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July 17, 2000

INTRAWARE INC (ITRA)

Quarterly Report (SEC form 10-Q)

The following discussion of our financial condition and results of operations should be read in conjunction with our financial statements and related notes. This discussion contains forward-looking statements that involve risks and uncertainties. Forward-looking statements include statements regarding the extent and timing of future revenues and expenses and customer demand, statements regarding the deployment of our products, and statements regarding our reliance on third parties. All forward-looking statements included in this document are based on information available to us as of the date hereof, and we assume no obligation to update any such forward-looking statement. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including but not limited to, those discussed in "Risk Factors" below and elsewhere in this quarterly report on Form
10-Q.

INTRAWARE OVERVIEW

Intraware, Inc. was incorporated in Delaware on August 14, 1996. We are the leading e-marketplace for web-based software and services targeted to IT professionals. Our services allow IT professionals to control the business software life cycle from their web browsersstarting with research and evaluation, through purchase, training, and deployment, to updates and management. We provide objective technical research; in-depth software analysis; an extensive selection of software, training, and resources; and a comprehensive software delivery, update and management system.

Software product sales revenue results from the sale of third party software products to customers and is recognized when there is evidence of an arrangement for a fixed and determinable fee that is probable of collection and the software is available for customer download through our web site. Software maintenance revenue results from the sale of third-party software maintenance agreements and is recognized ratably over the service period.

Online services and technology revenue results primarily from Intraware license revenue from large customers or OEM (Original Equipment Manufacturer) partners, software maintenance outsourcing arrangements with third-party software vendors delivered through INTRAWARE DELIVERY (formerly SUBSCRIBNET) and from various fee-based subscription research and evaluation services that we offer. Such revenues are generally recognized ratably over the service period.

We have a limited operating history upon which investors may evaluate our business and prospects. Since inception, we have incurred significant losses, and, as of May 31, 2000, had an accumulated deficit of approximately $61.1 million. We intend to expend significant financial and management resources on the development of additional services, sales and marketing, technology and operations to support larger-scale operations and greater service offerings. As a result, we expect to incur additional losses and continued negative cash flow from operations for the foreseeable future. Such losses are anticipated to increase significantly from current levels. There can be no assurance that our sales will increase or continue at their current level. There also can be no assurances that we will achieve or maintain profitability or generate cash from operations in future periods. Our future must be considered in light of the risks frequently encountered by companies in their early stage of development, particularly companies in new and rapidly evolving markets such as e-commerce. To address these risks, we must, among other things, maintain existing and develop new relationships with software publishers, continue to improve existing and develop new services, implement and successfully execute our business and marketing strategy, continue to develop and upgrade our technology and transaction-processing systems, provide superior customer service, respond to competitive developments and attract, retain and motivate qualified personnel. There can be no assurance that we will be successful in addressing such risks and the failure to do so would have a material adverse effect on our business, financial condition and results of operations. Our current and future expense levels are based largely on our planned operations and estimates of future sales. Sales and operating results generally depend on the volume and timing of orders received, which are difficult to forecast. We may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall. Accordingly, any significant shortfall in sales would have an immediate adverse effect on our business, financial condition and results of operations. In view of the rapidly evolving nature of our business and our limited operating history, we are unable to accurately forecast our sales and believe that period-to-period comparisons of our operating results are not necessarily meaningful and should not be relied upon as an indication of future performance.

RESULTS OF OPERATIONS

TOTAL REVENUE

Revenue increased to $41.5 million for the three months ended May 31, 2000 from $16.5 million for three months ended May 31, 1999. In addition, for the three months ended May 31, 2000, product revenue accounted for $36.5 million or 88.0% of revenue, while online service and technology revenue accounted for $5.0 million or 12.0% of revenue. For the three months ended May 31, 1999, product revenue accounted for $14 million or 85% of revenue, while online service and technology revenue accounted for $2.5 million or 15% of revenue.

Revenue growth was due to our broadband technology portfolio, expanding vendor base, experienced sales force and increasing customer demand for products and services.

COST OF NET REVENUES

Total cost of net revenues increased to $32.8 million for the three months ended May 31, 2000 from $12.8 million for the three months ended May 31, 1999. This increase in total cost of net revenues was primarily attributable to increases in the volume of third-party software and maintenance products that we sold.

Our gross margin decreased to 20.9% for the three months ended May 31, 2000 from 22.6% for the three months ended May 31, 1999.

Costs of revenue primarily consist of the cost of third-party products sold, content development and acquisition, internet connectivity and allocated overhead charges. We purchase third-party products at a discount to the third-party's established list prices according to standard reseller terms. The increase in the cost of revenue dollars was primarily due to higher product and service sales. The margin percentage decrease primarily reflects the fact that our product revenues and costs have grown at a faster rate than our online services and technology sales.

SALES AND MARKETING EXPENSES

For the three months ended May 31, 2000, sales and marketing expenses were $11.3 million or 27.2% of net revenue, an increase from $5.7 million or 34.8% of net revenue for the three months ended May 31, 1999.

Sales and marketing expenses consist primarily of employee salaries, benefits and commissions, advertising, promotional materials and trade show exhibit expenses. The increase is primarily the result of additional focused advertising and marketing expenditures as well as the addition of personnel and external sales offices throughout the United States, Canada and Europe. We plan to make significant investments in sales and marketing, to expand the direct sales force, increase marketing expenditures, and continue to develop strategic relationships to drive traffic to our web site and generate leads for products and services. The previous sentence is a forward-looking statement and actual results could differ materially from those anticipated.

PRODUCT DEVELOPMENT EXPENSES

For the three months ended May 31, 2000, product development expenses were $3.6 million or 8.7% of net revenue, an increase from $1.3 million or 7.9% of net revenue for the three months ended May 31, 1999.

Product development expenses primarily consist of personnel, consulting and equipment depreciation expenses. Costs related to research, design and development of products and services have also been charged to product development expense as incurred. The increase was primarily due to an increase in the number of product development personnel employed to support expansion of the Services online service offerings. We believe significant investments in product development and technological infrastructure are essential to our future success and expect that the amount of product development expense will increase in future periods. The previous sentence is a forward-looking statement and actual results could differ materially from those anticipated.

GENERAL AND ADMINISTRATIVE EXPENSES

For the three months ended May 31, 2000, general and administrative expenses were $4.0 million or 9.7% of net revenue, an increase from $1.1 million or 6.9% of net revenue for the three months ended May 31, 1999.

General and administrative expenses consist primarily of compensation for administrative and executive personnel, facility costs and fees for professional services. The increase is primarily due to the use of outside professional consulting services, including the ongoing implementation of sales force automation and accounting software packages. In addition, we required increased expenditures in accounting and legal functions for strategic partnering arrangements and for compliance with reporting obligations as a public company. Management expects general and administrative expenses to increase in future periods. The previous sentence is a forward-looking statement and actual results could differ materially from those anticipated.

STOCK-BASED COMPENSATION

For the three months ended May 31, 2000, stock-based compensation expenses were $770,000 or 1.9% of net revenue, a decrease from $870,000 or 5.3% of net revenue for the three months ended May 31, 1999.

Stock compensation expense is an ongoing charge through August 2002 that is related to employee stock options granted while we were not a public company.

AMORTIZATION OF INTANGIBLES

For the three months ended May 31, 2000, merger and acquisition related costs including amortization of intangibles were $932,000 or 2.2% of net revenue, an increase from $4,000 or 0.1% of net revenue for the three months ended May 31, 1999.

Merger and acquisition related costs including amortization of intangibles is a charge related to our acquisitions of BITSource, Inc. and Internet Image, Inc. This expense is an ongoing charge through September 2004.

INTEREST EXPENSE

For the three months ended May 31, 2000, interest expenses were $33,000 or 0.1% of net revenue, a decrease from $35,000 or 0.2% of net revenue for the three months ended May 31, 1999.

Interest expense relates to obligations under capital leases and borrowings under a bank line. The decrease in interest expense is primarily the result of funds received in our initial public offering.

INTEREST AND OTHER INCOME, NET

For the three months ended May 31, 2000, interest and other income, net were $241,000 or 0.6% of net revenue, a decrease from $740,000 or 4.5% of net revenue for the three months ended May 31, 1999.

The decrease in interest income is primarily the result of the reduction of our investment portfolio.

INCOME TAXES

From inception through May 31, 2000, we incurred net losses for federal and state tax purposes. We have recognized approximately $37,000 of state income taxes for the three months ended May 31, 2000. There were no state or federal taxes recognized for the three months ended May 31, 1999. As of May 31, 2000, Intraware had approximately $42 million of federal and $26 million of state net operating loss carryforwards available to offset future taxable income which expire in varying amounts between 2005 and 2012. Given our limited operating history, losses incurred to date and the difficulty in accurately forecasting our future results, management does not believe that the realization of the related deferred income tax asset meets the criteria required by generally accepted accounting principles. Accordingly, we have recorded a 100% valuation allowance against our deferred tax asset. Furthermore, as a result of changes in our equity ownership from our convertible preferred stock financing and our initial public offering, utilization of the net operating losses and tax credits is subject to substantial annual limitations. This is due to the ownership change limitations provided by the Internal Revenue Code of 1986, as amended, and similar state provisions. The annual limitation may result in the expiration of net operating losses and tax credits before utilization.

LIQUIDITY AND CAPITAL RESOURCES

As of May 31, 2000, we had approximately $14.6 million of cash and cash equivalents and $3.5 million in short-term marketable securities. Our principal commitments consist of obligations outstanding under bank credit lines, capital and operating leases, accounts payable and accrued expenses. Although we have no material commitments for capital expenditures, we anticipate an increase in the rate of capital expenditures consistent with our anticipated growth in operations, infrastructure and personnel.

On June 30, 2000 we issued approximately 2,500 shares of preferred stock which resulted in gross proceeds of approximately $25,000,000. The preferred stock was issued in three series. Each series will be convertible at a conversion price equal to 120% of the average closing bid price of our common stock determined during three separate month-long pricing periods, with one pricing period for each series of preferred stock. We may be required to redeem portions of the preferred stock in the event the price of our common stock falls below $12.50 during the pricing periods.

Including the proceeds from the issuance of the preferred stock, and assuming we do not have to redeem any shares of the preferred stock, we believe we have adequate resources for working capital and capital expenditures for at least twelve (12) months from the date of this report. Our future liquidity and capital requirements will depend upon numerous factors. The pace of expansion of our operations will affect these requirements. We may also have increased capital requirements in order to respond to competitive pressures. Also, we may need additional capital to fund acquisitions of complementary businesses and technologies. Our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement that involves risks and uncertainties. Actual results could vary materially as a result of the factors described above. If additional capital resources are required, we may seek to sell additional equity, debt securities or increase our bank line of credit. The sale of additional equity or convertible debt securities could result in additional dilution to our stockholders. There can be no assurance that any financing arrangements will be available in amounts or on terms acceptable to us.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 1999, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging ActivitiesDeferral of the Effective Date of FASB Statement No. 133an amendment of FASB Statement 133" ("SFAS 137"). SFAS 137 defers for one year the application of Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards of derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The adoption of Statement of Financial Accounting Standards No. 133 is not expected to have an impact on our results of operations, financial position or cash flows.

In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") 101, Revenue Recognition in Financial Statements which provides guidance related to revenue recognition based on interpretations and practices followed by the SEC. SAB 101 was effective the first fiscal quarter of fiscal years beginning after December 15, 1999 and requires companies to report any changes in revenue recognition as cumulative change in accounting principle at the time of implementation in accordance with Accounting Principles Board opinion 20, "Accounting Changes." In March 2000, the SEC issued SAB 101A "Amendment: Revenue Recognition in Financial Statements," which delays implementation of SAB 101 until the Company's first fiscal quarter of 2001. In June 2000, the SEC issued SAB 101B "Second Amendment: Revenue Recognition in Financial Statements," which delays the implementation of SAB 101 until the Company's fourth fiscal quarter of 2001. The Company will adopt SAB 101 and is currently in the process of evaluating the impact, if any, SAB 101 will have on its financial position or results of operations.

In March 2000, the FASB issued Interpretation No. 44, ("FIN 44"), Accounting for Certain Transactions Involving Stock Compensation - an Interpretation of APB 25. This Interpretation clarifies (a) the definition of employee for purposes of applying Opinion 25, (b) the criteria for determining whether a plan qualifies as a non compensatory plan, (c) the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. This Interpretation is effective July 1, 2000, but certain conclusions in this Interpretation cover specific events that occur after either December 15, 1998, or January 12, 2000. To the extent that this Interpretation covers events occurring during the period after December 15, 1998, or January 12, 2000, but before the effective date of July 1, 2000, the effects of applying this Interpretation are recognized on a prospective basis from July 1, 2000.

                                  RISK FACTORS

WE HAVE A HISTORY OF LOSSES, WE EXPECT FUTURE LOSSES AND WE MAY NOT EVER BECOME

PROFITABLE.

We have not achieved profitability, expect to incur net losses in the foreseeable future and may not ever become profitable in the future. We incurred net losses of $28.0 million for the year ended February 29, 2000, $15.0 million for the year ended February, 28, 1999, $6.0 million for the year ended February 28, 1998 and $1.5 million for the period from August 14, 1996 through February 28, 1997. In addition, we incurred net losses of $11.8 million for the three months ended May 31, 2000. As of May 31, 2000, we had an accumulated deficit of approximately $61.1 million. Net losses have increased for each of our quarters since inception and this trend may continue. We expect to continue to increase our sales and marketing, product development and administrative expenses. As a result we will need to generate significant additional revenues to achieve and maintain profitability.

We were founded in August 1996, and are an early stage company. We have a limited operating history that makes it difficult to forecast our future operating results. Although our revenues have grown in recent quarters, we cannot be certain that such growth will continue or that we will achieve sufficient revenues for profitability. If we do achieve profitability in any period, we cannot be certain that we will sustain or increase such profitability on a quarterly or annual basis. For more detailed information regarding our operating results and financial condition, please see "Management's Discussion and Analysis of Financial Condition and Results of Operations."

WE ARE SUBSTANTIALLY DEPENDENT ON THE SUN/NETSCAPE ALLIANCE AND THE TERMINATION

OF THIS RELATIONSHIP WOULD HAVE A SUBSTANTIAL, IMMEDIATE ADVERSE EFFECT ON OUR

BUSINESS.

For the three months ended May 31, 2000, we generated approximately 79% of our software product revenues from the sale of the Sun/Netscape Alliance's iPlanet software, and approximately 57% of our online service revenues from the outsourcing of INTRAWARE DELIVERY services to the Sun/Netscape Alliance. As a result, transactions with the Sun/Netscape Alliance and the sale of iPlanet products accounted for approximately 71% of our total net revenues in the three months ended May 31, 2000. We cannot assure you that the Sun/Netscape Alliance will continue to sell its software through us. If the Sun/Netscape Alliance limited or discontinued selling its software through us, or if demand for Sun/Netscape software decreased, our business would be adversely affected.

We provide online software update and license management services to Sun/Netscape Alliance customers through our INTRAWARE DELIVERY service under an agreement that expires on June 30, 2001. We cannot assure you that this agreement will be extended. Substantially all of our INTRAWARE DELIVERY revenues

to date have been generated through this Sun contract, and our failure to extend this contract at the end of its current term could have a material adverse effect on our INTRAWARE DELIVERY revenues and on our business as a whole.

If Sun and/or Netscape chose to offer its own electronic software delivery, tracking, maintenance or other services, which it is permitted to do under the current agreement, it would have a substantial and immediate adverse effect on our business, results of operations and financial condition.

THE LOSS OF ONE OR MORE OF OUR KEY CUSTOMERS COULD ADVERSELY AFFECT OUR

REVENUES.

We believe that a substantial amount of revenue from software product sales in any given future period may come from a relatively small number of customers. If one or more major customers were to substantially cut back software purchases or stop using our products or services, our operating results could be materially adversely affected. We do not have long-term contractual relationships with any of these customers because our customers purchase software on a transaction by transaction basis. As a result, we cannot assure you that any of our customers who purchase software through us will purchase from us in future periods.

OUR QUARTERLY FINANCIAL RESULTS ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS BECAUSE

OF MANY FACTORS AND ANY OF THESE COULD ADVERSELY AFFECT OUR STOCK PRICE.

We believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. It is likely that in some future quarter our operating results may be below the expectations of public market analysts and investors and as a result, the price of our common stock may fall. Our operating results have varied widely in the past, and we expect that they will continue to vary significantly from quarter to quarter due to a number of risk factors, including:

- demand for our online services and the products of our software vendors;

- the timing of sales of our online services and the products of our software vendors;

- loss of strategic relationships with major software vendors;

- the mix of our proprietary online services vs. software products sold;

- delays in introducing our online services or our vendors' software products according to planned release schedules;

- our ability to retain existing customers and attract new customers;

- changes in our pricing policies or the pricing policies of our software vendors;

- changes in the growth rate of Internet usage and acceptance by customers of electronic software delivery for large software purchases, particularly for international customers;

- technical difficulties, system failures or Internet downtime;

- the mix of domestic and international sales;

- certain government regulations;

- our ability to upgrade and develop our information technology systems and infrastructure;

- costs related to acquisitions of technology or businesses; and

- general economic conditions as well as those specific to the Internet and related industries.

We have experienced declining gross margins on revenues derived from software product sales and anticipate that such declines may continue. Also, as we shift a larger proportion of our sales and marketing resources toward our more recently introduced online services, such as INTRAWARE DEPLOYMENT, INTRAWARE VOLUME LICENSING and INTRAWARE E-LEARNING, we may experience one or more quarters of reduced software product sales. Any shortfall in our revenues would directly adversely affect our operating income or loss, and these fluctuations could affect the market price of our common stock.

We plan to significantly increase our operating expenses to expand our sales and marketing operations, broaden our customer support capabilities, and fund greater levels of product development. Our operating expenses, which include sales and marketing, product development and general and administrative expenses, are based on our expectations of future revenues and are relatively fixed in the short term. If revenues fall below our expectations and we are not able to quickly reduce our spending in response, our operating results would be adversely affected.

OUR NEWLY INTRODUCED ONLINE SERVICES MAY NOT BE ABLE TO GENERATE ANTICIPATED

REVENUES.

We have only recently started selling a number of online services such as INTRAWARE DEPLOYMENT, INTRAWARE VOLUME LICENSING and INTRAWARE E-LEARNING. We cannot assure you that these online services will result in additional customers and customer loyalty, significant additional revenues or improved operating margins in future periods. Additionally, we cannot assure you that software vendors will continue to find it strategically or economically justifiable for us to deliver the INTRAWARE DELIVERY service to their customers.

We had no significant online services and technology revenues until the quarter ended November 30, 1998, and for the three months ended May 31, 2000, revenues from online services and technology totaled only $5.0 million, which constituted 12.0% of our total revenues for that period. We do not expect these online services to increase substantially as a portion of our total revenue for at least the next three quarters. This projection, however, is a forward-looking statement and our actual results could differ materially from those anticipated as a result of a number of factors, including demand for our online services and the competitive service offerings of others. These online services are not only important to improving our operating results but also to continuing to attract and retain both our software vendor and corporate information technology professional customers, and in differentiating our online service offerings from those of our competitors.

OUR INDUSTRY IS HIGHLY COMPETITIVE AND WE CANNOT ASSURE YOU THAT WE WILL BE ABLE

TO EFFECTIVELY COMPETE.

The market for selling software products and related online services is highly competitive. We expect competition to intensify as current competitors expand their product offerings and new competitors enter the market. We have recently experienced, and expect to continue to experience, price competition on our software sales, particularly on large sales transactions. We cannot assure you that we will be able to compete

successfully against current or future competitors, or that competitive pressures faced by us will not adversely affect our business and results of operations.

Our current competitors include a number of companies offering one or more solutions for the researching, evaluation, purchase, deployment and maintenance of and training on business software. Because there are relatively low barriers to entry in the software and Internet services markets, we expect additional competition from other established and emerging companies. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any of which could have a significant adverse effect on our business and results of operations.

Many of our current and potential competitors have longer operating histories, significantly greater financial, technical, marketing and other resources, better name recognition, and a larger installed base of customers than we do. Many of our competitors may also have well-established relationships with our existing and prospective customers.

Our current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address customer needs and compete with our products. We also expect that the competition will increase as a result of software industry consolidations. As a result, we may not be able to effectively compete for customers.

WE ARE DEPENDENT ON MARKET ACCEPTANCE OF ELECTRONIC SOFTWARE DELIVERY, AND IF IT

DOES NOT ACHIEVE WIDESPREAD ACCEPTANCE, OUR BUSINESS WILL BE ADVERSELY AFFECTED.

Our success will depend in large part on acceptance by information technology professionals of electronic software delivery as a method of buying business software. If electronic software delivery does not achieve widespread market acceptance, our business will be adversely affected. Electronic software delivery is a relatively new method of selling software products and the growth and market acceptance of electronic software delivery is highly uncertain and subject to a number of risk factors. These factors include:

- the potential for state and local authorities to levy taxes on Internet transactions;

- the availability of sufficient network bandwidth to enable purchasers to rapidly download software;

- the number of software packages that are available for purchase through electronic software delivery as compared to those available through traditional delivery methods;

- the level of customer confidence in the process of downloading software; and

- the relative ease of such a process and concerns about transaction security.

Even if electronic software delivery achieves widespread acceptance, we cannot be sure that we will

overcome the substantial technical challenges associated with electronically delivering software reliably and consistently on a long-term basis. Furthermore, the proliferation of software viruses poses a risk to market acceptance of electronic software delivery. Any well-publicized transmission of a computer virus by us or another company using electronic software delivery could deter information technology professionals from utilizing electronic software delivery technology and our business could be adversely affected.

CONTINUED ADOPTION OF THE INTERNET AS A METHOD OF CONDUCTING BUSINESS IS

NECESSARY FOR OUR FUTURE GROWTH.

The widespread acceptance and adoption of the Internet by traditional businesses for conducting business and exchanging information is likely only in the event that the Internet provides these businesses with greater efficiencies and improvements. The failure of the Internet to continue to develop as a commercial or business medium would adversely affect our business.

FAILURE TO EXPAND INTERNET INFRASTRUCTURE COULD LIMIT OUR FUTURE GROWTH.

The recent growth in Internet traffic has caused frequent periods of decreased performance, and if Internet usage continues to grow rapidly, its infrastructure may not be able to support these demands and its performance and reliability may decline. If outages or delays on the Internet occur frequently or increase in frequency, overall web usage including usage of our web site in particular could grow more slowly or decline. Our ability to increase the speed and scope of our services to customers is ultimately limited by and dependent upon the speed and reliability of both the Internet and our customers' internal networks. Consequently, the emergence and growth of the market for our services is dependent on improvements being made to the entire Internet as well as to our individual customers' networking infrastructures to alleviate overloading and congestion.

INCREASED SECURITY RISKS OF ONLINE COMMERCE MAY DETER FUTURE USE OF OUR

SERVICES.

Concerns over the security of transactions conducted on the Internet and the privacy of users may also inhibit the growth of the Internet and other online services generally, and online commerce in particular. Our failure to prevent security breaches could significantly harm our business and results of operations. We cannot be certain that advances in computer capabilities, new discoveries in the field of cryptography, or other developments will not result in a compromise or breach of the algorithms we use to protect our customers' transaction data or our software vendors' products. Anyone who is able to circumvent our security measures could misappropriate proprietary information or cause interruptions in our operations. We may be required to incur significant costs to protect against security breaches or to alleviate problems caused by breaches. Any well-publicized compromise of security could deter people from using the web to conduct transactions that involve transmitting confidential information or downloading sensitive materials.

WE HAVE EXPERIENCED SIGNIFICANT GROWTH IN OUR BUSINESS IN RECENT PERIODS AND OUR

ABILITY TO MANAGE THIS GROWTH WILL AFFECT OUR BUSINESS.

Our ability to successfully offer products and services and implement our business plan in a rapidly evolving market requires an effective planning and management process. We have increased, and plan to continue to increase, the scope of our operations domestically and internationally. These expansion efforts could be expensive and put a strain on management, and if we do not manage growth properly, it could adversely affect our business. Our headcount has grown and may continue to grow substantially. In particular, we will need to expand our technology infrastructure, which will include making certain key employee hires in product development. These hires historically have been difficult and we can not assure you that we will be able to successfully attract and retain a sufficient number of qualified personnel.

WE NEED TO EXPAND OUR MANAGEMENT SYSTEMS AND CONTROLS IN ORDER TO SUPPORT OUR

ANTICIPATED GROWTH.

Our growth has placed, and our anticipated future growth will continue to place, a significant strain on our management systems and controls. We cannot assure you that we will be able to adequately expand our technology resources to support our anticipated growth. We expect that we will need to continue to improve our financial and managerial controls and reporting systems and procedures. Furthermore, we expect that we will be required to manage multiple relationships with various software vendors, customers and other third parties.

WE MAY NOT BE ABLE TO HIRE AND RETAIN SUFFICIENT SALES, MARKETING AND SUPPORT

PERSONNEL THAT WE NEED TO SUCCEED.

If we fail to hire and retain sufficient numbers of sales, marketing and support personnel, our business and results of operations would be adversely affected. Competition for qualified sales and marketing and support personnel is intense, and we might not be able to hire and retain sufficient numbers of qualified sales and marketing and support personnel. We need to substantially expand our sales operations and marketing efforts, both domestically and internationally, in order to increase market awareness and sales of the products and services we offer. These products and services require a sophisticated sales effort targeted at several people within the information technology departments of our prospective customers. We have recently expanded our direct sales force and plan to hire additional sales personnel.

We currently have a small customer service and support organization and will need to increase our staff to support new customers and the expanding needs of existing customers. Hiring customer service and support personnel is very competitive in our industry due to the limited number of people available with the necessary technical skills and understanding of the Internet. We cannot assure you that we will be able to hire and retain sufficient numbers of qualified customer service and support personnel.

OUR EXECUTIVE OFFICERS AND CERTAIN KEY PERSONNEL ARE CRITICAL TO OUR BUSINESS

AND THESE OFFICERS AND KEY PERSONNEL MAY NOT REMAIN WITH US IN THE FUTURE.

Our future success depends upon the continued service of our executive officers and other key technology, sales, marketing and support personnel and none of our officers or key employees is bound by an employment agreement for any specific term. If we lost the services of one or more of our key employees, or if one or more of our executive officers or employees decided to join a competitor or otherwise compete directly or indirectly with us, this could have a significant adverse effect on our business. In particular, the services of Peter Jackson, Chief Executive Officer, Paul Martinelli, Chief Technology Officer, James Brentano, Executive Vice President of Technology, and Mark Long, Executive Vice President of Strategic Development, would be difficult to replace.

WE INTEND TO EXPAND INTERNATIONAL OPERATIONS, AND UNCERTAINTY OF INTERNATIONAL

SALES EFFORTS COULD ADVERSELY AFFECT OUR BUSINESS.

We may not be able to successfully market, sell, deliver and support our services and our vendors' software products internationally. Our planned international expansion will require significant management attention and financial resources. If we are unable to expand our international operations successfully and in a timely manner, our business and operating results could be adversely affected.

To date, we have not had substantial revenues from sales to international customers. We intend to expand the scope of sales to international customers in future periods. In January 2000 we opened an office in the United Kingdom, and in March 2000 we opened an office in Canada. We have only limited experience in marketing, selling and supporting our services and our vendors' software products abroad. Additionally, we do not have any experience in developing foreign language versions of our services. This may be more difficult or take longer than we anticipate especially due to international problems, such as language barriers or currency exchange, and the fact that the Internet infrastructure in such foreign countries may be less advanced than the domestic Internet infrastructure and may result in longer response time and less accurate or consistent electronic software delivery.

In addition, our contracts with the Sun/Netscape Alliance currently allow us to market iPlanet products in the United States, Canada and the United Kingdom only (except in connection with our INTRAWARE DELIVERY service). Revenues from European customers may not be able to grow as planned unless we can obtain the rights to market iPlanet products in continental Europe.

OUR ACQUISITIONS COULD BE DIFFICULT TO INTEGRATE, DISRUPT OUR BUSINESS, DILUTE

STOCKHOLDER VALUE AND ADVERSELY AFFECT OUR OPERATING RESULTS.

We have just completed and currently intend to make additional investments in complementary companies, services and technologies. These acquisitions and investments could disrupt our ongoing business, distract our management and employees and increase our expenses. We could face difficulties in assimilating our acquired company's personnel and operations. In addition, the key personnel of the acquired company may decide not to work for us. Acquisitions of additional services or technologies also involve risks of incompatibility and the need for integration into our existing services and marketing, sales and support efforts. We may be required to spend additional time or money on integration which would otherwise be spent on developing our business and services. If we do not integrate our technology effectively or if management and technical staff spend too much time on integration issues, it could harm our business, financial condition and operating results. Also, if we finance the acquisitions by incurring debt or issuing equity securities, this could dilute our existing stockholders. Any amortization of goodwill or other assets, or other charges resulting from the costs of such acquisitions, could adversely affect our operating results.

WE FACE RISKS OF CLAIMS FROM THIRD PARTIES FOR INTELLECTUAL PROPERTY

INFRINGEMENT THAT COULD ADVERSELY AFFECT OUR BUSINESS.

Our services operate in part by making software products and other content available to our customers. This creates the potential for claims to be made against us, either directly or through contractual indemnification provisions with vendors. Any claims could result in costly litigation and be time-consuming to defend, divert management's attention and resources, cause delays in releasing new or upgrading existing services or require us to enter into royalty or licensing agreements. These claims could be made for defamation, negligence, copyright or trademark infringement, personal injury, invasion of privacy or other legal theories based on the nature, content or copying of these materials.

Litigation regarding intellectual property rights is common in the Internet and software industries. We expect that Internet technologies and software products and services may be increasingly subject to third-party infringement claims as the number of competitors in our industry segment grows and the functionality of products in different industry segments overlaps. There can be no assurance that our services do not infringe on the intellectual property rights of third parties.

In addition, we may be involved in litigation involving the software of third party vendors that we electronically distribute. Royalty or licensing agreements, if required, may not be available on acceptable

terms, if at all. A successful claim of infringement against us and our failure or inability to license the infringed or similar technology could adversely affect our business. Although we carry general liability insurance, our insurance may not cover all potential claims or may not be adequate to protect us from all liability that may be imposed.

We take steps to verify that our INTRAWARE DEPLOYMENT customers that download third-party software from our web site are entitled to deploy and use that software. However, there can be no assurance that this verification procedure will help us defend against claims by, or protect us against liability to, the owners of copyrights in that third-party software.

Our success and ability to compete are substantially dependent upon our internally developed technology, which we protect through a combination of patent, copyright, trade secret and trademark law. We are aware that certain other companies are using or may have plans to use the name "Intraware" as a company name or as a trademark or service mark. While we have received no notice of any claims of trademark infringement from any of those companies, we cannot assure you that certain of these companies may not claim superior rights to "Intraware" or to other marks we use. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our services or technology and we cannot be certain that the steps we have taken will prevent misappropriation of our technology.

WE MAY BE REQUIRED TO REDEEM A PORTION OF THE SERIES A, B AND C PREFERRED IF

THE PRICE OF OUR COMMON STOCK FALLS BELOW $12.50 PER SHARE DURING THE NEXT

SEVERAL MONTHS.

The terms of the series A, B and C preferred stock may require us to redeem a portion of the preferred stock if the price of our common stock falls below $12.50 per share during the next several months. If we are required to redeem a portion of the preferred stock our cash resources will be depleted which may require us to scale back our plans and operations. This would materially and adversely affect our business.

THE CONVERSION OF THE SERIES A, B AND C PREFERRED SHARES AND THE EXERCISE OF

THE RELATED WARRANTS WOULD RESULT IN SUBSTANTIAL NUMBERS OF ADDITIONAL SHARES

BEING ISSUED.

To the extent the series A, B and C preferred shares are converted or dividends on the series A, B and C preferred shares are paid in shares of common stock rather than cash, a significant number of shares of common stock may be sold into the market, which could decrease the price of our common stock and encourage short sales by holders of the series A, B and C preferred shares or others. Short sales could place further downward pressure on the price of our common stock.

The conversion of and the payment of dividends in shares of common stock in lieu of cash on the series A, B and C preferred shares may result in substantial dilution to the interests of other holders of our common stock. In addition, the conversion price of the series A, B and C preferred stock may be adjusted downward if the price of our common stock does not substantially increase or if we issue additional securities by June 30, 2002. Any of these downward adjustments could result in substantial additional dilution to our common stockholders.

WE MAY BE REQUIRED TO REDEEM OR PAY SUBSTANTIAL PENALTIES TO THE HOLDERS OF

THE SERIES A, B AND C PREFERRED STOCK AND RELATED WARRANTS IF SPECIFIC

EVENTS OCCUR.

In accordance with the terms of the documents relating to the issuance of the series A, B and C preferred stock and the related warrants, we are required to redeem or pay substantial penalties to a holder of the series A, B and C preferred shares under specific circumstances, including, among others:

- nonpayment of dividends on the series A, B and C preferred shares in a timely manner;

- failure to deliver shares of our common stock upon conversion of the series A, B and C preferred shares or upon exercise of the related warrants after a proper request;

- nonpayment of the redemption price at maturity of the series A, B and C preferred shares;

- failure to hold a meeting of our stockholders on or before September 30, 2000 to approve the issuance of the shares of common stock issuable upon conversion of and in lieu of cash dividends on the series A, B and C preferred stock and upon exercise of the related warrants;

- failure to comply with financial covenants regarding cash balances and cash burn rates; or

- failure to have a registration statement relating to the series A, B and C preferred shares and related warrants declared effective by the SEC on or before November 10, 2000, or after being declared effective, the unavailability of the registration statement to cover the resale of the shares of common stock underlying such securities.

POTENTIAL YEAR 2000 PROBLEMS WITH OUR INTERNAL OPERATING SYSTEMS OR THE SOFTWARE

PRODUCTS THAT WE RESELL COULD ADVERSELY AFFECT OUR BUSINESS.

Although to date we have not experienced any material problems attributable to the year 2000 problem with respect to our software products and internal systems, it is possible that software we distribute could contain undetected errors or defects associated with year 2000 date functions that may result in material costs or liabilities to us in the future. Moreover, the software we distribute interacts directly and indirectly with a large number of third-party hardware and software systems, each of which may contain or introduce undetected errors or defects. We are unable to predict to what extent our business may be affected if the software we distribute or the systems that operate in conjunction with that software experience a material year 2000 related failure. Any year 2000 defect in the software we distribute, or the software and hardware systems with which it operates, as well as any year 2000 errors caused by older non-current products that were not upgraded by our customers, could expose us to litigation that could require us to incur significant costs in defending the litigation or expose us to the risk of significant damages. The risks of this litigation may be particularly acute due to the mission-critical applications for which many of the products we distribute are used.

OUR MARKET MAY UNDERGO RAPID TECHNOLOGICAL CHANGE AND OUR FUTURE SUCCESS WILL

DEPEND ON OUR ABILITY TO MEET THE CHANGING NEEDS OF OUR INDUSTRY.

Our market is characterized by rapidly changing technology, evolving industry standards and frequent new product announcements. To be successful, we must adapt to our rapidly changing market by continually improving the performance, features and reliability of our services. We could incur substantial costs to modify our services or infrastructure in order to adapt to these changes. Our business could be adversely affected if we incur significant costs without adequate results, or find ourselves unable to adapt rapidly to these changes.

A DISASTER COULD SEVERELY DAMAGE OUR OPERATIONS.

We do not have a complete disaster recovery plan in effect and do not have fully redundant systems for our service at an alternate site. A disaster could severely damage our business and results of operations because our service could be interrupted for an indeterminate length of time. Our operations depend upon our ability to maintain and protect our computer systems, all of which are located in our principal headquarters in Orinda, California and at an offsite location managed by a third party in Santa Clara, California. Orinda and Santa Clara exist on or near known earthquake fault zones. Although the outside facility, which hosts our primary web and database servers, is designed to be fault tolerant, the system is vulnerable to damage from fire, floods, earthquakes, power loss, telecommunications failures, and similar events. Although we maintain insurance against fires, floods, earthquakes and general business interruptions, there can be no assurance that the amount of coverage will be adequate in any particular case.

ADDITIONAL GOVERNMENT REGULATIONS MAY INCREASE OUR COSTS OF DOING BUSINESS.

The law governing Internet transactions remains largely unsettled, even in areas where there has been some legislative action. The adoption or modification of laws or regulations relating to the Internet could adversely affect our business by increasing our costs and administrative burdens. It may take years to determine whether and how existing laws such as those governing intellectual property, privacy, libel and taxation apply to the Internet.

Laws and regulations directly applicable to communications or commerce over the Internet are becoming more prevalent. In its last two sessions, the United States Congress adopted Internet laws regarding children's privacy, copyrights and taxation. It appears that additional laws and regulations regarding protection of privacy on the Internet will be adopted at the state and federal levels in the United States. The European Union has enacted its own data protection and privacy directive, which required all 15 European Union Member States to implement laws relating to the processing and transmission of personal data by October 25, 1998. We must comply with these new regulations in both Europe and the United States, as well as any other regulations adopted by other countries where we may do business. The growth and development of the market for online commerce may prompt calls for more stringent consumer protection laws, both in the United States and abroad. Compliance with any newly adopted laws may prove difficult for us and may negatively affect our business.

YOU SHOULD NOT RELY ON FORWARD-LOOKING STATEMENTS BECAUSE THEY ARE INHERENTLY

UNCERTAIN.

You should not rely on forward-looking statements in this quarterly report. This quarterly report also contains forward-looking statements that involve risks and uncertainties. We use words such as "anticipates," "believes," "plans," "expects," "future," "intends" and similar expressions to identify such forward-looking statements. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this quarterly report. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us described below and elsewhere in this quarterly report.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company's exposure to market risk for changes in interest rates relate primarily to the Company's investment portfolio. The Company has not used derivative financial instruments in its investment portfolio. The Company places its investments with high quality issuers and, by policy, limits the amount of credit exposure to any one issue or issuer. At May 31, 2000 $14.6 million of the Company's cash, cash equivalents and investment portfolio carried maturity dates of less than 90 days, $3.5 million carried maturity dates of less than one year. The effect of changes in interest rates of +/- 10% over a six-month horizon would not have a material effect on the fair market value of the portfolio.