10-Q 1 j0067902e10vq.txt FREEMARKETS, INC. 10-Q -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 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 MARCH 31, 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 (I.R.S. Employer Incorporation or Organization) Identification No.) FREEMARKETS CENTER 15222 210 SIXTH AVENUE (Zip Code) PITTSBURGH, PA (Address of Principal Executive Offices)

Registrant's telephone number, including area code: (412) 434-0500 Registrant's URL: HTTP:WWW.FREEMARKETS.COM 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 March 31, 2003 was 41,653,931. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- FREEMARKETS, INC. FORM 10-Q FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003 INDEX

2 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; AMOUNTS 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 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 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 $3.60 in Q1 2003 and $17.52 in Q1 2002. 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 March 31, 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:

7 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 after this review that there was an other than temporary decline in the value of its investment in Adexa. As of March 31, 2003, the remaining book value of the 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. The restructuring reserve activity under the 2003 Restructuring Plan for the period ended March 31, 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. 8 The restructuring reserve activity under the 2001 Restructuring Plan for the period ended March 31, 2003 was:

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:

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 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. 9 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. The Company believes that the claims asserted against it are without merit, and it intends to defend these claims vigorously. 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. We serve our customers from 19 locations in 15 countries on five continents. Our team members provide service to customers in more than 35 languages through operations centers in Pittsburgh, Brussels and Singapore. 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 11 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 Savings 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. 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. GOODWILL We adopted Statement of Financial Accounting Standard ("SFAS") No. 142, "Goodwill and Other Intangible Assets" on January 1, 2002. This standard requires that goodwill no longer be amortized, and instead, be tested for impairment on a periodic basis. At March 31, 2003, we had $2.0 million in goodwill on our 12 consolidated balance sheet related to Surplus Record. In accordance with SFAS No. 142, it is our policy to assess the potential impairment of goodwill on an annual basis or earlier as circumstances dictate. 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, 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 statement of operations data as a percentage of revenues for the periods indicated:

THREE MONTHS ENDED MARCH 31, 2003 AND 2002 All references to "Q1 2003" and "Q1 2002" are for the three months ended March 31, 2003 and 2002, respectively. REVENUES Revenues decreased 20% from $43.2 million in Q1 2002 to $34.5 million in Q1 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 Q1 2002 and Q1 2003. Revenues and fees decreased 19% from $46.0 million in Q1 2002 to $37.3 million in Q1 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 the continued introduction of new products and services over the long-term will drive customer acquisition, market share expansion and overall revenue gains. 14 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 $18.9 million in Q1 2002 to $18.4 million in Q1 2003. As a percentage of revenues, cost of revenues increased from 44% in Q1 2002 to 53% in Q1 2003. The increase in cost of revenues as a percentage of revenues from Q1 2002 to Q1 2003 was primarily the result of the 20% decrease in revenues from Q1 2002 to Q1 2003 and an increase in bad debt expense of $610,000 from Q1 2002 to Q1 2003 due to the write-off of approximately $900,000 due from a single customer. The decrease in terms of absolute dollars was the net effect of higher bad debt expense and less incentive compensation and customer reimbursements. 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 increased from $5.1 million, or 12% of revenues in Q1 2002, to $6.5 million, or 19% of revenues in Q1 2003. The increase was primarily related to a 38% increase in the average number of research and development staff. The increase as a percentage of revenues was also due to the 20% decrease in revenues from Q1 2002 to Q1 2003. We expect that our research and development costs as a percentage of revenues in 2003 will be higher than 2002. SALES AND MARKETING. Sales and marketing costs decreased from $13.0 million, or 30% of revenues in Q1 2002, to $9.4 million, or 27% of revenues in Q1 2003. The decrease reflects a 12% decrease in average sales and marketing staff in Q1 2003 compared to Q1 2002 and a 44% decrease in marketing and trade show 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 $6.2 million, or 14% of revenues in Q1 2002, to $6.1 million, or 18% of revenues in Q1 2003. Costs were flat in terms of absolute dollars, but the increase as a percentage of revenues was primarily related to the 20% decrease in revenues in Q1 2003 compared to Q1 2002. We expect that our 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 Q1 2002 and Q1 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. 15 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 after this review that there was an other than temporary decline in the value of our investment in Adexa. As of March 31, 2003, the remaining book value of our original $6.0 million investment in Adexa was $889,000. RESTRUCTURING CHARGE. 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. 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, net increased from $747,000 in Q1 2002 to $1.0 million in Q1 2003. The increase was primarily attributable to cash collections of $200,000 from the settlement of patent infringement lawsuits in Q1 2003. In Q1 2002, we earned $769,000 at a weighted-average rate of return of 2.8%, compared to $814,000 at a rate of return of 2.5% in Q1 2003. PROVISION FOR INCOME TAXES. Provision for income taxes was $153,000 in Q1 2002 and $291,000 in Q1 2003, and is comprised of foreign income taxes. The increase from Q1 2002 to Q1 2003 is primarily attributable to the continued expansion of international locations throughout 2002 and Q1 2003. 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

Net cash provided by operating activities totaled $6.9 million in Q1 2002, compared to net cash used in operating activities of $6.6 million in Q1 2003. Cash provided by operating activities in Q1 2002 is primarily due to improvements in DSO and cash collections on record revenues in Q4 2001, partially offset by the timing of the payment of our annual incentive-based compensation payments. Cash used in operations in Q1 2003 is primarily due to operating losses incurred in Q1 2003 primarily due to the 20% decrease in revenues from Q1 2002 to Q1 2003 and the payment of our annual incentive-based compensation payments. Net cash from operating activities in Q1 2002 and Q1 2003 does not reflect $3.8 million received under our service contract with Visteon. 16 Net cash used in investing activities totaled $9.4 million in Q1 2002, compared to net cash provided by investing activities of $17.4 million in Q1 2003. In Q1 2002 and Q1 2003, we incurred $1.1 million and $219,000, respectively, of capital expenditures primarily related to our continued expansion of information technology hardware, and to a lesser extent certain office space improvements. As a result of the significant investments we have made in our operations, infrastructure and personnel in past years, 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 maximize our rate of return. The net cash outflow in Q1 2002 was $8.3 million, compared to net cash inflow of $17.6 million in Q1 2003. Net cash provided by financing activities totaled $5.8 million in Q1 2002, compared to net cash used in financing activities of $35,000 in Q1 2003. The positive financing cash flows in Q1 2002 primarily reflect proceeds of $2.5 million from the issuance of stock from the exercise of stock options and $3.8 million received in Q1 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 to Visteon in April 2000. The net cash used in financing activities in Q1 2003 primarily reflect $3.6 million to repurchase common stock and $874,000 in debt repayments, partially offset by $3.8 million received under our service agreement with Visteon. 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 old 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 March 31, 2003, $1.7 million was outstanding under the term loan and the interest rate was 4.75%. At March 31, 2003, $12.6 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 March 31, 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 March 31, 2003, we had purchased 853,500 shares at a weighted average cost of $4.23 per share. We will continue to invest in the growth of our business. In Q2 2003, we anticipate negative net cash flows as a result of operating losses in Q2 2003, with positive net cash flows in the second half of 2003. We may decide to use cash resources to fund the purchase of common shares or acquisitions of complementary businesses and technologies and, if we do so, we may experience negative cash flows. 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 March 31, 2003, our marketable investment allocation represents 18% 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 decided 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 March 31, 2003 from those presented in our Annual Report on Form 10-K, as filed with the SEC on March 14, 2003. 17 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 it 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 March 31, 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 (a) As of a date (the "Evaluation Date") within 90 days prior to the filing of this Form 10-Q, 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 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. (b) Subsequent to the date of the most recent evaluation of the Company's internal controls, there were no significant changes in the Company's internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses. 18 PART II -- OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS See Note 9 to the Condensed Consolidated Financial Statements. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS On March 7, 2003, the Board of Directors of the Company declared a dividend of one right (collectively, "Rights") to purchase one one-hundredth of a share of a newly created class of Series A Junior Participating Preferred Stock ("Series A Preferred Stock"), payable to stockholders of record at the close of business on March 11, 2003. The Rights will not be exercisable until 10 days after the public announcement that a person or group has become an "Acquiring Person" by obtaining beneficial ownership of 15% or more of the Company's outstanding common stock, or, if earlier, 10 business days (or a later date determined by the Board before any person or group becomes an Acquiring Person) after a person or group begins a tender or exchange offer which, if consummated, would result in that person or group becoming an Acquiring Person. Each Right entitles the holder (other than the Acquiring Person), upon certain specified events, to purchase, at an exercise price of $42.00 per Right (subject to adjustment), shares of common stock of the Company or an Acquiring Person having a value equal to two times the exercise price of the Right. The terms of the Rights are set forth in a Rights Agreement dated March 7, 2003 between the Company and American Stock Transfer & Trust Company, as Rights Agent, filed with the Securities and Exchange Commission on March 11, 2003 as Exhibit 4.1 to the Company's Current Report on Form 8-K. A summary description of the Rights is set forth in the Company's Form 8-A filed with the Securities and Exchange Commission on March 11, 2003. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits.

(b) Reports on Form 8-K. On March 11, 2003, the Company filed a Form 8-K reporting the adoption by its Board of Directors of a stockholder rights plan on March 7, 2003. * * * * * * 19 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 May 2, 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) 20 CERTIFICATIONS UNDER SECTION 302 OF SARBANES/OXLEY ACT I, David H. McCormick, certify that: 1. I have reviewed this quarterly report on Form 10-Q of FreeMarkets, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of and for the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant, and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls that could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 2, 2003 /s/ David H. McCormick -------------------------------------- David H. McCormick President and Chief Executive Officer 21 CERTIFICATIONS UNDER SECTION 302 OF SARBANES/OXLEY ACT I, Joan S. Hooper, certify that: 1. I have reviewed this quarterly report on Form 10-Q of FreeMarkets, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of and for the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant, and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls that could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 2, 2003 /s/ Joan S. Hooper -------------------------------------- Joan S. Hooper Executive Vice President, Chief Financial Officer, Secretary and Treasurer 22 EXHIBIT INDEX

FREEMARKETS INC 10-Q