##### Table of Contents



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

FORM 10-Q

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

For the quarterly period ended June 30, 2001

OR

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

FOR THE TRANSITION PERIOD FROM               TO

Commission file number 000-29757

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

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

300 Lakeside Drive, Suite 1500
OAKLAND, CA 94612
(Address of principal executive offices)(Zip Code)

(510) 238-4100
(Registrants telephone number, including area code)



---



Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

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  [   ]

As of July 31, 2001, the total number of outstanding shares of the
Registrants common stock was 42,402,809.





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TABLE OF CONTENTS



|                              |                                                                                               |                                                      |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ---------------------------------------------------- |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION
|                              | ITEM 1. FINANCIAL STATEMENTS                                                                 
|                              |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS               
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS     
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                              |                                                                                               | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|                              | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                              | Item 3. Quantitative and Qualitative Disclosures About Market Risk                           
|PART II. OTHER INFORMATION   
|                              | Item 1. Legal Proceedings                                                                    
|                              | Item 2. Changes in Securities and Use of Proceeds                                            
|                              | Item 4. Submission of Matters to a Vote of Security Holders                                  
|                              | Item 6. Exhibits and Reports On Form 8-K.                                                    
|SIGNATURES                   



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##### Table of Contents



INDEX

|                                                                                                          |  |  |             |  | 
|--------------------------------------------------------------------------------------------------------- |  |  | ----------- |  | 
|                                                                                                          |  |  | PAGE NUMBER
|                                                                                                          |  |  |            
|                                                                                                         
|PART I. FINANCIAL INFORMATION                                                                            
|                                                                                                         
|Item 1. Financial Statements:                                                                             |  |  |             | 
|                                                                                                         
|                                                                                                         
|                                                                                                         
|                                                                                                         
|Condensed
Consolidated Balance Sheets at June 30, 2001 and December 31, 2000                              |  |  | 3           | 
|                                                                                                         
|                                                                                                         
|                                                                                                         
|                                                                                                         
|Condensed
Consolidated Statements of Operations for the Three and Six Months Ended June 30,
2001 and 2000 |  |  | 4           | 
|                                                                                                         
|                                                                                                         
|                                                                                                         
|                                                                                                         
|Condensed
Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 2001 and 2000           |  |  | 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                                        |  |  | 22          | 
|                                                                                                         
|PART II. OTHER INFORMATION                                                                               
|                                                                                                         
|Item 1. Legal Proceedings                                                                                 |  |  | 22          | 
|                                                                                                         
|                                                                                                         
|                                                                                                         
|                                                                                                         
|Item 2. Changes In Securities And Use Of Proceeds                                                         |  |  | 23          | 
|                                                                                                         
|                                                                                                         
|                                                                                                         
|                                                                                                         
|Item 4. Submission Of Matters To A Vote Of Security Holders                                               |  |  | 23          | 
|                                                                                                         
|                                                                                                         
|                                                                                                         
|                                                                                                         
|Item 6. Exhibits And Reports On Form 8-K                                                                  |  |  | 23          | 
|                                                                                                         
|                                                                                                         
|                                                                                                         
|                                                                                                         
|Signatures                                                                                                |  |  | 25          | 

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)

|                                            |                                                                                                  |                                            |        |          |        |              |        |          |         | 
|------------------------------------------- | ------------------------------------------------------------------------------------------------ | ------------------------------------------ | ------ | -------- | ------ | ------------ | ------ | -------- | ------- | 
|                                            |                                                                                                  |                                            |        | JUNE 30, |        | DECEMBER 31,
|                                            |                                                                                                  |                                            |        | 2001     |        | 2000        
|                                            |                                                                                                  |                                            |        |          |        |             
|ASSETS                                      |                                                                                                  |                                            |        |          |        |              |        |         
|                                           
|                                           
|                                           
|                                           
|Current assets:                             |                                                                                                  |                                            |        |          |        |              |        |         
|                                           
|                                           
|                                           
|                                           
|                                            | Cash and cash equivalents                                                                        |                                            | $      | 20,142   |        |              | $      | 39,272   |        
|                                           
|                                           
|                                           
|                                           
|                                            | Short-term investments                                                                           |                                            |        | 10,298   |        |              |        | 29,926   |        
|                                           
|                                           
|                                           
|                                           
|                                            | Accounts receivable, net of allowance of $2,063 at
June 30, 2001 and $1,795 at December 31, 2000 |                                            |        | 12,954   |        |              |        | 14,177   |        
|                                           
|                                           
|                                           
|                                           
|                                            | Unbilled receivables                                                                             |                                            |        | 2,656    |        |              |        | 3,584    |        
|                                           
|                                           
|                                           
|                                           
|                                            | Prepaid expenses and other current assets                                                        |                                            |        | 2,067    |        |              |        | 3,075    |        
|                                            |                                                                                                  |                                            |        |          |        |              |        |         
|                                            |                                                                                                  | Total current assets                       |        |          | 48,117 |              |        |          | 90,034  | 
|                                           
|                                           
|                                           
|                                           
|Restricted cash                             |                                                                                                  |                                            | 5,351  |          |        |              | 5,189  |         
|                                           
|                                           
|                                           
|                                           
|Property and equipment, net                 |                                                                                                  |                                            | 11,903 |          |        |              | 11,901 |         
|                                           
|                                           
|                                           
|                                           
|Notes receivable from related parties       |                                                                                                  |                                            | 104    |          |        |              | 156    |         
|                                           
|                                           
|                                           
|                                           
|Intangible assets                           |                                                                                                  |                                            | 10,120 |          |        |              | 12,205 |         
|                                           
|                                           
|                                           
|                                           
|Other assets                                |                                                                                                  |                                            | 206    |          |        |              | 354    |         
|                                            |                                                                                                  |                                            |        |          |        |              |        |         
|                                            |                                                                                                  | Total assets                               |        | $        | 75,801 |              |        | $        | 119,839 | 
|                                            |                                                                                                  |                                            |        |          |        |              |        |         
|LIABILITIES AND STOCKHOLDERS EQUITY        |                                                                                                  |                                            |        |          |        |              |        |         
|                                           
|                                           
|                                           
|                                           
|Current liabilities:                        |                                                                                                  |                                            |        |          |        |              |        |         
|                                           
|                                           
|                                           
|                                           
|                                            | Accounts payable                                                                                 |                                            | $      | 3,454    |        |              | $      | 9,040    |        
|                                           
|                                           
|                                           
|                                           
|                                            | Accrued liabilities                                                                              |                                            |        | 8,611    |        |              |        | 13,146   |        
|                                           
|                                           
|                                           
|                                           
|                                            | Accrued restructuring                                                                            |                                            |        | 1,401    |        |              |        |         |        
|                                           
|                                           
|                                           
|                                           
|                                            | Accrued stock-based compensation                                                                 |                                            |        |         |        |              |        | 1,095    |        
|                                           
|                                           
|                                           
|                                           
|                                            | Deferred revenue                                                                                 |                                            |        | 9,366    |        |              |        | 8,661    |        
|                                           
|                                           
|                                           
|                                           
|                                            | Current portion of long-term debt                                                                |                                            |        | 116      |        |              |        | 134      |        
|                                            |                                                                                                  |                                            |        |          |        |              |        |         
|                                            |                                                                                                  | Total current liabilities                  |        |          | 22,948 |              |        |          | 32,076  | 
|                                           
|                                           
|                                           
|                                           
|Accrued restructuring, less current portion |                                                                                                  |                                            | 555    |          |        |              |       |         
|                                           
|                                           
|                                           
|                                           
|Long-term debt, less current portion        |                                                                                                  |                                            | 239    |          |        |              | 218    |         
|                                            |                                                                                                  |                                            |        |          |        |              |        |         
|                                            |                                                                                                  | Total liabilities                          |        |          | 23,742 |              |        |          | 32,294  | 
|                                            |                                                                                                  |                                            |        |          |        |              |        |         
|                                           
|                                           
|                                           
|                                           
|Stockholders equity:                       |                                                                                                  |                                            |        |          |        |              |        |         
|                                           
|                                           
|                                           
|                                           
|                                            | Common stock                                                                                     |                                            |        | 44       |        |              |        | 41       |        
|                                           
|                                           
|                                           
|                                           
|                                            | Additional paid-in capital                                                                       |                                            |        | 215,098  |        |              |        | 226,352  |        
|                                           
|                                           
|                                           
|                                           
|                                            | Treasury stock                                                                                   |                                            |        | (1,383   | )      |              |        |         |        
|                                           
|                                           
|                                           
|                                           
|                                            | Notes receivable from stockholders                                                               |                                            |        | (926     | )      |              |        | (3,868   | )      
|                                           
|                                           
|                                           
|                                           
|                                            | Unearned stock-based compensation                                                                |                                            |        | (4,142   | )      |              |        | (13,870  | )      
|                                           
|                                           
|                                           
|                                           
|                                            | Accumulated other comprehensive income (loss)                                                    |                                            |        | (452     | )      |              |        | 166      |        
|                                           
|                                           
|                                           
|                                           
|                                            | Accumulated deficit                                                                              |                                            |        | (156,180 | )      |              |        | (121,276 | )      
|                                            |                                                                                                  |                                            |        |          |        |              |        |         
|                                            |                                                                                                  | Total stockholders equity                 |        |          | 52,059 |              |        |          | 87,545  | 
|                                            |                                                                                                  |                                            |        |          |        |              |        |         
|                                            |                                                                                                  | Total liabilities and stockholders equity |        | $        | 75,801 |              |        | $        | 119,839 | 
|                                            |                                                                                                  |                                            |        |          |        |              |        |         

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
(In thousands, except per share data)
(Unaudited)

|                                                                                      |                                                                                                                                                                                                                                            |   |                          |        |                    |        |                  |        |      |        |         |        |   |        |         |        |  |        | 
|------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | - | ------------------------ | ------ | ------------------ | ------ | ---------------- | ------ | ---- | ------ | ------- | ------ | - | ------ | ------- | ------ |  | ------ | 
|                                                                                      |                                                                                                                                                                                                                                            |   |                          |        | THREE MONTHS ENDED |        | SIX MONTHS ENDED
|                                                                                      |                                                                                                                                                                                                                                            |   |                          |        | JUNE 30,           |        | JUNE 30,        
|                                                                                      |                                                                                                                                                                                                                                            |   |                          |        |                    |        |                 
|                                                                                      |                                                                                                                                                                                                                                            |   |                          |        | 2001               |        | 2000             |        | 2001 |        | 2000   
|                                                                                      |                                                                                                                                                                                                                                            |   |                          |        |                    |        |                  |        |      |        |        
|Revenue:                                                                              |                                                                                                                                                                                                                                            |   |                          |        |                    |        |                  |        |      |        |         |        |   |        |         |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Software license                                                                                                                                                                                                                           |   | $                        | 5,991  |                    |        | $                | 6,077  |      |        | $       | 10,131 |   |        | $       | 10,213 | 
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Services and other fees                                                                                                                                                                                                                    |   |                          | 4,868  |                    |        |                  | 7,798  |      |        |         | 11,760 |   |        |         | 13,768 | 
|                                                                                      |                                                                                                                                                                                                                                            |   |                          |        |                    |        |                  |        |      |        |         |        |   |        |         |       
|                                                                                      |                                                                                                                                                                                                                                            |   | Total revenue            |        |                    | 10,859 |                  |        |      | 13,875 |         |        |   | 21,891 |         |        |  | 23,981 | 
|                                                                                      |                                                                                                                                                                                                                                            |   |                          |        |                    |        |                  |        |      |        |         |        |   |        |         |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Cost of revenue:                                                                      |                                                                                                                                                                                                                                            |   |                          |        |                    |        |                  |        |      |        |         |        |   |        |         |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Software license                                                                                                                                                                                                                           |   |                          | 149    |                    |        |                  | 221    |      |        |         | 306    |   |        |         | 415    | 
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Services (exclusive of stock-based compensation of
$(82) and $1,770 for the three months ended June 30, 2001
and 2000, respectively, and $(897) and $5,818 for the six
months ended June 30, 2001 and 2000, respectively)                  |   |                          | 5,136  |                    |        |                  | 7,596  |      |        |         | 13,524 |   |        |         | 13,074 | 
|                                                                                      |                                                                                                                                                                                                                                            |   |                          |        |                    |        |                  |        |      |        |         |        |   |        |         |       
|                                                                                      |                                                                                                                                                                                                                                            |   | Total cost of revenue    |        |                    | 5,285  |                  |        |      | 7,817  |         |        |   | 13,830 |         |        |  | 13,489 | 
|                                                                                      |                                                                                                                                                                                                                                            |   |                          |        |                    |        |                  |        |      |        |         |        |   |        |         |       
|Gross profit                                                                          |                                                                                                                                                                                                                                            |   | 5,574                    |        |                    |        | 6,058            |        |      |        | 8,061   |        |   |        | 10,492  |       
|                                                                                      |                                                                                                                                                                                                                                            |   |                          |        |                    |        |                  |        |      |        |         |        |   |        |         |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Operating expenses:                                                                   |                                                                                                                                                                                                                                            |   |                          |        |                    |        |                  |        |      |        |         |        |   |        |         |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Sales and marketing (exclusive of stock-based
compensation of $(535) and $3,603 for the three months
ended June 30, 2001 and 2000, respectively and $(815) and
$8,734 for the six months ended June 30, 2001 and 2000,
respectively)       |   |                          | 8,657  |                    |        |                  | 11,493 |      |        |         | 20,597 |   |        |         | 21,682 | 
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Product development (exclusive of stock-based
compensation of $(946) and $847 for the three months
ended June 30, 2001 and 2000, respectively and $(639) and
$1,918 for the six months ended June 30, 2001 and 2000,
respectively)         |   |                          | 2,650  |                    |        |                  | 2,166  |      |        |         | 6,545  |   |        |         | 4,023  | 
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | General and administrative (exclusive of stock-based
compensation of $(151) and $515 for the three months
ended June 30, 2001 and 2000, respectively, and $(228)
and $1,339 for the six months ended June 30, 2001 and
2000, respectively) |   |                          | 3,045  |                    |        |                  | 3,048  |      |        |         | 7,037  |   |        |         | 5,049  | 
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Stock-based compensation                                                                                                                                                                                                                   |   |                          | (1,714 | )                  |        |                  | 6,735  |      |        |         | (2,579 | ) |        |         | 17,809 | 
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Amortization of intangibles                                                                                                                                                                                                                |   |                          | 1,152  |                    |        |                  | 237    |      |        |         | 2,297  |   |        |         | 427    | 
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Restructuring
and other expenses                                                                                                                                                                                                           |   |                          | 3,504  |                    |        |                  |       |      |        |         | 10,413 |   |        |         |       | 
|                                                                                      |                                                                                                                                                                                                                                            |   |                          |        |                    |        |                  |        |      |        |         |        |   |        |         |       
|                                                                                      |                                                                                                                                                                                                                                            |   | Total operating expenses |        |                    | 17,294 |                  |        |      | 23,679 |         |        |   | 44,310 |         |        |  | 48,990 | 
|                                                                                      |                                                                                                                                                                                                                                            |   |                          |        |                    |        |                  |        |      |        |         |        |   |        |         |       
|Loss from operations                                                                  |                                                                                                                                                                                                                                            |   | (11,720                  | )      |                    |        | (17,621          | )      |      |        | (36,249 | )      |   |        | (38,498 | )     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Interest income (expense), net                                                        |                                                                                                                                                                                                                                            |   | 489                      |        |                    |        | 1,619            |        |      |        | 1,398   |        |   |        | 2,284   |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Other income (expense), net                                                           |                                                                                                                                                                                                                                            |   | (53                      | )      |                    |        |                 |        |      |        | (53     | )      |   |        |        |       
|                                                                                      |                                                                                                                                                                                                                                            |   |                          |        |                    |        |                  |        |      |        |         |        |   |        |         |       
|Net loss                                                                              |                                                                                                                                                                                                                                            | $ | (11,284                  | )      |                    | $      | (16,002          | )      |      | $      | (34,904 | )      |   | $      | (36,214 | )     
|                                                                                      |                                                                                                                                                                                                                                            |   |                          |        |                    |        |                  |        |      |        |         |        |   |        |         |       
|Unrealized loss on marketable securities                                              |                                                                                                                                                                                                                                            |   | (37                      | )      |                    |        | (36              | )      |      |        | (14     | )      |   |        | (36     | )     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Foreign
currency translation gain (loss)                                              |                                                                                                                                                                                                                                            |   | (195                     | )      |                    |        | 372              |        |      |        | (603    | )      |   |        | 372     |       
|                                                                                      |                                                                                                                                                                                                                                            |   |                          |        |                    |        |                  |        |      |        |         |        |   |        |         |       
|Comprehensive Loss                                                                    |                                                                                                                                                                                                                                            | $ | (11,516                  | )      |                    | $      | (15,666          | )      |      | $      | (35,521 | )      |   | $      | (35,878 | )     
|                                                                                      |                                                                                                                                                                                                                                            |   |                          |        |                    |        |                  |        |      |        |         |        |   |        |         |       
|Basic and diluted net loss per share                                                  |                                                                                                                                                                                                                                            | $ | (0.28                    | )      |                    | $      | (0.42            | )      |      | $      | (0.87   | )      |   | $      | (1.37   | )     
|                                                                                      |                                                                                                                                                                                                                                            |   |                          |        |                    |        |                  |        |      |        |         |        |   |        |         |       
|Weighted average common shares used in computing basic
and diluted net loss per share |                                                                                                                                                                                                                                            |   | 40,164                   |        |                    |        | 37,698           |        |      |        | 39,949  |        |   |        | 26,444  |       
|                                                                                      |                                                                                                                                                                                                                                            |   |                          |        |                    |        |                  |        |      |        |         |        |   |        |         |       

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

4



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##### Table of Contents






VERSATA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)

|                                                                         |                                                                           |                                                                             |                                                                                            |                                                     |         |                  |         |         |         |        |         |  
|------------------------------------------------------------------------ | ------------------------------------------------------------------------- | --------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------ | --------------------------------------------------- | ------- | ---------------- | ------- | ------- | ------- | ------ | ------- | -
|                                                                         |                                                                           |                                                                             |                                                                                            |                                                     |         | SIX MONTHS ENDED
|                                                                         |                                                                           |                                                                             |                                                                                            |                                                     |         | JUNE 30,        
|                                                                         |                                                                           |                                                                             |                                                                                            |                                                     |         |                 
|                                                                         |                                                                           |                                                                             |                                                                                            |                                                     |         | 2001             |         | 2000   
|                                                                         |                                                                           |                                                                             |                                                                                            |                                                     |         |                  |         |        
|CASH FLOWS FROM OPERATING ACTIVITIES:                                    |                                                                           |                                                                             |                                                                                            |                                                     |         |                  |         |        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           | Net Loss                                                                    |                                                                                            | $                                                   | (34,904 | )                |         | $       | (36,214 | )     
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           | Adjustments to reconcile net loss to net cash
used in operating activities: |                                                                                            |                                                     |         |                  |         |         |         |       
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           |                                                                             | Depreciation and amortization                                                              |                                                     |         | 3,964            |         |         |         | 915    |        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           |                                                                             | Provision for doubtful accounts                                                            |                                                     |         | 1,159            |         |         |         | 1,136  |        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           |                                                                             | Forgiveness of promissory notes in excess of value of shares received                      |                                                     |         | 598              |         |         |         |       |        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           |                                                                             | Write-down of leasehold improvements and office furniture in
connection with restructuring |                                                     |         | 2,894            |         |         |         |       |        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           |                                                                             | Stock-based compensation expense                                                           |                                                     |         | (2,579           | )       |         |         | 17,809 |        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           | Change in operating assets and liabilities:                                 |                                                                                            |                                                     |         |                  |         |         |         |       
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           |                                                                             | Trade accounts receivable                                                                  |                                                     |         | (232             | )       |         |         | (8,858 | )      
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           |                                                                             | Unbilled receivables                                                                       |                                                     |         | 900              |         |         |         | (200   | )      
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           |                                                                             | Prepaid expenses and other current assets                                                  |                                                     |         | 899              |         |         |         | (1,070 | )      
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           |                                                                             | Restricted cash                                                                            |                                                     |         | (162             | )       |         |         | (5,059 | )      
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           |                                                                             | Other assets                                                                               |                                                     |         | 148              |         |         |         | (128   | )      
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           |                                                                             | Accounts payable and accrued liabilities                                                   |                                                     |         | (10,121          | )       |         |         | 4,105  |        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           |                                                                             | Accrued restructuring                                                                      |                                                     |         | 1,956            |         |         |         |       |        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           |                                                                             | Deferred revenues                                                                          |                                                     |         | 705              |         |         |         | 2,807  |        
|                                                                         |                                                                           |                                                                             |                                                                                            |                                                     |         |                  |         |        
|                                                                         |                                                                           |                                                                             |                                                                                            | Net cash used in operating activities               |         |                  | (34,775 | )       |         |        | (24,757 | )
|                                                                         |                                                                           |                                                                             |                                                                                            |                                                     |         |                  |         |        
|CASH FLOWS FROM INVESTING ACTIVITIES:                                    |                                                                           |                                                                             |                                                                                            |                                                     |         |                  |         |        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Maturities of short-term investments                                      |                                                                             |                                                                                            | 19,614                                              |         |                  |         |        |        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Purchases of short-term investments                                       |                                                                             |                                                                                            |                                                    |         |                  |         | (32,202 | )      
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Purchase of property and equipment                                        |                                                                             |                                                                                            | (4,749                                              | )       |                  |         | (3,887  | )      
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Proceeds from sale of property and equipment                              |                                                                             |                                                                                            | 283                                                 |         |                  |         |        |        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Decrease (increase) in notes receivable from related parties              |                                                                             |                                                                                            | 6                                                   |         |                  |         | (146    | )      
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Purchase of intangible assets                                             |                                                                             |                                                                                            |                                                    |         |                  |         | (250    | )      
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Cash paid in connection with acquisitions and subsequent earnout payments |                                                                             |                                                                                            | (187                                                | )       |                  |         | (101    | )      
|                                                                         |                                                                           |                                                                             |                                                                                            |                                                     |         |                  |         |        
|                                                                         |                                                                           |                                                                             |                                                                                            | Net cash provided by (used in) investing activities |         |                  | 14,967  |         |         |        | (36,586 | )
|                                                                         |                                                                           |                                                                             |                                                                                            |                                                     |         |                  |         |        
|CASH FLOWS FROM FINANCING ACTIVITIES:                                    |                                                                           |                                                                             |                                                                                            |                                                     |         |                  |         |        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           | Principal payments on capital lease obligations                             |                                                                                            |                                                     | (38     | )                |         |         | (12     | )     
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           | Principal payments on equipment loan                                        |                                                                                            |                                                     | (52     | )                |         |         | (44     | )     
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           | Net proceeds from issuance of convertible preferred stock                   |                                                                                            |                                                     |        |                  |         |         | 1,500   |       
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           | Net proceeds from issuance of common stock                                  |                                                                                            |                                                     |        |                  |         |         | 96,654  |       
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           | Proceeds from issuance of common stock under
employee stock purchase plan   |                                                                                            |                                                     | 1,429   |                  |         |         |        |       
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           | Proceeds from exercise of stock options and warrants                        |                                                                                            |                                                     | 101     |                  |         |         | 1,589   |       
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           | Repurchase of common stock from stockholders                                |                                                                                            |                                                     | (24     | )                |         |         | (6      | )     
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           | Purchase of treasury stock from former officer                              |                                                                                            |                                                     | (464    | )                |         |         |        |       
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           | Payments from stockholders on notes receivable                              |                                                                                            |                                                     | 5       |                  |         |         | 429     |       
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                           | Loans provided to stockholders                                              |                                                                                            |                                                     |        |                  |         |         | (650    | )     
|                                                                         |                                                                           |                                                                             |                                                                                            |                                                     |         |                  |         |        
|                                                                         |                                                                           |                                                                             |                                                                                            | Net cash provided by financing activities           |         |                  | 957     |         |         |        | 99,460  |  
|                                                                         |                                                                           |                                                                             |                                                                                            |                                                     |         |                  |         |        
|Effects of exchange rate changes on cash and cash equivalents            |                                                                           |                                                                             | (279                                                                                       | )                                                   |         |                  | 372     |        
|                                                                         |                                                                           |                                                                             |                                                                                            |                                                     |         |                  |         |        
|                                                                         |                                                                           |                                                                             |                                                                                            | Increase (decrease) in cash and cash equivalents    |         |                  | (19,130 | )       |         |        | 38,489  |  
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                         |                                                                           |                                                                             | 39,272                                                                                     |                                                     |         |                  | 20,655  |        
|                                                                         |                                                                           |                                                                             |                                                                                            |                                                     |         |                  |         |        
|CASH AND CASH EQUIVALENTS AT END OF PERIOD                               |                                                                           | $                                                                           | 20,142                                                                                     |                                                     |         | $                | 59,144  |        
|                                                                         |                                                                           |                                                                             |                                                                                            |                                                     |         |                  |         |        
|SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION                        |                                                                           |                                                                             |                                                                                            |                                                     |         |                  |         |        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Cash paid during the period for interest                                 |                                                                           | $                                                                           | 28                                                                                         |                                                     |         | $                | 32      |        
|                                                                         |                                                                           |                                                                             |                                                                                            |                                                     |         |                  |         |        
|SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
FINANCING ACTIVITIES      |                                                                           |                                                                             |                                                                                            |                                                     |         |                  |         |        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Common stock issued for notes receivable from stockholders               |                                                                           | $                                                                           |                                                                                           |                                                     |         | $                | 1,813   |        
|                                                                         |                                                                           |                                                                             |                                                                                            |                                                     |         |                  |         |        
|Conversion of preferred stock to common stock on date of public offering |                                                                           | $                                                                           |                                                                                           |                                                     |         | $                | 26      |        
|                                                                         |                                                                           |                                                                             |                                                                                            |                                                     |         |                  |         |        

5



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##### Table of Contents



|                                                                                        |  |   |       |  |  |                  |       |      |  |  |  | 
|--------------------------------------------------------------------------------------- |  | - | ----- |  |  | ---------------- | ----- | ---- |  |  |  | 
|                                                                                        |  |   |       |  |  | SIX MONTHS ENDED
|                                                                                        |  |   |       |  |  | JUNE 30,        
|                                                                                        |  |   |       |  |  |                 
|                                                                                        |  |   |       |  |  | 2001             |       | 2000
|                                                                                        |  |   |       |  |  |                  |       |     
|Issuance of convertible preferred stock in connection with acquisition                  |  | $ |      |  |  | $                | 1,087 |     
|                                                                                        |  |   |       |  |  |                  |       |     
|Property and equipment obtained through capital lease                                   |  | $ |      |  |  | $                | 30    |     
|                                                                                        |  |   |       |  |  |                  |       |     
|Acquisition of treasury stock in exchange for cancellation of note                      |  | $ | 919   |  |  | $                |      |     
|                                                                                        |  |   |       |  |  |                  |       |     
|Notes receivable cancelled in exchange for repurchase of common stock from
stockholders |  | $ | 1,518 |  |  | $                |      |     
|                                                                                        |  |   |       |  |  |                  |       |     

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




VERSATA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Our Company

Versata, Inc. was incorporated on August 27, 1991, and was reincorporated
in the State of Delaware on February 24, 2000. Versata, Inc. helps the worlds
leading companies achieve true business agility by enabling them to create
business rules for their business policies and processes, which are used to
automate the development of transaction-intensive, process-oriented
applications.

2. Interim Financial Information and Basis of Presentation

The accompanying unaudited condensed consolidated financial statements as
of June 30, 2001, and for the three and six month periods ended of June 30,
2001 and 2000, have been prepared 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, and include the accounts of Versata, Inc. and its
wholly-owned subsidiaries (collectively referred to as the Company or Versata.). Intercompany accounts have been eliminated in
consolidation. 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. In the
opinion of management, the unaudited condensed consolidated financial
statements reflect all adjustments (consisting of only normal recurring
adjustments) necessary for fair presentation of the financial position at June
30, 2001, and the operating results for the three and six month periods ended
June 30, 2001 and 2000, and cash flows for the six month periods ended June 30,
2001 and 2000. These unaudited condensed consolidated financial statements
should be read in conjunction with the Companys audited consolidated financial
statements and notes for the year ended December 31, 2000.

The unaudited condensed consolidated balance sheet at December 31, 2000
has been derived from the audited consolidated financial statements at that
date, but does not include all of the information and footnotes required by
generally accepted accounting principles in the United States of America for
complete financial statements.

Certain balances in prior fiscal years have been reclassified to conform to
the presentation adopted in the current fiscal year. The restricted cash balances have been reclassified as a separate caption
in the Consolidated Balance Sheet as of December 31, 2000.

3. Summary of Significant Accounting Policies

Revenue Recognition

Our Company derives revenue from two sources as follows: (i) software
license and maintenance revenue to end users, value added resellers (VARs),
system integrators, independent software vendors, and application service
providers; and (ii) service revenue which includes consulting, training
services and customer support. Our Company records revenue from licensing of
software products to end-users when a license agreement is signed by both
parties, the fee is fixed or determinable, collection is reasonably assured
and delivery of the product has occurred. Generally, our Company provides
payment terms that range from thirty days to ninety days from the invoice date.
Accordingly, payment terms that exceed ninety days are not considered fixed and
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, our Company
recognizes revenue for the delivered elements based upon the residual method.
Undelivered elements consist primarily of post contract customer support
(PCS) and other services such as consulting, mentoring and training. Services
are generally not considered essential to the functionality of the software.
Our Company recognizes revenue allocated to maintenance and support ratably
over the period of the maintenance and the support contracts, which is generally twelve months. For revenue related to consulting services,
our Company recognizes revenue as the

6



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##### Table of Contents



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.

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 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 their effect is antidilutive.
Potential common stock consists of unvested restricted common stock,
incremental common shares issuable upon the exercise of stock
options and, prior to our public offering, incremental preferred
shares issuable upon the exercise of warrants, and shares issuable upon
conversion of the Series A, Series B, Series C, Series D, Series E and Series F
convertible preferred stock.

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

|                                     |                                                                        |   |                    |         |                  |   |       |         |      |   |       |         |   |   |       |         |  
|------------------------------------ | ---------------------------------------------------------------------- | - | ------------------ | ------- | ---------------- | - | ----- | ------- | ---- | - | ----- | ------- | - | - | ----- | ------- | -
|                                     |                                                                        |   | THREE MONTHS ENDED |         | SIX MONTHS ENDED
|                                     |                                                                        |   | JUNE 30,           |         | JUNE 30,        
|                                     |                                                                        |   |                    |         |                 
|                                     |                                                                        |   | 2001               |         | 2000             |   | 2001  |         | 2000
|                                     |                                                                        |   |                    |         |                  |   |       |         |     
|Numerator:                           |                                                                        |   |                    |         |                  |   |       |         |      |   |       |         |   |   |       |        
|                                    
|                                    
|                                    
|                                    
|                                     | Net Loss                                                               |   | $                  | (11,284 | )                |   | $     | (16,002 | )    |   | $     | (34,904 | ) |   | $     | (36,214 | )
|                                     |                                                                        |   |                    |         |                  |   |       |         |      |   |       |         |   |   |       |        
|Denominator:                         |                                                                        |   |                    |         |                  |   |       |         |      |   |       |         |   |   |       |        
|                                    
|                                    
|                                    
|                                    
|                                     | Weighted average shares outstanding                                    |   |                    | 42,900  |                  |   |       | 40,117  |      |   |       | 42,070  |   |   |       | 28,756  |  
|                                    
|                                    
|                                    
|                                    
|                                     | Weighted average unvested shares of common stock
subject to repurchase |   |                    | (2,736  | )                |   |       | (2,419  | )    |   |       | (2,121  | ) |   |       | (2,312  | )
|                                     |                                                                        |   |                    |         |                  |   |       |         |      |   |       |         |   |   |       |        
|                                     | Denominator for basic and diluted calculation                          |   |                    | 40,164  |                  |   |       | 37,698  |      |   |       | 39,949  |   |   |       | 26,444  |  
|                                     |                                                                        |   |                    |         |                  |   |       |         |      |   |       |         |   |   |       |        
|Basic and diluted net loss per share |                                                                        | $ | (0.28              | )       |                  | $ | (0.42 | )       |      | $ | (0.87 | )       |   | $ | (1.37 | )      
|                                     |                                                                        |   |                    |         |                  |   |       |         |      |   |       |         |   |   |       |        

The following table sets forth potential shares of common stock that are
not included in the diluted net loss per share calculation above because to do
so would be antidilutive for the periods presented (in thousands):

|                                                     |                                                  |                                                                                                                     |  |                    |        |                  |  |       |       |      |  |       |        |  |  |       |        | 
|---------------------------------------------------- | ------------------------------------------------ | ------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ------ | ---------------- |  | ----- | ----- | ---- |  | ----- | ------ |  |  | ----- | ------ | 
|                                                     |                                                  |                                                                                                                     |  | THREE MONTHS ENDED |        | SIX MONTHS ENDED
|                                                     |                                                  |                                                                                                                     |  | JUNE 30,           |        | JUNE 30,        
|                                                     |                                                  |                                                                                                                     |  |                    |        |                 
|                                                     |                                                  |                                                                                                                     |  | 2001               |        | 2000             |  | 2001  |       | 2000
|                                                     |                                                  |                                                                                                                     |  |                    |        |                  |  |       |       |     
|Weighted average effect of common stock equivalents: |                                                  |                                                                                                                     |  |                    |        |                  |  |       |       |      |  |       |        |  |  |      
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Unvested common stock subject to repurchase      |                                                                                                                     |  | 2,736              |        |                  |  | 2,419 |       |      |  | 2,121 |        |  |  | 2,312 |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Options outstanding                              |                                                                                                                     |  | 9,901              |        |                  |  | 6,913 |       |      |  | 9,529 |        |  |  | 6,645 |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Shares resulting from the conversion of the:     |                                                                                                                     |  |                    |        |                  |  |       |       |      |  |       |        |  |  |       |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                  | Series A convertible preferred stock                                                                                |  |                    |       |                  |  |       |      |      |  |       |       |  |  |       | 625    | 
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                  | Series B convertible preferred stock                                                                                |  |                    |       |                  |  |       |      |      |  |       |       |  |  |       | 1,834  | 
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                  | Series C convertible preferred stock                                                                                |  |                    |       |                  |  |       |      |      |  |       |       |  |  |       | 2,616  | 
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                  | Series D convertible preferred stock                                                                                |  |                    |       |                  |  |       |      |      |  |       |       |  |  |       | 2,911  | 
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                  | Series E convertible preferred stock                                                                                |  |                    |       |                  |  |       |      |      |  |       |       |  |  |       | 1,876  | 
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                  | Series F convertible preferred stock                                                                                |  |                    |       |                  |  |       |      |      |  |       |       |  |  |       | 1,329  | 
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Warrants to purchase convertible preferred stock |                                                                                                                     |  |                   |        |                  |  | 95    |       |      |  |      |        |  |  | 151   |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Warrants to purchase common stock                |                                                                                                                     |  |                   |        |                  |  | 240   |       |      |  |      |        |  |  | 357   |       
|                                                     |                                                  |                                                                                                                     |  |                    |        |                  |  |       |       |      |  |       |        |  |  |      
|                                                     |                                                  | Total common stock equivalents excluded from the computation
of earnings per share as their effect was antidilutive |  |                    | 12,637 |                  |  |       | 9,667 |      |  |       | 11,650 |  |  |       | 20,656 | 
|                                                     |                                                  |                                                                                                                     |  |                    |        |                  |  |       |       |      |  |       |        |  |  |      

In April of 2001, the Company approved the issuance of 2,585,473 shares of
common stock to certain of its officers, which are subject to repurchase by the
Company. The repurchase rights relating to 1,382,873 of the
shares expire over two years, while the remaining 1,202,600 shares
granted are subject to repurchase rights which expire over 50 months.
The issuance of the 2,585,473 shares resulted in stock-based
compensation expense of $100,000 in the second quarter of 2001. An
additional $565,000 has been recorded as unearned stock-based
compensation and will be expensed on an accelerated basis over the
remaining 48 months in which the repurchase rights expire. In
connection with the issuance of restricted shares, 1,479,291 stock options held
by the same officers were cancelled.

7



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##### Table of Contents



Segment Information

Effective January 1, 1998, our Company adopted the provisions of SFAS No.
131, Disclosures about Segments of an Enterprise and Related Information.
Versata identifies its operating segments based on the business activities,
management responsibility and geographical location. Revenue for geographic
regions reported below are based upon the customers locations. Following is a
summary of the geographic information related to revenues (in thousands):

|                          |                     |   |                             |       |                           |   |        |        |      |   |        |        |  |   |        |        | 
|------------------------- | ------------------- | - | --------------------------- | ----- | ------------------------- | - | ------ | ------ | ---- | - | ------ | ------ |  | - | ------ | ------ | 
|                          |                     |   | THREE MONTHS ENDED JUNE 30, |       | SIX MONTHS ENDED JUNE 30,
|                          |                     |   |                             |       |                          
|                          |                     |   | 2001                        |       | 2000                      |   | 2001   |        | 2000
|                          |                     |   |                             |       |                           |   |        |        |     
|Software license revenue: |                     |   |                             |       |                           |   |        |        |      |   |        |        |  |   |        |       
|                         
|                         
|                         
|                         
|                          | United States       |   | $                           | 2,474 |                           |   | $      | 4,302  |      |   | $      | 4,813  |  |   | $      | 7,390  | 
|                         
|                         
|                         
|                         
|                          | Europe              |   |                             | 3,517 |                           |   |        | 1,459  |      |   |        | 5,178  |  |   |        | 2,454  | 
|                         
|                         
|                         
|                         
|                          | Other international |   |                             |      |                           |   |        | 316    |      |   |        | 140    |  |   |        | 369    | 
|                          |                     |   |                             |       |                           |   |        |        |      |   |        |        |  |   |        |       
|                          |                     | $ | 5,991                       |       |                           | $ | 6,077  |        |      | $ | 10,131 |        |  | $ | 10,213 |       
|                          |                     |   |                             |       |                           |   |        |        |      |   |        |        |  |   |        |       
|                         
|                         
|                         
|                         
|Services revenue:         |                     |   |                             |       |                           |   |        |        |      |   |        |        |  |   |        |       
|                         
|                         
|                         
|                         
|                          | United States       |   | $                           | 3,746 |                           |   | $      | 6,308  |      |   | $      | 9,038  |  |   | $      | 11,930 | 
|                         
|                         
|                         
|                         
|                          | Europe              |   |                             | 1,122 |                           |   |        | 1,490  |      |   |        | 2,385  |  |   |        | 1,838  | 
|                         
|                         
|                         
|                         
|                          | Other international |   |                             |      |                           |   |        |       |      |   |        | 337    |  |   |        |       | 
|                          |                     |   |                             |       |                           |   |        |        |      |   |        |        |  |   |        |       
|                          |                     | $ | 4,868                       |       |                           | $ | 7,798  |        |      | $ | 11,760 |        |  | $ | 13,768 |       
|                          |                     |   |                             |       |                           |   |        |        |      |   |        |        |  |   |        |       
|                         
|                         
|                         
|                         
|Total revenue:            |                     |   |                             |       |                           |   |        |        |      |   |        |        |  |   |        |       
|                         
|                         
|                         
|                         
|                          | United States       |   | $                           | 6,220 |                           |   | $      | 10,610 |      |   | $      | 13,851 |  |   | $      | 19,320 | 
|                         
|                         
|                         
|                         
|                          | Europe              |   |                             | 4,639 |                           |   |        | 2,949  |      |   |        | 7,563  |  |   |        | 4,292  | 
|                         
|                         
|                         
|                         
|                          | Other international |   |                             |      |                           |   |        | 316    |      |   |        | 477    |  |   |        | 369    | 
|                          |                     |   |                             |       |                           |   |        |        |      |   |        |        |  |   |        |       
|                          |                     | $ | 10,859                      |       |                           | $ | 13,875 |        |      | $ | 21,891 |        |  | $ | 23,981 |       
|                          |                     |   |                             |       |                           |   |        |        |      |   |        |        |  |   |        |       

Long-lived assets, predominantly intangibles and property, plant and
equipment, are based on the location of the assets, or, for intangibles, the
location of the entity owning the intangible asset. As of June 30, 2001, and
December 31, 2000, approximately $21,083,000 and $22,798,000, respectively, of
long-lived assets were located in the United States, $836,000 and $1,054,000,
respectively, were located in Europe, and $104,000 and $254,000, respectively,
were located elsewhere.

Recent Accounting Pronouncements

In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133 establishes a new model for
accounting for derivatives and hedging activities and supercedes and amends a
number of existing accounting standards. SFAS No. 133 requires that all
derivatives be recognized in the balance sheet at their fair market value and
that the corresponding derivative gains or losses be reported either in the
statement of operations or as a deferred item depending on the type of hedge
relationship that exists with respect to these derivatives. In July 1999, the
Financial Accounting Standards Board issued SFAS No. 137, Accounting for
Derivative Instruments and Hedging Activities  Deferral of the Effective Date
of FASB Statement No. 133. SFAS No. 137 deferred the effective date until
fiscal years commencing after June 15, 2000. In June 2000, the FASB issued SFAS
No. 138, Accounting for Certain Derivative Instruments and Certain Hedging
Activities  An Amendment of FASB Statement No. 133, which amended the
accounting and reporting standards for certain derivative instruments and
hedging activities. Accordingly, we have adopted SFAS No. 133 in the quarter
ending March 31, 2001, and the adoption did not have a material impact on our
financial condition or results of operations or cash flows.

In July 2001, the FASB issued
Statement of Financial Accounting Standards No. 141 (SFAS 141), Business
Combinations. SFAS 141 requires the purchase method of accounting for business
combinations initiated after June 30, 2001 and eliminates the
pooling-of-interests method. We believe that the adoption of SFAS 141 will not
have a significant impact on our financial statements.

In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 142 (SFAS 142), Goodwill and Other Intangible Assets, which is
effective for fiscal years beginning after March 15, 2001. SFAS 142 requires,
among other things, the discontinuance of goodwill amortization. In addition,
the standard 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 impairment
of existing goodwill and other intangibles. We are currently assessing but
have not yet determined the impact of SFAS 142 on our financial position and
results of operations.

8



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##### Table of Contents



4. Restructuring and Other Expenses

In January 2001, we implemented a cost cutting initiative that included
a reduction in total staff of approximately 70 people, or 13% of the
total workforce. This reduction impacted all departments, but primarily
reflected a shift in the strategy of our services organization.

In March 2001, the Company announced a restructuring plan to streamline
operations, enhance customer focus and reduce costs. Overall expense reductions
were necessary both to lower existing cost structure and to better align the
work force with customer needs. The restructuring plan was precipitated by the
changing economic conditions and declining revenues from recent past quarters.
Management effected the restructuring plan during the first quarter of 2001 by
eliminating approximately 107 employees and contractor positions in
all departments and reducing office space and related
overhead expenses beginning in the second quarter of 2001. In
connection with the reduction in office space, certain leasehold
improvements and office furniture totaling $2.9 million were written
off and included in restructuring and other expenses in the first
quarter of 2001.

Our Company holds an investment in the preferred stock of Tru Markets,
Inc., a privately held corporation. In January 2001, we provided the investee
with a $500,000 bridge loan. As of December 31, 2000 the investee was in the
process of developing its products and was actively negotiating with third
parties for additional financing to fund its operations. During March 2001, the
investees attempts to obtain sufficient additional financing
failed and the investee began efforts to sell the Company. The $500,000 loan
was recorded in restructuring and other expenses in the first quarter of 2001.
In June 2001, Tru Markets, Inc. was acquired by MortgageSight Holding
LLC (MortgageSight) and
our investment and loan were converted to 22.122 shares of preferred stock, or less than 1% of
MortgageSight.

In April 2001, we expensed our deductible amount for directors and
officers liability insurance of $350,000 as restructuring and other expenses.
This is a result of securities class action complaints filed
against us and several of our current and former officers and directors (see
Note 6).

In May 2001, the Company took further actions to restructure and
streamline operations which consisted primarily of additional
reductions of approximately 50
employee positions and several field offices. We expect that the majority of the
remaining restructuring actions such as office closures will be completed by
the end of the third quarter of 2001. Obligations related to subleasing will
continue until 2008 and are accrued for as of June 30, 2001.

The following table summarizes the components of the restructuring and
other expenses, by geographic region (in thousands):

|                                                |  |           |       |                |  |                |       |                |  |       |       |           |  |   |       |  |  |               |     |  |  |       |       | 
|----------------------------------------------- |  | --------- | ----- | -------------- |  | -------------- | ----- | -------------- |  | ----- | ----- | --------- |  | - | ----- |  |  | ------------- | --- |  |  | ----- | ----- | 
|                                                |  |           |       |                |  |                |       |                |  |       |       |           |  |   |       |  |  |               |     |  |  | Total
|                                                |  |           |       |                |  | Office closure |       | Asset          |  |       |       |           |  |   |       |  |  | Restructuring
|                                                |  | Employee  |       | and Subleasing |  | Disposal       |       | Nonrecoverable |  | Other |       | and
Other
|                                                |  | Severance |       | Costs          |  | Losses         |       | Loans          |  | Costs |       | Expenses 
|                                                |  |           |       |                |  |                |       |                |  |       |       |          
|First Quarter of 2001:                          |  |           |       |                |  |                |       |                |  |       |       |           |  |   |       |  |  |               |     |  |  |       |       | 
|                                               
|                                               
|                                               
|                                               
|United States                                   |  | $         | 1,033 |                |  | $              | 1,703 |                |  | $     | 3,210 |           |  | $ | 500   |  |  | $             | 334 |  |  | $     | 6,780 | 
|                                               
|                                               
|                                               
|                                               
|EMEA                                            |  |           | 111   |                |  |                |      |                |  |       |      |           |  |   |      |  |  |               |    |  |  |       | 111   | 
|                                               
|                                               
|                                               
|                                               
|Canada and Asia Pacific                         |  |           | 18    |                |  |                |      |                |  |       |      |           |  |   |      |  |  |               |    |  |  |       | 18    | 
|                                                |  |           |       |                |  |                |       |                |  |       |       |           |  |   |       |  |  |               |     |  |  |       |       | 
|Consolidated expense                            |  |           | 1,162 |                |  |                | 1,703 |                |  |       | 3,210 |           |  |   | 500   |  |  |               | 334 |  |  |       | 6,909 | 
|                                               
|                                               
|                                               
|                                               
|Cash payments prior to March 31, 2001           |  |           | 458   |                |  |                | 238   |                |  |       | 2,895 |           |  |   | 500   |  |  |               | 161 |  |  |       | 4,252 | 
|                                                |  |           |       |                |  |                |       |                |  |       |       |           |  |   |       |  |  |               |     |  |  |       |       | 
|Accrual balance, March 31, 2001                 |  | $         | 704   |                |  | $              | 1,465 |                |  | $     | 315   |           |  | $ |      |  |  | $             | 173 |  |  | $     | 2,657 | 
|                                                |  |           |       |                |  |                |       |                |  |       |       |           |  |   |       |  |  |               |     |  |  |       |       | 
|Second Quarter of 2001:                         |  |           |       |                |  |                |       |                |  |       |       |           |  |   |       |  |  |               |     |  |  |       |       | 
|                                               
|                                               
|                                               
|                                               
|United States                                   |  | $         | 450   |                |  | $              | 222   |                |  | $     | 369   |           |  | $ | 1,122 |  |  | $             | 572 |  |  | $     | 2,735 | 
|                                               
|                                               
|                                               
|                                               
|EMEA                                            |  |           | 758   |                |  |                |      |                |  |       |      |           |  |   |      |  |  |               |    |  |  |       | 758   | 
|                                               
|                                               
|                                               
|                                               
|Canada and Asia Pacific                         |  |           | 11    |                |  |                |      |                |  |       |      |           |  |   |      |  |  |               |    |  |  |       | 11    | 
|                                                |  |           |       |                |  |                |       |                |  |       |       |           |  |   |       |  |  |               |     |  |  |       |       | 
|Consolidated expense                            |  |           | 1,219 |                |  |                | 222   |                |  |       | 369   |           |  |   | 1,122 |  |  |               | 572 |  |  |       | 3,504 | 
|                                               
|                                               
|                                               
|                                               
|Non-cash portion                                |  |           |      |                |  |                |      |                |  |       | 200   |           |  |   | 598   |  |  |               |    |  |  |       | 798   | 
|                                               
|                                               
|                                               
|                                               
|Cash payments during the second quarter of 2001 |  |           | 1,417 |                |  |                | 535   |                |  |       | 484   |           |  |   | 524   |  |  |               | 447 |  |  |       | 3,407 | 
|                                                |  |           |       |                |  |                |       |                |  |       |       |           |  |   |       |  |  |               |     |  |  |       |       | 
|Accrual balance, June 30, 2001                  |  | $         | 506   |                |  | $              | 1,152 |                |  | $     |      |           |  | $ |      |  |  | $             | 298 |  |  | $     | 1,956 | 
|                                                |  |           |       |                |  |                |       |                |  |       |       |           |  |   |       |  |  |               |     |  |  |       |       | 

5. Related Party Transactions

In January, 2001, we provided a guarantee to a financial institution to
secure a loan of $1,000,000 made to an officer of our Company by the financial
institution. The guarantee and the loan were secured with 559,300 shares of our
Companys common stock owned by the officer and the officer delivered a full
recourse reimbursement agreement to our Company. In April 2001, the financial

9



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institution requested payment of the loan and we paid $988,000 under our
guarantee obligations. In connection with the payment by our Company, we
received the right to receive proceeds from the remaining 549,300 shares from
the officer as well as a guarantee to repay any amounts due in excess of the
value of the shares. On the date of the payment to the financial institution,
the fair market value of the 549,300 shares was $464,000 and has been recorded
as treasury shares, and $524,000 has been included in
restructuring and other expenses. In June 2001, the guarantee to repay amounts
due in excess of the value of the shares was forgiven in connection
with the separation and release agreement regarding the termination
of the officers employment discussed below.

In June 2001, in connection with the same officers termination of
employment, we cancelled promissory notes and accrued interest totaling
$1,517,000 in exchange for 770,009 shares of our Companys common stock owned
by the officer. On the date of the agreement, the fair market value of the
770,009 shares was $919,000 and has been recorded as treasury shares and
$598,000 has been included in restructuring and other expenses.

6. Legal Proceedings

Since April 11, 2001, several securities class action complaints were
filed against us, and certain of our current and former officers and directors.
The complaints allege violations of the federal securities laws. The complaints
seek an unspecified amount of damages on behalf of persons who purchased our
stock during the proposed class periods. The actions are subject to
consolidation under the Private Securities Litigation Reform Act of 1995, which
requires the consolidation of similar securities class actions and the
appointment of a lead plaintiff who pursues the action on behalf of the
consolidated class.

Until the consolidated amended complaint is filed, it is premature to come to
any conclusions as to the allegations and potential damages. We intend to
defend these actions vigorously. There can be no assurance that the pending
actions will be resolved without costly litigation, or in a manner that is not
materially adverse to our financial position, results of operations or cash
flows. No estimate can be made of the possible loss or possible range of loss
associated with the resolution of these contingencies.

Since June 11, 2001, several derivative action on behalf of Versata, Inc. were
filed against certain current and former officers and directors in California
state court. The complaints also name the Company as a nominal defendant. The
complaint 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.

At this early stage in the litigation, it is premature to come to any
conclusions as to the allegations and the impact that the claim could have on
the Company.




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

The following Managements Discussion and Analysis of Financial Condition
and Results of Operations of Versata should be read in conjunction with the
condensed consolidated financial statements of Versata and the accompanying
notes included in this Form 10-Q. This discussion contains forward-looking
statements within the meaning of the Private Securities Act of 1995. These
statements may contain words such as expects, anticipates, intends,
plans, believes, estimates, or other words indicating future results.
These forward-looking statements are based on managements current
expectations, assumptions and projections and entail various risks and
uncertainties including those set forth below under Risk Factors That May
Affect Future Results, that could cause actual results to differ materially
from those projected in the forward-looking statements. Versata undertakes no
obligation to revise or publicly 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 for
enterprise applications is developed and maintained. 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
from 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.

We derive our revenue
from the license of software products and from
the sale of related services. Our software is generally priced on a per server basis.
Software license revenue also includes product maintenance, which provides the
customer with unspecified software upgrades over a specified term, typically
twelve months. Services revenue consists of fees from professional services,
training, and customer support. Professional services include 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, while customer support is priced based on the
particular level of support chosen by the customer.

We recognize revenue in accordance with Statement of Position 97-2,
Software Revenue Recognition. Software license revenue is recognized when both
parties sign a license agreement, the fee is fixed or determinable, collection
is reasonably assured and delivery of the product has occurred. Our customers
usually purchase maintenance agreements for product updates, and revenue is
recognized ratably over the term of the agreement, typically one year, as a
component of software license revenue. We bill professional service fees
generally on a time-and-materials basis and recognize revenue as the services
are performed. Services are not generally essential to the functionality of
the software. In instances where the services are deemed essential to the
software, both the software license and consulting fees are recognized using
the percentage-of-completion method of contract accounting. Fees from
arrangements that provide for extended payment terms are recognized as revenue
when payments become due. The portion of fees related to either products
delivered or services rendered which are not due under our standard payment
terms is reflected in deferred revenue and in unbilled receivables until
payments become due. Deferred revenue balances also include amounts billed in
advance of services rendered.

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, companies that custom
develop and integrate software applications

10



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and companies that sell software applications over the Internet on a
subscription services basis, often referred to as application service
providers.

Net revenues from international sales represented 42.7% of our total
revenue in the second quarter of 2001 and 23.5% of our total revenue in the
same period last year. Net revenues from international sales represented 36.7%
of our total revenue in the six months ended June 30, 2001 and 19.4% of our
total revenue in the same period last year. The increase in the international
revenue mix during the first half of 2001 over the same period last year is a
result of the European office openings during the beginning of fiscal year
2000. In addition, revenue derived from our reseller agreement with
IBM accounted for 29.4% of our total revenues and 66.2% of our
international revenues in the second quarter of 2001.

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 and distribution costs. Our cost of
service revenue consists of salaries of professional service personnel, and
payments to third party consultants incurred in providing customer support,
training, and consulting services. Cost of services revenue as a percentage of
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.

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. 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 and had an
accumulated deficit of $156.2 million and $121.3 million as of June 30, 2001
and December 31, 2000, respectively.

In January 2001, we implemented a cost cutting initiative that included
a reduction in total staff of approximately 70 people, or 13% of the
total workforce. This reduction impacted all departments, but primarily
reflected a shift in the strategy of our services organization.

In March 2001, we announced a restructuring effort to realign the
companys expenses with a business plan geared to the changing economy. This
restructuring was designed to align the workforce with customer needs and focus
on core business products. The restructuring plan includes the discontinuation
of further development of non-core business products, facility consolidations,
and a reduction in total staff, including domestic and international employees
and contractors, including staff in our subsidiaries, of
approximately 107 positions across all departments. We
expensed $6.9 million for restructuring and other expenses in the
first quarter of 2001.

Our Company holds an investment in the preferred stock of Tru Markets,
Inc., a privately held corporation. In January 2001, we provided the investee
with a $500,000 bridge loan. As of December 31, 2000 the investee was in the
process of developing its products and was actively negotiating with third
parties for additional financing to fund its operations. During March 2001, the
investees attempts to obtain sufficient additional financing
failed and the investee began efforts to sell the Company. The $500,000 loan
was recorded in restructuring and other expenses in the first quarter of 2001.
In June 2001, True Markets, Inc. was acquired by MortgageSight
Holding LLC (MortgageSight) and
our investment and loan were converted to 22.122 shares of preferred stock, or less than 1% of
MortgageSight.

In April 2001, we expensed our deductible amount for directors and
officers liability insurance of $350,000 as restructuring and other expenses.
This is a result of securities class action complaints filed
against us and several of our current and former officers and directors (see
Note 6).

In May 2001, we
further reduced staff by approximately 50 positions, across all
departments, and closed additional field offices.
We expensed $3.5 million for restructuring and other expenses in the
second quarter of 2001.

11



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##### Table of Contents



Results of Operations

The following table sets forth for the periods indicated the percentage
revenues represented by certain lines in our Condensed Consolidated Statements
of Operations:

|                        |                                 |  |                             |       |                           |  |        |      |      |  |        |       |   |  |        |      |  
|----------------------- | ------------------------------- |  | --------------------------- | ----- | ------------------------- |  | ------ | ---- | ---- |  | ------ | ----- | - |  | ------ | ---- | -
|                        |                                 |  | THREE MONTHS ENDED JUNE 30, |       | SIX MONTHS ENDED JUNE 30,
|                        |                                 |  |                             |       |                          
|                        |                                 |  | 2001                        |       | 2000                      |  | 2001   |      | 2000
|                        |                                 |  |                             |       |                           |  |        |      |     
|Revenue:                |                                 |  |                             |       |                           |  |        |      |      |  |        |       |   |  |        |     
|                       
|                       
|                       
|                       
|                        | Software license                |  |                             | 55.2  | %                         |  |        | 43.8 | %    |  |        | 46.3  | % |  |        | 42.6 | %
|                       
|                       
|                       
|                       
|                        | Services                        |  |                             | 44.8  | %                         |  |        | 56.2 | %    |  |        | 53.7  | % |  |        | 57.4 | %
|                        |                                 |  |                             |       |                           |  |        |      |      |  |        |       |   |  |        |     
|Total revenue           |                                 |  | 100.0                       | %     |                           |  | 100.0  | %    |      |  | 100.0  | %     |   |  | 100.0  | %   
|                        |                                 |  |                             |       |                           |  |        |      |      |  |        |       |   |  |        |     
|                       
|                       
|                       
|                       
|Cost of Revenue:        |                                 |  |                             |       |                           |  |        |      |      |  |        |       |   |  |        |     
|                       
|                       
|                       
|                       
|                        | Software license                |  |                             | 1.4   | %                         |  |        | 1.6  | %    |  |        | 1.4   | % |  |        | 1.7  | %
|                       
|                       
|                       
|                       
|                        | Services                        |  |                             | 47.3  | %                         |  |        | 54.7 | %    |  |        | 61.8  | % |  |        | 54.5 | %
|                        |                                 |  |                             |       |                           |  |        |      |      |  |        |       |   |  |        |     
|Total cost of revenue   |                                 |  | 48.7                        | %     |                           |  | 56.3   | %    |      |  | 63.2   | %     |   |  | 56.2   | %   
|                        |                                 |  |                             |       |                           |  |        |      |      |  |        |       |   |  |        |     
|Gross profit            |                                 |  | 51.3                        | %     |                           |  | 43.7   | %    |      |  | 36.8   | %     |   |  | 43.8   | %   
|                        |                                 |  |                             |       |                           |  |        |      |      |  |        |       |   |  |        |     
|Operating expense:      |                                 |  |                             |       |                           |  |        |      |      |  |        |       |   |  |        |     
|                       
|                       
|                       
|                       
|                        | Sales and marketing             |  |                             | 79.7  | %                         |  |        | 82.8 | %    |  |        | 94.1  | % |  |        | 90.4 | %
|                       
|                       
|                       
|                       
|                        | Product development             |  |                             | 24.4  | %                         |  |        | 15.6 | %    |  |        | 29.9  | % |  |        | 16.8 | %
|                       
|                       
|                       
|                       
|                        | General and administrative      |  |                             | 28.0  | %                         |  |        | 22.0 | %    |  |        | 32.1  | % |  |        | 21.1 | %
|                       
|                       
|                       
|                       
|                        | Stock-based compensation        |  |                             | -15.8 | %                         |  |        | 48.5 | %    |  |        | -11.8 | % |  |        | 74.3 | %
|                       
|                       
|                       
|                       
|                        | Amortization of intangibles     |  |                             | 10.6  | %                         |  |        | 1.7  | %    |  |        | 10.5  | % |  |        | 1.8  | %
|                       
|                       
|                       
|                       
|                        | Restructuring
and other expense |  |                             | 32.3  | %                         |  |        | 0.0  | %    |  |        | 47.6  | % |  |        | 0.0  | %
|                        |                                 |  |                             |       |                           |  |        |      |      |  |        |       |   |  |        |     
|Total operating expense |                                 |  | 159.3                       | %     |                           |  | 170.7  | %    |      |  | 202.4  | %     |   |  | 204.3  | %   
|                        |                                 |  |                             |       |                           |  |        |      |      |  |        |       |   |  |        |     
|Loss from operations    |                                 |  | -107.9                      | %     |                           |  | -127.0 | %    |      |  | -165.6 | %     |   |  | -160.5 | %   
|                       
|                       
|                       
|                       
|Interest income, net    |                                 |  | 4.5                         | %     |                           |  | 11.7   | %    |      |  | 6.4    | %     |   |  | 9.5    | %   
|                       
|                       
|                       
|                       
|Other, net              |                                 |  | -0.5                        | %     |                           |  | 0.0    | %    |      |  | -0.2   | %     |   |  | 0.0    | %   
|                        |                                 |  |                             |       |                           |  |        |      |      |  |        |       |   |  |        |     
|Net loss                |                                 |  | -103.9                      | %     |                           |  | -115.3 | %    |      |  | -159.4 | %     |   |  | -151.0 | %   
|                        |                                 |  |                             |       |                           |  |        |      |      |  |        |       |   |  |        |     

Revenue

Total revenue consists of software license revenue and services revenue.
Total revenue decreased $3.0 million, or 21.7%, to $10.9 million in the
second quarter of 2001 from $13.9 million in the same period last year. For the
six months ended June 30, 2001, total revenue decreased $2.1 million, or
8.7%, to $21.9 million from $24.0 million in the same period last year. This
decrease is principally attributable to the decrease in services revenue, which
is a result of the decrease in IT spending due to overall market conditions, as
well as our shifting away from becoming a services provider.

Software License Revenue

Software license revenue decreased $0.1 million, or 1.4% to
$6.0 million in the second quarter of 2001 from $6.1 million in the same period last year. For
the six months ended June 30, 2001, software license revenue decreased $0.1
million, or 0.8%, to $10.1 million from $10.2 million in the same period last
year. Software license revenues are fairly consistent with the prior year
periods due to an increase in software license revenue from European customers,
offset by a decrease in domestic software license revenues.

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European software license revenues accounted for 58.7% of license revenues
in the second quarter of 2001 versus 24.0% in the same period last year.

Services Revenue

Services revenue decreased $2.9 million, or 37.6%, to $4.9 million in
the second quarter of 2001 from $7.8 million in the same period last year. For
the six months ended June 30, 2001, services revenue decreased $2.0 million,
or 14.6%, to $11.8 million from $13.8 million in the same period last year.
These decreases were attributable to the decrease in IT spending on consulting
services due to overall market conditions as well as our shift away from
providing consulting services implementation work to a strategy of providing
training and mentoring.

Cost of Revenue

Total cost of revenue consists of cost of software license revenue and
cost of service revenue. Total cost of revenue decreased $2.5 million, or
32.4%, to $5.3 million in the second quarter of 2001 from $7.8 million in the
same period last year. This decrease was mainly attributable to managements
restructuring plan initiated in the first quarter of 2001 which resulted in
savings in personnel, subcontracting, and office costs beginning in April of
2001. For the six months ended June 30, 2001, total cost of revenue increased
$0.3 million, or 2.5%, to $13.8 million, from $13.5 million in the same
period last year. This is due to an increase in services personnel from the
first quarter of 2001 over first quarter of 2000, offset by reductions at the
end of the first quarter of 2001 which resulted in savings in the second
quarter of 2001.

Cost of Software License Revenue

Cost of software license revenue consists of royalty payments to third
parties for technology incorporated into our product, the cost of manuals and
product documentation, as well as packaging and distribution costs. Cost of
software license revenue decreased $72,000 or 32.6%, to $149,000 in the
second quarter of 2001 from $221,000 in the same period last year. For the six
months ended June 30, 2001, cost of software license revenue decreased
$109,000, or 26.3%, to $306,000 from $415,000 in the same period last year.
Although software license revenues were fairly consistent with the same periods
in the prior year, the costs decreased due to a change in the mix of royalty
rates paid to third parties.

Cost of Services Revenue

Cost of service revenue consists of salaries of professional service
personnel and payments to third party consultants incurred in providing
customer support, training, and consulting services. Cost of service revenue
decreased $2.5 million, or 32.4%, to $5.1 million in the second quarter of
2001 from $7.6 million in the same period last year. This decrease is mainly
attributable to managements restructuring plan initiated in the first quarter
of 2001 which lowered personnel and subcontracting costs in the
second quarter from the prior year.
For the six months ended June 30, 2001, cost of service revenue increased
$0.4 million, or 3.4%, to $13.5 million from $13.1 million in the same period
last year. This increase was mainly attributable to the higher levels of
staffing in the first quarter of 2001 due to hiring of personnel in the latter
half of 2000. During the second quarter of 2001, however, services revenues
decreased from the same period last year, resulting in decreases in cost of
services as a result of the restructuring initiatives in response to the
revenue declines.

Operating Expenses

Operating expenses decreased $6.4 million, or 27.0%, to $17.3 million
in the second quarter of 2001 from $23.7 million in the same period last year.
For the six months ended June 30, 2001, operating expenses decreased $4.7
million, or 9.6%, to $44.3 million from $49.0 million in the same period last
year. The majority of the decreases were due to a decrease in stock-based
compensation and sales and marketing expenses, offset by an increase in
non-recurring expenses.

Sales and Marketing

Sales and marketing expense consists of salaries, commissions, and expense
from our sales offices, travel and entertainment expense and marketing
programs. Sales and marketing expense decreased $2.8 million, or 24.7%, to
$8.7 million in the second quarter of 2001 from $11.5 million in the same
period last year. For the six months ended June 30, 2001, sales and marketing
expenses decreased $1.1 million, or 5.0%, to $20.6 million from $21.7
million in the same period last year. These decreases were

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attributable to a reduction in the number of sales employees, primarily
the inside sales group, in connection with the reorganization in March of 2001
as well as a reduction in spending on marketing programs during the second
quarter of 2001.

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 increased $0.5 million, or
22.3%, to $2.7 million in the second quarter of 2001 from $2.2 million in the
same period last year. For the six months ended June 30, 2001, product
development expense increased $2.5 million, or 62.7%, to $6.5 million from
$4.0 million in the same period last year. These increases were primarily
attributable to increases in the number of personnel in Versatas product
development and engineering organization, following the acquisition of Verve,
Inc. in November 2000. To date, all software development costs have been
expensed in the period incurred.

General and Administrative

General and administrative expense consists of salaries for executive,
finance and administrative personnel, information systems costs and allowance
for doubtful accounts. General and administrative expense was $3.0 million in
both the second quarter of 2001 and 2000. For the
six months ended June 30, 2001, general and administrative expense increased $2.0 million, or 39.4%, to $7.0 million from $5.0 million in the same period
last year. The increase during the six months ended June 30, 2001 relates to
increases in the first quarter of 2001 compared to the first quarter of 2000,
and was attributable to a higher number of employees and an increase in
insurance and other costs to support a publicly traded company.

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 over the vesting
period of the related options, generally 50 months. Stock-based compensation
expense also includes expenses for stock granted to consultants in exchange for
services. Stock-based compensation expense decreased $8.4 million, or
125.4%, to a credit of $1.7 million for the second quarter of 2001 from an
expense of $6.7 million in the same period last year. For the six months ended
June 30, 2001, stock-based compensation expense decreased $20.4 million, or
114.5%, to a credit of $2.6 million in the second quarter of 2001 from
$17.8 million in the same period last year. The decreases are related to the
impact of option cancellations for terminated employees exceeding the
amortization for the period. Additional unvested outstanding options will
continue to vest over the next 35 months, which will result in additional
compensation expense of approximately $3.4 million in the aggregate in periods
subsequent to June 30, 2001. This future expense will be reduced in the event
of related option cancellations for employee terminations in the future.

Amortization of Intangibles

Amortization of intangibles expense increased $1.0 million, or 386.1%,
to $1.2 million for the second quarter of 2001 from $237,000 in the same period
last year. For the six months ended June 30, 2001, amortization of intangibles
expense increased $1.9 million, or 437.9%, to $2.3 million from $427,000 at
the same period last year. These increases are related to the acquisitions of
McGilly and Webink in the first quarter of 2000, and the acquisitions of Verve,
Inc in the fourth quarter of 2000.

Restructuring
and Other Expenses

Restructuring
and other expenses primarily relate to severance and office
consolidation costs. In March 2001, the Company announced a restructuring plan
to streamline operations, enhance customer focus and reduce costs. Overall
expense reductions were necessary both to lower existing cost structure and to
better align the workforce with customer needs. The restructuring plan was
precipitated by the changing economic conditions and declining revenues from
recent past quarters. Management effected the restructuring plan during the
first and second quarters of 2001 by eliminating approximately 227
employee and contractor positions across all departments and
reducing office space and related overhead expenses beginning in the second
quarter of 2001. We expect that the majority of the remaining restructuring
actions such as office closures will be completed by the end of the third
quarter of 2001. Obligations related to subleasing may continue until 2008 as
estimated and are accrued for as of June 30, 2001. We had
restructuring and other
expenses of $3.5 million in the second quarter of 2001 and $10.4 for the six
months ended June 30,2001. There were no such charges in the first quarter of
2000.

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Interest Income (Expense), Net

Interest income (expense), net is primarily comprised of interest income
from our cash and investments. We had net interest income of $489,000 for the
second quarter of 2001, a decrease of $1.1 million compared to net interest
income of $1.6 million for the second quarter of 2000. For the six months ended
June 30, 2001, net interest income was $1.4 million, a decrease of $0.9 million
from net interest income of $2.3 in the same period last year. These decreases
were due to the reduction of cash and cash equivalents in 2001 compared to the
same periods last year.

Provision for Income Taxes

We have incurred operating losses for all periods from inception through
June 30, 2001. 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.

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 the aggregate, net proceeds of approximately $167.2 million. We
have also funded our operations through equipment financing. As of June 30,
2001, we had $35.8 million in cash and cash equivalents,
short-term investments and restricted cash and $25.2 million in working capital. Net cash used in
operating activities was $34.5 million in the first six months of 2001 and
$24.8 million in the first six months of 2000. Net cash flows used by
operating activities in each period reflect net losses, offset by non-cash
expenses including stock-based compensation, restructuring charge due to fixed
asset write-off, depreciation, amortization, and provision for doubtful
accounts. The use of operating cash was also impacted to a lesser extent by
changes in working capital.

Net cash provided by investing activities was $15.0 million in the first
six months of 2001 and net cash used in investing activities was $36.6 million
in the first six months of 2000. The increase in cash provided by investing
activities during the first six months of 2001 primarily reflects the
maturities of short-term investments of $19.6 million in the first six months
of 2001 compared to purchases of investments of $32.2 million in the same
period last year. This increase is partially offset by increases in purchases of property and equipment in the first six
months of 2001 compared to the same period last year. Our capital expenditures
consisted primarily of purchases of office furniture, equipment and leasehold
improvements in connection with the relocation of the Companys headquarters in
the first quarter of 2001.

Net cash provided by financing activities was $957,000 in the first six
months of 2001 and $99.5 million in the first six months of 2000. The decrease
from the prior year is primarily due $96.7 million in proceeds from the initial
public offering in March 2000. The majority of cash provided by financing
activities in the first six months of 2001 relates to proceeds from the issuance
of common stock under the employee stock purchase plan. After the most recent
employee stock purchase plan purchase in August of 2001, the Company has
decided to suspend the plan indefinitely.

We believe that the net proceeds from the sale of common stock generated
by our initial public offering, together with funds generated from operations,
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 the future.
In the event additional financing is required, we may not be able to raise it
on acceptable terms or at all.

RISK FACTORS THAT MAY AFFECT FUTURE RESULTS

We operate in a rapidly changing environment that involves numerous risks,
some of which are beyond our control. The following discussion highlights some
of these risks.

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.
Any slowdown of the worldwide economy affects the buying decision of corporate
customers. Because our sales are primarily to Global 2000 customers, our
business also depends on general economic and business conditions. A reduction
in demand for computer software, caused by a weakening of the economy, such as
occurred in 2001, or otherwise, may result in decreased revenues or lower
revenue growth rates.

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The Internet Infrastructure Software Market is Highly Competitive and We May
Lose Market Share to Larger Competitors With Greater Resources.

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 have longer operating histories and
significantly greater financial, technical, marketing and other resources than
we do. As a result, they may be able to respond more quickly to new or changing
opportunities, technologies and customer requirements. Many of our competitors
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 Lead to a Disappointment of Market
Expectations.

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 such as occurred in the
fourth quarter of 2000 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 more
recently in 2001. 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;

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| |  |  | general economic and market conditions;                                                                                       
| | - |  | ------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | additions or departures of key personnel and 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.

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. We are currently subject to securities
litigation, and may be subject to additional litigation. This could cause us to
incur substantial costs and experience a diversion of managements attention
and resources.

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 the:



| |  |  | 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 first half of 2001, 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 adversely
affected if a number of large orders are either not received or are delayed,
due to cancellations, delays, or deferrals by customers. This circumstance
occurred in the first half of 2001. Revenue shortfalls below our
expectations could have an immediate and significant adverse effect on our
results of operations.

Our services revenue in any quarter is substantially dependent on our
license revenue. Services are normally purchased in conjunction with software,
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.

Our operating results have in the past been, and will continue to be,
subject to quarterly fluctuations as a result of a number of factors. These
factors include:



| |  |  | competition in the Internet infrastructure software market;                                   
| | - |  | ----------------------------------------------------------------------------------------------
|
| |  |  | the integration of people, operations, and products from acquired businesses and technologies;

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| |  |  | the overall trend toward industry consolidation;                                                                       
| | - |  | -----------------------------------------------------------------------------------------------------------------------
|
| |  |  | the introduction and market acceptance of new technologies and standards;                                              
|
| |  |  | variations in mix of products sold; and                                                                                
|
| |  |  | changes in general economic conditions and specific economic conditions in the Internet infrastructure software market.

Any of the above factors could have a material adverse impact on our
operations and financial results.

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.

We and certain of our directors and officers have been named as defendants
in several private securities class action lawsuits. In addition,
several derivative actions on behalf of our Company were filed
against certain current and former officers and directors in
California state court. Depending on the outcome of such litigation, we
may be required to pay substantial damages or settlement costs, which could
have a material adverse effect on our financial condition or results of
operations. Regardless of the outcome of these matters, we may incur
substantial defense costs and that 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 Delaware law,
in connection with our charter documents and 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.

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,
including a requirement that Versatas common stock have a minimum bid price of
$1.00 per share.

Our Company's common stock has not maintained a
minimum bid price of $1.00 over the last consecutive 30 trading days
as required by the Nasdaq National Market. Therefore, delisting
procedures may begin if the bid price of our common stock is not at
least $1.00 for a minimum of 10 consecutive trading days before
October 25, 2001.

If Versatas minimum closing bid
price is above $1.00 for 10 consecutive trading days during the 90 day notice
period, the delisting procedures will be halted. Versata anticipates that it
would appeal any determination to delist its common stock from the Nasdaq
National Market.

If Versatas common stock is delisted and any appeal we file receives an
unfavorable determination by NASD, our common stock would be removed from
listing on the Nasdaq National Market which could have a material adverse
effect on us and on the price of our common stock.

We Have Incurred Increasing 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 significant 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 June 30, 2001, we had an accumulated deficit
of $156.2 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.

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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.

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 Microsystem 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
Product 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

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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 products, our services
revenue will also likely decline. Our service revenue is 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 downturn in our software license revenue such as is likely at
least for some period during 2001 or a decline in the percentage of customers
who renew their annual support agreements, our services revenue could become
flat or decline.

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 packaged application
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, OEMs and systems integrators. We
intend to seek distribution arrangements with additional ISVs to embed our
Versata Logic Server and Versata Interaction Server 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.



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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.

We expect to
experience significant fluctuations in our future quarterly revenues
and operating results as a result of many factors, including: recent
adverse economic conditions, which may increase the likelihood that
customers will unexpectedly orders resulting in revenue shortfalls,
difficulty predicting the size and timing of customer orders,
particularly as a greater percentage of our revenues has shifted from
service revenues to license revenues; the difficulty in predicting
the mix of distribution channels, the acceptance of the introduction
or enhancement of our products or our competitors' products, and
changes in our competitors' product offerings and pricing policies;
whether we are unable to develop, introduce and market new products
on a timely basis; and potential fluctuations in demand or prices of
our products and services. As a result of all of these factors, we
believe that quarterly revenues and operating results are difficult
to forecast and period-to-period comparisons of our results of
operations are not necessarily meaningful and should not be relied
upon as indications of trends or future performance.

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 was not at fault, we could suffer
material expense and material diversion of management time in defending any
such lawsuits.

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Since the Licensing of Our Automation Technology is a Key Component of Sales,
Our Business May Suffer If We Cannot Protect Out Intellectual Property.

Approximately 55.2% of our revenue in the second quarter of 2001 was
derived from the license of software products. We rely on a combination
of contractual provisions, confidentiality procedures, and patent, trademark,
trade secret and copyright laws to protect the proprietary aspects of our
technology. We currently have a U.S. patent relating to our automated
development tool that uses a drag-and-drop metaphor. This patent is scheduled
to expire on April 9, 2016. In addition, we have a U.S. patent pending relating
to our business rules automation in database application development and
maintenance. We cannot predict whether this patent application will result in
an issued patent, or if a patent is issued, whether it will provide any
meaningful protection. Moreover, these legal protections afford only limited
protection and competitors may gain access to our intellectual property which
may result in the loss of our customers.

Despite our efforts to protect our proprietary rights, unauthorized
parties may attempt to copy aspects of our products or to obtain and use our
proprietary information. Litigation may be necessary to enforce our
intellectual property rights, to protect our trade secrets and to determine the
validity and scope of the proprietary rights of others. Any litigation could
result in substantial costs and diversion of resources with no assurance of
success and could seriously harm our business and operating results. In
addition, we sell our products internationally, and the laws of many countries
do not protect our proprietary rights as well as do the laws of the United
States. Our patent and future patents, if any, may be successfully challenged
or may not provide us with any competitive advantages.




Item 3. Quantitative and Qualitative Disclosures About Market Risk

Versata is exposed to a variety of risks, including changes in interest
rates affecting the return on its investments and, to a lesser extent, foreign
currency fluctuations. In the normal course of business Versata establishes
policies and procedures to manage its exposure to fluctuations in interest
rates and foreign currency values.

INTEREST RATE RISKS. Versatas exposure to interest rate risks results
primarily from its short-term investments. These securities have been
classified as cash equivalents when the maturity dates are less than 90 days at
the date of issuance, and as short-term investments when the maturity dates are
between 90 and 365 days at the date of issuance. Our interest
risk, based on a hypothetical increase in interest rates of 50 basis
points for the financial instruments included in our portfolio,
would be a decrease of approximately $13,000 in the value of our
portfolio.

FOREIGN CURRENCY RISKS. As of June 30, 2001, Versata had operating subsidiaries
located in the United Kingdom, Germany, Belgium, Hong Kong, Australia, and
France. Internationally, Versata invoices customers primarily in local
currency and we maintain only nominal foreign currency cash balances. Working
funds necessary to facilitate the short-term operations of our subsidiaries are
kept in local currencies in which they do business. We do not currently enter
into foreign currency hedge transactions. For the three months ended June 30, 2001, foreign
currency fluctuations have not had a material impact on our financial position
or results of operations.




PART II

OTHER INFORMATION




Item 1. Legal Proceedings

Securities Class Action

Since April 11, 2001, several securities class action complaints were
filed against us, and certain of our current and former officers and directors.
The complaints allege violations of the federal securities laws. The complaints
seek an unspecified amount of damages on behalf of persons who purchased our
stock during the proposed class periods. The actions are subject to
consolidation under the Private Securities Litigation Reform Act of 1995, which
requires the consolidation of similar securities class actions and the
appointment of a lead plaintiff who pursues the action on behalf of the
consolidated class.

Until the consolidated amended complaint is filed, it is premature to come to
any conclusions as to the allegations and potential damages. We intend to
defend these actions vigorously. There can be no assurance that the pending
actions will be resolved without costly litigation, or in a manner that is not
materially adverse to our financial position, results of operations or cash
flows. No estimate can be made of the possible loss or possible range of loss
associated with the resolution of these contingencies.

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State Derivative Action

Since June 11, 2001, several derivative action on behalf of Versata, Inc. were
filed against certain current and former officers and directors in California
state court. 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.

At this early stage in the litigation, it is premature to come to any
conclusions as to the allegations and the impact that the claim could have on
the Company.




Item 2. Changes in Securities and Use of Proceeds

(a) Sales of Unregistered Securities

None.

(b) Use of Proceeds

Versata has invested the net proceeds from its initial public offering of
common stock in interest bearing investment grade instruments. We expect to use
the net proceeds primarily to fund working capital, technology and product
development and sales and marketing. None of the net proceeds of our initial
public offering were paid to any of our directors or officers, or to any person
owning 10% or more of any class of our equity securities.




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

None.




Item 6. Exhibits and Reports On Form 8-K.

(a) The following exhibits are included herein:

|         |  |                                                                                                                                                                      |  |  |  | 
|-------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  |  | 
|EXHIBIT  |  |                                                                                                                                                                      |  |  |  | 
|NUMBER   |  | DESCRIPTION OF DOCUMENT                                                                                                                                              |  |  |  | 
|         |  |                                                                                                                                                                      |  |  |  | 
|2.1(1)   |  | Agreement and Plan of Reorganization by and among Versata, Inc., VATA Acquisition Corp., Verve, Inc.
and Certain Shareholders of Verve, Inc., dated October 18, 2000
|        
|        
|        
|        
|3.1(2)   |  | Amended and Restated Certificate of Incorporation of Versata.                                                                                                       
|        
|        
|        
|        
|3.2(2)   |  | Amended and Restated Bylaws of Versata.                                                                                                                             
|        
|        
|        
|        
|10.1(2)* |  | 2000 Stock Incentive Plan of Versata.                                                                                                                               
|        
|        
|        
|        
|10.2(2)* |  | Employee Stock Purchase Plan of Versata.                                                                                                                            
|        
|        
|        
|        
|10.3(2)  |  | Fourth Amended and Restated Investors Rights Agreement, among Versata and some of its stockholders,
dated November 30, 1999.                                       
|        
|        
|        
|        
|10.4(2)* |  | Form of Indemnification Agreement entered into between Versata and each of its directors and
executive officers.                                                    
|        
|        
|        
|        
|10.6(2)  |  | Agreement of Sublease dated October 18, 1999, between Versata and ICF Kaiser International, Inc.                                                                    
|        
|        
|        
|        
|10.8(2)  |  | Senior Loan and Security Agreement, dated August 20, 1999, between Versata and Phoenix Leasing
Incorporated, as amended on October 1, 1999.                         

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|         |  |                                                                                                                                              |  |  |  | 
|-------- |  | -------------------------------------------------------------------------------------------------------------------------------------------- |  |  |  | 
|EXHIBIT  |  |                                                                                                                                              |  |  |  | 
|NUMBER   |  | DESCRIPTION OF DOCUMENT                                                                                                                      |  |  |  | 
|         |  |                                                                                                                                              |  |  |  | 
|        
|        
|        
|        
|10.9(2)+ |  | Joint Product and Marketing Agreement, dated September 27, 1999, between Versata and IBM.                                                   
|        
|        
|        
|        
|10.10(3) |  | Lease agreement, dated as of April 10, 2000, by and between Versata and Kaiser Center, Inc. for the
sublease of office space in Oakland, CA.
|        
|        
|        
|        
|10.11(4) |  | Software Remarketing Agreement, effective September 27, 2000, between Versata and International
Business Machines Corporation.              
|        
|        
|        
|        
|21.1**   |  | Subsidiaries of Versata.                                                                                                                    



---

|+   |  | Specified portions of this agreement have been omitted and have been
filed separately with the Securities and Exchange Commission pursuant to a
request for confidential treatment.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|*   |  | Management contract or compensatory plan or arrangement.                                                                                                                           
|   
|   
|   
|   
|**  |  | Previously filed.                                                                                                                                                                  
|   
|   
|   
|   
|(1) |  | Incorporated by reference from the Companys Form 8-K dated December 1,
2000.                                                                                                      
|   
|   
|   
|   
|(2) |  | Incorporated by reference from the Companys Registration Statement on
Form S-1 (File No. 333-92451).                                                                              
|   
|   
|   
|   
|(3) |  | Incorporated by reference from the Companys Form 10-Q dated August 14,
2000.                                                                                                      
|   
|   
|   
|   
|(4) |  | Incorporated by reference from the Companys Form 10-Q dated September
24, 2000.                                                                                                   

(b) Reports on Form 8-K:

The Company did not
file any Reports on Form 8-K in this reporting period.

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VERSATA, INC.




SIGNATURES

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

VERSATA, INC.



|Date: August 14, 2001 | /s/   DOUGLAS ROBERTS
|--------------------- | ---------------------

| | Interim Chief Executive Officer
and Executive Vice President of
Worldwide Field Operations
| | ------------------------------------------------------------------------------------------



| | /s/   JIM DOEHRMAN
| | ------------------

| | Chief Operating Officer,
Chief Financial Officer, Secretary
and Executive Vice President
| | ----------------------------------------------------------------------------------------

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