Back to GetFilings.com

Table of Contents

UNITED STATES OF AMERICA

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the year ended October 31, 2004

OR

Commission file number: 0-29757

VERSATA, INC.

(Exact name of registrant as specified in its charter)

300 Lakeside Drive Suite 1300 Oakland, CA 94612 (510) 238-4100

(Address including zip code, of principal executive offices and

Registrant’s telephone number including area code)

Securities registered pursuant to Section 12(b) of the Act:

None

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

Common Stock, $0.001 par value

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.  ¨

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 voting stock held by non-affiliates of the registrant as of April 30, 2004, was $11,823,216 based on the last reported sale price of the registrant’s common stock as reported by the NASDAQ National Market for the last trading day prior to that date.

On January 10, 2005, 8,201,752 shares of the registrant’s common stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive proxy statement relating to its 2005 annual stockholders’ meeting to be held on May 25, 2005 are incorporated by reference into Part III of this annual report on Form 10-K.

Table of Contents

VERSATA, INC.

FORM 10-K

For The Year Ended October 31, 2004

TABLE OF CONTENTS

2

Table of Contents

FORWARD-LOOKING STATEMENTS

In addition to historical information, this report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties and are based on the beliefs and assumptions of our management, based on the information currently available to our management. These statements may contain words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” or other words indicating future results. Forward-looking statements in this release include without limitation, statements regarding the Company’s market opportunity; timing for the release of new products, product and marketing strategy; extending the Company’s technology leadership; continuing to grow the Company’s multi-channel distribution network; and leveraging technology alliances.

These statements are based on judgments with respect to, among other things, information available to us, future economic, competitive and market conditions and future business decisions. All are difficult or impossible to predict accurately and many of which are beyond our control. Accordingly, although we believe that the assumptions underlying the forward-looking statements are reasonable, any such assumption could prove to be inaccurate and therefore there can be no assurance that the results contemplated in the forward-looking statements will be realized. Factors that could cause or contribute to these differences include, but are not limited to, any unforeseen technical difficulties related to the Company’s products; elimination or lack of market interest in Company’s current or future products or services; inability to continue to develop competitive new products and services on a timely basis; introduction of new products or services by major competitors; lack of market acceptance in or interest in Company’s future strategy; and those risks discussed in the sections entitled “Business Risk Factors That May Affect Future Results” (Item 1) and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (Item 7). In light of significant uncertainties inherent in forward looking information included in this report on Form 10-K, the inclusion of this information should not be regarded as a representation that our plans and objectives will be achieved. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on the forward-looking statements.

3

Table of Contents

PART I

Overview

Versata, Inc. (Nasdaq: VATA), (“Versata” or the “Company”) was incorporated in California on August 27, 1991, and was reincorporated in the State of Delaware on February 24, 2000. Versata provides a way for companies to define and manage the business logic in their software systems at the business level rather than the system code level. This currently includes support for a company’s process and transaction business logic. Over the coming year, Versata plans to introduce additional support for decision logic and data mapping logic. The result is expected to be an integrated solution for all the logic components driving a company’s business systems.

Versata’s products are currently optimized for the building, maintenance and ongoing evolution of large, complex, data-intensive enterprise applications. These applications typically access multiple data sources, incorporate multiple database tables and user interfaces, execute very complex business transactions and support thousands of users. The Versata solution replaces time-intensive hand-coding efforts with simple, intuitive business rules definition and graphical process flow specification. Over the coming year, the Company plans to enhance its products to also support the development of end-user oriented decision support applications.

While Versata is confident that there is a continuing opportunity for its technology in its core market of application development products, it also believes that there may be a valuable additional opportunity in the emerging and related area of master data management. Master data management concerns the management of highly valuable corporate data that is shared across multiple business systems and used in support of business processes and transactions throughout the enterprise. Examples of master data would include customer data, product data, pricing data and other data types that vary from one industry to the next. Management of such data requires the specification and enforcement of business rules and business logic that ensure complete, consistent and accurate shared corporate data across all business systems within the enterprise.

Versata markets its products primarily through a direct sales force in North America and in Europe. The Company’s internal team is supported by a network of consulting and systems integration partners, companies selling pre-packaged software applications, and companies selling software applications over the Internet on a subscription basis.

Versata also offers comprehensive professional services such as ROI analysis, training, staff augmentation and project management as well as complete turnkey solution services and comprehensive customer support.

Versata Solutions

Versata offers a new, better choice for IT organizations struggling to decide whether to build or buy the enterprise software applications needed to manage their business. The Company’s proven solutions use business rules to abstract the most difficult hand-coding required to create new software. This approach combines the time-to-market strengths of packaged enterprise applications and the competitive differentiation of custom software, all while eliminating the drawbacks of both approaches. Through this innovation, the Company’s technology helps customers in the financial services, insurance, telecom, manufacturing and other fast-paced industries continually adapt to remain competitive. Other specific benefits of the Versata solutions include:

Efficient Application Creation With Business Rules

Versata dramatically simplifies how corporations build and manage their software systems, and enables continuous adaptation of those systems through business rules. Versata business rules define the fundamental behavior required of a business system, otherwise known as business logic, in an easy-to-understand declarative language. This allows data-intensive enterprise systems to be created significantly faster and for far less cost than would otherwise be required when using experienced programmers to do the work by hand. Moreover, as

4

Table of Contents

business conditions change, system modifications are no more difficult than changing the rules. In effect, the Company’s technology replaces time-intensive hand-coding by automatically compiling rules into reusable components that capture up to 95 percent of the business and process logic used in transactional systems.

Continuous Improvement Through Adaptive Enterprise Systems

Versata’s platform lets IT organizations create adaptive, real-time transaction processing, workflow and master data management systems. This allows organizations to respond immediately to sudden business process or policy changes. While other approaches could take days or weeks, Versata’s business-rules approach allows changes to be implemented in just hours. This technical breakthrough enables critical business systems to be continually adapted as market conditions change. As a result, Versata affords its customers the potential to be leaders in customer service within their respective industries in customer service, to achieve regulatory compliance and derive competitive differentiation.

New Master Data Management Capabilities

Versata business rules are ideal for unifying the inconsistent versions of common customer, product, pricing and security data that hinder the value of today’s integrated business applications. Versata master data management results in improved customer service and lower operational costs by eliminating the inefficiencies created by inconsistent records across different business applications. It also helps customers grow revenue through cross- and up-selling opportunities, and by rapidly achieving regulatory compliance. The Versata solution ensures master data consistency on a transaction-by-transaction basis, at the instant each piece of information is touched. And when new business processes or policies require complex modifications to the system, customers can implement them in hours through a single Versata business rules console, creating a key advantage over competitors who struggle for months to recode their own distributed applications. For example, within IBM there are a variety of customer information systems sharing master customer data. IBM has layered a master data management platform across these systems to manage and synchronize the information. This platform was built and is continuously adapted using current Versata tools. It affords IBM the ability to meet the rigorous demands of its business, as well as regulatory requirements. Two large banking institutions are also now working with Versata on a similar master data management solution.

Industrial Strength Transaction Processing

Versata business rules are designed for high performance and scalability, including a demonstrated 750,000 transactions and 2.25 million calls per day to the back-end IBM mainframe systems at British Telecom. This approach has also been adopted by many large and complex transactional applications, including those at CGI-AMS, Equifax, DaimlerChrysler, the U.S. Department of Labor, and Union Bank of California.

Business Strategy

The value of rapid development has been Versata’s primary message since inception. However, there have always been two key components to the Company’s product value proposition. The first is in application construction—specifically, faster and more cost-effective time to deployment for new applications created using Versata tools. The second component is in the area of application configuration and maintenance—specifically, the ability to quickly and easily configure applications at the time of deployment as well as to continuously adapt them at any point during the enterprise lifecycle.

Application Development

Versata believes that there is a strong ongoing opportunity for the Company in the application development market, particularly as it looks at introducing new platform capabilities like support for end-user configurable decision rules, support for declarative data model mapping, and support for rules auditing that would allow customers to easily create auditable applications supporting compliance requirements. However, Versata also

5

Table of Contents

believes that there may be a significant business opportunity in delivering value-added solutions that are both easily configurable and can be continuously adapted to meet changing business conditions and regulatory pressures. A good example of this is in the area of master data management.

Master Data Management

Versata has a unique opportunity to provide a configurable and adaptable master data management platform. Using business rules and intelligent automation, this platform can be configured and continuously adapted to implement proprietary company policies, as well as regulatory and compliance requirements.

Based on existing customer experience, Versata believes that the development of enterprise master data management systems will likely follow the same development process as that used for traditional application development: business analysts define the business rules required to properly operate on and maintain the shared master data; rules are then used by programmers to draw models, sketch out pseudo-code, and write programs that are intended to meet the original specifications; programs are then integrated with the rest of the company’s infrastructure resources and deployed to a production environment. With Versata, the programming step is eliminated. Business analysts specify the business logic, which is then directly executed by the Versata runtime product, the Versata Logic Server. This simplification enables companies to react faster to business demands by developing applications and data management solutions more efficiently, with an enhanced ability to change these solutions as business needs change.

Versata believes that its rules technology coupled with its existing customer experience gives it a competitive advantage in the areas of application development and master data management. However, the Company expects to continue innovating. During 2005, Versata plans to introduce additional types of business rules technologies, including decision rules, data integration rules and data transformation rules. These capabilities are expected to enhance the ability of customers to solve increasingly complex application development challenges, and bring further productivity to master data management projects using Versata.

Products

To meet its goal of helping developers operate at the business level rather than the system code level, Versata sells and supports products that facilitate the creation and ongoing management of large-scale, data- and transaction-intensive applications using declarative business rules. These products include: the Versata Logic Server, the Versata Studio, the Versata Process Logic Engine, and the Versata Business Activity Monitoring Dashboard.

6

Table of Contents

Current Products

7

Table of Contents

Although the Company intends to release Versata 6 and the Versata BAM Dashboard v2.0 with the functionalities described herein, there can be no assurance that these products will be released in a timely manner. Nor can it be guaranteed that each product will perform as described here.

Customers

During the fiscal year ended October 31, 2004, Versata licensed its products worldwide for use in a wide range of software applications in diverse markets such as financial services, health care, government, insurance, logistics, manufacturing, retail and telecommunications. New customers in 2004 included companies such as Cendant Corporation, Costaisa and GAD eG. In addition, several existing customers purchased additional software licenses, many because they moved their Versata-powered applications from development into production. Notable among the Company’s list of repeat customers during 2004 were British Telecom, CGI-AMS, Equifax, IBM, JPMorganChase, Merrill Lynch, the State of Utah and the U.S. Department of Labor.

The following are examples of the use of Versata’s products by selected new and repeat customers during the fiscal year ended October 31, 2004:

For the 2004 fiscal year, GAD eG accounted for approximately 14% of total Versata revenues. For the 2003 fiscal year, Fidelity (formerly FNIS) accounted for approximately 19% of total Versata revenues and CGI-AMS accounted for approximately 14% of total revenues. Fidelity accounted for approximately 14% of total revenues for the 2002 fiscal year.

Alliances

JBoss

JBoss, an open source software provider, and Versata entered into an agreement in May 2004 to provide full support for the JBoss Application Server in current and future versions of Versata products. In July 2004, Versata began shipping products for use with the JBoss Application Server.

8

Table of Contents

IBM

In August 2004, Versata joined IBM’s ISV Advantage initiative, which provides technical and marketing support to the Company to help meet the specific needs of small and medium-sized IBM business customers. In addition, IBM has named Versata a premier business partner, which gives the Company the authority to use the “IBM Premier Business Partner” designation and logo in all sales and marketing outreach.

Oracle

Oracle, the leader in database technology, provides database and other infrastructure technology that is utilized by Versata and Versata’s customers. In order to support the development, maintenance and sale of Versata products to Oracle customers, Versata joined the Oracle Partner Network. As a member of the Partner Network, Versata receives access to Oracle products for development and testing as well as other marketing benefits such as the use of Oracle Partner logos. A large number of the Company’s customers use Versata tools to build applications for Oracle databases.

BEA Systems

BEA Systems, one of the world’s leading e-business infrastructure software companies, has had an alliance partnership with Versata since 2000. Many of BEA’s largest customers are running Versata applications on BEA technology, including British Telecom and Merrill Lynch. As a Star Alliance Partner, Versata has access to BEA software, support and marketing resources to ensure that Versata and BEA products work together to address customer needs.

Competition

Application Development Market

The application development market is intensely competitive, subject to technological changes and affected by new product introductions and other marketing activities engaged in by industry participants. Versata expects the competition in this industry to persist and intensify as the market continues consolidating. Versata’s primary competition comes from companies developing their software applications internally using traditional programming approaches. However, the Company also competes with a number of other entities:

Versata has identified the principal competitive factors in the application development market as:

9

Table of Contents

Master Data Management Market

In contrast, Versata believes that the master data management arena is an emerging opportunity area with few competitors. However, industry analysts such as Meta Group, Tower Group and Gartner predict that known industry leaders and several smaller software companies will begin to innovate and deliver master data management offerings. Some of the potential competitors in this market segment will likely include Chordiant, DWL, SAP, Siebel and Soliton.

General competitive issues

In addition, the following factors affect Versata’s competitiveness in all markets in which it participates:

Services

An important component of Versata’s overall solution is its ability to provide customers with comprehensive professional services—from training, advice and mentoring, customer support, staff augmentation and rapid requirements development to complete turnkey development and deployment services. Through this comprehensive suite of offerings, Versata helps its customers rapidly respond to changing market conditions without facing internal staffing constraints. Versata’s services organization consists of staff consultants and technical support personnel. The Company can also engage a variety of system integration partners and independent contractors to augment its service offerings.

Consulting Services

Versata consulting services offer insight into the realities of complex transaction and process-based business application development. The Company’s services include system architecture, data modeling, system design, software application development, testing, configuration, installation, quality assurance, risk assessment and performance tuning. Versata also provides project management services to assist customers in developing and deploying large enterprise applications with multiple data sources, multiple database tables, and multiple user interfaces. The Company also offers complete turnkey services whereby Versata professionals and consulting partners deliver complete customized solutions. These services can be provided on-site or via remote electronic connection, offering a balance between personal interaction and speed of responsiveness. Many Versata customers have sought the expertise of Versata consultants during 2004.

Advisory Services

The Versata advisory services program is a rapid-response mechanism for customers with challenging development tasks and who would prefer hands-on help. Advisory services are provided by highly experienced application design and development professionals, any of whom can be obtained on an hourly or per-task basis. Customers can turn to advisory services when they have a specific “how to” question related to their application development or deployment projects.

Training Services

Versata offers its customers introductory and advanced training in the use of its products. These training services are offered in several geographic locations, either as standard public training classes located throughout the U.S. and Europe or on-site private training classes. Versata prices these services per course or on a per-day basis.

10

Table of Contents

Customer Support

Versata believes that a high level of customer service and support is essential to its success. The Company offers a range of customer support services including (i) daily Web, telephone, and e-mail support from its United States, Canada, Australia, Germany and United Kingdom facilities during business hours, (ii) 24-hour-a-day/seven-day-a-week production system support, (iii) 24-hour-a-day/seven-day-a-week self-service support through the Company’s online case tracking system, developer knowledge base and discussion groups, and electronic software delivery system, (iv) “how-to” support through the advisory services group and (v) on-site support upon request. The Company’s customers typically purchase annual maintenance and support contracts at prices dependent upon their desired level of service.

Services Partners

In addition to Versata’s internal services organization, the Company has relationships with resellers, professional service organizations and global system integrators that offer consulting, training and customer support services. These partners include IBM Global Services, Online Business Systems, and Capgemini. Versata’s service partners are encouraged to attend and complete a series of Versata training courses.

Sales and Marketing

Sales

Versata markets its products primarily through a direct sales force in North America and in Europe. As of December 31, 2004, Versata’s direct sales organization consisted of 12 professionals throughout North America and Europe.

Versata utilizes teams consisting of both sales and technical professionals to create organization- and need-specific proposals, presentations and demonstrations for each prospect. When competitively pitching for new business, the Company often delivers a proof of concept and/or an ROI analysis. In many of these engagements, the tangible results of Versata’s proof of concept and/or ROI analysis substantiate the ease-of-use and time-to-market advantages of the Versata platform.

Versata complements its direct sales force with channel sales through various types of relationships that either sell, or help sell, products and services. These relationships include:

Marketing

Versata supports its sales efforts through a variety of marketing initiatives implemented by both its corporate headquarters and its regional offices. The Company’s marketing organization focuses on creating market awareness for Versata’s solutions, generating sales leads, forming relationships with leading technology

11

Table of Contents

companies and educating industry analysts about its solutions. Versata conducts a variety of marketing initiatives worldwide to educate its target market. The Company has engaged in marketing activities such as business seminars, trade shows, press relations, industry analyst programs, ongoing public relations, direct mailings and telemarketing, managing and maintaining its corporate Website, and producing and distributing sales support materials. Versata’s marketing organization also participates in acquiring, organizing and prioritizing customer and industry feedback in order to help provide product direction to its development organizations. Versata formalized this customer-driven approach by establishing customer summit meetings to provide forums for discussing customer needs and requirements. Customer summit meetings provide a useful forum in which to share information, test product concepts and collect data on customer and industry needs.

Product Development

Most of Versata’s software products are developed internally by the Company’s own engineering team. This includes everything from core product definition to design, implementation and documentation. To maximize the ability of its engineering organization to rapidly respond to customer needs and market fluctuations, the Company has established a tightly integrated process whereby marketing, sales, services and product support personnel provide Versata’s engineering team with continuous feedback from the Company’s customers, partners and competitors. Versata believes this approach helps the Company innovate to produce products that directly address customer challenges as they emerge. Taking these important steps forward has required Versata to substantially improve its engineering resources and processes during 2004. Among the improvements is a new engineering team at Halifax, Nova Scotia. The team boasts decades of software architecture, design, development and delivery experience, which the Company believes creates a competitive advantage in an industry where continuous innovation is a must.

The net result of these engineering improvements is that Versata is now able to continuously integrate changes and consistently improve its software. In fiscal 2005, the Company intends to seek and invest in improvements in product design, development, testing, and quality assurance to further its goal of rapid responsiveness to customer and market feedback.

Intellectual Property and Licensing

Intellectual Property

Versata relies on a combination of intellectual property rights to establish and protect its intellectual property. These legal protections afford only limited protection for the Company’s technology, and it cannot provide any assurance that other companies will not develop technologies that are similar or superior to its technology. If the Company fails to protect its proprietary technology, the business could be seriously harmed.

While various proprietary intellectual property rights are important to Versata’s success, the Company believes that its business as a whole is not materially dependent on obtaining any particular patent. The Company currently has a U.S. patent relating to its automated development tool that uses a drag-and-drop metaphor. This patent is scheduled to expire on April 9, 2016. It is possible that other companies could successfully challenge the validity or scope of the patent and that the patent may not provide a competitive advantage. Versata enforces its copyright, trademark, service mark and trade name rights. Furthermore, as part of the Company’s proprietary protection procedures, it enters into non-disclosure agreements with its employees, consultants, customers, distributors and business partners and into license agreements with respect to its software, documentation and other proprietary information. The Company further seeks to avoid disclosure of its intellectual property by restricting access to its source code. Despite these precautions, third parties could copy or otherwise obtain and use the Company’s products or technology without authorization, or develop similar technology independently. In addition, the laws of many countries do not protect the Company’s proprietary rights to as great an extent as do the laws of the U.S.

Currently, Versata is not aware of any pending claims that its products, trademarks or other proprietary rights infringe upon the proprietary rights of third parties. While the Company relies on patent, copyright,

12

Table of Contents

trademark, trade secret laws and contractual restrictions to protect its technology, the Company believes that factors such as the creativity and technological skills of its personnel, new product developments, frequent product enhancements and reliable customer service and product maintenance are more essential to establishing and maintaining a technology leadership position. See the “Risk Factors” section under Item 1 for a discussion of the risks associated with proprietary rights.

Third Party Licensing

Versata integrates third-party software into its products. While the Company believes that alternative sources of such third-party software are available, and based upon past experience and standard industry practice such licenses generally could be obtained on commercially reasonable terms, any significant interruption in the supply of such products could adversely impact the Company’s sales of its products unless and until the Company could secure another supplier.

International Operations

We currently have international subsidiaries located in Australia, Canada, Germany, and the United Kingdom. In March 2004, we sold certain intangible assets of our French subsidiary to our German subsidiary. We no longer maintain a staff or offices in France.

Employees

As of December 31, 2004, we had 73 active employees and 11 contractors. Of these individuals, 17 employees and contractors were in sales and marketing, 24 employees and contractors were in product development, 15 employees were in professional services, 12 employees were in customer support, and 16 employees and contractors were in finance and administration. Our employees are not represented by any collective bargaining unit, and we believe our relations with employees are satisfactory.

Risk Factors That May Affect Future Results

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

Risks Related to Our Business

We Have Limited Working Capital and May Experience Difficulty in Obtaining Needed Funding, Which May Limit Our Ability to Effectively Pursue Our Business Strategies.

As of October 31, 2004, we had $9.8 million in cash and short-term investments, and working capital of approximately $5.1 million. To date, we have not achieved profitability or positive cash flow on a sustained basis. Although we believe that our current cash, cash equivalents, and any net cash provided by operations will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next twelve months, it is possible that events may occur that could render our current working capital reserves insufficient. Because our revenue is unpredictable and a significant portion of our expenses are fixed, a reduction in projected revenue or unanticipated requirements for cash outlays could deplete our limited financial resources, potentially to a serious degree. We may find it necessary to obtain additional equity or debt financing in fiscal 2005 or beyond. If we require additional external funding, there can be no assurance that we will be able to obtain it on a timely basis if at all, or, if available, on terms acceptable to us. Moreover, additional financing will cause dilution to existing stockholders. If we cannot secure adequate financing sources on a timely basis, then we would be required, at a minimum, to reduce our operating expenses, which would restrict our ability to pursue our business objectives and could adversely impact our ability to maintain our revenue levels.

13

Table of Contents

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

We have experienced operating losses in each quarterly and annual period since inception, and we expect to incur losses in the near future. Although we hope to achieve positive cash flow and GAAP profitability by the end of fiscal 2005, if our revenue grows less than we anticipate or if our operating expenses increase more than expected, we may never achieve profitability. As of October 31, 2004, we had an accumulated deficit of $210.9 million.

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

Our operating results have varied and may continue to vary substantially from period to period. The timing and amount of our license fees are subject to a number of factors that make estimating revenues and operating results prior to the end of a quarter uncertain. While we receive certain recurring revenues on royalty-based license agreements and also from deferred maintenance and support fees, a significant amount of license fees in any quarter is dependent on the execution of new license sales in a particular quarter. Our professional services revenue in any quarter is substantially dependent on our license revenue. Services are normally purchased in conjunction with software, although it is not a requirement. Should our license revenues decrease, there will be a reduced market for our services. Any revenue shortfall in services could have an immediate and significant adverse effect on our results of operations. Operating expenses for any year are normally based on the attainment of planned revenue levels for that year and are generally incurred ratably throughout the year. As a result, if revenues were less than planned in any period while expense levels remain relatively fixed; our operating results would be adversely affected for that period. In addition, unplanned expenses such as increases in salaries, third party software licensing fees, and cost of software development, could adversely affect operating results for the period in which such expenses were incurred.

Our Failure to Accurately Forecast Sales May Lead to a Disappointment of Market Expectations.

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

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

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

14

Table of Contents

The success of new products is dependent on several factors including proper new product definition, product cost, timely completion and introduction of new products, differentiation of new products from those of our competitors, and market acceptance of these products. Although the Company intends to release Versata 6 and the Versata BAM Dashboard v2.0 with the functionalities described herein during fiscal 2005, there can be no assurance that these products will be released in a timely manner, include the described functionalities, or achieve broad market acceptance. Our inability to run on new or increasingly popular operating systems, and/or our failure to successfully enhance and improve our products in a timely manner could have a material adverse effect on our business, results of operations, financial condition or cash flows. In addition, Versata may in the future discover errors in new releases or new products after the commencement of commercial shipments. Since many customers are using Versata products for mission-critical business operations, any of these occurrences could seriously harm the Company’s business and generate negative publicity.

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

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

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

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

We Depend on Technology Licensed from Third-party Software Developers and our Ability to Develop and Sell our Products and Services Could be Delayed or Impaired if We Fail to Maintain These License Arrangements.

We incorporate into our products third-party software that enables, enhances or compliments aspects of our products’ functionality. This third-party software may not continue to be available on commercially reasonable terms or with acceptable levels of support, or at all. Our inability to maintain these software licenses on current terms could delay or impair the sale of our products and services until equivalent software, if available, is identified, licensed or developed, and integrated. This could adversely affect our business and impair our future growth.

Versata had an OEM agreement with WebGain for TopLink, a Java object-to-relational persistence architecture, as a part of the Versata 5 platform. The TopLink architecture bridges the gap between object-oriented Java systems such as Versata and relational database systems such as Oracle. The original OEM agreement with WebGain expired in 2004. Oracle acquired the assets and intellectual property for the TopLink

15

Table of Contents

product from WebGain. Versata is working to put in place a new agreement with Oracle. There can be no assurance that Versata can finalize this agreement in a timely manner or with favorable terms. If Versata is not able to enter into a new agreement with Oracle, Versata could lose the right to use and distribute TopLink and remedies could include damages or injunctive relief.

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

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

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

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

Over the past several years, the American Institute of Certified Public Accountants has issued Statement of Position No. 97-2, Software Revenue Recognition (“SOP 97-2”), and Statement of Position No. 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions (“SOP 98-9”). In addition, in December 2003, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements (“SAB 104”), which explains how the SEC staff believes existing revenue recognition rules should be applied to or interpreted for transactions not specifically addressed by existing rules. These standards address software revenue recognition matters primarily from a conceptual level and do not include specific implementation guidance. We believe that our revenue has been recognized in compliance with SOP 97-2, SOP 98-9 and SAB 104. However, the accounting profession and regulatory agencies continue to discuss various provisions of these pronouncements with the objective of providing additional guidance on their application. These discussions and the issuance of new interpretations, once finalized, could lead to unanticipated reductions in recognized revenue. They could also drive significant adjustments to our business practices, which could result in increased administrative costs, lengthened sales cycles and other changes which could adversely affect our results of operations.

Issuance of New Laws or Accounting Regulations, or Re-interpretation of Existing Laws or Regulations, Could Materially Impact our Business or Stated Results.

From time to time, the government, courts and financial accounting boards issue new laws or accounting regulations, or modify or re-interpret existing ones. There may be future changes in laws, interpretations or

16

Table of Contents

regulations that would affect our financial results or the way in which we present them. Additionally, changes in the laws or regulations could have adverse effects on hiring and many other aspects of our business that would affect our ability to compete, both nationally and internationally. For example, recently issued accounting regulations requiring the company to account for employee stock option grants as an expense could have the result of our not using options as widely for our employees which could impact our ability to hire and retain key employees.

We Will Incur Increased Costs as a Result of Recently Enacted and Proposed Changes in Laws and Regulations Relating to Corporate Governance Matters and Public Disclosure.

Recently enacted and proposed changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002, rules adopted or proposed by the SEC and by the NASDAQ National Market and new accounting pronouncements will result in increased costs to us as we evaluate the implications of these laws, regulations and standards and respond to their requirements. To maintain high standards of corporate governance and public disclosure, we intend to invest substantial resources to comply with evolving standards. This investment will result in increased general and administrative expenses and a diversion of management time and attention from strategic revenue generating and cost management activities. In addition, these new laws and regulations could make it more difficult or more costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, on our board committees or as executive officers. We are taking steps to comply with the recently enacted laws and regulations in accordance with the deadlines by which compliance is required, but cannot predict or estimate the amount or timing of additional costs that we may incur to respond to their requirements.

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

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

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

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

Some of our products, incorporate intellectual property licensed from third parties or open source software. If we fail to successfully exclude such technology from our indemnification obligations, claims that such open source or third party technology infringes the intellectual property rights of a third party could materially and adversely affect our business and financial condition.

17

Table of Contents

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

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

We Depend on Increased Business from Our Current and New Customers and if We Fail to Generate Repeat and Expanded Business or Grow Our