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

                            ------------------------

                                    FORM 10-Q
                            ------------------------

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

                  FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002

                                       OR

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


                         COMMISSION FILE NUMBER: 0-30903

                            ------------------------
                                  VIRAGE, INC.
             (Exact name of registrant as specified in its charter)

            DELAWARE                                    38-3171505
(State or other jurisdiction of            (I.R.S. Employer Identification No.)
 incorporation or organization)

                           411 BOREL ROAD, 100 SOUTH
                        SAN MATEO, CALIFORNIA 94402-3116
                                 (650) 573-3210
(Address, including zip code, and telephone number, including area code, of the
                   registrant's principal executive offices)

                            ------------------------

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.
[X] Yes    [ ] No

     The number of outstanding shares of the registrant's  Common Stock,  $0.001
par value, was 20,754,239 as of August 1, 2002.

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                                       1
<PAGE>

                                  VIRAGE, INC.

                                      INDEX

                                                                            PAGE

PART I: FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)

   Condensed Consolidated Balance Sheets - June 30, 2002 and March 31, 2002..  3

   Condensed Consolidated Statements of Operations -- Three Months Ended
            June 30, 2002 and 2001...........................................  4

   Condensed Consolidated Statements of Cash Flows -- Three Months Ended
            June 30, 2002 and 2001...........................................  5

   Notes to Condensed Consolidated Financial Statements......................  6

Item 2. Management's Discussion and Analysis of Financial Condition
            and Results of Operations........................................ 14

Item 3.  Quantitative and Qualitative Disclosures About Market Risk.......... 29


PART II: OTHER INFORMATION

Item 1. Legal Proceedings.................................................... 30

Item 2. Changes in Securities and Use of Proceeds............................ 30

Item 3. Defaults Upon Senior Securities...................................... 31

Item 4. Submission of Matters to a Vote of Security Holders.................. 31

Item 5. Other Information.................................................... 31

Item 6. Exhibits and Reports on Form 8-K..................................... 31

Signature.................................................................... 32

                                       2
<PAGE>

PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

                                  VIRAGE, INC.
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                                 (in thousands)
                                   (unaudited)

                                                         June 30,      March 31,
                                                          2002           2002
                                                        ---------     ---------
                           ASSETS

Current assets:
  Cash and cash equivalents ........................    $   2,102     $   4,586
  Short-term investments ...........................       23,430        26,108
  Accounts receivable, net .........................        1,885         2,366
  Prepaid expenses and other current assets ........        1,118           220
                                                        ---------     ---------
      Total current assets .........................       28,535        33,280

Property and equipment, net ........................        3,028         3,701
Other assets .......................................        2,588         2,571
                                                        ---------     ---------
      Total assets .................................    $  34,151     $  39,552
                                                        =========     =========

            LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
  Accounts payable .................................    $     595     $     831
  Accrued payroll and related expenses .............        2,463         2,376
  Accrued expenses .................................        2,568         2,946
  Deferred revenue .................................        3,108         3,050
                                                        ---------     ---------
      Total current liabilities ....................        8,734         9,203

Deferred rent ......................................          324           290

Commitments and contingencies

Stockholders' equity:
  Common stock .....................................           21            21
  Additional paid-in capital .......................      121,553       121,387
  Deferred compensation ............................       (2,056)       (2,425)
  Accumulated deficit ..............................      (94,425)      (88,924)
                                                        ---------     ---------
      Total stockholders' equity ...................       25,093        30,059
                                                        ---------     ---------
      Total liabilities and stockholders' equity ...    $  34,151     $  39,552
                                                        =========     =========

                             See accompanying notes.

                                       3
<PAGE>

                                  VIRAGE, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                      (in thousands, except per share data)
                                   (unaudited)

                                                           Three Months Ended
                                                                June 30,
                                                         -----------------------
                                                           2002          2001
                                                         --------      --------

Revenues:
  License revenues .................................     $  1,611      $  1,882
  Service revenues .................................        1,624         2,047
  Other revenues ...................................           --            61
                                                         --------      --------
    Total revenues .................................        3,235         3,990
Cost of revenues:
  License revenues .................................          187           154
  Service revenues(1) ..............................        1,159         2,532
  Other revenues ...................................           --            57
                                                         --------      --------
    Total cost of revenues .........................        1,346         2,743
                                                         --------      --------
Gross profit .......................................        1,889         1,247
Operating expenses:
  Research and development(2) ......................        2,382         2,473
  Sales and marketing(3) ...........................        3,685         4,439
  General and administrative(4) ....................        1,142         1,332
  Stock-based compensation .........................          371           782
                                                         --------      --------
    Total operating expenses .......................        7,580         9,026
                                                         --------      --------
Loss from operations ...............................       (5,691)       (7,779)

Interest and other income, net .....................          190           568
                                                         --------      --------
Net loss ...........................................     $ (5,501)     $ (7,211)
                                                         ========      ========

Basic and diluted net loss per share ...............     $  (0.27)     $  (0.36)
                                                         ========      ========
Shares used in computation of basic and diluted
  net loss per share ...............................       20,687        20,133
                                                         ========      ========

(1) Excluding $5 in amortization of deferred employee  stock-based  compensation
    for the three  months  ended June 30, 2002 ($74 for the three  months  ended
    June 30, 2001).

(2) Excluding $23 in amortization of deferred employee stock-based  compensation
    for the three  months  ended June 30, 2002 ($117 for the three  months ended
    June 30, 2001).

(3) Excluding $31 in amortization of deferred employee stock-based  compensation
    for the three  months  ended June 30, 2002 ($233 for the three  months ended
    June 30, 2001).

(4) Excluding $312 in amortization of deferred employee stock-based compensation
    for the three  months  ended June 30, 2002 ($358 for the three  months ended
    June 30, 2001).

                             See accompanying notes.

                                       4
<PAGE>

                                  VIRAGE, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)
                                   (unaudited)

<TABLE>
<CAPTION>
                                                               Three Months Ended
                                                                    June 30,
                                                                    --------
                                                                2002        2001
                                                              --------    --------

<S>                                                           <C>         <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ..................................................   $ (5,501)   $ (7,211)
Adjustments to reconcile net loss to net cash used in
  operating activities:
  Depreciation and amortization ...........................        685         705
  Loss on disposal of assets ..............................        106          --
  Amortization of deferred compensation related to
    stock options .........................................        371         987
  Amortization of technology right ........................          9           9
  Amortization of warrant fair values .....................          3         219
  Changes in operating assets and liabilities:
    Accounts receivable ...................................        481        (159)
    Prepaid expenses and other current assets .............       (898)       (424)
    Other assets ..........................................        (26)         --
    Accounts payable ......................................       (236)       (139)
    Accrued payroll and related expenses ..................         87        (840)
    Accrued expenses ......................................       (378)        395
    Deferred revenue ......................................         58         300
    Deferred rent .........................................         34          56
                                                              --------    --------
Net cash used in operating activities .....................     (5,205)     (6,102)

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment ........................       (118)        (85)
Purchase of short-term investments ........................    (22,600)    (30,407)
Sales and maturities of short-term investments ............     25,278      23,328
                                                              --------    --------
Net cash provided by (used in) investing activities .......      2,560      (7,164)

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options, net of repurchases         10         (11)
Proceeds from employee stock purchase plan ................        151         489
                                                              --------    --------
Net cash provided by financing activities .................        161         478
                                                              --------    --------
Net decrease in cash and cash equivalents .................     (2,484)    (12,788)
Cash and cash equivalents at beginning of period ..........      4,586      19,680
                                                              --------    --------
Cash and cash equivalents at end of period ................   $  2,102    $  6,892
                                                              ========    ========

SUPPLEMENTAL DISCLOSURES OF NONCASH
OPERATING, INVESTING AND FINANCING ACTIVITIES:
Deferred compensation related to stock options ............   $     36    $     71
Reversal of deferred compensation upon employee termination   $     34    $    234
</TABLE>

                             See accompanying notes.

                                       5
<PAGE>

                                  VIRAGE, INC.
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 2002
                                   (unaudited)

1. Summary of Significant Accounting Policies

Basis of Presentation

    The accompanying  unaudited condensed consolidated financial statements have
been prepared in accordance with generally  accepted  accounting  principles for
interim  financial  information and in accordance with the  instructions to Form
10-Q and Article 10 of Regulation S-X.  Accordingly,  they do not include all of
the  information  and  footnotes  required  by  generally  accepted   accounting
principles for complete financial statements. In the opinion of management,  all
adjustments  (consisting  of normal  recurring  accruals)  necessary  for a fair
presentation  of the  financial  statements  at June 30,  2002 and for the three
month periods ended June 30, 2002 and 2001 have been included.

    The  condensed  consolidated  financial  statements  include the accounts of
Virage, Inc. (the "Company") and its majority owned subsidiaries, Virage Europe,
Ltd. and Virage GmbH. All  significant  intercompany  balances and  transactions
have been eliminated in consolidation.

    Results  for the  three  months  ended  June 30,  2002  are not  necessarily
indicative  of  results  for the entire  fiscal  year or future  periods.  These
financial  statements  should  be  read in  conjunction  with  the  consolidated
financial statements and the accompanying notes included in the Company's Annual
Report  on Form  10-K,  dated  June 14,  2002 as filed  with the  United  States
Securities and Exchange Commission.  The accompanying balance sheet at March 31,
2002 is derived from the Company's audited consolidated  financial statements at
that date.

Revenue Recognition

    The Company  enters into  arrangements  for the sale of licenses of software
products   and  related   maintenance   contracts,   application   services  and
professional   services  offerings;   and  also  receives  revenues  under  U.S.
government  agency  research  grants.  Service  revenues  include  revenues from
maintenance contracts,  application services,  and professional services.  Other
revenues are primarily U.S. government agency research grants.

    The Company's revenue  recognition policy is in accordance with the American
Institute of Certified Public  Accountants'  ("AICPA") Statement of Position No.
97-2 ("SOP 97-2"),  "Software Revenue  Recognition",  as amended by Statement of
Position  No.  98-4,  "Deferral  of the  Effective  Date of SOP 97-2,  "Software
Revenue  Recognition""  ("SOP  98-4"),  and  Statement  of  Position  No.  98-9,
"Modification of SOP No. 97-2 with Respect to Certain Transactions" ("SOP 98-9")
and is also  consistent  with the  Securities  and Exchange  Commission's  Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial  Statements." For
each  arrangement,  the Company  determines  whether  evidence of an arrangement
exists, delivery has occurred, the fee is fixed or determinable,  and collection
is  probable.  If any of these  criteria  are not met,  revenue  recognition  is
deferred  until such time as all  criteria are met.  The Company  considers  all
arrangements  with  payment  terms  extending  beyond  twelve  months  and other
arrangements  with  payment  terms  longer  than  normal  not  to  be  fixed  or
determinable.   If  collectibility  is  not  considered  probable,   revenue  is
recognized when the fee is collected. No customer has the right of return.

    Arrangements consisting of license and maintenance. For those contracts that
consist  solely of license  and  maintenance,  the  Company  recognizes  license
revenues  based  upon  the  residual   method  after  all  elements  other  than
maintenance  have  been  delivered  as  prescribed  by  SOP  98-9.  The  Company
recognizes  maintenance  revenues over the term of the  maintenance  contract as
vendor  specific  objective  evidence of fair value for maintenance  exists.  In
accordance with paragraph ten of SOP 97-2, vendor specific objective evidence of
fair value of  maintenance  is determined by reference to the price the customer
will be required to pay when it is sold separately  (that is, the renewal rate).
Each license agreement offers additional maintenance renewal periods at a stated
price.  Maintenance  contracts are  typically  one year in duration.  Revenue is
recognized  on a per copy  basis  for  licensed  software  when each copy of the
license requested by the customer is delivered.

                                       6
<PAGE>

                                  VIRAGE, INC.
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
                                  June 30, 2002
                                   (unaudited)

    Revenue is recognized on licensed software on a per user or per server basis
for a fixed fee when the product  master is delivered to the customer.  There is
no right of return or price  protection for sales to domestic and  international
distributors,  system  integrators,  or  value  added  resellers  (collectively,
"resellers").  In  situations  where the reseller has a purchase  order or other
contractual  agreement  from the end user that is immediately  deliverable,  the
Company recognizes revenue on shipment to the reseller, if other criteria in SOP
97-2 are met, since the Company has no risk of  concessions.  The Company defers
revenue on shipments to resellers if the reseller does not have a purchase order
or other contractual agreement from an end user that is immediately  deliverable
or  other  criteria  in SOP 97-2 are not met.  The  Company  recognizes  royalty
revenues upon receipt of the quarterly reports from the vendors.

    When licenses and maintenance are sold together with  professional  services
such  as  consulting  and  implementation,  license  fees  are  recognized  upon
shipment,  provided  that (1) the criteria in the previous  paragraph  have been
met, (2) payment of the license fee is not dependent upon the performance of the
professional   services,  and  (3)  the  services  do  not  include  significant
alterations to the features and functionality of the software.

    Should  professional  services  be  essential  to the  functionality  of the
licenses in a license arrangement which contains professional services or should
an arrangement not meet the criteria  mentioned above, both the license revenues
and  professional  service  revenues  are  recognized  in  accordance  with  the
provisions  of the AICPA's  Statement  of Position  No.  81-1,  "Accounting  for
Performance of Construction  Type and Certain  Production Type Contracts"  ("SOP
81-1").  When  reliable  estimates  are  available  for the  costs  and  efforts
necessary  to  complete  the  implementation  services  and  the  implementation
services do not include contractual milestones or other acceptance criteria, the
Company  accounts  for the  arrangements  under  the  percentage  of  completion
contract  method pursuant to SOP 81-1 based upon input measures such as hours or
days.  When such estimates are not available,  the completed  contract method is
utilized.  When an  arrangement  includes  contractual  milestones,  the Company
recognizes  revenues as such milestones are achieved provided the milestones are
not subject to any additional acceptance criteria.

    Application services. Application services revenues consist primarily of web
design and integration fees, video processing fees and application hosting fees.
Web design and integration  fees are recognized  ratably over the contract term,
which is generally six to twelve months.  The Company generates video processing
fees for  each  hour of  video  that a  customer  deploys.  Processing  fees are
recognized as encoding,  indexing and  editorial  services are performed and are
based upon  time-based  rates of video  content.  Application  hosting  fees are
generated by and based upon the number of video  queries  processed,  subject in
most cases to monthly minimums.  The Company recognizes  revenues on transaction
fees that are subject to monthly  minimums  based upon the monthly  minimum rate
since the Company has no further  obligations,  the payment terms are normal and
each month is a separate measurement period.

    Professional  Services.  The Company provides  professional services such as
consulting, implementation and training services to its customers. Revenues from
such services, when not sold in conjunction with product licenses, are generally
recognized as the services are performed provided all other revenue  recognition
criteria are met.

    Other revenues.  Other revenues consist primarily of U.S.  government agency
research  grants that are best  effort  arrangements.  The  software-development
arrangements are within the scope of the Financial  Accounting Standards Board's
("FASB")  Statement of Financial  Accounting  Standards  No. 68,  "Research  and
Development   Arrangements."   As  the  financial  risks   associated  with  the
software-development  arrangement rests solely with the U.S.  government agency,
the Company is recognizing  revenues as the services are performed.  The cost of
these services are included in cost of other revenues. The Company's contractual
obligation  is to  provide  the  required  level of  effort  (hours),  technical
reports, and funds and man-hour expenditure reports.

                                       7
<PAGE>

                                  VIRAGE, INC.
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
                                  June 30, 2002
                                   (unaudited)

Use of Estimates

    The  preparation  of  the  accompanying   unaudited  condensed  consolidated
financial  statements requires management to make estimates and assumptions that
effect the amounts reported in these financial statements.  Actual results could
differ from those estimates.

Cash Equivalents and Short-Term Investments

    The  Company  invests  its excess  cash in money  market  accounts  and debt
instruments and considers all highly liquid debt  instruments  purchased with an
original  maturity of three months or less to be cash  equivalents.  Investments
with an  original  maturity  at the time of  purchase  of over three  months are
classified as short-term  investments  regardless of maturity  date, as all such
instruments are classified as  available-for-sale  and can be readily liquidated
to meet current  operational needs. At June 30, 2002, all of the Company's total
cash    equivalents    and   short-term    investments    were   classified   as
available-for-sale  and  consisted  of  obligations  issued  by U.S.  government
agencies and multinational corporations, maturing within one year.

Comprehensive Net Loss

    The Company has adopted the Financial  Accounting Standards Board's ("FASB")
Statement of Financial  Accounting  Standards No. 130, "Reporting  Comprehensive
Income" ("FAS 130"). FAS 130 establishes standards for the reporting and display
of  comprehensive  income  (loss)  and its  components  in a full set of general
purpose  financial  statements.  To date,  unrealized gains and losses have been
insignificant and the Company has had no other significant  comprehensive income
(loss), and consequently, net loss equals total comprehensive net loss.

Net Loss per Share

    Basic and diluted net loss per share are  computed  in  conformity  with the
FASB's Statement of Financial Accounting Standards No. 128, "Earnings Per Share"
("FAS 128"),  for all periods  presented,  using the weighted  average number of
common shares outstanding less shares subject to repurchase.

    The following  table presents the  computation of basic and diluted net loss
per share and pro forma  basic  and  diluted  net loss per share (in  thousands,
except per share data):

                                                          Three Months Ended
                                                               June 30,
                                                     -------------------------
                                                       2002             2001
                                                     --------         --------

       Net loss .............................        $ (5,501)        $ (7,211)
                                                     ========         ========
       Weighted-average shares of
         common stock outstanding ...........          20,706           20,343
       Less: Weighted-average shares of
         common stock subject to
         repurchase .........................             (19)            (210)
                                                     --------         --------
       Weighted-average shares used
         in computation of basic and
         diluted net loss per share .........          20,687           20,133
                                                     ========         ========
       Basic and diluted net loss per
         share ..............................        $  (0.27)        $  (0.36)
                                                     ========         ========

                                       8
<PAGE>

                                  VIRAGE, INC.
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
                                  June 30, 2002
                                   (unaudited)

Impact of Recently Issued Accounting Standards

    In June 2001, the FASB issued  Statement of Financial  Accounting  Standards
No.  141,  "Business  Cominations  ("FAS  141")."  FAS 141  requires  use of the
purchase  method for all business  combinations  initiated  after June 30, 2001,
thereby  eliminating  use of the  pooling  method.  FAS 141  also  provides  new
criteria  to  determine  whether  an  acquired  intangible  asset  would  not be
recognized  separately  from  goodwill  unless  either  control  over the future
economic  benefits  results  from  contractual  or legal  rights or the asset is
capable of being separated or divided and sold, transferred,  licensed,  rented,
or  exchanged.  The  adoption  of FAS 141 did not have a material  impact on its
financial position or its results of operations or cash flows as the Company has
not participated in any business combinations through June 30, 2002.

    In June 2001, the FASB issued  Statement of Financial  Accounting  Standards
No. 142,  "Goodwill  and  Intangible  Assets  ("FAS  142")." FAS 142 states that
amortization  of goodwill  will no longer be required.  Instead,  impairment  to
goodwill is to be tested at least  annually at the reporting  unit level using a
two-step  impairment  test  whereby  the first step  determines  if  goodwill is
impaired and the second step measures the amount of the impairment  loss.  While
goodwill is to be tested for impairment annually, companies may need to test for
goodwill  impairment on an interim basis if an event or circumstance occurs that
might significantly reduce the fair value of a reporting unit below its carrying
amount.  Regarding amortization of intangible assets with finite lives, the FASB
requires  intangible assets to be amortized over their useful economic lives and
reviewed for  impairment.  Intangible  assets that have economic  lives that are
indefinite  would not be subject to  amortization  until there is evidence  that
their  lives no  longer  are  indefinite,  and would be  tested  for  impairment
annually using a lower of cost or fair value  approach.  The Company has adopted
FAS 142,  which has not had a material  impact on its financial  position or its
results of operations or cash flows as the Company has no goodwill or intangible
assets subject to the requirements of FAS 142.

    In August 2001, the FASB issued Statement of Financial  Accounting Standards
No. 144,  "Accounting  for the Impairment or Disposal of Long-Lived  Assets (FAS
144)," which addresses financial  accounting and reporting for the impairment or
disposal of long-lived  assets and  supersedes  FAS 121 and the  accounting  and
reporting  provisions of Accounting  Principles Board Opinion No. 30, "Reporting
the  Results of  Operations  for a Disposal  of a Segment  of a  Business."  The
Company  adopted FAS 144 as of April 1, 2002 and the adoption of this  statement
has not had a significant impact on the Company's financial position and results
of operations.

    In November 2001, the FASB issued a Staff Announcement (the "Announcement"),
Topic D-103, which concluded that the reimbursement of "out-of-pocket"  expenses
should be  classified  as revenue in the  statement of  operations.  The Company
adopted the  Announcement  in its fiscal fourth  quarter of its year ended March
31, 2002 and the  Announcement  did not have a material  affect on the Company's
operations, financial position or cash flows.

2. Commitments and Contingencies

    In the normal course of business,  the Company is subject to commitments and
contingencies,   including  operating  leases,   restructuring  liabilities  and
litigation  including  securities-related  litigation  and  other  claims in the
ordinary course of business. The Company records accruals for such contingencies
based  upon  its  assessment  of  the   probability  of  occurrence  and,  where
determinable,  an estimate of the liability.  The Company considers many factors
in making these  assessments  including  past history and the  specifics of each
matter.  The Company  reviews its  assessment  of the  likelihood of loss on any
outstanding contingencies as part of its on-going financial processes.  However,
actual results may differ from these estimates  under different  assumptions and
conditions.

                                       9
<PAGE>

                                  VIRAGE, INC.
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
                                  June 30, 2002
                                   (unaudited)
Restructuring

    During  the three  months  ended  June 30,  2002,  the  Company  implemented
additional  restructuring  programs  to better  align  operating  expenses  with
anticipated  revenues.  The Company  recorded a $731,000  restructuring  charge,
which  consisted  of  $625,000  in  employee  severance  costs and  $106,000  in
equipment  write-downs  across most of the expense  line items in the  Company's
consolidated  statement of operations  for the three months ended June 30, 2002.
The  restructuring  programs resulted in a reduction in force across all company
functions of  approximately  30  employees.  At March 31, 2002,  the Company had
$763,000  of accrued  restructuring  costs  related  to monthly  rent for excess
facility capacity, employee severance payments and other exit costs. The Company
expects to pay out all  restructuring  amounts  accrued as of June 30, 2002 over
the course of the next 12 months.

    The following  table  depicts the  restructuring  activity  during the three
months ended June 30, 2002 (in thousands):

<TABLE>
<CAPTION>
                                     Balance at                          Expenditures          Balance at
Category                           March 31, 2002      Additions      Cash       Non-cash     June 30, 2002
--------                           --------------      ---------      ----       --------     -------------
<S>                                    <C>              <C>          <C>          <C>               <C>
Excess facilities ..............       $460             $ --         $163         $ --              $297
Employee severance .............        259              625          235           --               649
Equipment write-downs ..........         --              106           --          106                --
Other exit costs ...............         44               --           --            6                38
                                       ----             ----         ----         ----              ----
   Total .......................       $763             $731         $398         $112              $984
                                       ====             ====         ====         ====              ====
</TABLE>

    During  the three  months  ended  June 30,  2001,  the  Company  implemented
restructuring  programs to better  align  operating  expenses  with  anticipated
revenues.  The Company recorded a $712,000 restructuring charge, which consisted
of $345,000  in facility  exit costs and  $367,000 in employee  severance  costs
across most of the expense line items in the Company's consolidated statement of
operations for the three months ended June 30, 2001. The restructuring  programs
resulted in a reduction in force across all company  functions of  approximately
35  employees.   At  June  30,  2001,   the  Company  had  $397,000  of  accrued
restructuring  costs  related to  monthly  rent for  excess  facility  capacity,
employee severance payments and other exit costs. The Company paid these accrued
amounts out over the course of the 12 months subsequent to June 30, 2001.

    The following  table  depicts the  restructuring  activity  during the three
months ended June 30, 2001 (in thousands):

                                                                     Balance at
Category                          Additions    Cash Expenditures   June 30, 2001
--------                          ---------    -----------------   -------------
Excess facilities.............     $    345          $    --          $   345
Employee severance............          367               315              52
                                   --------          --------         -------
   Total......................     $    712          $    315         $   397
                                   ========          ========         =======

   The Company has invested significant  resources into developing and marketing
its recently introduced  applications  products. The Company believes that these
solutions   products  broaden  the  value   proposition  to  business   software
application  users and  expects to derive  future  revenues as a result of these
product introductions. The market for the Company's application products is in a
relatively  early  stage.  The  Company  cannot  predict  how the market for its
application  products will develop,  and part of its strategic challenge will be
to convince enterprise customers of the productivity,  communications,  cost and
other benefits of its application  products.  The Company's  future revenues and
revenue growth rates will depend in large part on its success in creating market
acceptance  for its  application  products.  If the Company  fails to do so, its
products and services will not achieve widespread market acceptance, and may not
generate  significant  revenues to offset its  development,  sales and marketing
costs,  which will hurt its  business.  This could  lead to the  Company  taking
additional  restructuring actions in order to reduce costs and bring staffing in
line with anticipated requirements.

                                       10
<PAGE>

                                  VIRAGE, INC.
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
                                  June 30, 2002
                                   (unaudited)

    The Company has  experienced  excess  operating lease capacity and should it
continue to be unable to find a sub lessee at a rate equivalent to its operating
lease  rate,  the  Company  may be  required  to record a charge  for the rental
payments that it owes to its landlord relating to any excess facility  capacity.
The Company's management reviews its facility  requirements and assesses whether
any excess capacity exists as part of its on-going financial processes.

Litigation

   Beginning  on August  22,  2001,  purported  securities  fraud  class  action
complaints  were  filed in the United  States  District  Court for the  Southern
District of New York.  The cases were  consolidated  and the  litigation  is now
captioned as In re Virage, Inc. Initial Public Offering  Securities  Litigation,
Civ. No.  01-7866 (SAS)  (S.D.N.Y.),  related to In re Initial  Public  Offering
Securities  Litigation,  21 MC 92 (SAS) (S.D.N.Y.).  On or about April 19, 2002,
plaintiffs  electronically served an amended complaint. The amended complaint is
brought  purportedly on behalf of all persons who purchased the Company's common
stock from June 28, 2000 through  December 6, 2000. It names as  defendants  the
Company;  one  current  and one  former  officer  of the  Company;  and  several
investment  banking firms that served as underwriters  of the Company's  initial
public offering. The complaint alleges liability under Sections 11 and 15 of the
Securities Act of 1933 and Sections  10(b) and 20(a) of the Securities  Exchange
Act of 1934, on the grounds that the registration statement for the offering did
not disclose that: (1) the underwriters had agreed to allow certain customers to
purchase shares in the offerings in exchange for excess  commissions paid to the
underwriters;  and (2) the  underwriters  had arranged for certain  customers to
purchase  additional  shares in the  aftermarket at  predetermined  prices.  The
amended  complaint  also alleges  that false  analyst  reports  were issued.  No
specific damages are claimed.

     The  Company  is aware  that  similar  allegations  have been made in other
lawsuits filed in the Southern  District of New York  challenging over 300 other
initial  public  offerings and secondary  offerings  conducted in 1999 and 2000.
Those cases have been  consolidated  for pretrial  purposes before the Honorable
Judge Shira A.  Scheindlin.  On July 15, 2002, the Company (and the other issuer
defendants) filed a motion to dismiss. The Company believes that the allegations
against it and the  individual  defendants  are  without  merit,  and intends to
contest them vigorously.

    From time to time,  the Company may become  involved  in  litigation  claims
arising from its ordinary  course of business.  The Company  believes that there
are no  claims or  actions  pending  or  threatened  against  it,  the  ultimate
disposition of which would have a material adverse effect on the Company.

3.   Stockholders' Equity

Voluntary Stock Option Cancellation and Re-grant Program

     In February 2002, the Company offered a voluntary stock option cancellation
and re-grant  program to its  employees.  The plan allowed  employees with stock
options at exercise prices of $5.00 per share and greater to cancel a portion or
all of these unexercised  stock options  effective  February 6, 2002, if they so
chose, provided that should an employee participate,  any option granted to that
employee within the six months preceding February 6, 2002 was also automatically
cancelled.  On  February  6,  2002,  2,678,250  shares  with a  weighted-average
exercise price of $9.54 per share were cancelled pursuant to this program.  As a
result of this  program,  the Company is required to grant its  employees  stock
options on August 7, 2002 at the closing  market price as of that date (see Note
5).

                                       11
<PAGE>

                                  VIRAGE, INC.
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
                                  June 30, 2002
                                   (unaudited)

Warrant Issued to a Customer

     In December  2000,  the Company  entered into a services  agreement  with a
customer  and  issued an  immediately  exercisable,  non-forfeitable  warrant to
purchase  200,000 shares of common stock at $5.50 per share. The warrant expires
in December  2003. The value of the warrant was estimated to be $648,000 and was
based upon a Black-Scholes valuation model with the following assumptions:  risk
free interest rate of 7.0%, no dividend yield,  volatility of 90%, expected life
of three years,  exercise  price of $5.50 and fair value of $5.38.  The non-cash
amortization  of the warrant's value was recorded  against  service  revenues as
revenues from services were  recognized  over the one-year  services  agreement.
During the three months ended June 30, 2001,  the Company  recorded  $216,000 as
contra-service  revenues representing the pro-rata amortization of the warrant's
value for the aforementioned period (none during the three months ended June 30,
2002).

4.  Segment Reporting

The  Company  has two  reportable  segments:  the sale of  software  and related
software  support  services  including  revenues from U.S.  government  agencies
("software")  and the sale of its  application and  professional  services which
includes set-up fees,  professional  services fees,  video  processing fees, and
application  hosting  fees  ("application  and  professional   services").   The
Company's  Chief  Operating  Decision  Maker  ("CODM")  is the  Company's  Chief
Executive Officer who evaluates  performance and allocates  resources based upon
total revenues and gross profit (loss).  Discreet financial information for each
segment's profit and loss and each segment's total assets is not provided to the
Company's CODM, nor is it tracked by the Company.

    Information on the Company's  reportable segments for the three months ended
June 30, 2002 and 2001 are as follows (in thousands):

                                                         Three Months Ended
                                                              June 30,
                                                    -------------------------
                                                        2002          2001
                                                    -----------   -----------
            Software:

            Total revenues..................        $     2,250   $     2,586

            Total cost of revenues..........                386           358
                                                    -----------   -----------

            Gross profit....................        $     1,864   $     2,228
                                                    ===========   ===========

            Application and Professional Services:

            Total revenues..................        $       985   $     1,404

            Total cost of revenues..........                960         2,385
                                                    -----------   -----------

            Gross profit (loss).............        $        25   $      (981)
                                                    ===========   ===========

                                       12
<PAGE>

                                  VIRAGE, INC.
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
                                  June 30, 2002
                                   (unaudited)

5.  Subsequent Events (Unaudited)

NASDAQ National Market Trading Requirements

   The Company's stock is currently traded on the NASDAQ National Market and the
bid  price  for its  common  stock  has been  under  $1.00 per share for over 30
consecutive trading days. Under NASDAQ's listing maintenance  standards,  if the
closing bid price of the Company's  common stock is under $1.00 per share for 30
consecutive  trading  days,  NASDAQ may choose to notify the Company that it may
delist its common stock from the NASDAQ National  Market.  On July 24, 2002, the
Company  received  notice from NASDAQ that it is not in compliance with NASDAQ's
listing  maintenance  standards and that it has until October 22, 2002 to regain
compliance.  If at any  time  before  October  22,  2002  the bid  price  of the
Company's  common  stock  closes at $1.00 per share or more for a minimum  of 10
consecutive  trading days,  NASDAQ will  consider  notifying the Company that it
complies with the maintenance  standards.  If the Company is unable to meet this
minimum bid price  requirement by October 22, 2002, the Company  expects to have
the option of transferring to the NASDAQ SmallCap Market,  which makes available
a 180  calendar  day  extended  grace  period  for the  minimum  $1.00 bid price
requirement (instead of a 90 day grace period as provided by the NASDAQ National
Market).  In addition,  the Company  expects that it may also be eligible for an
additional  180  calendar day grace  period on the NASDAQ  SmallCap  Market (ie.
until July 21, 2003)  provided  that the Company  meets the other  non-bid price
related  listing  criteria.  If the  Company  transfers  to the NASDAQ  SmallCap
Market,  the Company  expects  that it may be  eligible to transfer  back to the
NASDAQ  National  Market  if  its  bid  price  maintains  the  $1.00  per  share
requirement  for 30 consecutive  trading days and it has  maintained  compliance
with all other continued  listing  requirements  for the NASDAQ National Market.
There can be no assurance that the Company's  common stock will remain  eligible
for trading on the NASDAQ National Market or the NASDAQ SmallCap Market.  If the
Company's stock were delisted, the ability of the Company's stockholders to sell
any of the Company's  common stock at all would be severely,  if not completely,
limited.

Issuance of Stock Options  Pursuant to Voluntary Stock Option  Cancellation  and
Re-grant Program

   On August 7, 2002, the Company issued  2,538,250 shares at $0.59 per share to
employees that participated in the Company's Voluntary Stock Option Cancellation
and Re-grant Program (described in Note 3 above).

                                       13
<PAGE>

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

    The following discussion and analysis of our financial condition and results
of operations  should be read in  conjunction  with the  "Selected  Consolidated
Financial Data",  the condensed  consolidated  financial  statements and related
notes contained  herein.  This discussion  contains  forward-looking  statements
within the meaning of Section 27A of the  Securities  Act and Section 21E of the
Exchange  Act.  We may  identify  these  statements  by the use of words such as
"believe",  "expect",  "anticipate",  "intend",  "plan" and similar expressions.
These  forward-looking  statements involve several risks and uncertainties.  Our
actual   results   may  differ   materially   from  those  set  forth  in  these
forward-looking  statements as a result of a number of factors,  including those
described  under  the  caption  "Risk  Factors"  herein.  These  forward-looking
statements  speak only as of the date of this report,  and we caution you not to
rely on these statements  without also  considering the risks and  uncertainties
associated with these statements and our business as addressed elsewhere in this
report.

    Virage, Inc. is a provider of software products,  professional  services and
application  services that enable owners of rich-media  and video assets to more
effectively communicate, manage, retrieve and distribute these rich-media assets
for improved  productivity  and  communications.  Depending on their  particular
needs and resources, our customers may elect to license our software products or
employ our application or professional services. Our customers include media and
entertainment companies, other corporations, government agencies and educational
institutions.

Recent Events

Application Products

   Recently,  we introduced four new  application  products:  VS Publishing,  VS
Webcasting,  VS Learning,  and VS  Production.  VS  Publishing  offers media and
entertainment  customers a streamlined  workflow for rich-media web  publishing,
including  a  simple   editorial   control  and  greater   website   programming
capabilities.  VS  Webcasting  allows  corporations  to  self-produce  live  and
on-demand  webcasting  events such as executive  communications,  human resource
broadcasts and webinars.  VS Learning is a new enterprise  software  application
for rich media training and e-learning that enables companies to create, manage,
publish and view on-demand  training courses and presentations  containing video
and other  rich-media  information.  Finally,  VS  Production  is an  integrated
software  solution for media and  entertainment  enterprises  that automates the
professional video production process from acquisition to distribution.

   These  products have been  developed and have shipped,  or are in their final
development  stages,  and we expect to have  shipped  them all by the end of our
second  fiscal  quarter.  We  continue  to  believe  that  the  success  of  our
application  products is critical to our future and have  heavily  invested  our
resources in the  development,  marketing,  and sale of them. The market for our
application  products is in a relatively early stage. We cannot predict how much
the market for our application  products will develop, and part of our strategic
challenge  will  be  to  convince  enterprise  customers  of  the  productivity,
communications,  cost, and other benefits of our solutions.  Our future revenues
and  revenue  growth  rates will depend in large part on our success in creating
market acceptance for our application products.

                                       14
<PAGE>

Business Restructuring Charges

   During  the  three  months  ended  June  30,  2002,  we  executed  additional
restructuring measures to reduce headcount and infrastructure and to consolidate
operations  worldwide.  We  re-evaluated  our cost structure and further reduced
headcount and  infrastructure  across all functional areas of the company in our
continued  efforts to limit our  future  expense  growth.  These  headcount  and
infrastructure  changes  resulted in a reduction  in force of  approximately  30
employees  worldwide  and the  recording  of $731,000 in business  restructuring
charges during the quarter.  A breakdown of our business  restructuring  charges
during the quarter and the remaining  restructuring  accrual as of June 30, 2002
is as follows:

<TABLE>
<CAPTION>
                                            Balance at                         Expenditures             Balance at
   Category                               March 31, 2002     Additions       Cash        Non-cash     June 30, 2002
   --------                               --------------     ---------       ----        --------     -------------
<S>                                          <C>             <C>            <C>           <C>            <C>
Excess facilities and other exit costs..     $   504         $    --        $ 169         $  --          $ 335
Employee separation and other costs.....         259             625          235            --            649
Equipment write-downs...................          --             106           --           106             --
                                             -------         -------        -----         -----          -----
     Total..............................     $   763         $   731        $ 404         $ 106          $ 984
                                             =======         =======        =====         =====          =====
</TABLE>

   Excess  Facilities  and Other Exit Costs:  Excess  facilities  and other exit
costs relate to lease  obligations and closure costs  associated with offices we
have vacated as a result of our cost reduction  initiatives.  Cash  expenditures
for excess  facilities  and other exit costs  during the three months ended June
30, 2002 primarily  represent  contractual  ongoing lease  payments.  In our San
Mateo,  CA  headquarters  location,  we have an operating  lease  commitment for
approximately  48,000  square feet of office  space,  an amount  higher than our
current needs. It is our management's best estimate that some of this space will
continue to be  under-utilized  for the next nine months and that we will not be
able to recoup all losses from our rental  payments  for the period from July 1,
2002 to March 31,  2003 by earning a profit from a sub lessee at some point over
the course of our obligation  period,  which continues  through  September 2006.
Should we continue to have excess  operating lease capacity  subsequent to March
31,  2003  and be  unable  to  find a sub  lessee  at a rate  equivalent  to our
operating  lease rate, we may be required to record  additional  charges for the
rental  payments that we owe to our landlord  relating to excess capacity within
this facility.  Our management  reviews our facility  requirements  and assesses
whether any excess capacity exists as part of our on-going financial processes.

   Employee  Severance:  Employee  separation  and other  costs,  which  include
severance, related taxes, outplacement and other benefits, totaled approximately
$625,000 during the three months ended June 30, 2002 (representing approximately
30 terminated employees),  and $235,000 was paid in cash during the three months
ended June 30, 2002. Personnel affected by the cost reduction initiatives during
the three months ended June 30, 2002 include  employees in positions  throughout
the  company  in  sales,  marketing,  services,  engineering,  and  general  and
administrative  functions  in all  geographies,  with a  particular  emphasis on
non-sales personnel in our United Kingdom subsidiary.

   Equipment Write-Downs:  As part of our cost restructuring efforts, we decided
to  substantially  downsize our subsidiary in the United  Kingdom,  primarily in
response to weak market  conditions  in Europe.  Pursuant to these  efforts,  we
reduced our European asset infrastructure by reducing a number of assets used by
terminated employees and wrote-off  approximately $106,000 of assets at net book
value. Our management reviews its capacity requirements and assesses whether any
excess capacity exists as part of our on-going financial processes.

Voluntary Stock Option Cancellation and Re-grant Program

   In February 2002, we canceled  2,678,250  stock options of certain  employees
who elected to  participate  in our  voluntary  stock  option  cancellation  and
re-grant  program.  Many  of our  employees  canceled  stock  options  that  had
significantly  higher  exercise  prices in  comparison to where our common stock
price currently  trades. On August 7, 2002, we issued 2,538,250 stock options to
current  employees  who  participated  in the program with a new exercise  price
equal to $0.59 per share.

                                       15
<PAGE>

   We believe that this program will help to retain our employees and to improve
our workforce morale.  However,  this program may cause dilution to our existing
stockholder base, which may cause our stock price to fall.

Critical Accounting Policies & Estimates

   The  discussion  and  analysis  of our  financial  position  and  results  of
operations are based upon our consolidated financial statements, which have been
prepared in accordance  with  generally  accepted  accounting  principles in the
United  States.  The  preparation  of these  consolidated  financial  statements
requires us to make estimates and judgments that affect the reported  amounts of
assets,   liabilities,   revenues,  and  expenses,  and  related  disclosure  of
contingent  assets  and  liabilities.   We  base  our  estimates  on  historical
experience and on various other  assumptions  that are believed to be reasonable
under  the  circumstances,  the  results  of which  form the  basis  for  making
judgments  about the  carrying  values of assets  and  liabilities  that are not
readily  apparent from other sources.  Estimates and assumptions are reviewed as
part of our management's on-going financial processes. Actual results may differ
from these estimates under different assumptions and conditions.

   We believe our critical  accounting policies and estimates include accounting
for  revenue  recognition  and the  accounting  and  related  estimates  for our
commitments and contingencies.

Revenue Recognition

    We enter into arrangements for the sale of licenses of software products and
related maintenance  contracts,  application services and professional  services
offerings;  and also receive  revenues  under U.S.  government  agency  research
grants.   Service  revenues   include   revenues  from  maintenance   contracts,
application services,  and professional  services.  Other revenues are primarily
U.S. government agency research grants.

      Our  revenue  recognition  policy  is  in  accordance  with  the  American
Institute of Certified Public  Accountants'  ("AICPA") Statement of Position No.
97-2 ("SOP 97-2"),  "Software Revenue  Recognition",  as amended by Statement of
Position  No.  98-4,  "Deferral  of the  Effective  Date of SOP 97-2,  "Software
Revenue  Recognition""  ("SOP  98-4"),  and  Statement  of  Position  No.  98-9,
"Modification of SOP No. 97-2 with Respect to Certain Transactions" ("SOP 98-9")
and is also  consistent  with the  Securities  and Exchange  Commission's  Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements.". For
each  arrangement,  we  determine  whether  evidence of an  arrangement  exists,
delivery has  occurred,  the fee is fixed or  determinable,  and  collection  is
probable.  If any of these criteria are not met, revenue recognition is deferred
until such time as all  criteria  are met. We  consider  all  arrangements  with
payment terms extending beyond twelve months and other arrangements with payment
terms longer than normal not to be fixed or determinable.  If  collectibility is
not considered  probable,  revenue is recognized  when the fee is collected.  No
customer has the right of return.

    Arrangements consisting of license and maintenance. For those contracts that
consist solely of license and maintenance,  we recognize  license revenues based
upon the residual  method after all elements  other than  maintenance  have been
delivered as prescribed by SOP 98-9. We recognize  maintenance revenues over the
term of the maintenance  contract as vendor specific  objective evidence of fair
value for  maintenance  exists.  In accordance  with  paragraph ten of SOP 97-2,
vendor specific objective evidence of fair value of maintenance is determined by
reference  to the price the  customer  will be  required  to pay when it is sold
separately (that is, the renewal rate). Each license agreement offers additional
maintenance  renewal  periods  at a  stated  price.  Maintenance  contracts  are
typically  one year in duration.  Revenue is  recognized on a per copy basis for
licensed  software  when each copy of the license  requested  by the customer is
delivered.

    Revenue is recognized on licensed software on a per user or per server basis
for a fixed fee when the product  master is delivered to the customer.  There is
no right of return or price  protection for sales to domestic and  international
distributors,  system  integrators,  or  value  added  resellers  (collectively,
"resellers").  In  situations  where the reseller has a purchase  order or other
contractual  agreement  from the end user that is  immediately  deliverable,  we
recognize revenue on shipment to the reseller, if other criteria in SOP 97-2 are
met,  since we have no risk of  concessions.  We defer  revenue on  shipments to
resellers if the reseller  does not have a purchase  order or other  contractual
agreement from an end user that is immediately  deliverable or other criteria in
SOP 97-2  are not  met.  We  recognize  royalty  revenues  upon  receipt  of the
quarterly reports from the vendors.

                                       16
<PAGE>

    When licenses and maintenance are sold together with  professional  services
such  as  consulting  and  implementation,  license  fees  are  recognized  upon
shipment,  provided  that (1) the criteria in the previous  paragraph  have been
met, (2) payment of the license fee is not dependent upon the performance of the
professional   services,  and  (3)  the  services  do  not  include  significant
alterations to the features and functionality of the software.

    Should  professional  services  be  essential  to the  functionality  of the
licenses in a license arrangement which contains professional services or should
an arrangement not meet the criteria  mentioned above, both the license revenues
and  professional  service  revenues  are  recognized  in  accordance  with  the
provisions  of the AICPA's  Statement  of Position  No.  81-1,  "Accounting  for
Performance of Construction  Type and Certain  Production Type Contracts"  ("SOP
81-1").  When  reliable  estimates  are  available  for the  costs  and  efforts
necessary  to  complete  the  implementation  services  and  the  implementation
services do not include contractual  milestones or other acceptance criteria, we
account for the arrangements under the percentage of completion  contract method
pursuant to SOP 81-1 based upon input measures such as hours or days.  When such
estimates are not available,  the completed contract method is utilized. When an
arrangement  includes  contractual  milestones,  we  recognize  revenues as such
milestones  are  achieved  provided  the  milestones  are  not  subject  to  any
additional acceptance criteria.

     Application  services.  Application  services revenues consist primarily of
account  set-up,  web design and  integration  fees,  video  processing fees and
application  hosting fees.  Account set-up,  web design and integration fees are
recognized  ratably over the  contract  term,  which is generally  six to twelve
months. We generate video processing fees for each hour of video that a customer
deploys.  Processing  fees are  recognized  as encoding,  indexing and editorial
services  are  performed  and are  based  upon  hourly  rates  per hour of video
content.  Application  hosting fees are  generated  based on the number of video
queries  processed,  subject to  monthly  minimums.  We  recognize  revenues  on
transaction  fees that are subject to monthly  minimums on a monthly basis since
we have no further obligations, the payment terms are normal and each month is a
separate measurement period.

    Professional  services. We provide professional services such as consulting,
implementation  and  training  services  to our  customers.  Revenues  from such
services,  when not sold in  conjunction  with product  licenses,  are generally
recognized as the services are performed.

    Other revenues.  Other revenues consist primarily of U.S.  government agency
research  grants that are best  effort  arrangements.  The  software-development
arrangements are within the scope of the Financial  Accounting Standards Board's
Statement of Financial  Accounting  Standards No. 68,  "Research and Development
Arrangements."  As the financial risks associated with the  software-development
arrangement rests solely with the U.S.  government agency, we recognize revenues
as the services are performed. The cost of these services is included in cost of
other revenues.  The Company's contractual obligation is to provide the required
level of effort (hours),  technical reports,  and funds and man-hour expenditure
reports.

    We follow  very  specific  and  detailed  guidelines,  discussed  above,  in
determining revenues; however, certain judgments and estimates are made and used
to determine revenue recognized in any accounting period.  Material  differences
may result in the amount  and  timing of  revenue  recognized  for any period if
different  conditions  were to prevail.  For  example,  in  determining  whether
collection is probable, we assess each customer's ability and intent to pay. Our
actual  experience  with  respect to  collections  could differ from our initial
assessment if, for instance,  unforeseen  declines in the overall  economy occur
and negatively impact our customers'  financial  condition.  To date, we believe
that our revenue  recognition has been proper and our related reserves have been
sufficient.

                                       17
<PAGE>

Commitments and Contingencies

    In the  normal  course  of  business,  we are  subject  to  commitments  and
contingencies,  including operating leases, restructuring liabilities, and legal
proceedings   and  claims  that  cover  a  wide  range  of  matters,   including
securities-related  litigation  and  other  claims  in the  ordinary  course  of
business. We record accruals for such contingencies based upon our assessment of
the  probability  of  occurrence  and,  where  determinable,  an estimate of the
liability.  We consider many factors in making these assessments  including past
history and the specifics of each matter. We believe that there are no claims or
actions  pending or  threatened  against  us that would have a material  adverse
effect on our  operating  results.  Further,  we review  our  assessment  of the
likelihood of loss on any outstanding  contingencies as part of our management's
on-going  financial  processes.  However,  actual  results may differ from these
estimates under different assumptions and conditions.

Results of Operations

    The following table sets forth  consolidated  financial data for the periods
indicated, expressed as a percentage of total revenues.

                                                Three Months Ended
                                                     June 30,
                                            -------------------------
                                              2002              2001
                                            -------            ------
Revenues:
  License revenues......................       50%                47%
  Service revenues......................       50                 51
  Other revenues........................       --                  2
                                             ----               ----
          Total revenues................      100                100
                                             ----               ----
Cost of revenues:
  License revenues......................        6                  4
  Service revenues......................       36                 63
  Other revenues........................       --                  2
                                             ----               ----
          Total cost of revenues........       42                 69
                                             ----               ----
Gross profit............................       58                 31
Operating expenses:
  Research and development..............       74                 62
  Sales and marketing...................      114                111
  General and administrative............       35                 33
  Stock-based compensation..............       11                 20
                                             ----               ----
          Total operating expenses......      234                226
                                             ----               ----
Loss from operations....................     (176)              (195)
Interest and other income, net..........        6                 14
                                             ----               ----
Net loss................................     (170)%             (181)%
                                             ====               ====

    We incurred a net loss of $5,501,000  during the three months ended June 30,
2002.  As of June 30, 2002, we had an  accumulated  deficit of  $94,425,000.  We
expect to continue to incur operating losses for the foreseeable future. In view
of the rapidly changing nature of our market and our limited operating  history,
we believe that period-to-period comparisons of our revenues and other operating
results  are  not  necessarily  meaningful  and  should  not be  relied  upon as
indications  of future  performance.  Our historic  revenue growth rates are not
necessarily sustainable or indicative of our future growth.

    Revenues.  Total revenues decreased to $3,235,000 for the three months ended
June 30,  2002 from  $3,990,000  for the three  months  ended June 30,  2001,  a
decrease of $755,000. This decrease was due to decreases in license, service and
other revenues.  International  revenues decreased to $714,000,  or 22% of total
revenues, during the three months ended June 30, 2002 from $1,164,000, or 29% of
total  revenues,  during the three  months  ended  June 30,  2001.  No  customer
accounted  for more than 10% of total  revenues  for the three months ended June
30, 2002.  Sales to two customers  (one of which was a reseller of our products)
each  accounted  for 16% of total  revenues  for the three months ended June 30,
2001.

                                       18
<PAGE>

    License revenues  decreased to $1,611,000 during the three months ended June
30, 2002 from  $1,882,000  during the three  months  ended June 30,  2001.  This
decrease is primarily due to lower unit sales of the  SmartEncode  product suite
during the three  months ended June 30, 2002  resulting  from fewer signed deals
and in response to the weakened overall technology spending environment.

     Service  revenues  decreased to $1,624,000  for the three months ended June
30, 2002 from $2,047,000 for the three months ended June 30, 2001, a decrease of
$423,000.  This  decrease  is the result of lower  revenues  in our  application
services  business,  primarily due to the non-renewal of our contract with Major
League  Baseball  Advanced Media  ("MLBAM").  Service  revenues during the three
months ended June 30, 2001 include $216,000 of warrant amortization  recorded as
contra-service revenues resulting from a warrant issued to MLBAM.

    Other  revenues  were  $61,000  during the three  months ended June 30, 2001
(none  during  the  three  months  ended  June  30,  2002).  This  decrease  was
attributable to the level of engineering  services performed pursuant to federal
government research contracts.

    Cost of Revenues.  Cost of license  revenues  consists  primarily of royalty
fees for third-party software products integrated into our products. Our cost of
service revenues includes personnel  expenses,  related overhead,  communication
expenses and capital  depreciation  costs for maintenance and support activities
and application and professional  services. Our cost of other revenues primarily
includes  engineering  personnel  expenses and related  overhead for engineering
research  for  government   projects.   Total  cost  of  revenues  decreased  to
$1,346,000,  or 42% of total revenues,  for the three months ended June 30, 2002
from $2,743,000,  or 69% of total revenues,  for the three months ended June 30,
2001. This decrease in total cost of revenues was due primarily to a decrease in
our cost of service  revenues,  slightly  offset by an  increase  in the cost of
license  revenues.  We expect our total cost of revenues to be  relatively  flat
during our second fiscal quarter in comparison to our first fiscal quarter ended
June 30, 2002, however our total cost of revenues is highly variable. Generally,
we expect that  increases or decreases in the dollar amount of our total cost of
revenues will  correlate with increases or decreases in the dollar amount of our
total revenues.

    Cost of license revenues increased to $187,000,  or 12% of license revenues,
during the three  months  ended June 30,  2002 from  $154,000,  or 8% of license
revenues,  during the three months ended June 30, 2001. This increase was due to
higher unit sales of our products  that are subject to  unit-based  (rather than
fixed-fee)  license royalty payments for the three months ended June 30, 2002 in
comparison to the three months ended June 30, 2001.

    Cost  of  service  revenues  decreased  to  $1,159,000,  or 71%  of  service
revenues,  for the three months ended June 30, 2002 from $2,532,000,  or 124% of
service revenues for the three months ended June 30, 2001. This decrease was due
to lower expenditures for our application  services  business,  primarily due to
the non-renewal of our contract with MLBAM.

    Cost of other  revenues was $57,000,  or 93% of other  revenues,  during the
three  months  ended  June 30,  2001 (none for the three  months  ended June 30,
2002).  This  decrease was  attributable  to the level of  engineering  services
performed pursuant to federal government research contracts.

    Research and Development Expenses. Research and development expenses consist
primarily of personnel and related costs for our development  efforts.  Research
and development expenses decreased to $2,382,000,  or 74% of total revenues, for
the three months ended June 30, 2002 from $2,473,000,  or 62% of total revenues,
for the three months ended June 30, 2001.  The decrease in absolute  dollars was
primarily due to lower variable  office and equipment  costs and reduced product
development  expenses.  We expect research and development  expenses to increase
modestly  for the  foreseeable  future as we believe  that  product  development
expenditures  are essential  for us to maintain and enhance our market  position
and expand into new user markets.  To date, we have not capitalized any software
development   costs  as  they  have  been   insignificant   after   establishing
technological feasibility.

                                       19
<PAGE>

     Sales and  Marketing  Expenses.  Sales and  marketing  expenses  consist of
personnel  and related costs for our direct sales force,  pre-sales  support and
marketing  staff,  and marketing  programs  including  trade shows and seminars.
Sales and marketing expenses decreased to $3,685,000, or 114% of total revenues,
during the three  months ended June 30, 2002 from  $4,439,000,  or 111% of total
revenues,  during the three months ended June 30, 2001. The decrease in absolute
dollars  was  primarily  due to  lower  variable  headcount  costs  and  reduced
discretionary marketing program spending. We expect sales and marketing expenses
to  remain  in the  range  of  relatively  flat  to a  modest  decrease  for the
foreseeable  future as we attempt to limit our overall  expense growth and focus
our marketing activities in specific areas.

    General and Administrative  Expenses.  General and  administrative  expenses
consist   primarily  of  personnel  and  related  costs  for  general  corporate
functions,  including finance, accounting,  legal, human resources,  facilities,
costs of our external audit firm and costs of our outside legal counsel. General
and administrative  expenses decreased to $1,142,000,  or 35% of total revenues,
for the  three  months  ended  June 30,  2002  from  $1,332,000  or 33% of total
revenues,  for the three months  ended June 30,  2001.  The decrease in absolute
dollars  was  primarily  due to  lower  variable  headcount  costs  and  reduced
professional  services  fees. We expect general and  administrative  expenses to
remain  relatively  flat for the  foreseeable  future as we attempt to limit our
overall expense growth.

    Stock-Based   Compensation   Expense.   Stock  based  compensation   expense
represents  the  amortization  of  deferred  compensation   (calculated  as  the
difference  between the exercise price of stock options granted to our employees
and the then deemed fair value of our common stock) for stock options granted to
our employees.  We recognized  stock-based  compensation expense of $371,000 and
$782,000  for the three months  ended June 30, 2002 and 2001,  respectively,  in
connection with the granting of stock options to our employees.  Our stock-based
compensation  expense for the three months ended June 30, 2002  decreased due to
the cancellation of stock options resulting from  participation in our voluntary
stock option cancellation and re-grant program for our employees during the year
ended March 31,  2002.  The  implementation  of this  cancellation  and re-grant
program   resulted  in  the   immediate   expensing   of  the  majority  of  our
employee-related  deferred compensation in our fourth fiscal quarter of 2002. As
a result,  our  stock-based  compensation  expenses  are,  and are  expected  to
continue to be, lower than fiscal 2002 levels.  We will continue to amortize the
remaining  deferred  compensation  balance as expense for  employees who did not
participate in our voluntary stock option cancellation and re-grant program.

    Interest and Other Income.  Interest and other income, net includes interest
income from cash and cash  equivalents.  Interest and other income  decreased to
$190,000 for the three  months  ended June 30, 2002 from  $568,000 for the three
months ended June 30, 2001, a decrease of $378,000. The decrease was a result of
lower  interest  rates and lower average cash  balances  during the three months
ended June 30, 2002.

    Provision  for  Income  Taxes.  We have not  recorded  a  provision  for any
significant federal and state or foreign income taxes in either the three months
ended  June 30,  2002 or 2001  because  we have  experienced  net  losses  since
inception,  which have  resulted in  deferred  tax  assets.  We have  recorded a
valuation   allowance  for  the  entire  deferred  tax  asset  as  a  result  of
uncertainties  regarding the  realization  of the asset balance  through  future
taxable profits.

Liquidity and Capital Resources

    As  of  June  30,  2002,  we  had  cash,  cash  equivalents  and  short-term
investments of $25,532,000, a decrease of $5,162,000 from March 31, 2002 and our
working  capital,  defined as  current  assets  less  current  liabilities,  was
$19,801,000,  a decrease of $4,276,000  in working  capital from March 31, 2002.
The decrease in our cash, cash equivalents,  and short-term  investments and our
working capital is primarily attributable to cash used in operating activities.

    Our operating  activities  resulted in net cash outflows of $5,205,000,  and
$6,102,000 for the three months ended June 30, 2002 and 2001, respectively.  The
cash  used  in  these  periods  was  primarily  attributable  to net  losses  of
$5,501,000  and  $7,211,000  in the three  months  ended June 30, 2002 and 2001,
respectively, offset by depreciation expense, losses on disposals of assets, and
non-cash, stock-based charges.

                                       20
<PAGE>

    Investing  activities  resulted  in cash  inflows  of  $2,560,000  and  cash
outflows  of  $7,164,000  for the three  months  ended  June 30,  2002 and 2001,
respectively.  Our  investing  activity  cash  inflows  were due to the sale and
maturity of our short-term  investments and our investing activity cash outflows
were primarily for the purchase of short-term  investments and capital equipment
during both  periods.  We expect that we will  continue to invest in  short-term
investments  and purchase  capital  equipment as we replace older equipment with
newer models.

    Financing  activities  provided  net cash  inflows of $161,000  and $478,000
during  the three  months  ended  June 30,  2002 and 2001,  respectively.  These
inflows were  primarily  from the proceeds of our employee  stock  purchase plan
during the three months ended June 30, 2002 and 2001.

    At June  30,  2002,  we have  contractual  and  commercial  commitments  not
included on our balance sheet primarily for our San Mateo,  California  facility
that we have an obligation to lease through September 2006. For the remainder of
our  fiscal  year  ended  March  31,  2003,  our  total  commitments  amount  to
$2,542,000.  Future full fiscal year  commitments are as follows:  $3,466,000 in
2004, $3,382,000 in 2005, $3,240,000 in 2006 and $1,844,000 in 2007 ($14,474,000
in total commitments as of June 30, 2002).

    We  anticipate  that our  current  cash,  cash  equivalents  and  short-term
investments  will be sufficient to meet our  anticipated  cash needs for working
capital and capital expenditures for the next 12 months. However, we may need to
raise additional  funds in future periods through public or private  financings,
or other sources,  to fund our operations  and potential  acquisitions,  if any,
until we achieve  profitability,  if ever. We may not be able to obtain adequate
or favorable  financing  when  necessary to fund our business.  Failure to raise
capital  when  needed  could harm our  business.  If we raise  additional  funds
through the issuance of equity  securities,  the  percentage of ownership of our
stockholders would be reduced.  Furthermore,  these equity securities might have
rights, preferences or privileges senior to our common stock.

                                       21
<PAGE>

Risk Factors

    The occurrence of any of the following risks could  materially and adversely
affect our business,  financial  condition and operating results.  In this case,
the trading  price of our common  stock could  decline and you might lose all or
part of your investment.

                          Risks Related to Our Business

Our revenues,  cost of revenues,  and expense  forecasts are based upon the best
information we have available,  but our operating results have historically been
volatile  and  there  are a number of risks  that  make it  difficult  for us to
foresee or accurately evaluate factors that may impact our forecasts.

    Our quarterly  operating  results have varied  significantly in the past and
are likely to vary significantly in the future. We believe that period-to-period
comparisons  of our results of operations  are not  meaningful and should not be
relied upon as indicators of future  performance.  Our operating results have in
past quarters fallen below securities analyst  expectations and will likely fall
below their expectations in some future quarter or quarters.

    We have limited  visibility  into future demand,  and our limited  operating
history makes it difficult for us to foresee or accurately evaluate factors that
may impact  such future  demand.  Our  visibility  over our  potential  sales is
typically limited to the current quarter and our visibility for even the current
quarter  is rather  limited.  In order to  provide a  revenue  forecast  for the
current quarter,  we must make  assumptions  about conversion of these potential
sales  into  current  quarter  revenues.  Such  assumptions  may  be  materially
incorrect due to competition for the customer order including pricing pressures,
sales execution issues,  customer  selection  criteria or length of the customer
selection cycle, the failure of sales contracts to meet our revenue  recognition
criteria,  our inability to perform professional  services timely, our inability
to hire and retain qualified personnel,  our inability to develop new markets in
Europe or Asia,  and other  factors  that may be beyond our control  such as the
strength of information  technology spending.  In addition, we are inexperienced
with our sales  cycle for these new  application  products to these users and we
cannot  predict how the market for our  application  products will develop.  Our
assumptions  about  conversion  of these  potential  sales into current  quarter
revenues could be materially incorrect.  We are reliant on third party resellers
for a significant portion of our license revenues and we have limited visibility
into the status of orders from such third parties.

    For quarters  beyond the current  quarter,  we have very limited  visibility
into potential sales opportunities, and thus we have a lower confidence level in
any revenue  forecast  or  forward-looking  guidance.  In  developing  a revenue
forecast  for such  quarters,  we assess any customer  indications  about future
demand,  general  industry  trends,   marketing  lead  development   activities,
productivity  goals for the sales force and expected growth in sales  personnel,
and any demand for products that we may have.

    Our cost of sales and  expense  forecasts  are based  upon our  budgets  and
spending  forecasts  for  each  area of the  Company.  Circumstances  we may not
foresee  could  increase cost and expense  levels beyond the levels  forecasted.
Such circumstances may include  competitive  threats in our markets which we may
need to address with  additional  sales and  marketing  expenses,  severance for
involuntary  reductions in headcount  should we determine cost cutting  measures
are  necessary  subsequent to our publicly  provided  guidance,  write-downs  of
equipment and/or  facilities in the event of unforeseen  excess capacity,  legal
claims,  employee turnover,  additional royalty expenses should we lose a source
of current technology,  losses of key management  personnel,  unknown defects in
our  products,   and  other  factors  we  cannot  foresee.  In  addition,   many
expenditures  are  planned or  committed  in advance in  anticipation  of future
revenues,  and if our  revenues  in a  particular  quarter  are  lower  than  we
anticipate,  we may be unable to reduce  spending in that quarter.  As a result,
any  shortfall  in revenues or a failure to improve  gross  profit  margin would
likely hurt our quarterly operating results.

                                       22
<PAGE>

The failure of any  significant  contracts to meet our policies for  recognizing
revenue may prevent us from achieving our revenue  objectives for a quarter or a
fiscal year, which would hurt our operating results.

    Our sales contracts are typically  based upon standard  agreements that meet
our revenue  recognition  policies.  However,  our future sales may include site
licenses,  consulting  services or other  transactions  with  customers  who may
negotiate  special terms and conditions  that are not part of our standard sales
contracts. In addition, customers may delay payments to us, which may require us
to account for those  customers'  revenues on a cash basis,  rather than accrual
basis,  of accounting.  If these special terms and conditions  cause sales under
these contracts to not qualify under our revenue recognition  policies, we would
defer  revenues to future  periods,  which may hurt our  reported  revenues  and
operating results.

    In addition,  customers  that  license our products may require  consulting,
implementation,  maintenance  and  training  services  and obtain  them from our
internal  professional  services,  customer support and training  organizations.
When  we  provide  these  services  in  connection   with  a  software   license
arrangement,  our revenue  recognition  policy may require us to  recognize  the
software license fee as the  implementation  services are performed or defer the
fee until the completion of the services,  which may hurt our reported  revenues
and operating results.

We have allocated significant product development, sales and marketing resources
toward the  deployment of our new  application  products and we face a number of
risks that may impede  market  acceptance  of these  products and such risks may
ultimately  prove our business  model  invalid,  thereby  hurting our  financial
results.

    We have invested  significant  resources  into  developing and marketing our
recently  introduced  application  products and do not know whether our business
model and strategy  will be  successful.  The market for these  products is in a
relatively  early stage.  We cannot predict how the market for our  applications
will develop, and part of our strategic challenge will be to convince enterprise
customers of the  productivity,  communications,  cost and other benefits of our
application  products.  Our future revenues and revenue growth rates will depend
in large part on our success in delivering  these new products  effectively  and
creating market acceptance for these products. If we fail to do so, our products
and  services  will not achieve  widespread  market  acceptance,  and we may not
generate  significant  revenues to offset our  development,  sales and marketing
costs,  which will hurt our  business.  Additionally,  our future  success  will
continue  to  depend  upon our  ability  to  develop  new  products  or  product
enhancements  that address  future needs of our target markets and to respond to
these changing standards and practices.

    In  addition,   resources  may  be  required  to  fund  development  of  our
application   products'   feature-sets  beyond  what  we  have  planned  due  to
unanticipated  marketplace  demands. We may determine that we are unable to fund
these  additional  feature-sets  due to financial  constraints  and may halt the
development of a product at a stage that the marketplace  perceives as immature.
We may also encounter that the marketplace for an application  product is not as
robust as we had expected and we may react to this by leaving the development of
a product at an early stage. Either of these product  development  scenarios may
impede market  acceptance of any of our new  application  products and therefore
hurt our financial results.

The length of our sales and deployment  cycle is uncertain,  which may cause our
revenues and operating results to vary significantly from quarter to quarter.

    During our sales cycle,  we spend  considerable  time and expense  providing
information to prospective  customers about the use and benefits of our products
and services without generating  corresponding  revenues. Our expense levels are
relatively  fixed in the  short-term  and based in part on our  expectations  of
future revenues. Therefore, any delay in our sales cycle could cause significant
variations in our operating  results,  particularly  because a relatively  small
number of customer orders represent a large portion of our revenues.

                                       23
<PAGE>

    Some of our largest  sources of revenues are  government  entities and large
corporations  that often  require  long testing and  approval  processes  before
making a decision to license our products.  In general,  the process of entering
into a licensing  arrangement  with a  potential  customer  may involve  lengthy
negotiations.  As a result,  our sales  cycle  has been and may  continue  to be
unpredictable.  In the past,  our sales  cycle has ranged from one to 12 months.
Our sales  cycle is also  subject  to  delays  as a result of  customer-specific
factors over which we have little or no control, including budgetary constraints
and internal approval procedures. In addition, because our technology must often
be integrated  with the products and services of other  vendors,  there may be a
significant delay between the use of our software and services in a pilot system
and our customers' volume deployment of our products and services.

    In addition,  we recently  introduced our new application  products that are
aimed  toward a  broadened  business  user base within our key  markets.  We are
inexperienced  with our sales cycle for these new application  products to these
users and we cannot  predict how the market for our  application  products  will
develop,  and part of our strategic challenge will be to convince these users of
the  productivity,  communications,  cost and other benefits of our  application
products.  Accordingly,  it is likely that delays in our sales cycles with these
application  products will occur and this could cause significant  variations in
our operating results.

We have not been profitable and if we do not achieve profitability, our business
may  fail.  If we need  additional  financing  we may not  obtain  the  required
financing on favorable terms and conditions.

    We have  experienced  operating  losses in each  quarterly and annual period
since we were formed and we expect to incur significant losses in the future. As
of June 30, 2002, we had an  accumulated  deficit of  $94,425,000.  We may incur
increasing  research  and  development,  sales and  marketing  and  general  and
administrative  expenses.  Accordingly,  our  failure to increase  our  revenues
significantly or improve our gross margins will harm our business.  In addition,
our cash, cash  equivalent and short-term  investment  resources  (collectively,
"cash resources") totaled $25,532,000 as of June 30, 2002 and we used $5,205,000
in our  operating  activities  during the three months  ended June 30, 2002.  We
anticipate that our operating  activities will use additional cash resources for
at  least  the  next 12  months.  This  almost  certainly  will  leave us with a
deteriorated  cash  position in  comparison  to our cash position as of June 30,
2002 and this may affect our ability to transact future strategic  operating and
investing  activities in a timely manner,  which may harm our business and cause
our stock price to fall.  The current  business  environment is not conducive to
raising additional financing.  If we require additional financing,  the terms of
such financing may heavily dilute the ownership  interests of current investors,
and cause our stock price to fall  significantly or we may not be able to secure
financing upon acceptable terms at all. Accordingly,  our stock price is heavily
dependent upon our ability to grow our revenues and manage our costs in order to
preserve cash resources.

Failure to comply with NASDAQ's listing  standards could result in our delisting
by NASDAQ from the NASDAQ National Market and severely limit the ability to sell
any of our common stock.

   Our stock is currently traded on the NASDAQ National Market and the bid price
for our  common  stock has been  under  $1.00 per share for over 30  consecutive
trading days. Under NASDAQ's listing maintenance  standards,  if the closing bid
price of our common  stock is under $1.00 per share for 30  consecutive  trading
days,  NASDAQ may  choose to notify us that it may delist our common  stock from
the NASDAQ  National  Market.  On July 24, 2002, we received  notice from NASDAQ
that we are not in compliance with NASDAQ's  listing  maintenance  standards and
that we have until October 22, 2002 to regain  compliance.  If at anytime before
October 22, 2002, the bid price of our common stock closes at $1.00 per share or
more  for a  minimum  of 10  consecutive  trading  days,  NASDAQ  will  consider
notifying us that we comply with its maintenance standards.  If we are unable to
meet this minimum bid price  requirement  by October 22, 2002, we expect to have
the option of transferring to the NASDAQ SmallCap Market,  which makes available
a 180  calendar  day  extended  grace  period  for the  minimum  $1.00 bid price
requirement.  In  addition,  we  expect  that  we may  also be  eligible  for an
additional  180  calendar day grace  period on the NASDAQ  SmallCap  Market (ie.
until July 21,  2003)  provided  that we meet the other  non-bid  price  related
listing criteria. However, we believe that a transfer to the NASDAQ SmallCap may
be  negatively  perceived  by the  market,  analysts  who  follow  our stock and
stockholders.  There can be no  assurance  that our  common  stock  will  remain
eligible  for  trading on the  NASDAQ  National  Market or the  NASDAQ  SmallCap
Market. If our stock were delisted,  the ability of our stockholders to sell any
of our common stock at all would be severely, if not completely, limited.

                                       24
<PAGE>

We expect the market price of our common stock to be volatile.

   The  market  price of our  common  stock  has  experienced  both  significant
increases in  valuation  and  significant  decreases  in  valuation,  over short
periods of time. We believe that factors such as  announcements  of developments
related to our business,  fluctuations in our operating results, failure to meet
securities analysts'  expectations,  general conditions in the software and high
technology industries and the worldwide economy,  announcements of technological
innovations,  new  systems or  product  enhancements  by us or our  competitors,
acquisitions,  changes in governmental  regulations,  developments in patents or
other  intellectual  property  rights  and  changes  in our  relationships  with
customers and suppliers could cause the price of our common stock to continue to
fluctuate  substantially.  In  addition,  in recent  years  the stock  market in
general,  and the market for small  capitalization and high technology stocks in
particular,  has  experienced  extreme price  fluctuations  that have often been
unrelated  to the  operating  performance  of affected  companies.  Any of these
factors could adversely affect the market price of our common stock.

Our  restructuring  efforts may not result in the intended  benefits.  We may be
required  to record  additional  restructuring  charges  and this may  adversely
affect the morale and  performance  of our  personnel  we wish to retain and may
also adversely affect our ability to hire new personnel.

    During the past few quarters,  including the quarter ended June 30, 2002, we
took steps to better align the resources required to operate  efficiently in the
prevailing  market.  Through these steps,  we reduced our headcount and incurred
charges for employee  severance and excess facility  capacity.  While we believe
that these steps help us achieve greater operating  efficiency,  we have limited
history  with such  measures  and the  results of these  measures  are less than
predictable. The Company currently believes additional steps may be required. We
believe  workforce   reductions  and  management   changes  create  anxiety  and
uncertainty  and may adversely  affect  employee  morale.  These  measures could
adversely  affect our  employees  that we wish to retain and may also  adversely
affect our ability to hire new personnel.  They may also affect customers and/or
vendors,  which could harm our  ability to operate as  intended  and which would
harm our business.

    In addition,  should we continue to have excess operating lease capacity and
we are unable to find a sub lessee at a rate  equivalent to our operating  lease
rate, we would be required to record additional  charges for the rental payments
that we owe to our  landlord  relating to any excess  facility  capacity,  which
would  harm  our  operating   results.   Our  management  reviews  our  facility
requirements  and  assesses  whether any excess  capacity  exists as part of our
on-going financial processes.

The prices we charge for our  products  and services may decrease or the pricing
assumptions  for our new  applications  products and services may be  incorrect,
either of which may impact our ability to develop a sustainable business.

    The prices we charge for our  products and services may decrease as a result
of  competitive  pricing  pressures,  promotional  programs  and  customers  who
negotiate price reductions.  For example,  some of our competitors have provided
their services without charge in order to gain market share or new customers and
key accounts.  The prices at which we sell and license our products and services
to our customers depend on many factors, including:

    o    purchase volumes;

    o    competitive pricing;

    o    the specific requirements of the order;

    o    the duration of the licensing arrangement; and

    o    the level of sales and service support.

                                       25
<PAGE>

    The  average  size  of  our  customer   license   orders  has  been  between
approximately $40,000 and $60,000 over the past several quarters.  Our sales and
marketing  costs are a high  percentage  of the  revenues  from our orders,  due
partly to the  expense of  developing  leads and  relatively  long sales  cycles
involved in selling products that are not yet considered "mainstream" technology
investments.  For the three months ended June 30, 2002,  our sales and marketing
expenses  totaled 114% of our total  revenues.  We recently  introduced  our new
applications  products in hopes of increasing both our revenues and average size
of our  customers'  orders and these  products have pricing  models based upon a
number of assumptions about the market for our products.  If our assumptions are
incorrect  or our  pricing  does  not  work as  intended,  we may not be able to
increase the average size of our customer  orders or reduce the costs of selling
and marketing for our products and,  therefore,  we may not be able to develop a
profitable and sustainable business.

Our service revenues and recently  introduced VS Production solution product may
have substantially lower gross profit margins than our license revenues,  and an
increase in service revenues or the VS Production  application products relative
to license revenues could harm our gross margins.

    Our service  revenues,  which includes fees for our application  services as
well as professional  services such as consulting,  implementation,  maintenance
and training,  were 50% and 51% of our total revenues for the three months ended
June 30, 2002 and 2001,  respectively.  In addition,  our recently introduced VS
Production  application  may  contain  a  hardware  element  that is  developed,
manufactured and marketed by a third-party partner and bundled with our software
and resold by us. Our service  revenues  have  substantially  lower gross profit
margins  than  our  license  revenues  and we  expect  that  our  VS  Production
application  may also have  substantially  lower gross  profit  margins than our
license revenues when we sell it with the hardware element.  Our cost of service
revenues  for the three months ended June 30, 2002 and 2001 were 71% and 124% of
our service  revenues,  respectively.  An increase  in the  percentage  of total
revenues  represented by service  revenues and/or our VS Production  application
when sold with a hardware  element  could  adversely  affect our  overall  gross
profit margins.

    Service  revenues  as a  percentage  of total  revenues  and cost of service
revenues  as a  percentage  of total  revenues  have varied  significantly  from
quarter  to  quarter  due  to  our  relatively   early  stage  of   development.
Historically,  the  relative  amount of service  revenues as compared to license
revenues  has  varied  based on  customer  demand for our  application  services
revenues.   Our  application  services  require  a  relatively  fixed  level  of
investment in staff,  facilities and  equipment.  We typically have operated our
application  service  business at a loss due to fixed  investments that exceeded
actual  levels of revenues  realized.  We have reduced the  application  service
fixed  investments over the past year.  However,  there is no assurance that the
level of  application  service  revenues in the new fiscal year will allow us to
recover our fixed costs and make a positive gross profit margin. In addition, we
have experienced an increase in the percentage of license  customers  requesting
professional  services as a result of our introduction of professional  services
in the fourth quarter of fiscal 2001, which will also impact the relative amount
of service revenues as compared to license  revenues.  We expect that the amount
and profitability of our professional services will depend in large part on:

    o    the software solution that has been licensed;

    o    the complexity of the customers' information technology environments;

    o    the resources directed by customers to their implementation projects;

    o    the size and complexity of customer implementations; and

    o    the extent to which outside consulting  organizations  provide services
         directly to customers.

Because  competition for qualified  personnel is intense,  we may not be able to
recruit or retain  personnel,  which could impact the development and acceptance
of our products and services.

    Our future success depends to a significant extent on the continued services
of our senior  management  and other key  personnel  such as senior  development
staff,  product  marketing staff and sales personnel.  The loss of key employees
would likely have an adverse effect on our business.  We do not have  employment
agreements with most of our senior management team. If one or more of our senior
management team were to resign,  the loss could result in loss of sales,  delays
in new product development and diversion of management resources.

                                       26
<PAGE>

    We may also be  required  to create  additional  performance  and  retention
incentives in order to retain our employees including the granting of additional
stock options to employees at current prices or issuing  incentive cash bonuses.
Such  incentives  may either dilute our existing  stockholder  base or result in
unforeseen  operating  expenses,  which may cause our stock  price to fall.  For
example,  in February 2002, we introduced a Voluntary Stock Option  Cancellation
and Re-grant Program in which a number of our employees  cancelled stock options
that had significantly  higher exercise prices in comparison to where our common
stock price currently trades. These employees will receive new options in August
2002 at exercise prices  equivalent to our common stock price at that date. This
may cause dilution to our existing  stockholder  base, which may cause our stock
price to fall.

    We  expect  that we will  need to hire  sales,  development,  marketing  and
administrative  personnel in the foreseeable  future.  Competition for personnel
throughout  our industry is intense.  We may be unable to attract or  assimilate
other highly qualified  employees in the future particularly given our continued
operating losses and weakening cash position.  We have in the past  experienced,
and we expect to continue to  experience,  difficulty in hiring  highly  skilled
employees with  appropriate  qualifications.  In addition,  new hires frequently
require  extensive  training before they achieve desired levels of productivity.
Some members of our existing  management  team have been  employed at Virage for
less than one year. We may fail to attract and retain qualified personnel, which
could have a negative impact on our business.

If the  protection  of our  intellectual  property is  inadequate or third party
intellectual  property is unavailable or if others bring  infringement  or other
claims against us, we may incur significant costs or lose customers.

    We depend on our ability to develop and maintain the proprietary  aspects of
our  technology.  Policing  unauthorized  use of our products is  difficult  and
software piracy may become a problem. We license our proprietary rights to third
parties,  who may not abide by our compliance  guidelines.  To date, we have not
sought patent protection of our proprietary rights in any foreign  jurisdiction,
and the laws of some foreign countries do not protect our proprietary  rights to
as great an extent as do the laws of the United  States.  Our efforts to protect
our   intellectual   property   rights   may  not  be   effective   to   prevent
misappropriation  of our technology or may not prevent the development by others
of products competitive with those developed by us.

    In addition,  other companies may obtain patents or other proprietary rights
that would limit our ability to conduct our  business  and could assert that our
technologies infringe their proprietary rights. We could incur substantial costs
to defend any litigation, and intellectual property litigation could force us to
cease using key  technology,  obtain a license,  or redesign our products.  From
time to time, we have received  notices  claiming that our technology  infringes
patents held by third parties and in addition may become  involved in litigation
claims arising from our ordinary  course of business.  We believe that there are
no claims or actions pending or threatened against us, the ultimate  disposition
of which would have a material  adverse effect on us. However,  in the event any
claim against us is  successful,  our operating  results would be  significantly
harmed.

    Furthermore,  we  license  technology  from  third  parties,  which  may not
continue to be available on commercially  reasonable  terms, if at all. The loss
of any of these licenses could result in delays in the licensing of our products
until  equivalent  technology,  if  available,  is  developed  or  licensed  for
potentially  higher fees and  integrated.  In the event of any such loss,  costs
could be increased and delays could be incurred, thereby harming our business.

Interruptions  to our  business  or  internal  infrastructure  from  unforeseen,
adverse  events or  circumstances  will disrupt our  business and our  operating
results will suffer.

    The worldwide  socio-political  environment has changed  dramatically  since
September 11, 2001. Our customers,  potential  customers and vendors are located
worldwide  and  generally  within major  international  metropolitan  areas.  In
addition,  the  significant  majority of our operations are conducted at offices
within a 60-mile radius of the major metropolitan  cities of San Francisco,  New
York City, Boston and London. Our business also requires that certain personnel,
including  our officers,  travel in order to perform  their jobs  appropriately.
Should a major  catastrophe  occur within the vicinity of any of our operations,
our customers'  and/or  potential  customers'  and/or vendors'  operations,  our
operations may be adversely impacted and our business may be harmed.

                                       27
<PAGE>

    Our  communications  and network  infrastructure  are a critical part of our
business  operations.  Our  application  services  business  is  dependent  upon
providing our customers with fast, efficient and reliable services.  To meet our
customers' requirements, we must protect our network against damage from any and
all sources, including among other things:

    o    human error;

    o    physical or electronic security breaches;

    o    computer viruses;

    o    fire, earthquake, flood and other natural disasters;

    o    power loss;

    o    telecommunications failure; and

    o    sabotage and vandalism.

    We have communications  hardware and computer hardware operations located at
Exodus  Communications'  facility in Santa  Clara,  California  and at Palo Alto
Internet  Exchange in Palo Alto, CA. We do not have complete  backup systems for
these operations.  A problem with, or failure of, our communications hardware or
operations  could result in  interruptions or increases in response times on the
Internet sites of our customers. Furthermore, if these third party partners fail
to adequately maintain or operate our communications  hardware or do not perform
our computer hardware operations  adequately,  our services to our customers may
not  be  available.  We  have  experienced  system  failures  in the  past.  Any
disruptions  could damage our reputation,  reduce our revenues or otherwise harm
our business.  Our insurance  policies may not adequately  compensate us for any
losses that may occur due to any failures or interruptions in our systems.

Our revenues may be harmed if general economic conditions do not improve.

    Our revenues are dependent on the health of the economy (in particular,  the
robustness of information  technology  spending) and the growth of our customers
and potential future customers.  The economic environment has not been conducive
to  companies  involved in  information  technology  infrastructure  for several
quarters and if this trend  continues,  our  customers  may continue to delay or
reduce  their  spending on our  software and service  solutions.  When  economic
conditions for information technology products weaken, sales cycles for sales of
software   products  and  related  services  tend  to  lengthen  and  companies'
information  technology  and business  unit budgets tend to be reduced.  If that
continues to happen,  our revenues could suffer and our stock price may decline.
Further,  if U.S. or global  economic  conditions  worsen,  we may  experience a
material  adverse  impact on our  business,  operating  results,  and  financial
condition.

Defects in our  software  products or  services  could  diminish  demand for our
products or could subject us to liability  claims and negative  publicity if our
customers'  systems,  information or video content is damaged through the use of
our products or our application services.

    Our  software  products  and  related  services  are complex and may contain
errors  that may be detected at any point in the life of the product or service.
We cannot assure you that,  despite  testing by us and our current and potential
customers,  errors will not be found in new products or releases  after shipment
or in the related services that we perform for our customers.  If our customers'
systems,  information or video content is damaged by software errors or services
that we perform for them, our business may be harmed. In addition,  these errors
or defects may cause  severe  customer  service and public  relations  problems.
Errors, bugs, viruses or misimplementation of our products or services may cause
liability  claims and  negative  publicity  ultimately  resulting in the loss of
market  acceptance of our products and services.  Our agreements  with customers
that attempt to limit our exposure to liability claims may not be enforceable in
jurisdictions where we operate.

                                       28
<PAGE>

We may need to make acquisitions or form strategic  alliances or partnerships in
order to remain  competitive in our market,  and potential future  acquisitions,
strategic alliances or partnerships could be difficult to integrate, disrupt our
business and dilute stockholder value.

    We may  acquire  or form  strategic  alliances  or  partnerships  with other
businesses  in the  future  in order to remain  competitive  or to  acquire  new
technologies.  As  a  result  of  these  acquisitions,  strategic  alliances  or
partnerships, we may need to integrate products, technologies,  widely dispersed
operations  and  distinct  corporate   cultures.   The  products,   services  or
technologies  of the acquired  companies may need to be altered or redesigned in
order to be made  compatible  with our software  products and  services,  or the
software  architecture  of our  customers.  These  integration  efforts  may not
succeed or may distract our management from operating our existing business. Our
failure to  successfully  manage  future  acquisitions,  strategic  alliances or
partnerships  could  seriously  harm our  operating  results.  In addition,  our
stockholders  would  be  diluted  if  we  finance  the  acquisitions,  strategic
alliances  or  partnerships  by  incurring  convertible  debt or issuing  equity
securities.

    In  addition  to the  above-stated  risks,  under the  Financial  Accounting
Standards Board's Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets" ("FAS 142"), any future goodwill resulting from any
future  acquisitions we may undertake will not be amortized but instead reviewed
at least  annually  for  impairment.  We will be required to test  goodwill  for
impairment using the two-step process prescribed in FAS 142. The first step is a
screen for  potential  impairment,  while the second step measures the amount of
impairment, if any. Should we enter into any future acquisition transactions and
general macroeconomic  deteriorate subsequent to the acquisition,  which affects
our business and operating results over the long-term,  and/or should the future
acquisition  target not provide the results that are anticipated when the merger
is consummated,  we could be required to record  accelerated  impairment charges
related to goodwill, which could adversely affect our financial results.

As we operate  internationally,  we face significant  risks in doing business in
foreign countries.

    We are subject to a number of risks associated with  international  business
activities, including:

    o    costs of customizing  our products and services for foreign  countries,
         including localization, translation and conversion to international and
         other foreign technology standards;

    o    compliance with multiple,  conflicting and changing  governmental  laws
         and regulations,  including changes in regulatory requirements that may
         limit our  ability to sell our  products  and  services  in  particular
         countries;

    o    import and export  restrictions,  tariffs  and  greater  difficulty  in
         collecting accounts receivable; and

    o    foreign currency-related risks if a significant portion of our revenues
         become denominated in foreign currencies.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

   At June 30, 2002, the Company's cash and cash equivalents consisted primarily
of bank deposits and money market funds.  The Company's  short-term  investments
consisted of commercial  paper,  municipal bonds, and federal agency and related
securities.  The Company did not hold any derivative financial instruments.  The
Company's  interest  income is  sensitive  to  changes in the  general  level of
interest  rates.  In this  regard,  changes  in  interest  rates can  affect the
interest earned on cash and cash equivalents and short-term investments.

                                       29
<PAGE>

PART II: OTHER INFORMATION

Item 1. Legal Proceedings.

   Beginning  on August  22,  2001,  purported  securities  fraud  class  action
   complaints  were filed in the United States  District  Court for the Southern
   District of New York. The cases were  consolidated  and the litigation is now
   captioned  as  In  re  Virage,   Inc.  Initial  Public  Offering   Securities
   Litigation,  Civ.  No.  01-7866  (SAS)  (S.D.N.Y.),  related to In re Initial
   Public Offering Securities Litigation, 21 MC 92 (SAS) (S.D.N.Y.). On or about
   April 19, 2002, the plaintiffs  electronically  served an amended  complaint.
   The amended  complaint  is brought  purportedly  on behalf of all persons who
   purchased the Company's  common stock from June 28, 2000 through  December 6,
   2000. It names as defendants  the Company,  two of our officers,  and several
   investment  banking firms that served as  underwriters  of our initial public
   offering.  The complaint  alleges  liability  under Sections 11 and 15 of the
   Securities  Act of 1933  and  Sections  10(b)  and  20(a)  of the  Securities
   Exchange Act of 1934, on the grounds that the registration  statement for the
   offering  did not disclose  that:  (1) the  underwriters  had agreed to allow
   certain  customers to purchase shares in the offerings in exchange for excess
   commissions paid to the  underwriters;  and (2) the underwriters had arranged
   for certain  customers to purchase  additional  shares in the  aftermarket at
   predetermined  prices.  The amended complaint also alleges that false analyst
   reports were issued. No specific damages are claimed.

   The  Company  is aware  that  similar  allegations  have  been  made in other
   lawsuits  filed in the  Southern  District of New York  challenging  over 300
   other initial public offerings and secondary  offerings conducted in 1999 and
   2000.  Those cases have been  consolidated  for pretrial  purposes before the
   Honorable  Judge Shira A.  Scheindlin.  On July 15,  2002,  we (and the other
   issuer defendants) filed a motion to dismiss. We believe that the allegations
   against our officers and us are without merit,  and we intend to contest them
   vigorously.

   From time to time,  the Company  may become  involved  in  litigation  claims
   arising from its ordinary course of business. The Company believes that there
   are no claims or  actions  pending or  threatened  against  it, the  ultimate
   disposition of which would have a material adverse effect on the Company.

Item 2. Changes in Securities and Use of Proceeds

    (d) Use of Proceeds.

         On July 5, 2000, we completed a firm  commitment  underwritten  initial
         public offering of 3,500,000  shares of our common stock, at a price of
         $11.00 per share.  Concurrently  with our initial public  offering,  we
         also sold 1,696,391 shares of common stock in a private  placement at a
         price of $11.00 per share. On July 17, 2000, our underwriters exercised
         their over-allotment option for 525,000 shares of our common stock at a
         price of $11.00 per share.  The shares of the common  stock sold in the
         offering and exercised via our underwriters' over-allotment option were
         registered  under  the  Securities  Act  of  1933,  as  amended,  on  a
         Registration Statement on Form S-1 (File No. 333-96315). The Securities
         and Exchange Commission  declared the Registration  Statement effective
         on June 28, 2000. The public  offering was  underwritten by a syndicate
         of  underwriters  led  by  Credit  Suisse  First  Boston,   FleetBoston
         Robertson  Stephens  Inc.  and  Wit  SoundView  Corporation,  as  their
         representatives.

         The  initial  public  offering  and private  placement  resulted in net
         proceeds of  $57,476,000,  after  deducting  $3,099,000 in underwriting
         discounts and commissions and $1,800,000 in costs and expenses  related
         to the offering. None of the costs and expenses related to the offering
         or the  private  placement  were paid  directly  or  indirectly  to any
         director,  officer,  general  partner  of Virage  or their  associates,
         persons owning 10 percent or more of any class of equity  securities of
         Virage or an  affiliate  of  Virage.  Proceeds  from the  offering  and
         private  placement  have  been  used for  general  corporate  purposes,
         including working capital and capital  expenditures.  The remaining net
         proceeds have been invested in cash,  cash  equivalents  and short-term
         investments.  The use of the  proceeds  from the  offering  and private
         placement  does not represent a material  change in the use of proceeds
         described in our prospectus.

                                       30
<PAGE>

Item 3. Defaults Upon Senior Securities

    None.

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

    None.

Item 5. Other Information

         The Company's  stock is currently  traded on the NASDAQ National Market
         and the bid price for its common  stock has been under  $1.00 per share
         for  over  30  consecutive   trading  days.   Under  NASDAQ's   listing
         maintenance standards, if the closing bid price of the Company's common
         stock is under $1.00 per share for 30 consecutive  trading days, NASDAQ
         may choose to notify the  Company  that it may delist its common  stock
         from the NASDAQ National Market. On July 24, 2002, the Company received
         notice from NASDAQ that it is not in compliance  with NASDAQ's  listing
         maintenance  standards and that it has until October 22, 2002 to regain
         compliance. If at any time before October 22, 2002 the bid price of the
         Company's  common stock closes at $1.00 per share or more for a minimum
         of 10  consecutive  trading days,  NASDAQ will  consider  notifying the
         Company that it complies with the maintenance standards. If the Company
         is unable to meet this  minimum  bid price  requirement  by October 22,
         2002,  the Company  expects to have the option of  transferring  to the
         NASDAQ  SmallCap  Market,  which  makes  available a 180  calendar  day
         extended  grace  period  for the  minimum  $1.00 bid price  requirement
         (instead of a 90 day grace  period as  provided by the NASDAQ  National
         Market). In addition,  the Company expects that it may also be eligible
         for an additional 180 calendar day grace period on the NASDAQ  SmallCap
         Market (ie.  until July 21, 2003)  provided  that the Company meets the
         other non-bid price related listing criteria.  If the Company transfers
         to the NASDAQ  SmallCap  Market,  the  Company  expects  that it may be
         eligible  to  transfer  back to the NASDAQ  National  Market if its bid
         price  maintains  the $1.00 per share  requirement  for 30  consecutive
         trading days and it has maintained  compliance with all other continued
         listing  requirements for the NASDAQ National  Market.  There can be no
         assurance  that the  Company's  common  stock will remain  eligible for
         trading on the NASDAQ National Market or the NASDAQ SmallCap Market. If
         the  Company's  stock  were  delisted,  the  ability  of the  Company's
         stockholders to sell any of the Company's  common stock at all would be
         severely, if not completely, limited.

Item 6. Exhibits and Report on Form 8-K.

   (a)  Exhibits

        Exhibit 99.1      Certification Pursuant to 18 U.S.C. Section 1350

   (b)  Reports on Form 8-K

        None

                                       31
<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.


                                          VIRAGE, INC.

Date:  August 14, 2002                    By:   /s/ Scott Gawel
                                                --------------------------------
                                                Scott Gawel
                                                Vice President, Finance &
                                                Acting Chief Financial Officer
                                                (Duly Authorized Officer and
                                                Principal Financial Officer)

                                       32