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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE: (949) 719-2200

          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.

          Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)

          As of April 30, 2003, 46,279,170 shares, $0.001 par value per share, of the registrant’s common stock were outstanding.

THE TRIZETTO GROUP, INC.
QUARTERLY REPORT ON
FORM 10-Q

For the Three Months Ended March 31, 2003

TABLE OF CONTENTS

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PART I—FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

THE TRIZETTO GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)

See Notes to Unaudited Condensed Consolidated Financial Statements

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THE TRIZETTO GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)

See Notes to Unaudited Condensed Consolidated Financial Statements

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THE TRIZETTO GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

See Notes to Unaudited Condensed Consolidated Financial Statements

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THE TRIZETTO GROUP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.     BASIS OF PREPARATION

          The accompanying unaudited condensed consolidated financial statements have been prepared by The TriZetto Group, Inc. (the “Company”) in accordance with generally accepted accounting principles for interim financial information that are consistent in all material respects with those applied in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002 and pursuant to the instructions to Form 10-Q and Article 10 promulgated by Regulation S-X of the Securities and Exchange Commission (the “SEC”). Accordingly, they do not include all of the information and notes to financial statements required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003, or for any future period. The financial statements and notes should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K as filed with the SEC on March 31, 2003.

2.       RECLASSIFICATIONS

          Certain reclassifications, none of which affected net loss, have been made to prior year amounts to conform to current year presentation.

3.     COMPUTATION OF NET LOSS PER SHARE

          Basic earnings per share (“EPS”) is computed by dividing net loss by the weighted average number of common shares outstanding for the period. Common shares issued in connection with business combinations, that are held in escrow, are excluded from the computations of basic EPS until the shares are released from escrow. Diluted EPS reflects the potential dilution that could occur from common shares issuable through stock options, warrants, shares held in escrow, and other convertible securities. The following is a reconciliation of the numerator (net loss) and the denominator (number of shares) used in the basic and diluted EPS calculations (in thousands, except per share data):

4.     STOCK-BASED COMPENSATION

          At March 31, 2003, the Company has two stock option compensation plans. The Company accounts for these plans under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and related Interpretations. Stock-based employee compensation costs of $138,000 and $253,000 for the three months ended March 31, 2003 and 2002, respectively, are reflected in net loss, net of related tax effect, as a result of the amortization of deferred stock compensation recorded in 2000 and prior representing the difference between the exercise price and estimated fair value of the Company’s common stock on date of grant. The following table illustrates the effect on net loss and net loss per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, “Accounting for Stock-Based Compensation”, to stock-based employee compensation (in thousands, except per share data):

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Such pro forma disclosures may not be representative of future pro forma compensation cost because options vest over several years and additional grants are anticipated to be made each year.

5.     SUPPLEMENTAL CASH FLOW DISCLOSURES

6.     REVOLVING CREDIT NOTE AND LOAN AND SECURITY AGREEMENT AND SECURED TERM NOTE

REVOLVING CREDIT NOTE AND LOAN AND SECURITY AGREEMENT

          In September 2000, the Company entered into a Loan and Security Agreement and Revolving Credit Note with a lending institution providing for a revolving credit facility in the maximum principal amount of $15.0 million. The revolving credit facility is secured by all of the Company’s receivables. In December 2002, the Loan and Security Agreement and Revolving Credit Note were further amended to provide for the maximum principal amount of $20.0 million and an expiration date of December 2004. Borrowings under the revolving credit facility are limited to and shall not exceed 85% of qualified accounts, as defined in the Loan and Security Agreement. The Company has the option to pay interest at prime plus 1% or a fixed rate per annum equal to LIBOR plus 3.25% payable in arrears on the first business day of each month. In addition, there is a monthly 0.0333% usage fee to the extent by which the maximum loan amount exceeds the average amount of the principal balance of the Revolving Loans during the preceding month. The usage fee is payable in arrears on the first business day of each successive calendar month. The revolving credit facility contains covenants to which the Company must adhere during the terms of the agreement. These covenants require the Company to maintain tangible net worth, as defined in the Loan and Security Agreement, of at least $50.0 million, to generate recurring revenue and net earnings before interest, taxes, depreciation and amortization equal to at least 70% of the amount set forth in the Company’s operating plan, and to maintain a minimum cash balance of $35.0 million. In addition, these covenants prohibit the Company from paying any cash dividend, distributions and management fees as defined in the agreement and from incurring capital expenditures in excess of 120% of the amount set forth in the Company’s operating plan during any consecutive 6-month period. As of March 31, 2003, the Company had outstanding borrowings on the Revolving Credit facility of $5.5 million, and was in compliance with all of its debt covenants.

SECURED TERM NOTE

          In September 2001, the Company executed a $6.0 million Secured Term Note facility with the same lending institution that is providing the revolving credit facility. Monthly principal payments of $200,000 were due under the note on the first of each month. Additionally, the note bore interest at prime plus 1% and was payable monthly in arrears. In December 2002, the Secured Term Note was amended to increase the total principal amount to $15.0 million. The Company has the option to pay interest at prime plus 1% or a fixed rate per annum equal to LIBOR plus 3.25%, payable in arrears on the first business day of each quarter. The first principal payment of $1.875 million is due in June 2003, with subsequent quarterly payments of $1.875 million due on the last day of each calendar quarter through September 2004. The note matures in December 2004, at which time the final payment of $3.75 million will be due. The Secured Term Note contains the same covenants set forth in the revolving credit

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facility documents. As of March 31, 2003, the Company had outstanding borrowings on the Secured Term Note of $15.0 million and was in compliance with all of its debt covenants.

7.    RESTRUCTURING AND RELATED IMPAIRMENT CHARGES

          In December 2001, the Company initiated a number of restructuring actions focused on eliminating redundancies, streamlining operations and improving overall financial results. These initiatives include workforce reductions, office closures, discontinuation of certain business lines and related asset write-offs.

          In December 2001, the Company announced a planned workforce reduction in Los Angeles, California; Novato, California; Baltimore, Maryland; Little Rock, Arkansas; Provo, Utah; Salt Lake City, Utah; Westmont, Illinois; Albany, New York; Glastonbury, Connecticut; and Trivandrum, India. This workforce reduction was expected to affect 168 employees. Severance and other costs related to this workforce reduction totaled $1.7 million, of which $1.0 million was included in restructuring and related impairment charges in 2001. A total of $651,000 in severance and other costs were charged to restructuring and related impairment charges in 2002. Such workforce reductions have been completed as of the fourth quarter 2002.

          Facility closures include the closure of the facilities in Novato, California; Birmingham, Alabama; Provo, Utah; Salt Lake City, Utah; Westmont, Illinois; Naperville, Illinois; Louisville, Kentucky; and Trivandrum, India. These closures have been completed as of the fourth quarter 2002.  

          The following table summarizes the activities in the Company’s restructuring reserves as of March 31, 2003 (in thousands):

          The remaining accrued restructuring balance of $1.1 million as of March 31, 2003, represents the Company's future commitments related to its facility closures as noted above.

          In addition to the workforce reductions and facility closures described above, the Company has discontinued certain business lines and has written off assets associated with these business lines. Specifically, the Company has discontinued certain website and software development activities and its hospital billing and accounts receivable business line and has written-off the assets associated with these activities. The Company has also written off assets in December 2001 associated with the closure of facilities. The following table summarizes the Company’s write-off of assets, in December 2001 (amounts in thousands):

8.     RECENT ACCOUNTING PRONOUNCEMENTS

          On December 31, 2002, the FASB issued Statement No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure” (“Statement 148”). Statement 148 amends FASB Statement No. 123, “Accounting for Stock-Based Compensation” (“Statement 123”), to provide alternative methods of transition to Statement 123’s fair value method of accounting for stock-based employee compensation. Statement 148 also amends the disclosure provisions of Statement 123 and APB Opinion No. 25, “Interim Financial Reporting” (“Opinion 25”), to the entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. While Statement 148 does not amend Statement 123 to require companies to account for employee stock options using the fair value method, the disclosure provisions of Statement 148 are applicable to all companies with stock-based employee compensation, regardless of whether they account for that compensation using the fair value method of Statement 123 or the intrinsic value method of Opinion 25. The Company has adopted the disclosure provisions of Statement 148 as of December 31, 2002. The Company has elected not to adopt the fair value measurement provisions of Statement 123.

          In July 2002, the FASB issued Statement No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“Statement 146”). Statement 146 addresses the accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)”. It also substantially nullifies EITF Issue No. 88-10, “Costs Associated with Lease Modification or Termination”. Statement 146 establishes an accounting model for costs associated with exit or disposal activities based on the FASB’s conceptual framework for recognition and measurement of liabilities. Under this model, a liability for costs associated with an exit or disposal activity should be initially recognized when it is incurred, that is, when the definition of a liability in FASB Concepts Statement No. 6, “Elements of Financial Statements”, is met, and be measured at fair value, consistent with FASB Concepts Statement No. 7, “Using Cash Flow Information and Present Value in Accounting Measurements”. This represents a significant change from the provisions of EITF 94-3 and Accounting Principles Board (APB) Opinion No. 30, “Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions”, under which such costs were generally recognized in the period in which an entity committed to an exit plan or a plan of disposal, and which did not require the initial liability to be measured at fair value. Statement 146 is effective for exit or disposal activities initiated after December 31, 2002. The Company has adopted the rules set forth in Statement 146 effective as of January 1, 2003. There was no effect on the Company’s financial statements resulting from the adoption of Statement 146.

          In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirement for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”). FIN 45 significantly changes current practice in the accounting for, and disclosure of, guarantees. Guarantees meeting the characteristics described in the FIN 45 which are not included in a long list of exceptions, are required to be initially recorded at fair value, which is different from the general current practice of recording a liability only when a loss is probable and reasonably estimable, as those terms are defined in FASB Statement No. 5, “Accounting for Contingencies”. FIN 45 also requires a guarantor to make significant new disclosures for virtually all guarantees even if the likelihood of the guarantor’s having to make payments under the guarantee is remote. FIN 45’s disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. FIN 45’s initial recognition and initial measurement provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year-end. The Company has adopted the rules set forth in FIN 45 effective as of December 31, 2002. The Company did not have any outstanding guarantees issued after December 31, 2002, required to be recorded as obligations.

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

          We offer a broad portfolio of healthcare information technology products and services that can be provided individually or combined to create a comprehensive solution. Focused exclusively on healthcare, we offer: proprietary enterprise software, including Facets^® and QicLink^™; outsourced services, including software hosting, business process outsourcing, and IT outsourcing; and consulting services. We provide products and services for three healthcare markets: health plans, benefits administrators and physician groups. For the three months ended March 31, 2003, these market segments represented 77%, 18%, and 5% of our total revenue, respectively. As of March 31, 2003, we served approximately 478 customers.

          We recognize revenue when persuasive evidence of an arrangement exists, the product or service has been delivered, fees are fixed and determinable, collectibility is probable and all other significant obligations have been fulfilled. Our revenue is classified into two categories: recurring and non-recurring. For the three months ended March 31, 2003, approximately 57% of our total revenue was recurring and 43% was non-recurring.

          We generate recurring revenue from several sources, including the provision of outsourcing services, such as software hosting and other business services, and the sale of maintenance and support for our proprietary software products. Recurring revenue is billed and recognized monthly over the contract term, typically three to seven years. Many of our outsourcing services agreements contain performance standards that require us to maintain a certain level of operating performance. Recurring software maintenance revenue is typically based on one-year renewable contracts. Software maintenance and support revenues are recognized ratably over the contract period. Cash for software maintenance received in advance is recorded on the balance sheet as deferred revenue.

          We generate non-recurring revenue from the licensing of our software. We follow the provisions of the Securities and Exchange Commission Staff Accounting Bulletin No. 101, “Revenue Recognition”, AICPA Statements of Position (“SOP”) 97-2 “Software Revenue Recognition” as amended, and EITF Issue 00-21, “Multiple Element Arrangements”. Software license revenue is recognized upon the execution of a license agreement, upon delivery of the software, when fees are fixed and determinable, when collectibility is probable and when all other significant obligations have been fulfilled. For software license agreements in which customer acceptance is a material condition of earning the license fees, revenue is not recognized until acceptance occurs. For arrangements containing multiple elements, such as software license fees, consulting services and maintenance, and where vendor-specific objective evidence (“VSOE”) of fair value exists for all undelivered elements, we account for the delivered elements in accordance with the “residual method”. Under the residual method, the arrangement fee is recognized as follows: (1) the total fair value of the undelivered elements, as indicated by vendor-specific objective evidence, is deferred and subsequently recognized in accordance with the relevant sections of SOP 97-2 and (2) the difference between the total arrangement fee and the amount deferred for the undelivered elements is recognized as revenue related to the delivered elements. For arrangements in which VSOE does not exist for each element, including specified upgrades, revenue is deferred and not recognized until delivery of the element without VSOE has occurred. We also generate non-recurring revenue from consulting fees for implementation, installation, data conversion, and training related to the use of our proprietary and third-party licensed products. We recognize revenues for these services as they are performed, if contracted for on a time and material basis, or using the percentage of completion method, if contracted for on a fixed fee basis.

          We may pay certain up-front fees in connection with the establishment of our hosting and outsourcing services contracts. The costs are capitalized and amortized over the life of the contract, provided that such amounts are recoverable from future revenue under the contract. If an up-front fee is not recoverable from future revenue, or it cannot be offset by contract cancellation penalties paid by the customer, the fee will be written off as an expense in the period it is deemed unrecoverable. Total up-front fees outstanding as of March 31, 2003 were $1.5 million.

          Cost of revenue includes costs related to the products and services we provide to our customers and costs associated with the operation and maintenance of our customer connectivity centers. These costs include salaries and related expenses for consulting personnel, customer connectivity centers personnel, customer support personnel, application software license fees, amortization of capitalized software development costs, telecommunications costs and maintenance costs.

          Research and development (“R&D”) expenses are salaries and related expenses associated with the development of software applications prior to establishing technological feasibility. Such expenses include compensation paid to engineering personnel and fees to outside contractors and consultants. Costs incurred internally in the development of our software products are expensed as incurred as R&D expenses until technological feasibility has been established, at which time any future production costs are properly capitalized and amortized to the cost of revenue based on current and future revenue over the

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remaining estimated economic life of the product. To the extent that amounts capitalized for R&D become impaired due to the introduction of new technology, such amounts will be written-off.

          Selling, general and administrative expenses consist primarily of salaries and related expenses for sales, sales commissions, account management, marketing, administrative, finance, legal, human resources and executive personnel, and fees for professional services.

          In accordance with FASB Statement No. 141, and Statement No. 142, goodwill and intangible assets deemed to have indefinite lives are not amortized. Instead, such amounts are subject to annual impairment tests, and the amount of any impairment will be written-off as an expense in the period such impairment is determined. Goodwill and intangible assets with indefinite lives are tested using the two-step process prescribed in Statement 142. The first required step is a screen for potential impairment, while the second step measures the amount of the impairment, if any. After the end of the fourth quarter of 2002, we performed an evaluation of our goodwill under Statement 142 and determined that it was impaired as of December 31, 2002. As a result, we recognized an impairment charge of $97.5 million to our goodwill in the fourth quarter of 2002 net of a tax effect of $5.5 million. During 2003, we will continue to evaluate these intangible assets for impairment as events and circumstances warrant. If an impairment is determined, further write-offs may be required.

          In accordance with FASB Statement No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, we review property, plant and equipment, capitalized research and development costs and purchased intangible assets for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Our asset impairment review assesses the fair value of the assets based on the future cash flows the assets are expected to generate. An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset, plus net proceeds expected from disposition of the asset (if any), are less than the carrying value of the asset. This approach uses our estimates of future market growth, forecasted revenue and costs and expected periods the assets will be utilized. When an impairment is identified, the carrying amount of the asset is reduced to its estimated fair value. After the end of the fourth quarter of 2002, we performed an evaluation of our long-lived assets under Statement 144 and determined that certain intangible assets were impaired as of December 31, 2002. As a result, we recognized an impairment charge of $33.5 million related to these assets in the fourth quarter of 2002. During 2003, we will continue to evaluate our intangible assets for impairment as events and circumstances warrant.

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REVENUE INFORMATION

Revenue by customer type and revenue mix for the three months ended March 31, 2003 and 2002, respectively, is as follows
(in thousands):

          Our total backlog is defined as the revenue we expect to generate in future periods from existing customer contracts. Our 12-month backlog is defined as the revenue we expect to generate from existing customer contracts over the next 12 months. Most of the revenue in our backlog is derived from multi-year recurring revenue contracts (including software hosting, business process outsourcing, IT outsourcing, and software maintenance). We classify revenue from software license and consulting contracts as non-recurring. Such revenue is included in the backlog when the software license or consulting contract is more than 12 months long.

          Backlog can change due to a number of factors, including unforeseen changes in implementation schedules, contract cancellations (subject to penalties paid by the customer), or customer financial difficulties. Unless we enter into new customer agreements that generate enough revenue to replace or exceed the revenue that is recognized in any given quarter, our backlog will decline. Our backlog at any date may not indicate demand for our products and services and may not reflect actual revenue for any period in the future.

Our 12-month and total backlog data are as follows (in thousands):

          Total bookings equal the total dollar value of the contracts signed in the quarter. Bookings can vary substantially from quarter to quarter, based on a number of factors, including the number and type of prospects in our pipeline, the length of time it takes a prospect to reach a decision and sign the contract, and the effectiveness of our sales force. Total bookings for each of the quarters are as follows (in thousands):

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RESULTS OF OPERATIONS

QUARTER ENDED MARCH 31, 2003 COMPARED TO THE QUARTER ENDED MARCH 31, 2002

          Revenue.     Total revenue in the first quarter 2003 increased $9.3 million, or 16%, to $69.0 million from $59.7 million for the same period in 2002. The increase primarily resulted from organic growth in our software license and consulting services.

          Recurring revenue in the first quarter of 2003 decreased $641,000 or 2%, to $39.1 million from $39.8 million for the same period in 2002. The decrease was due to a $1.5 million decrease in revenue from our outsourced business services which resulted from the loss of several outsourced business services payer and provider customers. This decrease was offset by organic growth in our software maintenance revenue, which totaled $901,000.

          Non-recurring revenue in the first quarter of 2003 increased $10.0 million, or 50%, to $29.9 million from $19.9 million for the same period in 2002. The increase was from organic growth in our software license revenue of $4.8 million and $5.2 million in our consulting revenue. One of our customers contributed approximately $7.3 million of non-recurring revenue in the first quarter 2003 which included software license revenue of $4.1 million and consulting services of $3.2 million.

          Cost of Revenue.     Cost of revenue in the first quarter of 2003 increased $7.5 million, or 19%, to $47.9 million from
$40.4 million for the same period in 2002. The increase was primarily due to the costs required to support the increase in our consulting services revenue. As a percentage of total revenue, cost of revenue approximated 69% in the first quarter of 2003 and 68% for the same period in 2002.  The overall gross margin (revenue minus cost of revenue) decreased from 32.3% in the first quarter of 2002 to 30.6% in the first quarter of 2003.  Several factors affect the gross margin, including the mix of recurring and non-recurring revenue and the utilization of our data centers.  In the first quarter, the decrease in the gross margin was the result of two main issues.  First, in the fourth quarter of 2002, several small recurring revenue contracts terminated due to acquisition or bankruptcy or were eliminated due to profitability concerns.  Recurring revenue customers are served by our data centers, which have fixed costs.  Thus, when recurring revenue declines, gross margins decline.  The loss of recurring revenue in the fourth quarter was partially offset by new business in the first quarter.

          The second reason for the decrease in gross margin was that we offered fixed-fee system implementations to certain new customers who purchased Facets (our proprietary administrative software for health plans) on a hosted, rather than a licensed, basis.  These fixed fee implementations helped establish our hosted-Facets offering in the market, but they had lower margins than implementations billed at standard rates.

          Research and Development (R&D) Expenses.     R&D expenses in the first quarter of 2003 increased $491,000, or 9%, to $5.9 million from $5.4 million for the same period in 2002. This increase was due primarily to increased costs related to the development of our proprietary software for the payer and benefits administration markets. As a percentage of total revenue, R&D expenses approximated 9% in the first quarters of 2003 and 2002. R&D expenses as a percentage of total R&D expenditures (which includes capitalized R&D expenses of $2.4 million in the first quarter of 2003 and $2.7 million for the same period in 2002) was 71% in the first quarter of 2003 and 67% for the same period in 2002. R&D expenses in the first quarter of 2003 and 2002 includes approximately $66,000 and $55,000 of amortization of deferred stock compensation, respectively.

          Selling, General and Administrative Expenses.     Selling, general and administrative expenses in the first quarter of 2003 increased $738,000, or 6%, to $14.0 million from $13.3 million for the same period in 2002. The increase primarily represented the expansion of our corporate support functions. As a percentage of total revenue, selling, general and administrative expenses approximated 20% in the first quarter of 2003 and 22% for the same period in 2002. Selling, general and administrative expenses in the first quarter of 2003 and 2002 includes approximately $325,000 and $432,000 of amortization of deferred stock compensation, respectively.

          Amortization of Goodwill and Intangible Assets.     Amortization of goodwill and intangible assets in the first quarter of 2003 decreased $3.2 million, or 49%, to $3.3 million from $6.5 million for the same period in 2002. The net decrease is the result of an impairment charge taken in December 2002. Future amortization expense relating to intangible assets is expected to be as follows (in thousands):

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          Interest Income.     Interest income in the first quarter of 2003 decreased $8,000, or 3%, to $317,000 from $325,000 for the same period in 2002. The decrease is due primarily to lower yields on investments in the first quarter of 2003 compared with the same period in 2002.

          Interest Expense.     Interest expense in the first quarter of 2003 increased $177,000, or 48%, to $545,000 from $368,000 for the same period in 2002. The increase relates primarily to the increase in the total principal amount outstanding on our Secured Term Note and increased capital lease obligations, offset by a decrease in interest expense related to our revolving credit facility due to a decrease in the prime rate compared to the first quarter of 2002.

          Provision for (Benefit from) Income Taxes.     Provision for income taxes was $300,000 in the first quarter of 2003 compared to a benefit from income taxes of $1.4 million for the same period in 2002. The decrease in tax benefit from the prior year is principally due to a decrease in the loss from the same period in 2002 and the valuation reserve recorded against the increase in deferred tax assets in 2003.

          Restructuring and Related Impairment Charges.     In December 2001, we initiated a restructuring focused on eliminating redundancies, streamlining operations and improving overall financial results. The restructuring included workforce reductions, office closures, discontinuation of certain business lines and related asset write-offs. The $79,000 restructuring charge in the first quarter of 2002 reflects severance costs related to planned workforce reductions. There were no restructuring charges in the first quarter of 2003 as this restructure was completed in 2002.

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LIQUIDITY AND CAPITAL RESOURCES

          Since inception, we have financed our operations primarily through a combination of cash from operations, private financings, borrowings under our debt facility, public offerings of our common stock and cash obtained from our acquisitions. As of March 31, 2003, we had cash, cash equivalents and short-term investments totaling $85.7 million, including $6.1 million in restricted cash.

          Cash provided by operating activities in the first quarter of 2003 was $9.7 million. Net cash provided during this period resulted from net losses of $2.7 million, offset by approximately $3.4 million in other net changes in operating asset and liability accounts and $9.0 million in non-cash charges such as depreciation and amortization, provision for doubtful accounts and sales returns, amortization of deferred stock compensation, amortization of intangibles, and the issuance of stock in connection with a prior acquisition. At the beginning of each calendar year, we bill and collect certain annual software maintenance fees related to our proprietary software licenses. Although cash is collected early in the year, revenue on these contracts is recognized ratably over the year. This results in higher amounts of cash received in the first six months of the year and lower amounts of cash received in the last six months of the year.

          Cash used in investing activities of $13.8 million in the first quarter of 2003 was primarily the result of our purchase of $2.3 million in property and equipment and software licenses, research and development costs of $2.4 million, the net purchase of $8.5 million in short-term investments, and $550,000 for the purchase of an intangible asset.

          Cash provided by financing activities of $178,000 in the first quarter of 2003 was primarily the result of $550,000 of proceeds from capital leases, $1.3 million of proceeds from borrowings under our debt facility, and $40,000 of proceeds from the issuance of common stock related to employee exercises of stock options.  These proceeds were reduced by payments made on our equipment line of credit, notes payable and capital lease obligations of $1.7 million.

          In December 1999, we entered into a lease line of credit with a financial institution. This lease line of credit was specifically established to finance computer equipment purchases through December 2000 and had a limit of $2.0 million. Borrowings under the lease line of credit at March 31, 2003 totaled approximately $62,000 and are secured by the assets under lease. In accordance with the terms of the lease line of credit, the outstanding balance is being repaid in monthly installments of principal and interest through June 2003.

          In September 2000, we entered into a Loan and Security Agreement and Revolving Credit Note with a lending institution providing for a revolving credit facility in the maximum principal amount of $15.0 million. The revolving credit facility is secured by all of the Company’s receivables. In December 2002, the Loan and Security Agreement and Revolving Credit Note were further amended to provide for the maximum principal amount of $20.0 million and an expiration date of December 2004. Borrowings under the revolving credit facility are limited to and shall not exceed 85% of qualified accounts, as defined in the Loan and Security Agreement. We have the option to pay interest at prime plus 1% or a fixed rate per annum equal to LIBOR plus 3.25% payable in arrears on the first business day of each month. In addition, there is a monthly 0.0333% usage fee to the extent by which the maximum loan amount exceeds the average amount of the principal balance of the Revolving Loans during the preceding month. The usage fee is payable in arrears on the first business day of each successive calendar month. The revolving credit facility contains covenants to which we must adhere during the terms of the agreement. These covenants require us to maintain tangible net worth, as defined in the Loan and Security Agreement of at least $50.0 million, to generate recurring revenue and net earnings before interest, taxes, depreciation and amortization equal to at least 70% of the amount set forth in our operating plan, and to maintain a minimum cash balance of $35.0 million. In addition, these covenants prohibit us from paying any cash dividend, distributions and management fees as defined in the agreement and from incurring capital expenditures in excess of 120% of the amount set forth in our operating plan during any consecutive 6-month period. As of March 31, 2003, we had outstanding borrowing on the Revolving Credit facility of $5.5 million, and we were in compliance with all of our debt covenants.

          In September 2001, we executed a $6.0 million Secured Term Note facility with the same lending institution that is providing the revolving credit facility. Monthly principal payments of $200,000 were due under the note on the first of each month. Additionally, the note bore interest at prime plus 1% and was payable monthly in arrears. In December 2002, the Secured Term Note was amended to increase the total principal amount to $15.0 million. We have the option to pay interest at prime plus 1% or a fixed rate per annum equal to LIBOR plus 3.25%, payable in arrears on the first business day of each quarter. The first principal payment of $1.875 million is due in June 2003, with subsequent quarterly payments of $1.875 million due on the last day of each calendar quarter through September 2004. The note matures in December 2004, at which time the final payment of $3.75 million will be due. The Secured Term Note contains the same covenants set forth in the revolving credit facility documents. As of March 31, 2003, we had outstanding borrowings on the Secured Term Note of $15.0 million, and we were in compliance with all of our debt covenants.

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          In November 2001, we entered into an agreement with an equipment financing company for $3.1 million, specifically to finance the acquisition of certain equipment. Principal and interest is payable monthly and the note is due in November 2005. Interest accrues monthly at LIBOR rate plus 3.13%. As of March 31, 2003, there was approximately $2.7 million principal balance remaining on the note.

          As of March 31, 2003, we have outstanding seven unused standby letters of credit in the aggregate amount of $6.1 million which serve as security deposits for certain capital leases, as well as a commitment to a customer. We are required to maintain a cash balance equal to the outstanding letters of credit, which is classified as restricted cash on the balance sheet.

The following tables summarizes our contractual obligations and other commercial commitments (in thousands):