NETM Netmanage (MM)

NETMANAGE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Interim financial data:

The accompanying interim unaudited condensed consolidated financial statements of NetManage, Inc. and subsidiaries (the “Company” or “NetManage”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“generally accepted accounting principles”) for interim financial information and in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation. Actual results for fiscal year 2007 could differ materially from those reported in this quarterly report on Form 10-Q. The Company believes the results of operations for interim periods are subject to fluctuation and may not be an indicator of future financial performance. The financial statements should be read in conjunction with the audited financial statements and notes thereto, included in the Company’s annual report on Form 10-K for the year ended December 31, 2006, as filed with the Securities and Exchange Commission on April 2, 2007 and as amended on April 30, 2007.

2. Summary of significant accounting policies:

Principles of consolidation

The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated.

Use of estimates

The preparation of condensed consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Foreign currency translation, foreign exchange contracts and comprehensive income (loss)

The functional currency of the Company’s foreign subsidiaries is the local currency. Gains and losses resulting from the translation of the foreign subsidiaries’ financial statements are included in accumulated other comprehensive income (loss) and reported as a separate component of stockholders’ equity. Gains and losses resulting from foreign currency transactions are included in net income (loss).

The Company currently does not enter into financial instruments for either trading or speculative purposes. There were no forward foreign exchange contracts used during the three and nine month periods ended September 30, 2007 and 2006.

Total comprehensive income (loss) is comprised of net income (loss) and other comprehensive earnings (losses) such as foreign currency translation gains or losses and unrealized gains or losses on available-for-sale marketable securities.

Cash and cash equivalents

Cash and cash equivalents includes all money deposited with financial institutions that can be withdrawn without notice and all short-term, highly liquid investments that are readily convertible to cash.

Investments

The Company accounts for its investments under the provisions of the Financial Accounting Standards Board’s (FASB) Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities . Under SFAS No. 115, the Company’s investments are classified as either available-for-sale or held-to-maturity securities. All available-for-sale securities are reported at fair value and held-to-maturity investments are valued using the amortized cost method. For available-for-sale securities, any unrealized gains and losses, net of tax, are reported in the condensed consolidated balance sheet as “Accumulated other comprehensive loss.”

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The following table summarizes the Company’s cash, cash equivalents and short-term investments as of September 30, 2007 (in thousands):

The following table summarizes the Company’s cash, cash equivalents, short-term and long-term investments as of December 31, 2006 (in thousands):

The contractual maturity dates for held-to-maturity securities and time deposits as of September 30, 2007 are all within the next twelve months.

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Property and equipment

Property and equipment are recorded at cost. Improvements, renewals and extraordinary repairs that extend the lives of the asset are capitalized; other repairs and maintenance are expensed as incurred. Depreciation and amortization is computed using the straight-line method over the following estimated useful lives:

Depreciation and amortization expense for the three and nine month periods ended September 30, 2007 was $0.2 million and $0.7 million, respectively. Depreciation and amortization expense for the three and nine month periods ended September 30, 2006 was $0.3 million and approximately $0.8 million, respectively.

Goodwill and other intangible assets, net

NetManage reviews for impairment of long-lived assets and certain identifiable intangibles whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. NetManage evaluates possible impairment of long-lived assets using estimates of undiscounted future cash flows. Impairment loss to be recognized is measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Management evaluates the fair value of long-lived assets and intangibles using primarily the estimated discounted future cash flows method.

Goodwill and other assets with indefinite lives are not amortized but are reviewed for impairment under SFAS No. 142, Goodwill and Other Intangible Assets . NetManage performs an annual impairment review during the fourth quarter of each year or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Under SFAS No. 142, goodwill impairment may exist if the net book value of a reporting unit exceeds its estimated fair value.

The following table provides a summary of the carrying amounts of other intangible assets that will continue to be amortized (in thousands):

The remaining net carrying amount of other intangible assets is expected to be amortized as follows (in thousands):

The aggregate amortization expense for the three and nine month periods ended September 30, 2007 was $0.1 million and $0.3 million, respectively. For the three and nine month periods ended September 30, 2006 the aggregate amortization expense was $0.2 million and $0.5 million, respectively.

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Accrued liabilities

Accrued liabilities at September 30, 2007 and December 31, 2006 consisted of the following (in thousands):

Other Long-term liabilities

Other Long-term liabilities at September 30, 2007 and December 31, 2006 consisted of the following (in thousands):

Concentrations of credit risk

Financial instruments, which potentially subject NetManage to concentrations of credit risk, consist principally of cash investments and trade receivables. NetManage has a cash investment policy that limits the amount of credit exposure to any one issuer and restricts placement of these investments to issuers evaluated as less than creditworthy. Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers comprising NetManage’s customer base and their dispersion across many different industries and geographies. No single customer accounted for more than 10% of accounts receivable as of September 30, 2007 and December 31, 2006. There were no customers that accounted for more than 10% of consolidated net revenues in the three and nine month periods ended September 30, 2007 and 2006.

Net income (loss) per share

Basic net income (loss) per share data has been computed using the weighted-average number of shares of common stock outstanding during the indicated periods. Diluted net income (loss) per share data has been computed using the weighted-average number of shares of common stock and potential dilutive common shares. Potential dilutive common shares include dilutive shares issuable upon the exercise of outstanding common stock options computed using the treasury stock method.

For the three and nine month periods ended September 30, 2007 and 2006, potentially dilutive securities, consisting of applicable stock options, are as shown in the following table. In the period in which a net loss is recorded, the potentially dilutive securities are not included in the computation of diluted net loss per share because to do so would be anti-dilutive.

The following table sets forth the computation of basic and diluted net income (loss) per share for the three and nine month periods ended September 30, 2007 and 2006 (in thousands, except per share amounts):

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Revenue recognition

NetManage derives revenue primarily from two sources: (1) product revenue, which includes software license and royalty revenue, and (2) support and services revenue, which includes software license maintenance and, to a lesser extent, consulting services. NetManage licenses its software products on a term and a perpetual basis. Its term-based arrangements are primarily for a period of 12 months. NetManage also licenses its software in both source code and object code format. NetManage applies the provisions of the American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 97-2, Software Revenue Recognition, and related amendments and interpretations to all transactions involving the licensing of software products.

NetManage recognizes revenue from the sale of software licenses to end users and resellers when the following criteria are met: persuasive evidence of an arrangement exists, the product has been delivered, the fee is fixed or determinable, and collection of the resulting receivable is reasonably assured. Delivery occurs when the product is delivered to a common carrier or when a software key has been transmitted to the customer.

Product is sold, without the right of return, except for distributor inventory rotation of old or excess product. Certain sales are made to North American distributors under agreements allowing rights of return and price protection on unsold merchandise. Accordingly, the Company defers recognition of such sales until the distributor sells the merchandise. NetManage recognizes sales to international resellers upon shipment, provided all other revenue recognition criteria have been met. NetManage gives rebates to customers on a limited basis. Both returns and rebates are included in the Company’s Condensed Consolidated Statements of Operations as a reduction of revenue.

At the time of the transaction, the Company assesses whether the fee associated with a revenue transaction is fixed or determinable and whether or not collection is reasonably assured. NetManage assesses whether the fee is fixed or determinable based on the payment terms associated with the transaction. If a significant portion of a fee is due after its normal payment terms, the Company accounts for the fee as not being fixed or determinable. In these cases, the Company recognizes revenue as the fees become due if the customer is credit-worthy or upon receipt of payment if the customer is not credit-worthy.

NetManage assesses whether or not collection is reasonably assured based on a number of factors, including past transaction history with the customer and the credit-worthiness of the customer. The Company does not request collateral from its customers. If collection of a fee is not reasonably assured, the Company recognizes revenue at the time collection becomes reasonably assured, which is generally upon receipt of payment.

For all sales, except those completed over the Internet, NetManage uses either a binding purchase order or equivalent customer commitment or signed license agreement as evidence of an arrangement. For sales over the Internet, it uses a credit card authorization as evidence of an arrangement. Sales through the Company’s distributors are evidenced by a master agreement governing the relationship together with binding purchase orders on a transaction-by-transaction basis.

For arrangements with multiple elements (for example, undelivered maintenance and support), the Company allocates revenue to each element of the arrangement based on vendor-specific objective evidence (VSOE) of the fair value of the undelivered elements. This means that revenue is deferred from the arrangement fee equivalent to the fair value of the undelivered elements. Fair values for the ongoing maintenance and support obligations are generally based upon separate sales of renewals to other customers or upon renewal rates quoted in the sales contracts. Fair value of services, such as training or consulting, is based upon separate sales of these services to other customers. However, if an arrangement includes an acceptance provision, acceptance occurs upon the earlier of receipt of a written customer acceptance or expiration of the acceptance period.

Service revenues are derived from providing customers with software updates for existing software products, user documentation and technical support under annual service agreements. These revenues are recognized ratably over the terms of such agreements. If such services are included in the initial licensing fee, the value of the services, determined based on VSOE of fair value, is unbundled and recognized ratably over the related service period. Service revenues derived from consulting and training are deferred and recognized when the services are performed and collection is deemed probable. To date, consulting revenue has not been significant.

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Income taxes

The Company accounts for income taxes under the liability method. Under the liability method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company is required to adjust its deferred tax liabilities in the period when tax rates or the provisions of the income tax laws change. Valuation allowances are established when necessary to reduce deferred tax assets to amounts that, more likely than not, are expected to be realized.

As part of the process of preparing condensed consolidated financial statements, the Company is required to estimate income taxes in each of the jurisdictions in which the Company operates. This process requires the Company to estimate its actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the condensed consolidated balance sheet. The Company must then assess the likelihood that its deferred tax assets will be recovered from future taxable income and to the extent it believes that recovery is not likely, a valuation allowance is established. Any adjustment to the valuation allowance in a period is recorded in the tax provision in the Condensed Consolidated Statement of Operations.

NetManage adopted FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109 (FIN 48) on January 1, 2007. This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109 and prescribes a minimum recognition threshold of more-likely-than-not to be sustained upon examination that a tax position must meet before being recognized in the financial statements. Under FIN 48, the impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Additionally, FIN 48 provides guidance on de-recognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition.

As a result of the adoption of FIN 48, the Company recognized a $23.1 million decrease in the deferred tax assets for unrecognized tax benefits related to tax positions taken in prior periods. This amount was fully offset by a valuation allowance. As such, this decrease has no impact to retained earnings in accordance with the provisions of FIN 48. At the adoption date, we had $24.1 million of unrecognized tax benefits, of which $24.0 million would affect the Company’s effective tax rate if recognized, without consideration of the related valuation allowance previously recorded. The Company did not recognize any adjustment to reserves for uncertain tax positions as a result of the implementation of FIN 48. Additionally, the Company reclassified $178,000 from current taxes payable to long-term taxes payable as of the adoption date. During the first three quarters of 2007, the Company’s FIN 48 reserve increased by $37,000, including $3,000 of accrued interest. The Company does not anticipate any unrecognized tax benefits in the next twelve months that would result in a material change to its financial position.

During the first three quarters of 2007 the Company recognized a $489,000 decrease in the deferred tax assets for unrecognized tax benefits related to tax positions taken in current period. This amount was fully offset by a valuation allowance.

The Company includes interest and penalties recognized in accordance with FIN 48 in the financial statements as a component of income tax expense. The Company had $11,000 of accrued interest at December 31, 2006.

Although the Company files U.S. federal, U.S. state, and foreign tax returns, the Company’s major tax jurisdictions are the U.S., Canada and Israel. The Company’s 1998-2006 tax years remain subject to examination by the IRS for U.S. federal tax purposes and the Company’s 2002-2006 tax years remain subject to examination by the appropriate governmental agencies for Canada and Israel tax purposes.

Share-based compensation

The fair value of the Company’s stock options granted to employees for the three and nine month periods ended September 30, 2007 and 2006, respectively, was estimated using the following weighted-average assumptions:

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Share-based compensation expense

Cost of revenues and operating expenses for the three and nine month periods ended September 30, 2007 and 2006, respectively includes share based compensation related to the adoption of SFAS No. 123(R), Share-Based Payment (SFAS 123(R)).

As required by SFAS 123(R), management made an estimate of expected forfeitures and is recognizing compensation costs only for those equity awards expected to vest.

At September 30, 2007, the total compensation cost related to unvested share-based awards granted to employees and directors under the Company’s stock option plans but not yet recognized was approximately $0.9 million, net of estimated forfeitures of $1.0 million. This cost will be amortized on a straight-line basis over a weighted-average period of approximately 2.8 years and will be adjusted for subsequent changes in estimated forfeitures.

Stock options and awards activity

The following is a summary of option activity for our stock option plans for the three month period ended September 30, 2007 (in thousands, except per share amounts):

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The following is a summary of option activity for our stock option plans for the nine month period ended September 30, 2007 (in thousands, except per share amounts):

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the market price of the Company’s common stock for the 1.1 million exercisable options where the market price was higher than the exercise price at September 30, 2007.

The aggregate intrinsic value of options exercised under the Company’s stock option plans, determined as of the date of the option exercise, was $14,051 and $40,142, respectively, for the three month periods ended September 30, 2007 and 2006, respectively. For the nine month periods ended September 30, 2007 and 2006, respectively, the aggregate intrinsic value of options exercised under the Company’s stock option plans, determined as of the date of the option exercise, was $119,529 and $133,479, respectively.

Recent accounting pronouncements

In February 2007, The Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115 (SFAS No. 159). SFAS No. 159 expands the use of fair value accounting but does not affect existing standards which require assets or liabilities to be carried at fair value. The objective of SFAS No. 159 is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Under SFAS No. 159, a company may elect to use fair value to measure eligible items at specified election dates and report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. Eligible items include, but are not limited to, accounts and loans receivable, available-for-sale and held-to-maturity securities, equity method investments, accounts payable, guarantees, issued debt and firm commitments. If elected, SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently assessing whether fair value accounting is appropriate for any of its eligible items and cannot estimate the impact, if any, on its results of operations and financial position.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (SFAS 157). SFAS 157 defines fair value, establishes guidelines for measuring fair value and expands disclosure requirements regarding fair value measurements. SFAS 157 does not require any new fair value measurements but simply eliminates inconsistencies in guidance as found in various prior accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, however earlier adoption is permitted, provided the Company has not yet issued financial statements, including interim periods, for that fiscal year. The Company is evaluating the requirements of SFAS 157 but does not expect that the adoption of SFAS 157 will have a significant impact on its Condensed Consolidated Financial Statements.

In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108 Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements , (SAB 108). SAB 108 provides interpretive guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of materiality assessment. SAB 108 requires that registrants consider both a ‘rollover’ method that focuses on the income statement impact of misstatements and the ‘iron curtain’ method that focuses on the balance sheet impact of misstatements. In the year of adoption, SAB 108 allows a one-time cumulative effect transition adjustment for errors that were not previously considered material, but are material under the provisions of SAB 108. SAB 108 must be applied to annual financial statements for fiscal years ending after November 15, 2006. The adoption of SAB 108 did not have an impact on the consolidated financial statements.

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In June 2006, the FASB issued FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109 (FIN 48) which clarifies the accounting for uncertainty in tax positions. This interpretation requires the Company to recognize in its financial statements the impact of a tax position if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The Company adopted the provisions of FIN 48 on January 1, 2007. Upon implementing FIN 48 and performing the analysis, the Company did not recognize any increase or decrease to reserves for uncertain tax positions.

3. Restructuring charges (recoveries):

The Company accrues for restructuring costs when it makes a commitment to a firm exit plan that specifically identifies all significant actions to be taken in conjunction with its response to a change in its strategic plan, product demand, expense structure or other factors such as the date it ceases to use a facility. The Company reassesses its prior restructuring accruals on a quarterly basis to reflect changes in the costs of its restructuring activities, and the Company records new restructuring accruals as commitments are made. Estimates are based on anticipated costs of such restructuring activities and are subject to change.

On February 22, 2007, the Company implemented a restructuring of operations designed to align its business units with its core business functions, to relocate certain of its functional operations, and to reduce operating expenses. As part of the restructuring, the Company reduced its workforce in excess of 10% and recorded a $2.0 million charge to operating expenses in the first three quarters of 2007. The distribution of this reduction in workforce is as follows:

The restructuring charge included approximately $1.0 million of expenses related to facilities no longer needed as of September 30, 2007 for company operations and approximately $1.3 million of employee and other-related expenses for employee terminations. The execution of the restructuring actions will require total cash expenditures of $2.3 million. These restructuring costs are expected to be funded from internal operations and existing cash balances. In the third quarter of 2007, the Company received a release of liability for leased office space in Ottawa, Canada. The release of liability resulted in the reduction of approximately $215,000 from the February 2007 restructuring reserve and approximately $126,000 and $40,000 of deferred rent respectively from other long-term liabilities and accrued liabilities respectively.

As of September 30, 2007, the Company had incurred costs totaling approximately $2.0 million related to the restructuring, which required approximately $1.2 million in cash expenditures. The remaining reserve related to this restructuring which is included in the accrued liabilities is approximately $788,000 of which $669,000 is included in accrued liabilities and $119,000 is included in long-term liabilities.

The following table lists the components of the February 2007 restructuring reserve for the nine month period ended September 30, 2007 (in thousands):

On January 31, 2003, the Company announced a restructuring of its operations in response to the sluggish North America and European economies. The Company concluded that it was necessary to refocus its operations and reduce its operating expenses and initially recorded $3.2 million in restructuring charges to its operating expenses. The Company subsequently recorded a reduction to the restructuring charge of $0.3 million primarily related to a sublease in Ottawa, Canada and for employee severance costs in Europe. The Company anticipates that the execution of the restructuring actions

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will require total cash expenditures of $2.8 million, which is expected to be funded from operations and existing cash balances. In the three month period ended March 31, 2006, the Company recorded an increase in the restructuring charge of $7,000 as an adjustment to the expected facility obligations in Ottawa, Canada. As of September 30, 2007, the Company had incurred net costs totaling $2.8 million related to the restructuring, which has required $2.8 million in cash expenditures. As of September 30, 2007, there are no more obligations for restructuring reserve related to the January 2003 restructuring.

The following table lists the components of the January 2003 restructuring reserve for the nine month period ended September 30, 2007 (in thousands):

In August 1998, following the acquisition of FTP Software Inc. (FTP), the Company initiated a plan to restructure its worldwide operations as a result of business conditions and in connection with the integration of the operations of FTP. In connection with this plan, the Company recorded a $7.0 million charge to operating expenses in 1998. For the nine month period ended September 30, 2007, the Company recorded a change in estimate of $353,000. The change in estimate is composed of adjustments to expected lease, sublease and associated obligations related to the Birmingham, U.K. facility and related foreign exchange adjustments on the long-term lease commitments and related sublease income. The remaining reserve related to this restructuring at September 30, 2007 is $457,000 of which $105,000 is included in accrued liabilities and $352,000 is included in long-term liabilities.

The following table lists the components of the FTP restructuring reserve for the nine month period ended September 30, 2007 (in thousands):