##### Table of Contents

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UNITED STATES OF AMERICA

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 April 30, 2003



OR



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



Commission file number: 0-29757



| | 
| | 



VERSATA, INC.

(Exact name of registrant as specified in its charter)



|Delaware                                                       |  | 68-0255203                          
|-------------------------------------------------------------- |  | ------------------------------------
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



300 Lakeside Drive
Suite 1500

Oakland, CA 94612

(Address including zip code, of principal executive offices)



(510) 238-4100

(Registrants telephone number including area code)



| | 
| | 



Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.



Yes x    No ̈



Indicate by check mark
whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).



Yes ̈No x



As of May 30, 2003, the total number of outstanding shares of the
Registrants common stock was 7,431,944.



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##### Table of Contents

VERSATA, INC.

FORM 10-Q QUARTERLY REPORT

TABLE OF CONTENTS



|                                                                                                                                  |  | Page
|--------------------------------------------------------------------------------------------------------------------------------- |  | ----
|PART I. FINANCIAL INFORMATION                                                                                                    
|                                                                                                                                  | 
|Item 1. Financial Statements (Unaudited):                                                                                         |  |     
|                                                                                                                                  | 
|Condensed Consolidated Balance Sheets as of April 30, 2003 and October 31, 2002                                                   |  | 3   
|                                                                                                                                  | 
|Condensed Consolidated Statements of Operations and Comprehensive Loss for the Three and Six Months Ended April 30, 2003 and 2002 |  | 4   
|                                                                                                                                  | 
|Condensed Consolidated Statements of Cash Flows for the Six Months Ended April 30, 2003 and 2002                                  |  | 5   
|                                                                                                                                  | 
|Notes to Condensed Consolidated Financial Statements                                                                              |  | 6   
|                                                                                                                                  | 
|Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations                                     |  | 10  
|                                                                                                                                  | 
|Item 3. Quantitative and Qualitative Disclosures About Market Risk                                                                |  | 24  
|                                                                                                                                  | 
|Item 4. Controls and Procedures                                                                                                   |  | 25  
|                                                                                                                                 
|PART II. OTHER INFORMATION                                                                                                       
|                                                                                                                                  | 
|Item 1. Legal Proceedings                                                                                                         |  | 26  
|                                                                                                                                  | 
|Item 6. Exhibits and Reports on Form 8-K                                                                                          |  | 26  
|                                                                                                                                  | 
|Signatures                                                                                                                        |  | 28  
|                                                                                                                                  | 
|Certifications                                                                                                                    |  | 29  



2



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##### Table of Contents

PART I. FINANCIAL INFORMATION



Item 1.    Financial Statements



VERSATA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

(Unaudited)



|                                                      |  | April 30, 2003 |          |   | October 31, 2002 |  
|----------------------------------------------------- |  | -------------- | -------- | - | ---------------- | -
|ASSETS                                                |  |                |          |   |                  |  
|Current assets:                                       |  |                |          |   |                  |  
|Cash and cash equivalents                             |  | $              | 13,527   |   |                  | $
|Short-term investments                                |  |                | 2,923    |   |                  |  
|Accounts receivable, net                              |  |                | 2,703    |   |                  |  
|Unbilled receivables                                  |  |                | 84       |   |                  |  
|Prepaid expenses and other current assets             |  |                | 1,202    |   |                  |  
|                                                      |  |                |          |   |                  |  
|Total current assets                                  |  |                | 20,439   |   |                  |  
|                                                      |  |                |          |   |                  |  
|Restricted cash                                       |  |                | 4,964    |   |                  |  
|Property and equipment, net                           |  |                | 2,911    |   |                  |  
|Intangibles, net                                      |  |                | 1,004    |   |                  |  
|Other assets                                          |  |                | 93       |   |                  |  
|                                                      |  |                |          |   |                  |  
|Total assets                                          |  | $              | 29,411   |   |                  | $
|                                                      |  |                |          |   |                  |  
|LIABILITIES AND STOCKHOLDERS EQUITY                  |  |                |          |   |                  |  
|Current liabilities:                                  |  |                |          |   |                  |  
|Accounts payable                                      |  | $              | 330      |   |                  | $
|Accrued liabilities                                   |  |                | 3,139    |   |                  |  
|Current portion of accrued restructuring and other    |  |                | 1,909    |   |                  |  
|Current portion of deferred revenue                   |  |                | 3,662    |   |                  |  
|Current portion of long-term debt                     |  |                | 38       |   |                  |  
|                                                      |  |                |          |   |                  |  
|Total current liabilities                             |  |                | 9,078    |   |                  |  
|                                                      |  |                |          |   |                  |  
|Accrued restructuring and other, less current portion |  |                | 1,324    |   |                  |  
|Deferred revenue, less current portion                |  |                | 1,283    |   |                  |  
|Long-term debt, less current portion                  |  |                |         |   |                  |  
|                                                      |  |                |          |   |                  |  
|Total liabilities                                     |  |                | 11,685   |   |                  |  
|                                                      |  |                |          |   |                  |  
|Stockholders equity:                                 |  |                |          |   |                  |  
|Common stock                                          |  |                | 44       |   |                  |  
|Additional paid-in capital                            |  |                | 215,902  |   |                  |  
|Treasury stock                                        |  |                | (40      | ) |                  |  
|Notes receivable from shareholders                    |  |                | (23      | ) |                  |  
|Unearned stock-based compensation                     |  |                | (135     | ) |                  |  
|Accumulated other comprehensive loss                  |  |                | (336     | ) |                  |  
|Accumulated deficit                                   |  |                | (197,686 | ) |                  |  
|                                                      |  |                |          |   |                  |  
|Total stockholders equity                            |  |                | 17,726   |   |                  |  
|                                                      |  |                |          |   |                  |  
|Total liabilities and stockholders equity            |  | $              | 29,411   |   |                  | $
|                                                      |  |                |          |   |                  |  



The accompanying notes
are an integral part of these

condensed consolidated financial statements.



3



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##### Table of Contents

VERSATA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(in thousands, except per share data)

(Unaudited)



|                                                                                                                                                                                                                                                                                                                    |  | Three MonthsEnded |        |   | Six Months Ended |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------ | - | ---------------- | -
|                                                                                                                                                                                                                                                                                                                    |  | April 30,2003     |        |   | April 30,2002    |  
|Revenue:                                                                                                                                                                                                                                                                                                            |  |                   |        |   |                  |  
|Software license                                                                                                                                                                                                                                                                                                    |  | $                 | 1,878  |   |                  | $
|Maintenance and support                                                                                                                                                                                                                                                                                             |  |                   | 1,542  |   |                  |  
|Professional services                                                                                                                                                                                                                                                                                               |  |                   | 1,057  |   |                  |  
|                                                                                                                                                                                                                                                                                                                    |  |                   |        |   |                  |  
|Total revenue                                                                                                                                                                                                                                                                                                       |  |                   | 4,477  |   |                  |  
|                                                                                                                                                                                                                                                                                                                    |  |                   |        |   |                  |  
|Cost of revenue:                                                                                                                                                                                                                                                                                                    |  |                   |        |   |                  |  
|Software license                                                                                                                                                                                                                                                                                                    |  |                   | 138    |   |                  |  
|Maintenance and support (excluding stock-based compensation of $56 and $94 for the three months ended April 30, 2003 and 2002 and
$117 and $260 for the six months ended April 30, 2003 and 2002, respectively)                                                                                                     |  |                   | 422    |   |                  |  
|Professional services (excluding stock-based compensation of $4 and $15 for the three months ended April 30, 2003 and 2002 and $10
and $25 for the six months ended April 30, 2003 and 2002, respectively)                                                                                                          |  |                   | 892    |   |                  |  
|                                                                                                                                                                                                                                                                                                                    |  |                   |        |   |                  |  
|Total cost of revenue                                                                                                                                                                                                                                                                                               |  |                   | 1,452  |   |                  |  
|                                                                                                                                                                                                                                                                                                                    |  |                   |        |   |                  |  
|Gross profit                                                                                                                                                                                                                                                                                                        |  |                   | 3,025  |   |                  |  
|                                                                                                                                                                                                                                                                                                                    |  |                   |        |   |                  |  
|Operating expense:                                                                                                                                                                                                                                                                                                  |  |                   |        |   |                  |  
|Sales and marketing (excluding stock-based compensation of $68 and $140 for the three months ended April 30, 2003 and 2002 and
$127 and $268 for the six months ended April 30, 2003 and 2002, respectively)                                                                                                        |  |                   | 1,646  |   |                  |  
|Product development (excluding stock-based compensation of $78 and $108 for the three months ended April 30, 2003 and 2002 and $97
and $161 for the six months ended April 30, 2003 and 2002, respectively)                                                                                                         |  |                   | 1,248  |   |                  |  
|General and administrative (excluding stock-based compensation of $34 and $58 for the three months ended April 30, 2003 and 2002
and $62 and $196 for the six months ended April 30, 2003 and 2002, respectively)                                                                                                   |  |                   | 657    |   |                  |  
|Stock-based compensation                                                                                                                                                                                                                                                                                            |  |                   | 121    |   |                  |  
|Amortization of intangibles                                                                                                                                                                                                                                                                                         |  |                   | 500    |   |                  |  
|Restructuring and other (excluding the benefit of $119 and $65 for the three months ended April 30, 2003 and 2002 and $119 and
$348 for the six months ended April 30, 2003 and 2002 relating to the reversal of previously recorded stock-based compensation related to employees terminated in the restructuring) |  |                   | 83     |   |                  |  
|                                                                                                                                                                                                                                                                                                                    |  |                   |        |   |                  |  
|Total operating expense                                                                                                                                                                                                                                                                                             |  |                   | 4,255  |   |                  |  
|                                                                                                                                                                                                                                                                                                                    |  |                   |        |   |                  |  
|Loss from operations                                                                                                                                                                                                                                                                                                |  |                   | (1,230 | ) |                  |  
|Interest income, net                                                                                                                                                                                                                                                                                                |  |                   | 41     |   |                  |  
|Other non-operating income (expense), net                                                                                                                                                                                                                                                                           |  |                   | 13     |   |                  |  
|                                                                                                                                                                                                                                                                                                                    |  |                   |        |   |                  |  
|Loss before provision for taxes                                                                                                                                                                                                                                                                                     |  |                   | (1,176 | ) |                  |  
|Benefit (provision) for taxes                                                                                                                                                                                                                                                                                       |  |                   | 7      |   |                  |  
|                                                                                                                                                                                                                                                                                                                    |  |                   |        |   |                  |  
|Net loss                                                                                                                                                                                                                                                                                                            |  | $                 | (1,169 | ) |                  | $
|                                                                                                                                                                                                                                                                                                                    |  |                   |        |   |                  |  
|Other comprehensive income (loss):                                                                                                                                                                                                                                                                                  |  |                   |        |   |                  |  
|Change in unrealized loss on marketable securities                                                                                                                                                                                                                                                                  |  |                   | (6     | ) |                  |  
|Change in foreign currency translation adjustments                                                                                                                                                                                                                                                                  |  |                   | (85    | ) |                  |  
|                                                                                                                                                                                                                                                                                                                    |  |                   |        |   |                  |  
|Comprehensive loss                                                                                                                                                                                                                                                                                                  |  | $                 | (1,260 | ) |                  | $
|                                                                                                                                                                                                                                                                                                                    |  |                   |        |   |                  |  
|Basic and diluted net loss per share                                                                                                                                                                                                                                                                                |  | $                 | (0.16  | ) |                  | $
|                                                                                                                                                                                                                                                                                                                    |  |                   |        |   |                  |  
|Weighted-average common shares outstanding                                                                                                                                                                                                                                                                          |  |                   | 7,326  |   |                  |  
|                                                                                                                                                                                                                                                                                                                    |  |                   |        |   |                  |  



The accompanying notes
are an integral part of these

condensed consolidated financial statements.



4



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VERSATA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)



|                                                                            |  | Six Months Ended |       
|--------------------------------------------------------------------------- |  | ---------------- | ------
|                                                                            |  | April 30, 2003   |       
|Cash flows from operating activities:                                       |  |                  |       
|Net loss                                                                    |  | $                | (2,339
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                  |       
|Depreciation and amortization                                               |  |                  | 1,922 
|Provision for doubtful accounts                                             |  |                  | (261  
|Loss on disposal of property and equipment                                  |  |                  | 34    
|Stock-based compensation                                                    |  |                  | 294   
|Cancellation of promissory note                                             |  |                  |      
|Change in operating assets and liabilities:                                 |  |                  |       
|Accounts receivable                                                         |  |                  | 711   
|Unbilled receivables                                                        |  |                  | 111   
|Prepaid expenses and other current assets                                   |  |                  | (213  
|Other assets                                                                |  |                  | 29    
|Accounts payable and accrued liabilities                                    |  |                  | (1,021
|Accrued restructuring and other                                             |  |                  | 1,092 
|Deferred revenue                                                            |  |                  | (552  
|                                                                            |  |                  |       
|Net cash used in operating activities                                       |  |                  | (193  
|                                                                            |  |                  |       
|Cash flows from investing activities:                                       |  |                  |       
|Purchases of short-term investments                                         |  |                  | (1,272
|Proceeds from sales of short-term investments                               |  |                  | 2,819 
|Proceeds from sales of restricted cash investments                          |  |                  | 297   
|                                                                            |  |                  |       
|Net cash provided by (used in) investing activities                         |  |                  | 1,844 
|                                                                            |  |                  |       
|Cash flows from financing activities:                                       |  |                  |       
|Payments on capital lease obligations and long term debt                    |  |                  | (254  
|Proceeds from exercise of stock options and warrants                        |  |                  |      
|Proceeds from sale of common stock held by former officer                   |  |                  | 8     
|Loans provided to stockholders                                              |  |                  |      
|                                                                            |  |                  |       
|Net cash provided by (used in) financing activities                         |  |                  | (246  
|                                                                            |  |                  |       
|Effects of exchange rate changes on cash and cash equivalents               |  |                  | (165  
|                                                                            |  |                  |       
|Increase (decrease) in cash and cash equivalents                            |  |                  | 1,240 
|Cash and cash equivalents at beginning of period                            |  |                  | 12,287
|                                                                            |  |                  |       
|Cash and cash equivalents at end of period                                  |  | $                | 13,527
|                                                                            |  |                  |       
|Supplemental disclosures of cash flow information:                          |  |                  |       
|Cash paid during the period for interest                                    |  | $                | 38    
|                                                                            |  |                  |       



The accompanying notes
are an integral part of these

condensed consolidated financial statements



|
|





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VERSATA, INC.



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



(Unaudited)



1.    The Company



Versata, Inc. (Versata or the Company) was incorporated in California on August 27, 1991, and was
reincorporated in the State of Delaware on February 24, 2000. Versata provides a business logic management system that enables the creation, execution, change and re-use of business logic (the heart of the application) for companies to
build large, distributed applications in the Java 2, Enterprise Edition (J2EE) infrastructure. Versata provides a declarative approach for transaction and process logic, which enables companies to deliver business logic as a key
strategic asset of their enterprise architecture.



On May 24,
2002, the Company implemented a one for six reverse stock split. Although there were no guarantees, the reverse stock split was implemented to allow the Companys common stock to trade above the $1.00 per share minimum bid price as required by
NASDAQ Marketplace Rules, and therefore, to help the Company to continue its listing on the NASDAQ National Market. All shares and per share amounts in these condensed consolidated financial statements have been restated to give effect to this
reverse stock split.



2.    Interim Financial
Information and Basis of Presentation



The accompanying
unaudited condensed consolidated financial statements as of April 30, 2003, and for the three and six months ended April 30, 2003 and 2002 include the accounts of Versata and its subsidiaries, all of which are wholly owned and located in North
America, Europe and Australia. All intercompany accounts and transactions have been eliminated in consolidation. Certain prior year balances have been reclassified to conform to the current year presentation.



We have prepared the condensed consolidated financial statements included
herein, without audit, in accordance with accounting principles generally accepted in the United States of America for interim financial statements and pursuant to the rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted pursuant to such
rules and regulations.



We believe that all necessary
adjustments, consisting of only normal recurring items, have been included in the accompanying financial statements to fairly present the results of the interim periods. The results of operations for the interim periods presented are not necessarily
indicative of the operating results to be expected for any subsequent interim period or for our fiscal year ended October 31, 2003. These unaudited condensed consolidated financial statements should be read in conjunction with the Companys
audited consolidated financial statements and notes for the fiscal year ended October 31, 2002.



3.    Recent Accounting Pronouncements



In June 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 146, Accounting for
Exit or Disposal Activities (SFAS 146). SFAS 146 addresses significant issues regarding the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities
that are currently accounted for under Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring) (EITF 94-3). The scope of SFAS 146 also includes costs related to terminating a contract that is not a capital lease and termination benefits that employees who are involuntarily terminated receive under the terms of a
one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred-compensation contract. SFAS 146 will be effective for exit or disposal activities that are initiated after December 31, 2002 and early application is
encouraged. The Company adopted SFAS 146 during the quarter ended January 31, 2003. The provisions of EITF 94-3 shall continue to apply for an exit activity initiated under an exit plan that met the criteria of EITF No. 94-3 prior to the adoption of
SFAS 146. The effect on adoption of SFAS 146 will change on a prospective basis the timing of when restructuring charges are recorded from a commitment date approach to when the liability is incurred.



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VERSATA, INC.



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



(Unaudited)



In November 2002, the EITF reached a consensus on Issue No. 00-21,Accounting for Revenue
Arrangements with Multiple Deliverables(EITF 00-21). EITF 00-21 sets out criteria for determining whether revenue on a deliverable can be recognized separately from other deliverables in a multiple deliverable arrangement. The
criteria considers whether the delivered item has stand-alone value to the customer, whether the fair value of the delivered item can be reliably determined and the rights of return for the delivered item. EITF 00-21 will be effective for fiscal
periods beginning after June 15, 2003. We do not believe the adoption of EITF 00-21 will have a material impact on our consolidated financial position, results of operations or cash flows.



In December 2002, the FASB issued Statement of Financial Accounting Standards
No. 148, Accounting for Stock-Based CompensationTransition and Disclosurean amendment of FASB Statement No. 123 (SFAS 148). This amendment provides alternative methods of transition for voluntary change to the fair
value based method of accounting for stock-based employee compensation. Additionally, prominent disclosures in both annual and interim financial statements are required for the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The Company adopted SFAS 148 during the quarter ended April 30, 2003 and we have provided the disclosures required under SFAS 148 in Note 4.



In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity (SFAS 150). SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity.
It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. SFAS 150 is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We do not believe the adoption of SFAS 150 will have a material impact on our consolidated financial
position, results of operations or cash flows.



4.    Stock Based Compensation Plans



We account for stock-based employee compensation arrangements in accordance with provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and
Financial Accounting Standards Board Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans (FIN 28), and we comply with the disclosure provisions of Statement of
Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123). Under APB 25, compensation expense is based on the difference, if any, on the date of grant, between the fair value of our Companys
common stock and the exercise price. SFAS 123 defines a fair value based method of accounting for an employee stock option or similar equity investment. We account for equity instruments issued to non-employees in accordance with the
provisions of SFAS 123 and Financial Accounting Standards Board Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or
Services (EITF 96-18).



Pro forma
information regarding net loss and net loss per share is required by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123), which also requires that the information be
determined as if our Company has accounted for its employee stock options granted under the fair value method. The fair value for these options was estimated using the minimum value method for periods to the date of our initial public offering and
the Black-Scholes option-pricing model thereafter.



The
following table illustrates the effect on net income and earnings per share as if the fair value based method had been applied to al outstanding and unvested awards in each period (in thousands, except per share data):



|                                                                                                                |  | Three MonthsEnded April 30, |        |   | Six Months Ended April 30, |  
|--------------------------------------------------------------------------------------------------------------- |  | --------------------------- | ------ | - | -------------------------- | -
|                                                                                                                |  | 2003                        |        |   | 2002                       |  
|Net loss, as reported                                                                                           |  | $                           | (1,169 | ) |                            | $
|Add: Stock based employee compensation expense included in reported net income                                  |  |                             | 121    |   |                            |  
|Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards |  |                             | (250   | ) |                            |  
|                                                                                                                |  |                             |        |   |                            |  
|Pro forma net loss                                                                                              |  | $                           | (1,298 | ) |                            | $
|Net loss per share:                                                                                             |  |                             |        |   |                            |  
|Basic and diluted  as reported                                                                                 |  | $                           | (0.16  | ) |                            | $
|Basic and diluted  pro forma                                                                                   |  | $                           | (0.18  | ) |                            | $



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VERSATA, INC.



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



(Unaudited)



5.    Restructuring and Other



The following table summarizes the restructuring and other activity during
the six months ended April 30, 2003 (in thousands):



|                                  |  | EmployeeSeverance |      |   | OfficeClosure andSubleasing Costs |   |       | OtherCosts |  | Total |    
|--------------------------------- |  | ----------------- | ---- | - | --------------------------------- | - | ----- | ---------- |  | ----- | ---
|Accrual balance, October 31, 2002 |  | $                 | 101  |   |                                   | $ | 1,429 |            |  | $     | 611
|Additions and reclassifications   |  |                   | 102  |   |                                   |   | 1,356 |            |  |       | 89 
|Cash paid                         |  |                   | (36  | ) |                                   |   | (157  | )          |  |       |   
|                                  |  |                   |      |   |                                   |   |       |            |  |       |    
|Accrual balance, January 31, 2003 |  | $                 | 167  |   |                                   | $ | 2,628 |            |  | $     | 700
|Additions and reclassifications   |  |                   | 219  |   |                                   |   | 58    |            |  |       |   
|Cash paid                         |  |                   | (151 | ) |                                   |   | (388  | )          |  |       |   
|                                  |  |                   |      |   |                                   |   |       |            |  |       |    
|Accrual balance, April 30, 2003   |  | $                 | 235  |   |                                   | $ | 2,298 |            |  | $     | 700
|                                  |  |                   |      |   |                                   |   |       |            |  |       |    



In November 2002 we
received $950,000 from a subtenant as a result of the termination of a sublease agreement between us and the subtenant as of October 31, 2002 and our releasing the subtenant from its liabilities under the terms of a Termination of Sublease
Agreement. As a result of the termination of the sublease, we increased our restructuring reserve during the quarter ended January 31, 2003, for the space occupied by the subtenant. The amount received from the subtenant was not recorded as income,
but rather is reflected as an offset to the original estimate of future sublease income and is included in additions to the reserve.



6.    Net Loss Per Share



Basic and diluted net loss per share is computed by dividing the net loss available to holders of common stock for the period by the weighted average
number of shares of common stock outstanding during the period. The calculation of diluted net loss per share excludes potential common stock if the effect is antidilutive. Potential common stock consists of 47,000 and 197,000 shares of unvested
restricted common stock, and 1,079,000 and 933,000 shares of outstanding stock options as of April 30, 2003 and 2002, respectively.



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



|                                                                       |  | Three MonthsEnded April 30, |        |   | Six Months Ended April 30, |  
|---------------------------------------------------------------------- |  | --------------------------- | ------ | - | -------------------------- | -
|                                                                       |  | 2003                        |        |   | 2002                       |  
|Numerator:                                                             |  |                             |        |   |                            |  
|Net Loss                                                               |  | $                           | (1,169 | ) |                            | $
|                                                                       |  |                             |        |   |                            |  
|Denominator:                                                           |  |                             |        |   |                            |  
|Weighted average shares outstanding                                    |  |                             | 7,389  |   |                            |  
|Weighted average unvested shares of common stock subject to repurchase |  |                             | (63    | ) |                            |  
|                                                                       |  |                             |        |   |                            |  
|Denominator for basic and diluted calculation                          |  |                             | 7,326  |   |                            |  
|Basic and diluted net loss per share                                   |  | $                           | (0.16  | ) |                            | $
|                                                                       |  |                             |        |   |                            |  





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VERSATA, INC.



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



(Unaudited)



7.    Legal Proceedings



Securities Class Action and State Derivative Actions



Since April 11, 2001, several securities class action complaints have been filed against us, and certain of our current and
former officers and directors. In August 2001, the class action lawsuits were consolidated in the United States District Court for the Northern District of California. On October 19, 2001, the lead plaintiffs filed an amended class action complaint
naming us and certain of our former officers and a current director as defendants. The amended class action complaint alleges claims under section 10(b) and section 20(a) of the Securities Exchange Act of 1934 and claims under sections 11 and 15 of
the Securities Act of 1933. The amended complaint sought an unspecified amount of damages on behalf of persons who purchased our stock during the class period between March 31, 2000 and April 30, 2001. In July 2002, the parties reached an agreement
to settle the class action lawsuit in order to avoid protracted and expensive litigation and the uncertainty of the outcome at a trial. The agreement for settlement does not constitute any admission of wrongdoing on the part of Versata or the
individual defendants. Our settlement calls for a payment of $9.75 million in cash by our insurance carriers, the issuance of 200,000 shares of our common stock, and for certain corporate therapeutics. The holders of the settlement stock have a put
option of $3.50 per share during a period of 20 trading days commencing one year from the date of distribution; provided however, the put options shall expire if Versata shares trade above $3.50 per share for 15 consecutive trading days during the
one year period following the date of distribution of the settlement stock. On February 14, 2003, the court approved the settlement agreement. We accrued $700,000 for this liability in accrued restructuring and other in fiscal 2002.



Since June 11, 2001, three derivative actions have been filed on our behalf
against certain current and former officers and directors in Superior Court of Alameda County, California. The complaints also name the Company as a nominal defendant. The complaints allege that the defendants breached their fiduciary duties, abused
their control of the corporation, and engaged in gross mismanagement of the corporation, by allegedly making or permitting the Company to make false financial statements and seek, among other things, compensatory damages. In July 2002, in
conjunction with the settlement of the securities litigation discussed above, the parties reached an agreement to settle the derivative action. The settlement calls for certain corporate therapeutics included in the settlement of the securities
litigation discussed above. As discussed, the agreement for settlement does not constitute any admission of wrongdoing on the part of Versata or the individual defendants. On February 14, 2003, the settlement agreement was approved by the court.





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|Item |  | 2.    Managements Discussion and Analysis of Financial Condition and Results of Operations
|---- |  | -------------------------------------------------------------------------------------------



Forward-Looking Statements



In addition to historical information, this Quarterly Report on Form 10-Q
contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties and are based on the beliefs and assumptions of our management, based on the
information currently available to our management. These statements may contain words such as expects, anticipates, intends, plans, believes, estimates, or other words
indicating future results. These statements are based on judgments with respect to, among other things, information available to us, future economic, competitive and market conditions and future business decisions. All are difficult or impossible to
predict accurately and many of which are beyond our control. Accordingly, although we believe that the assumptions underlying the forward-looking statements are reasonable, any such assumption could prove to be inaccurate and therefore there can be
no assurance that the results contemplated in the forward-looking statements will be realized. Factors that could cause or contribute to these differences include, but are not limited to, those discussed in the sections entitled Risk Factors
That May Affect Future Results. In light of significant uncertainties inherent in forward looking information included in this report on Form 10-Q, the inclusion of such information should not be regarded as a representation that our plans and
objectives will be achieved. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on the
forward-looking statements.



Overview



We provide software and services that accelerate and simplify the way
business logic is developed and maintained for enterprise applications. Business logic is an umbrella term referring to the aggregated set of business rules and business processes that govern and define a business operations. Business logic is
a critical part of todays new generation of enterprise applications, which are increasingly built in the Java 2, Enterprise Edition (J2EE) programming language.



From our incorporation in August 1991 through December 1994, we were a professional services company and generated revenue
from technical consulting projects. In January 1995, we commenced development efforts on our initial software products, from which we generated revenue in late 1995 through early 1998. In September 1996, we began development of our first Web-based
software product, which we began shipping commercially in September 1997. In September 1998, we introduced the first generation of what is now our suite of software products. To date, we have licensed our products and provided services to over 500
customers around the world.



We derive our revenue from
licensing our software and from the sale of related services. Our software is generally priced on a per central processing unit (CPU) basis. Maintenance and support revenue includes product maintenance, which provides the customer with
unspecified software upgrades over a specified term, typically twelve months, and customer support which is priced based on the particular level of support chosen by the customer. Professional services revenue consists of fees from consulting,
training, mentoring, staff augmentation and project management or rapid requirements development to complete turnkey solution services. Customers typically purchase these professional services from us to enlist our support by way of training and
mentoring activities directed at optimizing the customers use of our software product. Professional services are sold generally on a time-and-materials basis.



We market our products and services through our direct sales force, international distributors, consulting and system
integration partners, companies that sell pre-packaged software applications and companies that custom develop and integrate software applications. Our revenues to date have been derived predominantly from customers in North America and Europe.



Our cost of software license revenue consists of royalty
payments to third parties for technology incorporated into our products, the cost of manuals and product documentation, as well as packaging, distribution and electronic delivery costs. Our cost of maintenance and support revenue consists of
salaries of support personnel. Our cost of professional services revenue consists of salaries of professional service personnel and payments to third party consultants incurred in providing training, and consulting services. Cost of professional
services revenue as a percentage of professional services revenue is likely to vary significantly from period to period depending on overall utilization rates, the mix of services we provide and whether these services are provided by us or by
third-party contractors.



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Since our inception, we have incurred substantial costs to develop our technology and products, to
recruit and train personnel for our product development, sales and marketing and professional services departments, and to establish our administrative infrastructure. To date, all software development costs have been expensed in the period incurred
as such costs do not meet the requirements for capitalization under SFAS No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed (SFAS 86). Historically, our operating expenses have exceeded
the revenue generated by our products and services. As a result, we have incurred net losses in each quarter since inception.



Segment Information



Versata identifies its operating segments based on the business activities, management responsibility and geographical location. For both periods
presented, Versata operated in a single business segment. Revenue for geographic regions reported below is based upon the customers locations. Following is a summary of the geographic information related to revenues (in thousands):



|                                 |  | Three MonthsEnded April 30, |       | Six Months Ended April 30,
|-------------------------------- |  | --------------------------- | ----- | --------------------------
|                                 |  | 2003                        |       | 2002                      
|Software license revenue:        |  |                             |       |                           
|North America                    |  | $                           | 1,642 |                           
|Europe                           |  |                             | 236   |                           
|                                 |  |                             |       |                           
|                                 |  |                             | 1,878 |                           
|Maintenance and support revenue: |  |                             |       |                           
|North America                    |  | $                           | 1,084 |                           
|Europe                           |  |                             | 458   |                           
|                                 |  |                             |       |                           
|                                 |  |                             | 1,542 |                           
|Professional services revenue:   |  |                             |       |                           
|North America                    |  | $                           | 665   |                           
|Europe                           |  |                             | 392   |                           
|                                 |  |                             |       |                           
|                                 |  |                             | 1,057 |                           
|Total revenue:                   |  |                             |       |                           
|North America                    |  | $                           | 3,391 |                           
|Europe                           |  |                             | 1,086 |                           
|                                 |  |                             |       |                           
|                                 |  | $                           | 4,477 |                           
|                                 |  |                             |       |                           



Results of Operations



The following table sets forth, for the periods
indicated, the percentage of total revenue represented by the lines in our Unaudited Condensed Consolidated Statements of Operations:



|                                |  | Three MonthsEnded April 30, |    |  | Six Months  Ended April 30, |   
|------------------------------- |  | --------------------------- | -- |  | --------------------------- | --
|                                |  | 2003                        |    |  | 2002                        |   
|Revenue:                        |  |                             |    |  |                             |   
|Software license                |  | 42                          | %  |  | 22                          | % 
|Maintenance and support         |  | 34                          | %  |  | 33                          | % 
|Professional services           |  | 24                          | %  |  | 45                          | % 
|                                |  |                             |    |  |                             |   
|Total revenue                   |  | 100                         | %  |  | 100                         | % 
|                                |  |                             |    |  |                             |   
|Cost of revenue:                |  |                             |    |  |                             |   
|Software license                |  | 3                           | %  |  | 1                           | % 
|Maintenance and support         |  | 9                           | %  |  | 8                           | % 
|Professional services           |  | 20                          | %  |  | 37                          | % 
|                                |  |                             |    |  |                             |   
|Total cost of revenue           |  | 32                          | %  |  | 46                          | % 
|                                |  |                             |    |  |                             |   
|Gross profit                    |  | 68                          | %  |  | 54                          | % 
|                                |  |                             |    |  |                             |   
|Operating expense:              |  |                             |    |  |                             |   
|Sales and marketing             |  | 37                          | %  |  | 51                          | % 
|Product development             |  | 28                          | %  |  | 30                          | % 
|General and administrative      |  | 15                          | %  |  | 31                          | % 
|Stock-based compensation        |  | 3                           | %  |  | 8                           | % 
|Amortization of intangibles     |  | 11                          | %  |  | 12                          | % 
|Restructuring and other         |  | 2                           | %  |  | 13                          | % 
|                                |  |                             |    |  |                             |   
|Total operating expense         |  | 96                          | %  |  | 145                         | % 
|                                |  |                             |    |  |                             |   
|Loss from operations            |  | (28                         | )% |  | (91                         | )%
|Interest income, net            |  | 1                           | %  |  | 2                           | % 
|                                |  |                             |    |  |                             |   
|Loss before provision for taxes |  | (27                         | )% |  | (89                         | )%
|Provision for taxes             |  |                            |    |  | (1                          | )%
|                                |  |                             |    |  |                             |   
|Net loss                        |  | (27                         | )% |  | (90                         | )%
|                                |  |                             |    |  |                             |   



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Revenue



Total Revenue.Total revenue consists of software license revenue, maintenance and support revenue, and professional services revenue. Total
revenue for the three months ended April 30, 2003 was flat compared to the three months ended April 30, 2002 with revenue for both quarters at $4.5 million Total revenue for the six months ended April 30, 2003 decreased 13% compared to the six
months ended April 30, 2002 with revenue for the six months ended April 30, 2003 at $9.6 million compared to $11 million for the six months ended April 30, 2002.



Software License Revenue.Software license revenue increased by approximately $884,000, or 89% to $1.9 million in the
three months ended April 30, 2003 from $1 million in the three months ended April 30, 2002. Software license revenue increased by approximately $458,000, or 11% to $4.6 million for the six months ended April 30, 2003 from $4.1 million for the six
months ended April 30, 2002. The increase was mainly attributable to two large sales in the April 2003 quarter. Compared to 2002, we are selling more into our existing customer base and are seeing orders, in many cases, for deployment and production
licenses as customers finish applications and need to purchase software for deployment.



Maintenance and Support Revenue.Maintenance and support revenue for the three months ended April 30, 2003 was flat compared to the three months ended April 30, 2002 with revenue for both quarters at $1.5
million. Maintenance and support revenue increased by approximately $185,000, or 7% to $2.9 million for the six months ended April 30, 2003 from $2.7 million for the six months ended April 30, 2002. The increase is primarily attributable to
continuing maintenance and support agreements on prior license deals.



Professional Services Revenue. Services revenue decreased by $1 million, or 48%, to $1.1 million in the three months ended April 30, 2003 from $2 million in the three months ended April 30, 2002. Services revenue decreased by $2
million, or 49%, to $2.1 million for the six months ended April 30, 2003 from $4.1 million for the six months ended April 30, 2002. This decrease in services revenue is due to several factors. The primary factor is our high volume of sales to
existing customers who are becoming more proficient with our products and therefore require less professional services and mentoring to develop new applications. We believe this trend is likely to continue through the end of the fiscal year.
Additionally, as customers continue to face severe budget constraints, they are less willing to outsource development efforts when internal staff is not fully utilized.



Cost of Revenue



Total Cost of Revenue.Total cost of revenue decreased by $623,000, or 30%, to $1.5 million in the three months ended April 30, 2003 from $2.1
million in the three months ended April 30, 2002. Total cost of revenue decreased by $1.4 million, or 33%, to $2.8 million for the six months ended April 30, 2003 from $4.2 million for the six months ended April 30, 2002. This decrease was primarily
attributable to managements restructuring plan initiated to better align our costs with our revenue.



Cost of Software License Revenue. Cost of license revenue consists of royalties paid to third party vendors for use of their product embedded in
ours. Cost of software license revenue increased by $100,000, or 263%, to $138 thousand for the three months ended April 30, 2003 from $38 thousand for the three months ended April 30, 2002. Cost of software license revenue increased by $80,000, or
75%, to $186,000 for the six months ended April 30, 2003 from $106,000 for the six months ended April 30, 2002. The increase is primarily a result of an accrual for a $95,000 settlement with a vendor for additional third party royalty costs.



Cost of Maintenance and Support Revenue. Cost of
maintenance and support revenue consists of salaries of support personnel. Cost of maintenance and support revenue increased by $61,000, or 17%, to $422,000 for the three months ended April 30, 2003 from $361,000 for the three months ended April 30,
2002. Cost of maintenance and support revenue increased by $86,000, or 12%, to $786,000 for the six months ended April 30, 2003 from $700,000 for the six months ended April 30, 2002. The increase is a result of increased revenues and the result of
continuing to support our current maintenance and support agreements.



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Cost of Professional Services Revenue. Cost of service revenue consists of salaries of
professional service personnel and payments to third party consultants incurred in providing training and consulting services. Cost of service revenue decreased by $784,000, or 47%, to $892,000 for the three months ended April 30, 2003 from $1.7
million for the three months ended April 30, 2002. Cost of service revenue decreased by $1.6 million, or 45%, to $1.9 million for the six months ended April 30, 2003 from $3.4 million for the six months ended April 30, 2002. This decrease was mainly
attributable to the decrease in headcount in professional services and a reduction in the use of independent contractors. As of April 30, 2003, we had 19 employees in professional services as compared to 30 employees on April 30, 2002.



Gross Profit



Gross Profit. Gross profit increased by $558,000, or 23%, to $3 million in the three months ended April 30, 2003 from
$2.5 million in the three months ended April 30, 2002. Gross profit for the six months ended April 30, 2003 was flat compared the six months ended April 30, 2002 with gross profit at $6.7 million for both periods.



Operating Expenses



Operating Expenses.Operating expenses decreased $2.3 million, or 35%, to $4.3 million in the three months ended
April 30, 2003 from $6.6 million in the three months ended April 30, 2002. Operating expenses decreased $4.3 million, or 32%, to $9.1 million for the six months ended April 30, 2003 from $13.4 million for the six months ended April 30, 2002. The
majority of the decrease was due to our cost-cutting initiatives and reductions in our workforce.



Sales and Marketing. Sales and marketing expense consists of salaries, sales commissions, partners commissions, travel and entertainment expense,
and marketing programs. Sales and marketing expense decreased by $685,000, or 29%, to $1.6 million in the three months ended April 30, 2003 from $2.3 million in the three months ended April 30, 2002. Sales and marketing expense decreased by $2.1
million, or 39%, to $3.3 million for the six months ended April 30, 2003 from $5.3 million for the six months ended April 30, 2002. These decreases were largely attributable to approximately $853,000 reduction in salary and benefit expenses for the
six months ended April 30, 2003. In addition, sales and marketing expenses were lower for the six months ending April 30, 2003 as a result of decreased spending on marketing programs of $438,000 and a decrease of consulting expense of $84,000,
offset by additional partner commissions of $169,000. As of April 30, 2003, we had 26 employees in sales and marketing as compared to 40 employees on April 30, 2002.



Product Development. Product development expense includes costs associated with the development of new products,
enhancements to existing products, quality assurance and technical publication activities. These costs consist primarily of employee salaries and the cost of consulting resources that supplement our product development teams. Product development
expense decreased by $121,000, or 9%, to $1.2 million in the three months ended April 30, 2003 from $1.4 million in the three months ended April 30, 2002. Product development expense decreased by $183,000, or 6%, to $2.7 million for the six months
ended April 30, 2003 from $2.9 million for the six months ended April 30, 2002. All software development costs are expensed in the period incurred as they do not meet the requirements for capitalization under SFAS No. 86. As of April 20, 2003,
we had 31 employees in product development as compared to 37 employees as of April 30, 2002.



General and Administrative. General and administrative expense consists of salaries for executive, finance and administrative personnel, information systems costs and bad debt expense. General and
administrative expense decreased by $731,000, or 53%, to $657,000 in the three months ended April 30, 2003 from $1.4 million in the three months ended April 30, 2002. General and administrative expense decreased by $1.2 million, or 45%, to $1.5
million for the six months ended April 30, 2003 from $2.7 million for the six months ended April 30, 2002. The decrease was due to a reduction in salary and benefit expense of $331,000 for the six months ending April 30, 2003 versus the six months
ending April 30, 2002 related to the reductions in the number of general and administrative employees. Professional fees and outside labor costs decreased by $236,000 for the six months ending April 30, 2003 compared to the six months ended April
30, 2002, as a result of our cost cutting efforts and lower costs for external audit functions. As of April 20, 2003, we had 14 employees in general and administrative as compared to 21 employees as of April 30, 2002



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Stock-Based Compensation.Stock-based compensation expense includes the amortization of unearned
employee stock-based compensation, offset by reversals of previously expensed amounts for cancellations of the related options. Employee stock-based compensation expense is amortized on an accelerated basis (under FIN 28) over the vesting period of
the related options, generally 50 months. Stock-based compensation expense also includes expenses for stock options granted to consultants and employees in exchange for services. Stock-based compensation expense decreased by $229,000, or 65%, to
$121,000 for the three months ended April 30, 2003 from $350,000 for the three months ended April 30, 2002. Stock-based compensation expense decreased by $268,000, or 48%, to $294,000 for the six months ended April 30, 2003 from $562,000 for the six
months ended April 30, 2002. Additional unvested outstanding options will continue to vest over the next 11 months, which will result in additional compensation expense of approximately $135,000 in the aggregate in periods subsequent to April 30,
2003. This future expense will be reduced in the event of related option cancellations for employee terminations.



Amortization of Intangibles. Intangible assets consist of purchased technology that are being amortized on a straight-line basis over the expected
life of three years. Amortization expense decreased by $38,000, or 7%, to $500,000 for the three months ended April 30, 2003 from $538,000 for the three months ended April 30, 2002. Amortization expense decreased by $42,000, or 4%, to $973,000 for
the six months ended April 30, 2003 from $1 million for the six months ended April 30, 2002. The assets will be fully amortized by the end of fiscal 2003.



Restructuring and Other.Restructuring expense for the three months ended April 30, 2003 was $83,000, down $496,000, or 86%, from $579,000 for the
three months ended April 30, 2002. Our restructuring expense this quarter was primarily related to severance costs. Restructuring expense for the six months ended April 30, 2003 was $406,000, down $482,000, or 54%, from $888,000 for the six months
ended April 30, 2002. The decrease is primarily due to our restructuring efforts in prior periods resulting in expense controls over the last year and the stabilization of costs. Our restructuring expense for the six months ended April 30, 2003 was
primarily related to unused office space.



Interest Income,
Net. Interest income, net, is primarily comprised of interest income from our cash and investments offset by interest paid on our equipment loan and capital lease obligations. We had net interest income of $41,000 for the three months ended
April 30, 2003, a decrease of $65,000, or 61%, compared to net interest income of $106,000 for the three months ended April 30, 2002. We had net interest income of $122,000 for the six months ended April 30, 2003, a decrease of $121,000, or 50%,
compared to net interest income of $243,000 for the six months ended April 30, 2002. The reduction in interest income is primarily due to our reduced cash balance and lower interest rates earned.



Benefit (Provision) for Taxes. We have incurred operating losses for
all periods from inception through April 30, 2003. We have recorded a valuation allowance for the full amount of our deferred tax assets, as the future realization of the tax benefits is uncertain. During the three months ended April 30, 2003 we
reduced our accrued liability for a local tax by approximately $45,000 which resulted in a benefit for taxes during the period.



Liquidity and Capital Resources



Since inception, we have funded our operations primarily through the private sale of our equity securities and our initial public offering, resulting in
aggregate net proceeds of $167.2 million. We have also funded our operations through equipment financing. As of April 30, 2003, we had $16.5 million in cash and cash equivalents and short-term investments, $11.4 million in working capital and $5.0
million in restricted cash. Cash and cash equivalents consist of highly liquid investments in time deposits held at major banks, commercial paper, United States government agency discount notes, money market mutual funds and other money market
securities with original maturities of 90 days or less. Short-term investments include similar highly liquid investments with maturities between 91 days and 365 days. Working capital is current assets less current liabilities. Restricted cash
consists primarily of a time deposit held at a major bank that secures an irrevocable letter of credit for the benefit of our landlord in lieu of a cash security deposit.



Net cash used in operating activities was $193,000 and $6.1 million for the six months ended April 30, 2003 and 2002,
respectively. Net cash used in operating activities in each period reflects net losses offset by non-cash expenses, primarily depreciation and amortization and stock-based compensation. Net cash used in operating activities was also impacted by
changes in working capital. During the fiscal 2003 period, cash flows from operating activities decreased primarily due to decreases in accounts payable and accrued liabilities and increased primarily due to increases in accrued restructuring and
other. During the fiscal 2002 period, cash flows from operations decreased primarily due to decreases in accounts payable and decreases in accrued restructuring and other and increased primarily due to decreases in trade receivables.



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Net cash provided by investing activities was $1.8 million for the first six months of fiscal 2003
primarily due to the proceeds from sales of short-term investments. Net cash used in investing activities was $251,000 for the first six months of fiscal 2002 primarily due to purchases of short-term investments.



Net cash used in financing activities was $246,000 for the first six months
of fiscal 2003 primarily due to principal payments on capital lease obligations and long term debt. Net cash provided by financing activities was $854,000 for the first six months of fiscal 2002 primarily due to the proceeds from the sale of shares
held by a former officer.



We believe that our cash and cash
equivalents and short-term investments as of April 30, 2003 will be sufficient to meet our general expenses, working capital and capital expenditure requirements for at least the next twelve months. However, we may find it necessary to obtain
additional equity or debt financing in fiscal 2004 or beyond. In the event additional financing is required, we may not be able to raise it on acceptable terms or at all.



Critical Accounting Policies



Our discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these 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. In specific, management uses judgments and estimates in recognizing revenues, determining gains and losses on foreign currency, accruing contingencies,
establishing the allowance for doubtful accounts, assessing the realizability of long-lived assets, and applying significant assumptions to the future obligations for office closure and sublease accruals. On an on-going basis, we evaluate our
estimates. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.



We believe the following are critical accounting policies and
estimates used in the preparation of our consolidated financial statements.



Revenue Recognition



We
derive revenue from three sources as follows: (i) sale of software licenses to end users, value added resellers (VARs), distributors, system integrators and independent software vendors (ISVs), (ii) maintenance
and support of license holders (post-contract customer support or PCS) and (iii) services which include consulting, training, and mentoring. This policy establishes the standards for ensuring we recognize revenue consistently, and in
accordance with the American Institute of Certified Public Accountants (AICPA) Statement of Position 97-2, Software Revenue Recognition (SOP 97-2), as amended.



Under SOP 97-2, we record revenue from licensing of software products to end-users and system integrators, who use our
software to build systems for their customers, when both parties sign a license agreement, the fee is fixed or determinable, collection is reasonably assured and delivery of the product has occurred. For VARs and distributors, we recognize
revenue upon notification of sell-through, provided all other revenue recognition criteria are met. For sales to certain ISVs, where we receive non-refundable royalty payments and there is no obligation to provide PCS to the partner or the end
user, we recognize the license revenue when paid, provided all other revenue recognition criteria are met. When additional fees are paid for PCS, the amounts are deferred and revenue is recognized ratably over the period of the contracts, which is
generally twelve months.



Generally, we provide payment terms
that range from thirty to ninety days from the invoice date. Accordingly, payment terms that exceed ninety days are not considered fixed or determinable and revenue is recognized as payments become due.



When contracts contain multiple elements, and for which vendor specific
objective evidence (VSOE) of fair value exists for the undelivered elements, we recognize revenue for the delivered elements based upon the residual method. VSOE is generally the price for products sold separately or the renewal rate in
the agreement for PCS. Undelivered elements consist primarily of PCS and other services such as consulting, mentoring and training. Services are generally not considered essential to the functionality of the software. We recognize revenue allocated
to PCS ratably over the period of the contracts, which is generally twelve months. For revenue related to consulting services, we recognize revenue as the related services are performed. In instances where services are deemed essential to the
software, both the software license fee and consulting fees are recognized using the percentage-of-completion method of contract accounting as required under SOP 81-1.



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The portion of fees related to products delivered or services rendered which are not due under our
Companys standard payment terms are reflected in deferred revenue and in unbilled receivables.



Significant management judgments and estimates must be made in connection with determination of the revenue to be recognized in any accounting period. If
we made different judgments or utilized different estimates for any period, material differences in the amount and timing of revenue recognized could result.



Determining Functional Currencies for the Purpose of Consolidation



In preparing our consolidated financial statements, we are required to translate the financial statements of our foreign
subsidiaries from the currency in which they keep their accounting records, generally the local currency, into United States dollars. This process results in exchange gains and losses which, under the relevant accounting guidance, are either
included within the statement of operations or as a separate part of our stockholders equity under the caption cumulative translation adjustment.



If any subsidiarys functional currency is deemed to be the local currency, then any gain or loss associated with the
translation of that subsidiarys financial statements is included in cumulative translation adjustments. If we dispose of any of our subsidiaries, any cumulative translation gains or losses would be realized in our statement of operations. If
we determine that there has been a change in the functional currency of a subsidiary to the United States dollar, any translation gains or losses arising after the date of change would be included within our statement of operations.



The magnitude of these gains or losses is dependent upon movements in the
exchange rates of the foreign currencies in which we transact business against the United States dollar. These currencies include the United Kingdom Pound Sterling, the Euro, the Indian Rupee, Australian and Canadian dollars. Any future translation
gains or losses could be significantly higher than those noted in each of these periods. In addition, if we determine that a change in the functional currency of one of our subsidiaries has occurred at any point in time, we would be required to
include any translation gains or losses from the date of change in our statement of operations.



Cash and cash equivalents and short-term investments



We consider all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Our short-term investments
consist of debt securities with maturities greater than three months at the date of purchase. We classify all short-term investments as available for sale in accordance with Statement of Financial Accounting Standards No. 115, Accounting for
Certain Investments in Debt and Equity Securities, (SFAS 115). Accordingly, our short-term investments are carried at fair value as of the balance sheet date. Unrealized gains and losses are reported net of taxes as a component of
shareholders equity. The cost of securities sold is based upon the specific identification method. At each period end presented, amortized cost approximated fair value and unrealized gross gains or losses were insignificant, and during each of
the periods presented, realized gains were insignificant.



Allowance for Doubtful Accounts



We make
judgments as to our ability to collect outstanding receivables and provide allowances for the portion of receivables when collection becomes doubtful. Provisions are made based upon a specific review of all significant outstanding invoices. For
those invoices not specifically reviewed, provisions are provided at differing rates, based upon the age of the receivable. In determining these percentages, we analyze our historical collection experience and current economic trends. If the
historical data we use to calculate the allowance provided for doubtful accounts does not reflect the future ability to collect outstanding receivables, additional provisions for doubtful accounts may be needed and the future results of operations
could be materially affected.



Property and equipment



Property and equipment is stated at cost and is
depreciated using the straight-line method over the estimated useful lives of the related assets, which range from two to five years. Leasehold improvements are amortized on a straight-line basis over the life of the lease or the estimated useful
life of the asset, whichever is shorter. Equipment under capital lease is amortized using the straight-line method over the lesser of the lease term or their estimated useful lives.



Major additions and improvements are capitalized, while replacements, maintenance, and repairs that do not improve or extend
the life of the assets are charged to expense. In the period assets are retired or otherwise disposed of, the cost and related accumulated depreciation and amortization are removed from the accounts, and any gain or loss on disposal is included in
results of operations.



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Intangibles



Intangibles are accounted for in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets (SFAS 142), which is effective for fiscal years beginning after December 31, 2001. SFAS 142 requires, among other things, the discontinuance of goodwill amortization and includes provisions upon adoption for the
reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the testing for the
impairment of existing goodwill and other intangibles. Versata adopted SFAS 142 effective November 1, 2001.



Restructuring and other costs



Certain expenses incurred in the reorganization of the Companys operations are considered to be restructuring expenses. Restructuring provisions are
determined based on estimates prepared at the time the restructuring actions are approved by management. Office closure and sublease accruals are primarily related to future minimum lease payments for excess office space at the Companys
corporate headquarters, offset by payments received by the Company from subtenants in the space. Management uses estimates and applies significant assumptions to the future obligations for office closure and sublease accruals and although we base
our estimates on various assumptions that are believed to be reasonable under the circumstances, actual results may differ from these estimates under different assumptions or conditions. Severance accruals are primarily related to future severance
payments to employees that have been terminated from the Company. Other costs reflect the anticipated costs of the settlement agreement for the Securities Class Action and State Derivative Actions described in the Legal Proceedings footnote in the
attached notes to condensed consolidated financial statements.



Software development costs



Software
development costs are included in product development and are expensed as incurred. After technological feasibility is established, material software development costs are capitalized in accordance with Statement of Financial Accounting Standards
No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed (SFAS 86). The capitalized cost is then amortized on a straight-line basis over the estimated product life, or in the ratio of current
revenues to total projected product revenues, whichever is greater. The Company has defined technological feasibility as the establishment of a working model, and typically occurs when the beta testing commences, To date, the period between
achieving technological feasibility and the general availability of such software has been short and software development costs qualifying for capitalization have been insignificant. Accordingly, the Company has not capitalized any software
development costs.



Risk Factors That May Affect Future Results



We operate in a rapidly changing environment that
involves numerous risks and uncertainties. The following section lists some, but not all, of these risks and uncertainties, which may have a material adverse effect on our business, financial condition or results of operations. Investors should
carefully consider the following risk factors in evaluating an investment in our common stock.



Continued Weakening of World Wide Economic Conditions Realized in the Internet Infrastructure Software Market May Result in Decreased Revenues or Lower Revenue Growth Rates.



The revenue growth of our business depends on the overall demand for
computer software, particularly in the product segments in which we compete. The slowdown of the worldwide economy affects the buying decision of corporate customers, such as it has in the recent years. Because our sales are primarily to Global 2000
customers, our business also depends on general economic and business conditions. A further reduction in demand for computer software, caused by the further weakening of the economy, may result in decreased revenues or lower revenue growth rates.





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If We Do Not Effectively Compete With New and Existing Competitors, Our Revenues and Operating Margins Will
Decline.



The Internet infrastructure software market
in general, and the market for our software and related services in particular, are new, rapidly evolving and highly competitive. Many of our competitors, including but not limited to IBM, Microsoft, Oracle, BEA Systems, Inc., and Sun Microsystems
have longer operating histories and significantly greater financial, technical, marketing and other resources than we do. For example, IBM, who we have a strategic relationship with, recently announced the launch of a new product, IBM Rational Rapid
Developer, that the market may deem to compete with our development software, the Versata Logic Studio. Although we believe that our Versata Logic Studio does not directly compete with IBMs Rational Rapid Developer, we may not be able to
successfully or sufficiently differentiate our product from IBMs product. Additionally, IBMs continued efforts in the J2EE market could materially and adversely affect our business, operating results and financial condition.



Our competitors, such as the ones mentioned herein; also have more
extensive customer bases, broader customer relationships and broader industry alliances that they could leverage, thereby establishing relationships with many of our current and potential customers. These companies also have significantly more
established customer support and professional service organizations. In addition, these companies may adopt aggressive pricing policies or offer more attractive terms to customers, may bundle their competitive products with broader product offerings
or may introduce new products and enhancements. Furthermore, current and potential competitors may establish cooperative relationships among themselves or with third parties to enhance their products. As a result, it is possible that new competitors
or alliances among competitors may emerge and rapidly acquire significant market share. If we fail to compete successfully with our competitors, the demand for our products would decrease. Any reduction in demand could lead to loss of market share,
a decrease in the price of our products, fewer customer orders, reduced revenues, reduced margins, and increased operating losses. These competitive pressures could seriously harm our business and operating results.



New Versions and Releases of Our Products May Contain Errors or Defects and Result in
Loss of Revenue.



The software products we offer are
complex and, despite extensive testing and quality control, may have had, and in the future could have errors or defects, especially when we first introduce them. Typically we need to issue corrective releases of our software products to fix any
defects or errors. Defects or errors could also cause damage to our reputation, loss of revenues, product returns or order cancellations, lack of market acceptance of our products, and expose us to litigation. Accordingly, defects or errors
particularly if they are more numerous than expected could have a material and adverse effect on our business, results of operations and financial condition.



Our Failure to Accurately Forecast Sales May Impact our Cost Structure.



Our Company uses a pipeline system, a common industry practice, to forecast sales and trends in our business.
Our sales personnel monitor the status of all proposals, such as the date when they estimate that a customer will make a purchase decision and the potential dollar amount of the sale. We aggregate these estimates periodically in order to generate a
sales pipeline. We compare the pipeline at various points in time to look for trends in our business. While this pipeline analysis may provide us with some guidance in business planning and budgeting, these pipeline estimates are necessarily
speculative and may not consistently correlate to revenues in a particular quarter or over a longer period of time. A variation in the conversion of the pipeline into contracts or in the pipeline itself could cause our Company to improperly plan or
budget and thereby adversely affect our business or results of operations. In particular, the current slowdown in the economy is causing purchasing decisions to be delayed, reduced in amount or cancelled which will therefore reduce the overall
license pipeline conversion rates in a particular period of time.



The
Price of Our Common Stock is Volatile, and It May Fluctuate Significantly.



The market price of our common stock has fluctuated significantly and has declined sharply since our initial public offering in March 2000 and most recently in 2002. Our Companys stock price is affected by a
number of factors, some of which are beyond our control, including:



| |  |  | Quarterly variations in results, announcements that our revenue or income are below analysts expectations;
| | - |  | -----------------------------------------------------------------------------------------------------------



| |  |  | The competitive landscape;
| | - |  | --------------------------



| |  |  | Technological innovations by us or our competitors;
| | - |  | ---------------------------------------------------



| |  |  | Changes in earnings estimates or recommendations by analysts;
| | - |  | -------------------------------------------------------------



| |  |  | Sales of large blocks of our common stock, sales or the intention to sell stock by our executives and directors;
| | - |  | ----------------------------------------------------------------------------------------------------------------



| |  |  | General economic and market conditions;
| | - |  | ---------------------------------------



| |  |  | Additions or departures of key personnel;
| | - |  | -----------------------------------------



| |  |  | Estimates and projections by the investment community; and
| | - |  | ----------------------------------------------------------



| |  |  | Fluctuations in our stock trading volume, which is particularly common among highly volatile securities of software companies.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------



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As a result, our stock price is subject to significant volatility. In the past, following periods of
volatility or decline in the market price of a companys securities, securities class action litigation has at times been instituted against that company. Although we have settled the private securities class action lawsuit brought against us
and certain of our former officers and directors, we may be subject to additional litigation with a few class members who have opted out of joining the class for the settlement purposes. This could cause us to incur substantial costs and experience
a diversion of managements attention and resources.



Any Potential
Delisting of Versatas Common Stock from the NASDAQ National Market Could Harm Our Business.



Versatas common stock trades on the NASDAQ National Market, which has certain compliance requirements for continued listing of common stock.
Although in May 2003 we received notification from the NASDAQ Listing Qualifications Panel that we regained full compliance with the minimum bid price of $1 listing requirement and minimum market value of publicly held shares of $5 million listing
requirement, if we fail to meet these listing requirements again, or any other listing requirements, as our stock has been significantly volatile in the recent years, we may be subject to delisting.



Our Quarterly Revenues and Operating Results May Fluctuate in Future Periods.



Our revenues are relatively difficult to forecast and
vary from quarter to quarter due to various factors including:



| |  |  | Relatively long sales cycles for our products;
| | - |  | ----------------------------------------------



| |  |  | Size and timing of individual license transactions, the closing of which tend to be delayed by customers until the end of a fiscal quarter as a negotiating tactic;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Introduction of new products or product enhancements by us or our competitors;
| | - |  | ------------------------------------------------------------------------------



| |  |  | Potential for delay or deferral of customer implementations of our software;
| | - |  | ----------------------------------------------------------------------------



| |  |  | Changes in customer budgets;
| | - |  | ----------------------------



| |  |  | Seasonality of technology purchases and other general economic conditions; and
| | - |  | ------------------------------------------------------------------------------



| |  |  | Changes in our pricing policies or those of our competitors.
| | - |  | ------------------------------------------------------------



Accordingly, our quarterly results are difficult to predict until the end of the quarter. Delays in product delivery or closing of sales near the end of a
quarter caused quarterly revenues and net income to fall significantly short of anticipated levels in the past year, and given the current economic slowdown, may well occur in future quarters.



Our license revenues in any quarter are substantially dependent on orders
booked and shipped in that quarter. We typically receive and fulfill a majority of our orders within the quarter, with the substantial majority of our orders received in the last month of each fiscal quarter. As a result, we may not learn of revenue
shortfalls until late in a fiscal quarter, after it is too late to adjust expenses for that quarter. Since our operating expenses are relatively fixed and are based on anticipated revenue levels, a delay in bookings from even a small number of
license transactions could cause significant variations in revenues quarter to quarter and could cause net income to fall significantly short of anticipated levels. As an example, the dollar amounts of large orders for our products have been
increasing and therefore the operating results for a quarter could be materially and adversely affected if a number of large orders are either not received or are delayed, due to cancellations, delays, or deferrals by customers. Revenue shortfalls
below our expectations could have an immediate and significant adverse effect on our results of operations.



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Our services revenue in any quarter is substantially dependent on our license revenue. Services are
normally purchased in conjunction with software licenses, although it is not a requirement. Should our license revenues decrease, there will be a reduced market for our services. Any revenue shortfall in services could have an immediate and
significant adverse effect on our results of operations.



If our
customers do not renew their product support and maintenance agreements, we may lose a recurring revenue stream, which could harm our operating results.



Many of our customers subscribe for software support and maintenance services, which we recognize over the term of those
support and maintenance agreements. In fiscal year 2002, our maintenance and support revenue accounted for 29% of our total revenue. If a significant portion of those customers chose not to continue subscribing for product support and maintenance,
our recurring revenue from those services would be adversely affected, which could harm our business, operating results and financial condition.



We May Have to Delay Recognizing License or Service Related Revenue for a Significant Period, Which Could Negatively Impact Our Results of Operations.



Although we mainly enter into standard license
agreements and time-and- materials services agreements, we may occasionally have to delay recognizing license or service revenue for a significant period of time for a variety of types of transactions, including:



| |  |  | Transactions which contain currently undeliverable elements;
| | - |  | ------------------------------------------------------------



| |  |  | Transactions which involve services that include customization, deliverables, or customers acceptance;
| | - |  | -------------------------------------------------------------------------------------------------------



| |  |  | Transactions that include contingency-based payment terms or fees; and
| | - |  | ----------------------------------------------------------------------



| |  |  | Transactions with extended payment terms.
| | - |  | -----------------------------------------



These factors and other specific accounting requirements for software revenue recognition, require that we have very precise terms in our license
agreements to allow us to recognize revenue when we initially deliver software or perform services. Although we have a standard form of license agreement that meets the criteria for current revenue recognition on delivered elements, we negotiate and
revise these terms and conditions in some transactions. Sometimes we are unable to negotiate terms and conditions that permit revenue recognition at the time of delivery or even as work on the project is completed.



If Accounting Interpretations Relating to Revenue Recognition Change, Our Reported
Revenues Could Decline, or We Could be Forced to Make Changes in Our Business Practices.



Over the past several years, the American Institute of Certified Public Accountants has issued Statement of Position No. 97-2, Software Revenue
Recognition (SOP 97-2), and Statement of Position No. 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions (SOP 98-9). In addition, in December 1999, the Securities and
Exchange Commission staff issued Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (SAB 101), which explains how the SEC staff believes existing revenue recognition rules should be applied to or
interpreted for transactions not specifically addressed by existing rules. These standards address software revenue recognition matters primarily from a conceptual level and do not include specific implementation guidance. We believe that our
revenue has been recognized in compliance with SOP 97-2, SOP 98-9 and SAB 101. However, the accounting profession and regulatory agencies continue to discuss various provisions of these pronouncements with the objective of providing additional
guidance on their application. Most recently, in December 2002, the EITF reached a consensus on EITF Issue No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables(EITF 00-21) that sets out criteria for whether
revenue on a deliverable can be recognized separately form other deliverables in a multiple deliverable arrangement. While EITF 00-21 is not required to be adopted by the Company until November 1, 2003, the issuance of new interpretations on revenue
recognition could lead to unanticipated reductions in recognized revenue. They could also drive significant adjustments to our business practices, which could result in increased administrative costs, lengthened sales cycles and other changes which
could adversely affect our results of operations.



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The Private Securities Class Action Lawsuits and State Derivative Action Against Us and Certain of Our Directors
and Officers Could Have a Material Adverse Effect on Our Business, Financial Condition and Results of Operations.



Although the Court has approved our settlement agreement for the private securities class action lawsuit and the state derivative actions, a few class
members who opted out of joining the class for the settlement purposes may still pursue their own private actions against the Company. Such actions may cause a diversion of management time and attention.



Our liability insurance for actions taken by officers and directors provides
only limited liability protection. To the extent that these policies do not adequately cover our expenses related to any shareholder lawsuits, our business and financial condition could be seriously harmed. Under the Delaware General Corporation
Law, the Companys Certificate of Incorporation, as amended, the Bylaws, as amended, and the indemnification agreements we entered into with our executive officers and directors, we must indemnify our current and former officers and directors
to the fullest extent permitted by law. Subject to certain conditions, the indemnification may cover expenses and liabilities reasonably incurred in connection with the investigation, defense, settlement, or appeal of legal proceedings.



We Have Incurred Operating Losses Since Our Inception and are Likely to Incur Net
Losses and Negative Cash Flows for the Foreseeable Future.



We have experienced operating losses in each quarterly and annual period since inception, and we expect to incur losses in the future. If our revenue grows less than we anticipate or if our operating expenses increase more than expected or
are not reduced in the event of lower revenue, we may never achieve profitability. As of April 30, 2003, we had an accumulated deficit of $197.7 million. Although we have an objective of achieving profitability as soon as practical, we cannot assure
you that we will be successful. In order to achieve and maintain profitability, we will need to increase revenues while decreasing expenses.



We May Require Future Additional Funding to Stay in Business.



We may require additional financing for our operations. We have not been operating on a profitable basis and have relied on the sale of stock to finance
our operations. We may need to return to the capital markets in order to receive additional financing.



This additional financing may not be available to us on a timely basis if at all, or, if available, on terms acceptable to us. Moreover, additional
financing will cause dilution to existing stockholders.



If We Do Not
Develop and Enhance New and Existing Products to Keep Pace With Technological, Market and Industry Changes, Our Revenues May Decline.



The markets for our products are characterized by rapid technological advances in software development, evolving standards in software technology and
frequent new product introductions and enhancements. Product introductions and short product life cycles necessitate high levels of expenditures for research and development. To maintain our competitive position, we must:



| |  |  | Enhance and improve existing products and continue to introduce new products that keep pace with technological developments;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



| |  |  | Satisfy increasingly sophisticated customer requirements; and
| | - |  | -------------------------------------------------------------



| |  |  | Achieve market acceptance.
| | - |  | --------------------------



The success of new products is dependent on several factors including proper new product definition, product cost, timely completion and introduction of
new products, differentiation of new products from those of our competitors, and market acceptance of these products. There can be no assurance that we will successfully identify new product opportunities, develop and bring new products to market in
a timely manner, and achieve market acceptance of our products or that products and technologies developed by others will not render our products or technologies obsolete or noncompetitive. Our inability to run on new or increasingly popular
operating systems, and/or our failure to successfully enhance and improve our products in a timely manner could have a material adverse effect on our business, results of operations, financial condition or cash flows.



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If the Versata Products and Related Services Do Not Achieve Widespread Market Acceptance, the Source of
Substantially All of Our Revenue Will be at Risk.



We
cannot predict the level of market acceptance that will be achieved or maintained by our products and services. If either the Internet infrastructure software market in general, or the market for our software or related services in particular, fails
to grow or grows more slowly than we anticipate, or if either market fails to accept our products and related services, the source of substantially all of our revenue will be at risk. We expect to continue to derive substantially all our revenue
from and be dependent upon the Versata products and related services in the future. The market for the Versata products and related services is new, rapidly evolving and highly competitive, and we cannot be certain that a viable market for our
products will ever develop or be sustained. Our future financial performance will depend in large part on the successful development, introduction and customer acceptance of our new products, product enhancements and related services in a timely and
cost-effective manner. We expect to continue to commit significant resources to market and further develop our products and related services and to enhance the brand awareness of our software and services.



If Java Technology Does Not Continue to be Widely Adopted for E-business Application
Development, Our Business Will Suffer.



Our products
are based on Java technology, an object-oriented software programming language and distributed computing platform developed by Sun Microsystems. Java is a relatively new language and was developed primarily for the Internet and corporate intranet
applications. It is still too early to determine whether Java will achieve greater acceptance as a programming language and platform for enterprise applications. Alternatives to Java include Microsofts C# language and .net computing platform.
Should Java not continue to be widely adopted, or is adopted more slowly than anticipated, our business will suffer. Alternatively, if Sun Microsystems makes significant changes to the Java language or its proprietary technology, or fails to correct
defects and limitations in these products, our ability to continue improving and shipping our products could be impaired. In the future, our customers also may require the ability to deploy our products on platforms for which technically acceptable
Java implementations either do not exist or are not available on commercially reasonable terms.



We Depend on Increased Business from Our Current and New Customers and if We Fail to Generate Repeat and Expanded Business or Grow Our Customer Base, Our Products and Services Revenue Will Likely Decline.



In order to be successful, we need to broaden our
business by selling product licenses and services to current and new customers. Many of our customers initially make a limited purchase of our products and services for pilot programs. These customers may not choose to purchase additional licenses
to expand their use of our products. These and other potential customers also may not yet have developed or deployed initial software applications based on our products. If these customers do not successfully develop and deploy these initial
software applications, they may choose not to purchase deployment licenses or additional development licenses. In addition, as we introduce new versions of our products or new products, our current customers may not require the functionality of our
new products and may not license these products.



If we fail to
add new customers who license our software, our maintenance and support revenue and our professional services revenue will also likely decline. These revenues are derived from fees for professional services and customer support related to our
products. The total amount of services and support fees we receive in any period depends in large part on the size and number of software licenses that we have previously sold as well as our customers electing to renew their customer support
agreements. In the event of a further downturn in our software license revenue such as it occurred during fiscal 2002 and fiscal 2001, or a decline in the percentage of customers who renew their annual support agreements, our maintenance and support
revenue and our professional services revenue could become flat or further decline.



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Our Failure to Maintain Ongoing Sales Through Distribution Channels Will Result in Lower Revenues.



To date, we have sold our products principally
through our direct sales force, as well as through indirect sales channels, such as Independent Software Vendors (ISVs), systems integrators and independent consultants, application service providers (ASPs) and distributors,
particularly IBM. Our ability to achieve revenue growth in the future will depend in part on our success in making our direct sales force more efficient and in further establishing and expanding relationships with distributors, ASPs, ISVs, Original
Equipment Manufacturers (OEMs) and systems integrators. We intend to seek distribution arrangements with additional ISVs to embed our Versata Logic Server and Versata Process Logic Engine in their products. It is possible that we will
not be able to increase the efficiency of our direct sales force or other distribution channels, or secure license agreements with additional ISVs on commercially reasonable terms. Moreover, even if we succeed in these endeavors, it still may not
increase our revenues. If we invest resources in these types of expansion and our revenues do not correspondingly increase, our business, results of operations and financial condition will be materially and adversely affected.



We rely on informal relationships with a number of consulting and systems
integration firms to enhance our sales, support, service and marketing efforts, particularly with respect to implementation and support of our products as well as lead generation and assistance in the sales process. We will need to expand our
relationships with third parties in order to support license revenue growth. Many such firms have similar, and often more established, relationships with our principal competitors. It is possible that these and other third parties will not provide
the level and quality of service required to meet the needs of our customers, that we will not be able to maintain an effective, long term relationship with these third parties, and that these third parties will not successfully meet the needs of
our customers.



Our Business is Subject to Risks from International
Operations.



We conduct business internationally.
Accordingly, a portion of our revenues is derived from international sales and is therefore subject to the related risks including the general economic conditions in each country, the overlap of different tax structures, the difficulty of managing
an organization spread over various countries, changes in regulatory requirements, compliance with a variety of foreign laws and regulations, longer payment cycles and volatilities of exchange rates in certain countries. There can be no assurances
that we will be able to successfully address each of these challenges. Other risks associated with international operations include import and export licensing requirements, trade restrictions and changes in tariff rates.



A portion of our business is conducted in currencies other than the U.S.
dollar. Changes in the value of major foreign currencies relative to the value of the U.S. dollar may adversely affect revenues and operating results.



Also, any further terrorist activities or military or security operations involving the U.S. that are significant enough to further weaken the U.S. or
global economy could result in reductions in information technology spending, and deferrals, reductions or cancellations of customer orders for our products and services, which ultimately would have an adverse effect on our operating results.



If We Infringe the Patents or Proprietary Rights of Others Our Business,
Financial Condition and Operating Results Would Be Harmed.



We do not believe our products infringe the proprietary rights of third parties, but third parties may nevertheless assert infringement claims against us in the future. Regardless of whether these claims have merit, they can be time
consuming and expensive to defend or settle, and can harm our business and reputation. Furthermore, we may initiate claims or litigation against third parties for infringement of our proprietary rights or to establish the validity of our proprietary
rights. Litigation, whether resolved in our favor or not, could be time-consuming to defend, result in increased costs, divert managements attention and resources, cause product shipment delays or require us to enter into unfavorable royalty
or licensing agreements.



We May Incur Substantial Expenses If We are
Sued for Product Liability.



Our license agreements
with our customers typically contain provisions designed to limit our exposure to potential product liability claims. It is possible, however, that the limitation of liability provisions contained in our license agreements may not be effective as a
result of existing or future federal, state or local laws or ordinances or unfavorable judicial decisions. Although we have not experienced any product liability claims to date, sale and support of our products entails the risk of such claims, which
could be substantial in light of customers use of such products in mission-critical applications. If a claimant brings a product liability claim against us, it could have a material adverse effect on our business, results of operations and
financial condition. Our products interoperate with many parts of complicated computer systems, such as mainframes, servers, personal computers, application software, databases, operating systems and data transformation software. Failure of any one
of these parts could cause all or large parts of computer systems to fail. In such circumstances, it may be difficult to determine which part failed, and it is likely that customers will bring a lawsuit against several suppliers. Even if our
software is not at fault, we could suffer material expense and material diversion of managements time in defending any such lawsuits.



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We Periodically Have Restructured Our Sales Force, Which Can be Disruptive.



We continue to rely heavily on our direct sales force. In many years, we
have restructured or made other adjustments to our sales force in response to factors such as management changes, performance issues and other internal considerations. We recently made some adjustments to the organization of our sales force in
Europe and North America to focus on vertical markets. In the past, changes in the structure of the sales force and sales force management have generally resulted in a reduced productivity that may have affected revenues in one or more quarters. We
cannot assure you that we will not continue to restructure our sales force or that the transition issues associated with restructuring the sales force will not recur.



If We Lose Key Employees or Cannot Hire Key Qualified Employees, It May Adversely Affect Our Ability to Manage our Business, Develop
Our Products and Increase Our Revenues.



We believe
our continued growth and success depend to a large extent on the continued service of our senior management and other key employees and the hiring of key qualified employees. In the software industry, there is substantial and continuous competition
for highly skilled business, product development, technical and other personnel. We may experience increased compensation costs that are not offset by either improved productivity or higher prices. We may not be successful in recruiting new
personnel and in retaining and motivating existing personnel. Members of our senior management team have left Versata over the years for a variety of reasons and we cannot assure you that there will not be additional departures. Any changes in
management can be disruptive to our operations. In general, we do not have long-term employment or non-competition agreements with our employees. Part of our total compensation program includes stock options. The volatility or lack of positive
performance of our stock price may from time to time adversely affect our ability to retain or attract key employees.



Item 3.    Quantitative and Qualitative Disclosures About Market Risk



We are exposed to a variety of risks including changes in interest rates affecting the return on our cash investments and, to a lesser extent, foreign
currency fluctuations. In the normal course of business, we establish policies and procedures to manage our exposure to fluctuations in interest rates and foreign currency values.



Interest Rate Risks. We invest our cash in a variety of financial instruments, consisting principally of investments
in commercial paper, interest-bearing demand deposit accounts with financial institutions, money market funds and highly liquid debt securities of corporations, municipalities and the U.S. Government. These investments are denominated in U.S.
dollars. Cash balances in foreign currencies overseas are operating balances and are invested in short-term time deposits of the local operating bank.



All of the cash equivalents, short-term and long-term investments are treated as available-for-sale. Investments in both fixed rate and
floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than
expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities that have seen a decline in
market value due to changes in interest rates. However, the Company reduces its interest rate risk by investing its cash in instruments with short maturities.



Foreign Currency Risks. As of April 30, 2003, Versata had operating subsidiaries located in the United Kingdom, Germany, France, Canada, and
Australia. International sales were made mostly from the Companys foreign sales subsidiaries in the local countries and are typically denominated in the local currency of each country. These subsidiaries also incur most of their expenses in
the local currency. Accordingly, foreign subsidiaries use the local currency as their functional currency.



The Companys international business is subject to risks typical of an international business, including, but not limited to, differing economic
conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange volatility. Accordingly, the Companys future results could be materially adversely impacted by changes in these or
other factors.



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The Company is also exposed to foreign exchange rate fluctuations as the financial results of foreign
subsidiaries are translated into U.S. dollars in consolidation. As exchange rates vary, these results, when translated, may vary from expectations and adversely impact overall financial results. We do not currently enter into foreign currency hedge
transactions. Through April 30, 2003, foreign currency fluctuations have not had a material impact on our financial position or results of operations.



Item 4.    Controls and Procedures



(a) Evaluation of disclosure controls and procedures. Our chief executive officer and our chief financial officer, after evaluating the effectiveness of the Companys disclosure controls and
procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-14(c) and 15d-14(c)) as of a date (the Evaluation Date) within 90 days before the filing date of this quarterly report, have concluded that as of the
Evaluation Date, our disclosure controls and procedures were adequate and designed to ensure that material information relating to us and our consolidated subsidiaries would be made known to them by others within those entities.



(b) Changes in internal controls. There were no significant changes in our
internal controls or to our knowledge, in other factors that could significantly affect our disclosure controls and procedures subsequent to the Evaluation Date.







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PART II. OTHER INFORMATION



Item 1.    Legal Proceedings



Securities Class Action and State Derivative Actions



Since April 11, 2001, several securities class action complaints have been filed against us, and certain of our current and former officers and directors. In August 2001, the class action lawsuits were consolidated in
the United States District Court for the Northern District of California. On October 19, 2001, the lead plaintiffs filed an amended class action complaint naming us and certain of our former officers and a current director as defendants. The amended
class action complaint alleges claims under section 10(b) and section 20(a) of the Securities Exchange Act of 1934 and claims under sections 11 and 15 of the Securities Act of 1933. The amended complaint sought an unspecified amount of damages on
behalf of persons who purchased our stock during the class period between March 31, 2000 and April 30, 2001. In July 2002, the parties reached an agreement to settle the class action lawsuit in order to avoid protracted and expensive litigation and
the uncertainty of the outcome at a trial. The agreement for settlement does not constitute any admission of wrongdoing on the part of Versata or the individual defendants. Our settlement calls for a payment of $9.75 million in cash by our insurance
carriers, the issuance of 200,000 shares of our common stock, and for certain corporate therapeutics. The holders of the settlement stock have a put option of $3.50 per share during a period of 20 trading days commencing one year from the date of
distribution; provided however, the put options shall expire if Versata shares trade above $3.50 per share for 15 consecutive trading days during the one year period following the date of distribution of the settlement stock. On February 14, 2003,
the court approved the settlement agreement. We accrued $700,000 for this liability in accrued restructuring and other in fiscal 2002.



Since June 11, 2001, three derivative actions have been filed on our behalf against certain current and former officers and directors in Superior Court of
Alameda County, California. The complaints also name the Company as a nominal defendant. The complaints allege that the defendants breached their fiduciary duties, abused their control of the corporation, and engaged in gross mismanagement of the
corporation, by allegedly making or permitting the Company to make false financial statements and seek, among other things, compensatory damages. In July 2002, in conjunction with the settlement of the securities litigation discussed above, the
parties reached an agreement to settle the derivative action. The settlement calls for certain corporate therapeutics included in the settlement of the securities litigation discussed above. As discussed, the agreement for settlement does not
constitute any admission of wrongdoing on the part of Versata or the individual defendants. On February 14, 2003, the settlement agreement was approved by the court.



Litigation and Other Claims



From time to time, we become subject to legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While
the outcome of these proceedings and claims cannot be predicted with certainty, we do not believe that the outcome of any of these legal matters will have a material adverse effect on our consolidated results of operations, financial position or
cash flows.



Item 6.    Exhibits and Reports on Form 8-K



6(a) Exhibits.

EXHIBIT INDEX



|     | 
|---- | 
|99.1 | 
|     | 
|99.2 | 



6(b) Reports on Form 8-K:



The Company filed a Report on Form 8-K, dated February 11, 2003,
announcing changes in registrants certifying accountant and appointment of a new member to the board of directors.



The Company filed a Report on Form 8-K, dated March 11, 2003, announcing the Company had received a NASDAQ notification letter regarding non-compliance
with the minimum bid price requirement.



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The Company filed a Report on Form 8-K, dated May 20, 2003, announcing appointment of a new member to the
board of directors.



The Company filed a Report on Form 8-K,
dated May 29, 2003, announcing that Kevin Schick, Vice President of Marketing, resigned with the Company effective June 3, 2003.



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SIGNATURES



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



|Dated: June 13, 2003 |  | /s/    EUGENE
WONG                               
|-------------------- |  | -------------------------------------------------
|                     |  | Eugene Wong                                      
|                     |  | Chief Executive Officer and Director             
|                     |  | (Duly Authorized Officer)                        
|                     | 
|Dated: June 13, 2003 |  | /s/    JAMES
DOEHRMAN                            
|                     |  | James Doehrman                                   
|                     |  | Chief Operating Officer, Chief Financial Officer,
|                     |  | Secretary and Executive Vice President           
|                     |  | (Principal Financial Officer)                    





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CERTIFICATION



I, Eugene Wong,
certify that:



1. I have reviewed this
quarterly report on Form 10-Q of Versata, Inc.;



2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this quarterly report;



3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in
all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report.



4. The registrants other certifying officer and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:



a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;



b) evaluated the effectiveness of the registrants disclosure controls and procedures as of a date
within 90 days prior to the filing date of this quarterly report (the Evaluation Date); and



c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;



5. The
registrants other certifying officer and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee of registrants board of directors (or persons performing the equivalent functions):



a) all significant deficiencies in the design
or operation of internal controls which could adversely affect the registrants ability to record, process, summarize and report financial data and have identified for the registrants auditors any material weaknesses in internal controls;
and



b) any fraud, whether or not material,
that involves management or other employees who have a significant role in the registrants internal controls; and



6. The registrants other certifying officer and I have indicated in this quarterly report whether or not there were significant
changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material
weaknesses.





|Date: June 13, 2003 |  | By:                        /s/    EUGENE
WONG   
|------------------- |  | ------------------------------------------------
|                    |  | Eugene Wong Chief Executive Officer and Director

|
|



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CERTIFICATION



I, James Doehrman, certify that:



1. I have reviewed this quarterly report on Form 10-Q of Versata, Inc.;



2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or
omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;



3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report.



4. The registrants other certifying
officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:



a) designed such disclosure controls and procedures to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;



b) evaluated the effectiveness of the registrants disclosure controls and procedures as of a date
within 90 days prior to the filing date of this quarterly report (the Evaluation Date); and



c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;



5. The
registrants other certifying officer and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee of registrants board of directors (or persons performing the equivalent functions):



a) all significant deficiencies in the design
or operation of internal controls which could adversely affect the registrants ability to record, process, summarize and report financial data and have identified for the registrants auditors any material weaknesses in internal controls;
and



b) any fraud, whether or not material,
that involves management or other employees who have a significant role in the registrants internal controls; and



6. The registrants other certifying officer and I have indicated in this quarterly report whether or not there were significant
changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material
weaknesses.



|Date: June 13, 2003 |  | By:            /s/    JAMES
DOEHRMAN                                                        
|------------------- |  | --------------------------------------------------------------------------------------------
|                    |  | James Doehrman Executive Vice President, Chief Operating Officer and Chief Financial
Officer





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