INTERWOVEN INC
10-Q, 2000-11-14
PREPACKAGED SOFTWARE
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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-Q

[X]  Quarterly report pursuant to Section 13 or 15(d) of the Securities
     Exchange Act of 1934

               For the quarterly period ended September 30, 2000

                                       or

[_]  Transition report pursuant to Section 13 or 15(d) of the Securities
     Exchange Act of 1934

   For the transition period from       to

                        Commission File Number 000-27389

                                INTERWOVEN, INC.
             (Exact name of Registrant as specified in its charter)

                Delaware                               77-0523543
    (State or other jurisdiction of                 (I.R.S. Employer
     incorporation or organization)              Identification Number)

 1195 West Fremont Avenue, Suite 2000,                   94087
             Sunnyvale, CA                             (Zip Code)
    (Address of principal executive
                offices)

                                 (408) 774-2000
              (Registrant's telephone number including area code)

   Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]

   There were 49,843,200 shares of the Company's Common Stock, par value
$0.001, outstanding on November 2, 2000.

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<PAGE>

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                            Page
                                                                            No.
                                                                            ----
<S>                                                                         <C>
                       PART I FINANCIAL INFORMATION
Item 1--Financial Statements:
  Condensed Consolidated Balance Sheets as of September 30, 2000 and
   December 31, 1999.......................................................   3
  Condensed Consolidated Statements of Operations for the Three and Nine
   Months Ended September 30, 2000 and 1999................................   4
  Condensed Consolidated Statements of Cash Flows for the Nine Months Ended
   September 30, 2000 and 1999.............................................   5
  Notes to Condensed Consolidated Financial Statements.....................   6
Item 2--Management's Discussion and Analysis of Financial Condition and
 Results of Operations.....................................................  12
Item 3--Quantitative and Qualitative Disclosures about Market Risk.........  28
                         PART II OTHER INFORMATION
Item 1--Legal Proceedings..................................................  29
Item 2--Changes in Securities and Use of Proceeds..........................  29
Item 3--Defaults upon Senior Securities....................................  29
Item 4--Submission of Matters to a Vote of Securities Holders..............  29
Item 5--Other Information..................................................  29
Item 6--Exhibits and Reports on Form 8-K...................................  30
SIGNATURE..................................................................  31
</TABLE>

                                       2
<PAGE>

PART 1 FINANCIAL INFORMATION

Item 1 Financial Statements

                                INTERWOVEN, INC.

                     CONDENSED CONSOLIDATED BALANCE SHEETS
                    (In thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                    September 30, December 31,
                                                        2000          1999
                                                    ------------- ------------
                                                     (unaudited)
<S>                                                 <C>           <C>
                      ASSETS
Current assets:
  Cash and cash equivalents........................   $ 53,966      $ 10,983
  Short-term investments...........................    106,510        44,665
  Accounts receivable, net of allowance for
   doubtful accounts of $500 and $288,
   respectively....................................     37,474         5,158
  Prepaid expenses.................................      5,272           787
  Other current assets.............................      1,763           559
                                                      --------      --------
    Total current assets...........................    204,985        62,152
Investments........................................     57,021        16,464
Property and equipment, net........................      9,554         3,145
Intangible assets, net.............................     80,726           416
Restricted cash....................................        605           605
Other assets.......................................        689           297
                                                      --------      --------
                                                      $353,580      $ 83,079
                                                      ========      ========
       LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable.................................   $  2,828      $    834
  Accrued liabilities..............................     25,629         4,966
  Deferred revenue.................................     26,828         1,939
                                                      --------      --------
    Total current liabilities......................     55,285         7,739
Stockholders' Equity:
Preferred stock, $0.001 par value, no shares
 authorized, issued or outstanding.................         --            --
Common Stock, 100,000 shares authorized, 49,500
 (unaudited) and 45,773 issued and outstanding.....         24            23
Additional paid-in capital.........................    343,701       106,214
Notes receivable from stockholders.................       (105)         (202)
Deferred stock-based compensation..................     (7,208)       (4,732)
Accumulated deficit................................    (38,117)      (25,963)
                                                      --------      --------
    Total stockholders' equity.....................    298,295        75,340
                                                      --------      --------
                                                      $353,580      $ 83,079
                                                      ========      ========
</TABLE>

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

                                       3
<PAGE>

                                INTERWOVEN, INC.

                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                    (In thousands, except per share amounts)

<TABLE>
<CAPTION>
                                           Three Months
                                          Ended September    Nine Months Ended
                                                30,            September 30,
                                         ------------------  ------------------
                                           2000      1999      2000      1999
                                         --------  --------  --------  --------
                                                     (unaudited)
<S>                                      <C>       <C>       <C>       <C>
Revenues:
  License..............................  $ 26,538  $  2,556  $ 51,347  $  5,814
  Services.............................    12,878     1,701    26,190     3,447
                                         --------  --------  --------  --------
    Total revenues.....................    39,416     4,257    77,537     9,261
Cost of revenues:
  License..............................       317        28       584       147
  Services.............................    11,610     2,113    24,172     3,542
                                         --------  --------  --------  --------
    Total cost of revenues.............    11,927     2,141    24,756     3,689
Gross profit...........................    27,489     2,116    52,781     5,572
Operating expenses:
  Research and development.............     5,091     1,229    10,487     2,930
  Sales and marketing..................    21,212     3,833    45,130     9,058
  General and administrative...........     3,708       833     8,476     2,077
  Amortization of deferred stock-based
   compensation........................     1,504     1,017     2,954     2,685
  Amortization of acquired intangible
   assets..............................     5,006       249     5,109       249
  Writeoff of in-process research &
   development.........................     1,724        --     1,724        --
                                         --------  --------  --------  --------
    Total operating expenses...........    38,245     7,161    73,880    16,999
Loss from operations...................   (10,756)   (5,045)  (21,099)  (11,427)
Interest income and other income
 (expense), net........................     3,070       262     8,945       416
                                         --------  --------  --------  --------
Net loss...............................    (7,686)   (4,783)  (12,154)  (11,011)
                                         ========  ========  ========  ========
Accretion of mandatorily redeemable
 convertible preferred stock to
 redemption value......................        --    (6,877)       --   (13,227)
                                         --------  --------  --------  --------
Net loss attributable to common
 stockholders..........................  $ (7,686) $(11,660) $(12,154) $(24,238)
                                         ========  ========  ========  ========
Basic and diluted net loss per share
 (Note 1)..............................  $  (0.16) $  (1.36) $  (0.27) $  (3.26)
                                         ========  ========  ========  ========
Shares used in computing basic and
 diluted net loss per share............    46,953     8,594    45,128     7,444
                                         ========  ========  ========  ========
Pro forma basic and diluted net loss
 per share (Note 1)....................  $  (0.16) $  (0.14) $  (0.27) $  (0.37)
                                         ========  ========  ========  ========
Shares used in computing pro forma
 basic and diluted net loss per share..    46,953    33,740    45,128    29,914
                                         ========  ========  ========  ========
</TABLE>

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

                                       4
<PAGE>

                                INTERWOVEN, INC.

                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)

<TABLE>
<CAPTION>
                                                           Nine Months Ended
                                                             September 30,
                                                           -------------------
                                                             2000       1999
                                                           ---------  --------
                                                              (unaudited)
<S>                                                        <C>        <C>
Cash flows from operating activities:
Net loss.................................................. $ (12,154) $(11,011)
  Adjustments to reconcile net loss to net cash provided
   by (used in) operating activities:
    Depreciation..........................................     1,711       589
    Amortization of deferred stock-based compensation.....     2,954     2,685
    Amortization of acquired intangible assets............     5,109       249
    Issuance of Common Stock for services.................        --        27
    Provisions for doubtful accounts......................       212        18
    Writeoff of in-process research and development.......     1,724        --
  Changes in assets and liabilities, net of business
   combination:
    Accounts receivable...................................   (32,528)      (34)
    Prepaid expenses and other assets.....................    (7,429)   (1,177)
    Accounts payable......................................     1,994       695
    Accrued liabilities...................................    19,120       994
    Deferred revenue......................................    24,889     1,824
                                                           ---------  --------
      Net cash provided by (used in) operating
       activities.........................................     5,602    (5,141)
                                                           ---------  --------
Cash flows from investing activities:
Purchase of property and equipment........................    (8,055)   (1,269)
Purchases of investments..................................  (138,932)   (9,428)
Maturities of investments.................................    36,530         9
Cash paid for businesses acquired, net....................    (8,000)       --
                                                           ---------  --------
      Net cash used in investing activities...............  (118,457)  (10,688)
                                                           ---------  --------
Cash flows from financing activities:
Proceeds from exercise of Series B warrants into common
 stock....................................................        10        --
Proceeds from Series E Preferred Stock, net...............        --    18,462
Proceeds from issuance of Common Stock through stock
 options & ESPP plan......................................     3,343       831
Proceeds from issuance of Common Stock for follow-on
 offering.................................................   152,388        --
Repayment of stockholders loans...........................        97       240
Repurchase of Common Stock................................        --       (10)
Principal payments on debt and leases.....................        --      (140)
                                                           ---------  --------
      Net cash provided by financing activities...........   155,838    19,383
                                                           ---------  --------
Net increase in cash and cash equivalents.................    42,983     3,554
Cash and cash equivalents at beginning of period..........    10,983     9,022
                                                           ---------  --------
Cash and cash equivalents at end of period................ $  53,966  $ 12,576
                                                           =========  ========
</TABLE>

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

                                       5
<PAGE>

                               INTERWOVEN, INC.

             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. The Company and Summary of Significant Accounting Policies:

 The Company

   Interwoven, Inc. (the "Company") is a leading provider of software products
and services that help businesses and other organizations manage the
information that makes up the content of their web sites. In the Internet
industry this is often referred to as "web content management." The Company's
flagship software product, TeamSite, is designed to help customers develop,
maintain and extend large web sites that are essential to their businesses.
The Company also markets and sells its software products and services through
its wholly-owned subsidiaries in Australia, Canada, Germany, Hong Kong, Japan,
the Netherlands, Singapore and the United Kingdom. During the quarter ended
September 30, 2000, the Company incorporated wholly-owned subsidiaries in
France and Sweden.

 Basis of Presentation

   The unaudited interim condensed consolidated financial statements have been
prepared on the same basis as the annual consolidated financial statements
and, in the opinion of management, reflect all adjustments, which include only
normal recurring adjustments, necessary to present fairly the Company's
financial position, results of operations and cash flows as of September 30,
2000 and 1999. These condensed consolidated financial statements and notes
thereto are unaudited and should be read in conjunction with the Company's
audited financial statements and related notes included in the Company's 1999
Annual Report on Form 10-K. The results of operations for the nine months
ended September 30, 2000 are not necessarily indicative of results that may be
expected for any other interim period or for the full fiscal year.

 Revenue recognition

   In October 1997 and March 1998, the American Institute of Certified Public
Accountants ("AICPA") issued Statement of Position No. 97-2, "Software Revenue
Recognition" ("SOP No. 97-2") and Statement of Position No. 98-4, "Deferral of
the Effective Date of a Provision of SOP No. 97-2" ("SOP No. 98- 4"). SOP 98-4
deferred for one year the application of certain provisions of SOP 97-2. In
December 1998, the AICPA issued Statement of Position No. 98-9, "Modification
of SOP No. 97-2 with Respect to Certain Transactions" ("SOP No. 98-9"), which
is effective for transactions entered into beginning April 1, 1999. SOP 98-9
extends the effective date of SOP 98-4 and provides additional interpretive
guidance. The adoption of SOP 97-2, SOP 98-4 and SOP 98-9 have not had and are
not expected to have a material impact on the Company's results of operations,
financial position or cash flows.

   The Company's revenues are derived from licenses of its software products
and from services the Company provides to its customers. Revenues are
recognized for the various contract elements based upon vendor-specific
objective evidence of fair value of each element.

   License revenues are recognized when persuasive evidence of an agreement
exists, the product has been delivered, no significant post-delivery
obligations remain, the license fee is fixed or determinable and collection of
the fee is probable. The Company does not offer product return rights to
resellers or end users.

   Services revenues consist of professional services and maintenance fees.
Professional services primarily consists of software installation and
integration, business process consulting and training. Professional services
are billed on a time and materials basis and revenues are recognized as the
services are performed. Maintenance agreements are typically priced based on a
percentage of the product license fee and have a one-year term, renewable
annually. Services provided to customers under maintenance agreements include
technical product support and unspecified product upgrades. Deferred revenues
from advanced payments for maintenance agreements are recognized ratably over
the term of the agreement, which is typically one year.

                                       6
<PAGE>

                               INTERWOVEN, INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


 Principles of consolidation

   The condensed consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries after elimination of all significant
intercompany accounts and transactions.

 Use of estimates

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

 Comprehensive income

   Statement of Financial Accounting Standard (SFAS) No. 130, "Reporting
Comprehensive Income" establishes standards for reporting comprehensive income
and its components in financial statements. Comprehensive income, as defined,
includes all changes in equity (net assets) during a period from non-owner
sources. As of September 30, 2000 and 1999, the Company had not had any
transactions that were required to be reported in comprehensive income.

 Segment information

   The Company identifies its operating segment based on business activities,
management responsibility and geographic location. During all periods
presented, the Company operated in a single business segment. Through
September 30, 2000, foreign operation revenues or investments in foreign
operation long-lived assets have not been significant.

 Cash, cash equivalents and investments

   The Company considers all highly liquid investments with a maturity from
date of purchase of three months or less to be cash equivalents. Cash and cash
equivalents consist primarily of cash on deposit with banks and high-quality
money market instruments. All other liquid investments are classified as
short-term investments and long-term investments. Short-term investments and
long-term investments consist of commercial paper and corporate bonds.

   The Company determines the appropriate classification of investment
securities at the time of purchase and reevaluates such designation as of each
balance sheet date. At September 30, 2000, all investment securities were
designated as available-for-sale. Available-for-sale securities are carried at
fair value, using available market information and appropriate valuation
methodologies, with unrealized gains and losses reported within stockholders'
equity.

   Realized gains and losses and declines in value judged to be other-than-
temporary on available-for-sale securities are included in the statement of
operations. There were no such transactions in the nine months ended September
30, 2000. The cost of securities sold is based on the specific identification
method. Interest and dividends on securities classified as available-for-sale
are included in interest income within the consolidated statement of
operations.

   At September 30, 2000, the Company's available-for-sale securities
consisted of commercial paper $61.2 million, corporate notes $3.1 million,
corporate bonds $36.7 million, foreign debt securities $3.7 million, municipal
bonds $7.6 million, medium term notes $8.2 million, United States government
agencies $76.8 million

                                       7
<PAGE>

                               INTERWOVEN, INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

and money market funds $14.2 million. Of these securities, $48.1 million,
$106.5 million and $57.0 million were classified as cash equivalents, short-
term investments and long-term investments, respectively. The estimated fair
value of investments classified by the date of contractual maturity due within
one year is $154.6 million and due after one year is $57.0 million.

   As of September 30, 2000 the difference between the fair value and the
amortized cost of available-for-sale securities was insignificant; therefore,
no unrealized gains or losses were recorded in stockholders' equity. For the
nine months ended September 30, 2000, there were no realized gains and losses.

Note 2. Net loss per share

   The Company computes net loss per share in accordance with SFAS No. 128,
"Earnings per Share" and SEC Staff Accounting Bulletin (SAB) No. 98. Under the
provisions of SFAS No. 128 and SAB No. 98, basic net loss per share is
computed by dividing the net loss attributed to common stockholders for the
period by the weighted average number of shares of common stock outstanding
during the period excluding shares of common stock subject to repurchase. Such
shares of common stock subject to repurchase equaled an aggregate total of
4,199,442 (unaudited) and 2,259,686 (unaudited) as of September 30, 2000 and
1999, respectively.

   The following table sets forth the computation of basic and diluted net
loss per share for the periods indicated (in thousands, except per share
amounts):

<TABLE>
<CAPTION>
                                            Three months       Nine months
                                                ended             ended
                                            September 30,     September 30,
                                           ----------------  -----------------
                                            2000     1999     2000      1999
                                           -------  -------  -------  --------
                                             (unaudited)       (unaudited)
<S>                                        <C>      <C>      <C>      <C>
Numerator:
  Net loss attributable to common
   stockholders...........................  (7,686) (11,660) (12,154)  (24,238)
Denominator:
  Weighted average shares.................  49,213   12,793   54,399    20,100
  Weighted average unvested common stock
   subject to repurchase..................  (2,260)  (4,199)  (9,271)  (12,656)
                                           -------  -------  -------  --------
  Denominator for basic and diluted
   calculation............................  46,953    8,594   45,128     7,444
                                           -------  -------  -------  --------
Net loss per share:
  Basic and diluted....................... $ (0.16) $ (1.36) $ (0.27) $  (3.26)
                                           =======  =======  =======  ========
</TABLE>

Note 3. Pro forma net loss per share

   Pro forma net loss per share is computed using the weighted average number
of shares of common stock outstanding, including the pro forma effects of the
exercise of warrants and automatic conversion of the Company's Series A, B, C,
D and E Preferred Stock into shares of common stock effective upon the closing
of the Company's initial public offering as if such conversion occurred at the
beginning of the period, or at the date of issuance, if later. The resulting
pro forma adjustment for the three months ended September 30, 2000 and 1999
and the nine months ended September 30, 2000 and 1999 includes (i) an increase
in the weighted average shares used to compute the basic net loss per share of
0 (unaudited), 25,145,242 (unaudited), 0 (unaudited) and 22,468,383
(unaudited), respectively, and (ii) a decrease in the net loss attributable to
common stockholders for the accretion of mandatorily redeemable convertible
preferred stock of $0, $6,877,000 (unaudited), $0 and $13,227,000 (unaudited),
respectively. The calculation of diluted net loss per share excludes potential
shares of common stock as their effect would be antidilutive. Pro forma
potential common stock consists of common stock subject to repurchase rights
and shares of common stock issuable upon the exercise of stock options.

                                       8
<PAGE>

                               INTERWOVEN, INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


Note 4. Follow-on offering

   In February 2000, the Company completed its follow-on offering of 6,000,000
shares of common stock at $80.50. The Company sold 2,000,000 shares in this
offering and selling stockholders sold 4,000,000 shares. Net proceeds to the
Company were $152.4 million.

Note 5. Stock Split

   On June 1, 2000 the Company's Board of Directors approved a two-for-one
stock split of the outstanding shares of common stock in the form of a stock
dividend. These shares were distributed on July 13, 2000. All share and per
share information included in these consolidated financial statements have
been retroactively adjusted to reflect this stock split.

Note 6. 2000 Stock Incentive Plan

   In May 2000, the Company's Board of Directors adopted the 2000 Stock
Incentive Plan and reserved 2,000,000 shares of common stock for issuance upon
exercise of stock options granted thereunder. In September 2000, an additional
4,000,000 shares were reserved for issuance under such plan.

Note 7. Recent Pronouncements

   In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement No. 133 (SFAS 133), "Accounting for Derivative Instruments and
Hedging Activity", which was subsequently amended by Statement No. 137 (SFAS
137), "Accounting for Derivative Instruments and Hedging Activities: Deferral
of Effective Date of FASB 133" and Statement No. 138 (SFAS 138), "Accounting
for Certain Derivative Instruments and Certain Hedging Activities: an
Amendment of FASB Statement No. 133". SFAS 137 requires adoption of SFAS 133
in years beginning after June 15, 2000. SFAS 138 establishes accounting and
reporting standards for derivative instruments and addresses a limited number
of issues causing implementation difficulties for numerous entities. The
Statement requires the Company to recognize all derivatives on the balance
sheet at fair value. Derivatives that are not hedges must be recorded at fair
value through earnings. If the derivative qualifies as a hedge, depending on
the nature of the exposure being hedged, changes in the fair value of
derivatives are either offset against the change in fair value of hedged
assets, liabilities, or firm commitments through earnings or are recognized in
other comprehensive income until the hedged cash flow is recognized in
earnings. The ineffective portion of a derivative's change in fair value is
recognized in earnings. The Statement permits early adoption as of the
beginning of any fiscal quarter. SFAS 133 will become effective for the
Company's first fiscal quarter in 2001 and the Company does not expect
adoption to have a material effect on its financial statements.

   In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial
Statements". SAB 101 summarizes certain aspects of the staff's views in
applying generally accepted accounting principles to revenue recognition in
financial statements. On June 26, 2000, the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 101 A (SAB 101 A), which extends the
transition provision of SAB 101 to December 31, 2000 for a calendar year
company. The Company does not expect the adoption of SAB 101 will have a
material impact on its consolidated financial statements.

   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 noncompensatory 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

                                       9
<PAGE>

                               INTERWOVEN, INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

combination. FIN 44 is effective July 1, 2000, however 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.
Interwoven is currently assessing the impact, if any, of adopting this
interpretation.

Note 8. Business Combination

   Effective July 18, 2000, the Company acquired Neonyoyo, Inc. ("Neonyoyo"),
a leading developer of wireless technology that delivers targeted XML content
to handheld devices. The company issued approximately 1.1 million shares of
common stock and agreed to pay up to approximately $9.9 million cash in
exchange for the assets, liabilities and capital stock of Neonyoyo. The
company also assumed all outstanding options to purchase common stock of
Neonyoyo and reserved 16,929 shares of common stock and approximately $150,000
for issuance or payment upon exercise of these options. The transaction was
accounted for as a purchase with any excess of the purchase price over the
fair value of net assets being allocated to intangible assets that will be
amortized over their respective useful lives.

   The amounts and components of the purchase price of Neonyoyo along with the
allocation of the purchase price to assets acquired, were as follows (in
thousands):

<TABLE>
   <S>                                                                  <C>
   Common stock........................................................ $76,311
   Cash................................................................   9,949
   Transaction costs...................................................   1,967
   Incremental fair value of Neonyoyo stock options....................       6
                                                                        -------
     Total purchase price.............................................. $88,233
                                                                        =======
   Goodwill............................................................ $77,907
   Covenants not to compete............................................   6,929
   Writeoff of in-process research and development.....................   1,724
   Net book value of assets and liabilities Neonyoyo...................   1,091
   Acquired workforce..................................................     582
                                                                        -------
     Net assets acquired............................................... $88,233
                                                                        =======
</TABLE>

   The amounts allocated to acquired workforce and convenants not to compete
are being amortized over the assets' estimated useful life of two years. The
amount allocated to goodwill is being amortized over the asset's estimated
useful life of three years. Amortization of goodwill was $4.3 million and
amortization of intangible assets was $626,000 for the three months ended
September 30, 2000.

   The Company recorded deferred compensation liabilities of $2.3 million and
$3.1 million related to the assumption of Neonyoyo options and the exchange of
Interwoven shares for Neonyoyo shares, respectively. Amortization expense
related to these items was $0.9 million for the three months ended September
30, 2000.

                                      10
<PAGE>

                               INTERWOVEN, INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


   Because the acquisition was accounted for as purchase, the results of
operations of Neonyoyo have been included with those of the Company for the
period subsequent to the acquisition date. The following presents the
unaudited pro forma combined results of operations of Interwoven and Neonyoyo
for the nine-month period ended September 30, 2000. The combined results of
operations are not presented for the nine-month period ended September 30,
1999 as Neonyoyo had no operating activities in that period.

<TABLE>
<CAPTION>
                                                                    Nine Months
                                                                       Ended
                                                                   September 30,
                                                                       2000
                                                                   -------------
                                                                        (in
                                                                    thousands,
                                                                    except per
                                                                    share data)
<S>                                                                <C>
Revenue...........................................................    $77,537
Operating loss....................................................    (39,268)
Net loss..........................................................    (30,705)
Basic and diluted loss per share..................................    $ (0.65)
</TABLE>

Note 9. Subsequent Events

   In October 2000, the Company's Board of Directors approved (1) an amendment
to Interwoven's Third Amended and Restated Certificate of Incorporation to
increase the authorized number of shares of common stock issuable by
Interwoven from 100 million to 500 million shares, subject to stockholder
approval; (2) a two-for-one stock split in the form of a stock dividend,
subject to stockholder approval of the proposed amendment to Interwoven's
Certificate of Incorporation; and (3) an amendment to Interwoven's 1999 Equity
Incentive Plan to increase the number of shares of common stock reserved for
issuance thereunder by 4 million shares, subject to stockholder approval. Such
stockholder approvals will be sought at a special meeting of the Company's
stockholders, scheduled to be held on December 12, 2000.

   In October 2000, the Company acquired Ajuba Solutions, Inc. ("Ajuba") and
in November 2000 it acquired Metacode Technologies, Inc. ("Metacode"). Ajuba
is a developer of XML solutions. Metacode is a leading developer of content
tagging and taxonomy technology. The Company issued an aggregate value of
approximately $34 million of its stock, stock options and cash for the capital
stock and stock options of Ajuba and approximately $171 million of its stock,
stock options and cash for the capital stock and stock options of Metacode.
These transactions will be accounted for as purchases, with any excess of the
purchase price over the fair value of net assets being allocated to intangible
assets that will be amortized over appropriate useful lives.

                                      11
<PAGE>

Item 2. Management's Discussion and Analysis of Financial Condition and
        Results of Operations

   This report contains forward-looking statements, including statements
regarding our expectations, beliefs, intentions or strategies regarding the
future. Forward-looking statements are identified by the use of the future
tense, and words such as "believes", "anticipates", "expects", "intends",
"will", "may", and other similar expressions. All forward-looking statements
included in this document are based on the information available to us on the
date hereof, and we assume no obligation to update any such forward-looking
statements. Actual results may differ materially from the results discussed on
this report. Factors that might cause such a difference include those
discussed in "Factors That Affect Future Results". Readers are urged to review
and consider carefully the various disclosures made by us in this report and
in our other reports filed with the Securities and Exchange Commission,
including our 1999 Annual Report on Form 10-K, that advise interested parties
of risks and uncertainties that affect our business.

   The following discussion and analysis of the financial condition and
results of operations should be read in conjunction with our Financial
Statements and Notes appearing elsewhere in this Form 10-Q.

Overview

   Interwoven was incorporated in March 1995 to provide software products and
services for web content management. Designed specifically for the web, our
products allow large teams of people across an enterprise to contribute and
edit web content on a collaborative basis, reducing the time-to-web for
critical eBusiness initiatives. From March 1995 through March 1997, we were a
development stage company conducting research and development for our initial
products. In May 1997, we shipped the first version of our principal product,
TeamSite. We subsequently developed and released enhanced versions of TeamSite
and have introduced related products. We market and sell our products
primarily through a direct sales force and augment our sales efforts through
relationships with systems integrators and other strategic partners. We are
headquartered in Sunnyvale, California. We have domestic offices in the
metropolitan area of ten states. We also have international offices in ten
countries from the Pacific Rim to Western Europe and Canada. Our revenues to
date have been derived primarily from customer accounts in North America.

   We derive revenues from the license of our software products and from
services we provide to our customers. To date, we have derived virtually all
of our license revenues from licenses of TeamSite. License revenues are
recognized when persuasive evidence of an agreement exists, the product has
been delivered, no significant post-delivery obligations remain, the license
fee is fixed or determinable and collection of the fee is probable. Services
revenues consist of professional services and maintenance fees. Professional
services primarily consist of software installation and integration, business
process consulting and training. We generally bill our professional services
customers on a time and materials basis and recognize revenues as the services
are performed. Maintenance agreements are typically priced based on a
percentage of the product license fee, and typically have a one-year term that
is renewable annually. Services provided to customers under maintenance
agreements include technical product support and an unspecified number of
product upgrades as released by us during the term of a maintenance agreement.
Revenues from maintenance support agreements are recognized ratably over the
term of the agreement.

   Since inception, we have incurred substantial costs to develop our
technology and products, to recruit and train personnel for our engineering,
sales and marketing and services organizations, and to establish an
administrative organization. As a result, we have incurred net losses in each
quarter since inception and, as of September 30, 2000, had an accumulated
deficit of $38.1 million. We anticipate that our cost of services revenues and
operating expenses will increase substantially in future quarters as we grow
our service organization to support an increased level and expanded number of
services offered, increase our sales and marketing operations, develop new
distribution channels, fund greater levels of research and development, and
improve operational and financial systems. Accordingly, we expect to incur
additional losses for the foreseeable future as we continue to expand our
operations. In addition, our limited operating history makes the prediction of
future results of operations difficult and, accordingly, there can be no
assurance that we will achieve or sustain profitability.

                                      12
<PAGE>

   On June 1, 2000 our Board of Directors approved a two-for-one stock split
of the outstanding shares of common stock. These shares were distributed on
July 13, 2000. All share and per share information included in this report on
Form 10-Q have been retroactively adjusted to reflect this stock split.

   In September 2000, our Board of Directors approved an amendment to our 2000
Stock Incentive Plan to increase the number of shares of common stock reserved
for issuance thereunder by 4 million shares.

   In October 2000, our Board of Directors approved (1) an amendment to our
Third Amended and Restated Certificate of Incorporation to increase the
authorized number of shares of common stock issuable by us from 100 million to
500 million shares, subject to stockholder approval; (2) a two-for-one stock
split in the form of a stock dividend, subject to stockholder approval of the
proposed amendment to our Certificate of Incorporation; and (3) an amendment
to our 1999 Equity Incentive Plan to increase the number of shares of common
stock reserved for issuance thereunder by 4 million shares, subject to
stockholder approval. Such stockholder approvals will be sought at a special
meeting of our stockholders, scheduled to be held on December 12, 2000.

   In October 2000, we acquired Ajuba Solutions, Inc. ("Ajuba") and in
November 2000 we acquired Metacode Technologies, Inc. ("Metacode"). Ajuba is a
developer of XML solutions. Metacode is a leading developer of content tagging
and taxonomy technology. We issued an aggregate value of approximately $34
million of our Company stock, options to purchase our common stock and cash
for the capital stock and stock options of Ajuba and approximately $171
million of our Company stock, options to purchase our common stock and cash
for the capital stock and stock options of Metacode. These transactions will
be accounted for as purchases, with any excess of the purchase price over the
fair value of net assets being allocated to intangible assets that will be
amortized over appropriate useful lives.

Results of Operations

   Our license and services revenues have grown in each of the last 11
quarters, and in the nine months ended September 30, 2000, except that our
license revenues declined in the three months ended March 31, 1999 from that
in the three months ended December 31, 1998. The decline in that period
reflected the unusually high revenues in the prior period, due in part to a
few large license sales in that period.

   The increase in services revenues in the three and nine months ended
September 30, 2000 reflects an increase in both professional services and
maintenance fees, generated from a greater number of customers which licensed
our products in prior periods, and it reflects an increase in the number of
professional services staff and a higher effective staff utilization rate.

   As a result of our limited operating history and the emerging nature of the
market for web content management software and services in which we compete,
it is difficult for us to forecast our revenues or earnings accurately. It is
possible that in some future periods our results of operations may not meet or
exceed the expectations of public market analysts and investors. If this
occurs, the price of our common stock is likely to decline. Factors that have
caused our results to fluctuate in the past, and are likely to cause
fluctuations in the future, include:

  .  the size of customer orders and the timing of product and service
     deliveries;

  .  variability in the mix of products and services sold;

  .  our ability to retain current customers and attract new customers;

  .  the amount and timing of operating costs relating to expansion of our
     business, including our planned international expansion;

  .  the announcement or introduction of new products or services by us or
     our competitors;

  .  our ability to attract and retain personnel, particularly management,
     engineering and sales personnel and technical consultants;

  .  our ability to upgrade and develop our systems and infrastructure to
     accommodate our growth; and

  .  costs related to acquisition of technologies or businesses.

   As a result of these and other factors, we believe that period-to-period
comparisons of our results of operations may not be meaningful and should not
be relied upon as indicators of our future performance.


                                      13
<PAGE>

   The following table lists, for the periods indicated, our statement of
operations data as a percentage of total revenues:

<TABLE>
<CAPTION>
                                              Three Months       Nine Months
                                                  Ended             Ended
                                              September 30,     September 30,
                                              ----------------  ----------------
                                               2000     1999     2000     1999
                                              ------   -------  ------   -------
<S>                                           <C>      <C>      <C>      <C>
Revenues:
  License....................................     67%       60%     66%       63%
  Services...................................     33        40      34        37
                                              ------   -------  ------   -------
    Total revenues...........................    100       100     100       100
Cost of revenues:
  License....................................      1         1       1         2
  Services...................................     29        49      31        38
                                              ------   -------  ------   -------
    Total cost of revenues...................     30        50      32        40
Gross profit.................................     70        50      68        60
Operating expenses:
  Research and development...................     13        29      14        32
  Sales and marketing........................     54        90      58        98
  General and administrative.................      9        19      11        22
  Amortization of deferred stock-based
   compensation..............................      4        24       4        29
  Amortization of acquired intangible
   assets....................................     13         6       7         3
  Writeoff of in process research &
   development...............................      4         0       2         0
                                              ------   -------  ------   -------
    Total operating expenses.................     97       168      96       184
Loss from operations.........................    (27)     (118)    (28)     (124)
Interest income and other income (expense),
 net.........................................      9         6      12         5
                                              ------   -------  ------   -------
Net loss.....................................    (19)     (112)    (16)     (119)
                                              ======   =======  ======   =======
</TABLE>

Three months ended September 30, 1999 and 2000

 Revenues

   Total revenues increased 826% from $4.3 million for the three months ended
September 30, 1999 to $39.4 million for the three months ended September 30,
2000. This increase reflects sales to a larger number of new customers and at
a higher average sales price. The number of new customers increased from 33 in
the three months ended September 30, 1999 to 140 in the three months ended
September 30, 2000, and the average sales price increased from $179,000 to
$282,000. Our ability to attract new customers was a result of our developing
a larger and more experienced sales and marketing staff, which numbered 76
persons in the three months ended September 30, 1999 and 263 persons in the
three months ended September 30, 2000. The increase in average sales price was
a result of larger numbers of user seats being licensed in the average new
order, expanded product configurations, and price increases between the
comparable periods.

   License. License revenues increased 938% from $2.6 million for the three
months ended September 30, 1999 to $26.5 million for the three months ended
September 30, 2000. License revenues represented 60% and 67% of total
revenues, respectively, in those periods. This increase in license revenues in
absolute dollars reflects the same factors that caused total revenues to
increase from period to period.

   Services. Services revenues increased 657% from $1.7 million for the three
months ended September 30, 1999 to $12.9 million for the three months ended
September 30, 2000. Services revenues represented 40% and 33% of total
revenues, respectively, in those periods. The increase in services revenues
reflects a $6.3 million increase in professional services fees, a $3.2 million
increase in maintenance fees and a $1.6 million increase in training fees. The
increased professional services and maintenance fees were generated by an
expanded number of customers who licensed our products.

                                      14
<PAGE>

 Cost of Revenues

   License. Cost of license revenues includes expenses incurred to
manufacture, package and distribute our software products and related
documentation, as well as costs of licensing third-party software sold in
conjunction with our software products. Cost of license revenues increased
1,032% from $28,000 for the three months ended September 30, 1999 to $317,000
for the three months ended September 30, 2000. Cost of license revenues
represented 1% of license revenues in both periods. The increase in cost of
license revenues was attributable to an increase in royalties paid to third
party software vendors as well as an increase in the volume of products
shipped.

   We expect cost of license revenues to increase in absolute dollar amounts
in the future. We expect cost of license revenues as a percentage of license
revenue to vary from period to period depending upon the timing of payments to
third party software vendors and amounts of license revenue recognized in each
period.

   Services. Cost of services revenues consists primarily of salary and
related costs of our professional services, training, maintenance and support
personnel, as well as subcontractor expenses. Cost of services revenues
increased 449% from $2.1 million for the three months ended September 30, 1999
to $11.6 million for the three months ended September 30, 2000. Cost of
services revenues represented 124% and 90% of services revenues, respectively,
in those periods. This increase in absolute dollars of cost of services
revenues was attributable to an increase in the number of in-house services
personnel from 43 to 187, and a $3.5 million increase in subcontractor
expenses.

   We expect our cost of services revenues to increase for the foreseeable
future as we continue to expand our services staff and consulting
organizations. Since services revenues have lower gross margins than license
revenues, this expansion will reduce our gross margins if our license revenues
do not increase significantly. We expect cost of services revenues as a
percentage of services revenues to vary from period to period depending on
whether the services are performed by our in-house staff or by subcontractors,
and on the overall utilization rates of our in-house professional services
staff. Furthermore, the utilization of in-house staff or sub-contractors is
affected by the mix of services we provide.

 Gross Profit

   Gross profit increased 1,199% from $2.1 million for the three months ended
September 30, 1999 to $27.5 million for the three months ended September 30,
2000. Gross profit represented 50% and 70% of total revenues, respectively, in
those periods. This increase in absolute dollar amounts reflects increased
license and services revenues from a growing customer base. The increase in
gross profit percentage was a result of an improvement in gross margin of our
professional services organization. We have made and we will continue to make
investments in our professional services organization to increase the capacity
of that organization to meet the demand for services from our customers. We
expect gross profit as a percentage of total revenues to fluctuate from period
to period primarily as a result of changes in the relative proportion of
license and services revenues.

 Operating Expenses

   Research and Development. Research and development expenses consist
primarily of personnel and related costs to support product development
activities. Research and development expenses increased 314% from $1.2 million
for the three months ended September 30, 1999 to $5.1 million for the three
months ended September 30, 2000, representing 29% and 13% of total revenues in
those periods, respectively. This increase in absolute dollar amounts was due
to increases in the number of our product development personnel, which grew
from 36 to 86 persons, to increased use of subcontractors, and higher
associated wages, salaries and recruitment costs. The decrease in research and
development expenses as a percentage of total revenues relates to a higher
growth rate in total revenues, attributable to our rapidly increasing revenue
base, as compared to the growth rate in research and development expenses. We
believe that continued investment in research and development is critical to
our strategic objectives, and we expect that the dollar amounts of research
and development expenses will

                                      15
<PAGE>

increase in future periods. We expect that the percentage of total revenues
represented by research and development expenses will fluctuate from period to
period depending primarily on when we hire new research and development
personnel as well as the size and timing of product development projects. To
date, all software development costs have been expensed in the period
incurred.

   Sales and Marketing. Sales and marketing expenses consist primarily of
salaries and related costs for sales and marketing personnel, sales
commissions, travel and marketing programs. Sales and marketing expenses
increased 453% from $3.8 million for the three months ended September 30, 1999
to $21.2 million for the three months ended September 30, 2000, representing
90% and 54% of total revenues, respectively, in those periods. This increase
in absolute dollar amounts primarily relates to increases in sales and
marketing personnel costs of $5.1 million, higher sales commissions and
bonuses of $7.8 million and increased marketing-related costs of $605,000. The
decrease in sales and marketing expenses as a percentage of total revenues
relates to a higher growth rate in total revenues, attributable to our rapidly
increasing revenue base, when compared to the growth rate in sales and
marketing expenses. We expect that the dollar amounts of sales and marketing
expenses will increase in future periods as we continue to invest heavily in
order to expand our customer base and increase brand awareness. We also
anticipate that the percentage of total revenues represented by sales and
marketing expenses will fluctuate from period to period depending primarily on
when we hire new sales personnel, the timing of new marketing programs and the
levels of revenues in each period.

   General and Administrative. General and administrative expenses consist
primarily of salaries and related costs for accounting, human resources, legal
and other administrative functions, as well as provisions for doubtful
accounts. General and administrative expenses increased 345% from $833,000 for
the three months ended September 30, 1999 to $3.7 million for the three months
ended September 30, 2000, representing 19% and 9% of total revenues,
respectively. This increase in dollar amounts was due to additional staffing
of these functions to support expanded operations during the same period. The
decrease in general and administrative expenses as a percentage of total
revenues relates to a higher growth rate in total revenues, attributable to
our rapidly increasing revenue base, when compared to the growth rate in
general and administrative expenses. We expect general and administrative
expenses to increase in absolute dollars in 2000 as we add personnel to
support expanding operations and incur additional costs related to the growth
of our business. We expect that the percentage of total revenues represented
by general and administrative expenses will fluctuate from period to period
depending primarily on when we hire new general and administrative personnel
to support expanding operations as well as the size and timing of expansion
projects.

   Amortization of Deferred Stock-Based Compensation. In 1998 and 1999, we
recorded deferred stock-based compensation of $1.9 million and $7.3 million in
connection with stock options granted during 1998 and 1999, respectively. In
2000, we recorded deferred stock-based compensation of $5.4 million in
connection with granting of stock options and issuance of shares related to
the acquisition of Neonyoyo. These amounts represent the difference between
the exercise price of stock options granted or assumed during those periods
and the deemed fair value of our common stock at the time of the grants and
the difference between the market price of our common stock and the market
price of shares acquired in exchange for Neonyoyo. Amortization of deferred
stock-based compensation was $1.0 million and $1.5 million for the three
months ended September 30, 1999 and 2000, respectively. We expect amortization
of deferred stock-based compensation to be $3.8 million and $1.6 million for
fiscal year 2001 and 2002, respectively. We expect to incur similar charges
related to the Ajuba and Metacode acquisitions, however, such charges have not
yet been determined.

   Amortization of Acquired Intangible Assets. In July 1999, we recorded
intangible assets of approximately $800,000 in connection with the acquisition
of Lexington Software Associates Incorporated. Goodwill related to this
transaction approximated $300,000 and intangible assets related to the
workforce of Lexington Software approximated $500,000 of the purchase price.
The total purchase price for this acquisition was approximately $800,000. In
July 2000, we recorded intangible assets of approximately $85.4 million in
connection with the acquisition of Neonyoyo. Goodwill related to this
transaction approximated $77.9 million and intangible assets related to
workforce and covenants not to compete of Neonyoyo approximated $7.5 million
of the purchase price.

                                      16
<PAGE>

The total purchase price for this acquisition was approximately $88.2 million.
The purchase price was allocated to the tangible and intangible assets
acquired and liabilities assumed based upon their respective fair values at
the acquisition date. Amortization of acquired intangible assets was $249,000
and $5.0 million for the three months ended September 30, 1999 and 2000,
respectively. We expect amortization of acquired intangible assets to be $29.9
million and $28.2 million for fiscal year 2001 and 2002, respectively. We
expect to incur similar charges related to the Ajuba and Metacode
acquisitions, however, such charges have not yet been determined.

   Writeoff of In-Process Research & Development. Purchased in-process
research and development of $1.7 million related to acquisition of Neonyoyo
was recorded representing the present value of the estimated cash flows
expected to be generated by the purchased technology, which, at the
acquisition date, had not yet reached technological feasibility. We may incur
similar charges for the Ajuba and Metacode acquisitions, however, such charges
have not yet been determined.

 Interest Income and Other Expenses, Net

   Interest income and other expenses, net, increased from $262,000 for the
three months ended September 30, 1999 to $3.1 million for the three months
ended September 30, 2000 due to increased interest income earned, proceeds
from our initial public offering in October 1999 and our subsequent public
offering in February 2000.

Nine months ended September 30, 1999 and 2000

 Revenues

   Total revenues increased 737% from $9.3 million for the nine months ended
September 30, 1999 to $77.5 million for the nine months ended September 30,
2000. This increase reflects sales to a larger number of new customers and at
a higher average sales price. The number of new customers increased from 72 in
the nine months ended September 30, 1999 to 328 in the nine months ended
September 30, 2000, and the average sales price increased from $161,000 to
$300,000. Our ability to attract new customers was a result of our developing
a larger and more experienced sales and marketing staff, which numbered 76
persons in the nine months ended June 30, 1999 and 263 persons in the nine
months ended September 30, 2000. The increase in average sales price was a
result of larger numbers of user seats being licensed in the average new
order, expanded product configurations and price increases between the
comparable periods.

   License. License revenues increased 783% from $5.8 million for the nine
months ended September 30, 1999 to $51.3 million for the nine months ended
September 30, 2000. License revenues represented 63% and 66% of total
revenues, in those periods. This increase in license revenues in absolute
dollars reflects the same factors that caused total revenues to increase from
period to period.

   Services. Services revenues increased 660% from $3.4 million for the nine
months ended September 30, 1999 to $26.2 million for the nine months ended
September 30, 2000. Services revenues represented 37% and 34% of total
revenues in those periods. The increase in services revenues reflects a $13.5
million increase in professional services fees, a $6.2 million increase in
maintenance fees and a $3.0 million increase in training fees. The increased
professional services and maintenance fees were generated by an expanded
number of customers who licensed our products.

 Cost of Revenues

   License. Cost of license revenues includes expenses incurred to
manufacture, package and distribute our software products and related
documentation, as well as costs of licensing third-party software sold in
conjunction with our software products. Cost of license revenues increased
297% from $147,000 for the nine months ended September 30, 1999 to $584,000
for the nine months ended September 30, 2000. Cost of license revenues
represented 3% and 1% of license revenues in the nine months ended September
30, 1999 and September 30, 2000, respectively. The increase in cost of license
revenues was attributable to an increase in royalties paid to third party
software vendors as well as an increase in the volume of products shipped. The
decrease in cost of license revenues as a percentage of license revenues
relates to a small variable cost component of cost of license revenues that
increases to a lesser extent than the license revenue growth.

                                      17
<PAGE>

   We expect cost of license revenues to increase in absolute dollar amounts
in the future. We expect cost of license revenues as a percentage of license
revenue to vary from period to period depending upon the timing of payments to
third party software vendors and amounts of license revenue recognized in each
period.

   Services. Cost of services revenues consists primarily of salary and
related costs of our professional services, training, maintenance and support
personnel, as well as subcontractor expenses. Cost of services revenues
increased 582% from $3.5 million for the nine months ended September 30, 1999
to $24.2 million for the nine months ended September 30, 2000. Cost of
services revenues represented 103% and 92% of services revenues, respectively,
in those periods. This increase in cost of services revenues was attributable
to an increase in the number of in-house services personnel from 43 to 187,
and a $7.5 million increase in subcontractor expenses.

   We expect our cost of services revenues to increase for the foreseeable
future as we continue to expand our services staff and consulting
organizations. Since services revenues have lower gross margins than license
revenues, this expansion will reduce our gross margins if our license revenues
do not increase significantly. We expect cost of services revenues as a
percentage of services revenues to vary from period to period depending on
whether the services are performed by our in-house staff or by subcontractors,
and on the overall utilization rates of our in-house professional services
staff. Furthermore, the utilization of in-house staff or sub-contractors is
affected by the mix of services we provide.

 Gross Profit

   Gross profit increased 847% from $5.6 million for the nine months ended
September 30, 1999 to $52.8 million for the nine months ended September 30,
2000. Gross profit represented 60% and 68% of total revenues, respectively, in
those periods. This increase in absolute dollar amounts reflects increased
license and services revenues from a growing customer base. We have made and
we will continue to make investments in our professional services organization
to increase the capacity of that organization to meet the demand for services
from our customers. We expect gross profit as a percentage of total revenues
to fluctuate from period to period primarily as a result of changes in the
relative proportion of license and services revenues.

 Operating Expenses

   Research and Development. Research and development expenses consist
primarily of personnel and related costs to support product development
activities. Research and development expenses increased 258% from $2.9 million
for the nine months ended September 30, 1999 to $10.5 million for the nine
months ended September 30, 2000, representing 32% and 14% of total revenues in
those periods, respectively. This increase in absolute dollar amounts was due
to increases in the number of our product development personnel, which grew
from 36 to 86 persons, to increased use of subcontractors and to higher
associated wages, salaries and recruitment costs. The decrease in research and
development expenses as a percentage of total revenues relates to a higher
growth rate in total revenues, attributable to our rapidly increasing revenue
base, as compared to the growth rate in research and development expenses. We
believe that continued investment in research and development is critical to
our strategic objectives, and we expect that the dollar amounts of research
and development expenses will increase in future periods. We expect that the
percentage of total revenues represented by research and development expenses
will fluctuate from period to period depending primarily on when we hire new
research and development personnel as well as the size and timing of product
development projects. To date, all software development costs have been
expensed in the period incurred.

   Sales and Marketing. Sales and marketing expenses consist primarily of
salaries and related costs for sales and marketing personnel, sales
commissions, travel and marketing programs. Sales and marketing expenses
increased 398% from $9.1 million for the nine months ended September 30, 1999
to $45.1 million for the nine months ended September 30, 2000, representing
98% and 58% of total revenues, respectively, in those periods. This increase
in absolute dollar amounts primarily related to increases in sales and
marketing personnel costs of $10.2 million, higher sales commissions and
bonuses of $15.6 million and increased marketing-related costs of $1.6
million. The decrease in sales and marketing expenses as a percentage of total
revenues relates to a higher

                                      18
<PAGE>

growth rate in total revenues, attributable to our rapidly increasing revenue
base, when compared to the growth rate in sales and marketing expenses. We
expect that the dollar amounts of sales and marketing expenses will increase
in future periods as we continue to invest heavily in order to expand our
customer base and increase brand awareness. We also anticipate that the
percentage of total revenues represented by sales and marketing expenses will
fluctuate from period to period depending primarily on when we hire new sales
personnel, the timing of new marketing programs and the levels of revenues in
each period.

   General and Administrative. General and administrative expenses consist
primarily of salaries and related costs for accounting, human resources, legal
and other administrative functions, as well as provisions for doubtful
accounts. General and administrative expenses increased 308% from $2.1 million
for the nine months ended September 30, 1999 to $8.5 million for the nine
months ended September 30, 2000, representing 22% and 11% of total revenues,
respectively. This increase in dollar amounts was due to additional staffing
of these functions to support expanded operations during this same period. The
decrease in general and administrative expenses as a percentage of total
revenues relates to a higher growth rate in total revenues, attributable to
our rapidly increasing revenue base, when compared to the growth rate in
general and administrative expenses. We expect general and administrative
expenses to increase in absolute dollars in 2000 as we add personnel to
support expanding operations and incur additional costs related to the growth
of our business. We expect that the percentage of total revenues represented
by general and administrative expenses will fluctuate from period to period
depending primarily on when we hire new general and administrative personnel
to support expanding operations as well as the size and timing of expansion
projects.

   Amortization of Deferred Stock-Based Compensation. In 1998 and 1999, we
recorded deferred stock-based compensation of $1.9 million and $7.3 million in
connection with stock options granted during 1998 and 1999, respectively. In
2000, we recorded deferred stock-based compensation of $5.4 million in
connection with granting of stock options and issuance of shares related to
the acquisition of Neonyoyo. These amounts represent the difference between
the exercise price of stock options granted or assumed during those periods
and the deemed fair value of our common stock at the time of the grants and
the difference between the market price of our common stock and the market
price of shares acquired in exchange for Neonyoyo. Amortization of deferred
stock-based compensation was $2.7 million and $3.0 million for the nine months
ended September 30, 1999 and 2000, respectively. We expect amortization of
deferred stock-based compensation to be $3.8 million and $1.6 million for
fiscal year 2001 and 2002, respectively. We expect to incur similar charges
related to the Ajuba and Metacode acquisitions, however, such charges have not
yet been determined.

   Amortization of Acquired Intangible Assets. In July 1999, we recorded
intangible assets of approximately $800,000 in connection with the acquisition
of Lexington Software Associates Incorporated. Goodwill related to this
transaction approximated $300,000 and intangible assets related to the
workforce of Lexington Software approximated $500,000 of the purchase price.
The total purchase price for this acquisition was approximately $800,000. In
July 2000, we recorded intangible assets of approximately $85.4 million in
connection with the acquisition of Neonyoyo. Goodwill related to this
transaction approximated $77.9 million and intangible assets related to
workforce and covenants not to compete of Neonyoyo approximated $7.5 million
of the purchase price. The total purchase price for this acquisition was
approximately $88.2 million. The purchase price was allocated to the tangible
and intangible assets acquired and liabilities assumed based upon their
respective fair values at the acquisition date. Amortization of acquired
intangible assets was $249,000 for the nine months ended September 30, 2000
and $5.1 million for the nine months ended September 30, 2000. We expect
amortization of acquired intangible assets to be $29.9 million and $28.2
million for fiscal year 2001 and 2002, respectively. We expect to incur
similar charges related to the Ajuba and Metacode acquisitions, however, such
charges have not yet been determined.

   Writeoff of In-Process Research & Development. Purchased in-process
research and development of $1.7 million related to acquisition of Neonyoyo
was recorded representing the present value of the estimated after-tax cash
flows expected to be generated by the purchased technology, which, at the
acquisition date, had not yet reached technological feasibility. We may incur
similar charges for the Ajuba and Metacode acquisitions, however, such charges
have not yet been determined.

                                      19
<PAGE>

 Interest Income and Other Expenses, Net

   Interest income and other expenses, net, increased from $416,000 for the
nine months ended September 30, 1999 to $8.9 million for the nine months ended
September 30, 2000 due to increased interest income earned, proceeds from our
initial public offering in October 1999 and our subsequent public offering in
February 2000.

Liquidity and Capital Resources

   Net cash used in operating activities was $5.1 million in the nine months
ended September 30, 1999 and net cash provided by operating activities was
$5.6 million in the nine months ended September 30, 2000. Net cash provided by
operating activities reflected decreasing net losses offset in part by an
increase in accounts receivable, accrued liabilities and deferred revenue. Net
cash used in operating activities in prior periods primarily reflected net
losses.

   During the nine months ended September 30, 1999 and September 30, 2000
investing activities have included purchases of property and equipment,
principally computer hardware and software for our growing number of
employees. Cash used to purchase property and equipment was $1.3 million and
$8.1 million during the nine months ended September 30, 1999 and September 30,
2000, respectively. We expect that capital expenditures will increase with our
anticipated growth in operations, infrastructure and personnel. As of
September 30, 2000 we had no material capital expenditure commitments.

   During the nine months ended September 30, 1999 and September 30, 2000, our
investing activities included purchases and maturities of short-term and long-
term investments. Net purchases of investments approximated $9.4 million and
$102.4 million during the nine months ended September 30, 1999 and
September 30, 2000, respectively. As of September 30, 2000, we have not
invested in derivative securities or any other financial instruments that
involve a high level of complexity or risk. We expect that, in the future,
cash in excess of current requirements will continue to be invested in high
credit quality, interest-bearing securities.

   During the nine months ended September 30, 2000, our investing activities
included the acquisition of Neonyoyo. The net cash paid in connection with the
acquisition was $8.0 million, which consisted of $9.9 million included in
purchase price net of $1.0 million of cash assumed and collateral of $0.9
million to be paid to Neonyoyo shareholders upon satisfaction of
indemnification obligations.

   Net cash provided by financing activities in the nine months ended
September 30, 1999 and 2000 was $19.4 million and $155.8 million,
respectively. Net cash provided by financing activities primarily reflects the
proceeds of issuance of preferred stock and common stock, respectively, in
each of these periods.

   Prior to our initial public offering we raised a total of $37.0 million
from the sale of preferred stock, net of issuance costs, which was the primary
source of financing for our operations.

   In October 1999, we completed our initial public offering of 7,245,000
shares of our common stock, including the exercise of the underwriters'
overallotment option, at $8.50 per share. Realized net proceeds to us were
approximately $56.2 million.

   In February 2000, the Company completed its follow-on offering of 6,000,000
shares of common stock at $80.50. The Company sold 2,000,000 shares in this
offering and selling stockholders sold 4,000,000 shares. Realized net proceeds
to the Company were $152.4 million.

   At September 30, 2000, our sources of liquidity consisted of $217.5 million
in cash, cash equivalents and investments and $149.7 million in working
capital. We have a $5.0 million line of credit with Silicon Valley Bank, which
bears interest at the bank's prime rate, which was 9.00% at September 30,
2000. At September 30, 2000, the line of credit was unused. The line of credit
is secured by all of our tangible and intangible assets, and maintains minimum
quarterly unrestricted cash, cash equivalents and short term investments of
$75,000,000 as the financial covenants. We intend to maintain the line of
credit. As of September 30, 2000, we were in compliance with all related
financial covenants and restrictions under the line of credit.

                                      20
<PAGE>

   We believe that the current cash, cash equivalents, investments and funds
available under existing credit facilities and the net proceeds from the sale
of the common stock in our initial public offering and follow-on offering,
will be sufficient to meet our working capital requirements for at least the
next 12 months. Thereafter, we may require additional funds to support our
working capital requirements or for other purposes and may seek to raise
additional funds through public or private equity financing or from other
sources. There can be no assurance that additional financing will be available
on acceptable terms, if at all. If adequate funds are not available or are not
available on acceptable terms, we may be unable to develop or enhance our
products, take advantage of future opportunities, or respond to competitive
pressures or unanticipated requirements, which could have a material adverse
effect on our business, financial condition and operating results.

                      FACTORS THAT AFFECT FUTURE RESULTS

   Some of the statements under "Factors That Affect Future Results,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and elsewhere in this Form 10-Q constitute forward-looking
statements. In some cases, you can identify forward-looking statements by our
use of the future tense, and terms such as "may," "will," "should," "expect,"
"plan," "anticipate," "believe," "estimate," "predict," "potential,"
"continue" or the negative of these terms or other comparable terminology. The
forward-looking statements contained in this Form 10-Q involve known and
unknown risks, uncertainties and other factors that may cause industry trends
or our actual results, level of activity, performance or achievements to be
materially different from any future results, levels of activity, performance
or achievements expressed or implied by these statements. These factors
include those listed under "Factors That Affect Future Results" and elsewhere
in this Form 10-Q.

   Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. We are under no duty to update any of
the forward-looking statements after the date of this Form 10-Q to conform
these statements to actual results. You should not place undue reliance on
these forward-looking statements, which apply only as of the date of this Form
10-Q.

   The risks and uncertainties described below are not the only risks we face.
These risks are the ones we consider to be significant to your decision
whether to invest in our common stock at this time. We might be wrong. There
may be risks that you in particular view differently than we do, and there are
other risks and uncertainties that we do not presently know or that we
currently deem immaterial, but that may in fact harm our business in the
future. If any of these risks occur, our business, results of operations and
financial condition could be seriously harmed, the trading price of our common
stock could decline and you may lose all or part of your investment.

Our operating history is limited, so it will be difficult for you to evaluate
our business in making an investment decision.

   We were incorporated in March 1995 and have a limited operating history. We
are still in the early stages of our development, which makes the evaluation
of our business operations and our prospects difficult. We shipped our first
product in May 1997. Since that time, we have derived substantially all of our
revenues from licensing our TeamSite product and related services. In
evaluating our common stock, you should consider the risks and difficulties
frequently encountered by early stage companies in new and rapidly evolving
markets, particularly those companies whose businesses depend on the Internet.
These risks and difficulties, as they apply to us in particular, include:

  .  potential fluctuations in operating results and uncertain growth rates;

  .  limited market acceptance of our products;

  .  concentration of our revenues in a single product or family of products;

                                      21
<PAGE>

  .  our dependence on a small number of orders for most of our revenue;

  .  our need to expand our direct sales forces and indirect sales channels;

  .  our need to manage rapidly expanding operations;

  .  our need to attract and train qualified personnel; and

  .  our need to establish and maintain strategic relationships with other
     companies, some of whom may in the future become our competitors.

If we do not increase our license revenues significantly, we will fail to
achieve profitability.

   We have incurred net losses in each quarter since our inception, and we
expect our net losses to increase. We incurred net losses of $2.9 million in
1997, $6.3 million in 1998, $15.7 million in 1999 and $12.2 million for the
nine months ended September 30, 2000. As of September 30, 2000, we had an
accumulated deficit of approximately $38.1 million. To compete effectively, we
plan to continue to invest aggressively to expand our sales and marketing,
research and development, and professional services organizations.

   As a result, if we are to achieve profitability we will need to increase
our revenues significantly, particularly our license revenues. We cannot
predict when we will become profitable, if at all.

Our operating results fluctuate widely and are difficult to predict, so we may
fail to satisfy the expectations of investors or market analysts and our stock
price may decline.

   Our quarterly operating results have fluctuated significantly in the past,
and we expect them to continue to fluctuate unpredictably in the future. It is
possible that in some future periods our results of operations may not meet or
exceed the expectations of public market analysts and investors. If this
occurs, the price of our common stock is likely to decline. Further, we
anticipate that our sequential percentage rate of revenue growth will decline
in future quarters in part because of the difficulty of maintaining high
growth rates calculated off progressively larger base revenue numbers.

Acquisitions may harm our business by being more difficult than expected to
integrate, by diverting management's attention or by subjecting us to
unforeseen accounting problems.

   As part of our business strategy, we have acquired and in the future may
seek to acquire or invest in additional businesses, products or technologies
that we feel could complement or expand our business. If we identify an
appropriate acquisition opportunity, we might be unable to negotiate the terms
of that acquisition successfully, finance it, or integrate it into our
existing business and operations. We may also be unable to select, manage or
absorb current or future acquisitions successfully. Further, negotiation of
potential acquisitions, integration of acquired businesses, diverts management
time and other resources. We may have to use a substantial portion of our
available cash to consummate an acquisition. On the other hand, if we use our
securities for acquisitions, our stockholders could suffer significant
dilution. Further, we cannot assure you that any particular acquisition, even
if successfully completed, will ultimately benefit our business. These
difficulties could harm our business and operating results.

   In connection with our acquisitions, we may be required to write off
software development costs or other assets, incur severance liabilities,
amortization expenses related to goodwill and other intangible assets, or
incur debt, any of which could harm on our business, financial condition, cash
flows and results of operations. The companies we acquire may not have audited
financial statements, detailed financial information, or adequate internal
controls. There can be no assurance that an audit subsequent to the completion
of an acquisition will not reveal matters of significance, including with
respect to revenues, expenses, contingent or other liabilities, and
intellectual property. Any such write off could harm our financial results.

                                      22
<PAGE>

We face significant competition, which could make it difficult to acquire and
retain customers and inhibit any future growth.

   We expect the competition in the market in which we operate to persist and
intensify in the future. Competitive pressures may seriously harm our business
and results of operations if they inhibit our future growth, or require us to
hold down or reduce prices, or increase our operating costs. Our competitors
include:

  .  potential customers that utilize in-house development efforts; and

  .  developers of software that directly addresses the need for web content
     management, such as Vignette, Eprise, Documentum and Rational.

   We also face potential competition from companies--for example, Microsoft
and IBM--that may decide in the future to enter our market. Many of our
existing and potential competitors have longer operating histories, greater
name recognition, larger customer bases and significantly greater financial,
technical and marketing resources than we do. Many of these companies can also
leverage extensive customer bases and adopt aggressive pricing policies to
gain market share. Potential competitors may bundle their products in a manner
that discourages users from purchasing our products. Barriers to entering the
web content management software market are relatively low.

Our lengthy sales cycle makes it particularly difficult for us to forecast
revenue, requires us to incur high costs of sales, and aggravates the
variability of quarterly fluctuations.

   The time between our initial contact with a potential customer and the
ultimate sale, which we refer to as our sales cycle, typically ranges between
three and nine months depending largely on the customer. If we do not shorten
our sales cycle, it will be difficult for us to reduce sales and marketing
expenses. In addition, as a result of our lengthy sales cycle, we have only a
limited ability to forecast the timing and size of specific sales. This makes
it more difficult to predict quarterly financial performance, or to achieve
it, and any delay in completing sales in a particular quarter could harm our
business and cause our operating results to vary significantly.

We rely heavily on sales of one product, so if it does not achieve market
acceptance we are likely to experience larger losses.

   Since 1997, we have generated substantially all of our revenues from
licenses of, and services related to, our TeamSite product. We believe that
revenues generated from TeamSite will continue to account for a large portion
of our revenues for the foreseeable future. A decline in the price of
TeamSite, or our inability to increase license sales of TeamSite, would harm
our business and operating results more seriously than it would if we had
several different products and services to sell. In addition, our future
financial performance will depend upon successfully developing and selling
enhanced versions of TeamSite. If we fail to deliver product enhancements or
new products that customers want it will be more difficult for us to succeed.

We have announced plans to develop new products which are targeted at new
market opportunities, most notably business-to-business, wireless and context.
There is no guarantee these new initiatives will succeed or even that a market
for content management software will develop in these new areas.

   We are developing products which we believe improve the ability of buyers
and sellers to exchange product and other information through business-to-
business exchanges. We are also developing software that we believe will
enhance the quality of web content to be delivered over wireless devices and
we are developing products that automate the attachment of metadata to web
content. We have no way of knowing the results of these new efforts and we may
fail to develop appropriate products for any of these markets. Further, these
markets may not develop as rapidly or in the manner we anticipate. We have
made acquisitions that we believe enhance these efforts, but we may fail to
integrate these acquisitions properly. We will need to invest in further
product development or potentially make additional acquisitions to compete
effectively. In these new markets, we may face competition from companies that
we have not previously competed against.

                                      23
<PAGE>

We depend on our direct sales force to sell our products, so future growth
will be constrained by our ability to hire and train new sales personnel.

   We sell our products primarily through our direct sales force, and we
expect to continue to do so in the future. Our ability to sell more products
is limited by our ability to hire and train direct sales personnel and we
believe that there is significant competition for direct sales personnel with
the advanced sales skills and technical knowledge that we need. Some of our
competitors may have greater resources to hire personnel with that skill and
knowledge. If we were not able to hire experienced and competent sales
personnel, our business will be harmed. Furthermore, because we depend on our
direct sales force, any turnover in our sales force can significantly harm our
operating results. Sales force turnover tends to slow sales efforts until
replacement personnel can be recruited and trained to become productive.

If we do not continue to develop and maintain our indirect sales channels, we
will be less likely to increase our revenues.

   If we do not develop indirect sales channels, we may miss sales
opportunities that might be available through these other channels. For
example, domestic and international resellers may be able to reach new
customers more quickly or more effectively than our direct sales force.
Although we are currently investing and plan to continue to invest significant
resources to develop and maintain these indirect sales channels, we may not
succeed in establishing a channel that can market our products effectively and
provide timely and cost-effective customer support and services. In addition,
we may not be able to manage conflicts across our various sales channels, and
our focus on increasing sales through our indirect channel may divert
management resources and attention from direct sales.

We must attract and retain qualified personnel, which is particularly
difficult for us because we compete with other Internet-related software
companies and are located in the San Francisco Bay area, where competition for
personnel is extremely intense.

   Our success depends on our ability to attract and retain qualified,
experienced employees. We compete for experienced engineering, sales and
consulting personnel with Internet professional services firms, software
vendors, consulting and professional services companies. It is also
particularly difficult to recruit and retain personnel in the San Francisco
Bay area, where we are located. Although we provide compensation packages that
include incentive stock options, cash incentives and other employee benefits,
the volatility and current market price of our common stock may make it
difficult for us to attract, assimilate and retain highly qualified employees
in the future. In addition, our customers generally purchase consulting and
implementation services. While we have recently established relationships with
some third-party service providers, we continue to be the primary provider of
these services. It is difficult and expensive to recruit, train and retain
qualified personnel to perform these services, and we may from time to time
have inadequate levels of staffing to perform these services. As a result, our
growth could be limited due to our lack of capacity to provide those services,
or we could experience deterioration in service levels or decreased customer
satisfaction, any of which would harm our business.

If we do not improve our operational systems on a timely basis, we will be
more likely to fail to manage our growth properly.

   We have expanded our operations rapidly in recent years. We intend to
continue to expand our operational systems for the foreseeable future to
pursue existing and potential market opportunities. This rapid growth places a
significant demand on management and operational resources. In order to manage
our growth, we need to implement and improve our operational systems,
procedures and controls on a timely basis. If we fail to implement and improve
these systems in a timely manner, our business will be seriously harmed.

                                      24
<PAGE>

Difficulties in introducing new products and upgrades in a timely manner will
make market acceptance of our products less likely.

   The market for our products is characterized by rapid technological change,
frequent new product introductions and Internet-related technology
enhancements, uncertain product life cycles, changes in customer demands and
evolving industry standards. We expect to add new content management
functionality to our product offerings by internal development, and possibly
by acquisition. Content management technology is more complex than most
software, and new products or product enhancements can require long
development and testing periods. Any delays in developing and releasing new
products could harm our business. New products or upgrades may not be released
according to schedule or may contain defects when released. Either situation
could result in adverse publicity, loss of sales, delay in market acceptance
of our products or customer claims against us, any of which could harm our
business. If we do not develop, license or acquire new software products, or
deliver enhancements to existing products on a timely and cost-effective
basis, our business will be harmed.

Our products might not be compatible with all major platforms, which could
limit our revenues.

   Our products currently operate on the Sun Solaris operating system, Linux
operating system and Microsoft NT and Windows 2000 Platforms. In addition, our
products are required to interoperate with leading web content authoring tools
and web application servers. We must continually modify and enhance our
products to keep pace with changes in these applications and operating
systems. If our products were to be incompatible with a popular new operating
system or Internet business application, our business would be harmed. In
addition, uncertainties related to the timing and nature of new product
announcements, introductions or modifications by vendors of operating systems,
browsers, back-office applications and other Internet-related applications
could also harm our business.

We have no significant experience conducting operations internationally, which
may make it more difficult than we expect to expand overseas and may increase
the costs of doing so.

   We derive the majority of our revenues from sales to North American
customers. We are expanding our international operations and plan to do so for
the foreseeable future. There are many barriers to competing successfully in
the international arena, including:

  .  costs of customizing products for foreign countries;

  .  restrictions on the use of software encryption technology;

  .  dependence on local vendors;

  .  compliance with multiple, conflicting and changing governmental laws and
     regulations;

   .  longer sales cycles; and

   .  import and export restrictions and tariffs.

   As a result of these competitive barriers, we cannot assure you that we
will be able to market, sell and deliver our products and services in
international markets.

If we fail to establish and maintain strategic relationships, the market
acceptance of our products, and our profitability, may suffer.

   To offer products and services to a larger customer base our direct sales
force depends on strategic partnerships and marketing alliances to obtain
customer leads, referrals and distribution. If we are unable to maintain our
existing strategic relationships or fail to enter into additional strategic
relationships, our ability to increase our sales and reduce expenses will be
harmed. We would also lose anticipated customer introductions and co-marketing
benefits. Our success depends in part on the success of our strategic partners
and their ability to market our products and services successfully. In
addition, our strategic partners may not regard us as significant for their
own businesses. Therefore, they could reduce their commitment to us or
terminate their

                                      25
<PAGE>

respective relationships with us, pursue other partnerships or relationships,
or attempt to develop or acquire products or services that compete with our
products and services. The fact our partners have a need to provide their
customers with a content management solution, as evidenced by their
partnerships with us, may also lead them to consider developing or acquiring
products or services that compete with our products and services. Even if we
succeed in establishing these relationships, they may not result in additional
customers or revenues.

If our services revenues do not grow substantially, our total revenues are
unlikely to increase.

   Our services revenues represent a significant component of our total
revenues: 21% of total revenues for 1998, 36% of total revenues for 1999 and
31% of total revenues for the nine months ended September 30, 2000. We
anticipate that services revenues will continue to represent a significant
percentage of total revenues in the future. To a large extent, the level of
services revenues depends upon our ability to license products which generate
follow-on services revenue. Additionally, services revenues growth depends on
ongoing renewals of maintenance and service contracts. Moreover, if third-
party organizations such as systems integrators become proficient in
installing or servicing our products, our services revenues could decline. Our
ability to increase services revenues will depend in large part on our ability
to increase the capacity of our professional services organization, including
our ability to recruit, train and retain a sufficient number of qualified
personnel.

We might not be able to protect and enforce our intellectual property rights,
a loss of which could harm our business.

   We depend upon our proprietary technology, and rely on a combination of
patent, copyright and trademark laws, trade secrets, confidentiality
procedures and contractual provisions to protect it. We currently do not have
any issued United States or foreign patents, but we have applied for U.S.
patents. It is possible that a patent will not issue from our currently
pending patent applications or any future patent application we may file. We
have also restricted customer access to our source code and require all
employees to enter into confidentiality and invention assignment agreements.
Despite our efforts to protect our proprietary technology, unauthorized
parties may attempt to copy aspects of our products or to obtain and use
information that we regard as proprietary. In addition, the laws of some
foreign countries do not protect our proprietary rights as effectively as the
laws of the United States, and we expect that it will become more difficult to
monitor use of our products as we increase our international presence. In
addition, third parties may claim that our products infringe theirs.

Our failure to deliver defect-free software could result in greater losses and
harmful publicity.

   Our software products are complex and have in the past and may in the
future contain defects or failures that may be detected at any point in the
product's life. We have discovered software defects in the past in some of our
products after their release. Although past defects have not had a material
effect on our results of operations, in the future we may experience delays or
lost revenue caused by new defects. Despite our testing, defects and errors
may still be found in new or existing products, and may result in delayed or
lost revenues, loss of market share, failure to achieve acceptance, reduced
customer satisfaction, diversion of development resources and damage to our
reputation. As has occurred in the past, new releases of products or product
enhancements may require us to provide additional services under our
maintenance contracts to ensure proper installation and implementation.
Moreover, third parties may develop and spread computer viruses that may
damage the functionality of our software products. Any damage to or
interruption in the performance of our software could also harm our business.

Defects in our products may result in customer claims against us that could
cause unanticipated losses.

   Because customers rely on our products for business critical processes,
defects or errors in our products or services might result in tort or warranty
claims. It is possible that the limitation of liability provisions in our
contracts will not be effective as a result of existing or future federal,
state or local laws or ordinances or unfavorable judicial decisions. We have
not experienced any product liability claims like this to date, but we could
in the future. Further, although we maintain errors and omissions insurance,
this insurance coverage may not be adequate to cover us. A successful product
liability claim could harm our business. Even defending a product liability
suit, regardless of its merits, could harm our business because it entails
substantial expense and diverts the time and attention of key management
personnel.

                                      26
<PAGE>

Because the market for our products is new, we do not know whether existing
and potential customers will purchase our products in sufficient quantity for
us to achieve profitability.

   The market for web content management software in which we sell is new and
rapidly evolving. We expect that we will continue to need intensive marketing
and sales efforts to educate prospective clients about the uses and benefits
of our products and services. Various factors could inhibit the growth of the
market, and market acceptance of our products and services. In particular,
potential customers that have invested substantial resources in other methods
of conducting business over the Internet may be reluctant to adopt a new
approach that may replace, limit or compete with their existing systems. We
cannot be certain that a viable market for our products will emerge, or if it
does emerge, that it will be sustainable.

If widespread Internet adoption does not continue, or if the Internet cannot
accommodate continued growth, our business will be harmed because it depends
on growth in the use of the Internet.

   Acceptance of our products depends upon continued adoption of the Internet
for commerce. As is typical in the case of an emerging industry characterized
by rapidly changing technology, evolving industry standards and upon
alternative methods, generally requires understanding and accepting new ways
of conducting business and exchanging information. In particular, companies
that have already invested substantial resources in other means of conducting
commerce and exchanging information may be particularly reluctant or slow to
adopt a new, Internet-based strategy that may render their existing
infrastructure obsolete. If the use of the Internet fails to develop or
develops more slowly than expected, our business may be seriously harmed.

   To the extent that there is an increase in Internet use, an increase in
frequency of use or an increase in the required bandwidth of users, the
Internet infrastructure may not be able to support the demands placed upon it.
In addition, the Internet could lose its viability as a commercial medium due
to delays in development or adoption of new standards or protocols required to
handle increased levels of Internet activity. Changes in, or insufficient
availability of, telecommunications or similar services to support the
Internet also could result in slower response times and could adversely impact
use of the Internet generally. If use of the Internet does not continue to
grow or grows more slowly than expected, or if the Internet infrastructure,
standards, protocols or complementary products, services or facilities do not
effectively support any growth that may occur, our business would be seriously
harmed.

There is substantial risk that future regulations could be enacted that either
directly restrict our business or indirectly impact our business by limiting
the growth of Internet commerce.

   As Internet commerce evolves, we expect that federal, state or foreign
agencies will adopt new legislation or regulations covering issues such as
user privacy, pricing, content and quality of products and services. If
enacted, these laws, rules or regulations could indirectly harm us to the
extent that they impact our customers and potential customers. We cannot
predict if or how any future legislation or regulations would impact our
business. Although many of these regulations may not apply to our business
directly, we expect that laws regulating or affecting commerce on the Internet
could indirectly harm our business.

We have various mechanisms in place to discourage takeover attempts, which
might tend to suppress our stock price.

   Provisions of our certificate of incorporation and bylaws that may
discourage, delay or prevent a change in control include:

  .  we are authorized to issue "blank check" preferred stock, which could be
     issued by our board of directors to increase the number of outstanding
     shares and thwart a takeover attempt;

  .  we provide for the election of only one-third of our directors at each
     annual meeting of stockholders, which slows turnover on the board of
     directors;

  .  we limit who may call special meetings of stockholders;

                                      27
<PAGE>

  .  we prohibit stockholder action by written consent, so all stockholder
     actions must be taken at a meeting of our stockholders; and

  .  we require advance notice for nominations for election to the board of
     directors or for proposing matters that can be acted upon by
     stockholders at stockholder meetings.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

   We develop products in the United States and market our products in North
America, and, to a lesser extent in Europe and the Pacific Rim. As a result,
our financial results could be affected by factors such as changes in foreign
currency exchange rates or weak economic conditions in foreign markets. Since
a majority of our revenue is currently denominated in U.S. Dollars, a
strengthening of the Dollar could make our products less competitive in
foreign markets. Our interest income and expense is sensitive to changes in
the general level of U.S. interest rates, particularly since the majority of
our financial investments are in cash equivalents and investments. Due to the
nature of our financial investments, we believe we have minimal risk exposure.

Interest Rate Risk

   The primary objective of our investment activities is to preserve principal
while at the same time maximizing yields without significantly increasing
risk. To achieve this objective, we maintain our portfolio of cash equivalents
and short-term and long-term investments in a variety of securities, including
both government and corporate obligations and money market funds. As of
September 30, 2000, approximately 73% of our total portfolio matures in one
year or less, with the reminder maturing in less than two years. See Note 1 of
Notes to Condensed Consolidated Financial Statements. For a tabular
presentation of interest rate risk sensitive instruments by year of maturity,
including the market value and average interest rates for the Company's
investment portfolio as of December 31, 1999, see the Company's 1999 Form 10-K
filed with the Securities and Exchange Commission in March 2000.

   We did not hold derivative financial instruments as of September 30, 2000,
and have never held such instruments in the past. In addition, we had no
outstanding debt as of September 30, 2000.

Foreign Currency Risk

   Currently the majority of our sales and expenses are denominated in U.S.
Dollars, as a result we have experienced some foreign exchange gains and
losses, but such gains and losses have not been significant to date. While we
do expect to effect some transactions in foreign currencies in 2000, we do not
anticipate that foreign exchange gains or losses will be significant. We have
not engaged in foreign currency hedging activities to date.

Equity Price Risk

   We are exposed to equity price risk on the marketable portion of equity
investments as such investments are subject to considerable market risk due to
their volatility. Interwoven typically does not attempt to reduce or eliminate
its market exposure in these equity investments. As of September 30, 2000, the
position in equity investments did not reflect an unrealized gain or loss as
the carrying value of investments approximated fair value.

                                      28
<PAGE>

                                    PART II

                               OTHER INFORMATION

Item 1. Legal Proceedings

   Not applicable.

Item 2. Changes in Securities and Use of Proceeds

   (c) Changes in Securities

   During the period of this report, we issued to certain former stockholders
of Lexington Software Associates, Inc. ("LSA") 4,548 and 8,491 shares of
common stock upon exercise of warrants to purchase Series E Preferred Stock
issued in connection with our acquisition of LSA in July 1999, for an
aggregate cash consideration of $19,307 and upon net exercise, respectively.

   The warrants described under this heading became exercisable for common
stock upon the closing of our initial public offering on October 14, 1999,
when all of our preferred stock converted into common stock. These securities
were not registered under the Securities Act of 1933, as amended, in reliance
upon the exemption provided by Section 4(2) of the Securities Act and/or
Regulation D promulgated thereunder for transactions by an issuer not
involving a public offering.

   On July 18, 2000, in connection with our acquisition of Neonyoyo, Inc., we
issued approximately 1.1 million shares of our common stock in a private
transaction that was exempt from registration under the Securities Act
pursuant to Section 4(2) of the Securities Act or Regulation D thereunder.

Item 3. Defaults upon Senior Securities

   Not applicable.

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

   Not applicable.

Item 5. Other Information

   On June 1, 2000 our Board of Directors approved a two-for-one stock split
of the outstanding shares of common stock. These shares were distributed on
July 13, 2000. All share and per share information included in this report on
Form 10-Q have been retroactively adjusted to reflect this stock split.

   In September 2000, our Board of Directors approved an amendment to our 2000
Stock Incentive Plan to increase the number of shares of common stock reserved
for issuance thereunder by 4 million shares.

   In October 2000, our Board of Directors approved (1) an amendment to our
Third Amended and Restated Certificate of Incorporation to increase the
authorized number of shares of common stock issuable by us from 100 million to
500 million shares, subject to stockholder approval; (2) a two-for-one stock
split in the form of a stock dividend, subject to stockholder approval of the
proposed amendment to our Certificate of Incorporation; and (3) an amendment
to our 1999 Equity Incentive Plan to increase the number of shares of common
stock reserved for issuance thereunder by 4 million shares, subject to
stockholder approval. Such stockholder approvals will be sought at a special
meeting of our stockholders, scheduled to be held on December 12, 2000.

   In October 2000, we acquired Ajuba Solutions, Inc. ("Ajuba") and in
November 2000 we acquired Metacode Technologies, Inc. ("Metacode"). Ajuba is a
developer of XML solutions. Metacode is a leading developer of content tagging
and taxonomy technology. We issued an aggregate value of approximately
$34 million of our Company stock, options to purchase our common stock and
cash for the capital stock and

                                      29
<PAGE>

stock options of Ajuba and approximately $171 million of our Company stock,
options to purchase our common stock and cash for the capital stock and stock
options of Metacode. These transactions will be accounted for as purchases,
with any excess of the purchase price over the fair value of net assets being
allocated to intangible assets that will be amortized over appropriate useful
lives.

Item 6. Exhibits and Reports on Form 8-K

   (a) List of Exhibits:

<TABLE>
<CAPTION>
       Number                           Exhibit Description
       ------                           -------------------
       <C>    <S>
        2.01   Agreement and Plan of Merger by and among the Registrant Neonyoyo,
               Inc. and Agnes Pak dated July 10, 2000 (incorporated by reference
               from Exhibit 2.01 to the Registrant's current report on Form 8-K
               (File No. 000-27389), filed with Commission on August 2, 2000)
        21.1   Subsidiaries of the Registrant
        27.1   Financial Data Schedule (Filed Electronically)
</TABLE>

   (b) Reports on Form 8-K :

   A Current Report on Form 8-K was filed by the Registrant on August 2, 2000
to report the consummation of the acquisition of Neonyoyo, Inc. on July 18,
2000. This acquisition was reported under Item 2.

   A Current Report on Form 8-K/A was filed by the Registrant on September 29,
2000 to supplement its report with respect to its acquisition of Neonyoyo,
Inc. Pursuant to Item 7, financial statements were filed with respect to this
acquisition.

                                      30
<PAGE>

                                   SIGNATURE

   Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

                                          INTERWOVEN, INC.

Dated: November 14, 2000                  By:     /s/ Martin W. Brauns
                                             ----------------------------------
                                                     Martin W. Brauns
                                               President and Chief Executive
                                                          Officer
                                                 (Duly Authorized Officer)

Dated: November 14, 2000                  By:      /s/ David M. Allen
                                             ----------------------------------
                                                      David M. Allen
                                                 Senior Vice President and
                                                  Chief Financial Officer
                                                 (Principal Financial and
                                                    Accounting Officer)

                                       31
<PAGE>

                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
 Exhibit
 -------
 <C>     <S>
  21.1   Subsidiaries of the Registrant.
  27.1   Financial Data Schedule.
</TABLE>

                                       32


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