10-Q 1 j0314002e10vq.txt FREEMARKETS, 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 SEPTEMBER 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) 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 October 1, 2003 was 42,440,099. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- FREEMARKETS, INC. FORM 10-Q FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003 INDEX

PAGE ---- PART I -- FINANCIAL INFORMATION Item 1. Financial Statements: Condensed Consolidated Balance Sheets as of ~~June~~September 30, 2003 (unaudited) and December 31, 2002............................................ 3 Condensed Consolidated Statements of Operations for the three and ~~six~~nine months ended ~~June~~September 30, 2003 and 2002 (unaudited)...................~~.........~~ 4 Condensed Consolidated Statements of Cash Flows for the ~~six~~nine months ended ~~June~~September 30, 2003 and 2002 (unaudited)................................~~.....~~ 5 Notes to Condensed Consolidated Financial Statements...................................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....................... 1211 Item 3. Quantitative and Qualitative Disclosures About Market Risk............................................... 19 Item 4. Controls and Procedures............................. 19 PART II -- OTHER INFORMATION Item 1. Legal Proceedings................................... 2120 Item ~~4. Submission of Matters to a Vote of Security Holders................................................... 21 Item~~ 6. Exhibits and Reports on Form 8-K.................... 2120 Signature................................................... 2221

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

~~JUNE~~SEPTEMBER 30, DECEMBER 31, 2003 2002* ------------- ------------ (UNAUDITED) ASSETS Current assets: Cash and cash equivalents................................. $ 9391,~~256~~634 $ 94,593 Short-term marketable investments......................... 2614,~~234~~764 25,323 Accounts receivable, net.................................. 2227,~~660~~746 25,673 Other current assets...................................... 76,~~638~~652 8,457 --------- --------- Total current assets................................... ~~149~~140,~~788~~796 154,046 Long-term marketable investments............................ 1024,~~045~~998 15,107 Property and equipment, net................................. 1412,~~656~~877 20,159 Goodwill and other assets, net.............................. 4,~~465~~453 4,355 --------- --------- Total assets........................................... $ ~~178~~183,~~954~~124 $ 193,667 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.......................................... $ 3,~~998~~544 $ 4,063 Accrued incentive compensation............................ 45,~~326~~301 7,536 Accrued restructuring charges............................. ~~426~~2,726 119 Other current liabilities................................. 18,~~642~~707 21,608 Current portion of long-term debt......................... 1,~~428~~151 1,502 --------- --------- Total current liabilities.............................. 2831,~~820~~429 34,828 Accrued restructuring charges, net of current portion....... 2,~~462~~375 -- Long-term debt.............................................. ~~438~~358 1,328 --------- --------- Total liabilities...................................... 3134,~~720~~162 36,156 --------- --------- Commitments and contingencies Stockholders' equity: Common stock.............................................. ~~420~~424 424 Additional capital........................................ ~~582~~588,~~676~~827 575,043 Unearned stock-based compensation......................... (4937) (104) Stock purchase warrants................................... 76,388 76,388 Accumulated other comprehensive loss...................... (~~200~~85) (1) Accumulated deficit....................................... (~~512~~516,~~001~~555) (494,239) --------- --------- Total stockholders' equity............................. ~~147~~148,~~234~~962 157,511 --------- --------- Total liabilities and stockholders' equity............. $ ~~178~~183,~~954~~124 $ 193,667 ========= =========

--------------- * 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)

THREE MONTHS ENDED ~~SIX~~NINE MONTHS ENDED ~~JUNE~~SEPTEMBER 30, ~~JUNE~~SEPTEMBER 30, ------------------ ---------------------- 2003 2002 2003 2002 ------- ------- --------- --------- Revenues.................................................... $3436,~~633~~022 $4440,~~604~~388 $ 69105,~~153~~175 $ 87128,~~777~~165 ------- ------- --------- --------- Operating costs and expenses: Cost of revenues.......................................... 1716,~~749~~633 1918,~~322~~701 3652,~~148~~781 3856,~~182~~883 Research and development.................................. 6,~~211~~100 6,~~916~~953 1218,~~701~~801 1219,~~058~~011 Sales and marketing....................................... 97,~~976~~952 10,~~928~~677 1927,~~345~~297 2334,~~912~~589 General and administrative................................ 54,~~520~~935 65,~~351~~429 1116,~~571~~506 1218,~~574~~003 Stock compensation and warrant costs...................... 1,~~989~~974 21,~~010~~989 35,~~978~~952 46,~~019~~008 Investment write-down..................................... -- --371 -- 45,~~740~~111 Restructuring ~~charge~~charges...................................... --3,207 --(278) 47,~~719~~926 --(278) ------- ------- --------- --------- Total operating costs and expenses.......................... 4140,~~445~~801 4543,~~527~~842 88129,~~462~~263 95139,~~485~~327 ------- ------- --------- --------- Operating loss.......................................... (64,~~812~~779) (~~923~~3,454) (1924,~~309~~088) (711,~~708~~162) Interest and other income, net.............................. ~~1,065~~559 ~~1,029~~611 2,~~054~~613 12,~~776~~387 ------- ------- --------- --------- (Loss) ~~income~~ before taxes and change in accounting............. (54,~~747~~220) ~~106~~(2,843) (1721,~~255~~475) (58,~~932~~775) Provision for income taxes.................................. ~~216~~334 ~~193~~181 ~~507~~841 ~~346~~527 ------- ------- --------- --------- Loss before change in accounting........................ (54,~~963~~554) (873,024) (1722,~~762~~316) (69,~~278~~302) Cumulative effect of accounting change for goodwill......... -- -- -- (5,327) ------- ------- --------- --------- Net loss................................................ $(54,~~963~~554) $ (873,024) $(1722,~~762~~316) $ (1114,~~605~~629) ======= ======= ========= ========= Basic and diluted earnings per share before accounting change.................................................... $ (0.1411) $ (0.0007) $ (0.4253) $ (0.1522) ======= ======= ========= ========= Basic and diluted earnings per share after accounting change.................................................... $ (0.1411) $ (0.0007) $ (0.4253) $ (0.2835) ======= ======= ========= ========= Shares used in computing basic and diluted earnings per share..................................................... 4142,~~705~~055 41,~~396~~798 41,~~851~~920 41,~~144~~364 ======= ======= ========= =========

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)

~~SIX~~NINE MONTHS ENDED ~~JUNE~~SEPTEMBER 30, ------------------- 2003 2002 -------- -------- Cash flows from operating activities: Net loss.................................................. $(1722,~~762~~316) $(1114,~~605~~629) Adjustments to reconcile net loss to net cash from operating a activities: Depreciation and amortization............................. 710,~~082~~162 914,~~739~~809 Provision for bad debts................................... 1,~~044~~435 ~~415~~1,125 Stock compensation and warrant costs...................... 35,~~978~~952 46,~~019~~008 Investment write-down..................................... -- 45,~~740~~111 Cumulative effect of accounting change for goodwill....... -- 5,327 Non-cash restructuring costs.............................. 89 -- Cash from changes in: Accounts receivable....................................... 1(2,~~031~~571) ~~746~~3,681 Other assets.............................................. ~~687~~1,696 (~~622~~1,063) Accounts payable.......................................... (65519) ~~573~~(1,123) Other liabilities......................................... (~~3,441~~131) (54,~~677~~918) -------- -------- Net cash from operating activities................... (76,~~357~~203) 714,~~655~~328 -------- -------- Cash flows from investing activities: Purchases of marketable investments....................... (2646,~~058~~853) (18,~~303~~614) Maturities of marketable investments...................... 3047,~~044~~414 --11,221 Capital expenditures, net................................. (12,~~646~~958) (25,~~396~~032) -------- -------- Net cash from investing activities................... (2,~~340~~397) (2012,~~699~~425) -------- -------- Cash flows from financing activities: Repayment of debt......................................... (1,~~464~~821) (~~787~~1,171) Proceeds from debt........................................ 500 -- Proceeds from customer fees applied to warrant............ ~~6,563~~ 7,500 10,313 Proceeds from issuance of common stock.................... 1,040 2,202 Payments to acquire and retire stock...................... (3,581) -- Options exercised......................................... ~~622~~2,003 3,~~122~~521 -------- -------- Net cash from financing activities................... 35,~~680~~641 1214,~~037~~865 -------- -------- Net change in cash and cash equivalents..................... (12,~~337~~959) (116,~~007)~~768 Cash and cash equivalents at beginning of period............ 94,593 80,482 -------- -------- Cash and cash equivalents at end of period.................. $ 9391,~~256~~634 $ 7997,~~475~~250 ======== ======== Supplemental non-cash disclosure: Amounts due from customer characterized as payment for warrant................................................ $ 13,~~875~~750 $ 1,875 ======== ========

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 potentially dilutive common shares were excluded from basic and diluted earnings per share because their effect was antidilutive due to the Company's net loss in the periods presented:

THREE MONTHS ~~ENDED~~NINE ~~SIX~~ MONTHS ENDED ~~JUNE~~ENDED SEPTEMBER 30, ~~JUNE~~SEPTEMBER 30, --------------~~----~~ --------------~~------~~ 2003 2002 2003 2002 ------- ------- -----~~---~~ -----~~---~~ ~~Loss~~Stock ~~before~~options ~~change in accounting...................... $~~(~~5,963)~~treasury ~~$ (87~~method) ~~$(17,762) $ (6,278) Cumulative effect of accounting change for goodwill~~.......... ~~-- -- -- (5,327) ------- ------- -------- -------- Net loss~~...~~.......................~~ ~~$(5~~3,~~963)~~804 ~~$ (87) $(17~~2,~~762)~~319 ~~$(11~~3,~~605)~~166 ~~======= ======= ======== ======== Weighted average common shares used in computing basic and diluted earnings per share...... 41~~3,705 41,396 41,851 41,144 Basic and diluted earnings per share before accounting change.......................... $ (0.14) $ (0.00) $ (0.42) $ (0.15) Basic and diluted earnings per share after accounting change... $ (0.14) $ (0.00) $ (0.42) $ (0.28)706

Options and warrants to purchase 8.8 million and 9.6 million shares of common stock were outstanding as of September 30, 2003 and 2002, respectively, but were not included in the computation of diluted EPS because the exercise price was greater than the average market price of the common shares. 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", as amended by SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure":

THREE MONTHS ENDED ~~SIX~~NINE MONTHS ENDED ~~JUNE~~SEPTEMBER 30, ~~JUNE~~SEPTEMBER 30, -------------------- -------------------- 2003 2002 2003 2002 -------- -------- -------- -------- Net loss, as reported............ $ (4,554) $ (3,024) $(22,316) $(14,629) Add: Stock-based ~~options~~employee compensation expense included in reported net income......... 12 28 67 123 Less: Total stock-based employee compensation expense determined under fair value method for all awards......................... (9,636) (13,283) (28,389) (39,851) -------- -------- -------- -------- Pro forma net loss............... 2$(14,~~780~~178) 3$(16,~~980~~279) 3$(50,~~455~~638) 4$(54,~~755~~357) ======== ======== ======== ======== Earnings per share: As reported...................... $ (0.11) $ (0.07) $ (0.53) $ (0.35) Pro forma........................ $ (0.34) $ (0.39) $ (1.21) $ (1.31)

6 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 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 September 30, 2003, the Company had purchased 853,500 shares at a weighted average cost of $4.23 per share. COMPREHENSIVE LOSS The components of comprehensive loss were as follows:

THREE MONTHS ENDED ~~SIX~~NINE MONTHS ENDED ~~JUNE~~SEPTEMBER 30, ~~JUNE~~SEPTEMBER 30, --------------------- --------------------- 2003 2002 2003 2002 -------- -------- -------- -------- Net loss~~, as reported~~........................ $ (54,~~963~~554) $ (873,024) $(1722,~~762~~316) $(1114,~~605~~629) ~~Add:~~Change ~~Stock-based~~in ~~employee~~unrealized ~~compensation~~value ~~expense~~on ~~included~~investments, ~~in reported~~ net ~~income~~..............~~........~~ 2756 47(48) 55(107) 95(8) ~~Less:~~Translation ~~Total~~adjustment, ~~stock-based employee compensation expense determined under fair value method for all awards~~net.....~~.................~~ ~~(9,390)~~59 (~~13,283~~243) ~~(18,753)~~23 (~~26,567~~693) -------- -------- -------- -------- ~~Pro forma net loss............~~ $(154,~~326~~439) $(133,~~323~~315) $(3622,~~460~~400) $(3815,~~077~~330) ======== ======== ======== ======== ~~Earnings per share: As reported................... $ (0.14) $ (0.00) $ (0.42) $ (0.15) Pro forma..................... $ (0.37) $ (0.32) $ (0.87) $ (0.93)~~

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

~~THREE~~SEPTEMBER ~~MONTHS ENDED THREE MONTHS ENDED JUNE~~ 30, ~~MARCH~~DECEMBER 31, 2003 2002 -------------~~-----~~ ------------~~------~~ ~~2003~~(IN ~~2002~~THOUSANDS) ~~2003~~Unrealized ~~2002~~(losses) ~~-----~~gains ~~-----~~on ~~-----~~investments, ~~----- Weighted average risk-free interest rate~~net.................................. 3.~~0% 5~~.~~25% 4~~.~~75% 5~~.~~25% Expected life (number of years)~~...~~......~~ ~~6.3~~$(59) ~~5.2~~$ ~~6.5~~48 ~~5.2~~Cumulative ~~Volatility~~translation adjustments............~~..................~~ ~~100%~~(26) ~~100%~~(49) ~~120%~~---- ~~100%~~---- $(85) $ (1) ==== ====

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. During Q3 2002, the Company recorded a $371,000 loss on its investment in Adexa based on a valuation determined by a financing completed by Adexa in July 2002. The Company concluded after each of these reviews that there was an other than temporary decline in the value of its investment in Adexa. As of September 30, 2003, the remaining book value of the original $6.0 million investment in Adexa was $889,000. NOTE 5. RESTRUCTURING CHARGES Throughout 2003, the Company has initiated three restructuring programs. These programs were focused on eliminating certain positions throughout its global workforce, re-assessing the Company's facility needs and consolidating European operations to create a more profitable and efficient business. The following is a summary of these programs: WORKFORCE REDUCTION PLAN In the first quarter of 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. This represented 7 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) approximately 7% of total employees. The Company recorded a restructuring charge of $1.8 million in the first quarter of 2003 covering these severance costs, the majority of which will be paid by the end of 2003. FACILITY REDUCTION PLAN In the first quarter of 2003, the Company re-assessed its global headquarters office space in Pittsburgh, Pennsylvania, and ceased using one of the floors it leases through May 2010. The Company recorded a restructuring charge of $3.0 million in the first quarter of 2003 covering these lease costs. EUROPEAN RESTRUCTURING PLAN In the third quarter of 2003, in order to better serve the Company's customers and enable it to create a more leveraged, profitable and efficient business across Europe, the Company initiated a restructuring plan resulting in the elimination of 74 positions in its European business. The Company recorded a restructuring charge of $3.2 million in the third quarter of 2003 covering these severance and implementation costs. The restructuring reserve activity under these plans for the period ended September 30, 2003 was:

~~THREE~~BALANCE ~~MONTHS~~AT ~~ENDED~~INITIAL ~~SIX~~CHARGE ~~MONTHS~~AMOUNTS ~~ENDED~~UTILIZED ~~JUNE~~SEPTEMBER 30, ~~JUNE~~2003 ~~30,~~ --------------~~----~~ ----------------~~------~~ ~~2003 2002 2003 2002~~ ------- ----- -------- ~~--------~~WORKFORCE ~~Net~~REDUCTION ~~loss~~PLAN: Employee severance and termination benefit costs... $1,754 $1,692 $ 62 FACILITY REDUCTION PLAN: Lease costs.................... ~~$(5~~2,~~963)~~876 $169 ~~(87) $(17~~2,~~762)~~707 ~~$(11,605)~~Asset ~~Change in unrealized value on investments, net~~write-offs.............. ~~(25)~~89 ~~172~~89 ~~(163)~~-- 40EUROPEAN ~~Translation~~RESTRUCTURING ~~adjustment,~~PLAN: ~~net~~Employee severance and termination benefit costs.... 273,132 ~~(470)~~875 ~~(36)~~2,257 ~~(450)~~Implementation costs.......... 75 --~~-----~~ 75 ------ -------- -------- Total......................... $(57,~~961)~~926 $~~(385) $(17~~2,~~961)~~825 ~~$(12~~5,~~015)~~101 ======= ===== =~~=======~~ Less current portion.......... 2,726 ------ Restructuring accrual, net of current portion............. $2,375 ========

In addition, in the third quarter of 2002, the Company recognized a benefit of $278,000 as a result of a change in an estimate related to lease costs from a previous restructuring program. 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 the first quarter of 2002 as a cumulative effect of an accounting change. The Company completed its annual impairment test for 2003 in the first quarter of 2003. There was no indication of impairment as a result of this test. 8 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 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:

~~JUNE~~THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, ~~DECEMBER~~SEPTEMBER 3130, ~~2003 2002~~ ------------------- ----------------- ~~(IN~~2003 ~~THOUSANDS)~~2002 ~~Unrealized~~2003 ~~(losses)~~2002 ~~gains~~------- on------- ~~investments,~~------ ~~net~~------ Research and development............. $~~(115)~~ 2 $ 4817 ~~Cumulative~~$ ~~translation~~12 ~~adjustments~~$ 77 Sales and marketing.................. ~~(85)~~1,972 ~~(49)~~1,972 5,940 5,931 ------ ------ ~~$(200)~~------ ------ $1,974 ($1),989 $5,952 $6,008 ====== ====== ====== ======

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. 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 plaintiffs have filed a motion for class certification which is still pending before the Court. Discovery is in the early stages. 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 9 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) foregoing securities fraud 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. 10 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. 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 11 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. We assess whether the fees are fixed or determinable based on the payment terms associated with the transactions and whether the sales price is subject to refund or adjustment. We assess collectibility based primarily on the creditworthiness of the customer as determined by credit checks and analysis, as well as the customer's payment history. 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 by our customers without cause and 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 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. 12 STOCK COMPENSATION SFAS No. 123, "Accounting for Stock-Based Compensation", as amended by SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure", 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 instead 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:

~~BALANCE~~THREE ATMONTHS ~~INITIAL~~ENDED ~~CHARGE~~NINE ~~AMOUNTS~~MONTHS ~~UTILIZED~~ENDED ~~JUNE~~SEPTEMBER 30, ~~2003~~SEPTEMBER 30, ------------------- --------------------- 2003 2002 2003 2002 ------- ------- ~~Employee~~-------- ~~severance~~-------- Revenues and ~~termination benefit costs~~fees..............~~.....~~ $138,~~754~~835 $143,~~664~~201 $113,613 90$136,603 ~~Lease~~Less ~~costs~~fees characterized as payment for warrant..........~~.............~~ (2,~~876~~813) 89 (2,~~787~~813) ~~Asset~~(8,438) ~~write-offs..................~~(8,438) ~~89 89~~ ------- ------- -------- -------- ~~Total~~Revenues.......................~~......~~ $436,~~719~~022 $140,~~842~~388 2$105,~~877~~175 $128,165 ======= ======= ~~Less~~======== ~~current portion.............. 415 ------ Restructuring accrual, net of current portion................. $2,462~~ ========

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, 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. 13 RESULTS OF OPERATIONS The following table sets forth condensed consolidated statements of operations data as a percentage of revenues for the periods indicated:

THREE MONTHS ENDED ~~SIX~~NINE MONTHS ENDED ~~JUNE~~SEPTEMBER 30, ~~JUNE~~SEPTEMBER 30, ------------------- ----------------- 2003 2002 2003 2002 ------- ------- ------ ------ ~~Research~~Revenues............................ 100% 100% 100% 100% Operating costs and ~~development~~expenses: Cost of revenues.................. $46 546 $50 3044 $Research 10and $development.......... 6017 17 18 15 Sales and marketing............... 22 27 26 27 General and administrative........ 14 14 16 14 Stock compensation and warrant costs.......................... 5 5 5 5 Investment write-down............. -- 1~~,984~~ -- 4 Restructuring charges............. 9 (1~~,980~~) 38 (0) ----- ----- ----- ----- Operating loss................. (13) (9) (23) (9) Interest and other income,~~968~~ net...... 1 2 3~~,959~~ 2 ----- ----- ----- ----- Loss before taxes and change in accounting................... (12) (7) (20) (7) Provision for income taxes.......... 1 0 1 0 ----- ----- ----- ----- ~~$1,989~~Loss ~~$2,010~~before ~~$3,978~~change $in accounting................... (13) (7) (21) (7) Cumulative effect of accounting change for goodwill............... -- -- -- (4~~,019~~) ----- ----- ----- ----- Net loss....................... (13%) (7%) (21%) (11%) ====== ====== ====== ======

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 All references to "Q3 2003" and "Q3 2002" are for the three months ended September 30, 2003 and 2002, respectively. All references to "Nine Months 2003" and "Nine Months 2002" are for the nine months ended September 30, 2003 and 2002, respectively. REVENUES Revenues decreased 11% from $40.4 million in Q3 2002 to $36.0 million in Q3 2003, and decreased 18% from $128.2 million in Nine Months 2002 to $105.2 million in Nine 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 Q3 2002 and Q3 2003, and $8.4 million in each of Nine Months 2002 and Nine Months 2003. Revenues and fees decreased 10% from $43.2 million in Q3 2002 to $38.8 million in Q3 2003 and decreased 17% from $136.6 million in Nine Months 2002 to $113.6 million in Nine 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 and the first nine months of 2003, 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 14 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 the continued introduction of new products and services will drive customer acquisition, market share expansion and overall revenue gains over the long term. The following is a breakdown of revenues by product (in thousands):

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

THREE MONTHS ENDED ~~SIX~~THREE MONTHS ENDED ~~JUNE~~NINE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, ~~JUNE~~2003 SEPTEMBER 30, 2002 SEPTEMBER 30, 2003 SEPTEMBER 30, 2002 -------------------- -------------------- ~~2003 2002 2003 2002~~ ----- ----- ----------- --------------------- ~~Revenues..............................................~~$ ~~100~~% ~~100%~~OF ~~100%~~TOTAL ~~100~~$ % ~~Operating~~OF ~~costs~~TOTAL ~~and~~$ ~~expenses:~~% ~~Cost~~OF ofTOTAL ~~revenues,...................................~~$ 51% 43OF 52TOTAL 44 Research and development............................ 18 16 18 14 Sales and marketing................................. 29 25 28 27 General and administrative.......................... 16 14 17 14 Stock compensation and warrant costs................ 6 4 6 5 Investment write-~~down...............................~~ -- -- -- ~~5 Restructuring charges...............................~~ -- -- 7 -- ---- --- ---- ---------- ~~Operating loss................................... (20) (2) (28) (9) Interest and other income, net........................ 3 2 3 2~~ -------- ---------- -------- ---------- ~~(Loss) / income before taxes and change in accounting~~FullSource...........~~..........................~~ ~~(17)~~$26,822 069% ~~(25)~~$34,926 ~~(7)~~81% ~~Provision~~$ ~~for~~81,848 ~~income~~72% ~~taxes~~$113,345 83% All other............~~................~~ 012,013 031 18,275 019 31,765 28 23,258 17 --- ---- --- --- ~~Loss before change in accounting................. (17) (0) (26) (7) Cumulative effect of accounting change for goodwill...~~ -- -- --- ~~(6)~~ -------- --- -------- --- ~~Net~~Total ~~loss~~revenues and fees...............~~..........................~~ ~~(17~~$38,835 100%) (0$43,201 100%) ~~(26~~$113,613 100%) ~~(13~~$136,603 100%) ======= === ======= === ======== === ======== ===

OPERATING COSTS AND EXPENSES COST OF REVENUES. Cost of revenues decreased from $18.7 million, or 46% of revenues in Q3 2002 to $16.6 million, or 46% of revenues in Q3 2003, and decreased from $56.9 million, or 44% of revenues in Nine Months 2002 to $52.8 million, or 50% of revenues in Nine Months 2003. The increase in cost of revenues as a percentage of revenues from Nine Months 2002 to Nine Months 2003 was primarily the result of the 18% decrease in revenues, partially offset by 7% overall decrease in cost of revenues. The decrease in terms of absolute dollars is attributable to lower customer out-of-pocket costs in Q3 2003 and Nine Months 2003 in the amount of $363,000 and $1.1 million, respectively, and reduced overhead, primarily comprised of depreciation expense, of $1.4 million and $2.7 million in Q3 2003 and Nine Months 2003, respectively. 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 compared to 2002, but higher as a percentage of revenues due primarily to a reduction in revenues. RESEARCH AND DEVELOPMENT. Research and development costs decreased from $7.0 million, or 17% of revenues in Q3 2002 to $6.1 million, or 17% of revenues in Q3 2003, and decreased slightly from $19.0 million, or 15% in Nine Months 2002 to $18.8 million, or 18% in Nine Months 2003. The decrease in absolute dollars in both periods is primarily attributable to reduced consulting costs in the amount of $1.2 million and $2.4 million in Q3 2003 and Nine Months 2003, respectively, associated with the investments in our product development pipeline in 2002, partially offset by a 20% and 28% increase in average research and development staff in Q3 2003 and Nine Months 2003, respectively. 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 $10.7 million, or 27% of revenues in Q3 2002 to $8.0 million, or 22% of revenues in Q3 2003, and from $34.6 million, or 27% in Nine Months 2002 to $27.3 million, or 26% in Nine Months 2003. The decrease in absolute dollars in both periods is primarily attributable to a 17% and 15% decrease in the average number of sales and marketing staff in Q3 2003 and Nine Months 2003, respectively. The decrease is also attributable to reduced overhead, primarily comprised of depreciation expense of $701,000 and $2.3 million in Q3 2003 and Nine Months 2003, respectively, and cost cutting measures in discretionary spending such as marketing and advertising, recruiting and relocation costs. We 15 expect that our sales and marketing costs in fiscal 2003 will be lower in absolute dollars and as a percentage of revenues compared to 2002. GENERAL AND ADMINISTRATIVE. General and administrative costs decreased from $5.4 million, or 14% of revenues in Q3 2002 to $4.9 million, or 14% of revenues in Q3 2003, and from $18.0 million, or 14% of revenues in Nine Months 2002 to $16.5 million, or 16% in Nine Months 2003. The decrease in absolute dollars in both periods is primarily attributable to a 11% and 6% decrease in the average number of personnel in the areas of human resources, finance and facilities management in Q3 2003 and Nine Months 2003, respectively, as well as reduced overhead, primarily comprised of depreciation expense, of $293,000 and $1.3 million in Q3 2003 and Nine Months 2003, respectively. The increase in general and administrative costs as a percentage of revenues from Nine Months 2002 to Nine Months 2003 was primarily the result of the 18% decrease in revenues from Nine Months 2002 and Nine Months 2003. We expect that general and administrative costs in fiscal 2003 will be lower in absolute dollars compared to 2002, but higher as a percentage of revenues due primarily to a reduction in revenues. 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 Q3 2002 and Q3 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 Nine Months 2002 and Nine Months 2003, $14.3 million was amortized related to this warrant, with $8.4 million reflected as a reduction to our revenues (reducing the revenues under the Visteon service contract to zero) and $5.9 million as stock compensation and warrant costs. INVESTMENT WRITE-DOWN. In Q3 2002, we recorded a $371,000 loss on our investment in Adexa. The loss was based on a valuation determined by a financing completed by Adexa in July 2002. Also, in Q1 2002, we recorded a $4.7 million loss on our investment in Adexa based on Adexa's financial condition. In each instance, we concluded that there was an other than temporary decline in the value of our investment in Adexa. As of September 30, 2003, the remaining book value of our original $6.0 million investment in Adexa was $889,000. RESTRUCTURING CHARGES. Throughout 2003, we have initiated three restructuring programs. These programs were focused on eliminating certain positions throughout our global workforce, re-assessing our facility needs and consolidating European operations to create a more profitable and efficient business. We expect to generate annual savings of approximately $13.0 million as a result of these programs of which $7.2 million will be reflected in 2003 results. The following is a summary of these programs: WORKFORCE REDUCTION PLAN. In Q1 2003, in response to the continued economic slowdown, we executed a restructuring plan resulting in the elimination of 79 positions in its global workforce. This represented approximately 7% of total employees. We recorded a restructuring charge of $1.8 million in Q1 2003 covering these severance costs. The majority of the liability for employee severance and termination benefit costs will be paid by the end of 2003. FACILITY REDUCTION PLAN. Also in Q1 2003, we re-assessed our global headquarters office space in Pittsburgh, Pennsylvania, and ceased using one of the floors we lease through May 2010. We recorded a restructuring charge of $3.0 million in Q1 2003, covering these lease costs. We are continuing to evaluate our office space requirements at our headquarters. As a result of an evaluation completed in the fourth quarter of 2003, we ceased using one of the floors we lease through May 2010, and expect to record a restructuring charge of $1.9 million in the fourth quarter of 2003. EUROPEAN RESTRUCTURING PLAN. In Q3 2003, in order to better serve our customers and enable us to create a more leveraged, profitable and efficient business across Europe, we initiated a restructuring plan resulting in the elimination of 74 positions in its European business. We recorded a restructuring charge of $3.2 million in Q3 2003 covering these severance and implementation costs. The majority of the liability for employee severance and implementation costs will be paid by the end of 2003. We expect to close its Belgium office in Q4 2003, which will result in an additional charge of $3.0 million to $4.0 million to cover lease termination costs, non-cash write-off of assets related to the Brussels office and additional severance costs. 16 In Q3 2002, we re-evaluated our office space in one of our foreign offices and made an adjustment to the restructuring reserve in the amount of $278,000. INTEREST AND OTHER INCOME, NET Interest and other income decreased from $611,000 in Q3 2002 to $559,000 in Q3 2003, and increased from $2.4 million in Nine Months 2002 to $2.6 million in Nine Months 2003. The decrease from Q3 2002 to Q3 2003 is primarily the result of reduced interest income, partially offset by cash collections of $300,000 from the settlement of patent infringement lawsuits. The increase from Nine Months 2002 to Nine Months 2003 in Nine Months 2003 is primarily attributable to cash collections of $850,000 in Nine Months 2003 from the settlement of patent infringement lawsuits, partially offset by reduced interest income. In Q3 2002, we earned $758,000 at a weighted-average rate of return of 2.4%, compared to $324,000 at a weighted-average rate of return of 1.0% in Q3 2003. In Nine Months 2002, we earned $2.3 million at a weighted-average rate of return of 2.7%, compared to $1.8 million at a weighted-average rate of return of 1.8% in Nine Months 2003. PROVISION FOR INCOME TAXES Provision for income taxes was $181,000 in Q3 2002 and $334,000 in Q3 2003, and $527,000 in Nine Months 2002 and $841,000 in Nine Months 2003. The increase in both periods is attributable to an increase in 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. LIQUIDITY AND CAPITAL RESOURCES

~~THREE~~SEPTEMBER ~~MONTHS ENDED THREE MONTHS ENDED SIX MONTHS ENDED SIX MONTHS ENDED JUNE~~ 30, ~~2003~~DECEMBER ~~JUNE 30~~31, ~~2002 JUNE 30,~~ 2003 ~~JUNE 30,~~ 2002 ~~--------------------~~CHANGE -------------~~-------~~ ------------~~--------~~ -------~~-------------~~ ($ %IN OFTHOUSANDS) ~~TOTAL~~Cash $and %cash ~~OF TOTAL $ % OF TOTAL $ % OF TOTAL ------- ---------- ------- ---------- ------- ---------- ------- ---------- FullSource~~equivalents................. $~~24,001~~ ~~69% $36~~91,~~259~~634 ~~81%~~ $49 94,~~401~~593 ~~71%~~ $72(2,~~794~~959) ~~83%~~Marketable ~~All other~~investments.................... 1039,~~632~~762 ~~31 8~~40,~~345~~430 19(668) ~~19,752 29 14,983 17~~ ------- --- ------- --- ------- ~~---~~Total ~~-------~~cash ~~---~~and ~~Total revenues~~investments.............. $34131,~~633~~396 ~~100%~~ $44135,~~604~~023 ~~100%~~ $69(3,~~153~~627) ~~100% $87,777 100%~~ ======= === ======= === ======= ~~===~~Percentage ~~=======~~of ~~===~~total assets.............. 72% 70% 2 pts. Working capital........................... $109,367 $119,218 $(9,851) Current ratio............................. 4.5 to 1 4.4 to 1 Days sales outstanding (DSO).............. 58 51

~~THREE~~NINE MONTHS ENDED ~~THREE~~SEPTEMBER ~~MONTHS ENDED SIX MONTHS ENDED SIX MONTHS ENDED JUNE~~ 30, ~~2003 JUNE 30, 2002 JUNE 30, 2003 JUNE 30, 2002~~ -------------------- 2003 2002 CHANGE -------~~-------------~~ --------~~------------~~ --------~~------------~~ ($ %IN OFTHOUSANDS) ~~TOTAL~~Cash $flows %from OFoperating ~~TOTAL $ % OF TOTAL $ % OF TOTAL ------- ---------- ------- ---------- ------- ---------- ------- ---------- FullSource~~activities............. $26(6,~~813~~203) ~~72%~~ $39 14,~~071~~328 ~~82%~~ $55(20,~~026~~531) ~~74%~~Cash ~~$78,419~~flows ~~84%~~from ~~All~~investing ~~other~~activities...........~~...~~ 10(2,~~632~~397) ~~28 8~~(12,~~345~~425) ~~18 19~~10,~~752~~028 26Cash ~~14,983~~flows 16from ~~-------~~financing ~~--- ------- --- ------- --- ------- --- Total revenues and fees~~activities...........~~......~~ ~~$37~~5,~~445~~641 ~~100% $47~~14,~~416~~865 ~~100% $74~~(9,~~778 100% $93,402 100% ======= === ======= === ======= === ======= ===~~224)

Net cash provided by operating activities totaled $14.3 million in Nine Months 2002, compared to net cash used in operating activities of $6.2 million in Nine Months 2003. Cash provided by operating activities in Nine 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 Nine Months 2003 is primarily due to operating losses incurred in Nine Months 2003 primarily due to the 18% decrease in revenues from Nine Months 2002 to Nine Months 2003, an increase in DSO's and the 17 payment of our annual incentive-based compensation of $6.6 million. Net cash from operating activities in Nine Months 2002 and Nine Months 2003 does not reflect $10.3 million and $7.5 million, respectively, received under our service contract with Visteon. Net cash used in investing activities totaled $12.4 million in Nine Months 2002, compared to $2.4 million in Nine Months 2003. In Nine Months 2002 and Nine Months 2003, we incurred $5.0 million and $3.0 million, respectively, of capital expenditures primarily related to our continued expansion of information technology hardware. We expect our capital expenditures in fiscal 2003 will be lower than 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 Nine Months 2002 was $7.4 million, compared to net cash inflow of $561,000 in Nine Months 2003. Net cash provided by financing activities totaled $14.9 million in Nine Months 2002 and $5.6 million in Nine Months 2003. The positive financing cash flows in Nine Months 2002 reflect proceeds of $5.7 million from the issuance of common stock through the employee stock purchase plan and option exercises and $10.3 million received in Nine Months 2002 under our service contract with Visteon, partially offset by repayment of debt of $1.2 million. 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 Nine Months 2003 reflect proceeds of $3.0 million from the issuance of common stock through the employee stock purchase plan and option exercises and $7.5 million received under our service agreement with Visteon, partially offset by $3.6 million used to repurchase common stock and repayment of debt of $1.8 million. 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 September 30, 2003, $1.1 million was outstanding under the term loan and the interest rate was 4.5%. At September 30, 2003, $14.3 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 September 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 September 30, 2003, we had purchased 853,500 shares at a weighted average cost of $4.23 per share, all of which have been retired. In September 2003, an arbitrator in Portugal ruled in our favor in proceedings against a former Brazilian customer for amounts earned in 2000, which we wrote-off in 2001. The amount of the arbitration award was $1.7 million, which includes accrued interest from the date the invoices were due. We will record this award as a reduction to bad debt expense in cost of revenues on the cash basis of accounting due to the uncertainty of collection. We will continue to invest in the growth of our business. We expect that our cash, cash equivalents and marketable investments will increase in Q4 2003. However, we may decide to use 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 September 30, 2003 and December 31, 2002, our marketable investment allocation represents 30% of total cash and investments. 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 18 use cash resources to fund the purchase of common shares or acquisitions of complementary 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 September 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 September 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. 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. 19 PART II -- OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS See Note 9 to the Condensed Consolidated Financial Statements ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits

~~JUNE~~EXHIBIT ~~30,~~NUMBER ~~DECEMBER~~DESCRIPTION ~~31, 2003 2002 CHANGE~~ -------- ------------ ~~-------~~99.1 ($Certification INof ~~THOUSANDS)~~Chief ~~Cash~~Executive ~~and~~Officer ~~cash~~pursuant ~~equivalents....................~~to $Section ~~93,256~~302 $of ~~94,593~~the ~~$(1,337)~~Sarbanes-Oxley ~~Marketable~~Act ~~investments~~of 2002. 99.~~.....................~~2 ~~36,279~~Certification ~~40,430~~of ~~(4,151)~~Chief ~~--------~~Financial ~~--------~~Officer ~~-------~~pursuant ~~Total~~to ~~cash~~Section ~~and~~302 ~~investments.................~~of ~~$129,535~~the ~~$135,023~~Sarbanes-Oxley ~~$(5,488)~~Act ~~========~~of ~~========~~2002. ~~=======~~99.3 ~~Percentage~~Certification ofby ~~total~~the ~~assets.................~~Chief ~~72%~~Executive ~~70%~~Officer ~~2pt.~~and ~~Working~~Chief ~~capital..............................~~Financial ~~$120,968~~Officer ~~$119,218~~Relating $to ~~1,750~~a ~~Days~~Periodic ~~sales~~Report ~~outstanding~~Containing ~~(DSO).................~~Financial ~~56 51~~Statements

(b) Reports on Form 8-K. Form 8-K furnished on July 24, 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 second quarter of 2003). * * * * * * 20 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 October 29, 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) 21 EXHIBIT INDEX

SIX MONTHS ENDED JUNE 30, ------------------ 2003 2002 CHANGE ------- -------- -------- ($ IN THOUSANDS) Cash flows from operating activities........... $(7,357) $ 7,655 $(15,012) Cash flows from investing activities........... 2,340 (20,699) 23,039 Cash flows from financing activities........... 3,680 12,037 (8,357)

VOTES VOTES VOTES BROKER NOMINEE FOR AGAINST WITHHELD NON-VOTES ------- ---------- --------- --------- --------- Thomas J. Meredith.............................. 31,267,469 -- 5,250,874 -- David A. Noble.................................. 31,688,994 -- 4,829,349 --

VOTES VOTES BROKER VOTES FOR AGAINST ABSTAINED NON-VOTES ---------- --------- --------- --------- Ratification of the appointment of PricewaterhouseCoopers LLP.................... 31,462,517 4,985,329 72,947 --

EXHIBIT NUMBER DESCRIPTION ------- ----------- 99.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 99.2 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 99.3 Certification by the Chief Executive Officer and Chief Financial Officer Relating to a Periodic Report Containing Financial Statements

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