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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended June 30, 2004

OR

Commission File Number: 0-30925

BLUE MARTINI SOFTWARE, INC.

(Exact name of Registrant as specified in its charter)

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  ¨

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of July 29, 2004, there were approximately 12,293,069 shares of the Registrant’s common stock outstanding.

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BLUE MARTINI SOFTWARE, INC.

INDEX

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PART I.    FINANCIAL INFORMATION

BLUE MARTINI SOFTWARE, INC.

Condensed Consolidated Balance Sheets

(In thousands, except par value)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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BLUE MARTINI SOFTWARE, INC.

Condensed Consolidated Statements of Operations

(In thousands, except per share data)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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BLUE MARTINI SOFTWARE, INC.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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BLUE MARTINI SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1.    Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 30, 2004 are not necessarily indicative of the results that may be expected for any subsequent quarter or for the entire year ending December 31, 2004.

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

The balance sheet at December 31, 2003 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and notes thereto included in the Blue Martini Software, Inc. (“Blue Martini” or the “Company”) Annual Report on Form 10-K for the year ended December 31, 2003 filed with the Securities and Exchange Commission on March 15, 2004, as amended by Amendment No.1 on Form 10-K/A filed on March 24, 2004.

Note 2.    Letter of Credit

The Company obtained a letter of credit totaling $1.2 million as of December 31, 2002 in lieu of security deposits to secure facility lease obligations. As of June 30, 2004, the remaining balance on the letter of credit was $847,000, and the Company pledged $940,000 of cash equivalents as security for the letter of credit.

Note 3.    Restructuring Charges

In 2003 and 2002, the Company implemented various restructuring plans that resulted in reductions in force in 2003 and 2002 and lease cancellations in 2002. The following table summarizes the activities related to accrued restructuring charges (in thousands):

The remaining lease obligation will be paid over the remaining term of the underlying leases through April 2006.

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BLUE MARTINI SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Note 4.    Comprehensive Net Loss

Accumulated other comprehensive net loss refers to revenues, expenses, gains and losses that, under generally accepted accounting principles, are recorded in stockholders’ equity, but are excluded from net loss and consist primarily of unrealized gains or losses on available-for-sale investments and foreign currency translation adjustments. The components of comprehensive net loss are as follows (in thousands):

Note 5.    Net Loss Per Common Share

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):

Note 6.    Legal Actions

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

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BLUE MARTINI SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Note 7.    Accounting for Stock-Based Compensation

The Company has adopted Statement of Financial Accounting Standards (SFAS) No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure”, which amended SFAS 123, “Accounting for Stock-Based Compensation”. As permitted under SFAS 148, the Company has elected to continue to follow the intrinsic value method in accounting for its stock-based employee compensation arrangements. The following table illustrates the effect on net loss and net loss per share if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation (in thousands, except per share data):

For the above calculation, the fair value of each option granted was estimated on the date of grant using the Black-Scholes option-pricing model with no expected dividends. The risk-free interest rate used is the U.S. Treasury bill rates for the relevant expected useful lives. The Company estimated the expected useful lives based on vesting and purchase periods and terms of the options. The expected volatility was based on the historical volatility of the Company’s stock equal to the expected lives of the options. The following table shows the weighted average assumptions for stock options:

Stock options granted for the three months ended June 30, 2004 and 2003 had estimated fair values of $1.43 and $1.77, respectively, and $1.74 and $1.76 for the six months ended June 30, 2004 and 2003, respectively, as calculated using the Black-Scholes option valuation model.

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BLUE MARTINI SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

The weighted average fair values of common stock purchase rights (per-share) granted under the 2000 Employee Stock Purchase Plan were estimated using the Black-Scholes option-pricing model with the following weighted average assumptions used for purchases:

The weighted average estimated fair values of the common stock purchase rights granted under the 2000 Employee Stock Purchase Plan were $1.45 and $1.00 for the three months ended June 30, 2004 and 2003, respectively, and $1.36 and $2.12 for the six months ended June 30, 2004 and 2003, respectively, using the Black-Scholes option valuation model.

Note 8.    Significant Customer Information

For the three months ended June 30, 2004, no customer accounted for more than 10% of total revenues. Four customers each accounted for 17%, 17%, 12% and 11% of net accounts receivable; combined, those customers accounted for 57% of net accounts receivable.

Note 9.    Subsequent Event

On July 16, 2004, we implemented a restructuring plan to reduce our cost structure and reorganize the company to allow profitability at a lower license revenue level. We will record a restructuring charge in the third quarter of 2004 for severance cost and facility lease charges and estimate the charge to be approximately $1.5 million.

Note 10.    Recent Accounting Pronouncement

In March 2004, the Financial Accounting Standards Board issued Emerging Issues Task Force (EITF) Issue No. 03-1 (“EITF 03-1”), “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” EITF 03-1 includes new guidance for evaluating and recording impairment losses on debt and equity instruments, as well as new disclosure requirements for investments that are deemed to be temporarily impaired. The accounting guidance provided in EITF 03-1 is effective for fiscal years beginning after June 15, 2004, while the disclosure requirements are effective for annual periods ending after June 15, 2004. The Company does not expect the adoption of EITF 03-1 will have a material impact on its financial position, results of operations, or cash flows.

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The following discussion of the financial condition and results of operations of Blue Martini 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 our Annual Report on Form 10-K for the year ended December 31, 2003. 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, and Section 21E of the Securities Exchange Act of 1934, 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. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions, including those under Item 2 in the section entitled “Risk Factors” and elsewhere in this quarterly report and the risk factors fully described under Item 7 in our Annual Report on Form 10-K for the year ended December 31, 2003. All forward-looking statements and risk factors included in this document are made as of the date hereof, based on information available to us as of the date thereof, and we assume no obligation to update any forward-looking statement or risk factors, unless we are required to do so by law.

Overview

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

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

While the majority of our revenues to date have been derived from customers in the United States, international revenues accounted for 30% of our revenues for the six months ended June 30, 2004. We believe that international revenues may fluctuate as a percentage of revenues in the near term due to variability in the number and size of our license deals and related service engagements. Our quarterly operating results have experienced seasonal fluctuations in the past and may continue to fluctuate based on several factors, including our customers’ 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. The loss of a major customer or the delay or cancellation of anticipated significant license contracts would adversely affect our revenues and operating results in a particular quarterly period. Failure to obtain a significant number of new customers or additional orders from existing customers in any period would adversely affect our business and operating results. For the three months ended June 30, 2004, no customer accounted for more than 10% of total revenues. Four customers each accounted for 17%, 17%, 12% and 11% of net accounts receivable; combined, those customers accounted for 57% of net accounts receivable. See Note 9, Significant Customer Information, above.

Our operating expenses are based in part on our expectations of future revenues over the long term, and are largely fixed in the short term. As such, a delay in completion of new customer license contracts or the

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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 lower-than-expected revenues in a given quarter, resulting in greater-than-expected net losses for that quarter.

We believe that our greatest challenges as a company are to increase our sales pipeline, close sales transactions more expeditiously, maintain relationships with existing customers and thereby, achieve profitability. During 2003 and the first two quarters of 2004, our ability to sell was harmed by turnover in the leadership and staffing of our sales force and our marketing organization. In 2004, our license revenues for the second quarter were significantly below our expectations primarily due to the uncertainty surrounding information technology spending by potential customers, which we believe will continue in the near term. As a result, we decided to reduce our cost structure and started to take steps to downsize our organization and align both headcount and program expenditure resources with areas of highest revenue generation potential. We anticipate that our headcount will be reduced by approximately 25% to 150 employees by the end of the third quarter of 2004 and that our overall costs and expenses will be reduced by approximately 25% by the fourth quarter of 2004. See Note 10, Subsequent Events. In the late second quarter and early third quarter of 2004, we also filled key positions in our executive team. The new key members lead our North American sales, global marketing and global consulting services organizations. Our relationship with our partners continues to be important to us, and we plan to continue investing considerable effort in maintaining and developing those relationships moving forward. Finally, we continue to focus on effectively conveying the value that our sales optimization solutions can deliver to potential customers. To do this, we have developed a number of tools including financial models, white papers and presentations that help convey this message, but we need to deliver this message to significantly more of our sales engagements. We believe our improved cost structure, enhanced management team and continued focus on partners will help us achieve our goal of sustainable profitability.

Results of Operations for the Three and Six Months Ended June 30, 2004 and 2003

Revenues

License

The decrease in license revenues for the three months ended June 30, 2004 as compared to the same period in 2003 was due to a decrease in the number of transactions and the average selling price of our software licenses, which we attribute to the uncertainty in information technology spending by potential customers in the markets we are in. The increase in license revenue for the six months ended June 30, 2004 as compared to the same period in 2003 was due to the 90% increase in license revenue in the first quarter of 2004 compared to the same period in 2003 attributable to the increase in the number of transactions and the average selling price of our software license.

Service

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Service revenues include maintenance and professional services revenues. The decrease in professional services revenues for the three and six months ended June 30, 2004 as compared to the corresponding periods in the prior year was due to our continued transitioning of professional services to our system integrator partners. This decrease in professional service revenues was partially offset by a non-recurring milestone payment in the three and six months ended June 30, 2004. The increase in maintenance revenues for the three and six months ended June 30, 2004 as compared to the corresponding periods in the prior year resulted from the increase over time of the customer base under maintenance arrangements.

Cost of Revenues

Cost of License Revenues

Cost of license revenues consists primarily of royalties payable to third parties, and through the end of 2003, amortization of purchased intangible assets for software that is either embedded in or bundled with our products. Cost of license revenues was 14% of license revenues for the three months ended June 30, 2004 and 2003, and 10% and 16% for the six months ended June 30, 2004 and 2003, respectively. The decline in costs as a percentage of license revenues for the six months ended June 30, 2004 as compared to the corresponding period in the prior year is primarily due to the purchased intangibles being fully amortized at the end of 2003 and due to the impact of this fixed component of cost of license on a higher license revenue base. Since these purchased intangibles were fully amortized in December 2003, cost of license revenue, when expressed in dollar terms, decreased for the second quarter of 2004 as compared to the corresponding period in the prior year. In the near term, our cost of license revenues, when expressed in dollar terms, is expected to fluctuate with license revenues.

Cost of Service Revenues

Cost of service revenues consists primarily of salaries and other personnel-related expenses, reimbursable expenses, costs of services provided by third-party consultants engaged by the Company, allocated overhead costs, and depreciation of equipment used to provide consulting services, technical support and training. Allocated overhead costs for costs of services and other expense categories include facilities and information systems. Cost of service revenues was 58% and 69% of service revenues for the three months ended June 30, 2004 and 2003, respectively, and 57% and 69% for the six months ended June 30, 2004 and 2003, respectively. The decrease in dollar terms for the three and six months ended June 30, 2004 as compared to the corresponding periods in the prior year was primarily due to a decrease in headcount of approximately 17%. Our cost of service revenues is relatively fixed; however, when expressed as a percentage of related service revenues, cost of service revenues may fluctuate in the near term, based on fluctuations in related service revenues, and the extent to which we use subcontractors.

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Operating Expenses

Sales and Marketing

Sales and marketing expenses consist primarily of salaries, commissions, and other personnel-related expenses associated with our direct sales and marketing personnel, allocated overhead expenses, and costs of marketing programs including trade shows, promotional activities and media events. The decrease in sales and marketing expenses for the three months ended June 30, 2004 as compared to the same period in 2003 was primarily due to decreased commissions resulting from lower license revenues and a 10% decrease in our sales and marketing headcount. Sales and marketing expenses remained relatively flat for the six months ended June 30, 2004 and 2003. In dollar terms, we expect that sales and marketing expenses will decrease in the near term reflecting the reduction in force and cost structure implemented in July 2004. See Note 10, Subsequent Events.

Research and Development

Research and development expenses consist primarily of salaries and other personnel-related expenses for engineering personnel, allocated overhead costs, costs of contractors, and depreciation of equipment used in the development of our software products. To date, all costs related to the development of our software have been expensed as incurred. Our research and development operations in the three and six months ended June 30, 2004 remained at relatively the same levels as the corresponding periods in the prior year.

In the near term, we expect research and development expenses, in dollar terms, to decrease as a result of the reduction in force and cost structure implemented in July 2004. See Note 10, Subsequent Events.

General and Administrative

General and administrative expenses include costs associated with our finance, human resources, legal, and other administrative functions. These costs consist primarily of salaries and other personnel-related expenses, professional fees, insurance premiums, provision for doubtful accounts, equipment depreciation, and allocated overhead costs. The decrease in general and administrative expenses in the three and six months ended June 30, 2004 from the corresponding periods in the prior year was primarily due to headcount decrease of 14% in our general and administrative staff and other cost savings from lower insurance premiums and reductions in outside

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services costs. In the near term, we expect general and administrative expenses, in dollar terms, to decrease as a result of the reduction in force and cost structure implemented in July 2004. See Note 10, Subsequent Events.

Amortization of Deferred Stock Compensation

Amortization of deferred stock compensation consists of the amortization of deferred stock compensation using the accelerated method, net of an adjustment for unvested options of terminated employees during the quarter that reverses previously recognized expenses.

As of December 31, 2003, all deferred stock compensation was fully amortized. Deferred stock compensation expenses for the six months ended June 30, 2004 consists of a charge of $96,000 in the first quarter of 2004 due to the accelerated vesting of options in connection with a termination agreement with a former Company executive.

Stock Option Plans

Description of Plans. The Company’s stock option program consists of two plans: the 2000 Equity Incentive Plan and the 2000 Non-Employee Directors’ Stock Option Plan. Stock options granted under these plans expire no later than ten years from the grant date and generally vest over two to four years. The Incentive Plan is administered by our board of directors, which has the authority to designate participants and to determine the number and type of options to be granted, the time when options become exercisable, the method of payment and any other terms or conditions of the options. The Directors’ Plan designates participants and specifies the number, type, term and pricing of options granted, the exercisability and vesting schedule of such options, the method of payment and other terms and conditions. The Directors’ Plan is administered by our board of directors, which has the authority to determine provisions of options only to the extent not specified in the Directors’ Plan. Please refer to Note 10, Stockholders’ Equity, of the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 for further information regarding the Company’s stock plans.

The following table summarizes plan activity for the six months ended June 30, 2004 (in thousands, except per share amounts):

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The following table summarizes information about stock options as of June 30, 2004 (option amounts in thousands):

Interest Income and Other, Net

Interest income and other, net consists primarily of interest income from cash, cash equivalents and short-term investments. Interest income and other were $100,000 and $289,000 for the three months ended June 30, 2004 and 2003, respectively, and $329,000 and $645,000 for the six months ended June 30, 2004 and 2003, respectively. The decrease was due to the decline in balances of cash, cash equivalents and short-term investments over time while interest rates remain relatively low. We expect interest income to decrease as the amount of cash and cash equivalents available for investment decreases as cash is used in operations assuming interest rates remain at the current low level.

Liquidity and Capital Resources

Our cash and cash equivalents consist primarily of money market funds, commercial paper and U.S. treasury and government agency securities. All of our investments are classified as “available-for-sale” and carried at fair value based on quoted market prices in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.”

Net cash used in operating activities was $8.7 million and $9.0 million for the six months ended June 30, 2004 and 2003, respectively. The decrease was primarily due to a lower net loss net of non-cash charges of $326,000 and $1.8 million for the six months ended June 30, 2004 and 2003, respectively, partially offset by a decrease in cash generated from accounts receivable due to the timing of cash collections and a decrease in deferred revenues.

Net cash used in investing activities was $370,000 in the six months ended June 30, 2004 and net cash provided by investing activities was $12.9 million in the six months ended June 30, 2003. The difference was due primarily to the timing of sales and maturities of short-term investments. We do not expect any significant capital expenditures in the near future.

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Net cash provided by financing activities was $1.6 million and $316,000 for the six months ended June 30, 2004 and 2003, respectively. The increase was due primarily to increased proceeds from employee stock option exercises.

At June 30, 2004, we had aggregate operating lease commitments of approximately $6.7 million, payable through 2006, of which, approximately $2.0 million have been accrued and reflected on the balance sheet as accrued restructuring charges net of estimated sublease income.

Our liquidity, capital resources and results of operations in any period could be affected by the exercise of outstanding stock options and warrants and issuance of common stock under our employee stock purchase plan. The resulting increase in the number of outstanding shares could also affect our per share results of operations. However, we cannot predict the timing or amount of proceeds from the exercise of these stock options and warrants, or whether they will be exercised at all.

We expect that for the foreseeable future, our operating expenses will continue to 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 operating requirements for at least the next 12 months. Either within this time period or at some future date, if our current financial performance continues, we may need to raise additional funds in the future through public or private debt or equity financing. There can be no assurance that this additional financing will be available, or if available, will be on reasonable terms. If adequate funds are not available on acceptable terms, we may have to accept financing on terms we view as unreasonable or that are dilutive to our stockholders, or to cease operations. If we were to seek additional financing today, we do not believe it would be available on reasonable terms.

The uncertainty surrounding information technology spending and the existence or even the anticipation of an uncertain economic and political environment by potential customers in the markets we operate in has affected the demand for our applications, caused pricing pressures for our products, increased sales cycles and customer requests for extended payment terms. We expect current conditions to continue in future periods, which could in turn materially reduce our liquidity.

Contingent Matters

Refer to Part II, Item 1, Legal Proceedings for a discussion of legal contingencies.

Critical Accounting Policies

Please refer to the discussion of critical accounting policies in our Annual Report on Form 10-K for the year ended December 31, 2003 under Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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Factors That May Impact Future Operating Results

Set forth below and elsewhere in this quarterly report and in the other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this quarterly report. Prospective and existing investors are strongly urged to carefully consider the various cautionary statements and risks set forth in this quarterly report and our other public filings, including our annual report on Form 10-K. Some of these factors are as follows:

Risks Related to Our Financial Condition

Risks Related to Our Products

Risks Related to Our Market and Our Ability to Sell

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