PORTAL SOFTWARE INC
10-Q, 2000-12-14
COMPUTER PROGRAMMING SERVICES
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<PAGE>

                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549


                                   FORM 10-Q

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

                For the Quarterly Period Ended October 31, 2000

[_]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
     EXCHANGE ACT OF 1934

         For the transition period from ____________ to ______________

                       Commission File number 000-25829


                             PORTAL SOFTWARE, INC.
            (Exact Name of Registrant as Specified in Its Charter)


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

                            10200 South DeAnza Blvd
                         Cupertino, California  95014
                         ----------------------------
                   (Address of Principal Executive Offices)

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


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


On November 30, 2000, 171,670,245 shares of the Registrant's Common Stock,
$0.001 par value, were outstanding.
<PAGE>

                             PORTAL SOFTWARE, INC.
                                   FORM 10-Q

                    QUARTERLY PERIOD ENDED OCTOBER 31, 2000


                                     INDEX

<TABLE>
<CAPTION>
                                                                                               Page
                                                                                               ----
<S>                                                                                            <C>
Part I:  Financial Information

  Item 1: Financial Statements (Unaudited)

          Condensed Consolidated Balance Sheets at January 31, 2000 and October 31, 2000          3

          Condensed Consolidated Statements of Operations for the three and nine months           4
          ended October 31, 1999 and 2000

          Condensed Consolidated Statements of Cash Flows for the nine months                     5
          ended October 31, 1999 and 2000

          Notes to Condensed Consolidated Financial Statements                                    6

  Item 2: Management's Discussion and Analysis of Financial Condition and Results                12
          of Operations

  Item 3: Quantitative and Qualitative Disclosures About Market Risk                             28

Part II: Other Information

  Item 2: Changes in Securities and Use of Proceeds                                              29

  Item 6: Exhibits and Reports on Form 8-K                                                       30

Signature                                                                                        31

Exhibit Index                                                                                    32
</TABLE>

                                       2
<PAGE>

ITEM 1: FINANCIAL STATEMENTS

                             PORTAL SOFTWARE, INC.

                     CONDENSED CONSOLIDATED BALANCE SHEETS
                                 (in thousands)

<TABLE>
<CAPTION>
                                                                                    January 31,       October 31,
                                                                                       2000              2000
                                                                                   -------------     ------------
                                                                                                      (unaudited)
<S>                                                                                 <C>               <C>
Assets
Current assets:
  Cash and cash equivalents...................................................       $ 43,887          $ 29,981
  Accounts receivable, net....................................................         28,546            69,972
  Short-term investments......................................................        152,090           171,827
  Restricted short-term investments...........................................          5,312               240
  Prepaids and other current assets...........................................          4,516             5,889
                                                                                   ----------        ----------
    Total current assets......................................................        234,531           277,909
Property and equipment, net...................................................         18,785            44,411
Restricted long-term investments..............................................          5,856             6,376
Other assets..................................................................          6,537            12,337
                                                                                   ----------        ----------
                                                                                     $265,529          $341,033
                                                                                   ==========        ==========
Liabilities and Stockholders' Equity
Current liabilities:
  Accounts payable............................................................       $  7,655          $  7,854
  Accrued compensation........................................................          9,060            27,861
  Other accrued liabiliies....................................................          5,282            12,880
  Current portion of capital lease obligations................................            780               898
  Deferred revenue............................................................         32,857            44,584
                                                                                   ----------        ----------
    Total current liabilties..................................................         55,634            94,077
Long-term portion of capital lease obligations................................          1,525               834
Commitments...................................................................             --                --
Stockholders' equity:
  Common stock, $0.001 par value..............................................            159               163
  Additional paid-in capital..................................................        251,047           269,836
  Accumulated other comprehensive loss........................................           (639)             (524)
  Notes receivable from stockholders..........................................           (259)             (135)
  Deferred stock compensation.................................................         (6,379)           (3,374)
  Accumulated deficit.........................................................        (35,559)          (19,844)
                                                                                   ----------        ----------
    Stockholders' equity......................................................        208,370           246,122
                                                                                   ----------        ----------
                                                                                     $265,529          $341,033
                                                                                   ==========        ==========
</TABLE>

                            See accompanying notes.

                                       3
<PAGE>

                             PORTAL SOFTWARE, INC.

                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
              (in thousands, except per share amounts; unaudited)

<TABLE>
<CAPTION>
                                                                 Three Months Ended               Nine Months Ended
                                                                     October 31,                     October 31,
                                                              -------------------------       -------------------------
                                                                1999            2000             1999            2000
                                                              ---------      ----------       ----------     ----------
<S>                                                           <C>            <C>              <C>            <C>
Revenues:
 License fees..........................................       $  18,076      $   46,665       $   39,791     $  126,285
 Services..............................................           9,976          25,370           24,236         60,909
                                                              ---------      ----------       ----------     ----------
  Total revenues.......................................          28,052          72,035           64,027        187,194
                                                              ---------      ----------       ----------     ----------

Costs and expenses:
 Cost of license fees..................................             607           1,957            1,113          3,219
 Cost of services......................................           6,482          15,801           15,472         38,093
 Research and development..............................           6,757          14,653           17,213         39,753
 Sales and marketing...................................          11,795          26,339           27,952         72,091
 General and administrative............................           3,845           7,564            8,999         22,188
 Amortization of deferred stock compensation...........           1,801             939            6,812          3,005
                                                              ---------      ----------       ----------     ----------
  Total costs and expenses.............................          31,287          67,253           77,561        178,349
                                                              ---------      ----------       ----------     ----------
Income (loss) from operations..........................          (3,235)          4,782          (13,534)         8,845
Interest income (expense) and other income, net........           1,956           3,425            2,951          9,627
One-time gain upon expiration of put option on common
 stock.................................................              --              --            3,810             --
                                                              ---------      ----------       ----------     ----------

Income (loss) before income taxes......................          (1,279)          8,207           (6,773)        18,472
Provision for income taxes.............................            (400)         (1,218)          (1,216)        (2,757)
                                                              ---------      ----------       ----------     ----------
Net income (loss)......................................       $  (1,679)     $    6,989       $   (7,989)    $   15,715
                                                              =========      ==========       ==========     ==========
Basic net income (loss) per share......................       $   (0.01)     $     0.04       $    (0.07)    $     0.10
                                                              =========      ==========       ==========     ==========
Shares used in computing basic net income (loss) per
 share.................................................         145,881         159,434          115,592        157,090
                                                              =========      ==========       ==========     ==========
Diluted net income (loss) per share)...................       $   (0.01)     $     0.04       $    (0.07)    $     0.09
                                                              =========      ==========       ==========     ==========
Shares used in computing diluted net income (loss) per
 share.................................................         145,881         173,706          115,592        173,442
                                                              =========      ==========       ==========     ==========
</TABLE>

                            See accompanying notes.

                                       4
<PAGE>

                             PORTAL SOFTWARE, INC.

                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                           (in thousands; unaudited)

<TABLE>
<CAPTION>
                                                                                                    Nine Months Ended
                                                                                                        October 31,
                                                                                           ------------------------------
                                                                                                1999              2000
                                                                                           ------------------------------
<S>                                                                                        <C>                  <C>
OPERATING ACTIVITIES:
 Net income (loss).................................................................        $  (7,989)           $ 15,715
 Adjustments to reconcile net income (loss) to net cash provided by operating
  activities:
  Depreciation and amortization....................................................            1,552               5,694
  Amortization of deferred stock compensation......................................            6,812               3,005
  One-time gain upon expiration of put option on common stock......................           (3,810)                 --
  Changes in operating assets and liabilities:
   Accounts receivable, net........................................................           (2,619)            (41,426)
   Other current assets............................................................           (1,369)             (2,025)
   Other assets....................................................................             (252)             (1,801)
   Accounts payable................................................................            1,343               2,199
   Accrued compensation............................................................            7,005              18,801
   Other accrued liabilities.......................................................           (1,028)              7,588
   Deferred revenue................................................................            2,876              11,726
                                                                                          ==========          ==========
    Net cash provided by operating activities......................................            2,521              19,476
                                                                                          ==========          ==========
INVESTING ACTIVITIES
 Purchases of short-term investments...............................................         (147,316)            (98,044)
 Maturity of short-term investments................................................               --              84,320
 Purchases of long-term investments................................................           (5,948)             (2,747)
    Maturity of long-term investments..............................................               --               2,235
 Purchases of property and equipment...............................................           (5,956)            (32,043)
 Purchases of equity investments...................................................               --              (5,000)
                                                                                          ----------          ----------
    Net cash used in investing activities..........................................         (159,220)            (51,279)
                                                                                          ==========          ==========
FINANCING ACTIVITIES:
 Payments received from stockholder notes receivable...............................               --                 124
 Repayment of long-term debt.......................................................           (4,122)                 --
 Proceeds from line of credit......................................................            1,000                  --
 Repayment of line of credit.......................................................           (1,000)                 --
 Principal payments under capital lease obligations................................             (371)               (562)
 Proceeds from issuance of common stock, net of repurchases and issuance cost......          209,619              18,794
                                                                                          ----------          ----------
    Net cash provided by financing activities......................................          205,126              18,356
                                                                                          ==========            ========
 Effect of exchange rate on cash and cash equivalents..............................              (22)               (459)
Net increase (decrease) in cash and cash equivalents...............................           48,405             (13,906)
Cash and cash equivalents at beginning of period...................................           11,809              43,887
                                                                                          ==========          ==========
Cash and cash equivalents at end of period.........................................        $  60,214            $ 29,981
                                                                                          ==========          ==========
</TABLE>

                            See accompanying notes.

                                       5
<PAGE>

                             PORTAL SOFTWARE, INC.

        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)


(1)  Significant Accounting Policies:

  Nature of Business and Basis of Presentation

     Portal Software, Inc. or Portal, markets and supports real-time customer
management and billing software for a variety of Internet-based, wireless and
other services. Portal's software is a comprehensive solution that is designed
to meet the complex, mission-critical provisioning, accounting, reporting and
marketing needs of providers of Internet-based services. Portal markets its
products worldwide through a combination of a direct sales force and
distribution partners. Substantially all of Portal's license revenues are
derived from sales of its Infranet product.

     The accompanying unaudited condensed consolidated financial statements
include the accounts of Portal and its wholly-owned subsidiaries. All
significant intercompany balances and transactions have been eliminated in
consolidation. The balance sheet at October 31, 2000 and the statement of
operations for the three and nine months ended October 31, 2000 and cash flows
for the nine months ended October 31, 1999 and 2000 are unaudited. In the
opinion of management, these financial statements reflect all adjustments that
are necessary for a fair presentation of the results for and as of the periods
shown. The results of operations for such periods are not necessarily indicative
of the results expected for the full fiscal year or for any future period. The
condensed consolidated financial statement information as of January 31, 2000 is
derived from audited financial statements as of that date. These financial
statements should be read in conjunction with the financial statements and
related notes included in Portal's Annual Report on Form 10-K for the year ended
January 31, 2000, filed with the Securities and Exchange Commission on April 28,
2000.

  Revenue Recognition

     License revenues are comprised of fees for multiyear or perpetual licenses,
which are primarily derived from contracts with corporate customers and
resellers. Revenue from license fees is recognized when persuasive evidence of
an agreement exists, delivery of the product has occurred, no significant Portal
obligations with regard to implementation remain, the fee is fixed or
determinable and collectibility is probable. For electronic delivery, the
software is considered to have been delivered when Portal has provided the
customer with the access codes that allow for immediate possession of the
software. If the fee due from the customer is not fixed or determinable, revenue
is recognized as payments become due from the customer. If collectibility is not
considered probable, revenue is recognized when the fee is collected. Revenue on
arrangements with customers who are not the ultimate users (primarily resellers)
is not recognized until evidence of sell through to an end user has been
received.

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

     In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements"
("SAB 101"). SAB 101 summarizes certain of the SEC staff's views in applying
generally accepted accounting principles to revenue recognition. We will be
required to adopt SAB 101 in our fiscal quarter beginning November 1, 2000.
Portal believes that its revenue recognition policies are compliant with

                                       6
<PAGE>

(1)  Significant Accounting Policies (continued)

  Revenue Recognition (continued)

SAB 101 and that adoption of SAB 101 will not have a significant impact on
Portal's financial reporting.

  Concentration of Credit Risk

     Portal sells its software and services to customers consisting mainly of
North American, European and Asia-Pacific Internet service providers and
enhanced service developers. Portal performs ongoing credit evaluations of its
customers and does not require collateral. Portal maintains an allowance for
potential credit losses and such losses historically have been within
management's expectations.

     No individual customer accounted for greater than 10% of total revenue for
the three and nine months ended October 31, 2000 and the nine months ended
October 31, 1999. Two customers accounted for a total of 27% of total revenues
during the three months ended October 31, 1999.

  Segment Information

     Portal operates solely in one segment, the development and marketing of
CM&B software. Portal's foreign operations consist of sales, marketing and
support activities through its foreign subsidiaries and an overseas reseller
network. Operating losses generated by the foreign operations of Portal and
their corresponding identifiable assets were not material in any period
presented. Portal's chief operating decision maker reviews financial information
presented on a consolidated basis, accompanied by disaggregated information
about revenues by geographic region for purposes of making operating decisions
and assessing financial performance. Portal does not assess the performance of
its geographic regions on other measures of income or expense, such as
depreciation and amortization, gross margin or net income. In addition, as
Portal's assets are primarily located in its corporate office in the United
States and not allocated to any specific region, Portal does not produce reports
for, or measure the performance of its geographic regions based on any asset-
based metrics. Therefore, geographic information is presented only for revenues.

     Portal's export revenue represented 38% and 43% of total revenues for the
three months ended October 31, 1999 and 2000 and 34% and 40% for the nine months
ended October 31, 1999 and 2000. All of the export sales to date have been
denominated in U.S. dollars and were derived from sales to Europe, Latin America
and Asia-Pacific. Total export revenues for the three months ended October 31,
1999 and 2000 were $8.7 million and $17.3 million to customers in Europe and
$1.9 million and $13.4 million to customers in the Latin American and Asia-
Pacific regions. Total export revenues for the nine months ended October 31,
1999 and 2000 were $17.2 million and $44.6 million to customers in Europe and
$4.3 million and $29.3 million to customers in the Latin American and Asia-
Pacific regions.

  Cash and Cash Equivalents

     Portal considers all highly liquid, low-risk debt instruments with an
original maturity at the date of purchase of three months or less to be cash
equivalents. Through January 31, 1999, Portal maintained cash and cash
equivalents in money market accounts with major financial institutions for which
the carrying amount approximated its fair value. Upon completion of the initial
public offering in May 1999 and secondary offering in October 1999, Portal
received additional cash that was available for investment. At October 31, 2000,
cash equivalents and short-term investments consist primarily of commercial
paper, corporate notes, money market funds and government securities. All short-
term investments mature within 24 months.

     Portal classifies, at the date of acquisition, its cash equivalents and
short-term investments as available-for-sale in accordance with the provisions
of the FASB's Statement of Financial Accounting Standards No.115, "Accounting
for Certain Investments in Debt and Equity Securities" ("FAS 115").
Securities are reported at fair market value, with the related unrealized gains
and losses included within stockholders' equity. At October 31, 2000, unrealized
losses were $129,319 due primarily to the effects of increasing interest rates
on longer-term securities. It is not expected that a significant amount of the
unrealized loss will be realized. Debt and discount securities are adjusted for
straight-line amortization of premiums and accretion of discounts to maturity,
both of which are included in interest income. Realized gains and losses are
recorded using the specific identification method.

                                       7
<PAGE>

(1)  Significant Accounting Policies (continued)

  Cash and Cash Equivalents (continued)

     The following schedule summarizes the estimated fair value of Portal's
cash, cash equivalents and short-term investments (in thousands)

<TABLE>
<CAPTION>
                                                                            January 31,           October 31,
                                                                               2000                  2000
                                                                            ----------            -----------
                                                                                                  (unaudited)
<S>                                                                         <C>                    <C>
Cash and cash equivalents:
  Cash.............................................................         $   11,570             $    7,487
  Money market funds...............................................             12,142                 19,116
  Commercial paper.................................................             14,977                  3,378
  U.S. Government Securities.......................................              5,198                     --
                                                                            ----------             ----------
                                                                            $   43,887             $   29,981
                                                                            ==========             ==========
</TABLE>

Short-term investments at October 31, 2000 (in thousands, unaudited):

<TABLE>
<CAPTION>
                                                                        Gross Unrealized
                                                    ----------      -----------------------      ----------
                                                       Cost            Gain          Loss        Fair Value
                                                    ----------      ---------     ---------      ----------
  <S>                                               <C>             <C>           <C>            <C>
  Corporate notes..............................     $  119,448      $      --     $     (65)     $  119,383
  U.S. Government securities...................         45,370             --           (45)         45,325
  Commercial paper.............................          7,374             --           (15)          7,359
  Restricted investments.......................           (240)            --            --            (240)
                                                    ----------      ---------     ---------      ----------
                                                    $  171,952      $      --     $    (125)     $  171,827
                                                    ==========      =========     =========      ==========
</TABLE>

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

<TABLE>
<CAPTION>
                                                                         January 31,      October 31,
                                                                             2000             2000
                                                                         -----------      -----------
                                                                                          (unaudited)
  <S>                                                                     <C>              <C>
  Due within one year............................................         $  125,467       $  168,819
  Due within two years...........................................             75,822           33,229
  Restricted short-term investments..............................             (5,312)            (240)
                                                                          ----------       ----------
                                                                          $  195,277       $  201,808
                                                                          ==========       ==========
</TABLE>

     Restricted short-term investments at October 31, 2000 represent collateral
for a $200,000 surety bond required by a customer contract that expired on
October 31, 2000. On February 29, 2000, a $3,000,000 letter of credit issued to
Portal's landlord to guarantee payment of tenant improvements and a $750,000
surety bond required by a customer contract expired. The restricted short-term
investments are not available to support current operations and, consequently,
are classified as held-to-maturity. As a result, and in accordance with FAS 115,
unrealized gains and losses are not recorded. At October 31, 2000, amortized
cost approximated fair value.

     Restricted long-term investments represent collateral for two letters of
credit issued in lieu of security deposits for facility leases and consist of
corporate bonds maturing over a period of one to three years. The two letters of
credit for $2,250,000 and $3,000,000 are renewable annually until they expire on
December 31, 2010. The restricted long-term investments are classified as held-
to-maturity and, consequently, unrealized gains and losses are not recorded. At
October 31, 2000, amortized cost approximated fair value.

     Realized gains and losses from sales of each type of security were
immaterial for all periods presented.

                                       8
<PAGE>

(1)  Significant Accounting Policies (continued)

  Other Assets

     Other assets consisted of the following (in thousands):

<TABLE>
<CAPTION>
                                                                           January 31,        October 31,
                                                                              2000               2000
                                                                           -----------        -----------
                                                                                              (unaudited)
<S>                                                                       <C>                <C>
  Prepaid services - long term portion (see Note 2).....................   $     3,048        $     4,240
  Deposits and other....................................................         3,489              8,097
                                                                           -----------        -----------
                                                                           $     6,537        $    12,337
                                                                           -----------        -----------
</TABLE>

  Use of Estimates

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

  Net Income (Loss) Per Share

     Basic net income (loss) per share and diluted net income (loss) per share
are presented in conformity with the FASB's Statement of Financial Accounting
Standards No. 128, ``Earnings Per Share'', or FAS 128, for all periods
presented. In accordance with FAS 128, basic and diluted net income (loss) per
share have been computed using the weighted-average number of shares of common
stock outstanding during the period, less shares subject to repurchase. The
diluted calculation also includes common equivalent shares, when dilutive.

     For the three and nine months ended October 31, 1999, Portal has excluded
all convertible preferred stock, warrants for convertible preferred stock,
outstanding stock options, and shares subject to repurchase from the calculation
of diluted loss per common share because all such securities were antidilutive.

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

<TABLE>
<CAPTION>
                                                                   Three months ended        Nine months ended
                                                                       October 31,               October 31,
                                                                ----------------------   ----------------------
                                                                   1999        2000         1999       2000
                                                                ----------------------   ----------------------
<S>                                                             <C>          <C>         <C>           <C>
Basic:
Net income (loss).............................................  $ (1,679)    $  6,989     $ (7,989)    $ 15,715
                                                                --------     --------     --------     --------

    Weighted-average shares of common stock outstanding.......   153,088      163,015      124,611      161,600
    Less: Weighted-average shares subject to repurchase.......    (7,207)      (3,581)      (9,019)      (4,510)
                                                                --------     --------     --------     --------
Weighted-average shares used in computing basic net income
 (loss) per share.............................................   145,881      159,434      115,592      157,090
                                                                ========     ========     ========     ========
Basic net income (loss) per share.............................  $  (0.01)    $   0.04     $  (0.07)    $   0.10
                                                                --------     --------     --------     --------
Diluted:
Net income (loss).............................................  $ (1,679)    $  6,989     $ (7,989)    $ 15,715
                                                                --------     --------     --------     --------
   Shares used above..........................................   145,881      159,434      115,592      157,090
   Common equivalent shares...................................        --       14,272           --       16,352
                                                                --------     --------     --------     --------
Shares used in computing diluted net income (loss) per share..   145,881      173,706      115,592      173,442
                                                                ========     ========     ========     ========
Diluted net income (loss) per share...........................  $  (0.01)    $   0.04     $  (0.07)    $   0.09
                                                                ========     ========     ========     ========
</TABLE>

                                       9
<PAGE>

 Comprehensive Income (Loss)

     Comprehensive income (loss) is comprised of net income (loss) and other
comprehensive income (loss), which includes certain changes in equity of the
company that are excluded from net income (loss). Specifically, FAS 130 requires
foreign currency translation adjustments and changes in the fair value of
available-for-sale securities to be included in accumulated other comprehensive
income (loss). Comprehensive income (loss) for the nine months ended October 31,
1999 and 2000 is as follows (in thousands; unaudited):

<TABLE>
<CAPTION>
                                                                     Nine months ended
                                                                        October 31,
                                                                   ----------------------
                                                                     1999          2000
                                                                   -------        -------
<S>                                                                <C>             <C>
Net income (loss)                                                  $(7,989)       $15,715
Unrealized gain (loss) on marketable securities...........            (201)           573
Change in cumulative translation adjustment...............             (20)          (459)
                                                                   -------        -------
Comprehensive net income (loss)...........................         $(8,210)       $15,829
                                                                   =======        =======
</TABLE>


(2)  Agreement with Andersen Consulting LLC

     On April 12, 1999, Portal agreed to enter into a strategic alliance with
Andersen Consulting LLC under which Andersen Consulting LLC will provide
services to Portal and the parties agreed to expand their existing marketing
alliance and work closely together to expand their customer service and
marketing relationship. Under this arrangement, Andersen Consulting LLC agreed
to purchase up to 800,000 shares of common stock from Portal in a private
placement concurrent with Portal's initial public offering at the initial public
offering price, less the underwriting discount.

     Under this agreement, Portal agreed to pay Andersen Consulting LLC for its
services a minimum services fee in cash of $2.8 million and a cash settled put
for 400,000 of the shares to be purchased by Andersen Consulting LLC. This put
guaranteed a closing value of $6.0 million at the end of the first day of
trading for 400,000 common shares sold to Andersen and required Portal to pay
Andersen Consulting LLC in cash for any differences between the closing value of
these shares and $6.0 million. Upon the date of the arrangement, Portal recorded
the fair value of the put of approximately $3.8 million. The value of the put
was determined using the Black-Scholes model using a risk-free interest rate of
6.3%, an expected life of one month and a volatility factor of 100%.

     Upon completion of the initial public offering, the put option was settled.
Based on the closing price of Portal's common stock at the end of the first day
of trading, the net cash settlement of the put was computed at a value of zero.
As a result, a gain upon remeasurement of the liability of $3.8 million was
recorded as other income in the year ended January 31, 2000 and the initial fair
value of the put, approximately $3.8 million, was classified as a prepaid
service asset.

     Upon signing of the definitive agreement in March 2000, the services fee of
$2.8 million was paid and capitalized. The entire prepaid service asset of $6.6
million was allocated between current and long-term assets as appropriate and is
being amortized on a straight-line basis over the term of the agreement of
approximately four and one half years.

(3)  Income Taxes

     During the three and nine months ended October 31, 2000, Portal recognized
tax expense of $1.2 and $2.8 million, respectively, primarily related to tax on
earnings generated from domestic and foreign operations. Due to Portal's
positive earnings for the three and nine-month periods, Portal reversed a
portion of its valuation allowance against the previously established deferred
tax assets for which realization is considered more likely than not. The
effective tax rate for the three and nine months ended October 31, 2000 is based
on earnings estimates, which if revised, could result in an increased future
effective tax rate.

                                       10
<PAGE>

(4)  Subsequent Event

     In November 2000, Portal announced an agreement to acquire privately held
SOLUTION42. Under the terms of the agreement, Portal will issue, to the
shareholders of SOLUTION42, shares in a German Portal subsidiary that may be
exchanged for up to 7.5 million shares of Portal common stock. SOLUTION42 is a
German based provider of wireless voice mediation, provisioning and rating
technologies. The acquisition was completed in the fourth quarter of fiscal 2001
and will be accounted for as a purchase. Portal does not anticipate that any
significant amount of in-process research and development expense will be
recognized in connection with this transaction, subject to the completion of the
purchase price allocation process.

                                       11
<PAGE>

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

                                   Overview

  Portal Software, Inc. develops, markets and supports real-time customer
management and billing software, known as CM&B software, for providers of  a
variety of Internet-based, wireless and other services. In late 1993, Portal
began focusing on developing and marketing real-time CM&B software for the
Internet. The first generally available version of the product, named Infranet,
was shipped in May 1996.

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

  .  license fees from new customers;

  .  license fees for new products to existing customers; and

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

  Portal has generated its historical Infranet revenues from approximately 400
customers through October 31, 2000. Portal has established a series of
relationships with systems integrators and hardware platform, software and
service providers. Portal has derived, and anticipates that it will continue to
derive, a substantial portion of its revenues from customers that have
significant relationships with its market and platform partners.

                             RESULTS OF OPERATIONS

  The following table sets forth the results of operations for the three and
nine months ended October 31, 1999 and 2000 expressed as a percentage of total
revenues.

<TABLE>
<CAPTION>
                                                            Three Months Ended                   Nine Months Ended
                                                                 October 31,                        October 31,
                                                         ------------------------           -------------------------
                                                           1999              2000            1999              2000
                                                         -------            ------          -----             -------
<S>                                                      <C>             <C>                <C>             <C>
Revenues:
  License fees...................................           64 %              65 %              62 %             67 %
  Services.......................................           36                35                38               33
                                                        ------            ------            ------           ------
     Total revenues..............................          100               100               100              100
                                                        ------            ------            ------           ------
Costs and expenses:
  Cost of license fees...........................            2                 3                 2                2
  Cost of services...............................           23                22                24               20
  Research and development.......................           24                20                27               21
  Sales and marketing............................           42                36                44               38
  General and administrative.....................           14                11                14               12
  Amortization of deferred stock compensation....            7                 1                10                2
                                                        ------            ------            ------           ------
     Total costs and expenses....................          112                93               121               95
                                                        ------            ------            ------           ------
Income (loss) from operations....................          (12)                7               (21)               5
Interest income (expense) and other income, net..            7                 4                11                5
                                                        ------            ------            ------           ------
Income (loss) before income taxes................           (5)               11               (10)              10
Provision for income taxes.......................           (1)               (1)               (2)              (2)
                                                        ------            ------            ------           ------
Net income (loss)................................           (6)%              10 %             (12)%              8 %
                                                        ======            ======            ======           ======
</TABLE>

                                       12
<PAGE>

             Three and Nine Months Ended October 31, 1999 and 2000

                                    Revenues
                                    --------

  Total revenues were $72.0 million in the three months ended October 31, 2000,
an increase of approximately $44.0 million or 157% over the comparable period of
fiscal 2000 and $187.2 million in the nine months ended October 31, 2000, an
increase of approximately $123.2 million or 192% over the comparable periods in
fiscal 2000. License fees revenues increased as a percentage of total revenues
in the three and nine months ended October 31, 2000 compared to the three and
nine months ended October 31, 1999 primarily because license fees revenue growth
exceeded services revenue growth. No individual customer accounted for more than
10% of total revenue for the three and nine months ended October 31, 2000 and
the nine months ended October 31, 1999. Two customers accounted for a combined
27% of total revenues during the three months ended October 31, 1999.

  License fees totaled $46.7 million in the three months ended October 31, 2000,
an increase of approximately $28.6 million or 158% over the comparable period of
fiscal 2000 and $126.3 million in the nine months ended October 31, 2000, an
increase of approximately $86.5 million or 217% over the comparable periods in
fiscal 2000. The increase in license fees was primarily due to expanded
marketing activities, growth in Portal's sales force, and greater demand for and
acceptance of Infranet.

  Services revenues were $25.4 million in the three months ended October 31,
2000, an increase of approximately $15.4 million or 154% over the comparable
period of fiscal 2000 and $60.9 million in the nine months ended October 31,
2000, an increase of approximately $36.7 million or 151% over the comparable
periods in fiscal 2000. The increase in services revenues resulted, in part,
from the increase in support and maintenance service fees related to Portal's
growing customer base, both in terms of new directly supported sites and
additional users at existing sites, and the renewal of maintenance contracts. In
addition, the increase in services revenues resulted from increased demand for
Portal's consulting, maintenance and training services to meet the increased
number of Portal's customers.

<TABLE>
<CAPTION>
                                               Three Months                             Nine Months
                                             Ended October 31,      Percent          Ended October 31,     Percent
                                             ----------------                       ------------------
(in millions)                                 1999      2000        Change          1999        2000        Change
                                              ----      ----        ------          ----        ----        ------
<S>                                          <C>       <C>          <C>            <C>        <C>           <C>
Geographical Revenues:
 North America.........................      $17.5     $41.3         136 %         $42.5      $113.3          167 %
     Percentage of total revenues......         62 %      57 %                        66 %        60 %
 International
  Europe...............................        8.7      17.3          99 %          17.2        44.6          159 %
     Percentage of total revenues......         31 %      24 %                        27 %        24 %
  Intercontinental.....................        1.9      13.4         605 %           4.3        29.3          581 %
     Percentage of total revenues......          7 %      19 %                         7 %        16 %
                                            ------    ------                      ------      ------
  Total international..................       10.5      30.7         192 %          21.5        73.9          244 %
     Percentage of total revenues......         38 %      43 %                        34 %        40 %
                                            ------    ------                      ------      ------
Total revenues.........................      $28.1     $72.0         157 %         $64.0      $187.2          192 %
                                            ======    ======                      ======      ======
</TABLE>

  North American revenues, which are defined by Portal as revenues from the
United States and Canada, were $41.3 million in the three months ended October
31, 2000, an increase of approximately $23.8 million or 136% and $113.3 million
in the nine months ended October 31, 2000, an increase of approximately $70.8
million or 167% over the comparable periods in 1999. The increase in North
American revenues was primarily due to expanded marketing activities, greater
acceptance of Infranet and growth in Portal's sales force in the North American
market.

  International revenues for Europe (which are defined by Portal as Europe,
Middle East and Africa) and Intercontinental (which are defined by Portal as
Asia-Pacific, Japan and Latin America) totaled $30.7 million in the three months
ended October 31, 2000, an increase of approximately $20.2 million or 192% and
$73.9 million in the nine months ended October 31, 2000, an increase of
approximately $52.4 million or 244% over the comparable periods in 1999.
European revenues were $17.3 million in the three months ended October 31, 2000,
an increase of approximately $8.6 million or 99% and $44.6 million in the nine
months ended October 31, 2000, an increase of

                                       13
<PAGE>

approximately $27.4 million or 159% over the comparable periods in 1999.
Intercontinental revenues were $13.4 million in the three months ended October
31, 2000, an increase of approximately $11.5 million or 605% and $29.3 million
in the nine months ended October 31, 2000, an increase of approximately $25
million or 581% over the comparable period in 1999. The increase in
international revenues was primarily due to growth in Portal's direct sales
force and increased marketing efforts worldwide.

     International revenues represented 43% and 40% of total revenues for the
three and nine months ended October 31, 2000, compared with 38% and 34% in the
three and nine months ended October 31, 1999. In both the three and nine month
periods ended October 31, 2000, revenues from Europe were 24% of total revenues
and revenues from Intercontinental were 19% and 16% of total revenues,
respectively.

                                   Expenses

Cost of License Fees

     Cost of license fees consists of resellers' commission payments to systems
integrators and third-party royalty obligations with respect to third-party
technology included in Infranet. Cost of license fees was $2.0 million in the
three months ended October 31, 2000, an increase of approximately $1.4 million
or 233% and $3.2 million in the nine months ended October 31, 2000, an increase
of approximately $2.1 million or 191% from the comparable periods in 1999. The
increase in cost of license fees is primarily due to increased license revenue
and  resellers' commissions resulting from Portal expanding its base of systems
integrator partners. Gross margin for license fees was approximately 96% and 97%
in the three and nine months ended October 31, 2000 compared to approximately
97% in both of the comparable periods in 1999. Portal did not incur any
shipping, packaging or documentation costs, as its product was delivered
electronically over the Internet.

Cost of Services

     Cost of services primarily consists of maintenance, consulting and training
expenses. Cost of services was $15.8 million in the three months ended October
31, 2000, an increase of approximately $9.3 million or 143% and $38.1 million in
the nine months ended October 31, 2000, an increase of approximately $22.6
million or 146% over the comparable periods in 1999. The increase in cost of
services is primarily due to an increase in the number of consulting and
technical support personnel necessary to support both the expansion of Portal's
installed base of customers and new implementations. Gross margin for services
was approximately 38% and 37% in the three and nine months ended October 31,
2000 compared to approximately 35% and 36% in the comparable periods in 1999.
Portal expects cost of services to increase substantially during the remainder
of the fiscal year as a result of increased demand for services.

Research and Development Expenses

     Research and development expenses consist primarily of personnel and
related costs for Portal's development and technical support efforts. Research
and development expenses were $14.7 million in the three months ended October
31, 2000, an increase of approximately $7.9 million or 116% and $39.8 million in
the nine months ended October 31, 2000, an increase of approximately $22.6
million or 131% over the comparable periods in 1999. The increase was primarily
due to an increase in the number of research and development personnel necessary
to support both expanded functionality of Infranet and increases in Portal's
quality assurance, technical support and technical publications operations.
Portal currently believes its investment in research and development will
increase substantially during the remainder of the fiscal year as Portal hires
additional research and development employees. Portal has not capitalized any
software development costs to date.

Sales and Marketing Expenses

     Sales and marketing expenses consist of personnel and related costs for
Portal's direct sales force, marketing staff and marketing programs, including
trade shows, advertising and costs associated with Portal's recruitment of new
and maintenance of existing strategic partnerships. Sales and marketing expenses
were $26.3 million in the three months ended October 31, 2000, an increase of
approximately $14.5 million or 123% and $72.1 million in the nine months

                                       14
<PAGE>

ended October 31, 2000, an increase of approximately $44.1 million or 158% over
the comparable periods in 1999. The increase was due to a number of factors
including an increase in the number of sales and marketing personnel, the
opening of new sales offices in the United States, Europe and Asia-Pacific and
expenses incurred in connection with trade shows and additional marketing
programs. Portal expects that sales and marketing expenses will increase
substantially during the remainder of the fiscal year as Portal hires additional
sales and marketing personnel, increases spending on advertising and marketing
programs and establishes sales offices in additional domestic and international
locations.

General and Administrative Expenses

     General and administrative expenses consist primarily of personnel and
related costs for general corporate functions, including finance, accounting,
legal and human resources and facilities as well as information system expenses
not allocated to other departments. General and administrative expenses were
$7.6 million in the three months ended October 31, 2000, an increase of
approximately $3.8 million or 100% and $22.2 million in the nine months ended
October 31, 2000, an increase of approximately $13.2 million or 147% over the
comparable periods in 1999. The increase was primarily due to a higher number of
general and administrative personnel and additional legal and accounting costs
incurred in connection with business activities. Portal expects that general and
administrative expenses will increase substantially during the remainder of the
fiscal year as Portal hires additional general and administrative personnel and
continues to incur greater legal and accounting costs in connection with
expanding business activities.

Amortization of Deferred Stock Compensation

     Portal recorded deferred stock compensation of approximately $16.8 million
in fiscal year 1999, representing the difference between the exercise prices of
options granted to acquire certain shares of common stock during fiscal year
2000 and the deemed fair value for financial reporting purposes of Portal's
common stock on their respective grant dates. Portal amortized deferred
compensation expense of approximately $0.9 million and $3.0 million during the
three and nine months ended October 31, 2000 as compared to $1.8 and $6.8
million incurred during the comparable periods in 1999. This compensation
expense relates to options awarded to individuals in all operating expense
categories. Total deferred compensation at October 31, 2000 of approximately
$3.4 million is being amortized over the vesting periods of the options using a
graded vesting method. Amortization of deferred compensation is estimated to
total $3.7 million in fiscal year 2001, $1.9 million in fiscal year 2002 and
$0.7 million in fiscal year 2003.

Provision for Income Taxes

     The $1.2 and $2.8 million income tax provision shown for the three and nine
months ended October 31, 2000 is primarily the result of tax on earnings
generated from domestic and foreign operations.   Due to Portal's positive
earnings for the three and nine-month periods, Portal reversed a portion of its
valuation allowance against the previously established deferred tax assets for
which realization is considered more likely than not.   Under Statement of
Financial Accounting Standards No. 109 (FAS 109), deferred tax assets and
liabilities are determined based on differences between the financial reporting
and tax bases of assets and liabilities and are measured using the enacted tax
rates and laws that will be in effect when the differences are expected to
reverse.  FAS 109 provides for the recognition of deferred tax assets if
realization of such assets are more likely than not.  Based on the weight of
available evidence, Portal has provided a valuation allowance against certain
deferred tax assets.  Portal will continue to evaluate the realizability of the
deferred tax assets on a quarterly basis.

                        Liquidity and Capital Resources

     Cash, cash equivalents and short-term investments (including restricted
short-term investments) totaled $202.0 million at October 31, 2000, compared to
a balance of $201.3 million at January 31, 2000.

     Portal generated $19.5 million in cash from operations in the nine months
ended October 31, 2000, an increase of $17.0 million over the $2.5 million
generated in the comparable period ended October 31, 1999.  Net cash provided by
operations in the nine months ended October 31, 2000 was primarily comprised of
net income of $15.7 million, an $11.7 million increase in deferred revenue, a
$7.6 million increase in other accrued liabilities and an increase in accrued
compensation of $18.8 million.  Also, amortization of deferred stock
compensation, which is included in the

                                       15
<PAGE>

results of operations, but does not require the use of cash, amounted to $3.0
million for the nine months ended October 31, 2000. These increases were offset
by a $41.4 million increase in accounts receivable and a $3.8 million increase
in other current assets and other assets.

     Portal has continued to make significant investments in software, equipment
and facilities. During the nine months ended October 31, 2000, Portal purchased
computer equipment and software, made leasehold improvements and purchased other
capital equipment amounting to approximately $32.0 million, primarily to support
its ongoing and expanding operations and information systems.  None of the
equipment was funded from Portal's equipment lease line facility.

     Portal has raised equity capital from investors to fund its operations. In
fiscal 2000, Portal completed an initial public offering and concurrent private
placements of stock to Cisco Systems, Inc. and Andersen Consulting LLC that
collectively raised $102.4 million. Portal also completed a follow-on offering
in October 1999, which raised approximately $106.0 million, net of underwriting
commissions and expenses.  During the same period, Portal raised an additional
$6.6 million from sales of common stock issued from Portal's employee stock
purchase plan and upon the exercise of stock options by employees and warrants
by third parties, net of repurchases.  During the nine months ended October 31,
2000, Portal raised an additional $18.8 million from sales of common stock
issued from Portal's employee stock purchase plan and upon the exercise of stock
options by employees, net of repurchases.

     On April 12, 1999, Portal agreed to enter into a strategic alliance with
Andersen Consulting under which Andersen Consulting LLC agreed to provide
services to Portal and the parties agreed to expand their existing marketing
alliance and work closely together to expand their customer service and
marketing relationship. Under this agreement, Portal agreed to pay Andersen
Consulting LLC for its services a minimum services fee in cash of $2.8 million
and a cash settled put for 400,000 of the shares which were purchased by
Andersen Consulting LLC in a private placement concurrent with Portal's initial
public offering. This put guaranteed a closing value of $6.0 million at the end
of the first day of trading. Because the closing value exceeded $6.0 million,
Portal was not required to make any payment with respect to this put. The
definitive agreement was entered into, and the $2.8 million payment was made in
March 2000. The resulting intangible asset is being amortized over a period of
approximately four and one half years, the term of the alliance, beginning in
April 2000.

     Portal's capital requirements depend on numerous factors, including market
acceptance of Portal's products, the resources Portal devotes to developing,
marketing, selling and supporting its products, the timing and extent of
establishing international operations, and other factors. Portal expects to
devote substantial capital resources to hire and expand its sales, support,
marketing and product development organizations, to expand marketing programs,
to establish additional facilities worldwide and for other general corporate
activities. Although Portal believes that its current cash balances and cash
generated from operations will be sufficient to fund its operations for at least
the next 12 months, Portal may require additional financing within this time
frame. Additional funding, if needed, may not be available on terms acceptable
to Portal, or at all.

                       RECENT ACCOUNTING PRONOUNCEMENTS

     In June 1998, the Financial Accounting Standards Board ("FASB") issued
FAS No. 133, "Accounting for Derivative Instruments and Hedging Activities"
("FAS No. 133"). FAS 133 establishes methods for derivative financial
instruments and hedging activities related to those instruments, as well as
other hedging activities. In June 1999, the FASB delayed implementation of
FAS 133, so that implementation is now required for fiscal years beginning after
June 15, 2000. As Portal does not currently engage in hedging activities, Portal
expects that the adoption of FAS No. 133 will not have a material impact on its
financial position or results of operations. Due to the delayed effective date,
Portal will be required to implement FAS No. 133 for fiscal year 2002.

      RISKS ASSOCIATED WITH PORTAL'S BUSINESS AND FUTURE OPERATING RESULTS

  Portal's future operating results may vary substantially from period to
period. The price of our common stock will fluctuate in the future, and an
investment in our common stock is subject to a variety of risks, including but
not limited to the specific risks identified below. Inevitably, some investors
in our securities will experience gains while others

                                       16
<PAGE>

will experience losses depending on the prices at which they purchase and sell
securities. Prospective and existing investors are strongly urged to carefully
consider the various cautionary statements and risks set forth in this report.

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

IT IS DIFFICULT TO PREDICT OUR BUSINESS BECAUSE WE HAVE A LIMITED HISTORY
OPERATING AS A PROVIDER OF CM&B SOFTWARE

     The results of operations for the quarter ended October 31, 2000 contained
in this report are not necessarily indicative of results for fiscal year ending
January 31, 2001 or any other future period. Moreover, Portal has a relatively
brief operating history as a provider of CM&B software and had no meaningful
license revenue until 1996. Therefore, Portal will experience the risks and
difficulties frequently encountered by early stage companies in new and rapidly
evolving markets, including those discussed in this report. Our business
strategy may not prove successful, and we may not successfully address these
risks.

WE HAVE A SHORT HISTORY OF PROFITABILITY AND CANNOT BE CERTAIN THAT WE WILL
SUSTAIN OR INCREASE PROFITABILITY

     In order to be profitable, we must increase our revenues. We may not be
able to increase or even maintain our revenues, and we may not achieve
sufficient revenues or profitability in any future period. We incurred net
losses of approximately $7.6 million for fiscal year 2000, $17.4 million for
fiscal year 1999, $7.6 million for fiscal year 1998 and $2.3 million for fiscal
year 1997. We had a slight net profit in the fourth quarter of fiscal year 2000
and we had operating profits in the quarters ended April 30, 2000, July 31, 2000
and October 31, 2000.

     In addition, we expect to significantly increase our sales and marketing,
product development and administrative expenses. As a result, we will need to
generate significant revenues from sales of Infranet to maintain profitability.
We expect that we will face increased competition that may make it more
difficult to increase our revenues. Even if we are able to increase revenues, we
may experience price competition which would lower our gross margins and our
profitability. Another factor that will lower our gross margins is any increase
in the percentage of our revenues that is derived from indirect channels and
from services, both of which have lower margins. We cannot be certain that we
can sustain or increase operating and net profitability on a quarterly or annual
basis.

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

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

     . variations in demand for our products and services;

                                       17
<PAGE>

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

     .  the timing of sales of our products and services;

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

     .  delays in introducing new products and services;

     .  new product introductions by competitors;

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

     .  announcements of new versions of products that cause customers to
        postpone purchases of Portal's current products;

     .  the mix of products and services sold;

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

     .  the mix of domestic and international sales;

     .  costs related to acquisitions of technologies or businesses;

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

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

     .  our ability to expand our operations;

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

     .  global economic conditions generally, as well as those specific to ISPs
        and other providers of Internet-based services.

     We have difficulty predicting the volume and timing of orders. For example,
substantially all of our future revenues will come from licenses of Infranet and
related services, and the market for this product is in its early stages of
development and is therefore unpredictable. In any given quarter, our sales have
involved, and we expect will continue to involve, large financial commitments
from a relatively small number of customers. As a result, the cancellation or
deferral of even a small number of licenses of Infranet would reduce our
revenues, which would adversely affect our quarterly financial performance.
Also, we have often booked a large amount of our sales in the last month of the
quarter and often in the last week of that month. Accordingly, delays in the
closing of sales near the end of a quarter could cause quarterly revenue to fall
substantially short of anticipated levels.

     We record as deferred revenue fees from contracts that do not meet our
revenue recognition policy requirements. While a portion of our revenues each
quarter is recognized from deferred revenue, our quarterly performance will
depend primarily upon entering into new contracts to generate revenues for that
quarter. New contracts that we enter into may not result in revenue in the
quarter in which the contract was signed, and we may not be able to predict
accurately when revenues from these contracts will be recognized.

     We plan to significantly increase our operating expenses to expand our
sales and marketing operations, broaden our customer support capabilities,
develop new distribution channels and fund greater levels of research and
development. We determine our operating expenses largely on the basis of
anticipated revenue trends and a high percentage of our expenses are fixed in
the short term. As a result, a delay in generating or recognizing revenue could
cause significant variations in our operating results from quarter-to-quarter
and could result in substantial operating losses.

                                       18
<PAGE>

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

     We may also experience seasonality in our business.  In many software
companies, rate of growth of license fees revenues tends to decline from the
fourth quarter of one year to the first quarter of the next year, due in part
to the structure of sales compensation plans. If we experience such seasonality
in the future, our rate of growth or absolute revenues could decline in the
first quarter of a fiscal year compared to the preceding fourth quarter. In
addition, the European operations of many companies experience some flatness in
the summer months.  Portal may also experience such a pattern in its European
operations.  For example, the rate of growth in our European operations in the
second quarter of fiscal year 2001 was significantly lower than the rate of
growth in our other regions. Such seasonality may cause our results of
operations to fluctuate or become more difficult to predict and could cause us
to fail to meet internal or analyst expected financial results.

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

     To date, the sales cycle for Infranet has been three to nine months or
more. The long sales and implementation cycles for Infranet may cause license
revenues and operating results to vary significantly from period to period.
Along with systems integrators and our other distribution partners, we spend
significant time educating and providing information to our prospective
customers regarding the use and benefits of Infranet. Even after purchase, our
customers tend to deploy Infranet slowly and deliberately, depending on the
specific technical capabilities of the customer, the size of the deployment, the
complexity of the customer's network environment, and the quantity of hardware
and the degree of hardware configuration necessary to deploy Infranet.

OUR BUSINESS DEPENDS ON THE COMMERCIAL ACCEPTANCE OF INFRANET, AND IT IS
UNCERTAIN TO WHAT EXTENT THE MARKET WILL ACCEPT THIS PRODUCT

     Our future growth depends on the commercial success of Infranet.
Substantially all of our licensing revenues are derived from Infranet. Our
business will be harmed if our target customers do not adopt and purchase
Infranet. The market for Internet-based CM&B software is in its early stages of
development. In addition, some prospective customers may base their purchasing
decisions based on a vendor's ability to support their CM&B needs for both their
Internet-based services and their other existing or planned non-Internet service
offerings, such as fixed wire or mobile voice telephony or cable television. For
example, in the wireless communication area, many providers are currently
conducting or planning trials to select the CM&B and other technologies to be
used in their next generation wireless communication networks that will support
both voice and data communications. Our ability to address these current and
future non-Internet based service requirements with our current version of
Infranet and planned future enhancements may affect the market acceptance of
Infranet by prospective customers who desire an integrated CM&B solution for
their different services. Our future financial performance will also depend on
the successful development, introduction and customer acceptance of new and
enhanced versions of Infranet. We are not certain that our target customers will
widely adopt and deploy Infranet as their CM&B solution. In the future we may
not be successful in marketing Infranet or any new or enhanced products or
services. Our future revenues will also depend on our customers licensing
software for additional applicants or for additional subscribers. Their failure
to do so could harm our business.

     Significant technical challenges arise in our business because many of our
customers purchase and implement Infranet in phases, deploy Infranet across a
variety of computer hardware platforms and integrate it with a number of legacy
systems, third-party software applications and programming tools. Implementation
currently involves participation by our professional services group, which has
limited resources. Some customers may also require us to develop costly
customized features or capabilities, which increase our costs and consume our
limited customer service and support resources. Also, revenues we derive from
our services business have a significantly lower margin than revenues derived
from licensing Infranet. If new or existing customers have difficulty deploying
our products or require significant amounts of our professional services
support, our operating margins could be harmed.

                                       19
<PAGE>

UNPREDICTABLE FOREIGN PAYROLL TAXES MAY CAUSE OPERATING RESULTS TO FLUCTUATE IN
FUTURE PERIODS AND WE MAY FAIL TO MEET EXPECTATIONS

     We are generally subject to employer payroll taxes when our employees
exercise their stock options. The employer payroll taxes are assessed on each
employee's gain, which is the difference between the price of our common stock
on the date of exercise and the exercise price. During a particular period,
these payroll taxes could be material. These employer payroll taxes would be
recorded as an expense and are assessed at tax rates that varies depending upon
the employee's taxing jurisdiction in the period such options are exercised
based on actual gains realized by employees. However, because we are unable to
predict how many stock options will be exercised, at what price and in which
country during any particular period, we cannot predict, the amount, if any, of
employer payroll expense that will be recorded in a future period or the impact
on our future financial results.

WE MUST HIRE AND RETAIN QUALIFIED SALES PERSONNEL TO SELL INFRANET

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

     In addition, because we currently rely on indirect sales for a significant
portion of our market opportunities, we may miss sales opportunities that are
available through other sales distribution methods and other sources of leads,
such as domestic and foreign resellers. In the future, we intend to augment our
indirect sales distribution methods through additional third-party distribution
arrangements.  However, there is no guarantee that we will successfully augment
these arrangements or that the expansion of indirect sales distribution methods
will increase revenues.  We may be at a serious competitive disadvantage if we
fail to enhance these indirect sales channels.

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

     We have entered into relationships with third-party systems integrators, as
well as with hardware platform and software applications developers and service
providers. We have derived, and anticipate that we will continue to derive, a
significant portion of our revenues from customers that have significant
relationships with our market and platform partners. We could lose sales
opportunities if we fail to work effectively with these parties or fail to grow
our base of market and platform partners.

     Many of these partners also work with competing software companies, and our
success will depend on their willingness and ability to devote sufficient
resources and efforts to marketing our products versus the products of others.
We may not be able to enter into additional, or maintain our existing, strategic
relationships on commercially reasonable terms, or at all. Our agreements with
these parties typically are in the form of nonexclusive referral fee or reseller
agreements that may be terminated by either party without cause or penalty and
with limited notice. Therefore, there is no guarantee that any single party will
continue to market our products. If these relationships fail, we will have to
devote substantially more resources to the distribution, sales and marketing,
implementation and support of Infranet than we would otherwise, and our efforts
may not be as effective as those of our partners, either of which would harm our
business.

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

     A substantial portion of our license and services revenues in any given
quarter has been, and is expected to continue to be, generated from a limited
number of customers with large financial commitments. For example, two customers
accounted for 27% of total revenues for the quarter ended October 31, 1999 and
one customer accounted for 10% of total revenue during the year ended January
31, 2000.  As a result, if a large contract is cancelled or deferred or an
anticipated contract does not materialize, our business would be harmed. We have
initially targeted large ISPs,

                                       20
<PAGE>

including on-line divisions of telecommunications carriers and other providers
of Internet-based services, including the wireless divisions of
telecommunications carriers. Some of the industries we have targeted are
consolidating, which could reduce the number of potential customers available to
us. In addition, several large telecommunications companies have announced
decreases in their anticipated capital spending, which could have the effect of
reducing future orders of our products.

OUR BUSINESS WILL SUFFER DRAMATICALLY IF WE FAIL TO SUCCESSFULLY MANAGE OUR
GROWTH

     Our ability to successfully offer Infranet and new products and services in
a rapidly evolving market requires an effective planning and management process.
We continue to increase the scope of our operations domestically and
internationally and have grown our headcount substantially. Our business will
suffer dramatically if we fail to effectively manage this growth. On October 31,
2000, we had more than 1000 employees, compared to a total of 634 employees on
January 31, 2000. We expect to continue to hire new employees at a rapid pace.
This growth has placed, and our anticipated future operations will continue to
place, a significant strain on our management systems and resources and on our
internal training capabilities. We expect that we will need to continue to
improve our financial and managerial controls and reporting systems and
procedures, and will need to continue to expand, train and manage our work force
worldwide. Although we have recently occupied two new buildings for our
headquarters in Cupertino, California, we expect that we will also have to
continue to expand our facilities in California and other locations, and we may
face difficulties and significant expenses identifying and moving into suitable
office space.

OUR SIGNIFICANT INTERNATIONAL OPERATIONS AND OUR PLANNED EXPANSION OF OUR
INTERNATIONAL OPERATIONS MAKE US MUCH MORE SUSCEPTIBLE TO RISKS FROM
INTERNATIONAL OPERATIONS

     For the quarters ended October 31, 2000 and 1999, we derived approximately
43% and 38% of our revenue, respectively, from sales outside North America. As a
result, we face risks from doing business on an international basis, including,
among others:

     .  reduced protection for intellectual property rights in some countries;

     .  licenses, tariffs and other trade barriers;

     .  difficulties in staffing and managing foreign operations;

     .  longer sales and payment cycles;

     .  greater difficulties in collecting accounts receivable;

     .  political and economic instability;

     .  seasonal reductions in business activity;

     .  potentially adverse tax consequences;

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

     .  variance and unexpected changes in local laws and regulations.

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

     Further, our international revenues are denominated in U.S. dollars.
Therefore, a strengthening of the dollar versus other currencies could make our
products less competitive in foreign markets or collection of receivables more
difficult. We do not currently engage in currency hedging activities.

                                       21
<PAGE>

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

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

     Our success and ability to compete depend substantially upon our internally
developed technology, which we protect through a combination of patent,
copyright, trade secret and trademark law. Despite our efforts to protect our
proprietary rights, unauthorized parties may attempt to copy or otherwise obtain
and use our products or technology or to develop products with the same
functionality as our products. Policing unauthorized use of our products is
difficult, and we cannot be certain that the steps we have taken will prevent
misappropriation of our technology, particularly in foreign countries where the
laws may not protect our proprietary rights as fully as in the United States.
Others may develop technologies that are similar or superior to our technology.
Moreover, as the number of competitors in our industry segments grow and the
functionality of products in different industry segments overlaps, we expect
that our software products may in the future become subject to third-party
infringement claims. Some of our competitors in the market for CM&B software may
have filed or may intend to file patent applications covering aspects of their
technology upon which they may claim our technology infringes.  Several
companies have very large patent portfolios covering a wide variety of
technologies and may attempt to use their large portfolios to elicit license
fees from our company. Any litigation, brought by us or by others, could be
time-consuming and costly and could divert the attention of our technical and
management personnel. In addition, litigation could cause product shipment
delays or require us to develop non-infringing technology or enter into royalty
or licensing agreements. Such royalty or licensing agreements, if required, may
not be available on acceptable terms, or at all, and could have a material and
adverse impact on our gross margins and profitability. If a successful claim of
product infringement were made against us, our business could be significantly
harmed.

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

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

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

     .  loss of customers;

     .  failure to achieve market acceptance;

     .  diversion of development and implementation resources;

     .  injury to our reputation;

     .  increased service and warranty costs;

     .  legal actions by customers against us; and

     .  increased insurance costs.

     Our licenses with customers generally contain provisions designed to limit
our exposure to potential product liability claims, such as disclaimers of
warranties and limitations on liability for special, consequential and
incidental damages. In addition, our license agreements generally cap the
amounts recoverable for damages to the amounts paid by the licensee to us for
the product or service-giving rise to the damages. However, these contractual
limitations on liability may not be enforceable in certain jurisdictions and
under certain circumstances, particularly if the damages

                                       22
<PAGE>

relate to a Year 2000 problem, and we may be subject to claims based on errors
in our software or mistakes in performing our services including claims relating
to damages to our customers' internal systems. A product liability claim,
whether or not successful, could harm our business by increasing our costs,
damaging our reputation and distracting our management.

     Despite investigation and testing by us and our partners, Infranet and the
underlying systems and protocols running it may contain previously undetected
errors or defects associated with Year 2000 or other date functions. Several
customers, despite warnings regarding the use of non-Year 2000 certified
versions of Infranet, have continued to use non-certified versions, and decline
to upgrade to certified versions or implement maintenance fixes or bug releases
made available to them. Portal integrates certain third party software into
Infranet. These third party vendors may detect errors in their products after
previously indicating that their products are Year 2000 compliant. Such
revelations by our partners have occurred in the past and may occur in the
future; and these revelations have and could cause us to make changes in our
products in response.

IN THE PAST WE HAVE FAILED TO RELEASE CERTAIN NEW PRODUCTS AND UPGRADES ON TIME.
THESE DELAYS MAY RESULT IN:

 .    customer dissatisfaction;

 .    cancellation of orders and license agreements;

 .    negative publicity;

 .    loss of revenues;

 .    slower market acceptance; or

 .    legal action by customers against us.

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

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

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

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

     The market for CM&B software and services is characterized by:

     .  rapid technological change;

     .  frequent new product introductions;

     .  changes in customer requirements; and

     .  evolving industry standards.

                                       23
<PAGE>

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

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

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

     We compete in markets that are new, intensely competitive, highly
fragmented and rapidly changing. We face competition from providers of
traditional CM&B software such as Amdocs (which has recently acquired Solect
Technology) and the Kenan Systems division of Lucent; emerging providers of
Internet-specific billing software, such as Belle Systems, Geneva and Daleen
Technologies, Inc.; and providers of Internet-based services that develop
proprietary systems. We also compete with systems integrators and with internal
MIS departments of larger telecommunications carriers. We are aware of numerous
other major ISPs, software developers and smaller entrepreneurial companies that
are focusing significant resources on developing and marketing products and
services that will compete with Infranet. We anticipate continued growth and
competition in the on-line services and telecommunications industries and the
entrance of new competitors into the CM&B software market, and that the market
for our products and services will remain intensely competitive. We expect that
competition will increase in the near term and that our primary long-term
competitors may have not yet entered the market. Many of our current and future
competitors have significantly more personnel and greater financial, technical,
marketing and other resources than we do.

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

OUR BUSINESS SUBSTANTIALLY DEPENDS UPON THE CONTINUED GROWTH OF INTERNET-BASED
SERVICES, WIRLESS SERVICES AND OTHER EMERGING SERVICES

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

     Many of the companies that are marketing broadband access to the Internet
or are offering new services over the Internet, wireless networks and other
communication mediums are relatively new businesses. In the past year, many so
called "dot.com" companies have failed, and financing for emerging Internet
businesses appears to be increasingly more difficult for Internet companies to
obtain. We believe that a decline in the rate of growth experienced in our North
American operations in the third quarter of fiscal year 2001 is attributable in
part to the difficulty experienced by several potential customers in receiving
financing and a consequential impact on their decisions to make investments in
CM&B products and services. In addition, several large telecommunications
companies have announced decreases in their anticipated capital spending.To the
extent that our customers and potential customers reduce their capital spending
or fail to achieve sustained profitability or obtain adequate funding, the
market for our products may be adversely affected, and we could experience
greater risk and difficulty collecting receivables from those customers that do
purchase our products and services. Either or both of those results could harm
our business and financial results.

                                       24
<PAGE>

FUTURE REGULATION OF THE INTERNET MAY SLOW ITS GROWTH, RESULTING IN DECREASED
DEMAND FOR OUR PRODUCTS AND SERVICES AND INCREASED COSTS OF DOING BUSINESS

     Due to the increasing popularity and use of the Internet, it is possible
that state and federal regulators could adopt laws and regulations that may
impose additional burdens on those companies conducting business on-line. The
growth and development of the market for Internet-based services may prompt
calls for more stringent consumer protection laws. The adoption of any
additional laws or regulations may decrease the expansion of the Internet or
impose additional burdens on those companies conducting business on-line. A
decline in the growth of the Internet could decrease demand for our products and
services and increase our cost of doing business, or otherwise harm our
business. Moreover, the applicability to the Internet of existing laws in
various jurisdictions governing issues such as property ownership, sales tax,
libel and personal privacy is uncertain and may take years to resolve. Our costs
could increase and our growth could be harmed by any new legislation or
regulation, the application of laws and regulations from jurisdictions whose
laws do not currently apply to our business, or the application of existing laws
and regulations to the Internet and other on-line services.

OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO ATTRACT AND RETAIN ADDITIONAL
PERSONNEL, PARTICULARLY QUALIFIED SALES PERSONS

     We intend to hire a significant number of additional sales, support,
marketing, administrative and research and development personnel in fiscal year
2001 and beyond. Competition for these individuals is intense, and we may not be
able to attract, assimilate or retain highly qualified personnel in the future.
Our business cannot continue to grow if we cannot attract qualified personnel.
We currently have a small customer service and support organization and will
need to increase our staff to support new customers and the expanding needs of
our existing customers. Hiring qualified customer service and support personnel,
as well as sales, marketing, administrative and research and development
personnel, is very competitive in our industry, particularly in the San
Francisco Bay Area, where Portal is headquartered, due to the limited number of
people available with the necessary technical skills and understanding of the
Internet. We may experience greater difficulty attracting these personnel with
equity incentives as a public company than we did as a privately held company.
Our future success also depends upon the continued service of our executive
officers and other key sales, marketing and support personnel in general, and on
the services of John E. Little, our President and Chief Executive Officer, and
David S. Labuda, our Chief Technology Officer, in particular. None of our
officers or key employees is bound by an employment agreement for any specific
term. Our relationships with these officers and key employees are at will.

WE MAY EXPERIENCE DIFFICULTY INTEGRATING SOLUTION 42

     Portal acquired the business of SOLUTION42 in November 2000. We may
experience problems integrating the business of SOLUTION42 into our business.
Any integration problems could cause us to incur substantial unanticipated costs
and expenses, which would harm our operating results. If we fail to integrate
SOLUTION42's business successfully, we will incur substantial costs, which will
increase our expenses and reduce any earnings or potentially result in operating
losses. In addition, integration problems could divert management's attention
from other business opportunities, which could result in slower revenue growth
than anticipated or even declines in revenue. Integrating SOLUTION42's business
with our business will be complex, time-consuming, and expensive, particularly
due to the geographic distance between SOLUTION42's operations in Germany and
our headquarters in California. This integration may disrupt our business if it
is not completed in a timely, efficient and effective manner. We have never
attempted to integrate an acquisition of this size and we may not be successful
in doing so.

Specific integration challenges we will face include the following:

     .  retaining existing customers, employees and strategic partners of
        SOLUTION42;

     .  retaining and integrating management and other key employees of
        SOLUTION42;

     .  combining product offerings and product lines effectively and quickly,
        including technical integration by our engineering team;

                                       25
<PAGE>

     .  integrating sales efforts so that customers can easily do business with
        the combined company;

     .  transitioning multiple information technology systems to a single
        system;

     .  successfully developing and promoting a brand strategy and marketing it
        to existing and prospective customers; and

     .  developing and maintaining uniform standards, controls, procedures, and
        policies.

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

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

OUR REPORTED FINANCIAL RESULTS WILL SUFFER AS A RESULT OF PURCHASE ACCOUNTING
TREATMENT OF THE SOLUTION42 ACQUISITION AND THE AMORTIZATION OF GOODWILL AND
OTHER INTANGIBLE ASSETS

     Purchase accounting treatment of the acquisition of SOLUTION42 will result
in a large initial write-off and additional write-offs over the next several
years, which could have a material and adverse effect on our operating results
and the market price of our common stock. Under purchase accounting, we will
record the following as an asset on our balance sheet:

     .  the fair value of the consideration given for SOLUTION42'S outstanding
        common stock; and

     .  acquisition-related direct transaction costs, including the fees of our
        legal, accounting, and financial advisors.

     We will allocate these costs to individual SOLUTION42 assets acquired and
liabilities assumed. These assets and liabilities will include various
identifiable intangible assets such as acquired developed technology, acquired
trademarks and tradenames, and acquired workforce. Intangible assets, including
goodwill, will be amortized over a period corresponding to the life of the
relevant asset. In addition, we will allocate a portion of the purchase price
for acquiring SOLUTION42 to in-process research and development which will be
expensed in the fiscal quarter ending January 31, 2001.

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

     The trading price of our common stock has fluctuated substantially in the
past and will fluctuate in the future. This future fluctuation could be a result
of a number of factors, many of which are outside our control. Some of these
factors include:

     . quarter-to-quarter variations in our operating results;

     . failure to meet the expectations of industry analysts;

     . changes in earnings estimates by analysts;

                                       26
<PAGE>

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

     .  increased price competition;

     .  developments or disputes concerning intellectual property rights; and

     .  general conditions in the Internet industry.

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

                                       27
<PAGE>

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The following discussion about Portal's risk management activities includes
"forward-looking statements" that involve risks and uncertainties.  Actual
results could differ materially from those projected in the forward-looking
statements for the reasons described under the caption "Management's Discussion
And Analysis Of Financial Condition And Results Of Operations and Risks
Associated With Portal's Business And Future Operating Results."

Short-Term Investment Portfolio

     We do not hold derivative financial instruments in our short-term
investment portfolio. Our short-term investments consist of instruments that
meet high quality standards consistent with our investment policy. This policy
dictates that we diversify our holdings and limit our short-term investments to
a maximum of $5 million to any one issuer. Our policy also dictates that all
short-term investments mature in 24 months or less.

     The following table presents the amounts of cash equivalents and
investments that are subject to market risk and the weighted average interest
rates, by year of expected maturity for Portals' investment portfolios as of
October 31, 2000. This table does not include cash because cash is not subject
to market risk. It also does not include long-term investments as they are held
to maturity and, therefore, near-term changes in market rates will not result in
losses. (In thousands, except interest rates):

<TABLE>
<CAPTION>
                                       Maturing within         Maturing within
                                           1 Year                  2 Years           Thereafter             Total
                                       -----------------       -----------------     ------------         ---------
<S>                                    <C>                     <C>                   <C>                  <C>
   As of October 31, 2000:
Cash Equivalents....................          $ 22,494         $             --                --         $  22,494
   Weighted Average Yield...........              6.64 %                     --                --              6.64 %
Investments.........................           138,838                   33,229                --           172,067
   Weighted Average Yield...........              6.48 %                   6.93 %              --              6.57 %
                                              --------                 --------                          ----------
Total Portfolio.....................          $161,332         $         33,229                --         $ 194,561
   Weighted Average Yield...........              6.50 %                   6.93 %              --              6.58 %
</TABLE>

Impact of Foreign Currency Rate Changes

     During fiscal year 2000, most local currencies of our international
subsidiaries weakened against the U.S. dollar. Because we translate foreign
currencies into U.S. dollars for reporting purposes, currency fluctuations can
have an impact, though generally immaterial, on our results. Portal believes
that its exposure to currency exchange fluctuation risk has been insignificant
primarily due to the denomination of our sales transactions in U.S. dollars. For
the quarter ended October 31, 2000, there was an immaterial currency exchange
impact from our intercompany transactions. As of October 31, 2000, we did not
engage in foreign currency hedging activities.

     As a global corporation, Portal anticipates that its sales outside the
United States will increasingly be denominated in other currencies. In such
event, Portal will face exposure to adverse movements in foreign currency
exchange rates. These exposures may change over time as business practices
evolve and could have a material adverse impact on Portal's financial position
and results of operations. In order to reduce the effect of foreign currency
fluctuations, Portal may hedge its exposure on certain transactional balances
that are denominated in foreign currencies through the use of foreign currency
forward exchange contracts. The success of such activity will depend upon the
estimation of future transactions denominated in various currencies. To the
extent that these estimates are overstated or understated during periods of
currency volatility, Portal could experience unanticipated currency gains or
losses.

                                       28
<PAGE>

PART II:  OTHER INFORMATION

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS.

(a) On November 8, 2000, Portal filed, with the Delaware Secretary of State, an
amendment to its Restated Certificate of Incorporation to increase the
authorized number of shares of Common Stock from 250,000,000 to 1,000,000,000.
The increase was approved by Portal's stockholders in July 2000.

(d) Use of Proceeds from Sales of Registered Securities.

On May 11, 1999, Portal completed an initial public offering of its Common
Stock, $0.001 par value. The managing underwriters in the offering were Goldman,
Sachs & Co., Credit Suisse First Boston, BancBoston Robertson Stephens and
Hambrecht & Quist (the "Underwriters"). The shares of Common Stock sold in the
offering were registered under the Securities Act of 1933, as amended, on a
Registration Statement on Form S-1 (the "Registration Statement") (Reg. No.
333-72999) that was declared effective by the SEC on May 5, 1999. After
deducting the underwriting discounts and offering expenses, Portal received net
proceeds from the offering of approximately $58,642,000. None of Portal's net
proceeds of the offering were paid directly or indirectly to any director,
officer, general partner of Portal or their associates, persons owning 10% or
more of any class of equity securities of Portal, or an affiliate of Portal. Of
the net proceeds, Portal has used approximately $45,979,000 for capital
expenditures. Additionally, a portion of the net proceeds were used to repay
long-term debt and line of credit obligations of $5,122,000 and capital lease
obligations of $935,000. The remainder of the net proceeds is expected to be
used for general corporate purposes, including working capital, capital
expenditures and product development. A portion of the net proceeds may also be
used to acquire or invest in complementary businesses, technologies or product
offerings; however, there are no current material agreements or commitments with
respect to any such activities. The amounts actually expended for such purposes
may vary significantly and will depend on a number of factors, including
Portal's future revenues and cash generated by operations and the other factors
described under "Factors That May Affect Future Results". Accordingly, Portal
retains broad discretion in the allocation of the remaining net proceeds of the
offering.

                                       29
<PAGE>

ITEM 6:   EXHIBITS AND REPORTS ON FORM 8-K

          (a)  Exhibits

          3.3  Certificate of Amendment to Restated Certificate of Incorporation

          27   Financial Data Schedule

          (b)  Reports on Form 8-K:

          None.

                                       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.


December 14, 2000                            PORTAL SOFTWARE, INC.


                                             By /s/ JACK L. ACOSTA
                                               -------------------------------
                                             Jack L. Acosta
                                                  Vice President
                                                  and Chief Financial Officer
                                                  (on behalf of the Registrant
                                                  and as the Principal Financial
                                                  Officer)

                                       31
<PAGE>

                    EXHIBIT INDEX TO PORTAL SOFTWARE, INC.
                         QUARTERLY REPORT ON FORM 10-Q
                    FOR THE QUARTER ENDED OCTOBER 31, 2000

Exhibit Number      Description
--------------      -----------

3.3                 Certificate of Amendment to Restated Certificate of
                    Incorporation

27                  Financial Data Schedule

                                       32


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