10-Q 1 j0240301e10vq.txt FREEMARKETES, INC. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NUMBER 000-27913 FREEMARKETS, INC. (Exact Name of Registrant as Specified in its Charter) DELAWARE 04-3265483 (State or Other Jurisdiction of Incorporation or (I.R.S. Employer Identification No.) Organization) FREEMARKETS CENTER 210 SIXTH AVENUE PITTSBURGH, PA 15222 (Address of Principal Executive Offices) (Zip Code)

(412) 434-0500 (Registrant's Telephone Number, Including Area Code) HTTP:WWW.FREEMARKETS.COM (Registrant's URL) 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 Exchange Act Rule 12b-2. YES [X] NO [ ] The number of shares of the registrant's common stock outstanding as of the close of business on June 30, 2003 was 42,030,978. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- FREEMARKETS, INC. FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003 INDEX

PART I -- FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS FREEMARKETS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS ($ IN THOUSANDS)

--------------- * Summarized from audited December 31, 2002 balance sheet. The accompanying notes are an integral part of the condensed consolidated financial statements. 3 FREEMARKETS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

The accompanying notes are an integral part of the condensed consolidated financial statements. 4 FREEMARKETS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED; $ IN THOUSANDS)

The accompanying notes are an integral part of the condensed consolidated financial statements. 5 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NOTE 1. BASIS OF PRESENTATION The unaudited condensed consolidated financial statements have been prepared by FreeMarkets, Inc. and Subsidiaries (the "Company") and reflect all adjustments (all of which are normal and recurring in nature) that, in the opinion of management, are necessary for a fair presentation of the interim periods presented. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for any subsequent quarter or for the entire year ending December 31, 2003. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted in accordance with the rules and regulations of the Securities and Exchange Commission (the "SEC"). The unaudited condensed consolidated financial statements and notes included herein should be read in conjunction with the Company's audited consolidated financial statements and notes for the year ended December 31, 2002, included in the Company's Annual Report on Form 10-K filed with the SEC on March 14, 2003. NOTE 2. EARNINGS PER SHARE The following table presents the calculation of basic and diluted earnings per share:

The following potentially dilutive common shares were excluded because their effect was antidilutive:

6 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) The following table illustrates the effect on earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standard ("SFAS") No. 123, "Accounting for Stock-Based Compensation":

The weighted average fair value per option grant to employees was $4.94 and $9.79 in Q2 2003 and Q2 2002, respectively, and $3.62 and $10.58 in the six months ended June 30, 2003 and 2002 respectively. The fair value of each option grant was determined using the Black-Scholes pricing model, with the following assumptions for all grants:

NOTE 3. STOCKHOLDERS' EQUITY COMMON STOCK REPURCHASE PROGRAM In January 2003, the Board of Directors of the Company authorized the repurchase of up to 15% of the Company's outstanding common stock from time to time on the open market or in one or more negotiated transactions. As of June 30, 2003, the Company had purchased 853,500 shares at a weighted average cost of $4.23 per share. 7 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) COMPREHENSIVE LOSS The components of comprehensive loss were as follows:

The components of accumulated comprehensive income (loss) were as follows:

NOTE 4. INVESTMENT WRITE-DOWN During Q1 2002, the Company recorded a $4.7 million loss on its investment in Adexa, Inc. ("Adexa") based on Adexa's financial condition. The Company concluded that there was an other than temporary decline in the value of its investment in Adexa. As of June 30, 2003, the remaining book value of the original $6.0 million investment in Adexa was $889,000. NOTE 5. ACCRUED RESTRUCTURING COSTS 2003 RESTRUCTURING PLAN In Q1 2003, in response to the continued economic slowdown, the Company executed a restructuring plan resulting in the elimination of 79 positions in its global workforce. The estimated liability for employee severance and termination benefit costs will be paid by the end of Q3 2003. Additionally, the Company evaluated its office space in Pittsburgh, Pennsylvania, and ceased using one of the floors it leases through May 2010 in its global headquarters. In accordance with SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," the Company recorded a restructuring charge of $4.7 million in Q1 2003, covering these severance and lease costs. 8 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) The restructuring reserve activity under the Q1 2003 restructuring plan for the period ended June 30, 2003 was:

2001 RESTRUCTURING PLAN In April 2001, the Company closed its Austin, Texas office, formerly the headquarters of its iMark.com, Inc. ("iMark") subsidiary, and centralized the Company's asset recovery operations at its corporate headquarters in Pittsburgh, Pennsylvania. As a result of the closing of the Austin office, the Company recorded a $3.1 million restructuring charge covering the severance costs, lease termination costs and non-cash write-off of assets related to the Austin office. In June 2001, the Company closed two foreign offices and terminated certain employees in those and other offices. As a result, the Company recorded a $3.3 million restructuring charge covering severance and lease termination costs. As of June 30, 2003, substantially all amounts under this plan have been paid. NOTE 6. CUMULATIVE EFFECT OF ACCOUNTING CHANGE FOR GOODWILL The Company adopted the provisions of SFAS No. 142, "Goodwill and Other Intangible Assets", on January 1, 2002, and no longer records goodwill amortization. In connection with adopting this standard, the Company completed step one of the test for impairment, which indicated that the carrying value of Surplus Record, which was acquired by the Company in March 2000 for $18.0 million in cash, exceeded its estimated fair value, as determined utilizing various valuation techniques including discounted cash flow and comparative market analysis. Thereafter, given the indication of a potential impairment, the Company completed step two of the test. Based on that analysis, a transitional impairment loss of $5.3 million was recognized in Q1 2002 as a cumulative effect of an accounting change. NOTE 7. STOCK COMPENSATION AND WARRANT COSTS Stock compensation and warrant costs include charges resulting from stock options and warrants granted at exercise prices less than fair value. The following table shows the amounts of stock compensation and warrant costs by category had stock compensation and warrant costs been separately stated on the condensed consolidated statements of operations:

9 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NOTE 8. RECENT ACCOUNTING PRONOUNCEMENTS In November 2002, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45 clarifies the requirements of FASB Statement No. 5, "Accounting for Contingencies" relating to a guarantor's accounting for, and disclosure of, the issuance of certain types of guarantees. FIN 45 requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee. FIN 45 also requires enhanced disclosures in a company's interim and annual filings. FIN 45 is effective for guarantees issued or modified after December 31, 2002. The disclosure requirements were effective for financial statements of both interim and fiscal years ending after December 15, 2002. The adoption of this standard did not have a material impact on the Company's consolidated financial statements. In January 2003, the EITF released Issue No. 00-21 ("EITF 00-21"), "Revenue Arrangements with Multiple Deliverables," which addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. Specifically, EITF 00-21 addresses whether an arrangement contains more than one unit of accounting and the measurement and allocation to the separate units of accounting in the arrangement. EITF 00-21 is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company adopted this standard effective January 1, 2003, and it did not have a material impact on its consolidated financial statements. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends SFAS No. 133 by requiring that contracts with comparable characteristics be accounted for similarly. In particular, this Statement (1) clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative discussed in paragraph 6(b) of Statement 133, (2) clarifies when a derivative contains a financing component, (3) amends the definition of an underlying to conform it to language used in FIN 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others," and (4) amends certain other existing pronouncements. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, except as stated below and for hedging relationships designated after June 30, 2003. In addition, except as stated below, all provisions of SFAS No. 149 should be applied prospectively. The provisions of SFAS No. 149 that relate to SFAS No. 133 Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates. In addition, paragraphs 7(a) and 23(a), which relate to forward purchases or sales of when-issued securities or other securities that do not yet exist, should be applied to both existing contracts and new contracts entered into after June 30, 2003. The Company does not expect this standard will have a material impact on its consolidated financial statements. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) because that financial instrument embodies an obligation of the issuer. SFAS No. 150 is effective for contracts entered into or modified after June 30, 2003, except as stated below and for hedging relationships designated after June 30, 2003. In addition, except as stated below, all provisions of SFAS No. 150 should be applied prospectively. The provisions of this Statement that relate to SFAS No. 133 Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates. In addition, paragraphs 7(a) and 23(a), which relate to forward purchases or sales of when-issued securities or other securities that do not yet exist, should be applied to both existing contracts and new contracts entered into after June 30, 2003. The Company does not expect this standard will have a material impact on its consolidated financial statements. 10 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NOTE 9. SECURITIES CLASS ACTION COMPLAINTS Since April 27, 2001, eleven securities fraud class action complaints have been filed against the Company and two executive officers in federal court in Pittsburgh, Pennsylvania. The complaints, all of which assert the same claims, stem from the Company's announcement on April 23, 2001 that, as a result of discussions with the SEC, the Company was considering amending its 2000 financial statements for the purpose of reclassifying fees earned by the Company under a service contract with Visteon. All of the cases have been consolidated into a single proceeding. On October 30, 2001, the Company filed a motion seeking to dismiss all of the cases in their entirety. On January 17, 2003, the Court denied the motion to dismiss. The case is now in the class certification phase. In addition, on September 24, 2001, an individual claiming to be a FreeMarkets shareholder filed a shareholder's derivative action, nominally on behalf of FreeMarkets, against all of the Company's directors and certain of its executive officers. FreeMarkets is also named as a nominal defendant. The suit is based on the same facts alleged in the foregoing securities fraud class actions and was stayed pending a ruling on the Company's motion to dismiss those class actions. The Company believes that the plaintiffs' allegations are without merit and it intends to defend these claims vigorously. Since July 31, 2001, several securities fraud class action complaints have been filed in the United States District Court for the Southern District of New York alleging violations of the securities laws in connection with the Company's December 1999 initial public offering ("IPO"). In four of the complaints, the Company and certain of its officers are named as defendants, together with the underwriters that are the subject of the plaintiffs' allegations. Each of these cases has been consolidated for pretrial purposes into an earlier lawsuit against the underwriters of the Company's IPO. In addition, the cases have been consolidated for pretrial purposes with approximately 1,000 other lawsuits filed against other issuers, their officers, and underwriters of their initial public offerings. On April 19, 2002, a consolidated amended class action complaint (the "Consolidated Complaint") was filed. The Consolidated Complaint alleges claims against the Company and seven of its officers and/or directors, as well as seven investment banking firms who either served as underwriters or are successors in interest to underwriters of the Company's IPO. The Consolidated Complaint alleges that the prospectus used in the Company's IPO contained material misstatements or omissions regarding the underwriters' allocation practices and compensation in connection with the IPO, and also alleges that the underwriters manipulated the aftermarket for the Company's stock. Damages in an unspecified amount are sought, together with interest, costs and attorney's fees. The defendants filed a motion to dismiss the Consolidated Complaint. By stipulation and order dated October 9, 2002, the individual defendants were dismissed without prejudice from the Consolidated Complaint. On February 19, 2003, the court denied the Company's motion to dismiss. On June 25, 2003, a Special Committee of the Board of Directors of the Company approved a proposed settlement of the litigation under terms set forth in a Memorandum of Understanding and authorized the Company to enter into a definitive settlement agreement to be prepared in accordance with the Memorandum of Understanding. The anticipated settlement will be subject to court approval following notice to class members and a fairness hearing. Based on the memorandum of understanding, the Company believes that the anticipated settlement will have no material effect on the Company. 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes contained in this Quarterly Report on Form 10-Q ("Form 10-Q"). Certain statements contained in this Form 10-Q constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different than any expressed or implied by these forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential," "continue," or the negative of these terms or other comparable terminology. Furthermore, in addition to the risks described in this Form 10-Q, we are subject to specific risks and uncertainties related to our business model, strategies, markets and legal and regulatory environment. For a detailed discussion of some of these risks, please see the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2002, as filed with the SEC on March 14, 2003. OVERVIEW FreeMarkets provides software, services and information to help companies improve their sourcing and supply management processes and enhance the capabilities of their supply management organization. Our customers are buyers of industrial parts, raw materials, commodities and services. Our team members provide service to customers in more than 35 languages from 19 locations in 15 countries on five continents. Since our inception, FreeMarkets has provided software and services to help companies identify savings, enhance their sourcing efficiency and achieve their strategic sourcing goals by enabling them to source goods and services in our online markets. In providing these services we work with our customers to identify and screen suppliers and to assemble a request for quotation that provides detailed, clear and consistent information for suppliers to use in our online markets. Our web-based technology enables suppliers from around the world to submit bids for a customers' purchase orders in real-time interactive competition featuring "downward price" dynamic bidding. While we have provided this technology-enhanced service to buyers since 1995, we began to describe it using the "FullSource" name in 2001. In 2001, we also introduced our QS solution, which enables customers to conduct their own sourcing projects, including running their own online markets. During the second half of 2002, we introduced a number of new product offerings to expand our solutions beyond sourcing to address a broader set of supply management activities. Our development of a broader set of solutions in 2002 is part of a strategic transition from a company that offers a single technology-enhanced service to one with multiple software and service solutions. These activities include supply analysis and strategy, spend requirements management, sourcing, supplier development and supplier relationship management. We refer to these activities as Global Supply Management, or GSM. Our solutions combine software, services and information to address the GSM market. These solutions are ultimately designed to help companies lower costs and reduce their supply risks. RECENT DEVELOPMENTS We are considering closing our Brussels office and moving operations to regional locations throughout Europe, as well as the United States and Asia. We believe that the proposed changes will allow us to better serve our customers and enable us to create a more leveraged, profitable and efficient business across Europe. If we decide to implement the proposed restructuring plan, we expect that we would record a restructuring charge in the range of $6 million to $8 million in the third and/or fourth quarters to cover severance payments, remaining lease obligations and asset write-offs. If the restructuring plan is implemented, we expect that we would generate significant operational savings which we currently estimate to be approximately $5 million per year. 12 CRITICAL ACCOUNTING POLICIES The accompanying discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States of America ("US GAAP"). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We base our estimates and judgments on historical experience and all available information. However, future events are subject to change, and the best estimates and judgments routinely require adjustment. US GAAP requires us to make estimates and judgments in several areas, including those related to recording various accruals (such as incentive compensation and restructuring costs), income taxes, the useful lives of long-lived assets such as property and equipment and potential losses from contingencies and litigation. We believe the policies discussed below are the most critical to our financial statements because they are affected significantly by management's judgments, assumptions and estimates. REVENUE RECOGNITION We generate revenues under service and access agreements with our customers. While the vast majority of our agreements contain standard business terms and conditions, there are many agreements that contain complex terms and conditions. As a result, we are required to evaluate the scope and significance of contract provisions in order to determine the appropriate accounting. In addition, our revenue recognition policy requires an assessment as to whether the collectibility is probable, which inherently requires us to evaluate the creditworthiness of our customers. Our FullSource service agreements typically provide revenues from fixed monthly fees, and may also include performance incentive payments based on volume and/or savings. The structure in a particular service agreement may vary, depending upon the needs of our customer and the conventional practices in the supply market where our customer obtains its materials, commodities or services. The fees that we receive are for the use of our technology, supplier and supply market information, sourcing operations staff and facilities. Negotiated fees vary by customer, and reflect both the anticipated volume and the staffing, expertise and technology we anticipate committing to complete the services requested by our customers. We recognize revenues from our fixed monthly FullSource fees ratably as we provide access to our services over the related contract period. Our agreements range in length from a few months to as many as five years. At any given time, we have agreements of varying lengths with staggered expirations. Some of our agreements permit early termination without cause by our customers without penalty. Many of the service agreements for our FullSource offering include performance incentive payments that are contingent upon our customer achieving specific volumes and/or savings, as set forth in the respective agreements. We recognize these revenues as the thresholds are achieved. If our FullSource market volume grows, the revenues attributable to these incentive payments may also grow in terms of absolute dollars, but not necessarily as a percentage of revenues. The agreements for our QS offering provide for revenues from fixed monthly access fees. The fees that we receive are for providing access to our technology and for add-on services. Negotiated access fees for our QS offering vary by customer, and reflect the anticipated number of customer users and add-on services. We recognize revenues from our QS offering as we provide access or add-on services. The agreements for our new offerings, such as ES, Spend Visibility and Supplier Implementation provide for revenues from fixed monthly access fees. The fees that we receive are for providing access to our technology and for certain services. We recognize revenues from these new offerings as we provide access or services. Reimbursements, including those related to travel and other out-of-pocket expenses, are included in revenues, and an equivalent amount of reimbursable expenses are included in cost of revenues. Some customer agreements include multiple product and / or service offerings. In determining the appropriate amount of revenue to be recognized for each offering, the Company evaluates whether the offerings 13 have stand alone value to the customer, whether the fair value of the undelivered elements is reliably determinable, and whether delivery of the remaining offerings is probable and within the Company's control. In instances where all of these conditions are satisfied, the Company recognizes revenue for the offerings that have been delivered to the customer based on their relative fair values. ALLOWANCE FOR DOUBTFUL ACCOUNTS We evaluate the collectibility of our accounts receivable based on a combination of factors. In cases where we are aware of circumstances that may impair a specific customer's ability to meet its financial obligations to us, we record a specific allowance against amounts due to us. For all customers, we recognize allowance for doubtful accounts based on the length of time the receivables are past due, the current business environment and our historical experience. If the financial condition of our customers deteriorates or if the economic conditions worsen, additional allowances may be required in the future. STOCK COMPENSATION SFAS No. 123, "Accounting for Stock-Based Compensation" gives companies the option to adopt the fair value method for expense recognition of employee stock options or to continue to account for employee stock options using the intrinsic value method, as outlined under Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees". We have elected to continue to apply the intrinsic value method to account for employee stock options and disclose the pro forma effect as if the fair value method had been applied in the Notes to our consolidated financial statements. TREATMENT OF VISTEON FEES In April 2000, we entered into a five-year agreement with Visteon that provides for fixed monthly fees in return for our FullSource software and services. We exclude from revenues the amounts that we earn under this contract; however, cost of revenues includes the costs we incur in serving Visteon. At the time we executed this service contract, we granted a warrant for 1.75 million shares to Visteon with an exercise price of $.01 per share, and we continue to receive ongoing marketing and public relations benefits as a result of our relationship with Visteon. The warrant was valued at $95.5 million using the Black-Scholes pricing model at the date of the grant in April 2000. As a result of a review by the Securities and Exchange Commission ("SEC"), we exclude from our revenues the fees we earn from this contract, and we allocate those fees as payment for the warrant. However, we view our relationship with Visteon as a typical customer relationship. We provide Visteon with access to software, services and information to help them improve their sourcing and supply management processes and enhance the capabilities of their supply management organization. For all business and operational purposes in which revenue is a factor in the decision, including budgets, forecasts, allocation of resources, sales compensation, bonus decisions and other performance indicators (such as DSO), we treat the fees we earn from this contract in the same manner as revenues from other customers. Accordingly, we have referred, where applicable, to "revenues and fees" throughout Management's Discussion and Analysis of Financial Condition and Results of Operations in order to accurately describe our analysis of our operations. Below is a reconciliation of revenues under generally accepted accounting principles with revenues plus the fees we earn under our service contract with Visteon:

Our relationship with Visteon is a standard customer relationship (except for the warrant). We do not expect to recognize revenues under this Visteon service contract from the fees we earn during the term of the contract, 14 which expires in 2005, because we have determined, as a result of a review by the SEC, that we must allocate those fees as payment for the warrant that we granted to Visteon. RESULTS OF OPERATIONS The following table sets forth condensed consolidated statements of operations data as a percentage of revenues for the periods indicated:

THREE AND SIX MONTHS ENDED JUNE 30, 2003 AND 2002 All references to "Q2 2003" and "Q2 2002" are for the three months ended June 30, 2003 and 2002, respectively. All references to "Six Months 2003" and "Six Months 2002" are for the six months ended June 30, 2003 and 2002, respectively. REVENUES Revenues decreased 22% from $44.6 million in Q2 2002 to $34.6 million in Q2 2003, and decreased 21% from $87.8 million in Six Months 2002 to $69.2 million in Six Months 2003. As discussed earlier in "Treatment of Visteon Fees", we exclude from revenues the fees earned from our contract with Visteon, which were $2.8 million in each of Q2 2002 and Q2 2003, and $5.6 million in each of Six Months 2002 and Six Months 2003. Revenues and fees decreased 21% from $47.4 million in Q2 2002 to $37.4 million in Q2 2003 and decreased 20% from $93.4 million in Six Months 2002 to $74.8 million in Six Months 2003. The decrease in revenues is due to a combination of factors, including a change in the mix of products and services deployed by our customers, as well as the continued weak economic environment which we believe has caused our customers to defer their purchasing decisions. In 2002, several large customers renewed their FullSource access and service agreements at lower market volumes than the volumes provided in previously existing agreements, resulting in lower revenues from our FullSource offering in 2003. In addition, with the introduction of QS in early 2001, several FullSource-only customers have expanded their use of our products to include a broader mix of FullSource, QS and related services. As customers gain experience with our sourcing solutions, certain entities have migrated a portion of their sourcing requirements to our self-service technologies. In some cases, increased sales of additional products and services to existing customers have resulted in lower total revenues due to this migration. We do not believe that sales of new products in 2003 will compensate for the reduction in revenue from our FullSource offering, and anticipate that total revenues in 2003 will be less than 2002. We do expect that 15 the continued introduction of new products and services over the long-term will drive customer acquisition, market share expansion and overall revenue gains. The following is a breakdown of revenues by product (in thousands):

The following is a breakdown of revenues and fees by product (in thousands):

OPERATING COSTS AND EXPENSES COST OF REVENUES. Cost of revenues decreased from $19.3 million in Q2 2002 to $17.7 million in Q2 2003, and decreased from $38.2 million in Six Months 2002 to $36.1 million in Six Months 2003. The increase in cost of revenues as a percentage of revenues was primarily the result of the 22% and 21% decrease in revenues from Q2 2002 to Q2 2003 and Six Months 2002 and Six Months 2003, respectively, and an increase in bad debt expense of $629,000 from Six Months 2002 to Six Months 2003, due to the write-off of approximately $740,000 due from a single customer. The decrease in terms of absolute dollars in both periods is attributable to lower customer out-of-pocket costs and reduced overhead, primarily due to a decrease in depreciation expense in 2003 compared to 2002,partially offset by an increase in bad debt expense. Cost of revenues includes the costs we incur in performing our obligations under the Visteon service contract, even though the fees we earn under that contract are excluded from revenues. We expect our cost of revenues in fiscal year 2003 will be lower in absolute dollars, but higher as a percentage of revenues due primarily to a reduction in revenues. RESEARCH AND DEVELOPMENT. Research and development costs decreased from $6.9 million, or 16% of revenues in Q2 2002 to $6.2 million, or 18% of revenues in Q2 2003, and increased from $12.1 million, or 14% in Six Months 2002 to $12.7 million, or 18% in Six Months 2003. The decrease in absolute dollars in Q2 2003 compared to Q2 2002 is primarily attributable to reduced consulting costs associated with the investments in our product development pipeline in Q2 2002 partially offset by a 29% increase in average research and development staff. The increase in absolute dollars in Six Months 2002 compared to Six Months 2003 relates primarily to ongoing investments in our product development pipeline. We expect that research and development costs as a percentage of revenues in fiscal year 2003 will be higher than 2002. SALES AND MARKETING. Sales and marketing costs decreased from $10.9 million, or 25% of revenues in Q2 2002 to $10.0 million, or 29% of revenues in Q2 2003, and from $23.9 million, or 27% in Six Months 2002 to $19.3 million, or 28% in Six Months 2003. The decrease in absolute dollars is primarily attributable to a 19% and 15% decrease in the average number of sales and marketing staff in Q2 2003 and Six Months 2003, respectively. The decrease is also attributable to cost cutting measures in discretionary spending such as marketing and advertising, recruiting and relocation costs. We expect that our sales and marketing costs as a percentage of revenues in fiscal year 2003 will be relatively consistent with 2002. GENERAL AND ADMINISTRATIVE. General and administrative costs decreased from $6.4 million, or 14% of revenues in Q2 2002 to $5.5 million, or 16% of revenues in Q2 2003, and from $12.6 million, or 14% of revenues in Six Months 2002 to $11.6 million, or 17% in Six Months 2003. The decrease in absolute dollars is primarily attributable to a 6% and 3% decrease in the average number of personnel in the areas of human resources, finance and facilities management in Q2 2003 and Six Months 2003, respectively, as well as the net effect of reducing the 16 cost of our satellite offices. We expect that general and administrative costs as a percentage of revenues in fiscal year 2003 will be relatively consistent with 2002. STOCK COMPENSATION AND WARRANT COSTS. In April 2000, we recorded $95.5 million of unearned warrant costs related to a warrant granted to Visteon. This value was calculated using the Black-Scholes pricing model at the date of grant and is being amortized over a five-year period ending April 2005. In each of Q2 2002 and Q2 2003, $4.8 million was amortized related to this warrant, with $2.8 million reflected as a reduction to our revenues (reducing the revenues under the Visteon service contract to zero) and $2.0 million as stock compensation and warrant costs. In each of Six Months 2002 and Six Months 2003, $9.6 million was amortized related to this warrant, with $5.6 million reflected as a reduction to our revenues (reducing the revenues under the Visteon service contract to zero) and $4.0 million as stock compensation and warrant costs. INVESTMENT WRITE-DOWN. In Q1 2002, we recorded a $4.7 million loss on our investment in Adexa based on Adexa's financial condition. We concluded that there was an other than temporary decline in the value of our investment in Adexa. As of June 30, 2003, the remaining book value of our original $6.0 million investment in Adexa was $889,000. RESTRUCTURING CHARGES. In Q1 2003, in response to the continued economic slowdown, we recorded a restructuring charge covering the severance costs associated with the elimination of 79 positions in our global workforce. The estimated liability for severance and termination benefit costs will be paid by the end of Q3 2003. Additionally, in Q1 2003, we evaluated our office space in Pittsburgh, Pennsylvania, and ceased using one of the floors we lease in our global headquarters. The estimated liability for lease costs of $2.8 million will be paid in monthly installments over the non-cancelable lease term, which ends in May 2010. In accordance with SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," we recorded a restructuring charge of $4.7 million on Q1 2003, covering these severance and lease costs. We expect cost savings to be approximately $6.4 million on an annual basis as a result of this restructuring. INTEREST AND OTHER INCOME, NET Interest and other income increased from $1.0 in Q2 2002 to $1.1 million in Q2 2003, and increased from $1.8 million in Six Months 2002 to $2.1 million in Six Months 2003. The increase is primarily attributable to cash collections of $350,000 and $550,000 in Q2 2003 and Six Months 2003, respectively, from the settlement of patent infringement lawsuits in Q1 2003 partially offset by reduced interest income. In Q2 2002, we earned $790,000 at a weighted-average rate of return of 2.7%, compared to $660,000 at a weighted-average rate of return of 2.0% in Q2 2003. In Six Months 2002, we earned $1.6 million at a weighted-average rate of return of 2.8%, compared to $1.5 million at a weighted-average rate of return of 2.2% in Six Months 2003. PROVISION FOR INCOME TAXES Provision for income taxes was $193,000 in Q2 2002 and $216,000 in Q2 2003, and $346,000 in Six Months 2002 and $507,000 in Six Months 2003, all of which is comprised of foreign income taxes. CUMULATIVE EFFECT OF ACCOUNTING CHANGE FOR GOODWILL In Q1 2002, in connection with the implementation of SFAS No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Other Intangible Assets", we tested goodwill for impairment, and based on estimated future cash flows, recorded an impairment charge of $5.3 million. For further discussion, see Note 6 to the Condensed Consolidated Financial Statements. 17 LIQUIDITY AND CAPITAL RESOURCES

Net cash provided by operating activities totaled $7.7 million in Six Months 2002, compared to net cash used in operating activities of $7.4 million in Six Months 2003. Cash provided by operating activities in Six Months 2002 is primarily due to improvements in DSO and cash collections on record revenues in Q4 2001, partially offset by the payment of our annual incentive-based compensation of $9.4 million. Cash used in operations in Six Months 2003 is primarily due to operating losses incurred in Six Months 2003 primarily due to the 22% decrease in revenues from Six Months 2002 to Six Months 2003 and the payment of our annual incentive-based compensation of $6.6 million. Net cash from operating activities in Six Months 2002 and Six Months 2003 does not reflect $7.5 million and $6.6 million, respectively, received under our service contract with Visteon. Net cash used in investing activities totaled $20.7 million in Six Months 2002, compared to net cash provided by investing activities of $2.3 million in Six Months 2003. In Six Months 2002 and Six Months 2003, we incurred $2.4 million and $1.6 million, respectively, of capital expenditures primarily related to our continued expansion of information technology hardware, and to a lesser extent certain office space improvements. We expect our capital expenditures in fiscal 2003 will be consistent with 2002. Our investing activities also reflect the investment of funds in the normal course of our treasury management activities, which includes the movement of funds in and out of cash and cash equivalents and marketable investments to fund operations and maximize our rate of return. The net cash outflow of these funds in Six Months 2002 was $18.3 million, compared to net cash inflow into marketable investments of $4.0 million in Six Months 2003. Net cash provided by financing activities totaled $12.0 million in Six Months 2002 and $3.7 million in Six Months 2003. The positive financing cash flows in Six Months 2002 reflect proceeds of $5.3 million from the issuance of common stock through the employee stock purchase plan and option exercises and $7.5 million received in Six Months 2002 under our service contract with Visteon. We have determined, based on a review by the SEC in 2001, that we are required to classify these receipts as payment for the warrant that we granted in April 2000. The positive financing cash flows in Six Months 2003 reflect proceeds of $1.7 million from the issuance of common stock through the employee stock purchase plan and option exercises and $6.6 million received under our service agreement with Visteon, partially offset by $3.6 million used to repurchase common stock. In October 2001, we amended our bank credit facility to consist of a revolving credit facility with a maximum principal amount of $20.0 million and a $4.0 million term loan to be paid in 36 monthly installments, $3.7 million of which was used to retire borrowings under the previous revolving credit facility. Borrowings under the revolving credit facility and the term loan bear interest at the lender's prime rate and prime rate +0.50%, respectively. In February 2003, we again amended the revolving credit facility to reduce the availability from $20.0 million to $15.0 million and extend the maturity date through February 2004. As of June 30, 2003, 18 $1.3 million was outstanding under the term loan and the interest rate was 4.0%. At June 30, 2003, $13.8 million was available under the revolving credit facility based on eligible accounts receivable. Our current bank credit facility contains restrictive covenants, including a limitation on incurring additional indebtedness and paying dividends. Our bank credit facility also includes financial covenants as to maximum capital expenditures, minimum tangible net worth, minimum earnings and minimum quick ratio. We have pledged substantially all of our tangible assets as collateral for the current credit facility. As of June 30, 2003, we are in compliance with all covenants. In January 2003, the Board of Directors authorized the purchase of up to 15% of our outstanding common stock from time to time on the open market or in one or more negotiated transactions. As of June 30, 2003, we had purchased 853,500 shares at a weighted average cost of $4.23 per share, all of which have been retired. We will continue to invest in the growth of our business. We expect that our cash, cash equivalents and marketable investments will increase in the second half of 2003. However, we may decide to use these resources to fund the purchase of common shares or acquisitions of complementary businesses and technologies and, if we do so, our cash, cash equivalents and investments may decrease. Our allocation between cash and cash equivalents and marketable investments reflects our anticipated cash flow requirements in the future and current market interest rates. As of June 30, 2003, our marketable investment allocation represents 28% of total cash and investments, compared to 30% at December 31, 2002. We believe that our current resources will be sufficient to meet our working capital and capital expenditures for at least the next 18 to 24 months. If we are unable to continue to control costs or if we decide to use cash resources to fund the purchase of common shares or acquisitions of complimentary businesses or technologies, our resources may be depleted more quickly than we currently anticipate. In the event that additional financing is required, we may not be able to raise it on terms acceptable to us, if at all. There have been no material changes in our contractual obligations and commercial commitments during the quarter ended June 30, 2003 from those presented in our Annual Report on Form 10-K, as filed with the SEC on March 14, 2003. RECENTLY ADOPTED ACCOUNTING STANDARDS As discussed in Note 8 to the Condensed Consolidated Financial Statements, we implemented new accounting standards related to accounting for, and disclosure of, guarantees and the accounting for arrangements under which we will perform multiple revenue-generating activities beginning January 1, 2003. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There have been no material changes in our market risk exposure during the quarter ended June 30, 2003 that would require an update to the disclosure in our Annual Report on Form 10-K, as filed with the SEC on March 14, 2003. ITEM 4. CONTROLS AND PROCEDURES As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the Company's disclosure controls and procedures. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures as of the end of the period covered by this report have been designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by the Company in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. A controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls systems are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. 19 No change in the Company's internal control over financial reporting occurred during the Company's most recent fiscal quarter that has materially affected or is reasonable likely to materially affect, the Company's internal control over financial reporting. 20 PART II -- OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS See Note 9 to the Condensed Consolidated Financial Statements ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company held its Annual Meeting of Stockholders on May 21, 2003. Two matters were considered and voted upon at the Annual Meeting: the election of two persons to serve as Class I Directors for a three-year term and the ratification of the appointment of PricewaterhouseCoopers LLP as independent accountants to audit the financial statements of the Company and its subsidiaries for the fiscal year ending December 31, 2003. The nominations of Thomas J. Meredith and Davis A. Noble to serve as directors and the ratification of the appointment of PricewaterhouseCoopers LLP were considered and ultimately approved.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits

(b) Reports on Form 8-K. Form 8-K furnished on April 28, 2003 under Item 9, "Regulation FD Disclosure" but intended to be furnished under Item 12, "Results of Operations and Financial Condition" (with respect to a press release relating to the Company's performance in the first quarter of 2003). * * * * * * 21 SIGNATURE Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized in the City of Pittsburgh, Commonwealth of Pennsylvania on August 4, 2003. FREEMARKETS, INC. By: /s/ JOAN S. HOOPER ------------------------------------ JOAN S. HOOPER Executive Vice President, Chief Financial Officer, Secretary and Treasurer (Principal Financial and Accounting Officer) 22 EXHIBIT INDEX

FREEMARKETS INC 10-Q