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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-K



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|x | Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ------------------------------------------------------------------------------------



For the year ended December 31, 2003



OR



| ̈ | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ----------------------------------------------------------------------------------------



Commission File Number: 0-30925



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BLUE MARTINI SOFTWARE, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 94-3319751                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



2600 Campus Drive

San Mateo, California 94403

(Address of principal executive offices)



Telephone Number (650) 356-4000

(Registrants telephone number, including area code)



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Securities registered pursuant to Section 12(b) of the Act: None

Securities
registered pursuant to Section 12(g) of the Act: Common Stock



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



Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form
10-K.   x



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

Yes ̈No  x



The aggregate market value of the voting stock held by non-affiliates of the registrant,
based on the closing sale price of the Common Stock on June 30, 2003 as reported on the Nasdaq National Market was approximately $22,596,000. Shares of Common Stock held by each current executive officer and director and by each person who is known
by the registrant to own 5% or more of the outstanding Common Stock have been excluded from this computation in that such persons may be deemed to be affiliates of the registrant. Share ownership information of certain persons known by the
registrant to own greater than 5% of the outstanding common stock for purposes of the preceding calculation is based solely on information on Schedule 13G filed with the Commission and is as of June 30, 2003. This determination of affiliate status
is not a conclusive determination for other purposes.



The number of shares
outstanding of the registrants Common Stock as of February 25, 2004 was approximately 11,897,000.



DOCUMENTS INCORPORATED BY REFERENCE



Parts of the Proxy Statement for the registrants 2004 Annual Meeting of Stockholders are incorporated by reference in Part III of this Form 10-K Report.



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BLUE MARTINI SOFTWARE, INC.

ANNUAL REPORT

INDEX



|         |  |                      |  |                                                                                                                  |  |         
|-------- |  | -------------------- |  | ---------------------------------------------------------------------------------------------------------------- |  | --------
|         |  |                      |  |                                                                                                                  |  | Page No.
|PART I   |  | 3                   
|         |  |                      | 
|         |  | ITEM 1.              |  | BUSINESS                                                                                                         |  | 3       
|         |  | ITEM 2.              |  | PROPERTIES                                                                                                       |  | 9       
|         |  | ITEM 3.              |  | LEGAL PROCEEDINGS                                                                                                |  | 9       
|         |  | ITEM 4.              |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                              |  | 10      
|         | 
|PART II  |  | 11                  
|         |  |                      | 
|         |  | ITEM 5.              |  | MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |  | 11      
|         |  | ITEM 6.              |  | SELECTED CONSOLIDATED FINANCIAL DATA                                                                             |  | 12      
|         |  | ITEM 7.              |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                            |  | 14      
|         |  | ITEM 7A.             |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                       |  | 33      
|         |  | ITEM 8.              |  | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                                      |  | 33      
|         |  | ITEM 9.              |  | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                             |  | 33      
|         |  | ITEM 9A.             |  | CONTROLS AND PROCEDURES                                                                                          |  | 33      
|         | 
|PART III |  | 36                  
|         |  |                      | 
|         |  | ITEM 10.             |  | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                                               |  | 36      
|         |  | ITEM 11.             |  | EXECUTIVE COMPENSATION                                                                                           |  | 38      
|         |  | ITEM 12.             |  | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT                                                   |  | 38      
|         |  | ITEM 13.             |  | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                                   |  | 38      
|         |  | ITEM 14.             |  | PRINCIPAL ACCOUNTING FEES AND SERVICES                                                                           |  | 38      
|         | 
|PART IV  |  | 39                  
|         |  |                      | 
|         |  | ITEM 15.             |  | EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K                                                 |  | 39      
|         |  | SIGNATURES           |  | 42                                                                                                              
|         |  | FINANCIAL STATEMENTS |  | 43                                                                                                              



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PART I



In addition to historical information, this
annual report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements using terminology
such as can, may, believe, designed to, will, expect, plan, anticipate, estimate, potential, or continue, or the
negative thereof or other comparable terminology regarding beliefs, plans, expectations or intentions regarding the future. Forward-looking statements involve risks and uncertainties and actual results could differ materially from those discussed in
the forward-looking statements. All forward-looking statements and risk factors included in this document are made as of the date hereof, based on information available to Blue Martini Software, Inc. (the Company, Blue
Martini, or we) as of the date thereof, and the Company assumes no obligation to update any forward-looking statement or risk factors.



|ITEM 1. |  | BUSINESS
|------- |  | --------



Overview



Blue Martini LLC, a Delaware
limited liability company, was founded in June 1998 and was succeeded in January 1999 by Blue Martini Software, Inc.



Blue Martini provides software designed to help companies increase revenues by proactively guiding sales people, partners, and customers through sales interactions.
Companies can incorporate their specific sales and marketing expertise into our application software. The combination of this expertise along with the intelligence embedded in our applications - our intelligent selling systems - allows our customers
to automate important sales and marketing processes that otherwise would require significant time and effort from their product, marketing and sales experts. Our applications are designed to allow companies to extend their selling expertise
throughout their entire sales force as well as to their partners and end customers.



Our software applications can help our customers:



| | Increase sales by proactively recommending to sales people when they should contact customers, what products they should suggest, and what they should say;
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| | Increase sales and customer satisfaction by proactively and naturally guiding sales people, partners, and customers to the best solutions to meet their needs;
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------



| | Increase customer satisfaction by providing customers with a unified customer experience across multiple channels including the website, call center, e-mail campaigns, and in the
store;
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | Reduce costs to serve by providing customers with web-based self-service; and
|- | -----------------------------------------------------------------------------



| | Improve marketing efficiency by enabling marketers to easily define multi-step, multi-channel customer interactions and by providing marketers with analytical tools for better
targeting.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Leading companies throughout the world have
implemented our software, including AOL, Carrefour, Debenhams, DuPont, Harrahs, Kohls, Lanier, Saks Fifth Avenue and Sprint.



Products



Our software offerings include products for sales, marketing, and commerce.



Blue Martini Sales. We provide sales applications for both commercial and consumer sales. For the commercial portion of our business, we offer web-based applications that guide sales people, partners,
and end customers to the best solutions to meet their needs. Our software defines solutions, calculates pricing based on pre-defined parameters and customer input, supports interactive quoting, and quickly generates proposals and proposal revisions.
Our applications are intuitive and easy to use, and provide significant deployment flexibility. Our software also supports mobile, disconnected users (e.g., a mobile salesperson not connected to a computer network) for some applications.



For the consumer portion of our business, our applications recommend to sales people which
prospective customers they should contact and what they should communicate. Our applications also provide sales people with information that can help them sell more effectively, such as specific customer preferences and buying history. Sales people
can access our applications in the store, online, at the point-of-sale, or via wireless devices.



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Blue Martini Marketing. Blue Martini Marketing includes customer analytic and messaging applications. Our
analytics applications allow companies to analyze multi-channel customer information and make informed decisions about how to target and interact with customers. Our analytics applications allow business users to do reporting, data mining, and
online analytical processing (OLAP). Our messaging applications enable marketers to define multi-step, multi-channel interactions with customers, such as a new product introduction comprised of e-mails, calls, and personalized website content.



Blue Martini Commerce. Blue Martini Commerce enables companies
to deploy complex consumer or commercial websites. Blue Martini Commerce provides massive scalability, is highly extensible and supports all languages, currencies and virtually any payment methodology. Business users work within an intuitive
environment to manage their websites and can leverage powerful merchandising, catalog and content management, and integrated analytics capabilities to provide customers with compelling interactions. We also offer an integrated contact center with
Commerce.



Solution Benefits and Differentiating Factors



Our solutions are designed to deliver unique competitive advantages and benefits to our
customers:



Intelligence.Our intelligent selling systems are
powered by a suite of intelligent engines that uniquely differentiate us from traditional database applications. Where database applications are useful in tracking and presenting information, our intelligent engines enable companies to automate key
sales and marketing processes to reduce sales cycles and sell more effectively by gathering and collecting information from the customers internal experts. Our intelligent engines include:



| | an analytics engine that employs machine learning to segment customers and discover patterns of customer behavior;
|- | ------------------------------------------------------------------------------------------------------------------



| | a constraint engine that can model complex needs analysis, configuration, and pricing knowledge; and
|- | ----------------------------------------------------------------------------------------------------



| | a process-modeling engine that can interact intelligently with a customer over time and across multiple channels (e.g., email, a website, and a retail store).
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------



We believe that the breadth and depth of the intelligent systems
embedded in our applications provides Blue Martini with a unique competitive advantage. By continuing to focus research and development on extending these core intelligent systems, as well as the applications that leverage this intelligence, we hope
to be able to compete effectively in the marketplace against larger vendors that offer more basic customer-tracking functionality.



Flexible Architecture.Our J2EE (Java 2 Platform, Enterprise Edition) architecture is modular, allowing customers to implement point solutions today to
solve critical business issues, and later easily add other modules without extensive time-consuming integration. With our focus on enabling business users to operate applications, companies can easily and rapidly customize our applications to fit
their particular business needs, rather than forcing changing their business processes to suit the software.



Easy Deployment and Integration.Our applications are designed to be implemented quickly and efficiently and to fit easily within existing IT environments. Our applications can work stand-alone, as
integrated into a disparate applications environment, or as extensions of existing customer relationship management (CRM) applications, such as sales force automation and campaign management.



Scalable Operations.Our application suite architecture is designed to support
a large number of concurrent users, and our performance has undergone benchmark tests with excellent results. Our applications can be installed across any number of web and application servers, making it possible to support large amounts of content,
products and concurrent users.



Vertical Expertise. Blue Martini
has deployed solutions for leading manufacturers and retailers worldwide. Designed by industry experts in collaboration with customers, Blue Martini industry solutions for retail and manufacturing are modular point solutions that include
industry-specific functionality, starter templates, and best



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practices. Applications can be deployed individually or as a complete package, so companies have the flexibility to
address their most pressing issues quickly, with a roadmap to a future integrated solution. Blue Martini industry solutions are tailored to meet the unique competitive requirements inherent in each industry.



Services



While our business model focuses on the development and licensing of software, we also offer a comprehensive selection of services to our
customers, including professional, technical support and training services, as well as value-added data analysis services. In 2003, 2002 and 2001, revenues derived from these services accounted for 65%, 82% and 66% of our total revenues,
respectively.



Blue Martini Consulting. We offer professional
services to our customers for the deployment of our application suite and its integration with third-party software such as traditional call centers, sales force automation, merchandising, enterprise resource planning and supply chain management
systems. Our service professionals work directly with our customers as well as with third-party systems integrators and regional consulting organizations.



Blue Martini Support. We offer comprehensive technical support, designed to allow companies to quickly and effectively address technical issues as they
arise and to provide updates and upgrades to our customers.



Blue Martini
Training. We offer a comprehensive training curriculum designed for systems integrators and customers. Our courses not only train professionals in the use and implementation of our application suite but also educate business users on key
concepts such as personalization and data mining. We have training facilities in San Mateo, California and also conduct training in multiple locations in Europe and Asia.



Blue Martini Analytic Services. We offer our customers value-added data analysis services on both a subscription and time and
material basis. Our Blue Martini Analytic Services process and analyze transaction, clickstream, customer and product data to produce insights that help our clients understand, target and interact with their customers. Our dedicated Analytic
Services consultants apply state-of-the-art analysis tools, such as data mining and visualization, based on their extensive experience with industry best practices, information design, target marketing and merchandising. Our analytic service
investigations use the data mining and analytics, visualization, targeting and campaign management capabilities of our application suite.



Alliances



Blue Martini maintains alliances with consulting and system integrator firms, independent software vendors, and platform and infrastructure providers. Many of these alliances can be terminated by either party upon
thirty days notice .



Consulting and System Integrators (CSI).CSI alliance members typically manage the integration projects at our customer sites. We offer CSI alliance members partner program benefits such as discounted training fees, participation in joint marketing activities, access to our
software, and the opportunity to participate in joint development projects within related industries. In addition, we have active customer referral programs. Our CSI alliance members help us develop customer relationships, and similarly we recommend
our CSI alliance members to our customers. Our customers pay us directly for our application suite and pay our CSI alliance members directly for their services. By recruiting, training, and managing personnel deploying our software, CSI alliance
members permit us to focus on our core competencies, such as developing and distributing our software application suite and on providing additional product-specific technical expertise during consulting service engagements. Our CSI alliance members
include Accenture, AKQA, Axion Solutions, Acquity, eLogic Group, Enabler, Good Technology, IBM Global Services, Plaut Consulting, and Syntegra.



Independent Software Vendors (ISV).Our ISV alliance members deliver software products that complement our application suite. Their offerings include
fulfillment, transportation management, content enhancement, enterprise application integration, marketplace infrastructure and CRM. In addition, we partner with ISVs focused on specific market segments to enhance our market penetration
opportunities in the retail and manufacturing markets. Our ISV alliance members help us to develop customer relationships, and similarly we recommend our ISV alliance members to our customers. Our customers pay directly for our application suite and
typically pay our ISV alliance members



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directly for their products; however, we pay royalties to some alliance members where their technology is embedded in or
bundled with our solutions. Our ISV program facilitates the delivery of our pre-packaged adapters that connect the Blue Martini application suite to our alliance members software, or competitor software in place. Delivery of packaged adapters
requires software development at the outset as well as validation of the packaged software for each release of our application suite. Our ISV alliance members include Ariba, CyberSource, Equilibrium, Fujitsu-Siemens, IBM, Informatica, Macromedia,
and SAS Institute.



Platform and Infrastructure (PI).Our PI
alliance members provide our customers with the hardware and software infrastructure used for the deployment of our application suite. Our PI alliance members sell hardware, operating systems, database products, and software services. We perform the
software development work necessary to ensure that our software supports the platforms of our PI alliance members. Our customers pay us directly for our software application suite and pay our PI alliance members directly for their products and
services; however, we pay royalties to some alliance members where their technology is embedded in or bundled with our solutions. Our PI alliance members include Acxiom, BEA, IBM, Symbol Technologies, and TIBCO Software.



Technology



Our software application suite is built upon a three-tiered architecture designed to deliver
consistent, high performance operation in an uncertain environment where demand imbalances and hardware failures are common. Website requests are handled by a layer of web servers. These web servers return and cache static content, but forward
dynamic web requests to a layer of application servers. These application servers execute business logic that typically requires access to data stored in read-only catalog databases. To improve performance, our architecture automatically caches
catalog and session data in memory to avoid slow database access. These catalog databases can also be replicated to further improve support for large numbers of customers without interruption. Customers can easily handle increased website volume by
adding any combination of web, application or database servers. Read-write transaction databases record customer transactions as well as updates to end-customer profiles. Optionally, business logic for some functions can be executed as Java applets
on the client to further enhance performance and scalability.



Our software is
developed in the Java programming language to take advantage of the graphical user interface and functional libraries available in Java, as well as the speed of development made possible by other Java features such as pointer-less references and
automatic memory management.



Our application suite incorporates technologies
including a Java application server, full-text retrieval software, constraint engine, UI generation software, rules induction software, rules execution software, a workflow system, data transformation software, and visualization libraries. Our
application suite provides integrated data analysis, visualization, personalization, product configurations, solution design, and workflow.



Research and development expenses totaled $9.7 million, $13.4 million and $18.6 million for 2003, 2002 and 2001, respectively.



Sales Capabilities



We currently have sales offices in France, Japan, the Netherlands, the United Kingdom, and the United States. Our sales and marketing
headcount is 56 at December 31, 2003. For 2003, two customers each accounted for more than 10% of our total revenues. Masco Corporation and America Online, Inc. accounted for $4.3 million and $4.2 million, respectively, of revenues. In 2002 and
2001, no individual customer accounted for more than 10% of total revenues. Our total revenues were $32.6 million, $33.6 million, and $59.9 million for 2003, 2002 and 2001, respectively. International revenues for 2003, 2002 and 2001 were $7.6
million, $7.7 million and $14.4 million, respectively, representing 23% in 2003 and 2002 and 24% in 2001 of total revenues, respectively.



Acquisitions



In April 2002, we acquired The Cybrant Corporation (Cybrant) through the merger of a wholly owned subsidiary of Blue Martini with and into Cybrant, with Cybrant surviving as a wholly owned subsidiary of
Blue Martini (the Merger). The Cybrant products enable customers to sell complex products and services.



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Competition



The market for our product is intensely competitive, rapidly evolving, and subject to rapid technological change. Increased competition is likely to result in price
reductions, reduced gross margins and loss of market share, any one of which could reduce our future revenues or earnings. We expect the intensity of competition to increase in the future. We face competition primarily from the following:



| | Internally Developed Systems. Information technology, or IT, departments of potential customers have developed or may develop systems that provide for some or all of
the functionality of our product. We expect that internally developed application integration and process automation efforts will continue to be a principal source of competition for the foreseeable future. In particular, it can be difficult to
license our product to a potential customer whose internal development group has already invested substantially in, and made progress towards completion of, the systems that our product is intended to replace.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | Point Applications. Our products compete with stand-alone point solutions offered by providers such as BroadVision, Inc., Firepond, Inc., Selectica, Inc., Trilogy
Software, Inc., Unica Corporation, and Vignette Corporation.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | Components. Our products compete with components offered by vendors such as Art Technology Group, Inc. and Microsoft Corporation.
|- | ---------------------------------------------------------------------------------------------------------------------------------



| | Traditional CRM Software. Our products compete with CRM products offered by vendors such as E.piphany, Inc., Oracle Corp., PeopleSoft, Inc., SAP AG and Siebel Systems,
Inc.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Many of our competitors have greater resources and broader
alliance and customer relationships than we do. In addition, many of these competitors have extensive knowledge of our industry. Current and potential competitors have established, or may establish, cooperative relationships among themselves or with
third parties to offer a single solution and increase the ability of their products to address customer needs. Furthermore, our competitors may combine with each other and other companies may enter our markets by acquiring or entering into strategic
relationships with our competitors.



We believe that the principal competitive
factors affecting our market include:



| | vertical domain expertise;
|- | --------------------------



| | product functionality and features;
|- | -----------------------------------



| | product architecture and technology;
|- | ------------------------------------



| | incumbency of vendors;
|- | ----------------------



| | availability of global support;
|- | -------------------------------



| | relationship with system integrators;
|- | -------------------------------------



| | coverage of direct sales force;
|- | -------------------------------



| | ease and speed of product implementation;
|- | -----------------------------------------



| | vendor and product reputation;
|- | ------------------------------



| | financial condition of similar vendors;
|- | ---------------------------------------



| | ability of products to support large numbers of concurrent users; and
|- | ---------------------------------------------------------------------



| | price.
|- | ------



We believe that our primary competitive advantages are our vertical domain expertise, the breadth and depth of our products functionality and features, and our product architecture and technology. We may not be
able to compete effectively against current and potential competitors, especially those with greater financial, sales, marketing, professional services, technical support, training and other resources.



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Intellectual Property and Other Proprietary Rights



Our success depends in part on the development and protection of the proprietary aspects of
our technology as well as our ability to operate without infringing on the proprietary rights of others. To protect our proprietary technology, we rely primarily on a combination of trade secret, copyright, trademark and patent laws, as well as
confidentiality procedures and contractual restrictions.



We license
technologies from several software providers that are incorporated in our product. We anticipate that we will continue to license technology from third parties in the future. In particular, we license application server technology from BEA Systems,
Inc. and IBM Corporation, we license a rules engine from Blaze Software Inc. that automates the execution of business processes according to criteria set by our customers, and we license configuration technology from Array Technologies that is
incorporated in our interactive selling applications. The arrangement with IBM is comprised of a marketing agreement that expires December 2006, and an OEM license for IBMs WebSphere server that expires in December 2005. The license agreement
with Blaze expires in June 2007, the license agreement with BEA expires in July 2007, and the license agreement with Array Technologies is indefinite in term. We may not be able to renew our licenses for these technologies on commercially reasonable
terms, if at all. The loss of these technologies or other technologies that we license could prevent sales of our product and increase our costs until substitute technologies, if available, are developed or identified, licensed and successfully
integrated into our product. Even if substitute technologies are available, there can be no guarantee that we will be able to license these technologies on commercially reasonable terms, if at all.



We license the modules of our application suite and require our customers to enter into
license agreements that impose restrictions on their ability to reproduce, distribute and utilize the modules. In addition, we seek to avoid disclosure of our trade secrets through a number of means, including but not limited to, generally
restricting access to our source code and object code and requiring those entities and persons with access to our proprietary information to agree to confidentiality terms which restrict their use and disclosure. We seek to protect our software,
documentation and other written materials under trade secret and copyright laws, which afford only limited protection. We cannot assure that any of our proprietary rights with respect to our applications will be viable, or of value, in the future
since the validity, enforceability and type of protection of proprietary rights in Internet-related industries are uncertain and still evolving.



We have one issued patent relating to our configuration products, issued on June 11, 2002, and have several United States patent applications pending. It is possible that
some or all of the patents that we have applied for will not be issued, and even if issued, that some or all may be successfully defended. It is also possible that we may not develop proprietary products or technologies that are patentable, that any
patent issued to us may not provide us with any competitive advantages or that the patents of others will harm our ability to do business.



Despite our efforts to protect our proprietary rights and technology, unauthorized parties may attempt to copy aspects of our products or obtain the source code to our
software or use other information that we regard as proprietary or could develop software competitive to ours. Policing unauthorized use of our products is difficult, and while we are unable to determine the extent to which piracy of our software
exists, software piracy may be or become a problem. Our means of protecting our proprietary rights may not be adequate, and our competitors may independently develop similar technology or duplicate our product. Litigation may be necessary in the
future to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement or invalidity. Any such resulting litigation could
result in substantial costs and diversion of resources that could have a material adverse effect on our business, operating results and financial condition.



In the future, a third party may bring suit claiming that we or our current or future products infringe their patents, trade secrets or copyrights. Any claims, with or
without merit, could be costly and time-consuming to defend, divert our managements attention or cause product delays. We may not have patents that we could use defensively against a company bringing such a claim. If our product was found to
infringe a third partys proprietary rights, we could be required to enter into royalty or licensing agreements to be able to sell our product. Royalty and licensing agreements, if required, may not be available on terms acceptable to us, if at
all, which could harm our business.



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Employees



As of December 31, 2003, we had 210 employees, 171 of whom were based in North America, 27 were based in Europe, and 12 were based in Asia. Of these employees, 56 were in
sales and marketing, 59 were in product development, 67 were in professional services, technical support and training and 28 were in finance, human resources, legal, information systems and administrative functions. Our employees are not represented
by any collective bargaining agreements and we have never experienced a work stoppage. We believe our employee relations are good.



Availability of this Report



Our annual report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to reports filed or furnished pursuant to Sections 13(a) and
15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on our web site at www.bluemartini.com shortly after we electronically file such material with the SEC. The public may read and copy any materials we file with
the SEC at the SECs Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling 1-800-SEC-0330. The SEC also maintains a web site at
www.sec.gov that contains reports, proxy, and information statements, and other information regarding issues that file electronically. We assume no obligation to update or revise any forward looking statement in this annual report, whether as a
result of new information, future events or otherwise, unless it is required to do so by law.



|ITEM 2. |  | PROPERTIES
|------- |  | ----------



Our principal administrative, research and development, sales, consulting and marketing activities are conducted in 31,000 square feet of leased space in San Mateo, California. Leases covering approximately 12,000
square feet of this leased space expire in 2005, with the balance expiring in 2006. In addition, we have a lease covering approximately 7,000 square feet in Boca Raton, Florida that expires in 2006. Our European headquarters located in Bracknell,
United Kingdom includes 7,800 square feet, and the lease expires in 2004. We also lease satellite offices in cities elsewhere in the United States and in France, Japan, and the Netherlands, to support our worldwide sales and professional services
organizations.



|ITEM 3. |  | LEGAL PROCEEDINGS
|------- |  | -----------------



Beginning in July 2001, Blue Martini, Monte Zweben, William Zuendt, Andrew Verhalen, certain of our former officers and directors and Goldman Sachs and the other underwriters of our initial public offering, or IPO,
were named as defendants in several class action shareholder complaints filed in the United States District Court for the Southern District of New York, consolidated under the title In re Blue Martini Initial Public Offering Securities
Litigation. Plaintiffs claim that the defendants violated the federal securities laws because our IPO registration statement and prospectus allegedly contained untrue statements of material fact or omitted material facts regarding the
compensation to be received by, and the stock allocation practices of, the IPO underwriters. The plaintiffs seek unspecified monetary damages and other relief. Similar complaints were filed in the same Court against hundreds of other public
companies that conducted IPOs of their common stock since the mid-1990s. On August 8, 2001, all IPO-related lawsuits were consolidated for pretrial purposes before United States Judge Shira Scheindlin of the Southern District of New York. In
accordance with Judge Scheindlins orders, we did not answer the complaint, and no discovery was served. Also in accordance with Judge Scheindlins orders, plaintiffs filed amended consolidated complaints on April 19, 2002. We joined in a
global motion to dismiss the IPO Lawsuits on July 15, 2002. On or about October 9, 2002, our directors and officers were dismissed without prejudice pursuant to a stipulated dismissal and tolling agreement between the plaintiffs and certain
individual defendants. On November 1, Judge Scheindlin presided over an all-day hearing on the global motions to dismiss. On February 19, 2003, Judge Scheindlin issued a ruling on the global motion to dismiss; with respect to us, the motion was
granted in part and denied in part. In June 2003, we joined in a tentative global settlement that would, among other things, result in the dismissal with prejudice of all claims against all issuers and their officers and directors in the IPO-related
lawsuits, and the assignment to plaintiffs of certain potential claims that the issuers may have against their IPO underwriters. The tentative settlement provides that, in the event that the plaintiffs ultimately recover less than $1 billion in
settlement



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or judgment against the underwriter defendants in the IPO-related lawsuits, the plaintiffs would be entitled to payment
by each participating Issuers insurer of a pro rata share of any shortfall in the plaintiffs guaranteed recovery. The tentative settlement does not involve any payment or admission of wrongdoing by us. In July 2003, pursuant to the
authorization of a special litigation committee of the our Board of Directors, we entered into a non-binding memorandum of understanding reflecting the settlement terms described above. In September 2003, in connection with the possible settlement,
our officers and directors described above who had entered tolling agreements with plaintiffs agreed to extend those agreements so that they would not expire prior to any settlement being finalized. Although Blue Martini has approved this settlement
proposal in principle, it remains subject to a number of procedural conditions, as well as formal approval by the court.



In May 2002, a shareholders derivative complaint was filed in Superior Court of the State of California, County of San Mateo, entitled Richard D. Yager,
derivatively on behalf of Blue Martini Software, Inc., v. Zweben et al. The complaint purported to be filed on behalf of Blue Martini, and named us as a nominal defendant, along with Mr. Zweben, Mr. Verhalen Mr. Zuendt, certain of our former
officers and directors and Goldman Sachs, the managing underwriter of our IPO. The complaint alleged that the defendants breached fiduciary and other duties, were negligent, and were unjustly enriched because the IPO price of our stock allegedly was
set too low. The plaintiff sought unspecified monetary damages and other relief. The case was subsequently removed to the United States District Court for the Northern District of California. We filed a motion to dismiss incorporating the motion for
judgment on the pleading filed by co-defendant Goldman Sachs. In October 2002, the Court granted the motions to dismiss and motion for judgment on the pleadings without leave to amend and entered a judgment dismissing the complaint. In December
2002, the plaintiff filed a notice of appeal. In June 2003, the plaintiff voluntarily dismissed the appeal.



On or about July 24, 2002, a complaint was filed against Blue Martini in the Supreme Court of the State of New York, County of Queens. The complaint, captioned Fresh Direct, Inc. v. Blue Martini Software, Inc.,
was filed by a customer that had licensed our products and engaged us to perform related services. The complaint was amended on or about August 26, 2002, to change the plaintiff to Fresh Direct, LLC as successor to Fresh Direct, Inc.. The amended
complaint asserts claims for breach of contract, breach of warranty, negligent misrepresentation, fraud, and unjust enrichment. On or about September 18, 2002, we filed a motion to dismiss the amended complaint. On or about October 23, 2002, Fresh
Direct opposed the motion to dismiss and filed a cross-motion for leave to file a second amended complaint, which we subsequently opposed. On or about March 24, 2003, the Court issued an order which granted in part and denied in part our motion to
dismiss and granted Fresh Directs motion for leave to file the second amended complaint. In April 2003, we appealed the denial of the motion to dismiss, and in May 2003, we filed its answer to the second amended complaint and counterclaims for
breach of contract and fraud. In January 2004, argument was heard on the Companys appeal of the denial of the motion to dismiss. We believe that we have meritorious defenses and counterclaims against this lawsuit and intend to pursue them
vigorously. We believe that the ultimate outcome of this action will not have a material adverse effect on our financial position and results of operations.



In addition, we may be subject to additional legal proceedings and claims, asserted or unasserted, that are in the ordinary course of business. We cannot predict the
outcome of these proceedings and claims or their possible impact Blue Martini.



|ITEM 4. |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
|------- |  | ---------------------------------------------------



No matters were submitted to a vote of our security holders during the fourth quarter of 2003.



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##### Table of Contents

PART II



|ITEM  5. |  | MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
|-------- |  | ----------------------------------------------------------------------------------------------------------------



(a) Our common stock is listed on the Nasdaq National Market under the symbol
BLUE. The following high and low sales prices were reported by Nasdaq in each quarter during the last two years. All amounts have been adjusted to reflect our one-for-seven reverse stock split of our outstanding shares of common stock,
which was effective on November 13, 2002.



|                              |  |      |       |     |   |     
|----------------------------- |  | ---- | ----- | --- | - | ----
|                              |  | High |       | Low
|Year Ended December 31, 2003: |  |      |       |     |   |     
|Fourth quarter                |  | $    | 6.05  |     | $ | 4.34
|Third quarter                 |  | $    | 5.48  |     | $ | 3.50
|Second quarter                |  | $    | 4.00  |     | $ | 2.56
|First quarter                 |  | $    | 3.14  |     | $ | 2.66
|                              |  |     
|Year Ended December 31, 2002: |  |      |       |     |   |     
|Fourth quarter                |  | $    | 4.27  |     | $ | 2.24
|Third quarter                 |  | $    | 8.33  |     | $ | 3.71
|Second quarter                |  | $    | 11.83 |     | $ | 4.55
|First quarter                 |  | $    | 22.11 |     | $ | 9.10



The reported last sale price of our
common stock on the Nasdaq National Market on February 23, 2004 was $5.36. The approximate number of holders of record of the shares of our common stock was 315 as of February 23, 2004. This number does not include stockholders whose shares are held
in trust by other entities. The actual number of stockholders is greater than this number of holders of record. We estimate that the number of beneficial stockholders of the shares of our common stock as of February 23, 2004 was approximately
11,300.



We have sold and issued no unregistered securities during the period
covered by this report. We have not paid any cash dividends on our capital stock during the years 2003 and 2002. For the foreseeable future, we intend to retain our earnings to fund the development and growth of our business and, therefore, do not
anticipate paying any cash dividends. See Item 7, Managements Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital Resources.



11



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##### Table of Contents

Equity Compensation Plan Information



The number of shares issuable upon exercise of outstanding stock options, the weighted-average exercise price of the outstanding options,
and the number of stock options remaining for future issuance for each of our plans are summarized in the following table as of December 31, 2003. All amounts set forth below have been adjusted to reflect our one-for-seven reverse split of our
outstanding shares of our common stock, which was effective on November 13, 2002.



|                                                                                       |  |                                                                                          |  |                                                                         |      |                                                            |          
|-------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------- | ---- | ---------------------------------------------------------- | ---------
|Plan Category                                                                          |  | Number of securities tobe issued upon exerciseof outstanding options,warrants and rights |  | Weighted averageexercise price ofoutstandingoptions, warrantsand rights |      | Number of securitiesremaining availablefor future issuance
|Equity compensation plans approved by security holders                                 |  | 3,300,000                                                                                |  | $                                                                       | 5.14 |                                                            | 5,437,000
|Equity compensation plans not approved by security holders (warrants to non-employees) |  | 477,400                                                                                  |  | $                                                                       | 8.45 |                                                            |         
|                                                                                       |  |                                                                                          |  |                                                                         |      |                                                            |          
|Total                                                                                  |  | 3,777,400                                                                                |  | $                                                                       | 5.56 |                                                            | 5,437,000
|                                                                                       |  |                                                                                          |  |                                                                         |      |                                                            |          



See Note 10 of the Consolidated
Financial Statements included elsewhere in this annual report for more detailed information on the stock options and warrants.



|ITEM  6. |  | SELECTED CONSOLIDATED FINANCIAL DATA
|-------- |  | ------------------------------------



The following selected consolidated financial data is derived from our consolidated financial statements. This data should be read in conjunction with Item 7,
Managements Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements of Blue Martini Software, Inc. and the notes to consolidated financial statements included elsewhere in
this annual report. The consolidated statement of operations data set forth below for each of the years in the three-year period ended December 31, 2003 and the consolidated balance sheet data as of December 31, 2003 and 2002, are derived from, and
qualified by reference to, the audited financial statements appearing elsewhere in this annual report. The statement of operations data for the periods ended December 31, 2000 and 1999, and the balance sheet data as of December 31, 2001, 2000 and
1999, are derived from audited financial statements not included herein. All references to earnings per share and the number of common shares reflect the one-for-seven reverse stock split of our outstanding shares of common stock, effected on
November 13, 2002.



|                                           |  |                                       |        |      |   |        |  |      |        |      |   |        |  |   |       
|------------------------------------------ |  | ------------------------------------- | ------ | ---- | - | ------ |  | ---- | ------ | ---- | - | ------ |  | - | ------
|                                           |  | Year Ended December 31,              
|                                           |  | 2003                                  |        | 2002 |   | 2001   |  | 2000 |        | 1999
|                                           |  | (in thousands, except per share data)
|Consolidated Statement of Operations Data: |  |                                       |        |      |   |        |  |      |        |      |   |        |  |   |       
|Revenues:                                  |  |                                       |        |      |   |        |  |      |        |      |   |        |  |   |       
|License                                    |  | $                                     | 11,479 |      | $ | 5,915  |  | $    | 20,438 |      | $ | 42,650 |  | $ | 7,205 
|Service                                    |  |                                       | 21,116 |      |   | 27,708 |  |      | 39,476 |      |   | 31,601 |  |   | 4,027 
|                                           |  |                                       |        |      |   |        |  |      |        |      |   |        |  |   |       
|Total revenues                             |  |                                       | 32,595 |      |   | 33,623 |  |      | 59,914 |      |   | 74,251 |  |   | 11,232
|                                           |  |                                       |        |      |   |        |  |      |        |      |   |        |  |   |       
|Cost of revenues:                          |  |                                       |        |      |   |        |  |      |        |      |   |        |  |   |       
|License                                    |  |                                       | 1,607  |      |   | 3,812  |  |      | 4,122  |      |   | 3,754  |  |   | 719   
|Service                                    |  |                                       | 13,685 |      |   | 20,164 |  |      | 37,359 |      |   | 34,676 |  |   | 5,480 
|                                           |  |                                       |        |      |   |        |  |      |        |      |   |        |  |   |       
|Total cost of revenues                     |  |                                       | 15,292 |      |   | 23,976 |  |      | 41,481 |      |   | 38,430 |  |   | 6,199 
|                                           |  |                                       |        |      |   |        |  |      |        |      |   |        |  |   |       
|Gross profit                               |  |                                       | 17,303 |      |   | 9,647  |  |      | 18,433 |      |   | 35,821 |  |   | 5,033 
|                                           |  |                                       |        |      |   |        |  |      |        |      |   |        |  |   |       



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##### Table of Contents

|                                                                     |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |  
|-------------------------------------------------------------------- |  | - | ------- | - |  | - | ------- | - |  | - | ------- | - |  | - | ------- | - |  | - | ------- | -
|Operating expenses:                                                  |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |  
|Sales and marketing                                                  |  |   | 18,732  |   |  |   | 26,920  |   |  |   | 46,661  |   |  |   | 45,962  |   |  |   | 7,736   |  
|Research and development                                             |  |   | 9,713   |   |  |   | 13,380  |   |  |   | 18,623  |   |  |   | 14,671  |   |  |   | 7,076   |  
|General and administrative                                           |  |   | 6,786   |   |  |   | 7,590   |   |  |   | 10,900  |   |  |   | 11,449  |   |  |   | 1,348   |  
|Amortization of deferred stock compensation                          |  |   | 1,336   |   |  |   | (794    | ) |  |   | 12,014  |   |  |   | 30,571  |   |  |   |        |  
|Impairment of long-lived assets and goodwill                         |  |   | (673    | ) |  |   | 16,678  |   |  |   |        |   |  |   |        |   |  |   |        |  
|In-process research and development                                  |  |   |        |   |  |   | 800     |   |  |   |        |   |  |   |        |   |  |   |        |  
|Restructuring charges                                                |  |   | 180     |   |  |   | 6,363   |   |  |   | 6,257   |   |  |   |        |   |  |   |        |  
|                                                                     |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |  
|Total operating expenses                                             |  |   | 36,074  |   |  |   | 70,937  |   |  |   | 94,455  |   |  |   | 102,653 |   |  |   | 16,160  |  
|                                                                     |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |  
|Loss from operations                                                 |  |   | (18,771 | ) |  |   | (61,290 | ) |  |   | (76,022 | ) |  |   | (66,832 | ) |  |   | (11,127 | )
|Interest income and other, net                                       |  |   | 1,184   |   |  |   | 2,438   |   |  |   | 6,418   |   |  |   | 4,745   |   |  |   | 253     |  
|                                                                     |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |  
|Net loss                                                             |  | $ | (17,587 | ) |  | $ | (58,852 | ) |  | $ | (69,604 | ) |  | $ | (62,087 | ) |  | $ | (10,874 | )
|                                                                     |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |  
|Basic and diluted net loss per common share                          |  | $ | (1.61   | ) |  | $ | (5.80   | ) |  | $ | (7.62   | ) |  | $ | (10.63  | ) |  | $ | (3.31   | )
|                                                                     |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |  
|Shares used in computing basic and diluted net loss per common share |  |   | 10,950  |   |  |   | 10,140  |   |  |   | 9,136   |   |  |   | 5,839   |   |  |   | 3,281   |  
|                                                                     |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |  



|                                                  |  |                |        |      |   |        |  |      |         |      |   |         |  |   |       
|------------------------------------------------- |  | -------------- | ------ | ---- | - | ------ |  | ---- | ------- | ---- | - | ------- |  | - | ------
|                                                  |  | December 31,  
|                                                  |  | 2003           |        | 2002 |   | 2001   |  | 2000 |         | 1999
|                                                  |  | (in thousands)
|Consolidated Balance Sheet Data:                  |  |                |        |      |   |        |  |      |         |      |   |         |  |   |       
|Cash, cash equivalents and short-term investments |  | $              | 46,188 |      | $ | 60,750 |  | $    | 97,499  |      | $ | 156,341 |  | $ | 12,924
|Working capital                                   |  |                | 37,585 |      |   | 52,035 |  |      | 85,468  |      |   | 129,676 |  |   | 7,708 
|Total assets                                      |  |                | 52,080 |      |   | 69,592 |  |      | 122,421 |      |   | 199,824 |  |   | 20,360
|Long-term obligations                             |  |                |       |      |   |       |  |      |        |      |   | 117     |  |   | 544   
|Total stockholders equity                        |  |                | 36,719 |      |   | 51,105 |  |      | 102,462 |      |   | 156,171 |  |   | 10,295



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##### Table of Contents

|ITEM  7. |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|-------- |  | -------------------------------------------------------------------------------------



Overview of Operations



The following discussion of our financial condition and results of operations should be read in conjunction with the section below in the Item 7 entitled Risk
Factors and our consolidated financial statements and notes thereto.



We
provide software designed to enable companies to increase revenues by proactively guiding sales people, channel partners and customers through sales interactions. Our revenues are derived from the licensing of our software and the sale of related
services. The license agreement for our software typically provides for an initial fee for use of the software in perpetuity, with use limited by the number of servers (CPUs), business unit, geographic area, brand or other similar limitations.
Service revenues are principally derived from consulting services, maintenance and training. Our maintenance agreements typically are payable in advance, entitle customers to receive software updates, maintenance releases and technical support, and
have a one-year term. Consulting services and training are generally sold on a time-and-materials basis.



We market our application suite primarily through a direct sales force. We also engage in alliances with systems integrators and technology vendors to assist us in marketing and selling our software and related
services. Some of our customers use systems integrators to implement our product, and systems integrators are a significant influence in our customers purchasing decisions. We primarily target our products to customers competing in the
commercial and consumer markets.



While the majority of our revenues to date
have been derived from customers in the United States, international revenues accounted for 23% of our revenues for 2003 and 2002, and 24% for 2001. We believe that international revenues will fluctuate as a percentage of revenues in the near term.
Our quarterly operating results have experienced seasonal fluctuations in the past. Quarterly results fluctuate based on several factors, including our customers fiscal years, budgeting cycles, sales incentive plans, slow summer purchasing
patterns and general economic conditions in markets where we conduct business.



To date, we have derived a significant portion of our revenues from a small number of customers. In 2003, two customers each accounted for more than 10% of consolidated revenues. No single customer accounted for more than 10% of our total
revenues for 2002 or 2001. We expect that a small number of customers will continue to account for a substantial portion of our quarterly total revenues. Sales to our ten largest customers accounted for 54% of total revenues in 2003, 42% of revenues
in 2002 and 39% of revenues in 2001. The loss of a major potential or existing customer or the delay or cancellation of anticipated significant license contracts would adversely affect our revenues and operating results in a particular quarter.
Failure to obtain a significant number of new customers or additional orders from existing customers in any period would adversely affect our business and operating results.



Our operating expenses are based in part on our expectations of future revenues over the long term, and are largely fixed in the short term.
As such, a delay in completion of new customer license contracts or the recognition of revenues from one or more license contracts could cause significant variations in our operating results from quarter to quarter and could result in significant
variation in our quarterly results of operations.



Overview of 2003



2003 marked an improvement for Blue Martini Software, in that our license
revenues increased significantly and our net loss decreased as compared to 2002. We nearly doubled our license revenues to $11.5 million in 2003 from $5.9 million in 2002. We increased the total number of customers that have licensed our software
from 140 companies as of December 31, 2002 to over 160 companies as of December 31, 2003. We leveraged our e-commerce heritage to reposition ourselves as a leading provider of intelligent selling systems, systems that are designed to
enable companies to sell more. We implemented a new go-to-market strategy, allowing us to reach decision-making executives of potential customers. We improved our relationships with our partners, resulting in more significant joint customer wins
than in 2002.



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##### Table of Contents

Despite these improvements, the weak global economy adversely affected our operating performance during 2003. Throughout
much of 2003, 2002 and 2001, economic conditions in the United States and other countries we operated in either deteriorated or stabilized at depressed levels. Further, political uncertainties, including hostilities involving the United States,
increased corporations general cautiousness in setting their capital spending budgets.



These uncertain and weak economic conditions greatly impacted the information technology industry. Many corporations have increased efforts to identify and realize potential cost savings in these difficult economic
times, and as a result, have delayed their information technology spending. In addition, many companies have curtailed their information technology spending due to past capital expenditures anticipating growth that did not materialize.



These factors negatively affected our operations and financial performance. Many of our
customers and potential customers have delayed initiating the purchasing process, increased evaluation time to complete a software purchase and reduced their capital expenditure budgets.



We believe that our greatest challenges as a company are to close sales transactions more expeditiously, and to increase our sales pipeline.
During 2003, our ability to sell was harmed by turnover in the leadership and staffing of our sales force. In 2004, we need to communicate better to our potential customers the immediate value we believe our solutions offer, we need to provide
potential customers with a clear path to achieve that potential value, and we must grow our relationships with consulting and system integrator partners. We also need to increase our sales force productivity and ensure that new members of our sales
team become productive within a reasonable period. We also strive to improve our overall performance by strengthening our competitive position, controlling costs, effectively managing our cash flow and better aligning our management and
organizational structure to support our sales efforts.



The Results of
Operations section below discusses our 2003 results in more detail.



Results of Operations



Revenues



License



|                               |  |      |        |   |              |    |   |      |   |       |              |  |     |      |  |   |        |  
|------------------------------ |  | ---- | ------ | - | ------------ | -- | - | ---- | - | ----- | ------------ |  | --- | ---- |  | - | ------ | -
|                               |  |      |        |   | % Change     |    |   |      |   |       | % Change     |  |     |      | 
|                               |  | 2003 |        |   | 2003 to 2002 |    |   | 2002 |   |       | 2002 to 2001 |  |     | 2001 | 
|License revenue (in thousands) |  | $    | 11,479 |   |              | 94 | % |      | $ | 5,915 |              |  | (71 | )%   |  | $ | 20,438 |  
|Percentage of total revenues   |  |      | 35     | % |              |    |   |      |   | 18    | %            |  |     |      |  |   | 34     | %



The increase in license revenues in
dollar terms in 2003 as compared to 2002 was due to an increase in average size of license transactions per customer. Our average size of license transactions per customer more than doubled, from approximately $200,000 in 2002 to approximately
$450,000 in 2003. In 2003, we added 20 new customers, comparable with the number of new customers added in 2002. The increased size of license transactions per customer in 2003 compared to 2002 is a result of our segment and vertical focus, our
point solution selling strategy, and improved relationships with our business partners.



The decrease in license revenues in 2002 as compared to 2001 was due to a decrease in average size and number of license transactions due in part to the overall global and business conditions that adversely impacted information technology
spending, particularly by companies in our target markets. Our business is affected by the economic and business conditions of these target markets and the level of demand for information technology within these industries, resulting in an increase
in the average length of our sales cycles, a marked increase in competitive pricing pressure and a decrease in the average revenues derived from license transactions as well as in the total number of such license transactions in 2002 compared to
2001.



In addition, we began offering software products acquired from the
Cybrant acquisition in the second quarter of 2002. Because our professional services related to these arrangements were deemed essential to the functionality of the software, we initially accounted for license revenues from the Cybrant software
products using the percentage-



15



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##### Table of Contents

of-completion method under Statement of Position 81-1, Accounting for Performance of Construction-Type and Certain
Production-Type Contracts. In the fourth quarter of 2002, upon repeated successful implementations of the Cybrant application, we determined that our professional services were not essential to the functionality of the software, and as such, in
the fourth quarter of 2002, we began to recognize license transactions relating to the Cybrant software products upon delivery, instead of using the percentage-of-completion method, subject to meeting all other revenue recognition criteria.



Although 2003 marked an improvement in our license revenues, customers in our
target markets remained cautious with respect to their capital spending. We expect these conditions to persist in the foreseeable future; for that reason, we have adopted strategies that we believe will allow us to maintain or improve our results
even if the economic recovery is slow or delayed.



We are committed to
improving the performance of our sales operations and continuing to increase our license revenues in 2004. To support our sales efforts, we have eliminated certain positions to create an efficient and effective sales organization and are making
changes in both our sales and marketing organizations to achieve a consistent increase of the sales pipeline, consistent increase of pipeline-to-license conversion rates, higher average selling prices, and shorter time frame for new members of our
sales force to become productive. These changes will include new sales training programs, better selling methodology and a more targeted approach to partnering, as well as new sales and marketing leadership.



Service



|                               |  |      |        |   |              |     |    |      |   |        |              |  |     |      |  |   |        |  
|------------------------------ |  | ---- | ------ | - | ------------ | --- | -- | ---- | - | ------ | ------------ |  | --- | ---- |  | - | ------ | -
|                               |  |      |        |   | % Change     |     |    |      |   |        | % Change     |  |     |      | 
|                               |  | 2003 |        |   | 2003 to 2002 |     |    | 2002 |   |        | 2002 to 2001 |  |     | 2001 | 
|Service revenue (in thousands) |  | $    | 21,116 |   |              | (24 | )% |      | $ | 27,708 |              |  | (30 | )%   |  | $ | 39,476 |  
|Percentage of total revenues   |  |      | 65     | % |              |     |    |      |   | 82     | %            |  |     |      |  |   | 66     | %



Service revenues include revenues from
consulting (professional services), technical support (maintenance) and to a lesser extent training activities. In absolute dollar terms, services revenues decreased in 2003 from 2002 primarily as a result of driving consulting services to our
partners. Our maintenance revenues in 2003 were comparable with 2002.



The
decrease in service revenues in dollar terms in 2002 compared to 2001 was due primarily to reductions in both our maintenance revenues and our consulting service engagements. The reduction in maintenance revenue in 2002 was primarily a result of a
decrease in new license revenues and a decrease in renewal rates from our existing customer base as customers continued to manage their costs. The reduction in consulting revenues was primarily due to a decrease in the scope and the size of service
engagements resulting from an overall reduction in license activities. We expect our service revenues, in dollar terms, to grow in 2004 at a lower rate than the growth in license revenues.



16



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##### Table of Contents

Cost of Revenues



License



|                               |  |      |       |   |              |     |    |      |   |       |              |  |    |      |  |   |       |  
|------------------------------ |  | ---- | ----- | - | ------------ | --- | -- | ---- | - | ----- | ------------ |  | -- | ---- |  | - | ----- | -
|                               |  |      |       |   | % Change     |     |    |      |   |       | % Change     |  |    |      | 
|                               |  | 2003 |       |   | 2003 to 2002 |     |    | 2002 |   |       | 2002 to 2001 |  |    | 2001 | 
|Cost of license (in thousands) |  | $    | 1,607 |   |              | (58 | )% |      | $ | 3,812 |              |  | (8 | )%   |  | $ | 4,122 |  
|Percentage of total revenues   |  |      | 5     | % |              |     |    |      |   | 11    | %            |  |    |      |  |   | 7     | %



Cost of license revenues generally
consists of royalty payments to third parties, amortization of prepaid royalties and amortization of purchased intangible assets for technology that is either embedded in or bundled with our software. Cost of license revenues for 2002 includes
amortization of intangible assets acquired in the Cybrant acquisition as well as accelerated amortization totaling $638,000 related to technology rights in the form of prepaid royalties for which we reduced the estimated useful lives.



Cost of license revenues represented 14% of license revenues in 2003, 64% in 2002 and 20% in
2001. The decrease in costs of license revenues in dollar terms in 2003 from 2002 was due to the decrease in the amortization of purchased intangible assets as we wrote-off the majority of these assets as part of the impairment evaluation in 2002.
See impairment discussion below under the heading Impairment of Long-lived Assets and Goodwill. The decrease in costs of license revenues in dollar terms in 2002 from 2001 was due to the reduction in royalties expense arising from the
reduction in license revenues, which was partially offset by the assets we wrote off as part of the impairment evaluation in 2002.



As of December 31, 2003, all purchased technologies have been fully amortized. Accordingly, based on agreements currently in place, we expect the cost of license revenues
in 2004 to be comprised of a fixed amount of $110,000 per quarter and a variable amount estimated to be between 5% and 10% of license revenues for payments required under technology license arrangements.



Service



|                               |  |      |        |   |              |     |    |      |   |        |              |  |     |      |  |   |        |  
|------------------------------ |  | ---- | ------ | - | ------------ | --- | -- | ---- | - | ------ | ------------ |  | --- | ---- |  | - | ------ | -
|                               |  |      |        |   | % Change     |     |    |      |   |        | % Change     |  |     |      | 
|                               |  | 2003 |        |   | 2003 to 2002 |     |    | 2002 |   |        | 2002 to 2001 |  |     | 2001 | 
|Cost of service (in thousands) |  | $    | 13,685 |   |              | (32 | )% |      | $ | 20,164 |              |  | (46 | )%   |  | $ | 37,359 |  
|Percentage of total revenues   |  |      | 42     | % |              |     |    |      |   | 60     | %            |  |     |      |  |   | 62     | %



Cost of service revenues consists
primarily of salaries and other personnel-related expenses, costs of services provided by third-party subcontractors engaged by us, allocated overhead costs, and depreciation of equipment used to provide consulting services, technical support and
training. Allocated overhead costs for costs of services and other expense categories include facilities, information systems, and other corporate infrastructure costs. Cost of service revenues represented 65%, 73% and 95% of service revenues for
2003, 2002 and 2001, respectively. The decrease in 2003 from the 2002 and the decrease in 2002 from 2001 resulted primarily from reductions in force and other cost-saving actions implemented in these periods. In addition, in 2003, as part of the
allocation of the total credit of $2.1 million arising from the expiration of a potential reimbursement obligation related to a prior executive officer, we recorded a credit of $609,000. (See Note 7 of the Consolidated Financial Statements included
elsewhere in this annual report for further discussion.) Because our cost of service revenues are relatively fixed, our cost of services, when expressed as a percentage of related service revenues, may fluctuate in the near term, based primarily on
our related service revenues.



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Operating Expenses



Sales and Marketing



|                                   |  |      |        |   |              |     |    |      |   |        |              |  |     |      |  |   |        |  
|---------------------------------- |  | ---- | ------ | - | ------------ | --- | -- | ---- | - | ------ | ------------ |  | --- | ---- |  | - | ------ | -
|                                   |  |      |        |   | % Change     |     |    |      |   |        | % Change     |  |     |      | 
|                                   |  | 2003 |        |   | 2003 to 2002 |     |    | 2002 |   |        | 2002 to 2001 |  |     | 2001 | 
|Sales and marketing (in thousands) |  | $    | 18,732 |   |              | (30 | )% |      | $ | 26,920 |              |  | (42 | )%   |  | $ | 46,661 |  
|Percentage of total revenues       |  |      | 57     | % |              |     |    |      |   | 80     | %            |  |     |      |  |   | 78     | %
|Headcount                          |  |      | 56     |   |              |     |    |      |   | 75     |              |  |     |      |  |   | 115    |  



Sales and marketing expenses consist
primarily of salaries, commissions, and other personnel-related expenses associated with our direct sales and marketing personnel, allocated overhead costs, and costs of marketing programs including trade shows, advertisements, promotional
activities and media events. The 2002 and 2001 expense also included amortization of deferred marketing costs of $2.3 million and $3.5 million, respectively, related to warrants issued to a system integrator. The decreases in 2003 from 2002 and in
2002 from 2001 were due primarily to the reduction in the deferred marketing amortization expense, lower spending on marketing and advertising programs and lower personnel-related expenses resulting from reductions in force and other cost-saving
actions. Further, in 2003, as part of the total credit of $2.1 million arising from the expiration of a potential reimbursement obligation related to a prior executive officer, we recorded a credit of $667,000. (See Note 7 of the Consolidated
Financial Statements included elsewhere in this annual report for further discussion.) In addition, the unamortized balance of deferred marketing costs of $638,000 was written off as part of the impairment evaluation in 2002. We expect that sales
and marketing expenses in 2004 will increase from 2003 reflecting additional variable costs related as we commit to improve our sales operations and continue to increase our license revenues.



Research and Development



|                                        |  |      |       |   |              |     |    |      |   |        |              |  |     |      |  |   |        |  
|--------------------------------------- |  | ---- | ----- | - | ------------ | --- | -- | ---- | - | ------ | ------------ |  | --- | ---- |  | - | ------ | -
|                                        |  |      |       |   | % Change     |     |    |      |   |        | % Change     |  |     |      | 
|                                        |  | 2003 |       |   | 2003 to 2002 |     |    | 2002 |   |        | 2002 to 2001 |  |     | 2001 | 
|Research and development (in thousands) |  | $    | 9,713 |   |              | (27 | )% |      | $ | 13,380 |              |  | (28 | )%   |  | $ | 18,623 |  
|Percentage of total revenues            |  |      | 30    | % |              |     |    |      |   | 40     | %            |  |     |      |  |   | 31     | %
|Headcount                               |  |      | 59    |   |              |     |    |      |   | 59     |              |  |     |      |  |   | 77     |  



Research and development expenses
consist primarily of salaries and other personnel-related expenses for engineering personnel, allocated overhead costs,costs of contractors, and depreciation of equipment used in the development of our software products. Development costs
incurred in the research and development of new software products are expensed as incurred until technological feasibility has been established, at which time such costs are capitalized, subject to recoverability. To date, all costs related to the
development of our software have been expensed as incurred. The decrease in 2003 from 2002 was primarily due to the decrease in average headcount in 2003 to 59 compared to 81 in 2002 and a credit of $551,000 arising from the expiration of a
potential reimbursement obligation related to a prior executive officer in 2003. The credit of $551,000 is an allocation to research and development of the $2.1 million credit, which is discussed in further detail in Note 7 of the Consolidated
Financial Statements included elsewhere in this annual report. The decrease in 2002 from 2001 was primarily due to decreases in personnel-related expenses resulting from reductions in force, which started in 2001 and continued in 2002 and a credit
of $500,000 arising from a joint research and development effort with an alliance partner in 2002. We expect that research and development expenses in 2004 will be at a level similar to 2003 as we continue to enhance our suite of applications while
at the same time manage our cost structure.



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General and Administrative



|                                          |  |      |       |   |              |     |    |      |   |       |              |  |     |      |  |   |        |  
|----------------------------------------- |  | ---- | ----- | - | ------------ | --- | -- | ---- | - | ----- | ------------ |  | --- | ---- |  | - | ------ | -
|                                          |  |      |       |   | % Change     |     |    |      |   |       | % Change     |  |     |      | 
|                                          |  | 2003 |       |   | 2003 to 2002 |     |    | 2002 |   |       | 2002 to 2001 |  |     | 2001 | 
|General and administrative (in thousands) |  | $    | 6,786 |   |              | (11 | )% |      | $ | 7,590 |              |  | (30 | )%   |  | $ | 10,900 |  
|Percentage of total revenues              |  |      | 21    | % |              |     |    |      |   | 23    | %            |  |     |      |  |   | 18     | %
|Headcount                                 |  |      | 28    |   |              |     |    |      |   | 32    |              |  |     |      |  |   | 40     |  



General and administrative expenses
include costs associated with our finance, human resources, legal, and other administrative functions. These costs consist principally of salaries and other personnel-related expenses, professional fees, provision for doubtful accounts, equipment
depreciation, and allocated overhead costs. The decreases in 2003 from 2002 and 2001 were primarily due to the reductions in force, a credit of $232,000 arising from the expiration of a potential reimbursement obligation related to a prior executive
officer and other cost-saving actions, which started in 2001 and continued in 2002 and 2003. The credit of $232,000 is an allocation to general and administrative of the $2.1 million total credit, which is discussed further in Note 7 of the
Consolidated Financial Statements included elsewhere in this annual report. We expect that general and administrative expenses in 2004 will be at a level similar to 2003.



Stock-Based Compensation



|                                        |  |      |       |      |   |      |      |  |   |       
|--------------------------------------- |  | ---- | ----- | ---- | - | ---- | ---- |  | - | ------
|                                        |  | 2003 |       | 2002 |   |      | 2001
|Stock-based compensation (in thousands) |  | $    | 1,336 |      | $ | (794 | )    |  | $ | 12,014



Stock-based compensation consists of
the net amortization of deferred stock compensation relating to stock options that vest over time and the stock-based compensation expense associated with immediately vested stock options and warrants granted to non-employees. Deferred stock
compensation represented the difference between the exercise price of stock option grants to employees and the deemed fair market value of our common stock at the time of grant. Deferred stock-based compensation was amortized to expense over the
period during which the common stock and stock options vest using an accelerated method allowed by generally accepted accounting principles. The reported expense is net of adjustment for accelerated deferred stock compensation amortization
previously recognized for terminated employees. At December 31, 2003, the deferred stock compensation balance had been fully amortized.



We recorded deferred stock compensation of $590,000 and $271,000 in 2002 and 2001, respectively, using the intrinsic value method, which is based on the difference
between the exercise price of stock option grants to employees and the deemed fair market value of our common stock at the time of grant. We did not record any deferred stock compensation in 2003. In 2001, we granted immediately vested stock options
and warrants to certain non-employees resulting in charges of $56,000, which were valued based on the Black-Scholes option-pricing model.



Deferred stock compensation expense in 2003 included a charge of $319,000 for the variable plan accounting associated with a stock option exchange program initiated in
2002, under which 602,000 outstanding employee stock options with exercise prices at or above $12.39 per share (approximately 92% of the total eligible options) were exchanged for replacement stock options at the fair market value of $3.60 per
share, which vested over a five-month period ending in May 2003 and expired in September 2003. The charge reflected the net increase in our stock market price above the option exercise price through the date the underlying options were exercised or
expired. As of December 31, 2003, there were no variable stock awards outstanding and we expect no further variable plan award expenses in the near future.



Impairment of Long-Lived Assets and Goodwill.In September 2002, a sharp decline in our stock price
resulted in our market capitalization being significantly below our net asset value. We determined that this circumstance triggered a review of our long-lived assets in accordance with Statement of Financial Accounting Standards (SFAS)
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Accordingly, we performed an impairment analysis of our property and equipment, intangible assets and other long-lived assets, other than



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goodwill, and determined that the carrying amount of property and equipment, intangible assets and other long-lived
assets exceeded their respective fair values. As a result, we recorded an impairment charge of approximately $11.1 million. The remaining balances in property and equipment and acquisition-related technology and intangibles are depreciated and
amortized, respectively, over their remaining estimated lives, mostly through the end of 2003.



SFAS No. 142, Goodwill and Other Intangible Assets, requires that goodwill be tested for impairment if a SFAS No. 144 triggering event has occurred. Accordingly, we performed an impairment analysis of goodwill
arising from the Cybrant acquisition. As we have determined that we operate in a single segment with one reporting unit, the fair value of our reporting unit was determined based on our market capitalization on the date of the impairment testing. As
a result of this analysis, we wrote off all $5.6 million of goodwill in 2002.



We estimated the fair value of our long-lived assets based on a combination of the market, income and replacement cost approaches. In the application of the impairment testing, we were required to make estimates of future operating trends
and resulting cash flows and judgments on discount rates and other variables. Actual future results and other assumed variables could differ from these estimates.



The impairment charge to goodwill, other intangible assets and other long-lived assets from the impairment review resulted in a write-off of
the net book value as follows (in thousands):



|                               |  |   |       
|------------------------------ |  | - | ------
|Goodwill                       |  | $ | 5,608 
|Acquisition-related technology |  |   | 1,350 
|Other intangible assets        |  |   | 8,220 
|Property and equipment         |  |   | 1,500 
|                               |  |   |       
|Total                          |  | $ | 16,678
|                               |  |   |       



Further, in September 2003, we
recorded a benefit of $673,000 representing purchase price adjustments resulting from the final resolution of acquisition related costs, acquired liabilities and the retirement of shares held in escrow relating to the Cybrant acquisition.



In-Process Research and Development. Approximately
$800,000 of the purchase price in the Cybrant acquisition in April 2002 represented the estimated fair value of acquired in-process research and development projects that had not yet reached technological feasibility and had no alternative future
use. Accordingly, this amount was charged to expense upon the acquisition date. The value assigned to purchased in-process research and development comprises development projects that were labeled at the acquisition time as versions 4.2 and 5.0 of
the Cybrant product that were valued by employment of a discounted cash flow model using discount rate of 35%. Version 4.2 was commercialized in 2002; version 5.0 was commercialized in 2003.



Restructuring Charges



|                                     |  |      |     |      |   |       |  |   |      
|------------------------------------ |  | ---- | --- | ---- | - | ----- |  | - | -----
|                                     |  | 2003 |     | 2002 |   | 2001 
|Restructuring charges (in thousands) |  | $    | 180 |      | $ | 6,363 |  | $ | 6,257
|Decrease in headcount                |  |      | 10  |      |   | 120   |  |   | 200  



During 2003, 2002 and 2001, we
implemented restructuring plans intended to strengthen our future operating performance and competitive position by preserving cash and reducing costs. As part of these restructurings, we reduced our employee force by approximately 10 employees in
2003, 120 employees in 2002 and approximately 200 employees in 2001. Some of the restructuring actions also included vacating excess facilities. These actions resulted in net restructuring charges of $180,000 in 2003, $6.4 million in 2002 and $6.3
million in 2001.



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##### Table of Contents

As of December 31, 2003, the Company has accrued restructuring charges of $2.4 million related to excess facilities,
which will be paid through 2006. These accrued charges reflect estimates with respect to the time it will take to sublease the facilities, sublease terms, and sublease rates. Should there be changes in real estate market conditions or should it take
longer than expected to find a suitable tenant to sublease the remaining vacant facilities, adjustments to the idle facilities lease losses reserve may be necessary in future periods based upon then current actual events and circumstances. The
following tables summarize the activity related to restructuring activities in 2003 and 2002 (in thousands):



|                                  |  |                              |       |               |   |                  |  |   |               |   |  |                              |        |   |  |   |      
|--------------------------------- |  | ---------------------------- | ----- | ------------- | - | ---------------- |  | - | ------------- | - |  | ---------------------------- | ------ | - |  | - | -----
|                                  |  | Accrued at December 31, 2002 |       | Total Expense |   | Non-cash Charges |  |   | Cash Payments |   |  | Accrued at December 31, 2003
|Lease cancellations/idle facility |  | $                            | 3,418 |               | $ |                 |  | $ | (173          | ) |  | $                            | (814   | ) |  | $ | 2,431
|Severance and related charges     |  |                              | 58    |               |   | 180              |  |   |              |   |  |                              | (238   | ) |  |   |     
|                                  |  |                              |       |               |   |                  |  |   |               |   |  |                              |        |   |  |   |      
|                                  |  | $                            | 3,476 |               | $ | 180              |  | $ | (173          | ) |  | $                            | (1,052 | ) |  | $ | 2,431
|                                  |  |                              |       |               |   |                  |  |   |               |   |  |                              |        |   |  |   |      
|                                  |  |                              |       |               |  
|                                  |  | Accrued at December 31, 2001 |       | TotalExpense  |   | Non-cash Charges |  |   | Cash Payments |   |  | Accrued at December 31, 2002
|Lease cancellations/idle facility |  | $                            | 458   |               | $ | 3,335            |  | $ |              |   |  | $                            | (375   | ) |  | $ | 3,418
|Severance and related charges     |  |                              | 18    |               |   | 3,028            |  |   | (128          | ) |  |                              | (2,860 | ) |  |   | 58   
|                                  |  |                              |       |               |   |                  |  |   |               |   |  |                              |        |   |  |   |      
|                                  |  | $                            | 476   |               | $ | 6,363            |  | $ | (128          | ) |  | $                            | (3,235 | ) |  | $ | 3,476
|                                  |  |                              |       |               |   |                  |  |   |               |   |  |                              |        |   |  |   |      



Interest Income and Other, Net



Interest income and other, net consists of interest income from cash,
cash equivalents and short-term investments partially offset by interest expense associated with capital leases and foreign currency transaction gains and losses. Interest income and other, net was $1.2 million, $2.4 million and $6.4 million in
2003, 2002 and 2001, respectively. The decline in interest income in the three years from 2001 to 2003 was primarily due to lower interest rates and the decline in balances of cash, cash equivalents and short-term investments. Foreign currency
transaction losses were immaterial in 2003 and 2002 and approximately $300,000 in 2001. We expect interest income to decrease as the amount of cash and cash equivalents available for investment decreases as cash is used in operations and as
prevailing interest rates remain low.



Income Taxes



From inception to December 31, 2003, we incurred net losses for federal and state tax
purposes and have not recognized any tax provision or benefit. As of December 31, 2003, we had approximately $129 million of federal and $75 million of California state net operating loss carryforwards to offset future taxable income. The federal
net operating loss carryforwards will expire in 2019 through 2023. The California net operating loss carryforwards will expire in 2007 through 2013. Because of our limited operating history, our losses incurred to date and the difficulty in
forecasting our future results, management does not believe that the realization of the related deferred income tax asset is more likely than not. Therefore, we have recorded a valuation allowance against the net deferred income tax assets.



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Quarterly Results of Operations



The following tables set forth consolidated statement of operations data for each of the quarters in the two-year period ended December 31,
2003 (in thousands, except per share data).



|                                                                     |  |                                       |        |   |              |   |         |              |  |   |              |   |  |   |         |  
|-------------------------------------------------------------------- |  | ------------------------------------- | ------ | - | ------------ | - | ------- | ------------ |  | - | ------------ | - |  | - | ------- | -
|                                                                     |  | Three Months Ended                    |       
|                                                                     |  | Mar. 31,2003                          |        |   | Jun. 30,2003 |   |         | Sep. 30,2003 |  |   | Dec. 31,2003 |  
|                                                                     |  | (In thousands, except per share data) |       
|Consolidated Statement of Operations Data:                           |  |                                       |        |   |              |   |         |              |  |   |              |   |  |   |         |  
|Revenues:                                                            |  |                                       |        |   |              |   |         |              |  |   |              |   |  |   |         |  
|License                                                              |  | $                                     | 1,756  |   |              | $ | 2,510   |              |  | $ | 4,203        |   |  | $ | 3,010   |  
|Service                                                              |  |                                       | 5,901  |   |              |   | 5,363   |              |  |   | 4,851        |   |  |   | 5,001   |  
|                                                                     |  |                                       |        |   |              |   |         |              |  |   |              |   |  |   |         |  
|Total revenues                                                       |  | $                                     | 7,657  |   |              | $ | 7,873   |              |  | $ | 9,054        |   |  | $ | 8,011   |  
|                                                                     |  |                                       |        |   |              |   |         |              |  |   |              |   |  |   |         |  
|Gross profit                                                         |  | $                                     | 3,222  |   |              | $ | 3,843   |              |  | $ | 5,258        |   |  | $ | 4,980   |  
|                                                                     |  |                                       |        |   |              |   |         |              |  |   |              |   |  |   |         |  
|Net loss                                                             |  | $                                     | (5,431 | ) |              | $ | (4,749  | )            |  | $ | (4,467       | ) |  | $ | (2,940  | )
|                                                                     |  |                                       |        |   |              |   |         |              |  |   |              |   |  |   |         |  
|Basic and diluted net loss per common share                          |  | $                                     | (0.51  | ) |              | $ | (0.45   | )            |  | $ | (0.40        | ) |  | $ | (0.26   | )
|                                                                     |  |                                       |        |   |              |   |         |              |  |   |              |   |  |   |         |  
|Shares used in computing basic and diluted net loss per common share |  |                                       | 10,550 |   |              |   | 10,640  |              |  |   | 11,110       |   |  |   | 11,490  |  
|                                                                     |  |                                       |        |   |              |   |         |              |  |   |              |   |  |   |         |  
|                                                                     | 
|                                                                     |  | Three Months Ended                    |       
|                                                                     |  | Mar. 31,2002                          |        |   | Jun. 30,2002 |   |         | Sep. 30,2002 |  |   | Dec. 31,2002 |  
|Revenues:                                                            |  |                                       |        |   |              |   |         |              |  |   |              |   |  |   |         |  
|License                                                              |  | $                                     | 1,029  |   |              | $ | 1,584   |              |  | $ | 1,414        |   |  | $ | 1,888   |  
|Service                                                              |  |                                       | 7,480  |   |              |   | 6,940   |              |  |   | 7,116        |   |  |   | 6,172   |  
|                                                                     |  |                                       |        |   |              |   |         |              |  |   |              |   |  |   |         |  
|Total revenues                                                       |  | $                                     | 8,509  |   |              | $ | 8,524   |              |  | $ | 8,530        |   |  | $ | 8,060   |  
|                                                                     |  |                                       |        |   |              |   |         |              |  |   |              |   |  |   |         |  
|Gross profit                                                         |  | $                                     | 2,666  |   |              | $ | 1,973   |              |  | $ | 1,715        |   |  | $ | 3,293   |  
|                                                                     |  |                                       |        |   |              |   |         |              |  |   |              |   |  |   |         |  
|Net loss                                                             |  | $                                     | (7,254 | ) |              | $ | (13,086 | )            |  | $ | (28,042      | ) |  | $ | (10,470 | )
|                                                                     |  |                                       |        |   |              |   |         |              |  |   |              |   |  |   |         |  
|Basic and diluted net loss per common share                          |  | $                                     | (0.76  | ) |              | $ | (1.28   | )            |  | $ | (2.71        | ) |  | $ | (1.00   | )
|                                                                     |  |                                       |        |   |              |   |         |              |  |   |              |   |  |   |         |  
|Shares used in computing basic and diluted net loss per common share |  |                                       | 9,560  |   |              |   | 10,200  |              |  |   | 10,340       |   |  |   | 10,450  |  
|                                                                     |  |                                       |        |   |              |   |         |              |  |   |              |   |  |   |         |  



The above quarterly information has
been derived from our unaudited quarterly consolidated financial statements that, in the opinion of our management, include all adjustments necessary for a fair presentation of this information. We have experienced and expect to continue to
experience fluctuations in operating results from quarter to quarter. We incurred net losses in each quarter since inception and may continue to incur losses in the foreseeable future. No conclusions about our future results should be drawn based on
the results of our operations for any quarter, as quarterly results are not indicative of the results for a full fiscal year or any other period.



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Liquidity and Capital Resources



|                                                     |  |      |        |      |   |        |  |   |        
|---------------------------------------------------- |  | ---- | ------ | ---- | - | ------ |  | - | -------
|(in thousands)                                       |  | 2003 |        | 2002 |   | 2001  
|Cash and cash equivalents and short term investments |  | $    | 46,188 |      | $ | 60,750 |  | $ | 97,499 
|Working capital                                      |  |      | 37,585 |      |   | 52,035 |  |   | 85,468 
|Stockholders equity                                 |  |      | 36,719 |      |   | 51,105 |  |   | 102,462



As of December 31, 2003, we had cash,
cash equivalents and short-term investments of $46.2 million, down from $60.8 million as of December 31, 2002. Our cash and cash equivalents consist primarily of money market funds, commercial paper and U.S. treasury and government agency
securities. All of our investments are classified as available-for-sale and carried at fair value based on quoted market prices in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity
Securities.



During 2003, net cash used in operating activities was
$15.9 million compared to $35.6 million in 2002 and $51.7 million in 2001. The decreases in net cash used in operating activities in 2003 from 2002 and in 2002 from 2001 were due primarily to the decrease in our net losses in each of the years
resulting from extensive headcount reductions and other cost saving actions. These reductions in net losses were partially offset by the reduction of non-cash charges such as depreciation, amortization of deferred stock compensation, restructuring
and impairment of long-lived assets and goodwill. Our accounts receivables decreased in 2003 as we proactively managed collections of outstanding balances. Our days sales outstanding in 2003, 2002 and 2001 were 42, 63 and 34 days, respectively,
reflecting our efforts.



Net cash provided by investing activities were $21.4
million in 2003 and $31.1 million in 2002, principally related to the net sale of short-term investments partially offset by fixed asset purchases. Net cash provided by investing activities was $21.3 million in 2001, related to the net sale of
short-term investments, partially offset by purchase of property and equipment and intangible assets. We do not expect any major capital expenditures in the near future.



Net cash provided by financing activities was $2.9 million in 2003, resulting from proceeds from the issuance of common stock under our
employee stock option and stock purchase plans. In 2002, net cash used in financing activities was $394,000 consisting of repayments of debt and capital lease obligations offset by proceeds from the issuance of common stock. Most of the proceeds
from the 2003 stock options exercises were related to options from the stock option exchange program instituted in December 2002 that expired in September 2003. (See discussion in Note 10 of the Consolidated Financial Statements included elsewhere
herein.) Cash provided by financing activities was $3.2 million in 2001 and principally related to the net proceeds received from the issuance of common stock under our employee stock purchase plan. Depending on the level of employee stock option
and purchase activity and the prevailing market price for our stock, net cash provided by or used in financing activities may vary in the near term.



In June 2002, our board of directors authorized the repurchase of up to 5% of our outstanding common stock. As of December 31, 2002, we had repurchased and retired
approximately 91,000 shares of our common stock in open market transactions at prevailing market prices for a total cost of approximately $558,000, including commissions. If we repurchase our outstanding common stock, additional cash will be used.
Based on current conditions, we do not anticipate repurchasing additional shares under this program in the near term.



We expect that for the foreseeable future, our operating costs and expenses will continue to constitute a significant use of our cash resources. In addition, we may use
our cash resources to fund acquisitions or invest in other businesses, technologies or product lines. We currently anticipate that our existing cash resources will be sufficient to meet our presently anticipated operating requirements for at least
the next 12 months. We may seek to raise additional funds through public or private debt or equity financing. There can be no assurance that this additional financing will be available, or if available, will be on reasonable terms and not dilutive
to our stockholders. If adequate funds are not available on acceptable terms, we could have to accept financing on terms we viewed as unreasonable or that were dilutive to our stockholders, or to pursue alternative options, such as seeking a merger
or acquisition, or in the worst case, winding down our operations. If we were to seek additional financing today, we do not believe it would be available on reasonable terms.



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The existence or even the anticipation of an uncertain economic environment by potential customers in the markets in
which we operate has affected the demand for our applications, caused pricing pressures for our products, increased customer requests for extended payment terms, and impacted our sales activity during 2003, 2002 and 2001, and may continue to do so
in future periods, which could in turn affect our liquidity.



Commitments



Our principal commitments as of December 31, 2003 consisted of
obligations under operating leases, letter of credit agreements, and royalty agreements. We expect to fulfill our commitments through our working capital.



Letters of Credit. At December 31, 2003, $962,000 of cash equivalents is held in trust as security for a letter of credit for guarantee of lease payments
for leased office space. Such cash equivalents will be restricted until the expiration of the lease term in 2006.



Royalties. We license and incorporate into our products technologies from third party software providers. Under the terms of these license agreements, which
expire at various dates up to June 2007, we pay royalties at various rates and amounts, generally based on unit sales or revenues. Royalty expense was $1.1 million, $1.5 million and $4.3 million for 2003, 2002 and 2001, respectively.



Aggregate Contractual Obligations.The Company leases certain facilities,
including its corporate headquarters, under non-cancelable operating leases. Rent expense for 2003, 2002 and 2001 was $3.2 million, $4.2 million and $7 million, respectively. Future minimum lease payments under operating lease with non-cancelable
terms of more than one year as of December 31, 2003 are as follows (including lease commitments reflected in accrued restructuring liabilities on the consolidated balance sheet):



|                              |       |                        |                 |  |           |       |           |   |                  |  |   |   |  |   |  
|----------------------------- | ----- | ---------------------- | --------------- |  | --------- | ----- | --------- | - | ---------------- |  | - | - |  | - | -
|(in thousands)                |       | Payments Due by Period
|                              | Total |                        | Less than1 year |  | 1-3 years |       | 3-5 years |   | More than5 years
|Operating leases              |       | $                      | 8,567           |  | $         | 3,448 |           | $ | 5,119            |  | $ |  |  | $ | 
|Total contractual obligations |       | $                      | 8,567           |  | $         | 3,448 |           | $ | 5,119            |  | $ |  |  | $ | 



Use of Estimates and Critical
Accounting Policies



Our discussion and analysis of our financial
condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP. The preparation of these financial
statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures. We evaluate our estimates on an ongoing basis, including those related to revenue
recognition, allowances for doubtful accounts and accrued liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis
for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our accounting policies are
described in the notes to our financial statements. We have identified the following as critical estimates employed in applying critical accounting policies:



Revenue Recognition. We recognize revenue in accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended,
and recognize revenue when all of the following criteria are met: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred, (3) the fee is fixed or determinable and (4) collectibility is probable. We allocate revenue on software
arrangements involving multiple elements to each element based on the residual method prescribed by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions. Our determination of fair value of
each element in multiple-element arrangements is based on vendor-specific objective evidence (VSOE) for all undelivered elements in the arrangement and the residual value is allocated to the license. We limit our assessment of VSOE for each element,
including maintenance, to the price charged when the same element is sold separately. VSOE for maintenance is determined based upon the customers annual renewal rates.



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We identified two critical accounting estimates with respect to applying our revenue recognition policy in 2003 and in
the near future. The first critical accounting estimate relate to determining whether an option provided to the customer to purchase specified software products in the future represents an element of the present arrangement or is a separate
arrangement. We evaluate whether these options provide the customer with significant incremental discounts to the optional software. We primarily consider the discount of the optional products relative to the discount of the delivered software
products and the price paid by other customers for the same software in similar configurations; however, there is judgment involved in determining whether discounted prices on the optional software are incremental and significant. In cases where the
optional software is discounted at a higher rate than the delivered element, we defer some of the revenue related to the delivered element and recognize the deferred revenue when the optional software is delivered or when the option expires. To
date, we did not have to defer any such revenues.



The second critical
accounting estimate with respect to our revenue recognition policy related to estimating percentage of completion for certain services transactions that require such estimation. We review each transaction at quarter-end and apply an estimate of
percentage of completion to the contract amount to determine the appropriate revenue recognition. We calculate the percentage based on contractual milestones met or, when the contract does not involve milestones, on hours incurred relative to total
estimated hours to complete a project. We evaluate the reasonableness of our estimates based on the type of services we render and our overall role in a project. In cases where the percentage of completion method is appropriate, the license revenue
will be deferred and recognized based on the percentage completion of the project.



Allowance for Doubtful Accounts Receivable. Accounts receivable is recorded net of allowance for doubtful accounts and sales return reserve. We regularly review the adequacy of our accounts receivable allowance and sales
return reserve by considering the accounts receivable aging, customer concentrations, the customers expected ability to pay, our collection history with each customer, available information regarding customer satisfaction and current economic
trends. We review any outstanding past due balances to determine if an allowance is appropriate based on the risk category using the factors discussed above. In addition, we maintain a general allowance for doubtful accounts for all invoices by
applying a percentage based on the age category. The allowance for doubtful accounts and the realization reserve represent our best estimate, but changes in circumstances relating to accounts receivable may result in a requirement for additional
allowance or reserve in the future.



Accrued Liabilities. The
idle facility lease losses were based on our lease commitments offset by our best estimate expected sublease income and related costs. These estimates are based upon managements estimate of the time required to sublet the facility and the
amount of sublease income that will be generated once the facility is sublet. Should there be changes in real estate market conditions or should it take longer than expected to find a suitable tenant to sublease the remaining vacant facilities,
adjustments to the idle facilities lease losses reserve may be necessary in future periods.



Recent Accounting Pronouncements



In
April 2003, the FASB issued SFAS No. 149, Amendments of Statement 133 on Derivative Instruments and Hedging Activities, which amends and clarifies financial accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133. SFAS No. 149 is generally effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30,
2003. We adopted the provision of SFAS No. 149 as of July 1, 2003. The adoption of SFAS No. 149 did not have a material impact on our financial condition or results of operations.



In December 2003, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 104
Revenue Recognition, which codifies, revises and rescinds certain sections of SAB No. 101, Revenue Recognition, in order to make this interpretive guidance consistent with current authoritative accounting and
auditing guidance and SEC rules and regulations. The changes noted in SAB No. 104 did not have an impact on the Companys financial position or results of operations.



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Factors That May Impact Future Operating Results



Risks Related To Our Financial Condition



We have incurred losses throughout our operating history. These losses may continue
for the foreseeable future, and we may not achieve profitability. In 2003, we incurred net losses of $17.6 million; as of December 31, 2003, we had an accumulated deficit of $220.6 million. We expect to continue to incur losses on both a
quarterly and annual basis, and may continue to do so for the foreseeable future. Moreover, we expect to continue to incur significant costs of services and substantial operating expenses. Therefore, we will need to significantly increase our
revenues to achieve and maintain profitability and a positive cash flow. We may not be able to generate sufficient revenues to achieve profitability.



Our declining cash balance and volatile stock price have affected our potential and current customers and partners perception of our viability, which in
turn could affect our ability to close sales and partnership transactions.Concerns about our perceived financial viability were a factor in multiple potential and actual customer transactions and partner relationships during 2002 and 2001
and to a lesser extent in 2003. We attribute these concerns primarily to the following: we are not yet profitable and thus must use our cash balance (offset by revenues) to fund our operations; our stock price experienced a dramatic decline from
2001 to 2002; our stock price has been, and continues to be, volatile; and many of our competitors are better funded, more established, or significantly larger than we are. We will continue to use our cash balance (offset by revenues) to fund our
operations until we achieve profitability (which may not occur); thus, we expect our cash balance will continue to decline during 2004. Therefore, if these conditions do not improve significantly in the next year, we expect these concerns about our
perceived viability to continue.



Risks Related To Our Products



If we fail to keep pace with technological innovation, improve our
existing products, or develop new products, our application suite could become obsolete and our revenues would decline. The market for our application suite is marked by rapid technological change, frequent new product introductions,
Internet-related technology enhancements, uncertain product life cycles, changes in client demands and evolving industry standards. New products based on new technologies or new industry standards can render existing products obsolete and
unmarketable. To succeed, we will need to enhance our current application suite and develop new products on a timely basis to keep pace with developments related to Internet technology and to satisfy the increasingly sophisticated requirements of
our clients.



Enterprise application software technology is complex, and new
products and product enhancements can require long development and testing periods; we cannot be certain that we will successfully develop and market new products, new product enhancements or new products compliant with present or emerging Internet
technology standards. Our future revenues will depend, in significant part, on our ability to successfully develop and license new and enhanced versions of our application suite, and our ability to continue diversifying our offerings by developing
and licensing new products. If we are not able to successfully improve our existing products and develop new products, or if we develop new products and they do not achieve market acceptance, or if we were to experience delays in either, our
revenues are likely to decline.



If we fail to release new versions and
upgrades of our application suite in a timely manner, customers may license competing products and our revenues may decline.We may fail to introduce or deliver new products on a timely basis, if at all. In the past, we have experienced
delays in the commencement of commercial shipments of enhancements to our application suite. To date, these delays have not had a material impact on our revenues. If we are unable to ship or implement new products or enhancements to our application
suite when planned or at all, or fail to achieve timely market acceptance of these new products or enhancements, we may suffer lost sales and thus reduce our revenues. Our future operating results will depend on demand for our application suite,
including new and enhanced releases that are subsequently introduced.



If
our application suite does not successfully function for customers with large numbers of transactions, customers or product offerings, we may lose sales and suffer decreased revenues. Our application suite must be



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able to accommodate a large number of transactions, customers and product offerings. Large-scale usage presents
significant technical challenges that are difficult or impossible to predict. To date, our application suite has been deployed on a large scale by only a limited number of customers and, therefore, we can make no assurances that our application
suite is able to meet our customers demands for large-scale usage. If our customers experience difficulty with our application suite during periods of high traffic or usage, the reputation of our products would suffer and our revenues would be
likely to decline accordingly.



Our interactive selling application may
not be capable of handling our customers needs. Our interactive selling system is based on a powerful configuration engine that has proven successful for a number of customers. Nonetheless, it is possible that our system could fail to
successfully meet a customers needs if the customers configuration requirements are extremely complex, exceptionally broad in scope, or not fully understood by us.



Loss or inability of key technologies licensed to us by third parties could affect our ability to license our product. Our
products incorporate technologies licensed from third-party software providers. In particular, we license array database modeling and configuration technology from Array Technology A/S, and we license a rules engine from Blaze Software Inc. that
automates the execution of business processes according to criteria set by our customers. We may not be able to maintain or renew our license agreements for these technologies on terms that are acceptable to us (or at all). The loss of these
technologies could harm our ability to license our products and increase our costs until we identify or develop substitute technologies, license them, and integrate them into our product; even if substitute technologies are available, we may not be
able to license those technologies on terms that are acceptable to us (or at all).



If our product does not operate with the wide variety of hardware, software and operating systems used by our current and potential customers, our revenues would be harmed. We currently serve a customer base that uses a wide
variety of constantly changing hardware, software applications and operating systems. Our application suite will gain broad market acceptance only if it can support a wide variety of hardware, software applications, systems, and standards, including
those developed in the future.



Defects in our application suite could
diminish demand for our application suite and result in loss of revenues, decreased market acceptance, injury to our reputation and product liability claims. As is not unusual for software companies, we have in the past discovered software
errors and performance problems with various versions of our application suite after release, and, as a result, have experienced injury to our reputation, increased expenses, delays in the shipment of our application suite and our customers have
experienced difficulty in deploying and operating our application suite.



Errors in our application suite may be caused by defects in third-party software incorporated into our application suite. If so, we may not be able to fix these defects without the cooperation of these software providers. Since these
defects may not be as significant to our software providers as they are to us, we may not receive the rapid cooperation that we may require. We may not have the contractual right to access the source code of third-party software and, even if we
access the source code, we may not be able to fix the defect.



Since our
customers use our application suite for critical business applications such as e-commerce, any errors, defects or other performance problems of our application suite could damage our customers businesses. Consequently, these customers could
delay or withhold payment to us for our software and services, which could result in an increase in our provision for doubtful accounts or an increase in collection cycles for accounts receivable. In addition, these customers could seek significant
compensation from us for their losses. Even if unsuccessful, a product liability claim brought against us would likely be time consuming and costly and harm our reputation, and thus our ability to license to new customers. Even if a suit is not
brought, correcting errors in our application suite could increase our expenses. A customer suit is pending against us alleging that our products failed to perform as represented. The Company believes that it has meritorious defenses against these
allegations and intends to defend itself vigorously. See Part I, Item 3, Legal Proceedings.



If we are unable to protect our intellectual property or become subject to intellectual property infringement claims, we may lose a valuable asset or incur costly and time-consuming litigation. Our
success depends in part on the development and protection of the proprietary aspects of our technology as well as our ability to operate without infringing on the proprietary rights of others. To protect our proprietary technology, we rely primarily
on a



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combination of trade secret, copyright, trademark, and patent laws, as well as confidentiality procedures and contractual
restrictions. Despite our efforts to protect our proprietary rights and technology, unauthorized parties may attempt to copy aspects of our products or obtain the source code to our software or use other information that we regard as proprietary or
could develop software competitive to ours. Our means of protecting our proprietary rights may not be adequate, and our competitors may independently develop similar technology or duplicate our product. Litigation may be necessary in the future to
enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Any such litigation could result in
substantial costs and diversion of resources that could have a material adverse effect on our business, operating results, and financial condition.



We have one issued patent and several pending patent applications. It is possible that some of the patents that we have applied for will not be issued, and even if
issued, that some or all may be successfully challenged. It is also possible that we may not develop additional proprietary products or technologies that are patentable, that any patent issued to us may fail to provide us with competitive advantage,
and that the patents of others may materially harm our ability to do business.



In the future, a third party may bring suit claiming that our current or future products infringe its patents, trade secrets or copyrights. Any claims, with or without merit, could be costly and time-consuming to defend, divert our
managements attention, or cause product delays. We have only one currently issued patent that we could use defensively against any company bringing such a claim. If our product was found to infringe a third partys proprietary rights, we
could be required to enter into royalty or licensing agreements to be able to sell our product. Royalty and licensing agreements, if required, may not be available on terms that are acceptable to us (or at all), which could materially harm our
business.



Risks Related to Our Market and Our Ability to Sell



The current economic downturn has significantly affected demand for
our products and services and may continue to adversely impact future revenues.The existence of economic downturns in the markets in which we operate has decreased the demand for our applications, caused pricing pressures for our products,
and affected our sales activity during 2001, 2002 and 2003. In 2001, we signed 29 new license contracts, a decrease from 67 new license contracts signed in 2000; in 2002, we signed 21 new license contracts, a further decrease from 2001; and in 2003,
we signed 20 new license contracts, comparable to 2002. Due in part to the macroeconomic conditions during 2001, 2002 and 2003, customers reduced their information technology budgets and postponed or cancelled planned projects, including the
evaluation and purchase of new applications, upgrades to existing applications, and purchase of related services. As a result, our revenues have been negatively impacted, and may continue to be in the future.



The existence or even the anticipation of an uncertain economic environment by potential
customers in the markets in which we operate affected the demand for our applications, caused pricing pressures for our products, increased customer request for extended payment terms, substantially reduced our sales activity during 2001 and 2002,
and continued to affect sales in 2003. We expect it will continue to do so in future periods, which could in turn materially reduce our liquidity. In addition, ongoing financial, political, economic, and other uncertainties have further weakened the
global economy. Additional terrorist attacks, continued war or increased outsourcing of technology projects overseas could adversely affect our business, including revenues, financial condition, and results of operations.



Our budgeting and forecasting depend on estimates of revenue growth in our target markets.
Thus, the prevailing economic and political uncertainty makes it difficult to estimate anticipated license contract signings and future revenues. The future performance of the overall domestic and global economies and the resolution of current
international tension involving the United States will likely have a significant impact on our overall performance. To the extent that the current downturn continues or increases in severity or scope, we believe demand for our products and services,
and therefore future revenues, could be further reduced.



We may not be
able compete effectively with current and potential competitors.We compete in the highly competitive CRM market, which is subject to rapid technological change. We believe that our products, which are externally focused on increasing our
customers sales to their own customers, are fundamentally different from traditional CRM offerings, which focus internally on managing and reporting a customers sales efforts and



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opportunities. We may not be able to articulate the value we believe we offer with sufficient clarity and distinctiveness
to generate interest in our target markets. A principal source of competition is the internal information technology departments at potential customers, which may develop systems that provide for some or all of the functionality of our applications.
Our products also compete with products, components, or solutions offered by Art Technology Group, Inc., BroadVision, Inc., E.phipany, Inc., Firepond, Inc., Microsoft Corporation, Oracle Corp., PeopleSoft, Inc., SAP AG, Selectica, Inc., Siebel
Systems, Inc., Trilogy Software, Inc., Unica Corporation and Vignette Corporation.



Compared to us, many of these competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial resources. This may place us at a disadvantage in responding to our
competitors pricing strategies, technological advances, advertising campaigns, strategic partnerships and other initiatives. Competitive pressures and our perceived viability in this market may make it difficult for us to acquire and retain
customers, and may require us to reduce the price of our products which could reduce our revenues and result in increased operating losses.



The sales cycle for our products is long and variable, which makes it difficult to predict our future revenues and may cause our operating results to vary
significantly. Our revenues and results of operations are difficult to predict and may fluctuate substantially from quarter to quarter. For example, certain indicators that we relied upon in developing our license revenue forecasts, such as
our historical pattern of transaction timing and anticipated sales cycles, did not prove reliable during 2001, 2002 or 2003. During these periods, we continued to see extended sales cycles; our average sales period was six to twelve months in 2001,
2002, and 2003.



The period between initial contact with a prospective customer
and the licensing of our application suite varies and can range from three to more than twelve months. Because of this variable sales cycle, the timing of revenues from the licensing of our application suite is difficult to forecast. Factors
affecting our sales cycle, many of which are beyond our control, include:



| | Many of our license agreements close within the last few weeks of each quarter;
|- | -------------------------------------------------------------------------------



| | Customers consider a number of factors related to our products and services, as well as our financial condition, before committing to purchase our application suite. As a result, we
spend significant time and resources informing prospective customers about our company, application suite, and other offerings, which may not result in a completed transaction but may nonetheless impact our operating margins;
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | The licensing of our application suite is often an enterprise-wide decision by our customers that involves many factors and decision-makers; thus, if our customers management,
budget, or strategy changes, our ability to conclude license agreements may be affected;
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | Because a substantial portion of our quarterly revenues are derived from a small number of customers, delays in the signing of one or more large license agreements or the loss of a
significant customer order may materially affect revenues and our operating results;
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | Due in part to macroeconomic conditions, customers remain cautious about spending, and have increased requests for contract terms that affect our ability to recognize revenue. These
conditions may persist in the future;
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | Customer approval processes are unpredictable; delays in approvals, even after selection of a vendor, could impact the timing and amount of revenues recognized in a quarterly
period;
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | We have recently changed several aspects of our sales leadership, strategy and process with the intention of improving our sales pipeline and results, including changes in the way
we generate leads, hiring of additional salespeople and changes in the way we target and approach accounts. We expect that it may take up to twelve months to see positive results from these changes, although these changes may not show positive
results during that period or at all. As a result of these changes, our ability to market and license our software may be limited accordingly; and
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | The number, timing and significance of enhancements to our application suite, and the introduction by us or our competitors, of new software may affect customers purchasing
decisions.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Because of this variation in sales cycle length, it
is difficult for us to predict revenues and thus our operating results could be hard to estimate. For example, if our license results do not meet our internal expectations, our service offerings would be affected (since service revenues lag
licenses) and our services revenues would be reduced, which would harm our overall results since service expenses are relatively fixed in the short term.



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A small number of customers have accounted for a substantial portion of our revenues, and this pattern is likely to
continue for the foreseeable future; as a result, our revenues could decline due to the loss or delay of a single customer order, the delay in recognizing revenue associated with a single customer order, or the failure to collect revenue associated
with a single customer. Each quarter during our operating history, a relatively small number of customers has accounted for a significant portion of that quarters total revenues. We expect this to continue in the future. Thus, the loss
or delay of individual orders could have a significant impact on revenues and operating results.



The timing of recognition of customer revenue may also affect our results. Customer payments that do not meet our revenue recognition policy requirements are recorded as deferred revenue. Although new agreements may
not result in revenues in the quarter in which the agreement was signed, commissions and royalties may nonetheless become payable on such agreements during that quarter, which would impact our operating results.



We may not successfully establish ourselves in international markets or generate
significant revenues abroad, which could result in slower revenue growth and harm our business.In 2003, we generated approximately 23% of our total revenues from sales outside the United States. We have sales offices in, France, Japan,
Netherlands, and the United Kingdom, and have also generated sales in other countries. We may add others in the future. If we are not successful in continuing to license our application suite in international markets, or if we do not increase sales
from outside the United States, we could experience slower revenue growth and our business could be harmed. We anticipate devoting additional resources and management attention to expanding international opportunities. Our international expansion
carries with it a number of additional challenges, including:



| | greater difficulty in staffing and managing foreign operations;
|- | ---------------------------------------------------------------



| | expenses associated with foreign operations and compliance with applicable laws;
|- | --------------------------------------------------------------------------------



| | difficulty and costs of managing a global technical support service that provides around the clock support;
|- | -----------------------------------------------------------------------------------------------------------



| | political or economic changes or instability in a specific country or region;
|- | -----------------------------------------------------------------------------



| | expenses associated with localizing our product for foreign countries;
|- | ----------------------------------------------------------------------



| | differing intellectual property rights and the enforcement of such rights;
|- | --------------------------------------------------------------------------



| | protectionist laws and business practices that favor local competitors;
|- | -----------------------------------------------------------------------



| | different sales cycles and collection periods or seasonal reductions in business activity;
|- | ------------------------------------------------------------------------------------------



| | multiple, conflicting and changing governmental laws and regulations; and
|- | -------------------------------------------------------------------------



| | foreign currency restrictions and exchange rate fluctuations.
|- | -------------------------------------------------------------



Increasing government regulation of personal data, the Internet, imposition of sales and other taxes on products sold by our customers over the Internet and privacy
concerns could reduce the license of our application suite and harm our business. Federal, state or foreign agencies may adopt laws or regulations affecting personal data or the use of the Internet as a commercial medium. We expect that laws
and regulations relating to user privacy, pricing, content and quality of products and services could indirectly affect our business.



Current federal legislation limits the imposition of state and local taxes on Internet-related sales at this time. Congress may choose not to renew this legislation, in
which case state and local governments would be free to impose taxes on electronically purchased goods. The imposition of new sales or other taxes could limit the growth of Internet commerce in general and, as a result, the demand for our
application suite and services.



Businesses use our application suite to
capture information regarding their customers when those customers contact them on-line with customer service inquiries. Privacy concerns may cause visitors to withhold personal data, which would limit the effectiveness of our application suite.
More importantly, even the perception of privacy concerns, whether or not valid, may indirectly inhibit market acceptance of our application suite.



Risks Related To System Integrators



Our failure to develop and maintain strong relationships with consulting and system integrator firms (CSIs) would harm our ability to market our application suite,
which could reduce future revenues and increase our expenses.An increasing portion of our sales are influenced by the recommendation of our application suite by systems integrators, consulting firms and other third parties that help deploy
our application suite for our customers.



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Losing the support of these third parties may limit our ability to penetrate our existing or potential markets. These
third parties are under no obligation to recommend or support our application suite and could recommend or give higher priority to their own products and services or those of other companies. Our inability to gain the support of CSIs or a shift by
these companies toward favoring competing products could negatively affect our software license and service revenues.



Some CSIs also engage in joint marketing and sales efforts with us. If our relationships with these CSIs fail, we will have to devote substantially more resources to the
sales and marketing of our application suite. In many cases, these parties have extensive relationships with our existing and potential customers and influence the decisions of these customers. A number of our competitors have longer and more
established relationships with these CSIs than we do, and as a result those CSIs may be more likely to recommend competitors products and services and increase our expenses.



Our failure to develop and maintain strong relationships with systems integrators would harm our ability to implement our application
suite. Systems integrators assist our customers with the installation and deployment of our application suite, in addition to those products of our competitors, and perform custom integration of computer systems and software. If we are
unable to develop and maintain relationships with systems integrators, we would be required to hire additional personnel to install and maintain our application suite, which would result in higher expenses and delays in our ability to recognize
revenue.



Other Risks



Changes in accounting policies created and interpreted by authoritative agencies can
have a significant effect on our reported results and may even affect the reporting of transactions completed before a change is announced.We prepare our financial statements in conformity with accounting principles generally accepted in
the United States of America or GAAP. These principles are subject to interpretation by the Securities and Exchange Commission and various bodies formed to interpret and create accounting policies. A change in these policies can have a significant
effect on our reported results and may even affect the reporting of transactions completed before a change is announced. Our accounting policies that may be affected by changes in the accounting rules are as follows:



| | revenue recognition
|- | -------------------



| | accounting for business combinations
|- | ------------------------------------



| | stock-based compensation
|- | ------------------------



| | goodwill and other intangible assets accounting
|- | -----------------------------------------------



Changes to these or other rules or the questioning of current practices may have a significant adverse effect on our reported financial results or in the way in which we
conduct our business. See the discussion under Use of Estimates and Critical Accounting Policies in thus Annual Report for additional information about our critical accounting policies and some risks associated with these policies.



We may have difficulty retaining or recruiting qualified personnel,
which could impact the development and license of our application suite. Difficulty in hiring or retaining qualified personnel, or failure by newly hired personnel to develop necessary skills or reach expected levels of productivity, may
weaken our ability to develop and market our application suite. Our success also depends on the continued contributions of key engineering, sales and marketing, management, and professional services personnel. In particular, losing the services of
Monte Zweben, our Chairman and Chief Executive Officer, would be difficult to replace.



Our ability to increase our sales will depend on our ability to recruit, train and retain top-quality sales people who can target prospective customers senior management and generate and service large accounts. In our industry,
competition for qualified sales personnel is intense.



Our Chairman and
CEO maintains significant control over Blue Martini Software, which may lead to conflicts with other stockholders over corporate strategy and other issues. Our directors, executive officers, and holders of 5% or more of our outstanding
common stock owned approximately 41% of our outstanding common stock as of December 31, 2003. Monte Zweben, our Chairman and Chief Executive Officer, together with related entities, owned approximately 32% of our common stock as of this date. These
stockholders, acting together, and Mr. Zweben,



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individually, will be able to significantly influence all matters requiring approval by our stockholders, including the
election of directors and significant corporate transactions such as mergers or other business combination transactions. This control may delay or prevent a third party from acquiring or merging with us.



We have implemented anti-takeover provisions that could discourage or prevent a
takeover.Provisions of our amended and restated certificate of incorporation and bylaws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us. These provisions include:



| | establishment of a classified board of directors such that not all members of the board may be elected at one time;
|- | -------------------------------------------------------------------------------------------------------------------



| | authorizing the issuance of blank check preferred stock that could be issued by our board of directors to increase the number of outstanding shares and thwart a takeover
attempt;
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | prohibiting cumulative voting in the election of directors, which would otherwise allow less than a majority of stockholders to elect director candidates;
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------



| | limitations on the ability of stockholders to call special meetings of stockholders;
|- | ------------------------------------------------------------------------------------



| | prohibiting stockholder action by written consent and requiring all stockholder actions to be taken at a meeting of our stockholders; and
|- | -----------------------------------------------------------------------------------------------------------------------------------------



| | establishing advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted upon by stockholders at stockholder
meetings.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In addition, Section 203 of the Delaware General
Corporations Law and the terms of our stock option plans may discourage, delay or prevent a change in control of the Company.



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|ITEM  7A. |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|--------- |  | ----------------------------------------------------------



Foreign Currency Exchange



Through December 31, 2003, approximately 77% of our revenues were denominated in United States dollars and were primarily from customers in the United States and Canada,
and approximately 23% of our revenues were in various international currencies from various international customers. Our exposure to foreign currency exchange rate changes has not been material. We expect that future license and service revenues
will continue to be derived from international markets and may be denominated in the currency of the applicable market. Through December 31, 2003, we have maintained our international operations and have hired personnel in Europe and Asia Pacific.
We have incurred limited operating expenses denominated in foreign currencies. Our future operating results may become subject to significant fluctuations based upon changes in the exchange rates of foreign currencies in relation to the United
States dollar. In the future, we expect to engage in international sales denominated in both the United States dollar and in foreign currencies. An increase in the value of the United States dollar relative to foreign currencies could make our
products less competitive in international markets. Although we will continue to monitor our exposure to currency fluctuations and, when appropriate, may use economic hedging techniques in the future to minimize the effect of these fluctuations, we
can make no assurances that exchange rate fluctuations will not adversely affect our financial results in the future. Through December 31, 2003, the Company had not engaged in foreign currency hedging activities.



Fixed Income Securities



At December 31, 2003, we had an investment portfolio of fixed income securities, including those classified as cash equivalents, of $46.2
million compared to $60.8 million at December 31, 2002. Our exposure to financial market risk, including changes in interest rates, relates primarily to our investment portfolio. Our general policy is to limit the risk of principal loss and ensure
the safety of invested funds by limiting market and credit risk. This exposure is limited by the establishment and strict monitoring of compliance with our investment policy which provides for investments in fixed income securities with maturities
not exceeding 18 months. This policy also establishes credit quality standards and limits investment exposure to any one issuer. We do not invest in any derivative instruments. Due mainly to the relatively short-term nature of our available-for-sale
investment portfolio, the fair value of our investment portfolio or related income would not be significantly impacted by a 100 basis point increase or decrease in interest rates.



|ITEM  8. |  | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|-------- |  | -------------------------------------------



The financial statements required by this item are submitted as a separate section of this annual report on Form 10-K. See Item 15.



|ITEM  9. |  | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
|-------- |  | ------------------------------------------------------------------------------------



Not applicable.



|ITEM  9A. |  | CONTROLS AND PROCEDURES
|--------- |  | -----------------------



Quarterly Evaluation of Our Disclosure Controls and Internal Controls: As of December 31, 2003 (the Evaluation Date), we evaluated the
effectiveness of the design and operation of our disclosure controls and procedures (the Disclosure Controls), as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934, as amended, and our
internal controls and procedures for financial reporting (the Internal Controls). This evaluation (the Controls Evaluation) was done under the supervision and with the participation of management, including our CEO and CFO.
Rules adopted by the SEC require that we present the conclusions of the CEO and the CFO about the effectiveness of our Disclosure Controls and Internal Controls based on and as of the date of the Controls Evaluation.



33



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Certifications: Attached as Exhibits 31.1, 31.2 and 32.1 are two separate forms of certifications of the
CEO and the CFO. The certifications attached as Exhibits 31.1 and 31.2 are required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 (the Section 302 Certifications). The information contained in this Item 9A relates to
the Controls Evaluation referred to in the Section 302 Certifications, and should be read with the Section 302 Certifications for a more complete understanding of the topics presented.



Disclosure Controls and Internal Controls over Financial Reporting: Our management, including the CEO and the CFO, and has
responsibility for establishing and maintaining adequate disclosure and internal controls over our financial reporting. Disclosure Controls are procedures that are designed with the objective of ensuring that information required to be disclosed in
our reports filed under the Securities Exchange Act of 1934, such as this Annual Report on Form 10-K, is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms. Disclosure Controls are also designed
with the objective of ensuring that such information is accumulated and communicated to our management, including the CEO and the CFO, as appropriate to allow timely decisions regarding required disclosure. Internal Controls are procedures that are
designed with the objective of providing reasonable assurance regarding the reliability of financial reporting and include those policies and procedures that provide reasonable assurances that our transactions are properly authorized, our assets are
safeguarded against unauthorized or improper use, and our transactions and dispositions of assets are properly recorded and reported, all to permit the preparation of our financial statements in conformity with GAAP.



Limitations on the Effectiveness of Controls: Our management, including the CEO
and CFO, does not expect that our Disclosure Controls or our Internal Controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations
in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in
decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the
control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future
conditions. In addition, over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and not be detected.



Scope
of the Controls Evaluation: The CEO and CFO evaluation of our Disclosure Controls and our Internal Controls included a review of the controls objectives and design, our controls implementation and the effect of the controls on
the information generated for use in this Annual Report on Form 10-K. In the course of the Controls Evaluation, we sought to identify data errors, control problems or acts of fraud and to confirm that appropriate corrective actions, including
process improvements, were being undertaken. We will perform this type of evaluation on a quarterly basis so that the conclusions concerning controls effectiveness can be reported in our Quarterly Reports on Form 10-Q and Annual Report on Form 10-K.
The overall goals of these various evaluation activities are to monitor our Disclosure Controls and our Internal Controls and to make modifications as necessary. Our intent in this regard is that the Disclosure Controls and the Internal Controls
will be maintained as dynamic systems that change (including with improvements and corrections) as conditions warrant.



Among other matters, we sought in our evaluation to determine whether there were any significant deficiencies or material weaknesses in our
Internal Controls, or whether we have identified any acts of fraud involving personnel who have a significant role in our Internal Controls. This information was important both for the Controls Evaluation generally and because item 5 in the Section
302 Certifications require that the CEO and CFO disclose such information to the Audit Committee of our Board of Directors and to our independent auditors and to report on related matters in this section of the Annual Report on Form 10-K. In the
professional auditing literature, significant deficiencies are referred to as reportable conditions, which are control issues that could have a significant adverse effect on the ability to record, process, summarize and
report financial data in the financial statements. A material weakness is defined in the auditing literature as a particularly serious reportable condition where the internal control does not reduce to a relatively low level the risk
that misstatements caused by error or



34



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##### Table of Contents

fraud may occur in amounts that would be material in relation to the financial statements and not be detected within a
timely period by employees in the normal course of performing their assigned functions. We also sought to deal with other controls matters in the Controls Evaluation, and in each case if a problem was identified, we considered what revision,
improvement or correction to make in accordance with our on-going procedures.



Conclusions: Based upon the Controls Evaluation, our CEO and our CFO have concluded that, subject to the limitations noted above, our Disclosure Controls and Internal Controls and procedures are effective in alerting them on a
timely basis to material information related to us (including our consolidated subsidiaries) that is required to be included in our reports filed or submitted under the Securities and Exchange Act of 1934, as amended.



Changes in Internal Controls over Financial Reporting: In accordance with SEC
requirements, our CEO and CFO note that, during the the quarter ended December 31, 2003, there have been no changes in Internal Controls or in other factors that could materially affect or are reasonably likely to materially affect such controls,
including any corrective actions with regard to significant deficiencies and material weaknesses.



35



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##### Table of Contents

PART III



Certain information required by Part III
is omitted from this Report on Form 10-K since we will file a definitive Proxy Statement for our Annual Meeting of Stockholders to be held on June 4, 2004, pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended (the
Proxy Statement), not later than 120 days after the end of the fiscal year covered by this Report, and certain information included in the Proxy Statement is incorporated herein by reference.



|ITEM  10. |  | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
|--------- |  | --------------------------------------------------



|(a) | Executive Officers
|--- | ------------------



The following table sets forth certain information regarding our executive officers as of March 11, 2004:



|                |  |     |  |                                     
|--------------- |  | --- |  | ------------------------------------
|Name            |  | Age |  | Office(s)                           
|Monte Zweben    |  | 40  |  | Chairman and Chief Executive Officer
|Eran Pilovsky   |  | 43  |  | Chief Financial Officer             
|Mary Hamershock |  | 41  |  | Vice President, Human Resources     
|Claire Hough    |  | 44  |  | Vice President, Product Development 



Monte Zweben has served as our
Chairman and Chief Executive Officer since June 1998. From November 1997 to June 1998, Mr. Zweben was an Entrepreneur in Residence at Matrix Partners and Institutional Venture Partners, two venture capital firms. From October 1996 to November 1997,
Mr. Zweben was Vice President and General Manager at PeopleSoft, Inc., a provider of enterprise applications. From 1992 to December 1996, Mr. Zweben was Chairman, President and Chief Executive Officer of Red Pepper Software Company. From September
1986 to December 1992, Mr. Zweben was the Deputy Branch Chief of the NASA Ames Research Centers Artificial Intelligence Branch. Mr. Zweben serves on the board of directors of Advent Software, Inc. and the School of Computer Science at
Carnegie-Mellon University. Mr. Zweben has a masters degree in computer science from Stanford University and a bachelors degree in computer science and industrial management from Carnegie-Mellon University.



Eran Pilovsky has served as our Chief Financial Officer since August 2003, having
joined the Company as Vice President of Finance in March 2002. Prior to joining Blue Martini Software, from January 2000 to October 2001, Mr. Pilovsky served as Chief Financial Officer of Vyyo, Inc., a NASDAQ-listed supplier of broadband wireless
systems. From October 1997 to January 2000, he was a partner with Ernst & Young LLP, having joined Ernst & Youngs audit practice in September 1985. Mr. Pilovsky is a cum laude graduate of the University of San Francisco with a B.S. in
Business Administration, and is also a Certified Public Accountant in California.



Mary Hamershockhas served as our Vice President, Human Resources since May 2001, having joined the Company as Director, Human Resources in February 2000. Before joining Blue Martini, Ms. Hamershock served as an independent
consultant and Human Resources Director for Calico Commerce from March 1999 to February 2000. Prior to Calico Commerce, Ms. Hamershock served in recruiting and human resources roles for Netscape Communications from March 1996 to June 1998. Ms.
Hamershock has a bachelors degree of arts in history from Mills College.



Claire Houghjoined the Company in November 2002. From September 2001 to September 2002, Ms. Hough served as Vice President of Engineering for Napster Inc. From April 2000 to July 2001, Ms. Hough was Executive Vice President of
Products at eTime Capital. From September 1995 to April 2000, Ms. Hough was Vice President and General Manager of the Directory and Security Division at Netscape Communications Inc. Ms. Hough holds bachelors and masters degrees of
science in operations research from the University of California at Berkeley.



36



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|(b) | Directors
|--- | ---------



The following table sets forth certain information regarding our Board of Directors as of March 11, 2004, and their ages as of such date:



|                             |  |     |  |         
|---------------------------- |  | --- |  | --------
|Name                         |  | Age |  | Position
|Monte Zweben (1)             |  | 40  |  | Chairman
|Dennis Carey (1)             |  | 57  |  | Director
|Mel Friedman (1)(2)(3)(4)(5) |  | 65  |  | Director
|Dominic Gallello (3)(4)(5)   |  | 49  |  | Director
|Amal Johnson (2)             |  | 51  |  | Director
|Andrew Verhalen (2)          |  | 46  |  | Director
|Gary A. Wetsel               |  | 58  |  | Director
|William Zuendt (1)(3)(5)     |  | 56  |  | Director

---

|(1) | Member of the Audit Committee of the Board of Directors.
|--- | --------------------------------------------------------

|(2) | Member of the Compensation Committee of the Board of Directors.
|--- | ---------------------------------------------------------------

|(3) | Member of the Nominating Committee of the Board of Directors.
|--- | -------------------------------------------------------------

|(4) | Member of the Litigation Committee of the Board of Directors.
|--- | -------------------------------------------------------------

|(5) | Member of the Governance Committee of the Board of Directors.
|--- | -------------------------------------------------------------



Set forth below is biographical information of the Companys board of directors, other than Mr. Zweben who is an officer of Blue Martini as well as a director and
whose biographical information may be found in the section entitled Executive Officers above:



Dennis Careyhas served as a director since July 2002. Mr. Carey is executive vice president of Motorola, Inc. and president and chief executive officer of Motorolas Integrated Electronic Systems Sector.
Previously, Mr. Carey served as executive vice president of business development, strategy and corporate operations for The Home Depot, Inc. (Home Depot) from May 2001 to March 2002. He joined Home Depot in May 1998 as executive vice
president and chief financial officer and served in that capacity until May 2001. From 1994 to 1998, Mr. Carey was employed by AT&T Corp. (AT&T) in several roles, most recently as vice president and general manager, corporate
productivity and mergers and acquisitions from December 1996 to May 1998 and, prior to that, as vice president and chief financial officer for international operations from January 1996 to December 1996.



Mel Friedmanhas served as a director since May 2002. Mr. Friedman retired in 2002
from Sun Microsystems Inc. (Sun), where his most recent position was senior vice president of customer advocacy. Mr. Friedman has served in several other high-level roles for Sun, including president of Suns Microelectronics
division, vice president of worldwide operations for Suns systems operation, vice president of west coast operations, and vice president of supply management, since joining the company in 1989. Mr. Friedman is also currently a director of
Electroglas, Inc.



Dominic Gallello has served as a director since April
2003. Since September 2003, Mr. Gallello has served as chief executive officer of Graphisoft. From October 2002 to April 2003, Mr. Gallello served as executive vice president, Corporate Development for Macromedia, Inc. Mr. Gallello joined Macromedia
in October 2001, initially responsible for Macromedias Rich Media Division and serving as executive vice president, Products from June 2002 until October 2002. Before joining Macromedia, Mr. Gallello served as chief executive officer of
RedSpark, Inc., a provider of enterprise supply chain software, from its May 2000 inception as a spinoff of Autodesk Inc. to October 2001. Mr. Gallello joined Autodesk in 1992 and served in a number of executive positions there, including vice
president of Asia-Pacific, vice president of the Manufacturing Solutions Group, and executive vice president of the Design Solutions Group.



Amal Johnson has served as a director since January 2004. Ms. Johnson is currently a venture partner of Lightspeed Venture Partners, focusing on enterprise
software and infrastructure, having joined as a general partner in 1999. Previously, Ms. Johnson was president of Baan Supply Chain Solutions from January 1998 to December 1998, president of Baan Affiliates from January 1997 to December 1997, and
president of Baan Americas from October 1994 to December 1996. Prior to that, Ms. Johnson served as president of ASK Manufacturing Systems August 1993 to July 1994 and held executive positions at IBM 1987 to June 1993. Ms. Johnson serves on the
boards of MAE Software, Inc. and Alibris.



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Andrew Verhalen has served as a director since January 1999. Mr. Verhalen has been a general partner of entities
associated with Matrix Partners since April 1992. From 1986 to 1991, Mr. Verhalen served as a divisional vice president and general manager at 3Com Corporation. Mr. Verhalen currently serves on the board of directors of Digital Fountain, Inc. and
Onetta, Inc.



Gary A. Wetsel has served as a director since March 2004.
Since April 2002, Mr. Wetsel has served as executive vice president, chief financial officer and chief administrative officer of Aspect Communications Corp. From February 2000 to April 2002, Mr. Wetsel served as vice president and chief financial
officer for Zhone Technologies, Inc. From 1998 to February 2000, Mr. Wetsel served as president and chief executive officer of Warpspeed Communication Corp. Before Warpspeed, Mr. Wetsel held senior executive positions with several high tech
companies, including Wyse Technologies, Inc., Borland International, Inc., Octel Communications Corporation, Ungermann-Bass, Inc., and Rolm Corporation.



William Zuendt has served as a director of the Company since August 1998. Mr. Zuendt retired as president and chief operating officer of Wells Fargo & Company,
a bank holding company, and its principal subsidiary, Wells Fargo Bank in 1997 after serving in that position since 1994. Mr. Zuendt currently serves on the board of directors of Advent Software, Inc.



The other information required by this Item is incorporated by reference to the section
entitled Election of Directors in the Proxy Statement.



|ITEM  11. |  | EXECUTIVE COMPENSATION
|--------- |  | ----------------------



The information required by this Item is incorporated by reference to the section entitled Executive Compensation in the Proxy Statement.



|ITEM  12. |  | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
|--------- |  | --------------------------------------------------------------



The information required by this Item is incorporated by reference to the section entitled Security Ownership of Certain Beneficial Owners and Management in
the Proxy Statement.



|ITEM  13. |  | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
|--------- |  | ----------------------------------------------



The information required by this Item is incorporated by reference to the section entitled Certain Transactions in the Proxy Statement.



|ITEM  14. |  | PRINCIPAL ACCOUNTING FEES AND SERVICES
|--------- |  | --------------------------------------



The information required by this Item is incorporated by reference to the section entitled Principal Accounting Fees and Services in the Proxy Statement.



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PART IV



|ITEM 15. |  | EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
|-------- |  | ----------------------------------------------------------------



|(a) | The following documents are filed as part of this annual report:
|--- | ----------------------------------------------------------------



|   |  |                                            |  |                                                          
|-- |  | ------------------------------------------ |  | ---------------------------------------------------------
|1. |  | Financial Statements                      
|   | 
|   |  | Independent Auditors Report              
|   |  | Consolidated Financial Statements:        
|   |  |                                            |  | Balance Sheets                                           
|   |  |                                            |  | Statements of Operations                                 
|   |  |                                            |  | Statements of Stockholders Equity and Comprehensive Loss
|   |  |                                            |  | Statements of Cash Flows                                 
|   |  | Notes to Consolidated Financial Statements



|   |  |                                                                                                                                                                                                                         |  | 
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | 
|2. |  | Financial Statement Schedule                                                                                                                                                                                           
|   | 
|   |  | No financial statement schedules are filed herein. The schedules have been omitted because the information required to be set forth therein is not applicable or is shown in the
financial statements or notes thereto.



|
|

|   |  |                                                                                                                                       |  | 
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------- |  | 
|3. |  | Exhibits                                                                                                                             
|   | 
|   |  | The exhibits in the accompanying index to exhibits are filed or incorporated by reference as part of this Annual Report on Form 10-K.



|(b) | Reports on Form 8-K
|--- | -------------------



| |  |                                                                                                                                                                           
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | On October 21, 2003, the Registrant filed a Current Report on Form 8-K relating to the Registrants press release announcing financial results for the third quarter
2003.



EXHIBIT INDEX



|               |  |                                                                                                                                                            
|-------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                                
|               | 
|3.1            |  | Amended and Restated Certificate of Incorporation of the Registrant. (1)                                                                                   
|               | 
|3.2            |  | Certificate of Amendment to Amended and Restated Certificate of Incorporation of the Registrant. (11)                                                      
|               | 
|3.3            |  | Amended and Restated Bylaws of the Registrant. (2)                                                                                                         
|               | 
|4.1            |  | Specimen Stock Certificate following one-for-seven reverse split on November 13, 2002. (11)                                                                
|               | 
|10.1           |  | 2000 Equity Incentive Plan, as amended. (9)                                                                                                                
|               | 
|10.2           |  | 2000 Employee Stock Purchase Plan, as amended. (4)                                                                                                         
|               | 
|10.3           |  | 2000 Non-Employee Directors Stock Option Plan, as amended. (12)                                                                                           
|               | 
|10.4           |  | Commercial Office Lease Agreement by and between Peninsula Office Park Associates, L.P. and Registrant, as amended. (3)                                    
|               | 
|10.5           |  | Agreement and Plan of Merger by and between the Registrant and Blue Martini LLC dated January 12, 1999. (3)                                                
|               | 
|10.7           |  | Form of Indemnity Agreement by and between the Registrant and each of its directors and executive officers. (3)                                            
|               | 
|10.8           |  | License and Marketing Agreement by and between the Registrant and Neuron Data, Inc., now Blaze Software, Inc., dated March 31, 1999, as amended. (3)       
|               | 
|10.9           |  | Blue Martini Software Training Facility Agreement between the Registrant and Diversified Computer Consultants of California, Inc., dated March 1, 2000. (3)
|               | 
|10.10          |  | First Amendment to Lease between Peninsula Office Park Associates, L.P., and Registrant, dated May 12, 1999. (5)                                           



39



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##### Table of Contents

|      |  |                                                                                                                                                              
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------
|      | 
|10.11 |  | Second Amendment to Lease between Peninsula Office Park Associates, L.P., and Registrant, dated August 5, 1999. (5)                                          
|      | 
|10.12 |  | Third Amendment to Lease between Peninsula Office Park Associates, L.P., and Registrant, dated January 11, 2000. (5)                                         
|      | 
|10.13 |  | Blue Martini Software Training Facility Agreement between Diversified Computer Consultants, LLC and Registrant, dated September 13, 2000. (5)                
|      | 
|10.14 |  | Fourth Amendment to Lease between Peninsula Office Park Associates, L.P., and Registrant, dated December 20, 2000. (4)                                       
|      | 
|10.15 |  | Fifth Amendment to Lease between Peninsula Office Park Associates, L.P., and Registrant, dated February 16, 2001. (4)                                        
|      | 
|10.16 |  | Amendment to the License and Marketing Agreement by and between the Registrant and Neuron Data, Inc., now Blaze Software, Inc., dated December 22, 2000. +(4)
|      | 
|10.18 |  | Agreement and Plan of Merger and Reorganization, dated as of April 16, 2002, by and among Blue Martini and The Cybrant Corp. (7)                             
|      | 
|10.19 |  | Separation Agreement by and between the Registrant and Michael Borman dated October 9, 2002. (8)                                                             
|      | 
|10.20 |  | Agreement by and between the Registrant and Monte Zweben dated October 17, 2002. (8)                                                                         
|      | 
|10.21 |  | Agreement by and between the Registrant and Robert E. Cell dated October 17, 2002. (8)                                                                       
|      | 
|10.22 |  | Offer to Exchange Outstanding Options, dated November 4, 2002. (9)                                                                                           
|      | 
|10.23 |  | Agreement by and between the Registrant and Mary Hamershock dated October 17, 2002. (11)                                                                     
|      | 
|10.24 |  | Agreement by and between the Registrant and Claire Hough dated November 1, 2002. (11)                                                                        
|      | 
|10.25 |  | Agreement by and between the Registrant and Dave Buchanan dated April 16, 2002. (11)                                                                         
|      | 
|10.26 |  | Agreement by and between eePrise, Inc. (subsequently The Cybrant Corp.) and Array Technology ApS, dated July 26, 1999. +(11)                                 
|      | 
|10.27 |  | Agreement by and between the Registrant and Array Technology A/S, dated October 1, 2002 +(11)                                                                
|      | 
|21.1  |  | Subsidiaries of the Registrant. (10)                                                                                                                         
|      | 
|23.1  |  | Consent of KPMG LLP. (13)                                                                                                                                    
|      | 
|24.1  |  | Power of Attorney is contained on the signature pages.                                                                                                       
|      | 
|31.1  |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (13)                                                     
|      | 
|31.2  |  | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (13)                                                     
|      | 
|32.1  |  | Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2003. (13)                                                                                

---

|+ | Confidential treatment requested with respect to certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|1 | Filed in the Registrants Form 10-Q for the six-month period ended June 30, 2000, and incorporated herein by reference.
|- | -----------------------------------------------------------------------------------------------------------------------

|2 | Filed in the Registrants Registration Statement on Form S-8 (No. 333-55374), and incorporated herein by reference.
|- | -------------------------------------------------------------------------------------------------------------------

|3 | Filed in the Registrants Registration Statement on Form S-1 (No. 333-36062), as amended, and incorporated herein by reference.
|- | -------------------------------------------------------------------------------------------------------------------------------

|4 | Filed in the Registrants Form 10-K for the twelve-month period ended December 31, 2000, and incorporated herein by reference.
|- | ------------------------------------------------------------------------------------------------------------------------------

|5 | Filed in the Registrants Form 10-Q for the nine-month period ended September 30, 2000, and incorporated herein by reference.
|- | -----------------------------------------------------------------------------------------------------------------------------

|6 | Filed in the Registrants Form 10-K for the twelve-month period ended December 31, 2001, and incorporated herein by reference.
|- | ------------------------------------------------------------------------------------------------------------------------------

|7 | Filed as Exhibit 2.1 to the Registrants Current Report on Form 8-K filed on May 1, 2002, and incorporated herein by reference.
|- | -------------------------------------------------------------------------------------------------------------------------------

|8 | Filed in the Registrants Form 10-Q for the nine-month period ended September 30, 2002, and incorporated herein by reference.
|- | -----------------------------------------------------------------------------------------------------------------------------

|9 | Filed under Exhibit number 99(a)(1)(A) to the Schedule TO filed with the Securities and Exchange Commission on November 4, 2002, and incorporated herein by reference.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

|10 | Filed under Exhibit number 99(d)(1) to Amendment No. 2 to the Schedule TO filed with the Securities and Exchange Commission on December 13, 2002.
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------

|11 | Filed in the Registrants Form 10-K for the twelve-month period ended December 31, 2002, and incorporated herein by reference.
|-- | ------------------------------------------------------------------------------------------------------------------------------

|12 | Filed in the Registrants Amendment No.1 to Definitive Proxy Statement on Schedule 14A filed with the Securities and Exchange Commission on May 2, 2003, and incorporated herein
by reference.
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|13 | Filed herewith.
|-- | ---------------



41



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SIGNATURES



Pursuant to the requirements of
Section 13 or 15(d) 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, on March 11, 2004.



BLUE MARTINI SOFTWARE, INC.By:

/s/ MONTE ZWEBENMonte ZwebenChairman andChief Executive Officer




POWER OF
ATTORNEY



KNOW ALL PERSONS
BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Monte Zweben and Eran Pilovsky, and each or any one of them, his true and lawful
attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all
exhibits thereto, and other documents in connection therewith, with the Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to
be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming our signatures as they may be signed by ours said attorney-in-fact and any and all amendments to this Annual
Report on Form 10-K.



Pursuant to the requirements of the Securities Exchange
Act of 1934, this Annual Report on Form 10-K has been signed by the following persons in the capacities and on the dates indicated.



|                                         |  |                                                                      |  |               
|---------------------------------------- |  | -------------------------------------------------------------------- |  | --------------
|Signature                                |  | Title                                                                |  | Date          
|                                         |  |                                                                     
|/s/ MONTE ZWEBENMonte Zweben             |  | Chairman and Chief Executive Officer (Principal
Executive Officer)   |  | March 11, 2004
|                                         |  |                                                                     
|/s/ ERAN PILOVSKYEran Pilovsky.          |  | Chief Financial Officer (Principal Financial
and Accounting Officer) |  | March 11, 2004
|                                         |  |                                                                     
|/s/ DENNIS J. CAREYDennis J. Carey       |  | Director                                                             |  | March 11, 2004
|                                         |  |                                                                     
|/s/ MEL FRIEDMANMel Friedman             |  | Director                                                             |  | March 11, 2004
|                                         |  |                                                                     
|/s/ DOMINIC GALLELLODominic Gallello     |  | Director                                                             |  | March 11, 2004
|                                         |  |                                                                     
|/s/ AMAL JOHNSONAmal Johnson             |  | Director                                                             |  | March 11, 2004
|                                         |  |                                                                     
|/s/ ANDREW W. VERHALENAndrew W. Verhalen |  | Director                                                             |  | March 11, 2004
|                                         |  |                                                                     
|*Gary A. Wetsel                          |  | Director                                                             |  | March 11, 2004
|                                         |  |                                                                     
|/s/ WILLIAM F. ZUENDTWilliam F. Zuendt   |  | Director                                                             |  | March 11, 2004

---

|* | Joined the board on March 5, 2004.
|- | ----------------------------------



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##### Table of Contents

FINANCIAL STATEMENTS

BLUE MARTINI SOFTWARE, INC. AND SUBSIDIARIES

INDEX TO FINANCIAL STATEMENTS



|                                                                       |  |         
|---------------------------------------------------------------------- |  | --------
|                                                                       |  | Page No.
|                                                                       | 
|INDEPENDENT AUDITORS REPORT                                           |  | 44      
|                                                                       | 
|Consolidated Balance Sheets                                            |  | 45      
|                                                                       | 
|Consolidated Statements of Operations                                  |  | 46      
|                                                                       | 
|Consolidated Statements of Stockholders Equity and Comprehensive Loss |  | 47      
|                                                                       | 
|Consolidated Statements of Cash Flows                                  |  | 48      
|                                                                       | 
|Notes to Consolidated Financial Statements                             |  | 49      



43



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##### Table of Contents

INDEPENDENT AUDITORS REPORT



The
Stockholders and Board of Directors

Blue Martini Software, Inc.:



We have audited the accompanying consolidated balance sheets of Blue Martini Software, Inc. and subsidiaries as of December 31, 2003 and 2002 and the related
consolidated statements of operations, stockholders equity and comprehensive loss and cash flows for each of the years in the three-year period ended December 31, 2003. These consolidated financial statements are the responsibility of the
Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.



We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.



In our opinion, the consolidated financial statements referred to above present fairly, in
all material respects, the financial position of Blue Martini Software, Inc. and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year-period ended December
31, 2003, in conformity with accounting principles generally accepted in the United States of America.



/s/    KPMG LLP




Mountain View, California

January 20, 2004



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##### Table of Contents

BLUE MARTINI SOFTWARE, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(In thousands, except per share data)



|                                                                                                                         |  |              |          |   |      |   |          |  
|------------------------------------------------------------------------------------------------------------------------ |  | ------------ | -------- | - | ---- | - | -------- | -
|                                                                                                                         |  | December 31, |         
|                                                                                                                         |  | 2003         |          |   | 2002 |  
|ASSETS                                                                                                                   |  |              |          |   |      |   |          |  
|Current assets:                                                                                                          |  |              |          |   |      |   |          |  
|Cash and cash equivalents, including restricted cash of $962 in 2003 and $1,357 in 2002                                  |  | $            | 15,323   |   |      | $ | 7,729    |  
|Short-term investments                                                                                                   |  |              | 30,865   |   |      |   | 53,021   |  
|Accounts receivable, net of allowance of $604 in 2003 and $701 in 2002                                                   |  |              | 3,787    |   |      |   | 5,766    |  
|Prepaid expenses and other current assets                                                                                |  |              | 1,334    |   |      |   | 1,575    |  
|                                                                                                                         |  |              |          |   |      |   |          |  
|Total current assets                                                                                                     |  |              | 51,309   |   |      |   | 68,091   |  
|Property and equipment, net                                                                                              |  |              | 469      |   |      |   | 599      |  
|Intangible assets and other, net                                                                                         |  |              | 302      |   |      |   | 902      |  
|                                                                                                                         |  |              |          |   |      |   |          |  
|Total assets                                                                                                             |  | $            | 52,080   |   |      | $ | 69,592   |  
|                                                                                                                         |  |              |          |   |      |   |          |  
|                                                                                                                         |  |             
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                     |  |              |          |   |      |   |          |  
|Current liabilities:                                                                                                     |  |              |          |   |      |   |          |  
|Accounts payable                                                                                                         |  | $            | 891      |   |      | $ | 706      |  
|Accrued employee compensation                                                                                            |  |              | 2,951    |   |      |   | 5,603    |  
|Other current liabilities                                                                                                |  |              | 4,216    |   |      |   | 5,396    |  
|Accrued restructuring charges                                                                                            |  |              | 794      |   |      |   | 1,045    |  
|Deferred revenues                                                                                                        |  |              | 4,872    |   |      |   | 3,306    |  
|                                                                                                                         |  |              |          |   |      |   |          |  
|Total current liabilities                                                                                                |  |              | 13,724   |   |      |   | 16,056   |  
|                                                                                                                         |  |             
|Accrued restructuring charges, less current portion                                                                      |  |              | 1,637    |   |      |   | 2,431    |  
|                                                                                                                         |  |              |          |   |      |   |          |  
|Total liabilities                                                                                                        |  |              | 15,361   |   |      |   | 18,487   |  
|                                                                                                                         |  |             
|Stockholders equity:                                                                                                    |  |              |          |   |      |   |          |  
|Common stock; $0.001 par value; 500,000 shares authorized; 11,542 and 10,564 shares issued and outstanding, respectively |  |              | 12       |   |      |   | 11       |  
|Additional paid-in-capital                                                                                               |  |              | 258,143  |   |      |   | 255,290  |  
|Deferred stock compensation                                                                                              |  |              |         |   |      |   | (1,311   | )
|Accumulated other comprehensive income (loss)                                                                            |  |              | (850     | ) |      |   | 114      |  
|Accumulated deficit                                                                                                      |  |              | (220,586 | ) |      |   | (202,999 | )
|                                                                                                                         |  |              |          |   |      |   |          |  
|Total stockholders equity                                                                                               |  |              | 36,719   |   |      |   | 51,105   |  
|                                                                                                                         |  |              |          |   |      |   |          |  
|Total liabilities and stockholders equity                                                                               |  | $            | 52,080   |   |      | $ | 69,592   |  
|                                                                                                                         |  |              |          |   |      |   |          |  



See accompanying notes
to consolidated financial statements.



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BLUE MARTINI SOFTWARE, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(In thousands, except per share data)



|                                                                           |  |                         |         |   |      |   |         |      |  |   |         |  
|-------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                           |  | Year Ended December 31, |        
|                                                                           |  | 2003                    |         |   | 2002 |   |         | 2001 | 
|Revenues:                                                                  |  |                         |         |   |      |   |         |      |  |   |         |  
|License                                                                    |  | $                       | 11,479  |   |      | $ | 5,915   |      |  | $ | 20,438  |  
|Service                                                                    |  |                         | 21,116  |   |      |   | 27,708  |      |  |   | 39,476  |  
|                                                                           |  |                         |         |   |      |   |         |      |  |   |         |  
|Total revenues                                                             |  |                         | 32,595  |   |      |   | 33,623  |      |  |   | 59,914  |  
|Cost of revenues:                                                          |  |                         |         |   |      |   |         |      |  |   |         |  
|License                                                                    |  |                         | 1,607   |   |      |   | 3,812   |      |  |   | 4,122   |  
|Service*                                                                   |  |                         | 13,685  |   |      |   | 20,164  |      |  |   | 37,359  |  
|                                                                           |  |                         |         |   |      |   |         |      |  |   |         |  
|Total cost of revenues                                                     |  |                         | 15,292  |   |      |   | 23,976  |      |  |   | 41,481  |  
|                                                                           |  |                         |         |   |      |   |         |      |  |   |         |  
|Gross profit                                                               |  |                         | 17,303  |   |      |   | 9,647   |      |  |   | 18,433  |  
|                                                                           |  |                         |         |   |      |   |         |      |  |   |         |  
|Operating expenses:                                                        |  |                         |         |   |      |   |         |      |  |   |         |  
|Sales and marketing*                                                       |  |                         | 18,732  |   |      |   | 26,920  |      |  |   | 46,661  |  
|Research and development*                                                  |  |                         | 9,713   |   |      |   | 13,380  |      |  |   | 18,623  |  
|General and administrative*                                                |  |                         | 6,786   |   |      |   | 7,590   |      |  |   | 10,900  |  
|Amortization of deferred stock compensation                                |  |                         | 1,336   |   |      |   | (794    | )    |  |   | 12,014  |  
|Impairment of long-lived assets and goodwill                               |  |                         | (673    | ) |      |   | 16,678  |      |  |   |        |  
|In-process research and development                                        |  |                         |        |   |      |   | 800     |      |  |   |        |  
|Restructuring charges                                                      |  |                         | 180     |   |      |   | 6,363   |      |  |   | 6,257   |  
|                                                                           |  |                         |         |   |      |   |         |      |  |   |         |  
|Total operating expenses                                                   |  |                         | 36,074  |   |      |   | 70,937  |      |  |   | 94,455  |  
|                                                                           |  |                         |         |   |      |   |         |      |  |   |         |  
|Loss from operations                                                       |  |                         | (18,771 | ) |      |   | (61,290 | )    |  |   | (76,022 | )
|Interest income and other, net                                             |  |                         | 1,184   |   |      |   | 2,438   |      |  |   | 6,418   |  
|                                                                           |  |                         |         |   |      |   |         |      |  |   |         |  
|Net loss                                                                   |  | $                       | (17,587 | ) |      | $ | (58,852 | )    |  | $ | (69,604 | )
|                                                                           |  |                         |         |   |      |   |         |      |  |   |         |  
|Basic and diluted net loss per common share                                |  | $                       | (1.61   | ) |      | $ | (5.80   | )    |  | $ | (7.62   | )
|                                                                           |  |                         |         |   |      |   |         |      |  |   |         |  
|Shares used in computing basic and diluted net loss per common share       |  |                         | 10,950  |   |      |   | 10,140  |      |  |   | 9,136   |  
|                                                                           |  |                         |         |   |      |   |         |      |  |   |         |  
|                                                                           |  |                         |         |   |      |   |         |      |  |   |         |  
|*  Amounts exclude amortization of deferred stock compensation as follows: |  |                         |         |   |      |   |         |      |  |   |         |  
|Cost of service revenues                                                   |  | $                       | 277     |   |      | $ | 166     |      |  | $ | 3,732   |  
|Sales and marketing                                                        |  | $                       | 105     |   |      | $ | (358    | )    |  | $ | 1,982   |  
|Research and development                                                   |  | $                       | 292     |   |      | $ | 123     |      |  | $ | 1,425   |  
|General and administrative                                                 |  | $                       | 662     |   |      | $ | (725    | )    |  | $ | 4,875   |  



See accompanying notes
to consolidated financial statements.



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##### Table of Contents

BLUE MARTINI SOFTWARE, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders Equity and
Comprehensive Loss

Years Ended December 31, 2003, 2002 and 2001

(In thousands)



|                                                                                   |  |              |   |  |                          |    |   |                            |   |         |                                       |  |   |                     |   |  |                           |      |   |                    |   |          |   |  |   |         |   |  |   |         |  
|---------------------------------------------------------------------------------- |  | ------------ | - |  | ------------------------ | -- | - | -------------------------- | - | ------- | ------------------------------------- |  | - | ------------------- | - |  | ------------------------- | ---- | - | ------------------ | - | -------- | - |  | - | ------- | - |  | - | ------- | -
|                                                                                   |  | Common Stock |   |  | AdditionalPaid-InCapital |    |   | DeferredStockCompen-sation |   |         | AccumulatedOther Comp-rehensiveIncome |  |   | Accumu-latedDeficit |   |  | TotalStock-holdersEquity |      |   | Compre-hensiveLoss |  
|                                                                                   |  | Shares       |   |  | Amount                   |    |   |                            |   |         |                                       | 
|Balances, December 31, 2000                                                        |  | 9,854        |   |  | $                        | 11 |   |                            | $ | 261,001 |                                       |  | $ | (30,580             | ) |  | $                         | 282  |   |                    | $ | (74,543  | ) |  | $ | 156,171 |   |  |   |         |  
|Net loss                                                                           |  |              |   |  |                          |    |   |                            |   |         |                                       |  |   |                     |   |  |                           |      |   |                    |   | (69,604  | ) |  |   | (69,604 | ) |  | $ | (69,604 | )
|Net foreign currency translation gain                                              |  |              |   |  |                          |    |   |                            |   |         |                                       |  |   |                     |   |  |                           | 178  |   |                    |   |          |   |  |   | 178     |   |  |   | 178     |  
|                                                                                   |  |              |   |  |                          |    |   |                           
|Net unrealized gain in investments                                                 |  |              |   |  |                          |    |   |                            |   |         |                                       |  |   |                     |   |  |                           | 135  |   |                    |   |          |   |  |   | 135     |   |  |   | 135     |  
|                                                                                   |  |              |   |  |                          |    |   |                            |   |         |                                       |  |   |                     |   |  |                           |      |   |                    |   |          |   |  |   |         |   |  |   |         |  
|Total comprehensive loss                                                           |  |              |   |  |                          |    |   |                            |   |         |                                       |  |   |                     |   |  |                           |      |   |                    |   |          |   |  |   |         |   |  | $ | (69,291 | )
|                                                                                   |  |              |   |  |                          |    |   |                            |   |         |                                       |  |   |                     |   |  |                           |      |   |                    |   |          |   |  |   |         |   |  |   |         |  
|Issuance of common stock                                                           |  | 193          |   |  |                          | 1  |   |                            |   | 4,001   |                                       |  |   | (271                | ) |  |                           |     |   |                    |   |         |   |  |   | 3,731   |   |  |   |         |  
|Repurchases of common stock                                                        |  | (271         | ) |  |                          | (2 | ) |                            |   | (325    | )                                     |  |   |                    |   |  |                           |     |   |                    |   |         |   |  |   | (327    | ) |  |   |         |  
|Amortization of deferred stock compensation                                        |  |             |   |  |                          |   |   |                            |   |        |                                       |  |   | 11,888              |   |  |                           |     |   |                    |   |         |   |  |   | 11,888  |   |  |   |         |  
|Forfeiture of stock options due to employee terminations                           |  |             |   |  |                          |   |   |                            |   | (10,963 | )                                     |  |   | 10,963              |   |  |                           |     |   |                    |   |         |   |  |   |        |   |  |   |         |  
|Non-employee stock-based compensation                                              |  |             |   |  |                          |   |   |                            |   | 126     |                                       |  |   |                    |   |  |                           |     |   |                    |   |         |   |  |   | 126     |   |  |   |         |  
|Modification of common stock warrant issued in connection with marketing agreement |  |             |   |  |                          |   |   |                            |   | 164     |                                       |  |   |                    |   |  |                           |     |   |                    |   |         |   |  |   | 164     |   |  |   |         |  
|                                                                                   |  |              |   |  |                          |    |   |                            |   |         |                                       |  |   |                     |   |  |                           |      |   |                    |   |          |   |  |   |         |   |  |   |         |  
|Balances, December 31, 2001                                                        |  | 9,776        |   |  |                          | 10 |   |                            |   | 254,004 |                                       |  |   | (8,000              | ) |  |                           | 595  |   |                    |   | (144,147 | ) |  |   | 102,462 |   |  |   |         |  
|Net loss                                                                           |  |             |   |  |                          |   |   |                            |   |        |                                       |  |   |                    |   |  |                           |     |   |                    |   | (58,852  | ) |  |   | (58,852 | ) |  | $ | (58,852 | )
|Net foreign currency translation loss                                              |  |             |   |  |                          |   |   |                            |   |        |                                       |  |   |                    |   |  |                           | (293 | ) |                    |   |         |   |  |   | (293    | ) |  |   | (293    | )
|                                                                                   |  |              |   |  |                          |    |   |                           
|Net unrealized loss in investments                                                 |  |             |   |  |                          |   |   |                            |   |        |                                       |  |   |                    |   |  |                           | (188 | ) |                    |   |         |   |  |   | (188    | ) |  |   | (188    | )
|                                                                                   |  |              |   |  |                          |    |   |                            |   |         |                                       |  |   |                     |   |  |                           |      |   |                    |   |          |   |  |   |         |   |  |   |         |  
|Total comprehensive loss                                                           |  |              |   |  |                          |    |   |                            |   |         |                                       |  |   |                     |   |  |                           |      |   |                    |   |          |   |  |   |         |   |  | $ | (59,333 | )
|                                                                                   |  |              |   |  |                          |    |   |                            |   |         |                                       |  |   |                     |   |  |                           |      |   |                    |   |          |   |  |   |         |   |  |   |         |  
|Issuance of common stock                                                           |  | 320          |   |  |                          |   |   |                            |   | 1,970   |                                       |  |   |                    |   |  |                           |     |   |                    |   |         |   |  |   | 1,970   |   |  |   |         |  
|Issuance of common stock (non-cash)                                                |  | 60           |   |  |                          |   |   |                            |   | 197     |                                       |  |   |                    |   |  |                           |     |   |                    |   |         |   |  |   | 197     |   |  |   |         |  
|Repurchases of common stock                                                        |  | (167         | ) |  |                          |   |   |                            |   | (662    | )                                     |  |   |                    |   |  |                           |     |   |                    |   |         |   |  |   | (662    | ) |  |   |         |  
|Forfeiture of stock options due to employee terminations                           |  |             |   |  |                          |   |   |                            |   | (8,073  | )                                     |  |   | 8,073               |   |  |                           |     |   |                    |   |         |   |  |   |        |   |  |   |         |  
|Amortization of deferred stock compensation                                        |  |             |   |  |                          |   |   |                            |   |        |                                       |  |   | (794                | ) |  |                           |     |   |                    |   |         |   |  |   | (794    | ) |  |   |         |  
|Deferred compensation relating to stock options                                    |  |             |   |  |                          |   |   |                            |   | 590     |                                       |  |   | (590                | ) |  |                           |     |   |                    |   |         |   |  |   |        |   |  |   |         |  
|Issuance of stock and warrants for Cybrant acquisition                             |  | 575          |   |  |                          | 1  |   |                            |   | 7,034   |                                       |  |   |                    |   |  |                           |     |   |                    |   |         |   |  |   | 7,035   |   |  |   |         |  
|Issuance of warrants to non-employee                                               |  |             |   |  |                          |   |   |                            |   | 230     |                                       |  |   |                    |   |  |                           |     |   |                    |   |         |   |  |   | 230     |   |  |   |         |  
|                                                                                   |  |              |   |  |                          |    |   |                            |   |         |                                       |  |   |                     |   |  |                           |      |   |                    |   |          |   |  |   |         |   |  |   |         |  
|Balances, December 31, 2002                                                        |  | 10,564       |   |  |                          | 11 |   |                            |   | 255,290 |                                       |  |   | (1,311              | ) |  |                           | 114  |   |                    |   | (202,999 | ) |  |   | 51,105  |   |  |   |         |  
|Net loss                                                                           |  |             |   |  |                          |   |   |                            |   |        |                                       |  |   |                    |   |  |                           |     |   |                    |   | (17,587  | ) |  |   | (17,587 | ) |  | $ | (17,587 | )
|Net foreign currency translation loss                                              |  |             |   |  |                          |   |   |                            |   |        |                                       |  |   |                    |   |  |                           | (755 | ) |                    |   |         |   |  |   | (755    | ) |  |   | (755    | )
|Net unrealized loss in investments                                                 |  |             |   |  |                          |   |   |                            |   |        |                                       |  |   |                    |   |  |                           | (209 | ) |                    |   |         |   |  |   | (209    | ) |  |   | (209    | )
|                                                                                   |  |              |   |  |                          |    |   |                            |   |         |                                       |  |   |                     |   |  |                           |      |   |                    |   |          |   |  |   |         |   |  |   |         |  
|Total comprehensive loss                                                           |  |              |   |  |                          |    |   |                            |   |         |                                       |  |   |                     |   |  |                           |      |   |                    |   |          |   |  |   |         |   |  | $ | (18,551 | )
|                                                                                   |  |              |   |  |                          |    |   |                            |   |         |                                       |  |   |                     |   |  |                           |      |   |                    |   |          |   |  |   |         |   |  |   |         |  
|Issuance of common stock                                                           |  | 1,030        |   |  |                          | 1  |   |                            |   | 2,965   |                                       |  |   |                    |   |  |                           |     |   |                    |   |         |   |  |   | 2,966   |   |  |   |         |  
|Repurchases of common stock                                                        |  | (32          | ) |  |                          |   |   |                            |   | (51     | )                                     |  |   |                    |   |  |                           |     |   |                    |   |         |   |  |   | (51     | ) |  |   |         |  
|Issuance/retirement of shares held in escrow relating to the acquisition           |  | (20          | ) |  |                          |   |   |                            |   | (86     | )                                     |  |   |                    |   |  |                           |     |   |                    |   |         |   |  |   | (86     | ) |  |   |         |  
|Forfeiture of stock options due to employee terminations                           |  |             |   |  |                          |   |   |                            |   | (294    | )                                     |  |   | 294                 |   |  |                           |     |   |                    |   |         |   |  |   |        |   |  |   |         |  
|Stock compensation expense relating to variable plan accounting                    |  |             |   |  |                          |   |   |                            |   | 319     |                                       |  |   |                    |   |  |                           |     |   |                    |   |         |   |  |   | 319     |   |  |   |         |  
|Amortization of deferred stock compensation                                        |  |             |   |  |                          |   |   |                            |   |        |                                       |  |   | 1,017               |   |  |                           |     |   |                    |   |         |   |  |   | 1,017   |   |  |   |         |  
|                                                                                   |  |              |   |  |                          |    |   |                            |   |         |                                       |  |   |                     |   |  |                           |      |   |                    |   |          |   |  |   |         |   |  |   |         |  
|Balances, December 31, 2003                                                        |  | 11,542       |   |  | $                        | 12 |   |                            | $ | 258,143 |                                       |  | $ |                    |   |  | $                         | (850 | ) |                    | $ | (220,586 | ) |  | $ | 36,719  |   |  |   |         |  
|                                                                                   |  |              |   |  |                          |    |   |                            |   |         |                                       |  |   |                     |   |  |                           |      |   |                    |   |          |   |  |   |         |   |  |   |         |  



See accompanying notes
to consolidated financial statements.



47



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##### Table of Contents

BLUE MARTINI SOFTWARE, INC. AND SUBSIDIARIES



Consolidated Statements of Cash Flows



(In thousands)



|                                                                                                             |  |                         |         |   |      |   |         |      |  |   |          |  
|------------------------------------------------------------------------------------------------------------ |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | -------- | -
|                                                                                                             |  | Year Ended December 31, |        
|                                                                                                             |  | 2003                    |         |   | 2002 |   |         | 2001 | 
|Operating activities:                                                                                        |  |                         |         |   |      |   |         |      |  |   |          |  
|Net loss                                                                                                     |  | $                       | (17,587 | ) |      | $ | (58,852 | )    |  | $ | (69,604  | )
|Adjustments to reconcile net loss to net cash used in operating activities:                                  |  |                         |         |   |      |   |         |      |  |   |          |  
|Depreciation of property and equipment and amortization of intangible assets and other                       |  |                         | 1,231   |   |      |   | 7,934   |      |  |   | 12,907   |  
|Amortization of deferred stock compensation                                                                  |  |                         | 1,336   |   |      |   | (794    | )    |  |   | 12,014   |  
|Provision for doubtful accounts                                                                              |  |                         | (97     | ) |      |   | 190     |      |  |   | 1,410    |  
|Impairment of long-lived assets and goodwill                                                                 |  |                         | (673    | ) |      |   | 16,678  |      |  |   | 638      |  
|In-process research and development                                                                          |  |                         |        |   |      |   | 800     |      |  |   |         |  
|Non-cash restructuring charges                                                                               |  |                         |        |   |      |   | 128     |      |  |   | 2,107    |  
|Changes in operating assets and liabilities:                                                                 |  |                         |         |   |      |   |         |      |  |   |          |  
|Accounts receivable                                                                                          |  |                         | 2,076   |   |      |   | (73     | )    |  |   | 5,794    |  
|Prepaid expenses and other current assets                                                                    |  |                         | 241     |   |      |   | 1,112   |      |  |   | 2,770    |  
|Accounts payable, accrued employee compensation, accrued restructuring charges and other current liabilities |  |                         | (4,019  | ) |      |   | (794    | )    |  |   | (9,516   | )
|Deferred revenues                                                                                            |  |                         | 1,566   |   |      |   | (1,912  | )    |  |   | (10,188  | )
|                                                                                                             |  |                         |         |   |      |   |         |      |  |   |          |  
|Net cash used in operating activities                                                                        |  |                         | (15,926 | ) |      |   | (35,583 | )    |  |   | (51,668  | )
|                                                                                                             |  |                         |         |   |      |   |         |      |  |   |          |  
|Cash flows from investing activities:                                                                        |  |                         |         |   |      |   |         |      |  |   |          |  
|Cash acquired in acquisition                                                                                 |  |                         |        |   |      |   | 152     |      |  |   |         |  
|Purchases of property and equipment                                                                          |  |                         | (586    | ) |      |   | (443    | )    |  |   | (5,407   | )
|Purchases of intangible assets                                                                               |  |                         |        |   |      |   |        |      |  |   | (4,250   | )
|Purchases of short-term investments                                                                          |  |                         | (92,180 | ) |      |   | (43,771 | )    |  |   | (143,427 | )
|Sales and maturities of short-term investments                                                               |  |                         | 114,126 |   |      |   | 75,116  |      |  |   | 174,408  |  
|                                                                                                             |  |                         |         |   |      |   |         |      |  |   |          |  
|Net cash provided by investing activities                                                                    |  |                         | 21,360  |   |      |   | 31,054  |      |  |   | 21,324   |  
|                                                                                                             |  |                         |         |   |      |   |         |      |  |   |          |  
|Cash flows from financing activities:                                                                        |  |                         |         |   |      |   |         |      |  |   |          |  
|Net proceeds from issuance of common stock                                                                   |  |                         | 2,966   |   |      |   | 1,970   |      |  |   | 3,731    |  
|Repurchases of common stock                                                                                  |  |                         | (51     | ) |      |   | (662    | )    |  |   | (327     | )
|Repayment of debt and capital lease obligations                                                              |  |                         |        |   |      |   | (1,702  | )    |  |   | (216     | )
|                                                                                                             |  |                         |         |   |      |   |         |      |  |   |          |  
|Net cash provided by (used in) financing activities                                                          |  |                         | 2,915   |   |      |   | (394    | )    |  |   | 3,188    |  
|                                                                                                             |  |                         |         |   |      |   |         |      |  |   |          |  
|Effect of exchange rate changes on cash                                                                      |  |                         | (755    | ) |      |   | (293    | )    |  |   |         |  
|                                                                                                             |  |                         |         |   |      |   |         |      |  |   |          |  
|Net increase (decrease) in cash and cash equivalents                                                         |  |                         | 7,594   |   |      |   | (5,216  | )    |  |   | (27,156  | )
|Cash and cash equivalents at beginning of period                                                             |  |                         | 7,729   |   |      |   | 12,945  |      |  |   | 40,101   |  
|                                                                                                             |  |                         |         |   |      |   |         |      |  |   |          |  
|Cash and cash equivalents at end of period                                                                   |  | $                       | 15,323  |   |      | $ | 7,729   |      |  | $ | 12,945   |  
|                                                                                                             |  |                         |         |   |      |   |         |      |  |   |          |  
|Supplemental disclosure of non-cash investing and financing activities:                                      |  |                         |         |   |      |   |         |      |  |   |          |  
|Deferred stock compensation, net of forfeitures                                                              |  | $                       | (294    | ) |      | $ | 8,240   |      |  | $ | (10,692  | )
|                                                                                                             |  |                         |         |   |      |   |         |      |  |   |          |  
|Issuance/retirement of common stock and warrants for Cybrant Corp.                                           |  | $                       | (86     | ) |      | $ | 7,035   |      |  | $ |         |  
|                                                                                                             |  |                         |         |   |      |   |         |      |  |   |          |  
|Warrants issued in connection with lease financing and marketing arrangement                                 |  | $                       |        |   |      | $ |        |      |  | $ | 164      |  
|                                                                                                             |  |                         |         |   |      |   |         |      |  |   |          |  
|Warrants issued in connection with marketing agreement                                                       |  | $                       |        |   |      | $ | 230     |      |  | $ |         |  
|                                                                                                             |  |                         |         |   |      |   |         |      |  |   |          |  
|Stock issued to a terminated executive                                                                       |  | $                       |        |   |      | $ | 192     |      |  | $ |         |  
|                                                                                                             |  |                         |         |   |      |   |         |      |  |   |          |  



See accompanying notes
to consolidated financial statements.



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BLUE MARTINI SOFTWARE, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



1. Summary of
Significant Accounting Policies



The Company: Blue Martini
Software, Inc. (the Company) provides software designed to enable companies to sell more, by proactively guiding salespeople, partners, and customers through selling interactions, as well as services related to the implementation and
maintenance of the software.



Principles of Consolidation:The
consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.



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



Revenue Recognition:The Company derives its revenues from licenses of its software products and the related professional services and customer support
(maintenance) services. The Companys standard license agreements provide for an initial fee for use of the Companys products in perpetuity, typically limited to a number of servers (CPUs), business units, geographies, brands or other
similar limitations. The Company sells its suite of applications through a direct sales force. The Company licenses its software in multiple element arrangements in which typically the customer purchases a combination of software and maintenance. In
a typical arrangement, professional services are sold separately and are not considered essential to the functionality of the software.



The Company recognizes revenue in accordance with SOP 97-2, Software Revenue Recognition, as amended, and recognizes revenue when all of the following criteria are
met: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred, (3) the fee is fixed or determinable and (4) collectibility is probable. The Company defines each of these four criteria as follows:



Persuasive evidence of an arrangement exists. It is the Companys policy to have
a written contract signed by both the customer and the Company.



Delivery
has occurred. The Companys software is electronically delivered to the customer. Delivery is deemed to have occurred upon notification to the customer of a user ID and password for download of the software from a secure server.



The fee is fixed or determinable. The Companys policy is not to provide
customers the right to a refund of any portion of its license fees. If an arrangement fee is not considered fixed or determinable, revenue is recognized as payments become due.



Collectibility is probable. Collectibility is assessed on a customer-by-customer basis and the Companys experience in certain
geographies. Customers are subjected to a credit review process, which evaluates the customers financial positions and ultimately their ability to pay. If it is determined from the outset of an arrangement that collectibility is not probable
based upon the Companys credit review process, revenue is recognized on a cash-collected basis. Based on the Companys limited experience in certain geographies and where creditworthiness may be difficult to ascertain, the Company
recognizes revenue from these geographies upon cash collection.



The Company
allocates revenue on software arrangements involving multiple elements to each element based on the residual value method prescribed by SOP 89-9. Under the residual method, if VSOE of fair value exists for all undelivered elements, but does not
exist for the delivered element, revenue is allocated to the undelivered elements base on VSOE of fair market value and the residual is allocated to the delivered element. The Company limits its assessment of VSOE for each element to the price
charged when the same



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element is sold separately. The Company has analyzed all of the elements included in its multiple-element arrangements
and determined that it has sufficient VSOE to allocate revenue to maintenance and technical support services, professional services and training components of its perpetual license arrangements. The Company sells its professional services and
training separately, and has established VSOE on this basis. VSOE for maintenance is determined based upon the customers annual renewal rates. Accordingly, assuming all other revenue recognition criteria are met, revenue from perpetual
licenses is recognized upon delivery using the residual method. Fees for maintenance are deferred and recognized ratably over the term of the support period.



The Companys professional services generally are not essential to the functionality of the software. The Companys suite of applications is fully functional
upon delivery and implementation and does not require any significant modification or alteration. Customers purchase the Companys professional services to facilitate the implementation of the Companys technology but they may also decide
to use their own resources or appoint other professional service organizations to provide these services. Software products are negotiated independently from professional services, which may be based on a time-and-materials, milestone-achieved or
fixed fee basis. The Company generally recognizes revenue from professional services as the services are performed. For fixed-fee and milestone-based projects, the Company makes ongoing assessments throughout the duration of each engagement as to
whether a loss will be incurred on a project. Losses on projects are recognized in the period identified.



After the completion of its acquisition of Cybrant in April 2002, the Company began offering Cybrants software products for sale. Because the Companys professional services related to these arrangements
were deemed essential to the functionality of the software, the Company initially accounted for license revenues from the Cybrant software products using the percentage of completion method under SOP No. 81-1, Accounting for Performance of
Construction-Type and Certain Production-Type Contracts. In the fourth quarter of 2002, upon repeated successful implementations of the Cybrant application, it was determined that the Companys professional services were not essential to
the functionality of the software. Therefore, the Company began to recognize license transactions closed in the fourth quarter of 2002 relating to the Cybrant software products upon delivery instead of using the percentage of completion method,
subject to all other revenue recognition criteria.



Cost of license revenue
consists primarily of royalties paid to third parties for licensing of technology and amortization of purchased technology.



Cost of service revenues consist primarily of salaries and other personnel-related expenses, costs of services provided by third party consultants engaged by the Company,
and allocated overhead costs (including facilities, equipment depreciation, information systems, and other corporate infrastructure costs.)



Deferred revenues generally result from the following: deferred maintenance, cash received for professional services not yet rendered and license revenues relating to
arrangements where the Company has received cash and the revenue is not yet recognizable.



Cash, Cash Equivalents and Short-Term Investments: The Company considers all highly liquid investments with remaining maturities of three months or less at the date of purchase to be cash equivalents.
Cash and cash equivalents include money market funds, commercial paper and various deposit accounts. Cash equivalents are recorded at cost, which approximates fair value. The objective of the Companys investment policy is preservation of the
value of its investment portfolio while maintaining adequate financial liquidity. The Company invests in high-quality fixed-income investment securities with maturities of 18 months or less.



The Companys investments are classified as available-for-sale and are
carried at fair value based on quoted market prices. The Company has the intent to maintain a liquid portfolio and has the ability to redeem its investments at their carrying amounts. Therefore, all investments are classified as short-term. These
investments consist of fixed-income securities that include commercial paper, corporate bonds and notes, U.S. treasury securities, US government agency securities and asset-backed securities. Unrealized holding gains and losses are excluded from
earnings and are reported as a separate component of other comprehensive income until realized. Realized gains and losses from the sale of available-for-sale securities are determined on the specific identification basis. The Company reviews its
investments in



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marketable securities on a regular basis to determine whether or not each security has experienced an
other-than-temporary decline in fair value. The Company considers the security issuers cash position, earnings/revenue outlook, liquidity and management/ownership, among other things, in its review. If the Company concludes that an
other-than-temporary decline exists in its marketable equity securities, the Company writes down the investment to the market value and records the related write-down as an investment loss on its consolidated statement of operations. To date the
Company has not recorded any such investment losses.



Concentration of
Credit Risk: The Company places its cash, cash equivalents and investments with financial institutions with high credit ratings. The Companys accounts receivable are derived from licenses and services provided to customers principally
in North America, Europe and Asia. The Company performs ongoing evaluations of its customers financial condition and generally requires no collateral from its customers on accounts receivable. The Company maintains allowances for estimated
credit losses based on managements assessment of the likelihood of collection.



Property and Equipment: Property and equipment are recorded at cost. Depreciation of property and equipment is computed using the straight-line method over the estimated useful lives of the respective assets. Depreciation of
computer equipment is provided for over estimated useful lives ranging from 18 to 36 months, while furniture and office equipment are depreciated over estimated useful lives of 60 months. Leasehold improvements and assets recorded under capital
leases are amortized over the estimated useful lives of the assets or the lease term, whichever is shorter, and range from 36 to 60 months.



Software Development Costs: Development costs incurred in the research and development of new software products are expensed as incurred until technological
feasibility has been established, at which time such costs are capitalized, subject to recoverability. Technological feasibility is established upon the completion of an integrated working model. Costs incurred by the Company between completion of
the working model and the point at which the product is ready for general release have not been significant. Accordingly, the Company has charged all costs to research and development expense in the period incurred.



Long-lived Assets and Other Intangible Assets:In accordance with SFAS
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the Company reviews long-lived assets, including intangible assets other than goodwill, for impairment whenever events or changes in circumstances indicate
that the carrying value of an asset may not be recoverable based on expected undiscounted cash flows attributable to that asset. The amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired
asset.



Restructuring:The Companys restructuring charges
are comprised primarily of: (1) severance and associated employee termination costs resulting from the Companys reduction of workforce; and (2) lease termination costs and other costs related to excess facilities. These charges were incurred
pursuant to formal plans developed by management and accounted for in accordance with SEC SAB No.100 Restructuring and Impairment Charges and SFAS No. 146, Accounting for Costs Associated with Exit or Disposal
Activities, which supercedes Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a
Restructuring). The recognition of restructuring charges requires the Companys management to make judgments and estimates regarding the nature, timing, and amount of costs associated with the planned restructuring activity, including
estimating the time it will take to sublease excess facilities and determining sublease terms and rates. The Company evaluates the remaining accrued balances to ensure their adequacy and the utilization of the provisions are for their intended
purposes in accordance with developed restructuring plans.



Advertising:The Company expenses advertising costs as incurred. Advertising costs included in sales and marketing expense in the accompanying consolidated statements of operations for 2003, 2002, and 2001 were $71,000 $70,000 and $2.2 million,
respectively. In 2001, advertising agency fees and production costs in the amounts of $560,000 were paid to a firm whose chairman and chief creative officer was also a member of the Companys board of directors. In 2001, the Company reimbursed
this firm for third-party direct advertising placement fees of approximately $4.5 million. The Company did not have any such transactions in 2003 and 2002.



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Product Warranty: The Company provides its customers with a limited warranty on its software products. Such
warranties are accounted for in accordance with SFAS No. 5, Accounting for Contingencies. To date the Company has not incurred any costs related to warranty obligations. The Companys software license agreements generally include an
indemnification provision for claims from third parties relating to the companys intellectual property. Such indemnification provisions are accounted for in accordance with SFAS No. 5. The indemnification may be limited to a portion of the
amount paid by the customer. To date, claims under such indemnification provisions have not been significant.



Income Taxes:The Company uses the asset and liability method to account for income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities from a change in tax rates is recognized in income in the period the change is
enacted. A valuation allowance is established to reduce deferred tax assets to an amount whose realization is more likely than not.



Stock-Based Compensation:The Company has employee stock benefit plans, which are described more fully in Note 10: Stockholders
Equity. The Company has adopted the disclosure-only provisions of SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, which amended SFAS 123, Accounting for Stock-Based Compensation. As
permitted by SFAS No. 148, the Company accounted for stock option plans under the intrinsic value recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees,FASB Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans and FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock
Compensation, an interpretation of APB Opinion No. 25.



Under
APB Opinion No. 25, compensation expense for stock options is based on the difference, if any, on the date of the grant, between the fair value of the Companys stock and the exercise price. SFAS No. 148 defines a fair value method of
accounting for an employee stock option or similar equity investment. The Company discloses the pro forma net loss as if the fair value method had been adopted.



With the Companys adoption of the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation, the estimated fair
value of the options is assumed to be amortized to expense over the options vesting periods.



Foreign Currency: The financial statements of foreign subsidiaries are measured using the local currency of the subsidiary as the functional currency. Accordingly, assets and liabilities of the
subsidiaries are translated at current rates of exchange at the balance sheet date and all revenue and expense items are translated using average exchange rates. The resultant losses from translation at December 31, 2003 and 2002 were ($754,000) and
($293,000), respectively.



Foreign transaction gains and losses are included in
interest income and other, net, and, were not material for the years ended December 2003, 2002 and 2001. In addition, the Company did not hold any foreign currency derivative instruments at December 31, 2003, 2002 and 2001.



Accumulated Other Comprehensive Income (Loss): Other comprehensive income
(loss) includes unrealized gains and losses on available-for-sale investments and foreign currency translation adjustment gains (losses).



Net Loss Per Common Share: Basic net loss per common share is computed using the weighted-average number of outstanding shares of common stock during the
period, excluding shares of restricted stock subject to repurchase. Dilutive net loss per common share is computed using the weighted-average number of common shares outstanding during the period and, when dilutive, potential common shares from
options and warrants to purchase common stock and common stock subject to repurchase, using the treasury stock method. Potential common shares consist of unvested restricted common stock, stock options and warrants.



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The Company has adopted the disclosure-only provisions of SFAS 148 (enter title of SFAS), which amended SFAS No. 123,
Accounting for Stock-Based Compensation. The following table shows the Companys net loss for 2003, 2002 and 2001 had the Company applied the fair value recognition provisions of SFAS No. 148 (in thousands, except per share
amounts):



|                                                                                                          |  |                         |         |   |      |   |         |      |  |   |         |  
|--------------------------------------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                                          |  | Year Ended December 31, |        
|                                                                                                          |  | 2003                    |         |   | 2002 |   |         | 2001 | 
|Net loss, as reported                                                                                     |  | $                       | (17,587 | ) |      | $ | (58,852 | )    |  | $ | (69,604 | )
|Add (Deduct): Stock-based employee compensation included in reported net loss                             |  |                         | 1,336   |   |      |   | (794    | )    |  |   | 12,014  |  
|Deduct: Total stock-based employee compensation expense determined under fair value method for all awards |  |                         | (5,790  | ) |      |   | (6,968  | )    |  |   | (26,588 | )
|                                                                                                          |  |                         |         |   |      |   |         |      |  |   |         |  
|Pro forma net loss                                                                                        |  | $                       | (22,041 | ) |      | $ | (66,614 | )    |  | $ | (84,178 | )
|                                                                                                          |  |                         |         |   |      |   |         |      |  |   |         |  
|Earnings per share:                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  
|Basic and diluted - as reported                                                                           |  | $                       | (1.61   | ) |      | $ | (5.80   | )    |  | $ | (7.62   | )
|                                                                                                          |  |                         |         |   |      |   |         |      |  |   |         |  
|Basic and diluted - as pro forma                                                                          |  | $                       | (2.01   | ) |      | $ | (6.57   | )    |  | $ | (9.21   | )
|                                                                                                          |  |                         |         |   |      |   |         |      |  |   |         |  



The fair value of each option granted
was estimated on the date of grant using the Black-Scholes option-pricing model with no expected dividends and using the following assumptions: expected four-year lives for all options issued in 2001, expected lives ranging from five months to four
years for options granted in 2002 and expected lives of 3.7 years for options granted in 2003; 46%, 95% and 100% expected volatility for 2003, 2002 and 2001, respectively; and average risk-free interest rate of 3.2%, 2.7%, and 4.4% for the years
2003, 2002, and 2001, respectively. Under SFAS No. 123, the weighted-average fair values of options granted were $1.76, $1.98, and $2.70, for 2003, 2002, and 2001, respectively.



Under SFAS No. 123, the weighted-average fair values of common stock purchase rights (per-share) granted under the 2000 Employee Stock
Purchase Plan were $1.09, $2.44 and $0.15 for 2003, 2002 and 2001, respectively. The fair value of stock purchased under the Employee Stock Purchase Plan was estimated on the dates of grant using the Black-Scholes option-pricing model with no
expected dividends and using the following assumptions: expected lives of six months to two years; 65% expected volatility for 2003, 95% for 2002 and 100% for 2001; and average risk-free interest rate of 2.64%, 2% and 2.54% for the years 2003, 2002
and 2001, respectively.



The weighted-average number of shares of restricted
stock subject to repurchase for 2003, 2002, and 2001 were approximately 20,000, 87,000, and 347,000, respectively.



The following potential common shares outstanding have been excluded from the calculation of diluted net loss per share for all periods presented because the effect would
have been anti-dilutive (in thousands):



|                                                 |  |              |  |       |  |      
|------------------------------------------------ |  | ------------ |  | ----- |  | -----
|                                                 |  | December 31,
|                                                 |  | 2003         |  | 2002  |  | 2001 
|Shares issuable under stock options              |  | 3,300        |  | 3,807 |  | 2,030
|Shares of restricted stock subject to repurchase |  | 20           |  | 87    |  | 347  
|Shares issuable pursuant to warrants             |  | 477          |  | 442   |  | 153  



The weighted-average exercise prices
of stock options were $5.14, $6.25 and $33.67 at December 31, 2003, 2002, and 2001, respectively. The weighted-average purchase prices of restricted stock were $16.92, $7.21 and $3.52 at December 31, 2003, 2002 and 2001, respectively. The average
exercise prices of outstanding warrants were $8.45 at December 31, 2003 and 2002 and $9.13 at December 31, 2001.



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Common Stock Split:On November 13, 2002, the Company completed a one-for-seven reverse stock split of the
common stock affecting all outstanding shares of common stock, stock options and warrants of the Company. All references in the accompanying consolidated financial statements and notes thereto to earnings per share and the number of common shares
have been retroactively adjusted to reflect the reverse stock split.



Recent Accounting Pronouncements: In April 2003, the FASB issued SFAS No. 149, Amendments of Statement 133 on Derivative Instruments and Hedging Activities, which amends and clarifies financial accounting
and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133. SFAS No. 149 is generally effective for contracts entered into or modified after June 30,
2003, and for hedging relationships designated after June 30, 2003. The Company adopted the provision of SFAS No. 149 as of July 1, 2003. The adoption of SFAS No. 149 did not have a material impact on our financial condition or results of
operations.



In December 2003, the Securities and Exchange Commission
(SEC) issued Staff Accounting Bulletin (SAB) No. 104 Revenue Recognition, which codifies, revises and rescinds certain sections of SAB No. 101, Revenue Recognition, in order to make this
interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The changes noted in SAB No. 104 did not have an impact on the Companys financial position or results of operations.



2. Cybrant Acquisition



In April 2002, Blue Martini completed its acquisition of The Cybrant Corp.
(Cybrant). Cybrants products enabled its customers to automate complex selling processes and solve complex business problems internally through the use of the softwares solutions architecture. Through the acquisition, the
Company fortified its manufacturing and retail industry solutions by adding Cybrants interactive selling suite to its existing applications. The operating results of Cybrant have been included with the Companys results beginning with the
date of acquisition.



The purchase price was approximately $7.6 million,
comprised of (1) approximately 575,000 shares of common stock valued at $1.58 per share based on the average market price of Blue Martinis common stock over a five-day period including the two days before and the two days after the day the
terms of the acquisition were agreed to and announced, (2) warrants exchanged for the purchase of approximately 73,000 shares of common stock at a price of $6.44 per share, expiring in January and March 2007, and (3) $552,000 in costs related to the
transaction and exit activities. The amounts and components of the purchase price are presented below (in thousands):



|                                  |  |   |      
|--------------------------------- |  | - | -----
|Fair value of common stock issued |  | $ | 6,363
|Fair value of warrants exchanged  |  |   | 672  
|Restructuring and exit costs      |  |   | 352  
|Acquisition-related costs         |  |   | 200  
|                                  |  |   |      
|                                  |  | $ | 7,587
|                                  |  |   |      



The purchase price was allocated to
assets and liabilities acquired, based on a valuation analysis. Approximately 20% of the shares issued in the Merger were set aside in an escrow arrangement pending resolution of general representations and warranties.



Approximately $800,000 of the purchase price represented the estimated fair value of acquired
in-process research and development projects that had not yet reached technological feasibility and had no alternative future use. Accordingly, this amount was immediately charged to expense upon the acquisition date and was included in the
accompanying statements of operations for the year ended December 31, 2002. The value assigned to purchased in-process research and development was comprised of development projects that were labeled at the acquisition time as Versions 4.2 and 5.0
of the Cybrant product. The estimated fair value of these projects was determined by employment of a discounted cash flow model using a discount rate of 35%. The discount rates used take into consideration the stage of completion and the risks
surrounding the successful development and commercialization of each of the purchased in-process research and development projects that were valued. The acquired in-process technology Version 4.2 was commercialized in 2002. The acquired
in-process technology Version 5.0 was commercialized in 2003.



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The purchased technology and other intangible assets were being amortized to expense over two years assuming no residual
value. Goodwill arising from the acquisition was attributable to the expected synergies in combining product lines. The amount assigned to goodwill was not subject to amortization. See Note 6 for a discussion of the subsequent write-off of goodwill
and the majority of the intangible assets due to impairment.



The following
condensed balance sheet discloses the amounts assigned to the acquired assets and liabilities as of the acquisition date (in thousands):



|                                          |  |   |       
|----------------------------------------- |  | - | ------
|ASSETS                                    |  |   |       
|Cash                                      |  | $ | 152   
|Accounts receivable, net                  |  |   | 425   
|Prepaid expenses and other current assets |  |   | 325   
|Property and equipment, net               |  |   | 138   
|Purchased technology                      |  |   | 2,400 
|In-process research and development       |  |   | 800   
|Other intangible assets                   |  |   | 300   
|Goodwill                                  |  |   | 5,608 
|                                          |  |   |       
|Total assets                              |  | $ | 10,148
|                                          |  |   |       
|LIABILITIES:                              |  |   |       
|Accounts payable                          |  | $ | 81    
|Accrued employee compensation             |  |   | 331   
|Lease and debt obligations                |  |   | 1,580 
|Other current liabilities                 |  |   | 412   
|Deferred revenues                         |  |   | 157   
|                                          |  |   |       
|Total liabilities                         |  | $ | 2,561 
|                                          |  |   |       
|Net assets (purchase price)               |  | $ | 7,587 
|                                          |  |   |       



In September 2003, the Company
recorded a benefit of $673,000 representing purchase price adjustments resulting from the final resolution of acquisition related costs, acquired liabilities, and the retirement of shares held in escrow.



3. Short-Term Investments



The following is a summary of short-term investments (in thousands):



|                                             |  |                   |        |                      |   |                       |  |   |                    |   |  |   |       
|-------------------------------------------- |  | ----------------- | ------ | -------------------- | - | --------------------- |  | - | ------------------ | - |  | - | ------
|                                             |  | December 31, 2003
|                                             |  | Cost              |        | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | EstimatedFairValue
|Short-term Investments:                      |  |                   |        |                      |   |                       |  |   |                    |   |  |   |       
|Corporate obligations                        |  | $                 | 8,164  |                      | $ | 4                     |  | $ |                   |   |  | $ | 8,168 
|US treasury and government agency securities |  |                   | 22,608 |                      |   | 17                    |  |   | (2                 | ) |  |   | 22,623
|Asset-back securities                        |  |                   | 74     |                      |   |                      |  |   |                   |   |  |   | 74    
|                                             |  |                   |        |                      |   |                       |  |   |                    |   |  |   |       
|                                             |  | $                 | 30,846 |                      | $ | 21                    |  | $ | (2                 | ) |  | $ | 30,865
|                                             |  |                   |        |                      |   |                       |  |   |                    |   |  |   |       



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|                                             |  |                   |        |                      |   |                       |  |   |                    |   |  |   |       
|-------------------------------------------- |  | ----------------- | ------ | -------------------- | - | --------------------- |  | - | ------------------ | - |  | - | ------
|                                             |  | December 31, 2002
|                                             |  | Cost              |        | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | EstimatedFairValue
|Short-term Investments:                      |  |                   |        |                      |   |                       |  |   |                    |   |  |   |       
|Corporate obligations                        |  | $                 | 34,280 |                      | $ | 129                   |  | $ | (5                 | ) |  | $ | 34,404
|US treasury and government agency securities |  |                   | 16,592 |                      |   | 84                    |  |   |                   |   |  |   | 16,676
|Asset-back securities                        |  |                   | 1,920  |                      |   | 21                    |  |   |                   |   |  |   | 1,941 
|                                             |  |                   |        |                      |   |                       |  |   |                    |   |  |   |       
|                                             |  | $                 | 52,792 |                      | $ | 234                   |  | $ | (5                 | ) |  | $ | 53,021
|                                             |  |                   |        |                      |   |                       |  |   |                    |   |  |   |       



Realized gains and losses from the
sales of short-term and long-term investments for the years 2003, 2002, and 2001 were not material.



4. Accounts Receivable



Accounts
receivable consisted of the following (in thousands):



|                                |  |              |       |   |      |   |       |  
|------------------------------- |  | ------------ | ----- | - | ---- | - | ----- | -
|                                |  | December 31, |      
|                                |  | 2003         |       |   | 2002 |  
|Accounts receivable             |  | $            | 4,221 |   |      | $ | 5,704 |  
|Unbilled receivables            |  |              | 170   |   |      |   | 763   |  
|                                |  |              |       |   |      |   |       |  
|                                |  |              | 4,391 |   |      |   | 6,467 |  
|Allowance for doubtful accounts |  |              | (604  | ) |      |   | (701  | )
|                                |  |              |       |   |      |   |       |  
|                                |  | $            | 3,787 |   |      | $ | 5,766 |  
|                                |  |              |       |   |      |   |       |  



Additions to the allowance of doubtful
accounts in 2003, 2002 and 2001 were $100,000, $200,000 and $1.4 million, respectively. Write-offs of accounts receivable in 2003, 2002 and 2001 were $197,000, $10,000, and $1.8 million, respectively.



5. Property and Equipment



Property and equipment, excluding fully depreciated items, consisted of the following (in
thousands):



|                                                |  |              |       |   |      |   |     |  
|----------------------------------------------- |  | ------------ | ----- | - | ---- | - | --- | -
|                                                |  | December 31, |      
|                                                |  | 2003         |       |   | 2002 |  
|Computer equipment                              |  | $            | 1,255 |   |      | $ | 543 |  
|Furniture and office equipment                  |  |              |      |   |      |   | 126 |  
|                                                |  |              |       |   |      |   |     |  
|                                                |  |              | 1,255 |   |      |   | 669 |  
|Less: accumulated depreciation and amortization |  |              | (786  | ) |      |   | (70 | )
|                                                |  |              |       |   |      |   |     |  
|                                                |  | $            | 469   |   |      | $ | 599 |  
|                                                |  |              |       |   |      |   |     |  



During 2001, the Company evaluated the
future usage of its computer network infrastructure in light of the operating activities. Management committed to plans of disposal for certain of these assets, and accordingly, classified these assets as held-for-disposal and recorded an impairment
loss of $638,000 in 2001. This amount is not included in the restructuring charges in 2001, but has been allocated to the expense categories in the consolidated statement of operations according to the functional department of the underlying asset.
Depreciation of these assets ceased and the assets were disposed of in 2002.



In 2002, the Company performed an impairment analysis of its property and equipment and determined the carrying amount exceeded its fair value.As a result of this analysis, the Company wrote off $1.5 million of property and
equipment in fiscal 2002. See Note 6 for further discussion.



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6. Long-lived Assets and Other Intangibles, Net



Intangible assets and other, net consisted of the following (in thousands):



|                                        |  |              |      |   |      |   |       |  
|--------------------------------------- |  | ------------ | ---- | - | ---- | - | ----- | -
|                                        |  | December 31, |     
|                                        |  | 2003         |      |   | 2002 |  
|Purchased software licenses and patents |  | $            | 600  |   |      | $ | 600   |  
|Other                                   |  |              | 302  |   |      |   | 422   |  
|                                        |  |              |      |   |      |   |       |  
|                                        |  |              | 902  |   |      |   | 1,022 |  
|Less accumulated amortization           |  |              | (600 | ) |      |   | (120  | )
|                                        |  |              |      |   |      |   |       |  
|                                        |  | $            | 302  |   |      | $ | 902   |  
|                                        |  |              |      |   |      |   |       |  



In September 2002, a sharp decline in
the Companys stock price resulted in the Companys market capitalization being significantly below its net asset value. The Company determined that this condition triggered a review of its long-lived assets in accordance with SFAS No.
144. Accordingly, the Company performed an impairment analysis of its property and equipment, intangible assets and other long-lived assets, other than goodwill, as of September 30, 2002 and determined that the carrying amount of its property and
equipment, intangible assets and other long-lived assets exceeded their respective fair values. As a result, the Company recorded an impairment charge of approximately $11.1 million.



SFAS 142, Goodwill and Other Intangible Assets requires that goodwill be tested for impairment if a SFAS No. 144 triggering
event has occurred. Accordingly, the Company performed an impairment analysis of its goodwill arising from the Cybrant acquisition. As the Company has determined that it operates in a single segment with one reporting unit, the fair value of its
reporting unit was determined based on the Companys market capitalization on the date of the impairment testing. As a result of this analysis, the Company wrote off all $5.6 million of goodwill at September 30, 2002.



The Company estimated the fair value of its long-lived assets based on a combination of the
market, income and replacement cost approaches. In the application of the impairment testing, the Company was required to make estimates of future operating trends and resulting cash flows and judgments on discount rates and other variables. Actual
future results and other assumed variables could differ from these estimates.



The impairment charge to goodwill, other intangible assets and other long-lived assets from the impairment review resulted in a write-off of the net book value as follows:



|                               |  |   |       
|------------------------------ |  | - | ------
|Goodwill                       |  | $ | 5,608 
|Acquisition-related technology |  |   | 1,350 
|Other intangible assets        |  |   | 8,220 
|Property and equipment         |  |   | 1,500 
|                               |  |   |       
|Total                          |  | $ | 16,678
|                               |  |   |       



The remaining balances in property and
equipment and acquisition-related technology and intangibles are being depreciated and amortized, respectively, over their remaining estimated lives.



In addition to the above adjustments to long-lived assets, goodwill and other intangible assets, the Company also accelerated the amortization of $638,000 relating to
technology rights in the form of prepaid royalties based on a reduced estimate of useful lives for these assets in 2002.



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7. Accrued Employee Compensation



In December 2001, in connection with the employment agreement for one executive officer of the Company, a contingent liability to the
executives former employer related to the reimbursement of deferred compensation amounting to $2.1 million was included in accrued employee compensation as of December 31, 2002 and 2001. The executive officers employment with the Company
terminated in 2002, and the executive officer resumed employment with his former employer. As of December 31, 2003, the Companys potential obligation relating to the employment agreement had expired, and the $2.1 million accrual, which was
allocated between cost of service revenue and operating expenses, was reversed in the accompanying Statement of Operations for the year ended December 31, 2003.



8. Restructuring Charges



The Company implemented restructuring plans in 2001, 2002 and 2003, intended to strengthen the Companys future operating performance and competitive position by
preserving cash and reducing costs. As part of these restructurings, the Company reduced its employee force. The restructuring actions in 2003 and 2002 also included vacating excess facilities. These actions resulted in a net restructuring charge of
$180,000 in 2003 $6.4 million in 2002, and $6.3 million in 2001.



As of
December 31, 2003, the Company has accrued restructuring charges of $2.4 million related to excess facilities, which will be paid through 2006. These accrued charges reflect estimates with respect to the time it will take to sublease the facilities,
sublease terms, and sublease rates. Should there be changes in real estate market conditions or should it take longer than expected to find a suitable tenant to sublease the remaining vacant facilities, adjustments to the idle facilities lease
losses reserve may be necessary in future periods based upon then current actual events and circumstances. The following tables summarize the activity related to restructuring activities in 2003 and 2002 (in thousands):



|                                  |  |                              |       |               |   |                  |  |   |               |   |  |                              |        |   |  |   |      
|--------------------------------- |  | ---------------------------- | ----- | ------------- | - | ---------------- |  | - | ------------- | - |  | ---------------------------- | ------ | - |  | - | -----
|                                  |  | Accrued at December 31, 2002 |       | Total Expense |   | Non-cash Charges |  |   | Cash Payments |   |  | Accrued at December 31, 2003
|Lease cancellations/idle facility |  | $                            | 3,418 |               | $ |                 |  | $ | (173          | ) |  | $                            | (814   | ) |  | $ | 2,431
|Severance and related charges     |  |                              | 58    |               |   | 180              |  |   |              |   |  |                              | (238   | ) |  |   |     
|                                  |  |                              |       |               |   |                  |  |   |               |   |  |                              |        |   |  |   |      
|                                  |  | $                            | 3,476 |               | $ | 180              |  | $ | (173          | ) |  | $                            | (1,052 | ) |  | $ | 2,431
|                                  |  |                              |       |               |   |                  |  |   |               |   |  |                              |        |   |  |   |      
|                                  |  |                              |       |               |  
|                                  |  | Accrued at December 31, 2001 |       | Total Expense |   | Non-cash Charges |  |   | Cash Payments |   |  | Accrued at December 31, 2002
|Lease cancellations/idle facility |  | $                            | 458   |               | $ | 3,335            |  | $ |              |   |  | $                            | (375   | ) |  | $ | 3,418
|Severance and related charges     |  |                              | 18    |               |   | 3,028            |  |   | (128          | ) |  |                              | (2,860 | ) |  |   | 58   
|                                  |  |                              |       |               |   |                  |  |   |               |   |  |                              |        |   |  |   |      
|                                  |  | $                            | 476   |               | $ | 6,363            |  | $ | (128          | ) |  | $                            | (3,235 | ) |  | $ | 3,476
|                                  |  |                              |       |               |   |                  |  |   |               |   |  |                              |        |   |  |   |      



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9. Commitments and Contingencies



Lease Commitments:The Company leases certain facilities, including its corporate headquarters, under non-cancelable operating
leases. Rent expense for 2003, 2002 and 2001 was $3.2 million, $4.2 million and $7 million, respectively. Future minimum lease payments under operating lease with non-cancelable terms of more than one year as of December 31, 2003 are as follows
(excluding lease commitments reflected in accrued restructuring liabilities on the balance sheet) (in thousands):



|                         |  |   |      
|------------------------ |  | - | -----
|Year Ending December 31, |  |  
|2004                     |  | $ | 2,509
|2005                     |  |   | 2,348
|2006                     |  |   | 840  
|                         |  |   |      
|Total                    |  | $ | 5,697
|                         |  |   |      



Letters of Credit: The
Company maintains a letter of credit from a financial institution totaling $866,000 at December 31, 2003 in lieu of security deposits to secure facility lease obligations. No amounts have been drawn against the letter of credit. The Company pledged
$962,000 and $1.4 million as of December 31, 2003 and 2002, respectively, of cash equivalents held in trust as security for the letters of credit.



Royalties: The Company licenses technologies from third party software providers that are incorporated into the Companys product. Under the terms of
these license agreements, which expire at various dates up to June 2007, the Company pays royalties at various rates and amounts, generally based on revenues. Royalty expense was $1.1 million, $1.5 million and $4.3 million for 2003, 2002 and 2001,
respectively. Such costs are included in the cost of license revenues (for new licenses sold) and in cost of service revenues (for maintenance contracts sold).



Legal Actions: The Company is subject to legal proceedings and claims, asserted or unasserted, that are in the ordinary course of business. The Company
cannot predict the outcome of these proceedings and claims or the possible impact on the Company.



10. Stockholders Equity



Common Stock: Each share of common stock has the right to one vote. The holders of common stock are also entitled to receive dividends whenever funds are legally available and when declared by the board of directors subject to
the rights of holders of all classes of stock having priority rights as to dividends. No cash dividends have been declared or paid through December 31, 2003.



Common Stock Repurchase Program: In June 2002, the Companys board of directors authorized the repurchase of up to 5% of the Companys outstanding
common stock. As of December 31, 2002, the Company had repurchased and retired 91,000 shares of its common stock under this repurchase program in open market transactions at prevailing market prices for a total cost of approximately $558,000,
including commissions. The company did not repurchase shares under this program in 2003.



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Warrants: The Company issued warrants in 1999 thru 2002 in connection with marketing arrangements, leases,
alliance agreement, executive searches and the Cybrant acquisition. The following table lists details relating to the warrants.



|                                            |  |            |  |                |  |         |  |       |      
|------------------------------------------- |  | ---------- |  | -------------- |  | ------- |  | ----- | -----
|Agreements with Warrants                    |  | Issue Date |  | ExpirationDate |  | Shares  |  | Price
|Lease                                       |  | 12/1/99    |  | 1/1/10         |  | 6,400   |  | $     | 10.50
|Marketing and business development          |  | 4/17/00    |  | 4/17/08        |  | 43,000  |  | $     | 35.00
|Marketing and business development          |  | 9/28/01    |  | 4/17/08        |  | 300,000 |  | $     | 5.46 
|Executive search firm                       |  | 10/25/01   |  | 10/25/06       |  | 12,000  |  | $     | 7.70 
|Strategic alliance                          |  | 6/30/02    |  | 6/30/10        |  | 43,000  |  | $     | 6.16 
|Landlord - Cybrant acquisition              |  | 3/10/02    |  | 3/20/07        |  | 53,000  |  | $     | 6.44 
|Financial institution - Cybrant acquisition |  | 1/23/00    |  | 1/23/07        |  | 20,000  |  | $     | 6.44 
|                                            |  |            |  |                |  |         |  |       |      
|                                            |  |            |  |                |  | 477,400 |  |       |      
|                                            |  |            |  |                |  |         |  |       |      



The fair value of the warrants was
calculated based upon the Black-Scholes option pricing model using the fair value of the underlying common stock and assumptions on dividends, contractual life, risk free interest rate and expected volatility.



Stock Plans



2000 Equity Incentive Plan:The Company was initially authorized to issue up to 4.3 million shares in connection with
the Equity Incentive Plan (Incentive Plan) to employees and consultants. For a period of ten years commencing on January 1, 2001, the share reserve will increase automatically each January 1stby the greater of 5% of the Companys diluted shares outstanding (as defined by the plan), or the number of shares granted under the
Incentive Plan during the prior twelve-month period. The Incentive Plan provides for the issuance of stock purchase rights, common stock, incentive stock options or non-statutory stock options. At December 31, 2003, a total of 5.4 million shares
were available for future issuance under the Incentive Plan.



The stock
purchase rights are subject to a restricted stock purchase agreement whereby the Company has the right to repurchase the stock upon the voluntary or involuntary termination of the purchasers employment from the Company at the original issuance
price. The Companys repurchase right lapses at a rate determined by the board of directors, but at a minimum rate of 25% per year. As of December 31, 2003, approximately 20,000 shares of common stock, which have been issued to employees upon
the exercise of unvested options, are subject to repurchase, at a weighted-average repurchase price of $16.92 per share.



Under the Incentive Plan, the exercise price for incentive stock options is at least 100% of the stocks fair market value on the date of grant for employees owning
10% or less of the voting power of all classes of stock, and at least 110% of the fair market value on the date of grant for employees owning more than 10% of the voting power of all classes of stock. For nonstatutory stock options, the exercise
price is at least 85% of the stocks fair market value on the date of grant for employees owning 10% or less of the voting power of all classes of stock, and at least 110% of the fair market value on the date of grant for employees owning more
than 10% of the voting power of all classes of stock.



The Incentive Plan is
administered by the board of directors, which has the authority to designate participants and to determine the number and type of options to be granted, the time at which options are exercisable, the method of payment, and any other terms or
conditions of the options. Options generally have a term of up to 10 years and vest over up to four years.



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2000 Non-Employee Directors Stock Option Plan: Under the 2000 Non-Employee Directors Stock
Option Plan (Directors Plan) approximately 43,000 common shares were originally reserved for issuance. For a period of ten years commencing on January 1, 2001, the share reserve will increase automatically each January
1stby the greater of 0.25% of the Companys diluted shares outstanding (as defined by the plan) or
the number of shares granted under the Directors Plan during the prior twelve-month period. In March 2003, the Companys board of directors authorized the submission of proposed amendments including increasing the shares reserved for the
plan by 300,000. In June 2003, the Companys stockholders approved the amendments by a majority vote. As of December 31, 2003, a total of 291,000 shares were available for future issuance under the Directors Plan.



The following table summarizes plan activity for all plans (in thousands, except for per
share amounts):



|                                                                                                         |  |                         |   |      |                               |      |                 |        |   |                               |   |                 |  |       |                               |  |   |      
|-------------------------------------------------------------------------------------------------------- |  | ----------------------- | - | ---- | ----------------------------- | ---- | --------------- | ------ | - | ----------------------------- | - | --------------- |  | ----- | ----------------------------- |  | - | -----
|                                                                                                         |  | Year Ended December 31,
|                                                                                                         |  | 2003                    |   | 2002 |                               | 2001
|                                                                                                         |  | Number ofShares         |   |      | WeightedAverageExercise Price |      | Number ofShares |        |   | WeightedAverageExercise Price |   | Number ofshares |  |       | WeightedAverageExercise Price
|Outstanding, beginning of year                                                                           |  | 3,807                   |   |      | $                             | 6.25 |                 | 2,030  |   |                               | $ | 33.69           |  | 1,239 |                               |  | $ | 62.02
|Granted                                                                                                  |  | 1,594                   |   |      |                               | 3.44 |                 | 3,574  |   |                               |   | 3.53            |  | 1,542 |                               |  |   | 23.80
|Exercised                                                                                                |  | (790                    | ) |      |                               | 3.04 |                 | (66    | ) |                               |   | 9.01            |  | (31   | )                             |  |   | 33.04
|Canceled                                                                                                 |  | (1,311                  | ) |      |                               | 7.56 |                 | (1,731 | ) |                               |   | 32.70           |  | (720  | )                             |  |   | 62.30
|                                                                                                         |  |                         |   |      |                               |      |                 |        |   |                               |   |                 |  |       |                               |  |   |      
|Outstanding, end of year                                                                                 |  | 3,300                   |   |      | $                             | 5.14 |                 | 3,807  |   |                               | $ | 6.25            |  | 2,030 |                               |  | $ | 33.67
|                                                                                                         |  |                         |   |      |                               |      |                 |        |   |                               |   |                 |  |       |                               |  |   |      
|Exercisable, end of year                                                                                 |  | 1,544                   |   |      | $                             | 7.20 |                 | 481    |   |                               | $ | 26.05           |  | 799   |                               |  | $ | 37.80
|                                                                                                         |  |                         |   |      |                               |      |                 |        |   |                               |   |                 |  |       |                               |  |   |      
|Weighted-average fair value of options granted with exercise prices equal to fair value at date of grant |  | 1,594                   |   |      | $                             | 3.44 |                 | 3,459  |   |                               | $ | 3.64            |  | 1,542 |                               |  | $ | 18.90
|                                                                                                         |  |                         |   |      |                               |     
|Weighted-average fair value of options granted with exercise price less than fair value at date of grant |  |                        |   |      | $                             |     |                 | 115    |   |                               | $ | 0.07            |  |      |                               |  | $ |     



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The following table summarizes information about stock options as of December 31, 2003 (option amounts in thousands):



|                    |  |                     |  |                                                   |  |                                |        |                  |       |                                |   |       
|------------------- |  | ------------------- |  | ------------------------------------------------- |  | ------------------------------ | ------ | ---------------- | ----- | ------------------------------ | - | ------
|Options Outstanding |  | Options Exercisable
|Exercise Prices     |  | Number ofOptions    |  | Weighted AverageRemainingContractual Life (Years) |  | Weighted AverageExercise Price |        | Number ofOptions |       | Weighted AverageExercise Price
|$  0.07 - $1.75     |  | 47                  |  | 7.95                                              |  | $                              | 0.35   |                  | 47    |                                | $ | 0.35  
|$  2.52 - $2.76     |  | 1,590               |  | 5.25                                              |  |                                | 2.58   |                  | 719   |                                |   | 2.53  
|$  3.00 - $5.04     |  | 932                 |  | 9.3                                               |  |                                | 3.73   |                  | 162   |                                |   | 3.79  
|$  5.25 - $6.44     |  | 472                 |  | 8.59                                              |  |                                | 6.28   |                  | 363   |                                |   | 6.39  
|$  7.63 - $15.26    |  | 159                 |  | 6.75                                              |  |                                | 10.13  |                  | 153   |                                |   | 10.10 
|$17.50 - $42.00     |  | 91                  |  | 6.33                                              |  |                                | 40.57  |                  | 91    |                                |   | 40.57 
|$63.00 - $140.00    |  | 9                   |  | 6.54                                              |  |                                | 126.61 |                  | 9     |                                |   | 126.61
|                    |  |                     |  |                                                   |  |                                |        |                  |       |                                |   |       
|                    |  | 3,300               |  | 7.01                                              |  | $                              | 5.14   |                  | 1,544 |                                | $ | 7.20  
|                    |  |                     |  |                                                   |  |                                |        |                  |       |                                |   |       



Stock Options Exchange
Program: On December 4, 2002, the Company completed a stock option exchange program. Under the program, all outstanding employee stock options with exercise prices at or above $12.39 per share were eligible to be exchanged on a one-for-one
basis for stock options to purchase common stock with an exercise price set at the fair market value of the Companys common stock at the end of the offer period, which was $3.60. The Companys Chief Executive Officer, Chief Financial
Officer and directors were not eligible to participate in the program. Pursuant to this program, options for 602,000 shares were exchanged and reflected in the above table as both cancellations and grants. These replacement stock options vested in
equal monthly installments over a five-month period ending in May 2003 and expired in September 2003. Approximately 92% of the total eligible options were exchanged for replacement stock options; the balance was not exchanged. The Company accounted
for the replacement options as well as any eligible stock options that were not replaced under the variable plan accounting method in accordance with Accounting Principles Bulletin (APB) No. 25. Under variable plan accounting, the
Company recorded compensation expense during the term of the stock options to the extent there was a net increase in the Companys stock market price above $3.60, fair market value exercise price of the replacement stock options. As of
September 2003, variable accounting for these stock options resulted in a $319,000 compensation expense reflecting the net increase in the Companys stock market price above the option exercise price through the date the underlying options were
exercised or expired. As of December 31, 2003, there were no variable stock awards outstanding.



2000 Employee Stock Purchase Plan:Under the 2000 Employee Stock Purchase Plan approximately 571,000 shares were initially reserved for issuance. For a period of ten years commencing on January 1, 2001,
the share reserve will increase automatically each January 1stby the greater of 2.5% of the Companys
diluted shares outstanding (as defined by the plan) or the number of shares granted under the Employee Stock Purchase Plan during the prior twelve-month period. The 2000 Employee Stock Purchase Plan contains successive six-month offering
periods and the share price of stock purchased under the plan is 85% of the lower of the fair value of the common stock either at the beginning or the end of the period. Shares of common stock issued under the Purchase Plan totaled 239,000 in 2003,
254,000 in 2002 and 127,000 in 2001.



Stock-Based Compensation:
During 2002, the Company issued options to certain employees under the Incentive Plan with exercise prices below the fair value of the common stock at the date of grant. No options with exercise prices below the fair values of the common stock were
issued in 2003 and 2001. In accordance with the requirements of APB No. 25, the Company has recorded deferred stock compensation for the differences between the exercise price of the options and the fair value of the Companys stock at the date
of grant. The Company recorded deferred stock compensation of $590,000 for 2002. The deferred stock compensation was amortized to expense over the period during which the options vest, generally four



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years using a method consistent with FASB Interpretation No. 28 (FIN 28). Under the FIN 28 method, each
vested tranche of options is accounted for as a separate option grant awarded. Accordingly, the compensation expense is recognized over the period during which the services have been provided. During 2003, 2002 and 2001, the Company also recorded
approximately $294,000, $8.1 million and $11 million against deferred stock compensation related to the forfeiture of unvested stock options of terminated employees. The balance of deferred stock compensation was fully amortized as of December 31,
2003.



In November 2001, the Company issued approximately 35,000 shares of
unrestricted common stock to an executive officer under the Incentive Plan. At the date of issuance, the Company recorded deferred stock compensation of $271,000, which was fully amortized by December 31, 2002. Amortization for 2002 and 2001 were
$171,000 and $100,000, respectively. In October 2002, 59,509 shares of unrestricted common stock were issued to the same executive officer as part of a termination agreement.



In 2001, the Company granted approximately 3,000 immediately vested and exercisable common stock options to non-employees and recorded
related stock-based compensation of $56,000. The recorded amounts reflect the fair value of these stock options at their respective grant dates, calculated based upon the Black-Scholes option pricing model using the fair values of the underlying
common stock on the grant dates and the following weighted-average assumptions: no dividends; contractual life of 10 years; risk-free interest rate of 5.0%, for 2001 and, expected volatility of 100% for 2001. There were no grants of stock options to
non-employees in 2002.



11. Income Taxes



For financial reporting purposes, net loss includes the following components for the years
ended December 31, 2001, 2002 and 2003 (in thousands):



|         |  |                         |         |   |      |   |         |      |  |   |         |  
|-------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|         |  | Year Ended December 31, |        
|         |  | 2003                    |         |   | 2002 |   |         | 2001 | 
|Domestic |  | $                       | (16,746 | ) |      | $ | (55,627 | )    |  | $ | (56,755 | )
|Foreign  |  |                         | (841    | ) |      |   | (3,225  | )    |  |   | (12,849 | )
|         |  |                         |         |   |      |   |         |      |  |   |         |  
|         |  | $                       | (17,587 | ) |      | $ | (58,852 | )    |  | $ | (69,604 | )
|         |  |                         |         |   |      |   |         |      |  |   |         |  



As of December 31, 2003, the Company
has net operating loss carryforwards for federal and California income tax purposes of approximately $129 million and $75 million, respectively, available to reduce future income subject to income taxes. The federal net operating loss carryforwards
will expire in 2019 through 2023. The California net operating loss carryforwards will expire 2007 through 2013.



The 2003 income tax expense differed from the amounts computed by applying the U.S. federal income tax rate of 35% to pretax income as a result of the following (in
thousands):



|                                   |  |                         |        |   |      |   |         |      |  |   |         |  
|---------------------------------- |  | ----------------------- | ------ | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                   |  | Year Ended December 31, |       
|                                   |  | 2003                    |        |   | 2002 |   |         | 2001 | 
|Federal tax at statutory rate      |  | $                       | (6,157 | ) |      | $ | (20,599 | )    |  | $ | (24,362 | )
|Net operating losses not benefited |  |                         | 6,104  |   |      |   | 14,906  |      |  |   | 18,461  |  
|Deferred compensation              |  |                         |       |   |      |   |        |      |  |   | 5,376   |  
|Impairment of intangibles          |  |                         |       |   |      |   | 5,350   |      |  |   |        |  
|Other                              |  |                         | 53     |   |      |   | 343     |      |  |   | 525     |  
|                                   |  |                         |        |   |      |   |         |      |  |   |         |  
|                                   |  | $                       |       |   |      | $ |        |      |  | $ |        |  
|                                   |  |                         |        |   |      |   |         |      |  |   |         |  



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The types of temporary differences that give rise to significant portion of the Companys deferred tax assets and
liabilities are set out below (in thousands):



|                                 |  |                         |         |   |      |   |         |  
|-------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | -
|                                 |  | Year Ended December 31, |        
|                                 |  | 2003                    |         |   | 2002 |  
|Deferred tax assets:             |  |                         |         |   |      |   |         |  
|Accruals and reserves            |  | $                       | 4,016   |   |      | $ | 2,635   |  
|Plant and equipment              |  |                         | 1,477   |   |      |   | 2,143   |  
|Net operating loss carryforwards |  |                         | 49,513  |   |      |   | 40,910  |  
|Other capitalized costs          |  |                         | 2,003   |   |      |   | 2,105   |  
|Capitalized R&D Expenditure      |  |                         | 1,110   |   |      |   |        |  
|Credit carryforwards             |  |                         | 4,924   |   |      |   | 3,844   |  
|                                 |  |                         |         |   |      |   |         |  
|Total deferred tax assets        |  |                         | 63,043  |   |      |   | 51,637  |  
|Less: valuation allowance        |  |                         | (63,043 | ) |      |   | (51,637 | )
|                                 |  |                         |         |   |      |   |         |  
|Net deferred tax assets          |  | $                       |        |   |      | $ |        |  
|                                 |  |                         |         |   |      |   |         |  



Management has established a valuation
allowance for the portion of deferred tax assets for which realization is uncertain. The change in the total valuation allowance for 2003, 2002, and 2001 were increases of $11.4 million, $13.9 million and $22.3 million, respectively.



The valuation allowance of approximately $63 million attributable to total deferred tax
assets as of December 31, 2003 includes approximately $984,000 related to the exercise of stock options. Upon reversal of this portion of the valuation allowance, the tax benefit thus realized will be credited to stockholders equity.



As of December 31, 2003, the Company has available for carryover research and
experimental credits for federal and California income tax purposes of approximately $3.3 million and $2.6 million respectively, available to reduce future income taxes. The federal research and experimental tax credits will expire, if not utilized,
beginning in the year 2019. California research and experimental tax credits carry forward indefinitely until utilized.



The Tax Reform Act of 1986 imposes restrictions on the utilization of net operating loss and tax credit carryforwards in the event of an ownership change as
defined by the Internal Revenue Code. The Companys ability to utilize its net operating loss and credits carryforwards is subject to restriction pursuant to these provisions.



12. Geographic, Segment Reporting, and Significant Customer Information



SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information, establishes standards for the manner in which public companies report information about operating segments in annual and interim financial statements. It also establishes standards for related disclosures about products and
services, geographic areas and major customers. The method for determining what information to report is based on the way management organizes the operating segments within the Company for making operating decisions and assessing financial
performance.



The Companys chief operating decision-maker is considered
to be the chief executive officer (CEO). The CEO reviews financial information presented on a consolidated basis accompanied by disaggregated information about revenues by geographic region and sales teams for purposes of making operating decisions
and assessing financial performance. On this basis, the Company is organized and operates in a single segment: the design, development and marketing of software solutions.



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The Company markets its products primarily from its operations in the United States. International sales are primarily to
customers in Europe and Asia Pacific. Information regarding the Companys revenues in different geographic regions is as follows:



|              |  |                         |   |  |      |   |  |      |  
|------------- |  | ----------------------- | - |  | ---- | - |  | ---- | -
|              |  | Year Ended December 31, |  
|              |  | 2003                    |   |  | 2002 |   |  | 2001 |  
|Revenues:     |  |                         |   |  |      |   |  |      |  
|North America |  | 77                      | % |  | 77   | % |  | 76   | %
|Europe        |  | 20                      | % |  | 16   | % |  | 22   | %
|Asia          |  | 3                       | % |  | 7    | % |  | 2    | %
|              |  |                         |   |  |      |   |  |      |  
|              |  | 100                     | % |  | 100  | % |  | 100  | %
|              |  |                         |   |  |      |   |  |      |  



Significant customer information is as
follows: For 2003, two customers each accounted for $4.3 million and $4.2 million of total consolidated revenues or more than 10% of consolidated revenues; and in 2002 and 2001, no individual customer accounted for more than 10% of consolidated
revenues. At December 31, 2003 and 2002, two and three customers each, respectively, accounted from more than 10% of net accounts receivable outstanding. At December 31, 2001, no individual customer accounted for more than 10% of net accounts
receivable outstanding.



During 2001, one of the Companys directors was
also on the board of directors of one of the Companys customers. This customer accounted for less than 1% of Company revenues and 2001. The director resigned from the Company in 2001.



During 2002 and 2001, a customer for which another of the Companys directors served as
an executive officer accounted for approximately 1% of revenues in 2001 and less than 1% of revenues in 2002. The Company director resigned from the board in October 2002.



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