations of its customers and does not require collateral. Portal maintains an allowance for potential credit losses. No individual customer accounted for more than 10% of total revenues during the quarter ended April 30, 2002. One customer, AOL Time Warner, accounted for 15% of revenues during the quarter ended April 30, 2001.

Segment Information

Portal operates solely in one segment, the development and marketing of business infrastructure software. Portal’s foreign offices consist of sales, marketing and support activities through its foreign subsidiaries and an overseas reseller network as well as one development site in Germany. Operating losses generated by the foreign operations of Portal and their corresponding identifiable assets were not material in any period presented. Portal’s chief operating decision maker reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenues by geographic region for purposes of making operating decisions and assessing financial performance. Portal’s assets are primarily located in its corporate office in the United States and are not allocated to any specific region, therefore Portal does not produce reports for, or measure the performance of its geographic regions based on any asset-based metrics. Therefore, geographic information is presented only for revenues.

Portal’s export revenue represented 64% and 47% of total revenues in the quarters ending April 30, 2002 and 2001. Nearly all of the export sales to date have been denominated in U.S. dollars and were derived from sales to Europe (which is defined by Portal as Europe, Middle East and Africa) and Intercontinental (which is defined by Portal as Asia-Pacific, Japan and Latin America). European revenues for the quarters ending April 30, 2002 and 2001 were $12.2 million and $12.8 million, respectively, and Intercontinental revenues were $7.6 million and $8.1 million, respectively.

Cash, Cash Equivalents, Short-term and Long-Term Investments

Portal considers all highly liquid, low-risk debt instruments with an original maturity at the date of purchase of three months or less to be cash equivalents. As of April 30, 2002 and 2001, cash equivalents and short-term investments consist primarily of commercial paper, corporate notes, money market funds and government securities. All short-term investments mature within 24 months.

Portal classifies, at the date of acquisition, its cash equivalents and short-term investments as available-for-sale in accordance with the provisions of the FASB’s Statement of Financial Accounting Standards No.115, “Accounting for Certain Investments in Debt and Equity Securities” (“FAS 115”). Securities are reported at fair market value, with the related unrealized gains and losses included within stockholders’ equity. As of April 30, 2002, unrealized gains, for cash equivalents and short-term investments, were $0.3 million due primarily to the effects of decreasing interest rates on longer-term securities. It is possible that a portion of the unrealized gains will be realized, as many high-yielding corporate notes are being downgraded to a level at or below the minimum requirements of our investment policy. As this happens, these securities will be sold resulting in a realized gain. In addition, as cash is required to fund operations, some securities may need to be sold which will result in realizing gains. Debt and discount securities are adjusted for straight-line amortization of premiums and accretion of discounts to maturity, both of which are included in interest income. Realized gains and losses are recorded using the specific identification method and were immaterial for all periods presented

PORTAL SOFTWARE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The following schedules summarize the estimated fair value of Portal’s cash, cash equivalents and short-term investments (in thousands):

	April 30, 2002		January 31, 2002
	(unaudited)
Cash and cash equivalents:
Cash	$	12,617	$	7,895
Money market funds		3,670		16,435
U.S. Government securities		1,998		11,988

	$	18,285	$	36,318

Short term investments at April 30, 2002 (unaudited):

				Gross Unrealized
	Cost			Gain		Loss		Fair Value
Corporate notes	$	30,326		$	269	$	—	$	30,595
U.S. Government securities		45,278			44		—		45,322
Restricted investments		(1,609	)		—		—		(1,609	)

	$	73,995		$	313	$	—	$	74,308

Short-term investments at January 31, 2002:

				Gross Unrealized
	Cost			Gain		Loss		Fair Value
Corporate notes	$	39,086		$	583	$	—	$	39,669
U.S. Government securities		35,485			33		—		35,518
Commercial paper		1,993			1		—		1,994
Restricted investments		(1,718	)		—		—		(1,718	)

	$	74,846		$	617	$	—	$	75,463

The estimated fair value of short-term investments classified by date of maturity is as follows (in thousands):

	April 30, 2002			January 31, 2002
	(unaudited)
Due within one year	$	55,787		$	59,512
Due within two years		20,130			17,669
Restricted short-term investments		(1,609	)		(1,718	)

	$	74,308		$	75,463

As of April 30, 2002 and January 31, 2002, restricted short-term investments of $1.6 million and $1.7 million respectively, combined with restricted long-term investments of $15.4 million represent collateral for five letters of credit and one bank guarantee. The five letters of credit issued in lieu of a cash security deposit are renewable annually and expire on various dates from October 31, 2005 through March 5, 2021. The bank guarantee, issued to secure outstanding bank loans of former shareholders of Solution42, is

for $1.5 million and expires on April 30, 2003. Restricted investments consist of corporate bonds maturing over a period of up to two years.

The restricted long-term investments are classified as held-to-maturity and, consequently, unrealized gains and losses are not recorded. As of April 30, 2002 and January 31, 2002, amortized cost approximated fair value.

PORTAL SOFTWARE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Portal also invests in equity instruments of privately held companies for business and strategic purposes. These investments are included in other assets, in the amount of $1.5 million (total investment of $2.0 million net of a valuation allowance of $0.5 million) as of April 30, 2002 and January 31, 2002. The investments are accounted for using the cost method as Portal does not have the ability to exercise significant influence over the operations of these companies and Portal’s investment is less than 20% of the outstanding voting shares in each entity. Portal monitors its investments for other than temporary impairment, basing its assessment on a review of the investee’s operations and other indicators. Other indicators include, but are not limited to, limited capital resources, limited prospects of receiving additional financing and prospects for liquidity of the related securities.

During the fiscal year ended January 31, 2002, Portal recorded charges of $4.0 million to reflect the other than temporary decline in value of its equity investments. The remaining $1.5 million, referenced above, was determined to not be impaired based upon a review of the financial statements of the company in which we hold the investment. Even though the company is still generating losses, it has experienced growth in revenues and has continued its efforts to reduce its cost structure. Portal will continue to monitor its investment in this company for signs of deterioration.

Impairment of Long-Lived Assets

Long-lived assets and intangibles, including goodwill, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. On a regular basis, the estimated future net cash flows associated with the asset are compared to the asset’s carrying amount to determine if impairment has occurred. If such assets are deemed impaired, an impairment loss equal to the amount by which the carrying amount exceeds the fair value of the assets is recognized. If quoted market prices for the assets are not available, the fair value is calculated using the present value of estimated expected future net cash flows. The cash flow calculations are based on management’s best estimates, using appropriate assumptions and projections at the time. During the year ended January 31, 2002, Portal recorded charges of $199.2 million to reflect the impairment of goodwill and purchased developed technology related to Portal’s investments in Solution42 and BayGate.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ materially from those estimates.

Net Loss Per Common Share

In accordance with FAS 128, basic and diluted net loss per share have been computed using the weighted-average number of shares of common stock outstanding during the period, less shares subject to repurchase. For the three months ended April 30, 2002 and 2001, 2,703,551 and 6,738,642 stock options were excluded from the dilutive calculation, as their effect is antidilutive.

The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share data; unaudited):

	Three Months Ended April 30,
	2002			2001
Basic and diluted:
Net loss	$	(12,009	)	$	(46,822	)

Weighted-average shares of common stock outstanding		175,031			171,366
Less: Weighted-average shares subject to repurchase		(139	)		(1,679	)

Weighted-average shares used in computing basic net loss per share		174,892			169,687

Basic and diluted net loss per share	$	(0.07	)	$	(0.28	)

PORTAL SOFTWARE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Comprehensive Income (Loss)

Comprehensive income (loss) is comprised of net income (loss) and other comprehensive income (loss), which includes certain changes in equity of the company and changes in the fair value of available for sale securities that are excluded from net income (loss). Comprehensive income (loss) for the three months ended April 30, 2002 and 2001 is as follows (in thousands, unaudited):

	Three months ended April 30,
	2002			2001
Net loss	$	(12,009	)	$	(46,822	)
Unrealized gain (loss) on marketable securities		(303	)		54
Change in cumulative translation adjustment		658			(100	)

Comprehensive loss	$	(11,654	)	$	(46,868	)

(2) Recent Accounting Pronouncements

In July 2001, the Financial Accounting Standards Board (FASB) issued FAS 141 “Business Combinations” (FAS 141) and FAS 142 “Goodwill and Other Intangible Assets” (FAS 142). FAS 141 requires the purchase method of accounting for all business combinations and specifies criteria required to recognize and report intangible assets separate from goodwill. FAS 141 is effective for all business combinations accounted for using the purchase method that are completed after June 30, 2001 and for all business combinations initiated after June 30, 2001. The adoption of FAS 141 did not have a significant impact on our financial statements.

FAS 142 requires that goodwill and other intangible assets with indefinite useful lives be tested for impairment, at least annually, instead of being amortized. Intangible assets with finite useful lives will continue to be amortized over their estimated useful lives. Adoption of FAS 142 in its entirety is required for fiscal years beginning after December 15, 2001. Transitional provisions also require that upon adoption of FAS 142 in its entirety, intangible assets acquired in business combinations, accounted for using the purchase method and completed prior to July 1, 2001, must be classified using the criteria outlined in FAS 141. The adoption of FAS 142 did not have a significant impact on our financial statements.

In August 2001, the FASB issued FAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (FAS 144) which supersedes FAS 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of” (FAS 121). FAS 144 also supersedes certain aspects of the Accounting Principles Board Opinion Number 30 (APB 30), “Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,” as related to the reporting of the effects of a disposal of a segment of a business. FAS 144 will require expected future operating losses from discontinued operations to be displayed in discontinued operations in the period incurred rather than as of the measurement date as presently required by APB 30. Additionally, more dispositions may qualify as discontinued operations. Adoption of FAS 144 is required for fiscal years beginning after December 15, 2001. The adoption of FAS 144 did not have a significant impact on our financial statements.

In April 2002, the FASB issued FAS 145, “Rescission of FASB Statements No. 4, 44, and 62, Amendment of FASB Statement No. 13 (FAS 13), and Technical Corrections” which requires the gains and losses on extinguishments of debt to be classified as income or loss from continuing operations rather than as extraordinary items as previously required. Additionally, FAS 145 amends FAS 13, requiring certain modifications to capital leases be treated as sale-leaseback transactions and modifies the accounting for subleases when the original lessee remains as a guarantor. Adoption of FAS 145 is required for fiscal years beginning after May 15, 2002. The adoption of FAS 145 will not have a significant impact on our financial statements.

PORTAL SOFTWARE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(3) Restructuring

In fiscal 2002, Portal’s Board of Directors approved two plans to reduce its cost structure. The plans were a combination of a reduction in workforce, consolidations of facilities and asset write-offs. As a result of the restructuring plan, Portal incurred charges of $71.0 million in fiscal 2002. The estimated costs of abandoning leased facilities, including estimated costs to sublease were determined through assessment of market information trend analyses.

As of April 30, 2002, the remaining restructuring expense reserves were $31.4 million. The remaining severance is expected to be paid out through the second quarter of fiscal 2003. Facility related costs are expected to be paid out through April 2011. Actual future cash requirements may differ materially from the accrual at April 30, 2002, particularly if actual sublease income is significantly different from current estimates. A summary of restructuring activities along with the respective remaining reserves follows.

	Balance remaining January 31, 2002		Cash			Non-cash		Balance remaining July 31, 2002
	(In thousands)
Severance	$	1,950	$	(1,453	)	$	—	$	497
Facilities		29,976		(2,148	)		—		27,828
Asset write-offs		2,381		—			—		2,381
Other		674		(28	)		—		646

	$	34,981	$	(3,629	)	$	—	$	31,352

(4) Income Taxes

During the three months ended April 30, 2002, we recognized tax expense of $1.1 million primarily as a result of foreign withholding taxes on revenue and tax on earnings generated from our foreign operations. Under Statement of Financial Accounting Standards No. 109 (FAS 109), deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. FAS 109 provides for the recognition of deferred tax assets if realization of such assets are more likely than not. Based on the weight of available evidence, Portal has provided a valuation allowance against certain deferred tax assets. Portal will continue to evaluate the realizability of the deferred tax assets on a quarterly basis.

(5) Commitments and Contingencies

Legal Matters

On July 9, 2001, a purported class action complaint was filed in the Federal District Court Southern District of New York against Portal, certain of its officers and several underwriters of Portal’s initial public offering (“IPO”). The lawsuit alleges violations of Section 11 of the Securities Act of 1933, as amended, and Section 10(b) of the Securities Exchange Act of 1934, as amended, arising from alleged improprieties by the underwriters in connection with our 1999 IPO and follow-on public offering, and claims to be on behalf of all persons who purchased Portal Software shares from May 5, 1999 through December 6, 2000. Four additional nearly identical class actions were also filed in July and August 2001 based on essentially the same facts and allegations. Specifically, the complaints allege the underwriters charged certain of their customers fees in excess of those disclosed in the prospectus and engaged in certain allegedly improper activities in connection with the distribution of the IPO shares. The complaint was subsequently amended to allege similar claims with respect our secondary public offering in September 1999.

PORTAL SOFTWARE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

unspecified amount. A motion to dismiss addressing issues common to the companies and individuals who have been sued in these actions was filed, by Portal, on July 15, 2002.

In the opinion of management, resolution of this litigation is not expected to have a material adverse effect on the financial position of Portal. However, depending on the amount and timing, an unfavorable resolution of these matters could materially affect our future results of operations or cash flows in a particular period.

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

OVERVIEW

Portal develops, markets and supports product-based customer management and billing solutions for communications and content service providers. Portal’s convergent platform enables service providers to deliver voice, data, video and content services with multiple networks, payment models, pricing plans and value chains.

Beginning with fiscal year 1997, substantially all of our revenues have come from the license of one product line, Infranet, and from related services. Revenues consist of Infranet license, consulting, training, support and maintenance fees. License revenues are comprised of perpetual or multiyear license fees which are primarily derived from contracts with corporate customers and resellers. We believe that future license revenues will be generated from three sources:

•

license fees from new customers;

•

license fees for new products to existing customers; and

•

growth in the subscriber base of its existing customers, which will lead to increased revenue from subscriber-based licenses.

We have established a series of partnerships with systems integrators and hardware platform, software and service providers. We have derived, and anticipate that we will continue to derive, a substantial portion of our revenues from customers that have significant relationships with our market and platform partners.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The 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 disclosure of contingent liabilities. On a regular basis, we evaluate and may revise our estimates, including those related to the allowance for bad debts, investments, intangible assets, income taxes, accrued restructuring expenses and contingencies. We base our estimates on historical experience and various other assumptions that we believe 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. Actual results could differ materially from these estimates under different assumptions or conditions.

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

Revenue Recognition

We recognize revenue in accordance with current generally accepted accounting principles that have been prescribed for the software industry. Revenue recognition requirements are very complex and are affected by interpretations of the rules and an understanding of industry practices, both of which are subject to change. Our revenue recognition policy is significant because our revenue is a key component of our results of operations. We follow very specific and detailed guidelines in measuring revenue, several of which are discussed in Note 1 of the Notes to the Unaudited Condensed Consolidated Financial Statements; however, certain judgments affect the application of our revenue recognition policy.

Our revenue recognition policy takes into consideration the creditworthiness of the customer in determining the probability of collection as a criterion for revenue recognition. The determination of creditworthiness requires the exercise of judgment, which affects our revenue recognition. If a customer is deemed to be not creditworthy, all revenue under arrangements with that customer is recognized upon receipt of cash. The creditworthiness of customers is re-assessed on a regular basis and revenue is deferred until cash receipt, if appropriate. Additionally,

we enter into contracts with payment terms that extend beyond our normal credit period, which is currently 60 days. For such transactions, it is our policy to recognize such revenue only when payments are due, provided that the customer is deemed to be creditworthy. As stated previously, if the customer is deemed not creditworthy, revenue is recognized upon receipt of cash.

We also record a provision for estimated sales returns on product and service related sales in the same period as the related revenues are recorded. These estimates are based on historical sales returns, analysis of credit memo data and other known factors. If the historical data we use to calculate these estimates does not properly reflect future returns, revenue could be overstated.

Allowance for Bad Debts

The allowance for doubtful accounts is established through a charge to general and administrative expenses. This allowance is for estimated losses resulting from the inability of our customers to make required payments. It is a significant estimate and is regularly evaluated by us for adequacy by taking into consideration factors such as past experience, credit quality of the customer, age of the receivable balance, individually and in aggregate, and current economic conditions that may affect a customer’s ability to pay. The use of different estimates or assumptions could produce different allowance balances. Our customer base is highly concentrated in the communications and content service provider industries. Several of the leading companies in these industries have announced liquidity concerns. If collection is not probable at the time the transaction is consummated, we do not recognize revenue until cash collection. 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.

Accrued Restructuring Expenses

During the fiscal year ended January 31, 2002, we announced plans to restructure the company that were a combination of a reduction in workforce, consolidation of facilities and the write-off of assets. The restructuring charges during the year were based on actual and estimated costs incurred in connection with these restructuring plans. These estimates have been impacted by the rules governing the termination of employees, especially those in foreign countries. We have not recorded payments related to potential settlements, as these amounts are not reasonably estimable and probable. If, in the future, we were to agree upon additional severance payments, we would have to record additional restructuring charges in the period in which the settlement was determined to be reasonably estimable and probable. We have reduced the amount of the facilities restructuring charge by the estimated amount of sublease income. The assumptions we have made are based on the current market conditions in the various areas we have vacant space. These market conditions can fluctuate greatly due to such factors as changes in property occupancy rates and the rental prices charged for comparable properties. These changes could materially affect our accrual. If, in future periods, it is determined that we have over accrued for restructuring charges for the consolidation of facilities, the reversal of such over accrual would have a favorable impact on our financial statements in the period this was determined and would be recorded as a credit to restructuring charges. Conversely, if it is determined that our accrual is insufficient, an additional charge would have an unfavorable impact on our financial statements in the period this was determined.

RESULTS OF OPERATIONS

Revenues

	Three Months Ended April 30,
	2002			2001			Percent Change
	(in millions; unaudited)
License fees	$	12.7		$	20.8		(39	)%
Percentage of total revenues		41	%		47	%
Services		18.4			23.8		(23	)%
Percentage of total revenues		59	%		53	%

Total revenues	$	31.1		$	44.6		(30	)%

Total revenues decreased significantly in the three months ended April 30, 2002 from the comparable period in 2001. License fees revenue decreased as a percentage of total revenues in the quarter ended April 30, 2002 compared to the quarter ended April 30, 2001 as a result of a continued general economic slowdown affecting the primary markets for our products and services, and in particular, capital spending by communications service providers. No customer accounted for more than 10% of revenues during the quarter ended April 30, 2002. One customer, AOL Time Warner, accounted for 15% of revenues during the quarter ended April 30, 2001.

Services revenue decreased in the three months ended April 30, 2002 from the comparable period ended April 30, 2001. The decrease in services revenue decreased due to less consulting services as a result of fewer new customer implementations.

	Three Months Ended April 30,
	2002			2001			Percent Change
	(in millions; unaudited)
Geographical Revenues:
North America	$	11.3		$	23.7		(52	)%
Percentage of total revenues		36	%		53	%
International
Europe		12.2			12.8		(5	)%
Percentage of total revenues		39	%		29	%
Intercontinental		7.6			8.1		(6	)%
Percentage of total revenues		25	%		18	%

Total international		19.8			20.9		(5	)%
Percentage of total revenues		64	%		47	%

Total revenues	$	31.1		$	44.6		(30	)%

North American revenues, which are defined by us as revenues from the United States and Canada, decreased primarily due to a continued global deferral of capital expenditures by telecommunications companies as well as a general economic slowdown. These are primarily the factors which have also adversely affected our international sales, although to a lesser degree than in North America.

Expenses

	Three Months Ended April 30,
	2002			2001			Percent Change
	(in millions; unaudited)
Cost of license fees	$	0.1		$	0.2		(50	)%
Percentage of total revenues		—	%		—	%
Cost of services	$	10.9		$	20.7		(47	)%
Percentage of total revenues		35	%		46	%
Amortization of purchased developed technology	$	0.7		$	0.9		(22	)%
Percentage of total revenues		2	%		2	%
Research and development	$	11.6		$	17.5		(34	)%
Percentage of total revenues		37	%		39	%
Sales and marketing	$	14.9		$	27.4		(46	)%
Percentage of total revenues		48	%		61	%
General and administrative	$	4.4		$	10.5		(58	)%
Percentage of total revenues		14	%		24	%

Cost of License Fees

Cost of license fees consists of resellers’ commission payments to systems integrators and third-party royalty obligations with respect to third-party technology included in Infranet. Cost of license fees decreased during the quarter ended April 30, 2002 from the comparable period ended April 30, 2001. The decrease in cost of license fees is due to the decrease in revenue generated from our base of systems integrator partners.

Cost of Services

Cost of services primarily consists of maintenance, consulting and training expenses. The decrease in cost of services for the three months ended April 30, 2002 from the comparable period ended April 30, 2001 is primarily due to a reduction in our services workforce as a result of a reduced number of professional consulting projects. Gross margin for services was approximately 41% and 13% in the quarters ended April 30, 2002 and 2001, respectively. The increase in gross margin for services was due to fewer employees in our service workforce.

Amortization of Purchased Developed Technology

In fiscal year 2001, we recorded an asset of $17.9 million for purchased developed technology as a result of acquiring Solution42 and BayGate. Purchased developed technology was being amortized, on a straight-line basis, over the estimated useful life of the respective assets of three to four years. During fiscal 2002, we recorded charges of $2.5 million and $2.2 million to reflect the impairment of purchased developed technology related to our investments in BayGate and Solution42, respectively. As of January 31, 2002, we no longer have purchased developed technology related to our investment in BayGate due to a combination of impairment charges and amortization during fiscal 2002. For the quarters ended April 30, 2002 and 2001, we amortized purchased developed technology in the amount of $0.7 million and $0.9 million, respectively. Amortization of purchased developed technology will continue to negatively impact our operating results in the future. Future amortization expense of the remaining purchased developed technology related to our investment in Solution42 is currently estimated to be $2.7 million in fiscal year 2003, $2.7 million in fiscal year 2004 and $1.9 million in fiscal year 2005.

Research and Development Expenses

Research and development expenses consist primarily of personnel and related costs for our development and technical support efforts. Research and development expenses decreased during the quarter ended April 30, 2002 from the comparable period ended April 30, 2001. The decrease is primarily due to a reduction in Portal’s workforce as a result of cost reduction programs. Portal has not capitalized any software development costs to date.

Sales and Marketing Expenses

Sales and marketing expenses consist of personnel and related costs for our direct sales force, marketing staff and marketing programs, including trade shows, advertising and costs associated with the recruitment of new and maintenance of existing, strategic partnerships. Sales and marketing expenses decreased during the quarter ended April 30, 2002 over the comparable period ended April 30, 2001 primarily due to a decrease in the number of sales and marketing personnel as a result of our restructuring plans initiated in fiscal 2002.

General and Administrative Expenses

General and administrative expenses consist primarily of personnel and related costs for general corporate functions, including finance, legal, human resources, as well as information system and facilities expenses not allocated to other departments. General and administrative expenses decreased in the quarter ended April 30, 2002 from the comparable period ended April 30, 2001. The decrease was primarily due to a decrease in general and administrative personnel and a lower rate of increase in bad debt reserves.

Amortization of Deferred Stock Compensation

We recorded deferred stock compensation of approximately $16.8 million in fiscal year 1999 in connection with stock options and restricted stock issued in and prior to 1999 and $0.2 million in fiscal year 2002, in connection with the acquisition of BayGate. The deferred stock compensation reflects the difference between the exercise prices of options granted to acquire certain shares of common stock and the deemed fair value for financial reporting purposes of our common stock on their respective grant dates. We amortized deferred compensation expense of approximately $0.1 million and $0.6 million during the quarters ended April 30, 2002 and 2001, respectively. This compensation expense relates to options awarded to individuals in all operating expense categories. Total deferred compensation at April 30, 2002 of approximately $0.2 million is being amortized over the vesting periods of the options on a graded vesting method. Amortization of deferred compensation is estimated to $0.3 million in fiscal year 2003.

The following table shows the amounts of deferred stock compensation that would have been recorded under the following categories had deferred stock compensation not been separately stated on the statements of operations.

	Three Months Ended April 30,
	2002		2001
	(in thousands; unaudited)
Cost of services	$	17	$	91
Research and development		38		181
Sales and marketing		31		163
General and administrative		24		127

	$	110	$	562

Amortization of Goodwill

We recorded goodwill in connection with our acquisition of Solution42 in fiscal year 2001. During fiscal year 2002, we recorded an impairment of goodwill in the amount of $194.5 million. Goodwill was further reduced in fiscal 2002 by $3.5 million due to the reversal of excess accrued direct acquisition costs. As of January 31, 2002, there was no remaining balance in goodwill.

Provision for Income Taxes

Our taxes totaled $1.1 million in the three months ended April 30, 2002, primarily as a result of foreign withholding taxes on revenue and tax on earnings generated from our foreign operations. Although the Company recorded a net loss of $12.0 million for the three months ended April 30, 2002, the foreign operations were profitable for tax purposes primarily due to the intercompany charge back arrangements necessary under the local tax laws.

Liquidity and Capital Resources

Cash, cash equivalents and short-term investments (including restricted investments of $17.0 million) totaled $109.6 million at April 30, 2002, compared to a balance of $128.9 million at January 31, 2002.

We used cash totaling $17.0 million in operations in the quarter ended April 30, 2002, a decrease of $14.9 million from the $31.9 million used in the quarter ended April 30, 2001. Net cash used in operations in the quarter ended April 30, 2002 was primarily comprised of a net loss of $12.0 million, a decrease in deferred revenue of $7.7 million and a decrease in other accrued liabilities of $4.7 million. These decreases were partially offset by an increase in accrued compensation of $1.4 million. Adjustments made for non-cash expenses, such as depreciation, amortization and amortization of deferred stock compensation and purchased developed technology amounted to $4.4 million for the quarter ended April 30, 2002.

The total future cash outlay, for both restructuring plans enacted in fiscal 2002, is currently estimated to be approximately $28.9 million which includes severance related costs as well as lease liabilities related to the consolidation of facilities and is expected to be funded by available cash. Of the $28.9 million, lease payments for impacted facilities, net of expected sublease income, are expected to be $27.8 million over the next nine years. The foregoing constitutes forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements for the reasons described below under the caption “Risks Associated With Portal’s Business And Future Operating Results.”

Net cash used by investing activities was $1.4 million for the quarter ended April 30, 2002, an increase of $9.2 million from the $7.8 million provided in the quarter ended April 30, 2001. Net cash used in investing activities in the quarter ended April 30, 2002 was primarily comprised of the investments in software, equipment and facilities. During the quarter ended April 30, 2002, we purchased computer equipment and software, made leasehold improvements and purchased other capital equipment amounting to approximately $2.3 million, primarily to support our ongoing operations and information systems.

We have raised equity capital from investors to fund our operations. During the quarters ended April 30, 2002 and 2001, we raised an additional $0.2 million and $1.0 million, respectively, from sales of common stock issued from our employee stock purchase plan and upon the exercise of stock options by employees, net of repurchases.

In November 2000, we acquired Solution42. The liabilities assumed as part of the acquisition included short-term and long-term notes payable. In May 2001, we paid in full the short-term notes payable, which were comprised of two short-term notes each bearing interest at 6% per annum and were unsecured. The long-term notes payable are four mortgages for two facilities located in Germany. Two of the mortgages accrue interest at 4.45% per annum. Principal and interest are due in December 2010 and June 2011 on these two mortgages. As of April 30, 2002, the balances due on these loans were $0.6 million each. The other two mortgages accrue interest at 5.10% and 4.88% per annum. Principal and interest payments are made on a monthly basis. These two mortgages are due in October 2015 and November 2024. As of April 30, 2002, the balances due were $0.3 million and $0.2 million, respectively.

In the normal course of business, we enter into leases for new or expanded facilities in both domestic and international locations. These leases are for terms expiring April 2002 through March 2021. In connection with our facility leases, we issued five letters of credit in lieu of a security deposit for the facilities (see Note 1 in Notes to Unaudited Condensed Consolidated Financial Statements). Under all our facilities lease agreements, net of sublease income of $9.1 million, we are obligated to make payments of approximately $13.6 million, $13.2 million, $13.3 million, $13.3 million and $13.0 million in the years ending January 31, 2003, 2004, 2005, 2006 and 2007, respectively and a total of $75.3 million thereafter until expiration of the leases.

Due to the restructuring activities that occurred during fiscal 2002, several facilities were vacated or are under utilized. Some of these facilities have been subleased. We are also attempting to sublease additional surplus facilities, in various locations, comprising a total of approximately 180,000 square feet.

The following table summarizes our contractual obligations, including related interest charges, as of April 30, 2002 and the effect such obligations are expected to have on our liquidity and cash flows in future fiscal years ending January 31. Of the $138.7 million in non-cancelable operating leases, net of sublease income, $27.7 million has been included in accrued restructuring expenses as of April 30, 2002.

	Total		Less than 1 year		1-3 years		4-5 years		Over 5 years
	(in thousands; unaudited):
Long-term notes payable	$	2,410	$	72	$	192	$	192	$	1,954
Capital lease obligations		384		384		—		—		—
Non-cancelable operating leases, net of sublease income		138,732		10,655		26,512		26,312		75,253

	$	141,526	$	11,111	$	26,704	$	26,504	$	77,207

The following table summarizes our other commitments as of April 30, 2002 and the effect such commitments could have on our liquidity and cash flows in future periods if the letters of credit or the guarantees were drawn upon. Restricted investments represent the collateral for these commitments.

	Total		Less than 1 year		1-3 years		4-5 years		Over 5 years
	(in thousands; unaudited):
Letters of credit	$	12,830	$	—	$	—	$	256	$	12,574
Guarantees		1,528		1,528		—		—		—

	$	14,358	$	1,528	$	—	$	256	$	12,574

Our capital requirements depend on numerous factors, including market acceptance of our products, the resources we devote to developing, marketing, selling and supporting our products, our ability to sublease surplus facilities and other factors. Our expense levels for the first two quarters of fiscal year 2003 exceeded and our currently planned expense levels for the remaining fiscal quarters of fiscal year 2003 exceed the revenues we generated in the fourth quarter of fiscal year 2002. Although we believe that our current cash balances and cash generated from operations will be sufficient to fund our operations for at least the next 12 months, we may require additional financing within this time frame. We may seek financing at any time that we determine market conditions are favorable. Additional funding, if needed, may cause dilution to our stockholders or the incurrence of debt and such funding may not be available on terms acceptable to us, or at all.

RISKS ASSOCIATED WITH OUR BUSINESS AND FUTURE OPERATING RESULTS

Our future operating results may vary substantially from period to period. The price of our common stock will fluctuate in the future and an investment in our common stock is subject to a variety of risks, including but not limited to the specific risks identified below. Inevitably, some investors in our securities will experience gains while others will experience losses depending on the prices at which they purchase and sell securities. Prospective and existing investors are strongly urged to carefully consider the various cautionary statements and risks set forth in this report.

This report contains forward-looking statements that are not historical facts but rather are based on current expectations, estimates and projections about our business and industry, our beliefs and assumptions. Words such as “anticipates”, “expects”, “intends”, “plans”, “believes”, “seeks”, “estimates” and variations of these words and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. These risks and uncertainties include those described in this “Risks Associated With Portal’s Business and Future Operating Results” and elsewhere in this report. Forward-looking statements that were true at the time made may ultimately prove to be incorrect or false. Readers are cautioned not to place undue reliance on forward-looking statements, which reflect our management’s view only as of the date of this report. We undertake no obligation to update these statements or publicly release the results of any revisions to the forward-looking statements that we may make to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.

IT IS DIFFICULT TO PREDICT OUR BUSINESS BECAUSE WE HAVE A LIMITED HISTORY OPERATING AS A PROVIDER OF CUSTOMER MANAGEMENT AND BILLING SOFTWARE

Our results of operations for the quarter ended April 30, 2002 contained in this report are not necessarily indicative of results for our fiscal year ending January 31, 2003 or any other future period. In late 1993, we changed our strategic focus from operating as an Internet service provider to developing customer management and billing software for Internet-based businesses. Therefore, we have a relatively brief operating history as a provider of customer management and billing software and had no meaningful license revenue until 1996. Accordingly, we will experience the risks and difficulties frequently encountered by companies in new and rapidly evolving markets, including those discussed in this report. Our business strategy may not prove successful and we may not successfully address these risks.

WE EXPECT TO INCUR ADDITIONAL LOSSES AND CANNOT BE CERTAIN THAT WE WILL BE PROFITABLE

In order to be profitable, we must increase our revenues or reduce our expenses. We may not be able to increase or even maintain our revenues and we may not achieve sufficient revenues for profitability in any future period. We incurred net losses of approximately $395.5 million, $2.3 million and $7.6 million for fiscal year 2002, 2001 and 2000, respectively. We reported a net loss for the first two quarters of fiscal year 2003 and expect to experience a net loss for the third quarter of fiscal year 2003 and fiscal 2003. We recorded a substantial restructuring charge in the second, third and fourth quarters of fiscal year 2002 in connection with a reduction in force and other expense reduction efforts initiated during the year.

Our projected expenses for the third quarter of fiscal 2003 are targeted to exceed the amount of our anticipated second quarter revenues. As a result, if we do not generate increased revenues from sales of our products or reduce expenses, we will not be profitable. The decrease in capital expenditures by communications companies as well as the general economic slowdown has adversely affected our revenues and will make it difficult to increase revenues until spending in our target markets increases. We also expect that we will face increased competition that may make it more difficult to increase our revenues. Even if we are able to increase revenues, we may experience price competition which would lower our gross margins and our profitability. Another factor that would lower our gross margins is any increase in the percentage of our revenues that is derived from indirect channels and from services, both of which have lower margins. We have also undertaken a number of cost reduction efforts. Failure to achieve the desired reductions in our expenses will further increase our losses. We cannot be certain that we will again achieve operating or net profitability on a quarterly or annual basis.

OUR REVENUES WILL BE ADVERSELY AFFECTED AS A RESULT OF ECONOMIC CONDITIONS AND STOCK MARKET VALUATIONS AFFECTING OUR TARGET MARKETS

We primarily market our products and services to providers of communications and content services. The substantial number of business failures and the decline in the market value of “dot-com” and other technology companies in the past few years has made it more difficult for emerging communication and electronic content companies to obtain financing for their operations. Moreover, the market value, financial results and prospects of many large and established companies, including many large telecommunications companies, have also declined or degraded significantly. Emerging growth and established communications and content companies have continued to reduce or defer their purchases of software and related products and the introduction of many new communication services has been delayed or cancelled. Cancellation of existing or planned services also adversely impact potential professional service, maintenance and support revenues. Any general decrease by our customers and potential customers in their rate of software and network investments results in a significant decrease in our revenues and operating income. These trends in technology and software spending dramatically hurt our business in fiscal year 2002 and will continue to seriously harm our business until conditions improve.

The current economic and capital spending downturn affecting our markets has made it increasingly difficult for us to collect accounts receivable and increased the time required to collect them. A number of customers have ceased to operate or have become insolvent. Failure to collect accounts receivable in a timely manner has in the past and may continue to result in increased write-offs, higher accounts receivable reserves and lower cash reserves that would adversely affect our financial results and available cash resources.

OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE IN FUTURE PERIODS AND WE MAY FAIL TO MEET EXPECTATIONS

Our revenues and operating results may vary significantly from quarter to quarter due to a number of factors. For example, we achieved profitability in each of the first three quarters of fiscal year 2001 and reported net losses in the last seven quarters. In future quarters, our operating results may be below the expectations of one or more public market analysts and investors and the price of our common stock may fall. Failure by technology companies to meet or exceed analyst expectations or any resulting changes in analyst recommendations or ratings frequently results in substantial decreases in the market value of the stock of such companies. For example, the market value of our stock decreased significantly after the release of our financial results for the quarters ended October 31, 2000 and April 30, 2001. Factors that could cause quarterly fluctuations include:

•

variations in demand for our products and services, including decreases caused by reductions in technology spending within our target markets;

•

the timing and execution of individual contracts, particularly large contracts that would materially affect our operating results in a given quarter;

•

the timing of sales of our products and services;

•

our ability to develop and attain market acceptance of enhancements to Infranet and new products and services;

•

market acceptance of new communications services for which our products are intended to support;

•

delays in introducing new products and services;

•

new product introductions by competitors;

•

changes in our pricing policies or the pricing policies of our competitors;

•

announcements of new versions of products that cause customers to postpone purchases of our current products;

•

the mix of products and services sold;

•

the mix of sales channels through which our products and services are sold;

•

the mix of domestic and international sales;

•

costs related to acquisitions of technologies or businesses;

•

the timing of releases of new versions of third-party software and hardware products that work with our products;

•

our ability to attract, integrate, train, retain and motivate a substantial number of sales and marketing, research and development, technical support and other management personnel with the needed competencies;

•

our ability to expand our operations;

•

the amount and timing of expenditures related to expansion of our operations; and

•

global economic conditions generally, as well as those specific to providers of communications and content services.

We have difficulty predicting the volume and timing of orders for new license transactions. In any given quarter, our sales have involved, and we expect will continue to involve, large financial commitments from a relatively small number of customers. As a result, the cancellation or deferral of even a small number of licenses of Infranet would reduce our revenues, which would adversely affect our quarterly financial performance. Also, we have often booked a large amount of our sales in the last month of the quarter and often in the last week of that month. Accordingly, delays in the closing of sales near the end of a quarter could cause quarterly revenue to fall substantially short of anticipated levels. Furthermore, delays in the closing of license transactions may result in a consequential delay or loss of services revenues relating to the projects for which the software would be licensed.

We have recorded as deferred revenue the fees from contracts that do not meet our revenue recognition policy requirements. 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 that we enter into may not result in revenue in the quarter in which the contract is signed and we may not be able to predict accurately when revenues from these contracts will be recognized.

We determine our operating expenses largely on the basis of anticipated revenue trends and a high percentage of our expenses are fixed in the short and medium term. As a result, a failure or delay in generating or recognizing revenue could cause significant variations in our operating results from quarter-to-quarter and could result in substantial operating losses.

OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE IN FUTURE PERIODS DUE TO SEASONAL VARIATIONS AND WE MAY FAIL TO MEET EXPECTATIONS

We may also experience seasonality in our business. In many software companies, the rate of growth or absolute amount of license fee revenues tends to decline from the fourth quarter of one year to the first quarter of the next year, due in part to the structure of sales compensation plans. Our revenue in the first quarter of fiscal year 2002 and 2003 was significantly lower than the preceding fourth quarter. If we experience such seasonality in the future our rate of growth or absolute revenues could decline in the first quarter of a fiscal year compared to the preceding fourth quarter. In addition, the European operations of many companies experience some flatness in the summer months. We may also experience such a pattern in our European operations. Such seasonality may cause our results of operations to fluctuate or become more difficult to predict and could cause us to fail to meet internal or analyst expected financial results.

IT IS DIFFICULT TO PREDICT THE TIMING OF INDIVIDUAL ORDERS BECAUSE INFRANET HAS A LONG AND VARIABLE SALES CYCLE

To date, the sales cycle for Infranet generally has been three to nine months or more. The long sales and implementation cycles for Infranet may cause license revenues and operating results to vary significantly from period to period. Furthermore, the revenues derived from a sale may not be recognized immediately and could be spread over an extended period. Along with systems integrators and our other distribution partners, we spend significant time educating and providing information to our prospective customers regarding the use and benefits of Infranet. Even after purchase, our customers tend to deploy Infranet slowly and deliberately, depending on the specific technical capabilities of the customer, the size of the deployment, the complexity of the customer’s network environment and the quantity of hardware and the degree of hardware configuration necessary to deploy Infranet.

OUR BUSINESS DEPENDS ON THE COMMERCIAL ACCEPTANCE OF OUR PRODUCTS AND IT IS UNCERTAIN TO WHAT EXTENT THE MARKET WILL ACCEPT THEM

Our future growth depends on the commercial success of our Infranet family of products. Substantially all of our license fees revenues are derived from our Infranet product family. Our business will be harmed if our target customers do not adopt and purchase Infranet. Prospective customers may base their purchasing decisions based on a vendor’s ability to support their customer management and billing needs for both their new services and their other existing service offerings, such as fixed wire or mobile voice telephony or cable television. Our ability to address these current and future service requirements with our current version of Infranet and planned future enhancements may affect the market acceptance of Infranet by prospective customers who desire an integrated customer management and billing solution for their different services. Our future financial performance will also depend on the successful development, introduction and customer acceptance of new and enhanced versions of our products. We are not certain that our target customers will widely adopt and deploy Infranet as their customer management and billing solution. In the future we may not be successful in marketing Infranet or any new or enhanced products or services. Our future revenues will also depend on our customers licensing software for additional applications or for additional subscribers. Their failure to do so could harm our business.

Our customers deploy Infranet across a variety of computer hardware platforms and integrate it with a number of legacy systems, third-party software applications and programming tools. Customers frequently use professional services from Portal, third party system integrators or their own internal information technology organizations, or a combination thereof. Our ability to generate and increase our professional services revenues will depend in large part on the number of new license transactions and on our ability to gain a significant portion of the services associated with the implementation of Infranet-related projects. We are not certain that our target customers will widely adopt and use our professional services. In the future we may not be successful in marketing our services our failure to do so could harm our business.

The revenues we derive from our services business have a significantly lower margin than revenues derived from licensing Infranet. Accordingly, the mix of license revenues and service revenues in any period will affect our operating margins for that period. Failure to meet analyst expectations for operating margins and profitability could cause a decrease in the market value of our common stock.

OUR QUARTERLY REVENUE IS GENERATED FROM A LIMITED NUMBER OF CUSTOMERS AND OUR CUSTOMER BASE IS CONCENTRATED AND THE LOSS OF ONE OR MORE OF OUR CUSTOMERS COULD CAUSE OUR BUSINESS TO SUFFER

A substantial portion of our license and services revenues in any given quarter has been, and is expected to continue to be, generated from a limited number of customers with large financial commitments. For example, America Online accounted for more than 10% of our total revenues during each of the quarters of fiscal year 2002. As a result, if a large contract is cancelled or deferred or an anticipated contract does not materialize, our business would be harmed. Our total revenues could also be adversely affected if revenues from a significant customer in one period are not replaced with revenues from that customer or other customers in subsequent periods. For example, America Online did not account for 10% or more of our total revenues in the first quarter of fiscal year 2003 because they have completed payment of the license fees for their initial order. The communication and content industries we have targeted are consolidating, which could reduce the number of potential customers available to us. In addition, several large telecommunications companies have announced decreases in their anticipated capital spending, which could have the effect of reducing future orders of our products. Moreover, many of our customers may have purchased sufficient quantities of our products to satisfy their current or anticipated requirements. For all of these reasons our business could suffer in the future.

OUR INABILITY TO SUBLEASE SURPLUS OFFICE SPACE WOULD INCREASE OUR USE OF CASH AND OPERATING EXPENSES AND ADVERSELY EFFECT OPERATING RESULTS

We must periodically change our office facilities in various locations as the number of existing and projected employees changes for those locations or as existing leases expire. Securing and building out facilities takes significant lead time. Furthermore, because of the need to satisfy projected future expansion, the amount of space we have leased is generally more than the amount currently required. Significant office leases have terms of between 5 and 20 years. As a result, we frequently sublease the portions of leased facilities that we have leased to meet our future expansion plans but do not currently need. In addition, our reductions in our workforce undertaken over the past year have substantially reduced our facilities requirements in several locations. As a result, we are attempting to sublease the facilities that we have previously leased but do not currently need. Portal has leased approximately 73,120 square feet and 38,140 square feet for its regional headquarters facilities in Herndon, Virginia and Slough, United Kingdom, respectively, for terms of ten and twenty years, respectively. The amounts leased exceed our current requirements and we plan to sublease a majority of the facilities for a substantial portion, if not the entire balance, of the lease term. Moreover, we also plan to sublease a facility in Cupertino that Portal vacated earlier this year and that comprises approximately 93,200 square feet and is leased through December 2010. There is currently a large amount of vacant commercial real estate in the San Francisco Bay Area. Moreover, currently prevailing rental rates in many locations are lower than those that we are obligated to pay under the leases. We may therefore encounter significant difficulties or delays in subleasing such surplus space and may not be able to sublease it for rents equal to those that we are obligated to pay. To the extent that we are unable to sublease this and other surplus space at an amount equal to our rent obligations for that space or to the extent sublessees fail to perform their obligations to pay rent, we could incur greater operating expenses than we initially planned or included within accrued restructuring charges. Such increases in operating expenses in a period could cause us to exceed our planned expense levels and adversely affect our financial results for that period. Furthermore, inability to sublease such space may adversely affect our planned uses of cash and our capital resources. Moreover, we have reduced the amount of the facilities restructuring charges we accrued in fiscal year 2002 by the estimated amount of sublease income. The assumptions we have made are based on the current market conditions in the various areas we have vacant space. These market conditions can fluctuate greatly, thus causing our accrual to be inaccurate. If, in future periods, it is determined that we have over accrued for restructuring charges as related to the consolidation of facilities, the reversal of such over accrual would have a favorable impact on our financial statements in the period this was determined. Conversely, if it is determined that our accrual is insufficient, an additional charge would have an unfavorable impact on our financial statements in the period this was determined.

OUR BUSINESS WILL SUFFER DRAMATICALLY IF WE FAIL TO SUCCESSFULLY PLAN AND MANAGE CHANGES IN THE SIZE OF OUR OPERATIONS

Our ability to successfully offer our products and services in a rapidly evolving market requires an effective planning and management process. We have experienced rapid changes in our number of employees in recent years. On July 31, 2002, we had 705 employees compared to 1,478 employees on April 30, 2001 and 634 employees on January 31, 2000. These changes have placed, and our anticipated future operations will continue to place, a significant strain on our management resources and our ability to train and allocate sufficient personnel resources to achieve our many objectives. We expect that we will need to continue to improve our financial and managerial controls and reporting systems and procedures and will need to continue to expand, train and manage our worldwide work force. We expect that we will have to change our facilities in certain locations and we may face difficulties and significant expenses identifying and moving into suitable office space and subleasing or assigning any surplus space.

In addition, reduction in the number of employees can result in significant severance, administrative and legal expenses. Reductions in the number of personnel may also adversely affect, or delay, various sales, marketing and product development programs and activities. This may increase the potential likelihood of other risks, such as delays in product introductions. Our business will suffer dramatically if we fail to effectively manage changes in the size and scope of our operations.

WE MUST HIRE AND RETAIN QUALIFIED SALES PERSONNEL TO SELL OUR PRODUCTS

Our financial success and our ability to increase revenues in the future depend considerably upon the productivity of our direct sales force that has historically generated a majority of our license revenues. This productivity will depend to a large degree on our success in recruiting, training and retaining qualified direct salespeople. There is strong competition for direct sales personnel with the skills and expertise necessary to sell our products. Our business will be harmed if we fail to hire or retain qualified sales personnel, or if newly hired salespeople fail to develop the necessary sales skills or develop these skills more slowly than we anticipate.

WE ALSO USE SYSTEMS INTEGRATORS AND OTHER STRATEGIC RELATIONSHIPS TO IMPLEMENT AND SELL INFRANET

We have entered into relationships with third-party systems integrators, as well as with hardware platform and software applications developers and service providers. We have derived, and anticipate that we will continue to derive, a significant portion of our market opportunities and revenues from these relationships. We could lose sales opportunities if we fail to work effectively with these parties or fail to grow our base of market and platform partners. We may also be at a serious competitive disadvantage if we fail to maintain and enhance these indirect sales channels. Many of these partners also work with competing software companies and our success will depend on their willingness and ability to devote sufficient resources and efforts to marketing and resale of our products versus the products of others. We may not be able to enter into additional, or maintain our existing, strategic relationships on commercially reasonable terms, or at all. Our agreements with these parties typically are in the form of nonexclusive referral fee or reseller agreements that are effective for a limited period of time and may be renewed only by mutual agreement of both parties. Therefore, there is no guarantee that any single party will continue to market our products. If these relationships fail, we will have to devote substantially more resources to the distribution, sales and marketing, implementation and support of our products than we would otherwise which would substantially increase our costs, and our efforts may not be as effective as those of our partners, either of which would harm our business.

OUR SIGNIFICANT INTERNATIONAL OPERATIONS MAKE US MUCH MORE SUSCEPTIBLE TO RISKS FROM INTERNATIONAL OPERATIONS

For the quarters ended April 30, 2002 and 2001, we derived approximately 64% and 47% of our revenue, respectively, from sales outside North America. As a result, we face risks from doing business on an international basis, including, among others:

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reduced protection for intellectual property rights in some countries;

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licenses, tariffs and other trade barriers;

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fluctuations in the value of local currencies relative to the United States Dollar and greater difficulties in collecting accounts receivable;

•

difficulties in staffing and managing foreign operations;

•

longer sales and payment cycles;

•

political and economic instability;

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seasonal reductions in business activity;

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potentially adverse tax consequences;

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compliance with a wide variety of complex foreign laws and treaties; and

•

variance and unexpected changes in local laws and regulations.

We currently have offices in a number of foreign locations including Australia, Canada, China, France, Germany, Italy, Japan, Malaysia, Mexico, Poland, Singapore, Spain, South Korea, Sweden, Taiwan and the United Kingdom and may establish additional facilities in other parts of the world. Expansion of our existing international operations and entry into additional international markets will require significant management attention and financial resources. We cannot be certain that our investments in establishing facilities in other countries will produce desired levels of revenue. In addition, we have sold Infranet internationally for only a few years and we have limited experience in developing localized versions of Infranet and marketing and distributing them internationally.

To date we have typically denominated nearly all of our international license revenues in U.S. dollars. Therefore, a strengthening of the dollar versus other currencies could make our products less competitive in foreign markets or collection of receivables more difficult. Because our foreign denominated revenues have been minimal, we have not engage in currency hedging activities. Commencing in fiscal year 2003, we plan to denominate a larger number of international transactions in euros and certain other currencies (see also “Impact of Foreign Currency Rate Changes” in Item 3 below). In such event, we will face greater 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. In order to reduce the effect of foreign currency fluctuations, we may hedge our exposure on certain transactional balances that are denominated in foreign currencies through the use of foreign currency forward exchange contracts. Failure to effectively hedge foreign currency fluctuations would adversely affect our financial results.

To the extent that we are unable to successfully manage our international business due to any of the foregoing factors, our business could be adversely affected.

OUR PROPRIETARY RIGHTS MAY BE INADEQUATELY PROTECTED AND THERE IS A RISK OF INFRINGEMENT

Our success and ability to compete depend substantially upon our internally developed technology, which we protect through a combination of patent, copyright, trade secret and trademark law. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology or to develop products with the same functionality as our products. Policing unauthorized use of our products is difficult and we cannot be certain that the steps we have taken will prevent misappropriation of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. Others may develop technologies that are similar or superior to our technology. Moreover, as the functionality of products in different industry segments overlaps, we expect that our software products may in the future become subject to third-party infringement claims. Some of our competitors in the market for customer management and billing software may have filed or may intend to file patent applications covering aspects of their technology upon which they may claim our technology infringes. Any litigation, brought by us or by others, could be time-consuming and costly and could divert the attention of our technical and management personnel. In addition, litigation could cause product shipment delays or require us to develop non-infringing technology or enter

into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on acceptable terms, or at all, and could have a material and adverse impact on our gross margins and profitability. If a successful claim of product infringement were made against us, our business could be significantly harmed.

OUR BUSINESS WILL SUFFER IF OUR SOFTWARE CONTAINS SIGNIFICANT ERRORS OR OUR PRODUCT DEVELOPMENT IS DELAYED

We face possible claims and higher costs as a result of the complexity of our products and the potential for undetected errors. Due to the “mission critical” nature of Infranet, undetected errors are of particular concern. Complex software, such as ours, always contains undetected errors. The implementation of Infranet, which we accomplish through our services division and with our partners, typically involves working with sophisticated software, computing and communications systems. If we experience difficulties with an implementation or do not meet project milestones in a timely manner, we could be obligated to devote more customer support, engineering and other resources to a particular project and to provide these services at reduced or no cost. If our software contains significant undetected errors or we fail to meet our customers’ expectations or project milestones in a timely manner we could experience:

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loss of or delay in revenues and loss of market share;

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loss of customers;

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failure to achieve market acceptance;

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diversion of development and implementation resources;

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injury to our reputation;

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increased service and warranty costs;

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legal actions by customers against us; and

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increased insurance costs.

Our licenses with customers generally contain provisions designed to limit our exposure to potential product liability claims, such as disclaimers of warranties and limitations on liability for special, consequential and incidental damages. In addition, our license agreements generally cap the amounts recoverable for damages to the amounts paid by the licensee to us for the product or service giving rise to the damages. However, these contractual limitations on liability may not be enforceable, in certain jurisdictions and under certain circumstances, and we may be subject to claims based on errors in our software or mistakes in performing our services including claims relating to damages to our customers’ internal systems. A product liability claim, whether or not successful, could harm our business by increasing our costs, damaging our reputation and distracting our management.

IF WE FAIL TO RELEASE PRODUCTS ON TIME, OUR BUSINESS WILL SUFFER

In the past we have failed to release certain new products and upgrades on time. These delays may result in:

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customer dissatisfaction;

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cancellation of orders and license agreements;

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negative publicity;

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loss of revenues;

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slower market acceptance; or

•

legal action by customers against us.

Our business may be harmed if we are unable to develop, license or acquire new products or enhancements to Infranet on a timely and cost-effective basis, or if these products or enhancements are not accepted by the market.

WE INCORPORATE SOFTWARE LICENSED FROM THIRD PARTIES INTO INFRANET AND ANY SIGNIFICANT INTERRUPTION IN THE AVAILABILITY OF THESE THIRD-PARTY SOFTWARE PRODUCTS OR DEFECTS IN THESE PRODUCTS COULD HARM OUR BUSINESS IN THE SHORT-TERM

Portions of Infranet incorporate software developed and maintained by third-party software vendors, such as operating systems, tools and database vendors. We expect that we may have to incorporate software from third party vendors and developers to a larger degree in our future products. Any significant interruption in the availability of these third-party software products or defects in these products or future products could harm our sales unless and until we can secure another source. We may not be able to replace the functionality provided by the third-party software currently offered with our products if that software becomes obsolete, defective or incompatible with future versions of our products or is not adequately maintained or updated. The absence of, or any significant delay in, the replacement of that functionality could result in delayed or lost sales and increased costs and could harm our business in the short-term.

OUR FUTURE SUCCESS WILL DEPEND ON OUR ABILITY TO MANAGE TECHNOLOGICAL CHANGE

The market for our products and the services they are used to support is characterized by:

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rapid technological change;

•

frequent new product introductions;

•

changes in customer requirements; and

•

evolving industry standards.

Future versions of hardware and software platforms embodying new technologies and the emergence of new industry standards could render our products obsolete. Our future success will depend upon our ability to develop and introduce a variety of new products and product enhancements to address the increasingly sophisticated needs of our customers.

Infranet is designed to work on a variety of hardware and software platforms used by our customers. However, Infranet may not operate correctly on evolving versions of hardware and software platforms, programming languages, database environments, accounting and other systems that our customers use. We must constantly modify and improve our products to keep pace with changes made to these platforms and to back-office applications and other systems. This may result in uncertainty relating to the timing and nature of new product announcements, introductions or modifications, which may harm our business. If we fail to modify or improve our products in response to evolving industry standards, our products could rapidly become obsolete, which would harm our business.

THE MARKETS IN WHICH WE SELL OUR PRODUCT ARE HIGHLY COMPETITIVE AND WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY

We compete in markets that are intensely competitive and rapidly changing. We face competition from providers of customer management and billing software, such as Amdocs Ltd., Convergys Corporation (which has acquired Geneva Technology Ltd.), CSG Systems International, Inc. and ADC Telecommunications, Inc. We also compete with systems integrators and with internal information technology departments of larger communications providers. Many of our current and future competitors have significantly more personnel and greater financial, technical, marketing and other resources than us. We are aware of other companies that are focusing significant resources on developing and marketing products and services that will compete with us. Furthermore, in recent years a number of our competitors have been acquired by companies larger than us who have sought to expand their CM&B solutions capabilities. The failure of Portal to develop and market products and services that compete successfully with those of other suppliers in the market would harm our business. Portal anticipates that the market for its products and services will remain intensely competitive.

Our competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements than we can. Also, current and potential competitors have greater name recognition and more extensive customer bases that they can use to compete more effectively. Increased competition could result in price reductions, fewer customer orders, reduced gross margins and loss of market share, any of which could harm our business.

OUR BUSINESS SUBSTANTIALLY DEPENDS UPON THE CONTINUED GROWTH OF COMMUNICATION AND CONTENT SERVICES

We sell our products to organizations providing new and emerging communications and content services provided over a variety of communication networks including Internet, fixed line, wireless and satellite networks. Consequently, our future revenues and profits, if any, substantially depend upon the market acceptance and expanded use of services provided through the Internet and other communication methods. Rapid growth in the use of these services is a recent phenomenon and it may not continue. As a result, a broad base of regular users of such services may not develop and the market may not accept recently introduced services and products that rely upon the adoption of such services, such as Infranet.

Many of the companies that are marketing broadband access to the Internet or are offering new services over the Internet, wireless networks and other communication mediums are relatively new businesses. In the past two years, many so called “dot.com” companies have failed and financing for emerging Internet businesses has been increasingly more difficult to obtain. We believe that the decline experienced in our North American operations since the third quarter of fiscal year 2001 is attributable in part to the difficulty experienced by several potential customers in receiving financing and a consequential impact on their decisions to make investments in customer management and billing products and services. Moreover, the market value, financial results and prospects of many large and established companies, including many large telecommunications companies, have also declined or degraded significantly. Emerging growth and established communications companies recently have been reducing or deferring their purchases of software and related products and the introduction of many new communication services has been delayed or cancelled. This trend in technology and software spending has hurt and will continue to seriously harm our business until conditions improve. Any general decrease by our customers and potential customers in their rate of software and network investments would result in a significant decrease in our revenues and operating income. To the extent that our customers and potential customers fail to achieve sustained profitability or obtain adequate funding, we could experience greater risk and difficulty collecting receivables from those customers that do purchase our products and services which would in turn harm our business and financial results.

FUTURE REGULATION OF THE INTERNET OR NEXT GENERATION COMMUNICATION SERVICES MAY SLOW THEIR GROWTH, RESULTING IN DECREASED DEMAND FOR OUR PRODUCTS AND SERVICES AND INCREASED COSTS OF DOING BUSINESS

It is possible that state and federal regulators could adopt laws and regulations that may impose additional burdens on those companies providing communications and content services. The growth and development of new services may prompt calls for more stringent consumer protection laws or for imposition of additional taxes. The adoption of any additional laws or regulations affecting communication services may slow their adoption or impose additional burdens on those companies providing such services. A decline in the growth of next generation communication services could decrease demand for our products and services and increase our cost of doing business, or otherwise harm our business.

OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO ATTRACT AND RETAIN QUALIFIED PERSONNEL

Despite overall reductions in our total headcount, we will continue to hire sales, support, marketing, administrative and research and development personnel in fiscal year 2003 and beyond. Competition for these individuals is intense and we may not be able to attract, assimilate or retain highly qualified personnel in the future. Our business cannot succeed if we cannot attract qualified personnel. Our future success also depends upon the continued service of our executive officers and other key sales, marketing and support personnel in general.

WE ARE CURRENTLY A PARTY TO SECURITIES LITIGATION CLASS ACTION LAWSUITS WHICH, IF DETERMINED ADVERSELY, COULD NEGATIVELY AFFECT OUR BUSINESS AND RESULTS OF OPERATIONS

On July 9, 2001, a purported class action complaint was filed in the Federal District Court Southern District of New York against Portal, certain of its officers and several underwriters of the Company’s initial public offering (“IPO”). The lawsuit alleges violations of Section 11 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934, arising from alleged improprieties by the underwriters in connection with our 1999 IPO and follow-on public offering, and claims to be on behalf of all persons who purchased shares from May 5, 1999 through December 6, 2000. Four additional nearly identical class actions were also filed in July and August 2001 based on essentially the same facts and allegations. Specifically, the complaints allege the underwriters charged some of their customers fees in excess of those disclosed in the prospectus and engaged in allegedly improper activities in connection with the distribution of the IPO shares. The complaint was subsequently amended to allege similar claims with respect to our secondary public offering in September 1999.

The cases have been consolidated into a single action, and a consolidated complaint was filed on April 19, 2002. These actions are part of the IPO Securities Litigation against over 300 issuers and nearly 40 underwriters alleging claims virtually identical to those alleged against us. The action seeks damages in an unspecified amount. A motion to dismiss addressing issues common to the companies and individuals who have been sued in these actions was filed on July 15, 2002.

An unfavorable resolution of these matters could materially affect our future results of operations or cash flows in a particular period. In addition, the litigation has been, and may continue to be, time-consuming and costly and could divert the attention of our management personnel.

ACQUISITIONS OF ADDITIONAL COMPANIES OR TECHNOLOGIES MAY RESULT IN FURTHER DISRUPTIONS TO OUR BUSINESS AND MANAGEMENT DUE TO DIFFICULTIES IN ASSIMILATING PERSONNEL AND OPERATIONS

We may make additional acquisitions or investments in other companies, products or technologies in the future. If we make any acquisitions, we will be required to assimilate the operations, products and personnel of the acquired businesses and train, retain and motivate key personnel from the acquired businesses. We may be unable to maintain uniform standards, controls, procedures and policies if we fail in these efforts. Similarly, acquisitions may cause disruptions in our operations and divert management’s attention from day-to-day operations, which could impair our relationships with our current employees, customers and strategic partners. The issuance of equity securities for any acquisition could be substantially dilutive to our stockholders. In addition, our profitability may suffer because of acquisition-related costs or amortization costs for acquired goodwill and other intangible assets.

FINANCIAL DIFFICULTIES OF COMPANIES WE HAVE INVESTED IN COULD ADVERSELY AFFECT OUR FINANCIAL RESULTS

We have made investments in three companies and may make investments in others in the future. If at any time our investment in a company were deemed impaired, we may be required to reduce the book value of that investment, which would in turn reduce our earnings in that period. Such investments could be deemed impaired, for example, if the financial condition of those companies deteriorates. As of April 30, 2002 and 2001, respectively, we had approximately $1.5 million (total investment of $2.0 million net of a valuation allowance of $0.5 million) and $5.8 million (total investment of $6.0 million net of a valuation allowance of $0.2 million) invested in other companies. During fiscal 2002, we recorded a write-down of $4.0 million related to other than temporary impairment of these investments. Because the financial condition of these companies is outside our control, we cannot predict if, or when, the value of such investments would be required to be reduced.

THE PRICE OF OUR COMMON STOCK HAS BEEN AND WILL BE VOLATILE

The trading price of our common stock has fluctuated significantly in the past and will continue to fluctuate in the future. For example the price of our common stock through April 30, 2002 has fluctuated between $83.93 and

$0.76 per share. Future fluctuation could be a result of a number of factors, many of which are outside our control. Some of these factors include:

•

quarter-to-quarter variations in our operating results;

•

failure to meet the expectations of industry analysts;

•

changes in earnings estimates by us or by analysts;

•

general conditions in the communications and content service industries;

•

announcements and technological innovations or new products by us or our competitors;

•

increased price competition; and

•

developments or disputes concerning intellectual property rights.

In addition, the stock market has experienced extreme price and volume fluctuations, which have particularly affected the market prices of many Internet and computer software companies, including ours, and which have often been unrelated to the operating performance of these companies or our company. Decreases in the trading prices of stocks of technology companies are often precipitous. For example, the price of our stock dropped rapidly and significantly during the first quarter of fiscal year 2001, during the fourth quarter of fiscal year 2001 and during the first quarter of fiscal year 2002.

IF THE MARKET FOR OUR PRODUCTS DOES NOT IMPROVE, WE MAY BE FORCED TO INCUR RESTRUCTURING CHARGES IN ADDITION TO THE $71 MILLION CHARGE WE INCURRED IN THE FISCAL YEAR ENDED JANUARY 31, 2002

During the fiscal year ended January 31, 2002, we incurred charges of $41.3 million, $19.3 million and $10.4 million for the fiscal quarters ended July 31, 2001, October 31, 2001 and January 31, 2002, respectively, in connection with restructuring plans implemented to reduce our cost structure. These restructuring plans were implemented in response to the continued global deferral of capital expenditures by telecommunications companies, as well as the general downturn in the economy. If the deterioration in the telecommunications and Internet industries continues and capital expenditures continue to be deferred or our business otherwise continues to suffer, we may be forced to implement additional restructuring plans to further reduce our cost structure and incur additional restructuring charges. Any additional restructuring charges would have a material adverse effect on our financial results.

THE ADDITIONAL IMPAIRMENT OF INTANGIBLE ASSETS FROM OUR ACQUISITION OF SOLUTION42 AND BAYGATE AND OTHER ACQUISITIONS AND INVESTMENTS WOULD REQUIRE US TO INCUR CHARGES RELATED TO THE IMPAIRMENT OF GOODWILL AND DEVELOPED TECHNOLOGY

During the fiscal year ended January 31, 2002, we recorded charges of $199.2 million in connection with the impairment of goodwill and developed technology related to our acquisitions of Solution42 and BayGate. During the fiscal year ended January 31, 2002, we identified indications of impairment of the intangible assets arising from these acquisitions, including the deterioration of the business climate and the prospects and our intentions for Solution42 and BayGate as wholly-owned subsidiaries. If the indications of impairment continue, we could be forced to write-down some or all of the $7.3 million of remaining developed technology from the Solution42 acquisition and, potentially, goodwill and developed technology from future acquisitions, which would have a material adverse effect on our financial condition and results of operations.

ANTI-TAKEOVER PROVISIONS IN OUR CHARTER DOCUMENTS, STOCKHOLDER RIGHTS PLAN AND IN DELAWARE LAW COULD PREVENT OR DELAY A CHANGE IN CONTROL AND, AS A RESULT, NEGATIVELY IMPACT OUR STOCKHOLDERS

We have taken a number of actions that could have the effect of discouraging a takeover attempt. For example, we have adopted a stockholder rights plan that would cause substantial dilution to a stockholder, and substantially increase the cost paid by a stockholder, who attempts to acquire us on terms not approved by our board of directors. This could prevent us from being acquired or reduce the price paid by any potential acquirer. In addition, our certificate of incorporation grants the board of directors the authority to fix the rights, preferences and privileges of and issue up to 4,000,000 shares of preferred stock without stockholder action. Although we have no present intention to issue shares of preferred stock, such an issuance could have the effect of making it more difficult and less attractive for a third party to acquire a majority of our outstanding voting stock. Preferred stock may also have other rights, including economic rights senior to our common stock that could have a material adverse effect on the market value of our common stock. In addition, we are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law. This section provides that except in certain limited circumstances a corporation shall not engage in any business combination with any interested stockholder during the three-year period following the time that such stockholder becomes an interested stockholder. This provision could have the effect of delaying or preventing a change of control of Portal.

WE RECEIVED A LETTER FROM NASDAQ STATING THAT IF WE ARE UNABLE TO COMPLY WITH THE MINIMUM BID PRICE OF $1.00, OUR COMMON STOCK WILL BE DELISTED

We received a letter dated August 6, 2002, from the staff of the Nasdaq Stock Market, or Nasdaq, which notified us that the bid price for our common stock had been below $1.00 per share for a period of thirty consecutive days. Nasdaq advised us that we would be given a period of ninety days within which to comply with the minimum bid price requirement in order to maintain the listing of our common stock on the Nasdaq National Market. If we are unable to demonstrate compliance with the minimum bid requirement for ten consecutive days on or before November 4, 2002, Nasdaq will provide us with written notification that our common stock will be delisted. At that time we may appeal the staff’s decision to a Nasdaq Listing Qualification Panel. In the alternative, we may apply to transfer our securities to the Nasdaq SmallCap Market. If we submit a transfer application and pay the applicable listing fees by November 4, 20002, initiation of de-listing proceedings will be stayed pending Nasdaq’s review of our transfer application. If the transfer application is approved, we will have a 180 day grace period ending on February 3, 2003 from meeting the Nasdaq SmallCap listing requirements and will be eligible for an additional 180 day grace period if we meet the initial listing requirements for the Nasdaq SmallCap Market. We intend to pursue all available options to meet the Nasdaq listing requirements. If our common stock is delisted from the Nasdaq National Market, sales of our common stock would likely be conducted on the SmallCap Market or in the over-the-counter market or potentially in regional exchanges. This may have a negative impact on the liquidity and price of our common stock and investors may find it more difficult to purchase or dispose of, or to obtain accurate quotations as to the market value of, our common stock. See Item 5 below.

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The following discussion about Portal’s 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 “Management’s Discussion And Analysis Of Financial Condition And Results Of Operations — Risks Associated With Portal’s Business And Future Operating Results.”

Short-Term Investment Portfolio

We do not hold derivative financial instruments in our short-term investment portfolio. Our short-term investments consist of instruments rated the equivalent of Standard & Poor’s and Moody’s short-term rating A1/P1 or long-term rating of at least A/A2. This policy dictates that we diversify our holdings and limit our short-term investments to a maximum of $5 million to any one issuer. Our policy also dictates that all short-term investments mature in 24 months or less.

The following table presents the amounts of cash equivalents and investments that are subject to market risk and the weighted average interest rates, by year of expected maturity for Portals’ investment portfolios as of April 30, 2002. This table does not include cash because cash is not subject to market risk. It also does not include long-term investments as they are held to maturity and, therefore, near-term changes in market rates will not result in losses. (In thousands, except weighted average yields):

	Maturing Within 1 Year			Maturing Within 2 Years			Thereafter		Total
Cash Equivalents	$	5,668		$	—		$	—	$	5,668
Weighted Average Yield		1.75	%		—			—		1.75	%
Investments		55,788			20,129			—		75,917
Weighted Average Yield		3.41	%		3.24	%		—		3.36	%

Total Portfolio	$	61,456		$	20,129		$	—	$	81,585

Weighted Average Yield		3.25	%		3.24	%		—		3.25	%

Impact of Foreign Currency Rate Changes

During fiscal year 2002, most local currencies of our international subsidiaries weakened against the U.S. dollar. Because we translate foreign currencies into U.S. dollars for reporting purposes, currency fluctuations can have an impact, though generally immaterial, on our results. We believe that our exposure to currency exchange fluctuation risk has been insignificant primarily due to the denomination of nearly all of our sales transactions in U.S. dollars. For the quarter ended April 30, 2002, there was a $0.4 million currency exchange impact from our intercompany transactions. To date, we have not engaged in foreign currency hedging.

As a global concern, we anticipate that our sales outside the United States will increasingly be denominated in other currencies. In such event, we will 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.

PART II: OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

On July 9, 2001, a purported class action complaint was filed in the Federal District Court Southern District of New York against Portal, certain of its officers and several underwriters of Portal’s initial public offering (“IPO”). The lawsuit alleges violations of Section 11 of the Securities Act of 1933, as amended and Section 10(b) of the Securities Exchange Act of 1934, as amended, arising from alleged improprieties by the underwriters in connection with our 1999 IPO and follow-on public offering, and claims to be on behalf of all persons who purchased Portal Software shares from May 5, 1999 through December 6, 2000. Four additional nearly identical class actions were also filed in July and August 2001 based on essentially the same facts and allegations. Specifically, the complaints allege that the underwriters charged certain of their customers fees in excess of those disclosed in the prospectus and engaged in certain allegedly improper activities in connection with the distribution of the IPO shares. The complaint was subsequently amended to allege similar claims with respect our secondary public offering in September 1999.

The cases have been consolidated into a single action, and a consolidated complaint was filed on April 19, 2002. These actions are part of the IPO Securities Litigation against over 300 issuers and nearly 40 underwriters alleging claims virtually identical to those alleged against Portal. The action seeks damages in an unspecified amount. A motion to dismiss addressing issues common to the companies and individuals who have been sued in these actions was filed on July 15, 2002.

ITEM 5. REQUIREMENTS FOR CONTINUED LISTING ON THE NASDAQ NATIONAL MARKET

Our common stock must gain and then maintain a minimum bid price of $1.00 per share in order to remain eligible for continued listing on the Nasdaq National Market. We received a letter dated August 6, 2002, from the staff of Nasdaq which notified us that the bid price for our common stock had been below $1.00 per share for a period of thirty consecutive days. Nasdaq advised us that we would be given a period of ninety days within which to comply with the minimum bid price requirement for at least ten consecutive trading days in order to maintain listing on the Nasdaq National Market.

If we are unable to comply with the minimum bid requirement on or before November 4, 2002, Nasdaq will provide us with written notification that our common stock will be delisted. At that time we may appeal Nasdaq’s decision to a Nasdaq Listing Qualification Panel. In the alternative, we may apply to transfer our securities to the Nasdaq SmallCap Market. If we submit a transfer application and pay the applicable listing fees by November 4, 20002, initiation of delisting proceedings will be stayed pending Nasdaq’s review of our transfer application. If the transfer application is approved, we will have a 180 day grace period ending on February 3, 2003 from meeting the Nasdaq SmallCap listing requirements and will be eligible for an additional 180 day grace period if we meet the initial listing requirements for the Nasdaq SmallCap Market. We intend to pursue all available options to meet the Nasdaq listing requirements.

In addition to the $1.00 minimum bid price per share requirement described above, we must also comply with the other quantitative and qualitative requirements set forth in the Nasdaq National Market Listing Requirements in order to maintain the listing of our common stock on the Nasdaq National Market. In particular, companies currently included in the Nasdaq National Market meet each of the following standards:

1. Net tangible assets of at least $4,000,000 (until November 1, 2002) or at least $10,000,000 in stockholders’ equity;

2. a public float of at least 750,000 shares;

3. a market value of public float of at least $5,000,000;

4. a minimum bid price of $1 per share;

5. at least 400 round lot shareholders;

6. at least two market makers; and

7. compliance with Nasdaq corporate governance rules.

In the event we are unable to satisfy the requirements for continued listing on the Nasdaq National Market, we may not be able to satisfy the requirements for listing on the Nasdaq SmallCap Market on an ongoing basis. The requirements for continued listing on the Nasdaq SmallCap Market are listed below:

1. either (a) net tangible assets of at least $2,000,000 (until November 1, 2002) or at least $2,500,000 in stockholders’ equity, (b) net income in two of the last three years of at least $500,000, or (c) a market capitalization of at least $35,000,000;

2. a public float of at least 500,000 shares;

3. a market value of public float of at least $1,000,000;

4. a minimum bid price of $1.00 per share;

5. at least two market makers;

6. at least 300 round lot shareholders; and

7. compliance with Nasdaq corporate governance rules.

We believe that maintaining the listing of our common stock on the Nasdaq National Market is in our best interest and in the best interest of our stockholders. Inclusion in the Nasdaq National Market increases liquidity and may potentially minimize the spread between the “bid” and “asked” prices quoted by market makers. Further, a Nasdaq National Market listing may enhance our access to capital and increase our flexibility in responding to anticipated capital requirements. We believe that prospective investors will view an investment in our common stock more favorably if our shares qualify for listing on the Nasdaq National Market.

We also believe that the current per share price level of our common stock has reduced the effective marketability of our shares of common stock because of the reluctance of many leading brokerage firms to recommend low-priced stock to their clients. Certain investors view low-priced stock as speculative and unattractive. In addition, a variety of brokerage house policies and practices tend to discourage individual brokers within those firms from dealing in low-priced stock. Such policies and practices pertain to the payment of brokers commissions and to time-consuming procedures that make the handling of low-priced stocks unattractive to brokers from an economic standpoint.

In addition, because brokerage commissions on low-priced stock generally represent a higher percentage of the stock price than commissions on higher-priced stock, the current share price of the common stock can result in individual stockholders paying transaction costs (commissions, markups or markdowns) that represent a higher percentage of their total share value than would be the case if the share price were substantially higher. This factor also may limit the willingness of institutions to purchase our common stock at its current low share price.

In addition, if our common stock is not listed on the Nasdaq National Market and the trading price of our common stock were to remain below $1.00 per share, trading in our common stock would also be subject to certain rules promulgated under the Exchange Act which require additional disclosures by broker-dealers in connection with any trades involving a stock defined as a “penny stock” (generally, a non-Nasdaq equity security that has a market price of less than $5.00 per share, subject to certain exceptions). In such event, the additional burdens imposed upon broker-dealers to effect transactions in our common stock could further limit the market liquidity of our common stock and the ability of investors to trade our common stock.

If our common stock is delisted from the Nasdaq National Market, we may not qualify for listing on the Nasdaq SmallCap Market. In such an event, sales of our common stock would likely be conducted only in the over-the-counter market or potentially in regional exchanges. This may have a negative impact on the liquidity and price of our common stock and investors may find it more difficult to purchase or dispose of, or to obtain accurate quotations as to the market value of, our common stock. Furthermore, if our common stock is not listed on the Nasdaq National Market, we will not be eligible for certain exemptions from the various state securities or “blue sky” laws, which would make it more difficult for us to raise capital through issuances of securities.

ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits:

3.6 (2)

Certificate of Designation for Series A Junior Participating Preferred Stock (included in exhibit 4.4 below)

4.4 (2)

Rights Agreement, dated as of August 16, 2002 between the Company and Equiserve, which includes the form of Certificate of Designation for Series A Junior Participating Preferred Stock as Exhibit A, the form of Right Certificate as Exhibit B and the Summary of Rights to Purchase Series A Preferred Stock as Exhibit C.

20 (1)

Report on Form 8-K dated July 16, 2002

99.1

Periodic Report Certification of the Chief Executive Officer and Chief Financial Officer

(b) Reports on Form 8-K:

On July 16, 2002 Portal filed a Form 8-K which discloses the transitional provisions as required upon adoption of FAS 142 in its entirety.

On July 31, 2002 Portal filed a report on Form 8-K which discussed the acquisition of Solution42. This was filed to incorporate by reference required information in the Registration Statement on Form S-3, as amended on August 7, 2002.

On August 20, 2002, Portal filed a report on Form 8-K which disclosed that on August 16, 2002, Portal’s Board of Directors adopted a Stockholder Rights Plan designed to deter coercive takeover tactics.

(1)

Incorporated herein by reference from Current Report on Form 8-K (No. 000-25829).

(2)

Incorporated herein by reference from Current Report on Form 8-K, filed on August 20, 2002.

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.

August 27, 2002

PORTAL SOFTWARE, INC.

By:		/S/ HOWARD A. BAIN III
		Howard A. Bain III Chief Financial Officer (On behalf of the Registrant and as the Principal Financial Officer)



By:		/s/ BRET L. ENGLAND
		Bret L. England Vice President of Finance (Principal Accounting Officer)

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