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

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FORM 10-Q
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X Quarterly report pursuant to Section 13 or 15(d) of the Securities
--- Exchange Act of 1934

For the quarterly period ended June 30, 2001

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

Commission File Number: 0-30925

BLUE MARTINI SOFTWARE, INC.
(Exact name of registrant as specified in its charter)

Delaware 94-3319751
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) 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)

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
----- -----

As of August 2, 2001 there were approximately 68,445,000 shares of the
registrant's common stock outstanding.

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BLUE MARTINI SOFTWARE, INC.

INDEX

PART I. FINANCIAL INFORMATION Page No.
--------

Item 1. Condensed Consolidated Financial Statements:

Condensed Consolidated Balance Sheets
June 30, 2001 and December 31, 2000 .......................................... 3

Condensed Consolidated Statements of Operations
Three and six months ended June 30, 2001 and 2000 ............................ 4

Condensed Consolidated Statements of Cash Flows
Six months ended June 30, 2001 and 2000 ...................................... 5

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

Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations .................................................... 9

Item 3. Quantitative and Qualitative Disclosures About Market Risk .................... 25

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.............................................................. 25

Item 4. Submission of Matters to a Vote of Security Holders ........................... 26

Item 6. Exhibits and Reports on Form 8-K............................................... 26

Signatures .................................................................... 27

PART I. FINANCIAL INFORMATION
- ------------------------------

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

BLUE MARTINI SOFTWARE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)
(Unaudited)

ASSETS June 30, 2001 December 31, 2000
------------- -----------------

Current assets:
Cash and cash equivalents.................................. $ 29,409 $ 40,101
Short-term investments..................................... 25,301 62,183
Accounts receivable, net................................... 6,609 12,584
Prepaid expenses and other current assets.................. 5,357 6,942
------------ ------------
Total current assets................................... 66,676 121,810
Property and equipment, net.................................... 9,894 8,713
Long-term investments.......................................... 61,176 51,402
Intangible assets and other, net............................... 5,130 6,373
------------ ------------
Total assets........................................... $ 142,876 $ 188,298
============ ============

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Accounts payable........................................... $ 2,172 $ 4,434
Accrued employee compensation.............................. 7,761 9,411
Other current liabilities.................................. 10,081 14,233
Deferred revenues.......................................... 8,416 15,249
Current portion of long-term obligations................... 166 209
------------ ------------
Total current liabilities.............................. 28,596 43,536
Long-term obligations, less current portion.................... 104 117
------------ ------------
Total liabilities...................................... 28,700 43,653
------------ ------------
Stockholders' equity:
Common stock............................................... 69 69
Additional paid-in-capital................................. 259,190 260,943
Deferred stock compensation................................ (25,992) (42,106)
Accumulated other comprehensive income..................... 911 282
Accumulated deficit........................................ (120,002) (74,543)
------------ ------------
Total stockholders' equity............................. 114,176 144,645
------------ ------------
Total liabilities and stockholders' equity............. $ 142,876 $ 188,298
============ ============

See accompanying notes to condensed consolidated financial statements.

BLUE MARTINI SOFTWARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

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

Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -----------------------------
2001 2000 2001 2000
---------- ---------- ---------- ----------

Revenues:
License ................................... $ 6,033 $ 8,421 $ 14,056 $ 14,491
Service ................................... 9,575 6,599 22,081 11,210
---------- ---------- ---------- ----------
Total revenues ...................... 15,608 15,020 36,137 25,701
---------- ---------- ---------- ----------
Cost of revenues:
License ................................... 1,178 751 2,357 1,312
Service ................................... 11,437 10,464 25,329 16,701
---------- ---------- ---------- ----------
Total cost of revenues .............. 12,615 11,215 27,686 18,013
---------- ---------- ---------- ----------
Gross profit ........................ 2,993 3,805 8,451 7,688
---------- ---------- ---------- ----------
Operating expenses:
Sales and marketing ....................... 14,309 12,847 31,196 21,427
Research and development .................. 4,973 4,914 12,364 9,316
General and administrative ................ 5,012 5,407 11,997 7,935
Restructuring charges ..................... -- -- 2,107 --
---------- ---------- ---------- ----------
Total operating expenses ............ 24,294 23,168 57,664 38,678
---------- ---------- ---------- ----------
Loss from operations ................ (21,301) (19,363) (49,213) (30,990)

Interest and other, net ...................... 1,547 79 3,754 139
---------- ---------- ---------- ----------
Net loss ............................ $ (19,754) $ (19,284) $ (45,459) $ (30,851)
========== ========== ========== ==========

Basic and diluted net loss per common share .. $ (0.31) $ (0.76) $ (0.72) $ (1.22)
========== ========== =========== ==========
Shares used in computing basic and diluted
net loss per common share ................. 63,500 25,420 62,810 25,220
========== ========== =========== ==========

See accompanying notes to condensed consolidated financial statements.

BLUE MARTINI SOFTWARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)
(Unaudited)

Six Months Ended
June 30,
------------------------------------
2001 2000
------------ -----------

Operating activities:
Net loss ........................................................ $ (45,459) $ (30,851)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization ................................ 4,513 1,530
Amortization of stock compensation and warrants .............. 11,378 14,125
Provision for doubtful accounts .............................. 1,075 1,040
Restructuring charges ........................................ 291 --
Changes in operating assets and liabilities:
Accounts receivable .......................................... 4,900 (8,963)
Prepaid expenses and other assets ............................ 1,828 (1,850)
Accounts payable, accrued employee compensation and
other current liabilities .................................. (3,974) 9,560
Deferred revenues ............................................ (6,833) 14,257
----------- -----------
Net cash used in operating activities ................... (32,281) (1,152)
----------- -----------
Cash flows from investing activities:
Purchases of property and equipment ............................. (4,825) (4,475)
Payment on short-term installment plan for the purchase of
intangible assets............................................. (4,250) --
Sales and maturities of available-for-sale investments, net ..... 27,737 2,294
----------- -----------
Net cash provided by (used for) investing activities .... 18,662 (2,181)
----------- -----------
Cash flows from financing activities:
Net proceeds from issuance of common stock ...................... 3,219 3,824
Repurchases of common stock ..................................... (236) (31)
Payment of issuance costs related to initial public offering .... -- (852)
Repayment of debt and capital lease obligations ................. (56) (250)
----------- -----------
Net cash provided by financing activities ............... 2,927 2,691
----------- -----------
Net decrease in cash and cash equivalents .......................... (10,692) (642)
Cash and cash equivalents at beginning of period ................... 40,101 10,362
----------- -----------
Cash and cash equivalents at end of period ......................... $ 29,409 $ 9,720
=========== ===========
Supplemental disclosures of noncash operating, investing and financing
activities:
Property and equipment acquired under capital lease
obligations $ -- $ 265
=========== ===========
Deferred stock compensation $ -- $ 46,781
=========== ===========
Warrants issued in connection with lease financing and
marketing arrangement $ -- $ 14,008
=========== ===========

See accompanying notes to condensed consolidated financial statements.

BLUE MARTINI SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Basis of Presentation

The condensed consolidated financial statements included herein are
unaudited and reflect all adjustments (consisting only of normal recurring
adjustments) which are, in the opinion of management, necessary for a fair
presentation of the financial position, results of operations and cash flows for
the interim periods. These condensed consolidated financial statements should be
read in conjunction with the consolidated financial statements and notes
thereto, together with Management's Discussion and Analysis of Financial
Condition and Results of Operations contained in the Blue Martini Software, Inc,
("Blue Martini Software" or the "Company") Annual Report on Form 10-K for the
year ended December 31, 2000. The results of operations for the three and six
months ended June 30, 2001 are not necessarily indicative of the results for the
entire year ending December 31, 2001.

Note 2. 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, and from convertible preferred stock, using the
"if-converted" method. Potential shares consist of convertible preferred stock,
unvested restricted common stock, stock options and warrants.

The following potential common shares 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):

Six Months Ended
June 30,
------------------------
2001 2000
-------- ---------

Shares issuable under stock options ......... 13,681 6,138
Shares of restricted stock subject to
repurchase ............................... 4,876 10,450
Shares issuable pursuant to warrants ........ 2,445 2,445
Shares of convertible preferred stock on an
"as-if-converted" basis .................. -- 23,297

The weighted average exercise price of stock options outstanding was $6.81
and $3.81 at June 30, 2001 and 2000, respectively. The weighted average purchase
price of restricted stock was $0.45 and $0.35 at June 30, 2001 and 2000,
respectively. The weighted average exercise price of warrants was $4.94 at June
30, 2001 and 2000.

Note 3. Comprehensive Income (Loss)

Other comprehensive income refers to revenues, expenses, gains and losses
that under generally accepted accounting principles are recorded as an element
of stockholders' equity, but are excluded from net income. The components of
accumulated comprehensive loss are as follows (in thousands):

Three Months Ended Six Months Ended
June 30, June 30,
------------------------- --------------------------
2001 2000 2001 2000
--------- ---------- --------- ---------

Net loss ........................................ $(19,754) $(19,284) $ (45,459) $(30,851)
Unrealized gains (losses) on available-for-sale
investments, net of tax ....................... (58) -- 433 --
Change in accumulated translation
adjustment .................................... 196 -- 196 --
-------- -------- --------- --------
Total comprehensive loss ..................... $(19,616) $(19,284) $ (44,830) $(30,851)
======== ======== ========= ========

Note 4. Cash and Cash Equivalents, and Short and Long-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 institutional money market funds,
commercial paper and various deposit accounts. Cash equivalents are recorded at
cost, which approximates fair value.

The Company's investments are classified as "available-for-sale" and are
carried at fair value based on quoted market prices. These investments consist
of corporate obligations that include commercial paper, corporate bonds and
notes, U.S. government agency securities and asset-backed securities. Those
investments with original maturities greater than three months and less than
twelve months are considered short-term investments and those with original
maturities greater than twelve months are considered long-term investments.
Unrealized holding gains and losses, net of the related tax effect, 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.

Note 5. Restructuring Charges

During the quarter ended March 31, 2001, the Company initiated actions
resulting in recognition of a $2.1 million restructuring charge. This charge
included $1.4 million for the cancellation of facility lease contracts and $0.7
million for severance payments to employees involuntarily terminated and the
write-down of certain operating assets to be disposed of. These restructuring
actions resulted in the termination of approximately 60 employees.

In July 2001, the Company announced and began to implement a supplemental
restructuring plan designed to reduce costs and preserve cash. The supplemental
restructuring plan consisted of terminating approximately 130 full-time
employees; canceling or vacating certain facility leases as a result of those
employee terminations; writing off the unamortized costs of abandoned assets;
and canceling contracts that were not critical to the Company's core business
strategy. The total cost of these actions will result in a restructuring charge
of $4 million to $6 million during the quarter ending September 30, 2001.

Note 6. Segment Reporting

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 for
purposes of making operating decisions and assessing financial performance. The
financial information is identical to the information presented in the
accompanying consolidated statements of operations and the Company had no
significant foreign operations through December 31, 1999. For the three months
ended June 30, 2001 and 2000, revenues derived from customers outside the United
States, principally in Europe, Asia and Latin America, represented 33% and 20%
of consolidated revenues, respectively. For the six months ended June 30, 2001
and 2000, revenues derived from customers outside the United States represented
26% and 20% of consolidated revenues, respectively. On this basis, the Company
is organized and operates in a single segment: the design, development and
marketing of software solutions.

Note 7. Recent Accounting Pronouncements

In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
133, Accounting for Derivative Instruments and Hedging Activities. The new
standard establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. It requires companies to record
derivatives on the balance sheet as assets or liabilities, measured at fair
value. Accounting for changes in the values of those derivatives depends on the
intended use of the derivatives and whether they qualify for hedge accounting.
SFAS 133, as amended by SFAS 137 and SFAS 138, is effective for fiscal years
beginning after June 15, 2000. The Company has not entered into derivatives
contracts either to hedge existing risks or for speculative purposes.
Accordingly, the Company does not expect adoption of the new standard to affect
its consolidated financial statements.

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

The following discussion of the financial condition and results of
operations of Blue Martini Software should be read in conjunction with the
Management's Discussion and Analysis of Financial Condition and Results of
Operations and the Consolidated Financial Statements and the Notes thereto
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2000. This quarterly report on Form 10-Q contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended
("Securities Act"), and Section 21E of the Securities Exchange Act of 1934
("Exchange Act"), as amended, including statements using terminology such as
"can," "may," "believe," "designated 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 the Company as of the date thereof, and the Company assumes no
obligation to update any forward-looking statement or risk factors.

Overview

Blue Martini Software competes in the external Customer Relationship
Management (eCRM) market and provides enterprise software applications and
services that enable companies to understand, target and interact with their
customers and business partners across multiple touch points, including
websites, mobile wireless devices, cellular phones, e-mail and online
marketplaces. Our products' analytic capabilities are designed to allow
companies to develop insights regarding customer behavior, and then use these
insights to provide customers with relevant products, content and offerings.

Blue Martini Software's comprehensive packaged applications are designed to
offer extensive capabilities out-of-the-box, enabling companies to implement
eCRM solutions quickly and accelerate their time to benefit. Our application
suite is designed to be business-user friendly, allowing non-technical employees
to manage the day-to-day online content, campaigns and programs. In addition,
our application suite is extensible, thereby allowing developers to create
differentiating capabilities.

Blue Martini Software's target customers include senior sales, marketing,
information technology and service executives in larger, established companies.
We primarily target our products to manufacturing, retail, financial services
and consumer goods industries. As of June 30, 2001, we had licensed our
application suite to more than 100 customers worldwide.

We recognize revenues in accordance with Statement of Position ("SOP")
97-2, Software Revenue Recognition, as modified by SOP 98-9. SOP 97-2, as
modified, generally requires revenue earned on software arrangements involving
multiple elements such as software products, upgrades, enhancements, post
contract customer support ("PCS"), installation, training, etc. to be allocated
to each element based on the relative fair values of the elements. The fair
value of an element must be based on evidence that is specific to the vendor. If
evidence of fair value does not exist for all elements of a license agreement
and PCS is the only undelivered element, then all revenues for the license
arrangement is recognized ratably over the term of the agreement. If evidence of
fair value of all undelivered elements exists but evidence does not exist for
one or more delivered elements, then revenue is recognized using the residual
method. Under the residual method, the fair value of the undelivered elements is
deferred, and the remaining portion of the arrangement fee is recognized as
revenue.

Our revenues are derived from the licensing of our application suite and
the sale of related services. The license agreement for our application suite
typically provides for an initial fee to use the software in perpetuity. License
revenues are recognized when persuasive evidence of an agreement exists,
delivery of the product has occurred, the fee is fixed or determinable and
collectibility is probable, assuming no significant future obligations or
customer acceptance rights exist. If an acceptance period is contractually
provided, revenues are recognized upon the earlier of customer acceptance or the
expiration of that period. In instances where delivery is electronic and all
other criteria for revenue recognition have been achieved, the product is
considered to have been delivered when the customer either takes possession by
downloading the software or the access code to download the software has been
provided to the customer. Payments received in advance of revenue recognition
are recorded as deferred revenues.

Services revenues are principally derived from consulting services,
technical support and training. Our maintenance agreements entitle customers to
receive software updates, maintenance releases and technical support.
Maintenance is typically paid in advance and the related revenues are deferred
and recognized ratably over the term of the maintenance contract, which is
typically one year. A majority of our customers use systems integrators to
implement our product. Consulting services and training are typically sold on a
time-and-materials basis and revenues from these services are recognized when
the services are performed and collectibility is deemed probable.

We market our application suite through a direct sales force. We also
engage in alliances with systems integrators and technology vendors to assist us
in marketing and selling our application suite and related services. While our
revenues to date have been derived principally from customers in the United
States, international revenues accounted for 33% and 26% of our revenues for the
three and six months ended June 30, 2001, respectively. For the three and six
months ended June 30, 2000, international revenues accounted for 20% of our
total revenues. We believe international revenues will represent a significant
portion of our total revenues in the future but may fluctuate as a percentage of
total revenues in the near term as we build out our international presence.
Although we have a limited operating history, we believe that our quarterly
operating results may experience seasonal fluctuations. For instance, quarterly
results may fluctuate based on our customers' fiscal year, 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. For the quarter ended June 30, 2001, sales to one customers
individually represented 20% of our total revenues while for the same period of
2000, one customer accounted for 13% while a second customer accounted 11% of
our total revenues. While we do not anticipate that any one customer will
represent more than 10% of total revenues in 2001, we do expect that a limited
number of customers will continue to account for a substantial portion of our
license revenues in a given quarter. As a result, if we lose a major customer or
if anticipated significant license contracts are delayed or cancelled, our
revenues and operating results in a particular quarterly period would be
adversely affected. In addition, customers that have accounted for significant
revenues in the past may not generate revenues in any future period. If we fail
to obtain a significant number of new customers or additional orders from
existing customers in any period, our business and operating results would be
harmed.

We believe our success requires expanding our customer base, growing our
relationships with consulting and system integrator partners and continuing to
enhance our application. There can be no assurance that we will be successful in
accomplishing any of these goals. We currently expect to continue to incur net
losses for the next several quarters. Our operating expenses are based in part
on our expectations of future revenues and are relatively 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 net losses in a given quarter being greater than expected.

Results of Operations

The following table presents selected financial data for the periods
indicated as a percentage of total revenues:

Three Months Ended Six Months Ended
June 30, June 30,
------------------------ -------------------------
2001 2000 2001 2000
---------- --------- --------- ---------

Revenues:
License ................................ 39 % 56 % 39 % 56 %
Service ................................ 61 44 61 44
------ ------ ------ ------
Total revenues ................... 100 100 100 100
------ ------ ------ ------
Cost of revenues:
License ................................ 8 5 7 5
Service ................................ 73 70 70 65
------ ------ ------ ------
Total cost of revenues ........... 81 75 77 70
------ ------ ------ ------
Gross profit ..................... 19 25 23 30
------ ------ ------ ------
Operating expenses:
Sales and marketing .................... 92 85 86 84
Research and development ............... 32 33 34 36
General and administrative ............. 32 36 33 31
Restructuring charges .................. - - 6 -
------ ------ ------ ------
Total operating expenses ......... 156 154 159 151
------ ------ ------ ------
Loss from operations ............. (137) (129) (136) (121)
Interest and other, net ................... 10 1 10 1
------ ------ ------ ------
Net loss ......................... (127) % (128)% (126) % (120) %
====== ====== ====== ======

Revenues

License. License revenues decreased from $8.4 million for the three months
ended June 30, 2000 to $6.0 million for the three months ended June 30, 2001.
For the six months ended June 30, 2001, license revenues decreased to $14.1
million from $14.5 million for the comparable period in 2000. The decreases in
license revenues for the three and six month periods ended June 30, 2001 as
compared to the comparable periods in 2000 were due to a decrease in software
licenses to new customers. We believe that current economic conditions have
resulted in decreased demand in our target markets, and in particular, we have
experienced an increase in the average length of our sales cycles as compared to
prior years. The future direction of the overall domestic and global economies
will have a significant impact on our overall performance. To the extent that
the current downturn continues or increases in severity, we believe demand for
our products and services, and therefore future revenues, will be reduced as
compared to prior periods.

Service. Service revenues increased from $6.6 million for the three months
ended June 30, 2000 to $9.6 million for the three months ended June 30, 2001.
For the six months ended June 30, 2001, service revenues increased to $22.1
million from $11.2 million for the comparable period in 2000. The increases in
service revenues for the three and six months ended June 30, 2001 as compared to
the same periods in 2000 were due to an increase in the number of consulting
service engagements and customer maintenance agreements. We expect that our
service revenues will fluctuate as a percentage of total revenues. Service
revenues are anticipated to decrease as a percentage of total revenues over the
long term as systems integrators and other professional services organizations
provide the consulting services, technical support and training that we
currently provide. A reduction in the number of application suite licenses to
new or existing customer will impact services and will result in lower revenues
from our customer training, consulting services and technical support
organizations. In the near term, we expect service revenues to decrease based on
the number of license contracts signed in the quarter ended June 30, 2001.

Cost of Revenues

License. Cost of license revenues consists of royalties payable to third
parties and amortization of purchased intangibles for software that is either
embedded in or bundled with our products. Cost of license revenues increased
from $751,000 for the three months ended June 30, 2000 to $1.2 million for the
three months ended June 30, 2001. These amounts represented 9% of license
revenues in 2000 and 20% in 2001. For the six months ended June 30, 2001, cost
of license revenues increased to $2.4 million from $1.3 million for the
comparable period in 2000. These amounts represented 17% and 9% of license
revenues for these periods. The increases for the three and six months ended
June 30, 2001 as compared to the same periods in 2000 were principally the
result of amortization of certain intangible assets acquired in December 2000.
We expect our license revenues will impact cost of license revenues in future
periods. To the extent license revenues increase, we expect cost of license
revenues to increase in absolute dollars but to decline slightly as a percentage
of license revenues as a result of royalty agreements that typically contain
declining royalty rates.

Service. Cost of service revenues consists primarily of salaries and other
personnel-related expenses, amortization of deferred stock compensation and
depreciation of equipment used to provide consulting services, technical support
and training. Cost of service revenues increased from $10.5 million for the
three months ended June 30, 2000 to $11.4 million for the three months ended
June 30, 2001. These amounts represented 159% of service revenues in 2000 and
119% in 2001. For the six months ended June 30, 2001, cost of service revenues
increased to $25.3 million from $16.7 million for the comparable period in 2000.
These amounts represented 115% of service revenues in 2001 and 149% in 2000. The
increase in absolute dollars for the three and six month periods ended June 30,
2001 as compared to the same periods in 2000 resulted from the expansion of our
consulting services, technical support and training organizations to support the
growth in new licenses, partially offset by a decrease in the amortization of
deferred stock compensation. 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.

Operating Expenses

Sales and Marketing. Sales and marketing expenses consist primarily of
costs of our direct sales and marketing personnel, amortization of deferred
stock compensation, as well as costs of marketing programs including trade
shows, advertisements, promotional activities and media events. Sales and
marketing expenses increased from $12.8 million for the three months ended June
30, 2000 to $14.3 million for the three months ended June 30, 2001. For the six
months ended June 30, 2001, marketing and sales expenses increased to $31.2
million from $21.4 million for the comparable period in 2000. The increases for
the three and six month periods ended June 30, 2001 as compared to the same
periods in 2000 were primarily attributable to an increase in sales and
marketing personnel expenses, increased amortization of stock warrants and
increased spending for marketing and advertising programs, partially offset by a
decrease in sales commissions and amortization of deferred stock compensation.

Research and Development. Research and development expenses consist
primarily of salaries and related expenses for engineering personnel,
amortization of deferred stock compensation, costs of contractors and
depreciation of equipment used in the development of our software product.
Research and development expenses increased from $4.9 million for the three
months ended June 30, 2000 to $5.0 million for the three months ended June 30,
2001. For the six months ended June 30, 2001, research and development expenses
increased to $12.4 million from $9.3 million for the comparable period in 2000.
The growth in expenses for the three and six months ended June 30, 2001 as
compared to the comparable periods in 2000 was primarily due to an increase in
personnel-related expenses resulting from the addition of engineering personnel
to support the development and enhancement of our products and an increase in
professional fees related to product development activities, partially offset by
a decrease in the amortization of deferred stock compensation. To date, we have
expensed all internal software development costs as incurred.

General and Administrative. General and administrative expenses include
costs associated with our finance, human resources, legal, information systems
and other administrative functions and consist principally of salaries and
related expenses, professional fees, amortization of deferred stock
compensation, provisions for doubtful accounts and equipment depreciation.
General and administrative expenses decreased from $5.4 million for the three
months ended June 30, 2000 to $5.0 million for the three months ended June 30,
2001. The decrease in general and administrative expenses for the three months
ended June 30, 2001 as compared to the comparable period in 2000 was
attributable to decreased amortization of deferred stock compensation and a
decrease in the provision for doubtful accounts, partially offset by an
increases in expenses for administrative personnel and professional fees. For
the six months ended June 30, 2001, general and administrative expenses
increased to $12.0 million from $7.9 million for the comparable period in 2000.
The growth in expenses for the six months ended June 30, 2001 as compared to the
comparable period in 2000 was attributable to increased amortization of deferred
stock compensation, personnel expenses and professional fees.

Restructuring charges. During the quarter ended March 31, 2001, the Company
initiated actions resulting in recognition of a $2.1 million restructuring
charge. This charge included $1.4 million for the cancellation of facility lease
contracts and $0.7 million for severance payments to employees involuntarily
terminated and the write-down of certain operating assets to be disposed of.
These restructuring actions resulted in the termination of approximately 60
employees.

Stock Compensation. Deferred stock compensation represents the difference
between the exercise price of stock option grants to employees and the deemed
fair value of our common stock at the time of those grants. We recorded deferred
stock compensation of $2.2 million for the period from inception to December 31,
1998, $10.4 million in 1999 and $50.6 million in 2000. We are amortizing
deferred stock compensation to expense over the period during which the stock
options vest, generally four years, using an accelerated method allowed by
generally accepted accounting principles. Such amortization amounted to $2.6
million and $7.6 for the three months ended June 30, 2001 and June 30, 2000,
respectively, and $9.6 million and $11.9 million for the six months ended June
30, 2001 and 2000, respectively. Amortization expense in the quarter ended June
30, 2001 was reduced by $2.6 million to reflect adjustments associated with
unvested options forfeited by terminated employees.

During the six months ended June 30, 2001 and the comparable period in
2000, we granted and immediately vested, stock options to non-employees. In
connection with these grants, we recorded non-cash compensation expense of
$56,000 and $1.4 million for the six months ended June 30, 2001 and the
comparable period in 2000. This reflects the fair value of these stock options
based on the Black-Scholes option-pricing model.

The amortization of deferred stock compensation, combined with the expense
associated with stock options granted to non-employees, relates to the following
items in the accompanying condensed consolidated statements of operations (in
thousands):

Three Months Ended Six Months Ended
June 30, June 30,
------------------------- ---------------------------
2001 2000 2001 2000
----------- ---------- ---------- ----------

Cost of revenues..................... $ 301 $ 1,991 $ 1,913 $ 3,094
Sales and marketing.................. 261 1,912 1,630 3,304
Research and development............. 67 1,206 1,255 3,373
General and administrative........... 1,981 2,472 4,850 3,571
--------- -------- -------- --------
$ 2,610 $ 7,581 $ 9,648 $ 13,342
========= ======== ======== ========

Amortization of deferred stock compensation is estimated to total $16.6
million for 2001, $7.7 million for 2002, $2.7 million for 2003 and $.2 million
for 2004. Amortization of deferred stock compensation will be reduced in future
periods to the extent options are terminated prior to being vesting.

Interest and Other, Net

Interest income and other, net consists of interest income from cash, cash
equivalents and available-for-sale short and long-term investments partially
offset by interest expense associated with capital leases, and foreign currency
transaction gains and losses. Interest income and other, net increased from
$79,000 for the three months ended June 30, 2000 to $1.5 million for the three
months June 30, 2001. For the six months ended June 30, 2001, interest income
and other, net increased to $3.8 million from $139,000 in the comparable period
in 2000. The increase was due primarily to higher balances of cash, cash
equivalents and short and long-term investments as a result of our initial
public offering in July 2000. Foreign currency transaction losses for the three
and six months ended June, 2001 were $197,000 and $233,000, respectively. For
the three and six months ended June 30, 2000, foreign currency transaction gains
and losses were immaterial.

Income Taxes

From inception to June 30, 2001, we incurred net losses for federal and
state tax purposes and have not recognized any tax provision or benefit. Because
of our limited operating history, our losses incurred to date and the difficulty
in accurately forecasting our future results, management does not believe that
the realization of the related deferred income tax asset meets the criteria
required by generally accepted accounting principles. Therefore, we have
recorded a 100% valuation allowance against the deferred income tax assets.

Liquidity and Capital Resources

As of June 30, 2001, we had cash, cash equivalents and short and long-term
investments of approximately $115.9 million.

For the six months ended June 30, 2001, net cash used in operating
activities was $32.3 million compared to $1.2 million in the comparable period
in 2000. Net cash used in operating activities for the first six months of 2001
and for the comparable period in 2000 was primarily the result of net losses of
$45.5 million and $30.9 million, respectively, which included restructuring
charges of $2.1 million in the first six months of 2001 and amortization of
deferred stock compensation, warrants and intangible assets of $11.4 million for
the first six months of 2001 and $14.1 million for the comparable period in
2000.

Net cash of $18.7 million was provided by investing activities for the six
months ended June 30, 2001 resulting from maturities of available-for-sale
investments, partially offset by cash used to purchase intangible assets and
computer hardware and software, office furniture and equipment. For the six
months ended June 30, 2000, net cash used for investing activities was $2.2
million and principally related to the purchase of short and long-term
investments, and to purchase computer hardware and software, office furniture
and equipment.

Net cash provided by financing activities was $2.9 million for the six
months ended June 30, 2001 and $2.7 million for the comparable period in 2000.
The cash provided by financing activities for the six months ended June 30, 2001
was principally related to proceeds from shares issued under our stock option
and employee stock purchase plans. The cash provided by financing activities for
the first six months of 2000 was principally related to the issuance of common
stock under our stock option plans.

Our liquidity, capital resources and results of operations in any period
could be impacted by the exercise of outstanding stock options and warrants. For
example, at June 30, 2001, we had outstanding options to purchase 13.7 million
shares of our common stock at a weighted average exercise price of $6.81 per
share, and had approximately 13 million additional shares reserved for future
grant under our stock option plans. In addition, we have issued warrants which
are now exercisable to purchase 2.4 million shares of common stock at an
weighted average exercise price of $4.94 per share Accordingly, our liquidity
and capital resources may be impacted in future periods by cash proceeds upon
exercise of these securities and from securities reserved for future issuance
under our stock option plans. In addition, our per share results of operations
could also be impacted by the increased number of outstanding shares. However,
we cannot predict the timing or amount of proceeds from the exercise of these
securities, if they are exercised at all.

We expect that for the foreseeable future, our operating expenses and
planned capital expenditures will constitute a significant use of our cash
balances. In addition, we may use cash to fund acquisitions or invest in other
businesses, technologies or product lines. We currently anticipate that our
existing cash and investments will be sufficient to meet our presently
anticipated working capital, capital expenditure and our operating requirements
for the next several quarters. However, we may require additional funds either
within this time period or at some future date. We may seek to raise these
additional funds through public or private debt or equity financing to meet
these additional working capital requirements. 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, our business and operating results could be
adversely affected. If we were to seek additional financing today, we do not
believe it would be available on reasonable terms.

Factors That May Impact Future Operating Results
- ------------------------------------------------

Our short operating history makes it difficult to evaluate our business and
prospects.

You must consider our business and prospects given the risks, expenses and
challenges we might encounter because we are at an early stage of development in
a new and rapidly evolving market. We were founded in June 1998 and licensed our
first software product in late March 1999, and our sales and service
organizations are new. Due to our short operating history, our future financial
performance is not predictable and may not meet analyst projections for revenues
or other operating results, thereby disappointing investors and resulting in a
significant decline in our stock price.

We have incurred losses during our operating history and expect losses to
continue for the foreseeable future and we may not achieve or maintain
profitability.

We have incurred net losses in each quarterly period since our inception.
As of June 30, 2001, we had an accumulated deficit of $120 million. We expect to
continue to incur losses on both a quarterly and annual basis for the
foreseeable future. Moreover, we expect to continue to incur significant sales
and marketing and research and development expenses. Further, we will incur
substantial stock compensation expense in future periods, which represents
non-cash charges incurred due to the issuance of stock options prior to the
closing of our initial public offering on July 28, 2000. Therefore, we will need
to significantly increase our revenues to achieve and maintain profitability. We
may not be able to generate sufficient revenues to achieve profitability.

The current economic downturn has significantly impacted demand for our products
and services and may adversely impact future revenues.

The majority of our revenues has been and is expected to continue to be
derived from customers in the United States. Recent economic indicators,
including growth in gross domestic product, reflect a decline in economic
activity in the United States. Some reports have indicated an even more
significant decline in spending by corporations in the area of information
technology, which includes the eCRM market. Because current conditions in the
domestic and global economies are extremely uncertain, it is difficult to
estimate the level of growth for the economy as a whole. It is even more
difficult to correlate the impact of macro-economic conditions on our sales
activities. We believe that current economic conditions have caused decreased
demand in our target markets, and in particular, have increased the average
length of our sales cycles.

Because our budgeting and forecasting are dependent upon estimates of
revenue growth in the markets we target, the prevailing economic uncertainty
renders estimates of anticipated license contract signings and future revenues
difficult to make. The future performance of the overall domestic and global
economies will have a significant impact on our overall performance. To the
extent that the current downturn continues or increases in severity, or results
in a similar downturn worldwide, we believe demand for our products and
services, and therefore future revenues, could be further reduced.

Our product has a long and variable sales cycle, which makes it difficult to
predict our future results 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 the six-month period ended June 30, 2001. Despite engaging
with a number of customer prospects during the quarter ended June 30, 2001, we
continued to see the extended sales cycles and postponed customer IT spending
that was also prevalent in the first quarter of 2001. To the extent that there
continues to be economic uncertainty or perceived uncertainty in global
economies, we believe our operating results could be materially and adversely
affected.

The period between initial contact with a prospective customer and the
licensing of our application suite varies and can range from three to twelve
months. The timing of revenues from the licensing of our application suite is
difficult to forecast for a variety of reasons, including the following factors:

. A significant portion of our license agreements are completed within
the last few weeks of each quarter. Recently, this pattern has become
more pronounced, and as a result, any revenue shortfalls for a
quarterly period may not be known until late in the quarter;

. Our sales cycle is long and complex as customers consider a number of
factors before committing to purchase our application suite. Factors
considered by customers when evaluating our application suite include
product benefits, cost and time of implementation, ability to operate
with existing and future computer systems and the ability to
accommodate increased transaction volume and product reliability. As a
result, we spend significant time and resources informing prospective
customers about our application suite, which may not result in a
completed transaction and impact our operating margins;

. Because the licensing of our application suite is often an
enterprise-wide decision by our customers that involves many factors,
our ability to license our product may be impacted by changes in the
strategic importance of eCRM projects to our customers, budgetary
constraints or changes in customer management;

. The contract value of individual license agreements can vary
significantly, therefore, delays in the signing of one or more large
license agreements or the loss of a significant customer order could
have a material impact on our revenues and results of operations
because a substantial portion of our quarterly revenues are derived
from a small number of customers;

. The existence or even the anticipation by potential customers of
economic downturns in the markets in which we operate has in the
quarter ended June 30, 2001 and may continue in future periods to
decrease the demand for our applications, cause pricing pressures for
our products and substantially reduce our sales activity. As a result
of these macroeconomic conditions, customers have during the quarter
ended June 30, 2001 and may continue in future periods to unexpectedly
postpone or cancel planned eCRM projects, including the evaluation and
purchase of new applications or upgrades to existing applications;

. Customer evaluation, purchasing and budgeting processes vary
significantly from company to company, and a customer's internal
approval and expenditure authorization process can be difficult and
time consuming. Delays on approvals, even after selection of a vendor,
could impact the timing and amount of revenues recognized in a
quarterly period;

. Changes in our sales incentive plans may have an unpredictable impact
on our sales cycle and contracting activities; and

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

Several factors may require us to defer recognition of license revenue for
a significant period of time after entering into a license agreement, including
instances where we are required to deliver either unspecified additional
products or specified upgrades for which we do not have
vendor-specific-objective-evidence of fair value. While we have a standard
software license agreement that provides for revenue recognition provided that
delivery has taken place, collectibility from the customer is probable and
assuming no significant future obligations or customer acceptance rights exist,
customer negotiations and revisions to these terms could impact our ability to
recognize revenues at the time of delivery. Also, the additional time needed to
negotiate mutually acceptable terms that culminate in an agreement to license
our application suite could also extend the sale cycle.

Slowdowns or variances from internal expectations in our quarterly license
contracting activities may impact our service offerings and may result in lower
revenues from our customer training, consulting services and technical support
organizations. Our ability to maintain or increase service revenues is highly
dependent on our ability to increase the number of license agreements we enter
into with customers.

Because our operating expenses are based on our expectations for future
revenues and are relatively fixed in the short term, any revenue shortfall below
expectations could have an immediate and significant adverse effect on our
consolidated results of operations and financial condition.

Recent cost-reduction efforts may not result in anticipated savings and may
adversely impact our productivity and service level .

In March and July of 2001, we announced reductions in our workforce of
approximately 13% and 25%, respectively, and instituted various cost control
measures. These cost control efforts involve various aspects of our business
operations. The failure to achieve these cost savings could have a material
adverse effect or our financial condition. Moreover, even if we are successful
with these efforts and generate the anticipated cost savings, there can be no
assurance that these actions will not adversely impact our productivity and
adversely impact our business and results of operations.

Because a small number of customers have accounted, and are likely to continue
to account, for a substantial portion of our revenues, our revenues could
decline due to the loss or delay of a single customer order.

A relatively small number of customers account for a significant portion of
our total quarterly revenues. The loss or delay of individual orders could have
a significant impact on revenues and operating results. One customer accounted
for 20% of our revenues for the three-month period ended June 30, 2001, while in
the same period of 2000, two customers accounted for 24% of our total revenues.
We expect that revenues from a limited number of new customers will continue to
account for a large percentage of total revenues in future periods. Our ability
to attract new customers will depend on a variety of factors, including the
performance, quality, breadth, depth and price of our current and future
products. Our failure to add new customers that make significant licenses of our
application suite and services would reduce our future revenues.

We record as deferred revenues payments from customers that do not meet our
revenue recognition policy requirements. Since some of our quarterly revenues
are recognized from deferred revenues, our quarterly results will depend
primarily upon entering into new agreements to generate revenues for that
quarter. New agreements may not result in revenues in the quarter in which the
agreement was signed and commissions and royalties may become payable, and we
may not be able to predict accurately when revenues from these agreements will
be recognized. Similarly, declines in deferred revenues from prior quarters may
disappoint investors and could result in a significant decline in our stock
price. We expect the level of our deferred revenues to fluctuate in future
periods.

All of our revenues to date have been derived from the licensing of our
application suite and the sale of related services, and if we fail to
successfully upgrade or enhance our application suite and introduce new
products, our revenues would decline.

All of our revenues to date have been derived from the licensing of our
application suite and the sale of related services. For the six months ended
June 30, 2001, 39% of our total revenues were derived from the licensing of our
application suite as compared to 56% in the same period of 2000. Since
introducing our products in March 1999, license revenues have accounted for 53%
of our total revenues. The decrease in the percentage of revenues derived from
license sales for the six months ended June 30, 2001 resulted primarily from a
decrease in the license sales when compared to the same period ended June 30,
2000 and the increases in service revenues for the same period. Our future
revenues will depend, in significant part, on our successful development and
license of new and enhanced versions of our application suite and of other new
products. If we are not able to successfully develop new products or these new
products do not achieve market acceptance, our revenues would be reduced.

We are the target of several securities class action complaints and are at risk
of securities class action litigation, which could result in substantial costs
and divert management attention and resources.

During July 2001, several securities class action complaints were filed
against the underwriters of the Company's initial public offering, the Company,
its directors and certain of its officers in the United States District Court
for the Southern District of New York. The complaint alleges that the
underwriters entered into certain arrangements with investors in connection with
our initial public offering, and that these alleged arrangements should have
been and were not disclosed in the registration statement and prospectus. The
complaints seek unspecified monetary damages and attorneys fees and other costs.
We expect that these cases will be consolidated into a single case. The Company
believes that it has meritorious defenses against the lawsuits and intends to
defend itself vigorously.

In addition, in the past, other types of securities class action litigation
have been brought against companies following a decline in the market price of
their securities. This risk is especially acute for us because technology
companies have experienced greater than average stock price volatility in recent
years, particularly since mid-2000 and, as a result, technology companies have
been subject to a greater number of securities class action claims than
companies in other industries. We may in the future be the target of additional
securities class action litigation. Securities litigation could result in
substantial costs and divert management's attention and resources, which could
harm our business.

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. 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
the products and services of other companies or to their own products. 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 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 these 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 delays in our ability to recognize
revenue and higher expenses.

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 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 by only a limited number of
customers and, therefore, we cannot assure you 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, it could damage our reputation and reduce our revenues.

If our product does not operate with a wide variety of hardware, software and
operating systems used by our 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 only gain broad market acceptance if it can support a wide variety of
hardware, software applications and systems. If our product is unable to support
a variety of these products, our revenues would be harmed. Our business depends
on the following factors, among others:

. our ability to integrate our application suite with multiple hardware
systems and existing software systems and to modify our product as new
versions of packaged applications are introduced;

. our ability to anticipate and support new standards, especially
Internet-based standards; and

. our ability to integrate additional software modules under development
with our existing application suite.

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.

We have in the past discovered software errors and performance problems
with our application suite after commencement of commercial shipment, 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 result in damage to the businesses of
our customers. 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, both of which could disappoint investors and result in a significant
decline in our stock price. 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.

If we fail to introduce new versions and releases 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 could fail to increase our revenues. Our future
operating results will depend on demand for our application suite, including new
and enhanced releases that are subsequently introduced.

We may not successfully enter international markets or generate significant
revenues abroad, which could result in slower revenue growth and harm our
business.

To date, we have generated limited revenues from sales outside the United
States. We have established sales offices in the United Kingdom, Canada,
Germany, Sweden, France, Netherlands, Italy, Hong Kong, Singapore, Japan and
Australia. If we fail to license our application suite in international markets,
we could experience slower revenue growth and our business could be harmed. We
anticipate devoting significant resources and management attention to expanding
international opportunities. Expanding internationally subjects us to a number
of risks, including:

. greater difficulty in staffing and managing foreign operations;

. expenses associated with foreign operations and compliance with
applicable laws;

. changes in a specific country's or region's political or economic
conditions;

. expenses associated with localizing our product for foreign countries;

. differing intellectual property rights;

. protectionist laws and business practices that favor local
competitors;

. longer 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.

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

If we are unable to hire or retain qualified personnel, or if newly hired
personnel fail to develop the necessary skills or to reach expected levels of
productivity, our ability to develop and market our application suite will be
weakened. Our success also depends on the continued contributions of our key
management, engineering, sales and marketing and professional services
personnel. In particular, Monte Zweben, our Chairman, President 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 are able to target prospective
customers' senior management, and who can generate and service large accounts.
There is a shortage of qualified sales personnel in our industry and competition
for them is intense.

Failure of our prospective technology customers to receive necessary funding
could harm our business.

Our customers include rapidly growing technology companies. Most privately
and publicly held technology companies require outside cash sources to continue
operations. Recently, funding has been less available for technology companies
as a result of the stock market decline and public and private investor concern
regarding technology-based businesses. These factors have reduced demand for our
application suite from technology-based customers and reduced demand for
additional services from current technology-based customers. Failure by existing
customers in this industry to receive or generate adequate funding has and may
continue to result in provisions for uncollectible accounts receivable from such
companies.

Increasing government regulation of the Internet, imposition of sales and other
taxes on products sold by our customers over the Internet and privacy concerns
relating to the Internet could reduce the license of our application suite and
harm our business.

Federal, state or foreign agencies may adopt laws or regulations affecting
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 2002, 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.

If we are unable to meet rapid changes in technology, our existing application
suite could become obsolete.

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. 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. 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. Any delays in developing and releasing enhanced
or new products could harm our business.

We have no issued patents. 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 combination of trade secret, copyright,
trademark and patent laws, as well as confidentiality procedures and contractual
restrictions.

We have no issued patents. We presently 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. 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.

It is possible that 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 our without merit, could be costly and
time-consuming to defend, divert our management's attention or cause product
delays. We have no patents 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 acceptable to us, if at all, which could
harm our business.

Rising energy costs and power system shortages in California may result in
increased operating expenses and reduced net income, and harm our operations due
to power loss.

California is currently experiencing an energy crisis and has recently
experienced significant power shortages. As a result, energy costs in
California, including natural gas and electricity, may rise significantly over
the next year. Because our principal operating facilities are located in
California, our operating expenses may increase significantly if this trend
continues. In addition, California has on some occasions implemented, and may in
the future continue to implement, rolling blackouts throughout the state. If
blackouts interrupt our power supply, we may be temporarily unable to operate.
Any such interruption in our ability to continue operations could delay the
development, marketing and sale of our application suite. Future interruptions
could damage our reputation, harm our ability to retain existing customers and
to obtain new customers, and could result in lost revenue, any of which could
have an adverse effect on our operating results.

Our directors and executive officers maintain significant control over Blue
Martini Software, which may lead to conflicts with other stockholders over
corporate governance.

Our directors, executive officers and holders of 5% or more of our
outstanding common stock beneficially owned approximately 56.9% of our
outstanding common stock as of July 13, 2001. Monte Zweben, our Chairman,
President and Chief Executive Officer, together with related entities,
beneficially owned approximately 39.4% of our common stock as of this date.
These stockholders, acting together, and Mr. Zweben, 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.

Intangible asset risk

We have approximately $4.8 million of intangible assets. At June 30, 2001
we believe our intangible assets are recoverable. However, changes in the
economy, the business in which we operate and our own relative performance could
change the assumptions used to evaluate intangible asset recoverability. We
continue to monitor those assumptions and their effect on the estimated
recoverability of our intangible assets.

There may be sales of a substantial amount of our common stock in the near
future that could cause our stock price to fall.

Some of our current stockholders hold a substantial number of shares, which
they are able to sell in the public market, subject to restrictions under the
Securities Act. Sales of a substantial number of shares of our common stock
within a short period of time could cause our stock price to fall. In addition,
the sale of these shares could impair our ability to raise capital through the
sale of additional stock.

We have implemented anti-takeover provisions that could discourage or prevent a
takeover, even if an acquisition would be beneficial to our stockholders.

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, even if doing so would be beneficial to our
stockholders. These provisions include:

. establishment of a classified board of directors requiring 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.

Recent Accounting Pronouncements

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency Exchange Rate Risk

Through June 30, 2001, the majority of our recognized revenues have been
denominated in United States dollars and were from both domestic and
international customers. Our exposure to foreign currency exchange rate changes
has been immaterial. 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 June 30, 2001, we have expanded our
international operations and have hired personnel in Europe and Asia Pacific. We
have incurred 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. We expect to continue to engage in international sales
denominated in United States dollars. 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 cannot assure you that exchange rate fluctuations will not adversely affect
our financial results in the future. Through June 30, 2001, the Company had not
engaged in foreign currency hedging activities.

Interest Rate Risk

Our exposure to financial market risk, including changes in interest rates,
relates primarily to our investment portfolio. We typically do not attempt to
reduce or eliminate our market exposure on our investment securities because a
substantial majority of our investments are in fixed rate securities with
maturities not exceeding 18 months. We do not invest in any derivative
instruments. The fair value of our investment portfolio or related income would
not be significantly impacted by either a 100 basis point increase or decrease
in interest rates due mainly to the relatively short-term nature of our
available-for-sale investment portfolio.

PART II. OTHER INFORMATION
- ---------------------------

Item 1. Legal proceedings

In July 2001, a class action complaint was filed in the U.S. District Court
for the Southern District of New York. The complaint asserts claims under the
Securities Act and the Exchange Act against the underwriters of the Company's
initial public offering, the Company, its directors and certain of its officers.
The complaint alleges that the underwriters entered into certain arrangements
with investors in connection with the Company's initial public offering, and
that these alleged arrangements should have been and were not disclosed in the
registration statement and prospectus. The complaint seeks unspecified monetary
damages and attorneys' fees and other costs. Since the filing of the complaint,
press releases have indicated that a number of similar complaints have been
filed on behalf of various plaintiffs. The Company expects that these cases will
be consolidated with the first action into a single case. The Company believes
that it has meritorious defenses against the lawsuits and intends to defend
itself vigorously.

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

The Company's annual meeting of stockholders was held on June 7, 2001 (the
"Annual Meeting"). The following matters were considered and voted upon at the
Annual Meeting:

(a) To elect two directors, A. Michael Spence and Andrew W. Verhalen to
hold office until the 2004 annual meeting of stockholders. The votes
cast and withheld for such nominees were as follows:

Votes For Votes Withheld
--------- --------------

A. Michael Spence................ 66,023,753 140,169
Andrew W. Verhalen............... 66,111,592 52,330

Directors continuing in office until the 2002 Annual Meeting:

Edward H. Vick
William F. Zuendt

Directors continuing in office until the 2003 Annual Meeting:

James C. Gaither
Monte Zweben

(b) To ratify the selection of KPMG LLP as independent accountants for the
Company for the year ended December 31, 2001. Shares voting:

For.............................. 66,068,881
Against.......................... 49,031
Withheld......................... 46,010
Broker non-vote.................. --

Based on these voting results, each of the directors nominated was elected
and the second matter was approved.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

The following exhibits are filed herewith:

Exhibit
Number Description
------ -----------
3.1 Amended and Restated Certificate of Incorporation of the
Registrant. /1/
3.2 Amended and Restated Bylaws of the Registrant. /2/
4.1 Specimen Stock Certificate. /3/
10.1 2000 Equity Incentive Plan, as amended. /4/
10.2 2000 Employee Stock Purchase Plan, as amended. /4/

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

/1/ Incorporated by reference to the Registrant's Form 10-Q for the six-month
period ended June 30, 2000.

/2/ Incorporated by reference to the Registrant's Registration Statement on
Form S-8 (No. 333-55374).

/3/ Incorporated by reference to the Registrant's Registration Statement on
Form S-1 (No. 333-36062), as amended.

/4/ Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 2000.

(b) Reports on Form 8-K

No reports on Form 8-K were filed during the quarter ended June 30,
2001.

SIGNATURES

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

Dated: August 10, 2001

BLUE MARTINI SOFTWARE, INC.
(Registrant)

/S/ Monte Zweben
----------------------
Monte Zweben
Chairman, President and Chief Executive Officer

/S/ John E. Calonico, Jr.
-------------------------
John E. Calonico, Jr.
Vice President and Chief Financial Officer
(Principal Financial Accounting Officer)